Time was, the perfect stockbroker was equal parts salesman and stockpicker, but these days you have to throw a good measure of lawyering into the mix.
Trouble is, professional-grade legal expertise does not come easy, and a little knowledge in this area can indeed prove very dangerous. Anthony Barkate's experience with the SEC is illustrative in this regard.
Barkate's problems started in 1998 when he began selling the financial products of TLC Investments & Trade and its related entities. The products were interesting ones — promissory notes with investment agreements that provided a tax-lien certificate representing the right to collect delinquent taxes on realty. TLC and the investor were supposedly tenants in common in the realty that secured the notes. A minimum $20,000 investment guaranteed an annual return of between 10 percent and 12 percent.
If this sounds too good to be true, there's good reason for that: It was. In 2000, a U.S. District Court enjoined the Ponzi scheme and appointed a permanent receiver for TLC.
Been Found Out
Barkate's broker/dealer first discovered his TLC activity in 1999, when he submitted a proposed Web site (for another NASD member firm with which he was dually registered) and in-house counsel smelled trouble in the various online references to the TLC investments. The firm then conducted an audit and promptly terminated Barkate — for good reason, it turned out. The NASD found that he failed to inform his b/d of approximately 93 private securities transactions in which he sold $6.8 million worth of instruments and received over $400,000 in selling compensation from an outside entity (nearly 50 percent of his annual revenue).
Barkate was convinced that the sanctions against him were off-base, and he appealed the bar imposed upon him by the NASD. While mounting his case, and subsequent appeal, he argued that he had tried in good faith to get the facts about the TLC notes and was told by a lawyer that they weren't securities. In essence, he said, “I'm not a lawyer; I spoke to one and he gave me bad advice.” Here is some further detail on his assertions and the regulators' opinions about them:
The TLC notes aren't really securities and, as such, I didn't believe their sale was a private “securities” transaction.
Section 3(a)(10) of the Securities Exchange Act of 1934 defines a “security” as “any note…or…investment contract.” In Barkate's case, the SEC concurred with the NASD's finding that the TLC notes satisfied the Supreme Court's four-point “family resemblance test” to determine if a note is a security (Reves v. Ernst & Young):
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The instruments paid a high rate of interest.
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The instruments were widely distributed throughout the United States.
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On their face and in marketing materials used in selling them, the instruments were identified as investments.
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No other scheme of regulation is applicable.
Further, the TLC instruments presented a fairly classic case of the accepted definition of a security — an investment in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial efforts of others. Investors expended a minimum of $20,000 for each TLC investment contract with the expectation of profits to be derived from the rate of return “guaranteed” by TLC through its efforts to purchase and liquidate real property or acquire tax liens thereon.
Finally, and perhaps more to the point, the SEC noted that a U.S. District Court ruled that the TLC investment contracts at issue were securities.
Even if the notes are considered securities, I asked an attorney and was told that they weren't, and I relied upon that lawyer's counsel in good faith.
The “advice of counsel” defense requires that the applicant:
Make a complete disclosure to the attorney of the intended action.
Request the attorney's advice of the legality of the intended action.
Receive counsel's advice that the conduct would be legal.
Rely in good faith on that advice.
The SEC didn't believe that Barkate met these conditions. More specifically, it said that those seeking consideration for relying upon erroneous legal counsel must at least retain their own independent lawyer and seek his counsel about the facts at issue. In this case, Barkate relied upon TLC's outside counsel, who apparently opined that the instruments were not securities. True, this is a legal opinion, but it's one that is easily renedered by a conflicted lawyer‥ Thus, Barkate was remiss in relying solely on that opinion.
Although not dispositive on the issue, the SEC also noted that despite having received several warnings from his b/d (at meetings and in firm policy/procedures materials) about the dangers of engaging in private securities transactions, Barkate never contacted the b/d concerning any aspect of the contemplated transaction, including whether the instruments met the definition of notes or securities. Such contact might not have tipped the scales in his favor, but it certainly would have been some indication of good faith on his part to get an unbiased answer to a critical question.
So, what's the moral of this story? Simple: When in doubt, hire your own lawyer.
Writer's BIO: Bill Singer is a partner with the law firm of Gusrae, Kaplan & Bruno.
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