Online Microcap Finder Fee Platform Raises FINRA Regulatory Concerns

May 12, 2016

An enterprising registered person rolled out an online Finder's Platform seeking to introduce investors to microcap issuers. An online Finder's Platform, now that's a cool idea. Microcap issuers?  Ummm . . . how can I put this delicately . . . maybe not such a wonderful thing. Let's face it, few things on Wall Street have fallen into more disfavor than anything associated with the microcap scene.  That being said, however, maybe creating an online community where smaller companies are introduced to legitimate financing could alleviate a lot of the promotional fraud and unsustainable funding that afflicts that end of the market. Note my use of "maybe" and "could" in that last sentence. Apparently, the online platform thing didn't go off without a hitch because today's Blog discusses a recent FINRA regulatory settlement with that innovative registered rep's member firm.

Case In Point

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, MSC-BD, LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of MSC-BD, LLC, Respondent (AWC  2014039285101, May 2, 2016).

Since 2007, Respondent MSC-BD, LLC. has been a FINRA member firm and presently has two branch office and 12 registered representatives. The AWC asserts that Respondent does not have any prior relevant formal disciplinary history.

The Finder Platform

During the relevant period of January 2014 through August 2014, the AWC asserts that a newly registered representative of MSC-BD:

[C]onducted a type of investment banking consulting business (the "Finder Platform") through the Firm, generally acting as a "finder" of potential investors for microcap issuers pursuant to Consulting Agreements between those issuers and the Finder Platform.

During the relevant period, MSC-BD, through the association of the Representative and his Finder Platform, entered a new line of business. Specifically, pursuant to Consulting Agreements with microcap issuers, the Representative "introduced" potential investors, typically private funds, to the issuer clients of the Finder Platform. He also consulted with those issuer clients regarding the potential financing. If a potential investor provided financing, the Firm received 10% of the "Finder's Fee" payable to the Finder Platform, in exchange for the compliance oversight of MSC-BD.

In addition, financing deals resulting from the Representative' s introductions generally took the form of equity lines of credit or convertible notes, which ultimately involved sales of unregistered securities in reliance on exemptions from the registration requirements of Section 5 of the Securities Act. Financing deals also took the form of transactions under Section 3(a)(10) of the Securities Act, which involved the purchase and conversion of issuer debt and its conversion to stock through a court-approved settlement.

The Failed-To List

FINRA looked over the Finder Platform and didn't like what it saw, and particularly didn't care for MSC-BD's role. The AWC alleges that MSC-BD failed to:

  • establish a supervisory system and written supervisory procedures  reasonably designed to:
    • ensure that the registered representative ("RR") had conducted adequate due diligence on the Finder Platform's issuer clients before introducing them to potential investors, or that an investment in those issuers would be suitable for the potential investors;
    • detect and prevent the RR from causing the firm to participate in unlawful securities transactions or those in violation of Section 5 of the Securities Act's registration requirements. Although MSC-BD received transaction-based compensation from the RR's introductions, the firm did not:
      • review the resulting financing deals;
      • screen the terms or the other participants in those financing deals; and
      • request or review the transaction documents that were ultimately created to effect those deals.
  • enforce an unwritten policy of placing issuer clients of the Finder Platform on the firm's Restricted List upon the execution of a Consulting Agreement between the issuer client and the Finder Platform. As a result, the AWC alleges that MSC-BD failed to maintain current restricted lists with respect to the issuer clients of the Finder Platform; and, moreover, MSC-BD's Restricted List did not contain the name of the contact person responsible for the addition of securities to the list, as required by NASD Notice to Members 91-45.
  • reasonably investigate or evidence its review of the RR's trading activity in an outside brokerage account involving issuer clients of the Finder Platform as required by NASD Rule 3010(d)(1). Examples of trading activity warranting further review included:
    • the deposit of a large volume of physical share certificates,
    • the&n immediate sales of the shares, and
    • the wiring of the proceeds from the account; and
  • evidence an adequate supervisory review of the RR's electronic email communications, as required by NASD Rule 3010(d)(1).
As a result of the foregoing, FINRA deemed that MSC-BD had violated NASD Rules 3010(a), 3010(b)(1), and 3010(d)(1) and FINRA Rule 2010.


Separately, the AWC asserted that during the relevant period, the RR had disclosed certain outside business activities ("OBA") to the MSC-BD, among which was his consulting for a family fund. Despite having received notice of the family fund OBA, MSC-BD allegedly failed to adequately review and evaluate the RR's activity. Pointedly, the AWC cited MSC-BD's failure to maintain records evidencing any analysis of the OBA, including any conflicts of interest analysis or whether the firm should have limited the OBA. Further, MSC-BD did not evaluate whether the RR's consulting arrangement with the family fund (which FINRA alleges gave him a beneficial interest in the fund's investments) constituted private securities transactions.

As a result of the foregoing, FINRA deemed that MSC-BD had violated FINRA Rules 3270 and 2010.

FINRA Sanctions

In accordance with the terms of the AWC, FINRA imposed upon MSC-BD a Censure and $15,000 fine. The AWC notes that:

Pursuant to the General Principles Applicable to all Sanction Determinations contained in the Sanction Guidelines, FINRA imposed a lower fine in this case after it considered, among other things, the firm's revenues and financial resources. See Notice to Members 06-55.

Bill Singer's Comment

Cutting through all the above verbiage, we find ourselves dealing with a fairly simple issue (setting aside the family fund OBA aspect): a member firm's compliance oversight of a new RR's attempt to generate fees from introducing investors to microcap issuers listed on an online finder's platform. 

In fairness to FINRA, we have seen too many dubious attempts to market microcap issuers with the result that investors got fleeced and brokerage firms were exposed to severe regulatory and criminal liability. What was frequently marketed as a legit investment opportunity turned out to be just another gussied-up stock promo scam hidden behind the glitz of a Dotcom name or some social media hyperbole. 

Is the MSC-BD AWC commendable, preemptive regulation, or is it a Luddite reaction to innovation? In the not-too distant past, the roll-out of the type of online platform at issue in this settlement might have been considered innovative entrepreneurship. The problem with such outside-the-box ideas on Wall Street is that they have littered the landscape with the detritus of rampant fraud and criminality, which was fostered, in part, by regulators who were spectators in the stands rather than umpires and referees on the field of play. On the other hand, overzealous regulation kills innovation and fosters illicit conduct by driving market participants to financing from shadowy and predatory sources. Somewhere, somehow, we need to find a balance.

The MSC-BD AWC is well drafted and replete with adequate content and context to make it helpful. If nothing else, FINRA has alerted its members to the need to create and implement compliance policies and practices necessary to monitor the conduct of an online Finder's Platform.