Unregistered Securities

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Jan 6, 2010 10:30 am

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BrokeAndBroker.com
An irreverent Wall Street Blog
by Bill Singer

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Unregistered Securities: Unless and Unlawful

http://www.brokeandbroker.com/index.php?a=blog&id=286

Section 5 of the Securities Act of 1933 is as primordial a securities law as there is.  It is truly one of the building blocks of our system of securities regulation.  In somewhat ominous language, the section starts off by noting that unless a registration statement is in effect as to a security, it shall be unlawful to sell said security. Whenever you see something that includes the words "unless" and "unlawful," you sure as hell better be careful.  See the section reprinted in full below:


Section 5 -- Prohibitions Relating to Interstate Commerce and the Mails 

a.      Sale or delivery after sale of unregistered securities 

      Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly-- 

         1. to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or 

         2. to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale. 

b.      Necessity of prospectus meeting requirements of section 10 

      It shall be unlawful for any person, directly or indirectly-- 

         1. to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed under this title, unless such prospectus meets the requirements of section 10; or

         2. to carry or cause to be carried through the mails or in interstate commerce any such security for the purpose of sale or for delivery after sale, unless accompanied or preceded by a prospectus that meets the requirements of subsection (a) of section 10. 

c.       Necessity of filing registration statement 

      It shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security, or while the registration statement is the subject of a refusal order or stop order or (prior to the effective date of the registration statement) any public proceeding or examination under section 8. 

Reduced to basics, Section 5 requires all issuers to register non-exempt securities with the Securities and Exchange Commission (SEC).  The section further imposes the obligation to use a compliant prospectus subject to a registration statement to effectuate such sales.

Notwithstanding this longstanding law, many still run afoul of it – unintentionally, inadvertently or otherwise.  It is often the case with relatively short and simple rules that they become subject to interpretation – too much of which occurs around the office water cooler.  Commonsense is not always the best way to read what has been cobbled together by legislators.  It’s the damn nuance of these things that will kill you.  Beg and plead all you want with the highway cop about not seeing the sign, but I’ll bet that while you’re rambling on he is writing out the ticket.  As Wall Street struggles to return to health and as businesses seek to tap into whatever capital is still available, it is likely that we will be reading more and more about unregistered securities transactions.

In recent months, http://RRBDlaw.com has been reporting about increased regulatory actions involving unregistered securities. See:

http://www.rrbdlaw.com/enforcement-actions/tags.php?term=Unregistered Securities 

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In the Matter of Peter Herbert Hackstedde and Ross William Sindelar (FINRA OS/2006004707201/December 2009), Hackstedde and Sindelar acquired unregistered and non-exempt shares from an issuer with a view to distribution and, therefore were statutory underwriters. They distributed, or caused the distribution of, unregistered and non-exempt securities to the public.

Pursuant to an Offer of Settlement, the Financial Industry Regulatory Authority (FINRA) fined Hackstedde $301,896.93 ((includes $286,896.93 disgorgement of profits) and suspended him for thirty business days.  Sindelar was fined $418,904.91 (includes $$403,904.91 disgorgement of profits) and suspended thirty business days.

In IIn the Matter of Patrick Francis Harte Jr. (FINRA 2006003672401/December 2009), Harte failed to supervise registered representatives who engaged in the sale of unregistered securities, and failed to take adequate measures to ensure that the registered representatives and employees he supervised complied with the requirements of Section 5 of the Securities Act.

FINRA imposed a $10,000 fine upon Harte and suspended him in Principal capacities only for six month.  He was further ordered to requalify as a Principal before functioning in that capacity.

In the Matter of Alan Frank Pacella (FINRA 2007009934702/November 2009), before entering sales orders, Pacella relied on his member firm’s compliance department to review whether the shares were freely tradable. The compliance department conducted its tradability review in the ordinary course of business and incorrectly approved the securities for public resale, even though the shares were restricted. FINRA took the position that Pacella had or should have had the company’s Articles of Incorporation and press release, thereby allowing him to determine that the securities were not registered for public sale and not subject to an exemption.

Pursuant to a settlement, FINRA imposed a censure upon Pacella and fined him $10,000.

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Jan 7, 2010 2:10 pm

"In the Matter of Alan Frank Pacella (FINRA 2007009934702/November 2009), before entering sales orders, Pacella relied on his member firm’s compliance department to review whether the shares were freely tradable. The compliance department conducted its tradability review in the ordinary course of business and incorrectly approved the securities for public resale, even though the shares were restricted. FINRA took the position that Pacella had or should have had the company’s Articles of Incorporation and press release, thereby allowing him to determine that the securities were not registered for public sale and not subject to an exemption. <?: PREFIX = O />

Pursuant to a settlement, FINRA imposed a censure upon Pacella and fined him $10,000."

OK, so, you ask compliance to confirm that something is ok to do, something that is not a normal everyday occurance in your business, and it turns out compliance was wrong and YOU pay the fine?  WTF?  Just goes to show you, under most all circumstances the rep is wrong unless proven otherwise....

Jan 7, 2010 9:13 pm

Your posts can get a little tough to read, it seems like they are being reformatted from some other site and the flow gets washed. It can be tough to see what link to click on and if it is a link that relates to the story or another page. There also seems to be quite a bit of content that does not correctly convert on this site- just an FYI…

Jan 8, 2010 8:28 am

To play devil’s advocate with you guys - compliance didn’t sell the securities, the rep did.  Both parties made the wrong call in doing this unusual business but the rep sold them.

I understand that this is a WTF moment though.  And I'm sure from an "office politics" standpoint, the FA could make a case with the firm for a little "assistance" on the fine.   More than likely the FA also contacted the wrong compliance department - although if this were the case, then the compliance person should have referred them to the experts.  I probably would have worked my way through 4 different departments before getting an answer I trusted (but hindsight being 20/20 I would most likely not thought of this as a big deal).