Who Wouldn't Want a Licensed Broker-Dealer?

Unlicensed investment brokers across the country are scurrying to Kaplan and Sylvan Learning Centers in order to pass required exams and become registered with FINRA. Those who, for years, have said that they didn't need the license in order to get clients, fund deals and collect commissions have concluded that now, they do. Why? Certainly in the wake of financial scandals and investor mistrust, both public and private companies are undergoing more rigorous scrutiny.


In addition, both investors and entrepreneurs have become much more savvy about the protection that policing organizations like FINRA and the SEC afford them, and those organizations are vigorously pursuing complaints, perhaps in part to rebuild public trust. The resulting penalties for offending investment bankers including fines, jail time, and bans from working with any other broker-dealers. See www.finra.org and www.sec.gov for details of recent judgments.


What is the value of a license? Perhaps a better question is, what are the dangers for any or all parties (the investor, entrepreneur, and investment banker) if the latter is not licensed?


1. Right of rescission: Melinda LeGaye, President of MGL Consulting Corporation in The Woodlands, Texas, provides FINRA-required compliance auditing services for broker-dealers. She recommends that “entrepreneurs seeking equity capital in the form of a private placement...utilize the services of a broker-dealer firm that is registered with FINRA, the SEC, and with the states where the offers will be made. “Otherwise”, she warns, “there are potential rescission issues associated with sales by non-registered dealers.” In other words, a deal can be revoked and funds returned, even after it has closed.


2. No back-end fees: According to the SEC and FINRA, unlicensed fundraisers, who, therefore, have not agreed to be bound by the code of ethical conduct, are not allowed to be paid a percentage of funds raised from investors. They can be paid a retainer or a consulting fee, but not a “back-end fee” or commission. In the past, many entrepreneurs did not know this so they paid the successful, unlicensed fundraisers anyway, pleased to have the capital. Now, however, the word is out. An unlicensed money-raiser could walk away from a closing with no commission at all.


3. Deal transparency: Licensed broker-dealers and their representatives swear to interact with clients according to a code of ethics outlined for the public on FINRA's website. These rules pertain to both internal and external conduct. For example, the list addresses what can/cannot be promised verbally or in writing, reasonable fees, what services can and cannot be rendered, and full disclosure of deal terms, personal involvement, and timely introduction to “promised” investors. At the office, all records must be accessible and audited, and even a complaint log must be kept available for any clients who request it. Unlicensed money raisers may determine their own higher or lower standards of ethics. Warning: if a fundraiser sounds too good to be true, s/he probably is (unlicensed).


4. Public records: The public can check for free the professional background of any FINRA-licensed representatives or broker-dealers (http://brokercheck.finra.org/Search/Search.aspx), as well as the backgrounds of people who used to be licensed and left the industry for one reason or another. This resource includes such information as prior employers, number of licenses, and any sanctions or complaints. All entrepreneurs and investors should check out all investment bankers they consider. If the names are not on BrokerCheck, the people are not licensed. Why hire them? If they are listed then look at the back of the report for any disclosures that might discourage you from hiring them.


5. Recourse: If disgruntled investors or entrepreneurs seek recourse against an unlicensed investment banker, they have access to the court system, of course, but that process is often expensive and time-consuming. Sometimes the legal fees alone are larger than the amount disputed. In increasing numbers, thousands of clients have availed themselves of FINRA arbitration (see www.finra.org for statistics and information). Clients have access to one to three arbitrators in a binding process that is reasonably-priced from the very organization authorized to punish, ban, and publicize the offences of the broker-dealer – a powerful ally.


How much does it cost to become a licensed broker or registered representative? Are financial considerations alone prohibitive enough to discourage ethical “finders” or unregistered investment bankers from becoming FINRA licensed? Consider the following prices to become a registered representative in Texas: $100 to $265 for each licensing exam (Series 63 – state; Series 7 or 79 – national; Series 24 – supervisor); $150 to $500 for each study guide or class; $285 to sell securities in Texas; $50 to $500 for annual continued education courses, and $20 to be fingerprinted. Cost: about $800 and up. Why wouldn't someone do this to protect himself, his clients, and the deal!


Furthermore, just as in the Real Estate profession, a newly-registered representative cannot work alone, but must affiliate with a broker (firm) that assumes liability for supervision of the representatives by experienced professionals with more licenses (at least a Series 24) and experience. This supervision includes the representative's correspondence, accounts, sales, contracts, and fees.


A broker-dealer firm must conform to additional requirements designed to protect clients, which cost money that unlicensed fund-raisers do not incur. For example, registered broker-dealers must have independent annual financial audits ($10,000+), an internal or external Compliance Officer and a Financial Operations Principal ($50,000+), FINRA fees ($10,000), fidelity bond ($450+), SIPC fees ($1500+), and a minimum net capital requirement ($5,000 - $250,000+). Additional fees for scrupulous firms include e-mail supervision and background checks of employees, as well as background checks and anti-money laundering checks of potential investors and clients. The range of fees reflects the number and types of investment banking services and transactions. To open a minimal service, two person broker-dealer requires an initial investment of thousands of dollars intended to ensure competency and client protections – costs not incurred by unregistered “investment bankers” or “financial advisors” because no one requires them to do so.


The costs, examinations, scrutiny, and background checks surely deter unscrupulous unlicensed service providers from becoming licensed, and may serve as a disincentive for honest folks who just don't want the trouble. Buy, why on earth wouldn't an investor or company manager seeking investment banking services engage FINRA-licensed investment bankers who are willing to undertake such scrutiny and additional education in order to provide deal transparency, public records, arbitration services, and a published code of ethics? Caveat emptor.

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