FINRA Sanctions For Unregistered Distribution Upheld

Midas Securities, 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 case here.

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 required.

Read more commentary on SEC administrative opinions at SEC Tea Party, a blog by Robert Fusfeld.

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