Caution: Aggressive Interpretation of Broker-Dealer Registration Provisions Could Be Hazardous to Your Liberty

Let’s do some compare and contrast, starting with a fairly unremarkable case the SEC filed in the Northern District of Texas on November 20th.  In that action, the Commission sued the father-son duo of Paul and Jeffrey Downey in a securities offering fraud involving an oil and gas company. In its litigation release the SEC says that in 2010-11, the Downeys:

used Quest, an Albany, Texas-based oil and gas company, to fraudulently offer Quest preferred stock and limited partnership units in an entity called Permian Advanced Oil working interests in oil and gas leases from Quest and receive revenue from those leases. With assistance from unregistered salesman John Leonard, the Downeys raised $4.8 million from approximately 17 investors. The PAOR offering was fraudulent on account of blatantly deceptive misstatements about Quest and PAOR.

As you might have expected, the SEC charged the Downeys with violations of the antifraud provisions.  It also charged Leonard with violating Section 15(a) of the Exchange Act, because he was allegedly acting as a securities broker without being registered as such.   Leonard wasn’t charged with fraud. All told, a pretty ordinary matter.

Now let’s turn to the November 2014 newsletter from the North Carolina Securities Division, in particular the 5-Minute Challenge Section on page 6.  In that section, the newsletter challenges investors to spend five minutes calling the Securities Division to see if their brokers are properly registered. After all, if they’re selling securities, they have to be registered to do that. And one thing the Securities Division knows is, selling securities without being registered is a sure sign of no good. They make this remarkable statement in exactly this way: “While registration in and of itself is no guarantee against fraud, we can say with 100% certainty that any NOT registered who is supposed to be is definitely committing fraud.” That is to say that absent other facts suggesting fraudulent activity, a person selling securities without being registered under North Carolina law (specifically, N.C. Gen. Stat. § 78A-36) is presumed to be defrauding his customers.

Apparently, the idea is that the material omission in explaining unregistered status is the fraud on investors. Also, remember that the N.C. Securities Division has criminal authority, not just civil enforcement power. So under their interpretation, a broker whose registration has lapsed for whatever reason and continues work is committing fraud and risks going to prison. They “can say that with 100% certainty.”

As far as I know, this notion has never been tried out in courts. There certainly aren’t reported cases testing the idea. I also don't think the SEC has ever taken this position.  I’d be very interested to learn if readers are aware of other state authorities that have.

UPDATE (Apr. 29, 2015):  The N.C. Securities Division no longer says this! Instead, in its most recent newsletter it says, "While registration in and of itself is no guarantee against fraud, not being registered is a very big warning flag." To me, this amendment seems to be a much more reasonable position to take.