by T. GormanPosted on Posted in SECActions

Who is a broker — a question thought long settled but which is the focus of a recent Commission action and dissent by a Commissioner. Brokers are required to register with the Commission by Section 15(a)(1) of the Exchange Act. That Section, along with the Exchange Act, became law in 1934 following the well know hearings conducted by Ferdinand Pecora in Congress. See generally, The Pecora Report, U.S. Senate Committee on Banking and Currency at 20-25 (1934). Those hearings disclosed for the first time that many market professionals had conflicts and traded for their own account.

While passage of the Exchange Act should have resolved the question of who is a broker, it is at the heart of a recent Commission proceeding and a dissent by Commissioner Peirce. In the Matter of Neovest, Inc., Adm. Proc. File No. 3-20375 (June 29, 2021)(here); Commissioner Hester M. Pierce, Statement Regarding Neovest, Inc. (June 29, 2021)(here).

Neovest

The firm operates what it calls “the premier broker-neutral electronic trading solution,” according to the Commission’s Order Instituting Proceedings or OIP. The firm’s primary product, its OEM platform that provided a variety of services and allowed “customers to directly route their orders to buy and sell equities and options to more than 360 customer-selected broker-dealers for execution.” While at one time the firm owned a broker-dealer, its operations were terminated in late 2006 when Neovest was acquired by a major New York bank.

Neovest has about 550 customers. Most are institutional investors and asset managers that use the OEM Platform for routing their orders to brokers for execution. Neovest has been paid transaction-based services since before its acquisition.

Beginning in 2004, and continuing until early 2018, the firm replicated an internal databased containing customer authentication information set up locally at one of Neovest’s most active longstanding customers. This permitted the customer to log on the OEM Platform without going through the company server. There was no supervision. If the firm had registered as a broker it would have had greater supervision and written policies and procedures to safeguard customer information and inspections, according to the OIP.

The Order concludes that the firm violated Exchange Act Section 15(a) which makes it unlawful for “any broker or dealer ‘to effect any transaction in . . any security . . .” unless registered with the agency. The company consented to the entry of a cease-and-desist order based on Section 15(a) and paid a $2.7 million penalty.

The Dissent

Commissioner Peirce’s dissent argues that there a no findings of fact demonstrating that the company operated as a broker. Neovest offered its “web-based order and execution management system . . . [to facilitate] the exchange of information . . .between customers . . .” according to the Dissent. The services were packaged “in a software application that permitted asset managers and institutional investors to access data and analytical tools . . . and send orders to . . . broker-dealers . . .” according to the dissent.

The conclusion by the Commission that somehow Neovest violated Exchange Act Section 15(a) is not supported by the findings in the OIP. To the contrary, the central point of the proceeding brought against the firm appears to be two fold. First, the company was paid for services through transaction-based compensation. Second, Neovest would benefit from having better internal procedures and policies. The former has, of course, been an element in evaluating who might be a broker. It is not, nevertheless, the only point – not every firm that is paid in this manner must register as a securities broker.

The second point also fails to support the institution of the action against the firm. While there is no doubt that being a registered broker-dealer under Section 15(a) would improve the firm’s controls and record keeping, that is not a reason to impose registration. To the contrary, it is a byproduct of such a requirement. In the end, there is nothing to demonstrate that Neovest acted as a securities broker implementing the purchase and sale of securities for clients.

Comment

The question presented here would seem to begin and end primarily with the language of Section 15(a). As the Supreme Court has repeatedly stated, to analyze the obligations under a statute, begin with the statutory text. See, e.g., Cyan Inc. v. Beaver County, 138 S.Ct. 1061, 1069 (2018).

In this case the statutory text is clear. It states, “The term ‘broker’ means any person engaged in the business of effecting transactions in securities for the account of others.” Here the SEC’s Order Instituting Proceedings quotes the statutory text at the end of the fact section, but fails to apply it. One can search in vain for any facts demonstrating that Neovest effected transactions in securities for other; that the firm purchased, sold or did anything with a security for any person. The reason –that is not the business of the company.

To the contrary, it seems apparent from the facts alleged in the OIP that what Neovest did was facilitate the use of brokers by institutional investors and other customers. The reward for helping other comply with the law – being named as a Respondent in an enforcement action for violating it.

