07 Mar The Risk of Hiring an Unlicensed Intermediary
Would you take an Uber, fly in a plane or go under the knife for gall bladder surgery with someone who failed to hold a current license, relevant to the task at hand? Regardless of the profession, there is a certain level of discipline and at least a baseline of industry expertise and understanding that come from knowing someone has jumped through the requisite hoops. More importantly, however, is the knowledge that your issuance of securities in a capital raise or buy/sell-side transaction is well above board from the all-seeing-eye of the SEC. There are a number of inherent risks for buyers, sellers and the intermediaries if no FINRA licensing exists. Regulation is certainly changing here and we are still in a state of “flux,” but when it comes to reliance on applicable law, you can never be too careful.
Risk on the Brokers
An unlicensed broker shoulders ] much of the risk associated with not being licensed to perform transactions that involve the sale of securities. A typical business broker may work under the guise of at least one of the following assumptions:
- The broker may hold a relevant commercial real estate license, covering him/her on transactions that combine a business sale with the sale of some real estate.
- The intermediary may also claim to work only on transactions that involve the sale of assets and not the direct sale of the securities themselves. This is certainly a safer world to play in and with smaller businesses many buyers love asset sales for tax and other reasons, however, challenges remain as many a deal can quickly shift from an asset to a stock sale at which point the intermediary is “dealing in securities.”
- The intermediary may be working on behalf of a buyer in which case s/he is will be claiming a “finder’s fee” from the buyer. While this helps sidestep some of the issues relative to both intermediary and seller, it is never in the best interest of a business seller to engage in a proprietary deal. A broad, strategic auction is always best for maximizing seller value.
While many truly “main street” brokers work on companies small enough that the SEC typically turns a blind eye, there are many deals that should have included the requisite FINRA licensing to ensure both the seller and intermediary are protected from potential liability.
The real risk in nearly any transaction falls on the shoulders of the intermediary. An unlicensed intermediary is exposed to the potential of not getting paid on a stock deal if the seller is wry enough in his/her contract drafting and process. In addition, there is always the potential that a deal could be “unwound” or “reversed” citing the unlicensed broker as one of the reasons for a deal going sideways. While both of these situations are rare, they do occur. You can follow the updates via the SEC website. E&O insurance can only provide a proverbial parachute for so much of the transaction, especially when we are talking about lack of appropriate licensing.
Risk on the Issuer
Issuers themselves are not immune to the risks associated with working with an unlicensed intermediary in securities transactions. Company buyers and sellers run the risk of increased liability exposure in securities transactions. This is especially true as it relates to raising debt or equity securities. The SEC is especially stringent on capital raising activities, especially as it relates to retail and even accredited investors. Intermediaries are required to “trust, but verify.” The same should go for anyone looking to raise capital from an investment bank.
While the JOBS Act has graciously carved-out options for M&A Advisors doing deals sub-$100M and for limited representatives utilizing equity crowdfunding portals, risk still remains that many of these groups have not yet applied even the relaxed scrutiny of the JOBS Act. Many are relying on the SEC’s no-action letter for merger and acquisition advisors until further details are forthcoming. To my understanding, the no-action letter remains in force, but the risks of working with unlicensed brokers still remain, particularly with capital raising and larger stock-based transactions.