Legal Consequences for Using or Acting as an Unregistered Broker-dealer in the Cannabis Industry

• Jurisdiction: California,United States
• Author: Meital Manzuri
• Publication year: 2020
• Citation: Vol. 38 No. 4

Legal Consequences for Using or Acting as an Unregistered Broker-Dealer in the Cannabis Industry

Meital Manzuri

Meital Manzuri is the Managing Partner for Manzuri Law in Los Angeles. With over twelve years' experience in the field and, as one of the first cannabis business attorneys in California, she has earned a prominent reputation for advising commercial cannabis businesses on myriad issues, including licensing and regulatory compliance, corporate and transactional law, joint ventures, M&A, best business practices, risk mitigation, and criminal defense^*

I. INTRODUCTION

As the cannabis industry continues to grow, the players have begun to change a bit and cannabis business owners face the daunting task of navigating the private and public markets along with many hefty regulations. Whether it is finding private investors to raise capital via a private placement or looking for merger and acquisition ("M&A") activity, cannabis operators and their legal counsel should be aware of individuals or firms that claim they have connections to private investors or an ability to make introductions to interested buyers or potential acquisitions. Those parties are likely acting as broker-dealers and, if unregistered, can pose significant legal headaches for a business and its legal counsel down the road.

This article will proceed as follows. Section II will define the term "broker-dealer" as well as provide insight into when a third party might be acting in the capacity of a broker-dealer. Section III will discuss the legal consequences of a cannabis business that engages with an unregistered broker-dealer to help raise money in the private markets from the viewpoint of the business, the unregistered broker-dealer, and the investors. Section IV will discuss the legal consequences of a cannabis business engaging an unregistered broker-dealer in M&A activity from the viewpoint of the buyer, the unregistered broker-dealer, and the seller. Lastly, Section V will discuss instances of enforcement against unregistered broker-dealers in the cannabis industry.

II. WHAT IS A BROKER-DEALER?

A broker is "engaged in the business of effecting transactions in securities for the accounts of others."¹ Factors the SEC considers when determining whether an individual or firm is acting as a broker include: finding investors for issuers (which includes acting in a "consultant" capacity), engaging or finding investors for venture capital, angel financing, or private placements, acting as "placement agents" for private placement of securities, or finding buyers and sellers of businesses.²

While the terms "broker" and "dealer" are typically used in conjunction, technically a dealer is "engaged in the business of buying and selling securities for his own account, through a broker or otherwise."³ The factors the SEC considers include the following:

• a person who issues or originates securities that he or she also buys and sells;
• a person who holds himself or herself out as being willing to buy and sell a particular security on a continuous basis; or
• a person who runs a matched book of repurchase agreements.⁴

For the purposes of this article, the definition of broker is the more relevant consideration because it relates to finders, which are the focus of this article.

Even with these definitions, crossing the threshold into acting as a broker-dealer can at times be unclear. In addition, the SEC will look at the activities that the actual party performs.⁵ Thus, the following questions about the third party are pertinent:

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• Does the party participate in important parts of a securities transaction, including solicitation, negotiation, or execution of the transaction?
• Does the party's compensation for participation in the transaction depend upon, or is it related to, the outcome or size of the transaction or deal?
• Is the party engaged in the business of effecting or facilitating securities transactions?
• Does the party handle the securities or funds of others in connection with securities transactions?⁶

A "yes" to any of these questions means that the party must be registered as a broker-dealer.

While there are some exemptions from broker-dealer registration requirements⁷ in addition to SEC No-Action Letters in which the SEC states that it will forgo enforcement in certain factual scenarios,⁸ most individuals and firms participating in the above activities must register with a self-regulatory organization (most commonly the Financial Industry Regulatory Authority ("FINRA")) and the SEC. Additionally, some states require registration to conduct business within the respective state. California requires registration in most instances.⁹ Registration allows organizations like FINRA to help reduce fraud by establishing practices that registered broker-dealers must adhere to, and it encourages more transparency by allowing businesses to vet a registered broker-dealer for past violations before forming a business relationship.

Given these regulations, there are a few business participants in particular that a cannabis operator should reasonably be wary of. Firstly, real estate agents are not considered to be registered broker-dealers by the SEC. As the SEC notes, "[t]here is no general exception from the broker-registration requirements for licensed real estate brokers or agents who engage in the business of effecting transactions in . . . securities."¹⁰ Similarly, a licensed attorney probably would still be deemed...