This is not the way for the Commission to encourage respect for the law, compliance with the law. In the future the Commission would do well to listen to the views of Commissioner Peirce on this point and carefully examine the text of the statute being applied in view of the available facts before approving the filing of an enforcement action.

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by T. GormanPosted on Posted in SECActions

The U.S. has the deepest, most liquid capital markets in the world. Those markets have $45 trillion in equity and $50 trillion in the fixed income and Treasury, corporate bonds and muni markets. The question many have been asking since Gary Gensler took over as SEC Chair is what is the agency going to do not just to preserve these markets but to continue their improvement. Last week, while speaking at London City Week on June 23, 2021, Mr. Gensler outline at least part of his program (here).

Three areas are key, according to the new Chair: 1) Public company disclosure; 2) market structure; and 3) transparency. First, in the area of company disclosure, Chair Gensler cited two key issues he has directed the staff to study. One is climate change and the other people. On the former, Mr. Gensler has directed the staff to develop recommendations around “governance, strategy, and risk management related to climate risk. In addition, staff is looking into a range of specific metrics, such as greenhouse gas emission, to determine which are most relevant to investors in our markets,” he stated.

Mr. Gensler also asked the staff to assess requirements for companies that have made forward looking climate commitments or companies that have operations in other jurisdictions that have targets. These requests follow the receipt of 400 comment letters addressing these question that were received by Commissioner Allison Herren Lee.

Another area is people. Investors want to better understand this key asset of every company. Accordingly, the staff is assessing the question of disclosure around people. This might include a number of metrics such as those involving workforce turnover, training, and diversity. This type of disclosure can aid investors in putting their capital to work in areas that fit their needs and interests.

A second area of focus is market structure. Key in this area, according to Chair Gensler, is efficiency and competition. While just over half of investments go to equity markets like Nasdaq, just under 50% of investor capital goes to alternative trading markets. The significant interest in these alternative venues is not reflected in the National Best Bid and Offer quote. Accordingly, the Chair has asked the staff to consider if this model best promotes efficiency and competition.

Another question centers on payment for order flow. That practice is banned in a number of jurisdictions which include the U.K., Canada and Australia. The EU has raised concerns regarding the practice. This practice will apparently be considered in conjunction with the staff’s overall evaluation of market structure.

The Chair also asked the staff to evaluate the transparency and resiliency of the manner in which Treasury securities are purchased and sold. This evaluation will be undertaken in conjunction with Treasury, the Federal Reserve and the CFTC.

The final point focuses on transparency. Here Mr. Gensler identified four areas where the rules need to be updated. Those are: Beneficial ownership which has not been updated since 1968; security-based swaps which involves issues such as the collapse of family office Archegos Capital Management; short selling; and company buy-backs of their securities. New rule writing in each of these areas, as well as those discussed above, have the promise of significantly impacting all market participants.

Comment

Chair Gensler has outlined an impressive number of research projects that will keep the staff and agency busy for far more than the immediate future. Analyzing issues as diverse as climate change, corporate work staff composition, the efficiency of the markets, short selling, payment for order flow and company stock buy-backs is sure to strike a cord with every group of market participants as well as those on Capitol Hill.

Many of the issues identified are likely to be very controversial and even political. Environmental disclosure metrics, for example, are likely to attract the interest of a number of powerful interests ranging from environment organizations, investors who favor certain metrics and political interest who will argue that the Commission should stick to financial and corporate governance questions and not medal in these areas.

Others, such as corporate work force composition and diversity, are likely to draw interest from other diverse market participants. Many may argue that work place standards have nothing to do with the federal securities laws; others may contend that investors are very interested in the composition of the work force at a firm in which they have capital invested because this metric can make all the difference in issuer performance over time. Indeed, virtually every issue identified by Chair Gensler has this potential.

Mr. Gensler should be congratulated for taking on these difficult issues – many in his position might put on the blinders and keep to the straight and narrow of accounting standards and similar matters. At the same time, it is critical that Mr. Gensler steer the agency on the correct path, mandating disclosure and not picking winners and looser among different metrics. The new Chair has made a great start; the proof is in the long-term performance – as always.

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