Sometimes The Regulated Obey More While The Regulators Could Care Less

Written By: Phil Feigin

After spending 20 years in state securities regulation and enforcement, I would have supported a law making the sale of a security a felony. In 20 years, no citizen had ever called me to report they had made money investing. Everyone lost. In call after call, letter after letter, one investor after another complained of investment deception, fraud and abuse, at the hands of a brokerage industry that was nothing more than a band of corrupt swindlers. Losses incurred in private placements—especially Reg. D, Rule 506 deals—showed they were the work of the devil. From my perspective, the lawyers who represented these guys were all crooked aiders and abettors. Abject cynicism and universal suspicion borne of all this were hard siren songs to resist.

Helping me temper those extremes and gain some balance was my experience as a state regulators’ liaison to the State Regulation Committee of the Business Law Section of the ABA for several years. Attending ABA meetings and otherwise interacting with committee members gave me a broader perspective on regulation and the professions we were charged with overseeing. The state securities law practitioners who participated on the State Reg. Committee were from some of the most highly respected and sophisticated firms, dealing (for the most part) with legitimate and worthy clients. Not quite the “clientele” I dealt with back home.

The experience opened my otherwise myopic eyes to the possibility that, every once in a while, it was the regulators who were screwing up and not the regulated. I dare say that my participation and that of the state colleagues who attended meetings with me opened some private sector eyes as well to problems confronting state regulation. It is unfortunate that, generally speaking, NASAA (the North American Securities Administrators Association), state administrators and others have not attended the State Reg. meetings in recent years. In my view, both the state regulators and the Bar and the public we serve would benefit greatly from the interaction.

State regulators may not realize the extent to which the legitimate private sector goes to comply with laws and rules, even some laws and rules that the regulators themselves might not view with much priority. I find it ironic that the industry is often much more worried about complying with some regulations than are the regulators themselves. I’ll cite three examples.

Form D.  Before enactment of the National Securities Markets Improvement Act (“NSMIA”) in 1996, I think most regulators made sure the filing fee check that came with Form D cleared, and then threw the forms in some dark room, never to be seen, let alone referenced, again. More attention to the Form has been paid since 1996, but at least in most states, not all that much more. Yet many an associate and paralegal have sweated bullets trying to get the darn things filed correctly and on time. Maybe I’m speaking out of school, but with the exception of a few states, Form D remains more of a pain to states and the SEC than of any significant regulatory benefit. The Recession may have changed that a bit from a state revenue perspective, and it will change even more substantively after the JOBS Act Rule 506 changes kick in, but generally speaking, I think the Bar takes compliance with Form D filing requirements a lot more seriously than most state regulators and the SEC take them. For the regulators, it has been more of a pain than it’s worth.

The Model State Commodity Code.  I have written on this subject elsewhere so I will not belabor the point. Suffice to say that the 19 states with the Code in one form or another have all but forgotten it exists, while precious metals companies around the globe struggle still to comply with its outdated restrictions. This is another case where the private sector spends much more time and energy complying with regulations than do the regulators enforcing them.

Brokerage Registration and Licensing Requirements.  Show me a Merrill Lynch or UBS broker who is detected doing business with clients in a state where he/she is not registered or licensed, and BLAM, the regulators will come down on him, his supervisors and his firm like a ton of bricks, with demands of refund of commissions, perhaps adoption of enhanced supervision, a consent order, and maybe even a fine to boot. However, show me an unlicensed “finder” who makes a living brokering private placements and hedge funds on commission or locating merger/acquisition partners and helping to negotiate the deal for a “success” fee, and, absent fraud, the regulators are nowhere to be found, even if the brokers advertise. Meanwhile, issuer counsel tears his/her hair out trying to convince otherwise lawful issuer clients that these unlicensed people are far more than “Paul Anka” finders, are acting in clear violation of the law, and, in many states, it is also illegal for the issuers to hire them.

Several committees of the ABA have been working to get the SEC and the states to adopt a system of “merger broker” and “private placement broker” regulation for years, but without much success. I think the lack of action from the regulators is due, at least in part, to:

(1)     many other and higher regulatory priorities;

(2)     a general lack of complaints of fraud; and

(3)     the realization that if the regulators adopt such a new regulatory regime, they will be forced to come down hard on those who fail to comply thereafter, which circles back to Point 2 and an unwillingness to devote scarce enforcement resources to pure licensing/registration cases.

Now comes the JOBS Act and crowdfunding, or more accurately, the prospects of securities crowdfunding and funding portal regulation that will be part of the rules once promulgated. Investment crowdfunding hopefuls all over the country are chomping at the bit to get started, clamoring to be the first with the most. However, for better or worse, JOBS Act-style crowdfunding is currently, entirely and undeniably illegal, as is serving as a portal.

Here I am advising clients, people who want to be legitimate players in the crowdfunding marketplace, to hold their water until the rules are finalized and effective and they are in full compliance with them. The SEC and state regulators both have warned those who want to crowdfund against gun-jumping because crowdfunding isn’t legal yet. Even so, the number of Internet sites whose sponsors appear to be serving as funding portals facilitating crowdfunding of offerings NOW, as we speak, brings to mind those early kinetoscopes of the Cimarron Strip land rush. These sites and companies appear to be openly ignoring the law and the warnings, yet there’s nary an injunctive action or cease and desist order anywhere to be found. Again, most in this embryonic market sector are dutifully obeying the law and biding their time, even though it seems the regulators could care less, seemingly occupied elsewhere.

Unregistered private placement and merger brokers have proliferated to such an extent that they have all but achieved an air of legitimacy through regulatory neglect. The regulators need only peruse the Yellow Pages or Yahoo to find a career’s worth of unlicensed miscreants. Now, it’s happening all over again with investment crowdfunding. It’s getting harder and harder to convince clients it is the wrong way to go.


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