Due to the globalization of business dealings, issues often arise with respect to the proper registration of foreign persons as “brokers” or “dealers” under the U.S. federal securities laws (colloquially referred to as “broker-dealers”). Sometime, it is a U.S. person soliciting outside of the United States. Other times, it is a non-U.S. resident who may be reaching out to the U.S. persons. Below is a brief analysis of how the U.S. federal registration requirements apply to such international brokers.
First, the basics. Section 15(a)(1) of the Securities Exchange Act of 1934 (the “Exchange Act”) makes it unlawful for any “broker” or “dealer” to use interstate commerce to “effect any transactions in, or induce or attempt to induce the purchase or sale of, any security.” The term “broker” is defined in Section 3(a)(4) of the Exchange Act to mean any “person engaged in the business of effecting transactions in securities for the account of others.” Through numerous no-action letters, we know that the hallmarks of broker activity are: solicitation of potential investors, negotiation of deal terms, handling securities and/or funds, settling transactions, and receiving compensation that is tied to the success of the offering. Further, the courts look at whether this person is “in the business” of doing so, i.e., certain degree of regularity.
There are several exemptions to the registration requirements for municipal securities brokers, government securities brokers, associated persons of the issuer (more on this in the next blog post), and online investment portals. There is also a narrow common law exception for “finders” that with time has become so narrow that I am not certain it still exists.
B-Ds located in the U.S.
The approach with respect to broker-dealers that are located in the United States but work only with foreign investors is unsettled. The SEC’s general position was to require registration of broker-dealers physically located in the United States even if their activities were only directed at foreign investors located outside of the United States. This broad extraterritorial approach was limited by the U.S Supreme Court holding in Morrison v. National Australia Bank Ltd. in 2010, that held that Section 10(b) of the Exchange Act only applied to conduct in connection with the domestic securities transactions (note that the case was about a different section of the Exchange Act, but courts later extended the analysis to broker-dealer registration provisions). In particular, the Court held: “When a statute gives no clear indication of an extraterritorial application, it has none.”
Section 929P of the Dodds-Frank Act, enacted into law less than one month after the Morrison decision, supported the SEC extraterritorial approach by amending the Securities Act and the Exchange Act to provide that the U.S. courts have jurisdiction over “(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors, or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” However, certain courts still applied the Morrison approach where the matters required interpretation of U.S. securities laws. For example, in SEC v Benger (2013), the court held that the broker-dealer registration requirements did not apply to a person located in the United States that solicited foreign investors to invest into foreign securities. It was unclear how to reconcile the Morrison case with the Congressional intent until the Tenth Circuit’s decision in SEC v. Charles D. Scoville and Traffic Monsoon LLC that just became available in January 2019. The heart of the case was the SEC civil enforcement action against defendants running a worldwide ponzi scheme. The Court affirmed that the SEC correctly used the conduct-and-effects test to reach a securities transaction outside of the United States. So, while the conduct-and effects test brought back by the Dodd-Frank Act will be used in governmental actions, as stated here, private actions under the antifraud provisions will continue to be governed by the Morrison test. Another great analysis that supports the above can be found here.
Foreign B-Ds located outside of the U.S.
Foreign brokers that operate outside of the United States generally have to register with the SEC if they use any interstate commerce to effect securities transactions with persons in the United States. This would include the use of the Internet and advertising materials. There are, however, several significant exceptions for this general rule codified in Rule 15a-6 under the Exchange Act.
Although repeating the entire Rule here is beyond the scope of this blog post, I would like to draw your attention to several of its provisions. The first one exempts from registration requirements those foreign broker-dealers that engage in “unsolicited transactions” in the United States. As the SEC clarified in its FAQ (Question 9), there could be more than one such transaction. However, the focus should be on the foreign broker-dealer activities to determine whether solicitation had occurred. The SEC warned that it interprets “solicitation” broadly to include phone calls encouraging use of such broker-dealer’s services, advertising materials, and trading recommendations.
Another exception allowed foreign broker-dealers to forego registration in the U.S. for direct solicitation of securities transactions (and the effecting of such transactions without involving a U.S. broker-dealer) so long as such solicitations were directed at foreign persons temporarily present in the United States. The SEC noted in FAQ Question 1 that, although the question of “temporary presence” was a factual one, it was the overall intention of the SEC to exclude from the registration requirements those foreign broker-dealers who effected transactions with a foreign person located in the U.S. with whom they had a “bona fide, pre-existing relationship before the foreign person entered the U.S., so long as such person: (1) is not a U.S. citizen and (2) is not a lawful permanent resident of the U.S. (i.e., a “Green Card holder”).”
There are several more exemptions included in the Rule that are beyond the scope of this summary blog post.
In conclusion, as you can see, the broker-dealer registration requirements are quite complex as they apply to foreign broker-dealers soliciting and effecting transactions with U.S. persons or on U.S. soil. Foreign broker-dealers, whether they are in the U.S. or not, should carefully consider application of the U.S. securities laws to their broker-dealer activities as they interact with their clients.
This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author Arina Shulga.