On October 24, 2011, the Securities and Exchange Commission (the SEC) announced the settlement of an investigation into alleged securities laws violations by Banco Espirito Santo S.A. (BES), a commercial bank headquartered in Portugal.1 The SEC charged BES with acting as an unregistered broker-dealer and investment advisor to US customers.2 As part of the settlement, BES agreed to pay nearly $7 million in disgorgement, prejudgment interest, and penalties and to make all of its US clients whole for any realized or unrealized investment losses plus interest.3
The SEC Enforcement Action
BES is a Portuguese commercial bank that provides a broad range of financial services to customers around the world. BES has a network of international branches and is publicly traded on the Euronext stock exchange. BES's US customers consisted primarily of Portuguese citizens who had emigrated to the United States.
The SEC charges were based on the following facts as stated in the BES Order:
- BES maintained customer relationships with approximately 3,800 US persons between 2004 and 2009.
- A BES marketing department located in Portugal mailed materials offering securities to bank customers outside of Portugal, including to customers residing in the United States. The SEC noted that although the materials were not specifically tailored to US residents, they were still sent to US-based customers.
- BES operated a customer service call center located in Portugal that handled account-related inquiries and requests for all BES customers worldwide. The call center included two Lisbon-based representatives dedicated to servicing the bank's US customers. These representatives fielded on average 5-6 calls per day originating from the United States, with most conversations taking place in Portuguese.
US customers were also contacted via telephone calls initiated by the call center, which sought to inform them that certain of their investments held in BES accounts were maturing, such as certificates of deposit. During these phone calls BES representatives offered to the US customers various financial products, including securities, in which they could reinvest their funds. The representatives were not registered representatives of an SEC-registered broker-dealer, nor were any of the contacts intermediated by an SEC registered broker-dealer.
- BES created an International Private Banking division based in Portugal to service affluent international clients. The International Private Banking division included a relationship manager specifically dedicated to the US market (the Dedicated RM). Approximately 225 US clients were contacted and serviced by the Dedicated RM. The Dedicated RM visited the United States at least twice a year for two to three weeks at a time, meeting with approximately thirty to fifty US clients during each stay. The Dedicated RM also serviced US clients from Portugal by telephone, facsimile, and email.
During these communications, the Dedicated RM discussed the US clients' personal banking accounts as well as other financial products, including securities, helped to effect transactions in financial products, and advised US clients to buy, sell or hold such financial products. None of the persons who served as the Dedicated RM during the review period was registered or associated with an SEC-registered investment adviser or SEC-registered broker-dealer.4
Regulatory Framework For Broker-Dealers under the Exchange Act
The term "broker-dealer" is not itself defined in the Exchange Act, but is commonly used to refer to entities that act as either or both a "broker" and/or a "dealer."
Section 3(a)(4) of the Exchange Act, in general (subject to certain exceptions not relevant to this discussion), defines a "broker" as "any person engaged in the business of effecting transactions in securities for the account of others." Based on no-action guidance from the SEC Staff, activities that may be deemed (alone or in combination) to confer "broker" status include:
- Soliciting clients to enter into securities transactions
- Assisting issuers in structuring prospective securities transactions or helping issuers to identify potential purchasers of securities
- Participating in the order-taking or order-routing process or otherwise bringing buyers and sellers of securities together
- Receipt of compensation that is contingent on the success of a securities transaction or that is based on the amount or value of a securities transaction5
Section 3(a)(5) of the Exchange Act, in general (subject to certain exceptions not relevant to this discussion), defines a "dealer" as "any person engaged in the business of buying and selling securities for such person's own account through a broker or otherwise." Activities that have been identified (alone or in combination) by the SEC Staff as indicators of "dealer" (rather than "investor" or "trader" status) include:
- Participating in a selling group, underwriting securities or purchasing or selling securities as principal from or to customers rather than from or to only brokers or dealers
- Carrying a dealer inventory or holding oneself out as a dealer or market-maker or as otherwise willing to buy or sell particular securities on a continuous basis
- Quoting a market in securities or publishing any quotations on or through any quotation system used by dealers, brokers or institutional investors or otherwise quoting prices, other than on a limited basis through a retail screen broker
- Handling money or securities, or executing or clearing securities transactions, for third parties
- Issuing or originating securities
- Extending or arranging for the extension of credit to others in connection with securities
- Engaging in trading transactions for the benefit of others, rather than consistently with one's own judgment and investment and liquidity objectives6
Rule 15a-6 under the Exchange Act (Rule 15a-6) provides the principal "safe harbor" exemptions from SEC registration for non-US broker-dealers that engage in certain limited activities with US persons. Although Rule 15a-6 does permit non-US broker-dealers to effect "unsolicited" securities transactions with US persons, it is important to note that this exemption is typically viewed quite narrowly by the SEC.7
Rule 15a-6 also permits non-US brokerdealers to engage in certain securities activities with specified categories of institutional investors, provided that (among other requirements) the transactions are effected by an SECregistered broker-dealer.8
Significantly, however, Rule 15a-6 does not provide an exemption that would allow a non-US broker-dealer to service and maintain accounts for customers after they have moved to the United States.9 Moreover, Rule 15a-6 provides an exemption solely for purposes of the Exchange Act's broker-dealer registration requirements; it does not provide an exemption for purposes of state broker-dealer registration requirements.10 Accordingly, an entity that wishes to engage in securities transactions with US persons must ensure that its activities are in compliance not only with US federal law, but also with the laws of each state in which it engages in such activities or otherwise has contact (including, e.g., each state in which the US persons with whom it is engaging in such securities activities resides).
