Are Vendors Who Are Paid In Stock Now "Dealers?"
The United States Court of Appeals for the 11th Circuit, on April 9, 2015, issued its decision in SEC v. Big Apple Consulting USA, 783 F.3d 786, 809 (11th Cir. 2015), which affirmed determinations of violations of Sections 5 and 17(a) of the Securities Act of 1933 and Section 15(a) and Rule 10b-5 of the Securities Exchange Act of 1934 brought against a financial public relations firm and affiliated persons. While the opinion addressed a number of issues of interest to litigators defending SEC enforcement actions (which are beyond the scope of this advisory), one of the court’s findings raises an important issue for vendors to public companies that are compensated with stock: whether accepting stock as a substantial portion of compensation puts a vendor within the definition of a securities “dealer,” subject to Section 15(a)’s prohibitions against acting as a dealer without registration.
Big Apple Consulting provided investor relations and public relations services to microcap companies. It was often paid in stock of its client companies. The SEC brought an enforcement action against Big Apple and certain of its affiliates alleging, among other things, a violation of Section 5 of the Securities Act arising from the sale of the client company stock. The District Court granted the SEC’s Motion for Summary Judgment on the Section 5 claim. The Court of Appeals, in considering the defendants’ challenge to the finding of Section 5 violations based on the exemption contained in Section 4(1) for persons other than issuers, dealers and underwriters, found that defendants, as a matter of law, were both “underwriters” and “dealers,” thereby making the exemption unavailable. Big Apple, both in the specific circumstances at issue, and generally, received most of its compensation in the form of its clients’ stock, which it sold to generate proceeds to fund operations and earn a profit. Those facts led the court to conclude that Big Apple was “in the business of buying and selling” securities, thereby putting it within the definition of a “dealer” under both Section 2(a)(12) of the Securities Act and Section 3(a)(5)(A) of the Exchange Act.
Although the Court left some wiggle room by noting that “[W]hile evidence of some profits from buying and selling securities may alone be inconclusive proof, the defendants’ entire business model was predicated on the purchase and sale of securities” (emphasis in original), any provider of goods and services to a company who receives significant compensation in the form of client stock may find itself exposed to a claim that it is acting as an unregistered dealer in violation of Section 15(a) of the Exchange Act. A private trader may similarly be found to be a dealer, since the Court ignored factors that historically were considered in distinguishing a private trader from a dealer, such as having customers, engaging in marketplace functions such as market-making, and holding oneself out as an industry professional.
If your business accepts payment in client stock, you should consult a securities attorney to see if this ruling might affect you. How the SEC will use this new tool is unknown, but as the Supreme Court recognized in Dirks v. SEC, 463 U.S. 646, 665 fn. 24 (1983), relying “… on the reasonableness of the SEC’s litigation strategy, . . . can be hazardous, as the facts of this case make plain.”