Jay S. Lee, Exchange Act Rel. 66200, January 20, 2012
This case is significant for two reasons. It restates clearly the duty that
brokerage firms have to investigate sales of large amounts of stock of little
known issuers. Most important, from a supervisory standpoint, it finds
supervisory procedures inadequate that require reasonable inquiry, but do not
specify the type of inquiry that must be undertaken. Vague boilerplate written
supervisory procedures will are not adequate.
FINRA sanctioned Midas Securities and its president, Lee. The Commission upheld
the sanctions. The sanctions here resulted from Midas' unregistered sale of
securities on behalf of a Bulgarian customer who it knew to be involved in
stock promotions. The customer had been sued by the SEC in a still pending case
for his role in Spam promotions of another stock. Further, Lee and Midas had
previously been sanctioned by FINRA for the sale of unregistered securities.
The Commission rejected the defense that the firm could rely on the fact that
the certificates had no restrictive legend. When a customer seeks to sell a
large block of a little known stock the broker is required to undertake a
searching inquiry to determine whether the customer is engaged in a
distribution. Reliance on lack of a restrictive legend on the certificates is
insufficient. Also, the issuer here had been the subject of a reverse merger
only weeks before, often a red flag that a distribution may be taking place.
Further exacerbating the situation was the fact that Midas reps knew the
customer was a stock promoter who received stock directly from issuers in
payment for his activities.
The Commission also rejected the defense claim that the broker could escape
liability as the trades were unsolicited. The Commission has never recognized
this as a defense as "a broker [relying on the Section 4(4) defense cannot
merely act as an order taker." The Commission also rejected the defense
claim that FINRA had not established the existence of an unregistered
distribution. It reiterated long standing precedent that any person relying on
an exemption from the registration requirements must establish that exemption
as an affirmative defense when the stock has not been registered as was the
The Commission also found the firms supervisory procedures inadequate. Midas'
procedures required it to conduct a "reasonable inquiry"into
unregistered sales of large amounts of little known securities. However, the
Commission characterized those procedures as "minimal" and found them
to be deficient because they did not specify the type of inquiry that was
Read more commentary on SEC administrative
opinions at SEC
Tea Party, a blog by Robert Fusfeld.
For more information about LexisNexis
products and solutions connect with us through our corporate site.