SEC Releases Findings of Broker Dealers Involved in Sale of Securities of Microcap Companies

By Evan Rosser

What’s Happening:

On October 9, 2014, the SEC released findings from its examination of 22 broker-dealers identified as being frequently involved in the sale of the securities of microcap companies. Specifically, the SEC evaluated compliance with the firms’ obligations to (1) perform a “reasonable inquiry” in connection with customers’ unregistered sales of securities, when the firms are relying on the exemption set forth in Section 4(a)(4) of the Securities Act, and (2) file suspicious activity reports (SARs), required under the Bank Secrecy Act and the Exchange Act, in response to “red flags” related to such sales.

The SEC also issued responses to FAQs, providing additional information on the exemptions and steps to take regarding the exemption and red flag procedures.

Of the 22 firms examined, more than 80% were issued letters of deficiency for material control weaknesses and/or potential violations of law. Most of these firms were also referred to the Division of Enforcement or another regulator for possible criminal investigation. The SEC also announced that the subsidiaries of a large broker-dealer sold billions of penny stock shares for customers during a four-year period, ignoring red flags that the offerings were being conducted without an applicable registration exemption. The firm and its subsidiary agreed to settle, paying more than $1.5 million in disgorgement and prejudgment interest from commissions they earned, and a combined penalty of $1 million.

What You Should Do:

  • Review your firm’s procedures around the sale of low-priced, microcap securities and your anti-money laundering (AML) procedures. The message from the SEC and FINRA is that this issue remains a regulatory priority.
  • Ensure that your procedures define what a reasonable inquiry is, given your firm’s particular nature, volume, branches, or individuals involved.
  • Ensure your supervisory procedures for conducting a reasonable inquiry when relying on Section 4(a)(4) are designed to provide additional discussion of potential red flags.
  • Establish what information must be gathered and what questions must be answered when personnel encounter red flags.
  • Ensure your procedures recognize that the red flags of a possible unregistered sale of securities implicate your AML procedures and may require the filing of a SAR.
  • Establish procedures to confirm SARs are filed when unusual or suspicious activity is discovered in connection with customers’ sales of microcap securities.
  • Establish supervisory reviews that should be conducted to determine whether the securities were resold in compliance with an available exemption. The burden is on the broker-dealer to establish the securities were properly registered, or were sold in accordance with a legitimate exemption from registration.
  • In the absence of restrictive legends on stock certificates, establish procedures to confirm whether the securities can be resold in unregistered transactions.
  • Establish procedures to confirm that shares delivered into a customer’s account in electronic form through a transfer from DTCC, or the issuer’s transfer agent, were not restricted securities.

How Oyster Can Help:

Oyster Consulting is ready to help your firm assess its policies and procedures, identify required actions, recommend best practices, provide training to your personnel, and help you tailor your procedures to your business. Oyster will also provide you with insights from regulatory guidance, recent enforcement cases, and industry best practices regarding the sale of low-priced, “microcap” securities.

About The Author
Photo of Evan Rosser

Evan Rosser

Evan Rosser is an experienced and respected securities industry professional with over 25 years of experience managing complex securities investigations for NASD/FINRA and providing compliance expertise to both broker-dealers and investment advisors.  Evan has served as CCO for both investment advisors and broker-dealers, as well as providing compliance support to numerous broker-dealers and registered investment advisors.