Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The SEC has issued a Risk Alert and FAQs to remind broker-dealers of their obligations when they sell unregistered securities on behalf of clients.  This occurs when founders and employees sell their initial stakes in companies that have gone public or when investors sell securities in public companies that were acquired in private placements.

The publication of the staff guidance was accompanied by the announcement of an enforcement action against two firms for improperly selling billions of shares of penny stocks through such unregistered offerings.

The Risk Alert summarizes deficiencies that were discovered by the SEC’s Office of Compliance Inspections and Examinations, or OCIE, during a targeted sweep of 22 broker-dealers frequently involved in the sale of microcap securities.  The sweep uncovered widespread deficiencies including:

  • Insufficient policies and procedures to monitor for and identify potential red flags in customer-initiated sales.
  • Inadequate controls to evaluate how customers acquired the securities and whether they could be lawfully resold without registration.
  • Failure to file suspicious activity reports, as required by the Bank Secrecy Act, when encountering unusual or suspicious activity in connection with customers’ sales of microcap securities.

While the Risk Alert and enforcement actions were directed at penny and micro-cap stocks, I wouldn’t be surprised if many broker dealers ratchet up their compliance in this area.  So expect more questions and a longer time line when trying to sell unregistered securities.  For instance, expect a lot of questions even if you tender a certificate that does not have restrictive legends.  The SEC says reasonable inquiry must still be made.


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