Practical Considerations
Non-US broker-dealers (including non- US banks that engage in "broker" or "dealer" activities) should be aware that there are only very limited circumstances in which they may engage in securities transactions with US investors without being registered and regulated as "brokers" and/or "dealers" under US law. Moreover, the relevant "safe harbor" exemptions relate almost exclusively to institutional investors, and thus, non-US brokerdealers should be particularly wary of transactions with individual (or "retail") US-based clients.
With the increased movement of persons around the world, it should not be unexpected for a non-US brokerdealer to find that it has accounts for clients who were once residents of the broker-dealer's home country but who now may be considered US persons for purposes of applicable US securities laws. Because of the potentially broad jurisdictional reach of the US securities laws, non-US broker-dealers are thus subject to the risk of becoming subject to such US jurisdiction, either as a result of these migratory patterns or otherwise. Accordingly, we suggest that non-US broker-dealers consider the various policies and procedures that may be implemented to avoid or reduce the potential for these risks, including, e.g., conducting periodic reviews to determine whether its existing clients continue to reside in the broker-dealer's home country (or other jurisdiction in which it is authorized to engage in broker-dealer activities). If a non- US broker-dealer finds that certain of its clients have moved to the United States or have otherwise requested that account statements and other documentation be sent to a US location, the broker-dealer should consider taking steps to move the client's account to an SEC-registered affiliate (if applicable) or consult with US counsel to determine whether other possible avenues are available to ensure that it continues to be in compliance with applicable US law.
Footnotes
1 Banco Espirito Santo S.A., Order Instituting Administrative and Cease-And-Desist Proceedings, SEC Release No. 34-65608 (October 24, 2011) (the Order). BES consented to the issuance of the Order without admitting or denying any of the findings in the Order.
2 Specifically, the SEC charged BES with violations of Section 15(a) of the US Securities Exchange Act of 1934 (the Exchange Act) (relating to registration of broker-dealers) and Section 203(a) of the US Investment Advisers Act of 1940 (relating to registration of investment advisers). In addition, because the securities it sold to US investors were sold in transactions that were not registered (or properly exempt from registration) under the US Securities Act of 1933 (the Securities Act), the SEC also charged BES with violations of Sections 5(a) and 5(c) of the Securities Act. This Client Alert focuses solely on the broker-dealer registration aspects of the Order.
3 BES also reached similar settlements with the securities regulators in the five US states where most of its US customers were based (specifically, New York, New Jersey, Connecticut, Rhode Island, and Massachusetts) for alleged violations of state securities laws stemming from the same conduct.
4 The SEC noted in the Order that BES had a wholly owned subsidiary that was registered as a broker-dealer with the SEC, which it could have used as an intermediary for its securities transactions with US persons but choose not to do so.
5 See, e.g., MuniAuction Inc., SEC Staff No-Action Letter (available March 13, 2000).
6 See, e.g., Continental Grain Company, SEC Staff No-Action Letter (available November 6, 1987); Fairfield Trading Corp., SEC Staff No-Action Letter (available January 10, 1988).
7 To understand how broadly the SEC views the concept of solicitation (which generally would include any action intended to induce a securities transaction, develop goodwill or make the broker-dealer known in the United States), consider its statement in the release adopting Rule 15a-6 that a non-US broker-dealer could be deemed to have solicited a US investor who on his own initiative opened an account with the non-US broker-dealer and became a regular customer. SEC Release No. 34-27017 (July 11, 1989).
8 A detailed explanation of Rule 15a-6 is beyond the scope of this Client Alert. However, brokerdealers and others should be aware that these arrangements can be quite complex and should be initiated only after consulting with US counsel.
9 Rule 15a-6 permits non-US broker-dealers to contact and effect securities transactions with a non-US person "temporarily present" in the United States with whom the non-US brokerdealer had a bona fide pre-existing relationship before the non-US person entered the United States. However, this exemption is generally viewed as allowing continuing contacts while the non-US person is in the United States for a brief period of time, such as on vacation, and not for extended stays, relocations or permanent moves under circumstances in which the person could be viewed as a "resident" of the United States (even if they continue to be a citizen of a non-US jurisdiction).
10 See supra Note 3.
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