Who is a Broker?

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.