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October 2011 Archives

At Last – Congress Takes Steps to Facilitate Entrepreneurs’ Ability to Raise Capital

Presently, the Securities and Exchange Commission (SEC) prevents companies from issuing shares for capital unless they register with the SEC. However, a House panel recently approved legislation sanctioning “crowdfunding.” The legislation would allow new businesses to raise up to $5 million, with individual contributions capped at $10,000 (or 10% of an investor’s annual income), without registering with the SEC. The Entrepreneurial Access to Capital Act, HR 2930 is sponsored by Rep. Patrick McHenry (R-NC), who explained that it will create jobs by connecting entrepreneurs to the everyday investor.As detailed in a previous posting, crowdfunding is an innovative form of financing that enables people to pool money, typically comprised of small individual contributions, to invest in a particular company or venture.  Crowdfunding often facilitates entrepreneurs in their earliest stages, when funding can be hard to secure from traditional sources like banks and/or venture capital firms. Companies like Kickstarter have already implemented crowdfunding, enabling enterprising inventors, artists, filmmakers, and the like to receive donations to launch their projects.  Micro-lending services are thriving in philanthropic pursuits as well, organizations like DonorsChoose and Kiva.The current raise of crowdfunding has prompted federal regulators to re-examine the existing rules governing capital raising. For instance, in a recent testimony SEC Director Meredith Cross noted that many view the prohibition on general solicitation as a “significant impediment to capital raising.” Moreover, some members of Congress have questioned the SEC as to whether certain laws governing entrepreneurs’ efforts to raise capital have become anachronistic given the rise of the internet and the proliferation of new ways to share and spread ideas.The Entrepreneurial Access to Capital Act now moves from a subcommittee to the full House Financial Services Committee where it will be given further consideration.For additional information please contact Brent Cunningham, Associate by email at [email protected] or by phone at (619) 298-2880.

U.S. Court of Appeals Holds that FINRA Lacks Authority to Collect Fines Through Court Proceedings

A recent decision by the United States Court of Appeals for the Second Circuit found that the Financial Industry Regulatory Authority (“FINRA”) has no legal authority to bring an action in court to collect fines imposed on its members. This decision exposes a noticeable gap in FINRA’s enforcement powers; it can levy fines, but it cannot seek enforcement concerning collection of those fines in court.The case involved a former penny-stock brokerage firm, Fiero Brothers, and its owner, John J. Fiero (“Fiero”). A disciplinary proceeding found that Fiero and his firm violated Section 10(b) of the Exchange Act for a manipulative activity known as “naked short-selling.” The firm was expelled from FINRA and Fiero was barred from the industry. In addition to the expulsion, a $1 million fine was imposed which FINRA eventually attempted to collect in court. Fiero and his firm then filed a declaratory judgment action in federal court seeking a ruling that FINRA did not have authority to bring a court action to collect the fine. In reversing the lower court’s holding, the Second Circuit concluded that FINRA lacks the authority to bring court actions to collect disciplinary fines it has imposed. The court noted, however, that FINRA still has the authority to enforce its fines by revoking a member’s registration, resulting in expulsion from the industry, which itself provides a strong incentive for firms and individuals to pay fines imposed by FINRA.On its face, the decision seems to reduce FINRA’s enforcement power and remove some of the “teeth” from its ability to enforce its rules. However, from a practical perspective, FINRA still maintains its most effective weapons: suspension or a permanent bar from serving as a broker-dealer or registered representative of a broker-dealer. FINRA also still has the power to initiate a disciplinary proceeding against any FINRA member or associated person for violating any FINRA rule, SEC regulation, or statutory provision of federal securities laws. Accordingly, while the decision is an important one for individuals who are willing to walk away from the broker-dealer industry, FINRA still has significant powers to impose fines for violations of its rules and enforce those fines through the threatened suspension or expulsion from the industry. In addition, the court noted that FINRA may propose a rule change granting it the authority to collect fines through the courts.For additional information regarding this case, please contact Brent Cunningham, Associate Attorney, at [email protected] or 619-298-2880.

SEC Proposes Regulations Implementing the Volcker Rule

On October 12, 2011, the SEC, together with the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), issued proposed regulations implementing Section 619 of the Dodd-Frank Act, popularly referred to as the “Volcker Rule.” Among other things, the Volcker Rule generally (i) prohibits banking entities from engaging in short-term proprietary trading activities; and (ii) limits banking entities from investing in or having certain relationships with a hedge fund or private equity fund.To implement the Rule, the proposal would require affected entities to develop a robust, comprehensive internal compliance program and to report certain permitted "market-making" trading activities to the appropriate federal supervisory agency. In anticipation of this significantly increased compliance burden, covered entities may want to consider establishing internal controls and procedures to comply with the rule, and begin educating and training staff on the implications and application of the ban on proprietary trading.The proposal does provide for limited exceptions from the general prohibitions discussed above. For example, banking entities would be permitted to make hedging investments to mitigate risk and would be permitted to organize and make limited investments in a hedge fund or private equity fund, subject to certain de minimus threshold requirements. Banks would nevertheless be prohibited from engaging in these exempted activities if doing so would result in a material conflict of interest, or would expose the bank to high-risk assets or trading strategies.Comments on the proposal are due by January 13, 2012 and may be submitted using the Commissions’ Internet Comment Form. For additional information about the Volcker Rule and the proposed regulations implementing it, please contact Zac Rosenberg, Associate Attorney by email at [email protected] or by phone at (619) 298-2880.

News Alert: Mitigating Risks Associated with Master/Sub-Account Arrangements

On September 29, 2011, the SEC issued a Risk Alert warning of concerns regarding trading through sub-accounts, and offered suggestions to help the securities industry address those risks. Generally, in the master/sub-account trading model, a top-level customer[1] opens an account with a registered broker-dealer that permits the customer to have subordinate accounts for different trading activities. The master account usually will be subdivided into subunits for the use of individual traders or groups of traders. In some instances, these sub-accounts are further divided to such an extent that the master account customer and the registered broker-dealer may not know the actual identity of the underlying traders. Although these arrangements may be used for legitimate business purposes, this structure may expose both the customer and broker-dealer to significant risks or violations of securities laws. For example, the SEC has identified the following risks associated with master/sub-account trading model: money laundering, insider trading, market manipulation, account intrusions, unregistered broker-dealer activity, and excessive leverage. To mitigate these risks and to reduce the opportunity for violations of securities laws, consider utilizing the following controls with master/sub-account trading models:

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