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Online Microcap Finder Fee Platform Raises FINRA Regulatory Concerns
May 12, 2016
An enterprising registered person rolled out an online
Finder's Platform seeking to introduce investors to microcap issuers. An online
Finder's Platform, now that's a cool idea. Microcap issuers? Ummm . . . how can I put this delicately . . .
maybe not such a wonderful thing. Let's face it, few things on Wall Street have
fallen into more disfavor than anything associated with the microcap scene. That being said, however, maybe creating an
online community where smaller companies are introduced to legitimate financing
could alleviate a lot of the promotional fraud and unsustainable funding that
afflicts that end of the market. Note my use of "maybe" and
"could" in that last sentence. Apparently, the online platform thing didn't go off without a hitch because today's
BrokeAndBroker.com Blog discusses a
recent FINRA regulatory settlement with that innovative registered rep's member
firm.
Case In
Point
For the purpose of proposing a
settlement of rule violations alleged by the Financial Industry Regulatory
Authority ("FINRA"), without admitting or denying the findings, prior
to a regulatory hearing, and without an adjudication of any issue, MSC-BD, LLC
submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which
FINRA accepted. In the Matter of MSC-BD, LLC, Respondent
(AWC 2014039285101, May 2,
2016).
Since 2007, Respondent MSC-BD,
LLC. has been a FINRA member firm and presently has two branch office and 12
registered representatives. The AWC asserts that Respondent does not have any
prior relevant formal disciplinary
history.
The Finder
Platform
During the relevant period of
January 2014 through August 2014, the AWC asserts that a newly registered
representative of MSC-BD:
[C]onducted a type of investment banking consulting business (the "Finder Platform") through the Firm, generally acting as a "finder" of potential investors for microcap issuers pursuant to Consulting Agreements between those issuers and the Finder Platform.During the relevant period, MSC-BD, through the association of the Representative and his Finder Platform, entered a new line of business. Specifically, pursuant to Consulting Agreements with microcap issuers, the Representative "introduced" potential investors, typically private funds, to the issuer clients of the Finder Platform. He also consulted with those issuer clients regarding the potential financing. If a potential investor provided financing, the Firm received 10% of the "Finder's Fee" payable to the Finder Platform, in exchange for the compliance oversight of MSC-BD.In addition, financing deals resulting from the Representative' s introductions generally took the form of equity lines of credit or convertible notes, which ultimately involved sales of unregistered securities in reliance on exemptions from the registration requirements of Section 5 of the Securities Act. Financing deals also took the form of transactions under Section 3(a)(10) of the Securities Act, which involved the purchase and conversion of issuer debt and its conversion to stock through a court-approved settlement.
The Failed-To
List
FINRA looked over the Finder
Platform and didn't like what it saw, and particularly didn't care for MSC-BD's
role. The AWC alleges that MSC-BD failed to:
- establish a supervisory system and written supervisory procedures reasonably designed to:
- ensure that the registered representative ("RR") had conducted adequate due diligence on the Finder Platform's issuer clients before introducing them to potential investors, or that an investment in those issuers would be suitable for the potential investors;
- detect and prevent the RR from causing the firm to participate in unlawful securities transactions or those in violation of Section 5 of the Securities Act's registration requirements. Although MSC-BD received transaction-based compensation from the RR's introductions, the firm did not:
- review the resulting financing deals;
- screen the terms or the other participants in those financing deals; and
- request or review the transaction documents that were ultimately created to effect those deals.
- enforce an unwritten policy of placing issuer clients of the Finder Platform on the firm's Restricted List upon the execution of a Consulting Agreement between the issuer client and the Finder Platform. As a result, the AWC alleges that MSC-BD failed to maintain current restricted lists with respect to the issuer clients of the Finder Platform; and, moreover, MSC-BD's Restricted List did not contain the name of the contact person responsible for the addition of securities to the list, as required by NASD Notice to Members 91-45.
- reasonably investigate or evidence its review of the RR's trading activity in an outside brokerage account involving issuer clients of the Finder Platform as required by NASD Rule 3010(d)(1). Examples of trading activity warranting further review included:
- the deposit of a large volume of physical share certificates,
- the&n immediate sales of the shares, and
- the wiring of the proceeds from the account; and
- evidence an adequate supervisory review of the RR's electronic email communications, as required by NASD Rule 3010(d)(1).
As a result of the foregoing, FINRA
deemed that MSC-BD had violated NASD Rules 3010(a), 3010(b)(1), and 3010(d)(1)
and FINRA Rule 2010.
OBA
Separately, the AWC asserted
that during the relevant period, the RR had disclosed certain outside business
activities ("OBA") to the MSC-BD, among which was his consulting for a family fund.
Despite having received notice of the family fund OBA, MSC-BD allegedly failed
to adequately review and evaluate the RR's activity. Pointedly, the AWC cited
MSC-BD's failure to maintain records evidencing any analysis of the
OBA, including any conflicts of interest analysis or whether the firm should
have limited the OBA. Further, MSC-BD did not evaluate whether the RR's
consulting arrangement with the family fund (which FINRA alleges gave him a
beneficial interest in the fund's investments) constituted private securities
transactions.
As a result of the
foregoing, FINRA deemed that MSC-BD had violated FINRA Rules 3270 and
2010.
FINRA
Sanctions
In accordance with the terms of
the AWC, FINRA imposed upon MSC-BD a Censure and $15,000 fine.
The AWC notes that:
Bill Singer's CommentPursuant to the General Principles Applicable to all Sanction Determinations contained in the Sanction Guidelines, FINRA imposed a lower fine in this case after it considered, among other things, the firm's revenues and financial resources. See Notice to Members 06-55.
Cutting through all the above
verbiage, we find ourselves dealing with a fairly simple issue (setting aside the family fund OBA aspect): a member firm's compliance oversight of a new RR's attempt to generate fees from
introducing investors to microcap issuers listed on an online finder's platform.
In fairness to FINRA, we have seen too many dubious attempts to market microcap issuers with the result that investors got fleeced and brokerage firms were exposed to severe regulatory and criminal liability. What was frequently marketed as a legit investment opportunity turned out to be just another gussied-up stock promo scam hidden behind the glitz of a Dotcom name or some social media hyperbole.
Is the MSC-BD AWC commendable, preemptive regulation, or is it a Luddite reaction to innovation? In the not-too distant past, the roll-out of the type of online platform at issue in this settlement might have been considered innovative
entrepreneurship. The problem with such outside-the-box ideas on Wall Street is that they have littered the landscape with the detritus of rampant fraud and criminality, which was fostered, in part, by regulators who were spectators in the stands rather than umpires and referees on the field of play. On the other hand,
overzealous regulation kills innovation and fosters illicit conduct by driving market participants to financing from shadowy and predatory sources. Somewhere, somehow, we need to find a
balance.
The MSC-BD AWC is well
drafted and replete with adequate content and context to make it helpful. If nothing else, FINRA has alerted its members to the need to create and implement compliance policies and practices necessary to monitor the conduct of an online Finder's Platform.