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Enforcement News: Unregistered Broker-Dealer Activity Relating to Pre-IPO Funds

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  • Posted on: Mar 6 2023

By: Jeffrey M. Haber

The Securities Exchange Act of 1934 (“Exchange Act”) governs the way in which the securities markets and its brokers and dealers operate. Under the Exchange Act, most “brokers” and “dealers” must register with the Securities and Exchange Commission (“SEC” or the “Commission”) and join a “self-regulatory organization,” or SRO. Section 15(a)(1) of the Exchange Act, 15 U.S.C. §78o(a).

Under Section 3(a)(4)(A) of the Exchange Act, 15 U.S.C. §78c(a)(4)(A), a broker is defined as a person or entity that regularly: (i) participates in the solicitation, negotiation, or execution of securities transactions, (ii) receives transaction-based compensation contingent on the value or success of securities transactions or (iii) handles investor funds or securities. 

Apart from the foregoing, individuals and businesses need to register as a broker when, among other things, they: (a) find investors or customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies (or mutual funds, including hedge funds) or other securities intermediaries; (b) find investment banking clients for registered broker-dealers; (c) act as “placement agents” for private placements of securities; (d) provide support services to registered broker-dealers; (e) act as “independent contractors,” but are not “associated persons” of a broker-dealer; and (f) are otherwise engaged in the business of effecting or facilitating securities transactions.

Unlike a broker, who acts as agent, a dealer acts as principal. Section 3(a)(5)(A) of the Exchange Act defines a “dealer” as a person or entity that (i) holds himself/herself out as being willing to buy and sell securities on a continuous basis or (ii) originates securities that they buy and sell. Individuals who buy and sell securities for themselves generally are considered traders and not dealers.

The SEC considers the regulatory regime applicable to broker-dealers to be a cornerstone of the U.S. federal securities laws because it provides important safeguards to investors and market participants. Among other things, registered broker-dealers must (a) satisfy comprehensive recordkeeping, reporting, and supervisory obligations, and (b) pass inspection and examination by the SEC and SRO. In addition, broker-dealers must address conflicts of interest and implement policies and procedures that are reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules, including, without limitation, safeguarding customer information and preventing identity theft.

On March 3, 2023, the SEC announced (here) that it charged Silver Edge Financial LLC (“Silver Edge”), Equity Acquisition Company Ltd. (“EAC”), the owners of both companies, and sales staff of Silver Edge Financial with unregistered broker-dealer activity relating to their sales of interests in shares of various pre-IPO companies. 

In the cease-and-desist orders (the “Orders”), the SEC found that, since January 2019, Silver Edge, its owner Daniel J. Mackle, Sr., and six salespeople sold interests in two funds that were set up as series LLCs, with each series representing an interest in shares of a single pre-IPO company. The underlying assets in these series were interests in shares of companies that were expected to undertake an initial public offering or other liquidity event within two-to-five years. The SEC alleged that Silver Edge, Mackle, and the salespeople solicited accredited investors and raised more than $65 million while failing to register as brokers with the Commission.

The SEC also find that EAC and its founder, Carsten Klein, acted as unregistered dealers in connection with their business of obtaining pre-IPO shares and offering them for sale to various pre-IPO funds, including the Silver Edge funds. The SEC alleged that EAC purchased more than 14 million shares of pre-IPO companies, including a number of highly anticipated offerings, and sold more than $13.4 million in shares to various pre-IPO funds, while keeping the remaining shares in inventory.

Commenting on the enforcement action, Carolyn M. Welshhans, Associate Director of the SEC’s Enforcement Division, stated: “The SEC’s registration requirements ensure that broker-dealers fulfill important responsibilities and regulatory obligations, such as submitting to regulatory inspections and maintaining appropriate books and records. Individuals and entities in the pre-IPO space, including dealers, must comply with the SEC’s registration provisions when selling securities backed by pre-IPO shares and cannot avoid essential regulatory oversight.”

In the Orders, the SEC alleged that respondents violated Section 15(a) of the Securities Exchange Act of 1934. 

Without admitting or denying the findings, all respondents agreed to cease and desist from future violations. Silver Edge and Mackle agreed to pay disgorgement and prejudgment interest of more than $2.5 million and a civil penalty of $975,000, and they agreed to industry and penny stock bars with the right to reapply after five years. EAC and Klein agreed to pay disgorgement and prejudgment interest of more than $3.6 million and a civil penalty of $269,360. Silver Edge, Mackle, EAC, and Klein also agreed to undertakings to ensure the legal and orderly distribution of pre-IPO interests. The six salespeople agreed to pay civil penalties ranging from $61,000 to $124,320 and to industry and penny stock bars. The Orders can be found on the same page as the press release announcing the proceeding (here).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

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