By Rodney F. Tonkovic, J.D.
A petition for certiorari asks the Supreme Court to address whether the SEC exceeded its statutory authority by applying broker-dealer registration requirements to the petitioners, who were acting as underwriters. The petitioners point to the distinct statutory definitions of "broker" and "underwriter" and assert that the imposition of broker registration requirements to those acting as underwriters is contrary to the statutory scheme. The petition further asks the Court to correct what it argues are a number of factual errors made by the Ninth Circuit. A response is due on January 29, 2021 (Feng v. SEC, December 22, 2020).
EB-5 program commissions. In 2015, the SEC charged attorney Hui Feng, and his law firm, with defrauding foreign investors in the U.S. Immigrant Investor Program (the EB-5 Program), which provides a path to legal U.S. residency to foreign nationals investing in certain U.S.-based projects. According to the complaint, Feng offered and sold EB-5 investments to legal clients while collecting undisclosed commissions from the promoters of the investments. The complaint argued that the defendants had fiduciary, legal, and ethical duties to disclose the receipt of the commissions and the conflicts of interest the compensation created. The Commission charged Feng with fraud under the securities laws and with failing to register as a broker-dealer.
Ninth Circuit affirms Feng is a broker-dealer. Before the district court, Feng argued that he had acted as an immigration attorney, not a "broker." The court disagreed, however, finding that the uncontroverted evidence established that Feng acted as a broker and thus violated the registration requirement. The Ninth Circuit affirmed. The court noted that the district court employed the totality-of-the-circumstances approach favored by a number of courts to find that rather than traditional legal work, Feng's work more resembled indicia of broker activity. The circuit panel also confirmed that Feng had engaged in securities fraud, based in part on violating his fiduciary duties to his clients, including the duty to disclose material conflicts of interest.
Expansion of registration requirement. The petition argues that the SEC has improperly expanded the Exchange Act's broker-dealer registration requirement to encompass primary offerings of securities. Observing that the federal securities laws are understood to constitute a single consistent scheme, the petition says that the Securities Act regulates new issues of securities and the Exchange Act regulates trading in the secondary market. It is also generally agreed that individuals or firms operating in the primary market do not trigger the broker-dealer registration requirements of the Exchange Act. But, the petition asserts, the Commission has routinely exceeded this authority by extending the registration requirements beyond secondary markets and over-the-counter trading.
In this case, the petitioners served to introduce issuers to potential investors for primary market transactions that did not involve an exchange or over-the-counter market transaction. Until this case, the petition remarks, the SEC's "obvious statutory overreach" in imposing the broker-dealer registration requirements on parties operating only in primary markets has gone unchallenged. The petitioners argue that their activities placed them squarely in the category of "underwriter" under the Securities Act—and underwriters are not required to register. The SEC has blatantly disregarded clear statutory distinctions, the petitioners maintain, and this has also led to ongoing conflicts in the federal courts, with different courts arriving at different conclusions about whether the broker registration requirements apply to those who work only in the primary market.
Fraud claims. The petition also takes issue with the Ninth Circuit's upholding of the district court's finding that Feng committed fraud. Feng argues that the Ninth Circuit erroneously "bootstrapped" a state law fiduciary duty claim (based on the obligation to disclose conflicts of interest pursuant to New York Rules of Professional Conduct) as grounds for the violation of the antifraud provisions. In doing so, the Ninth Circuit has gone against Supreme Court precedent holding that a state law fiduciary duty claim is not an actionable federal securities law claim and further that not all alleged failures to disclose are actionable as fraud, the petition says.
Finally, the petition asserts that the Ninth Circuit was simply wrong in finding that the petitioners acted with scienter and that Feng's compensation arrangement was material. Feng asserts that his not disclosing the "industry standard" fee arrangement was "a business decision" and that he simply wanted to avoid negotiating fee rebates with his clients. Continuing in this vein, Feng says that the payment of a commission is a standard practice in the EB-5 industry and that his clients "did not care" about the fees, which were disclosed in the PPMs anyway.
The petition is No. 20-862.