Bankruptcy Reminds Companies of the Need for Registered Broker-Dealers in Capital Raising Efforts

Amy Natterson Kroll, Carl A. Valenstein and Margaret R. Blake of Bingham McCutchen LLP

Last year, Neogenix Oncology Inc., (“Neogenix” or “Company”) a biotech firm based in Rockville, Maryland and New York, surprised investors by filing for Chapter 11 bankruptcy protection. [1] To those in the biotech industry, Neogenix, by all accounts, was a successful company with more than 500 shareholders and what seemed to be numerous clinical developments. Perhaps even more surprising than the actual Chapter 11 filing was the reason behind it. It seems an inquiry by the U.S. Securities and Exchange Commission in late 2011 into the Company’s capital raising efforts uncovered payments by the Company to unlicensed individuals (i.e., individuals who should have been licensed with a registered broker­dealer) who assisted in the Company’s capital raising. Reliance on unregistered persons resulted in “significant potential rescission liability and the inability to present audited financial statements” leaving the Company “unable to raise funds.” [2]

Under the Securities Exchange Act of 1934 (the “Exchange Act”), offers and sales of securities in the U.S. must be made by a registered broker­dealer or appropriately licensed individuals associated with a registered broker­dealer. [3] Despite increased awareness in the securities industry, many issuers, public and private, continue to rely on the elusive “finders” exemption, which the SEC has all but eliminated as a possible alternative to using registered personnel in sales of securities. A true finder, under SEC guidance, introduces the buyers and sellers of securities and then steps away from any subsequent involvement in the transaction. The SEC has noted in no­action guidance, that where a “finder” does anything more than introduce the parties (e.g., assists in negotiating on behalf of a party, participates in discussions regarding the pricing of a security), s/he may be deemed as acting as an unregistered broker­dealer. [4] In addition, a finder ideally should be compensated on a flat­fee basis and not be paid a commission or a fee based on the success of a transaction. However, depending on the facts and circumstances, a finder engaging in more than introductory activity who is paid a flat fee may be deemed an unregistered broker­dealer regardless of the flat fee arrangement. [5] In sum, the finder exemption is very narrow, and the risks associated with relying on it are very real.

In the case of Neogenix, the company engaged several “finders” to assist with the offer and sale of its securities. How those individuals were paid is not clear, but the payments and the finders' arrangements in question came to the attention of the SEC. Following its inquiry, the SEC determined the finders used by Neogenix were required to be licensed. As a result of the use of unregistered broker­dealers in the offer and sale of securities, Neogenix opened itself up to the possibility of shareholder suits for rescission of the purchases and sales of the securities. [6]

The company — in an effort to clean its slate — decided to sell itself to another entity owned by Neogenix shareholders and to declare Chapter 11 bankruptcy. In a letter, dated July 25, 2012, from the Chairman to Neogenix shareholders, Mr. Feldman set forth the details of the transaction and introduced Precision Biologics as a “stalking horse” bidder in the purchase of Neogenix.

Often considered an afterthought in capital raisings, an issuer must take care to ensure that anyone assisting in the offer or sale of its securities is properly licensed or relying on a valid exemption from licensing and is otherwise in compliance with all relevant U.S. securities laws. [7] The story of Neogenix emphasizes how important this is for any transaction involving the offer and sale of securities. As illustrated here, the ripple effect of relying on incorrect or outdated guidance could be detrimental.

[1] See Letters from Philip M. Arlen, M.D., President & Chief Executive Officer, Neogenix to Neogenix Shareholders regarding the filing and facts underlying the filing.

[2] Letter from Philip M. Arlen, M.D., President & Chief Executive Officer, Neogenix to Neogenix Shareholders (Feb. 6, 2012).

[3] 15 U.S.C. §78o (2012)

[4] See, e.g., Revocation of Prior No­Action Granted to Dominion Resources, Inc. (Publicly Available March 7, 2000); Davenport Management, Inc., SEC No­Action Letter (Publicly Available April 13, 1993); International Business Exchange Corporation, SEC No­Action Letter Publicly Available Dec. 12, 1987); IMF Corporation, SEC No­Action Letter (Publicly Available May 15, 1978).

[5] See, e.g., Colonial Equities Corp, SEC No­Action Letter (Publicly Available June 28, 1988) where staff in the Division of Market Regulation granted no­action relief for an arrangement where two unregistered persons associated with an insurance agency would assist in identifying potential investors for a broker­dealer. The relief was granted only after the incoming request was modified with respect to the initial proposed compensation arrangement — changing from a commission­based fee to a flat fee that does “not vary in relation to the net­brokerage commissions generated...” In addition, an adjustment of the fee was allowed, upward or downward, but “only once in each 12­month period, and only on a prospective basis, to take into account Colonial’s cost­benefit analysis of the services provided.”

[6] Under Section 29(b) of the Exchange Act (15 U.S.C. §78cc(b) (2012)), contracts entered into in violation of the Act may be rendered void. Courts have used this statute to declare void securities transactions entered into with unregistered broker­dealers. State law rescission rights may exist even where the unregistered finder did not contract directly with investors.

[7] For example, an associated person of the issuer may qualify for an exemption from broker­dealer registration under Exchange Act Rule 3a4­1. Under that rule, an associated person of the issuer is deemed not to be a broker (and thus may assist in the capital raising of the issuer) where the person is not subject to a statutory disqualification as that term is defined in Section 3(a)(39) of the Exchange Act, not compensated by commissions based on the transaction in securities and is not an associated person of a broker­dealer. In addition, the person must meet one of several conditions related to the extent of their activity on behalf of the issuer as set forth in the rule. See Exchange Act Rule 3a4­1(a)(4)(i) ­ (iii). Rule 3a4­1, by its terms, is a non­exclusive safe harbor, so it is possible, although dependent on the specific facts, for an issuer employee to be outside of the rule without necessarily violating Exchange Act Section 15(a).

Amy Natterson Kroll, Partner,

Amy Kroll counsels U.S. and non-U.S. broker-dealers on U.S. regulatory requirements and best practices. Amy has particular experience with issues related to the equity capital markets, such as research activities and research analysts, supervisory controls and internal controls, and cross-border trading. Through her work, she has developed a command of the issues of special concern to regional full-service and mid-market brokerage firms.

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Carl A. Valenstein, Partner,

Carl’s practice focuses on domestic and international corporate and securities matters, mergers and acquisitions, project development, and asset finance covering a wide range of industries and geographical regions. He has particular experience in the life science, telecom/electronics and cruise line industries and has worked extensively in Latin America and the Caribbean, Europe, Africa, and the Middle East.

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Margaret R. Blake, Of Counsel,

Peggy Blake focuses her practice on regulatory and compliance matters applicable to U.S. and non-U.S. broker-dealers under the Securities Exchange Act of 1934, as well as FINRA rules and the rules of other self-regulatory organizations. She counsels clients on all aspects of broker-dealer registration, the continuing membership process, broker-dealer acquisitions, and general regulatory and compliance issues. Peggy also has advised U.S. and non-U.S. investment advisers and private funds on applicable regulatory requirements under the Investment Advisers Act of 1940 and the Investment Company Act of 1940, respectively. She has advised U.S. and non-U.S. issuers on the Securities Act rules applicable to offshore offerings (Regulation S) and private placements (Regulation D) and has assisted global custodian banks in addressing issues of interest in the U.S. and abroad, including compliance obligations under the Investment Company Act of 1940.

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Bingham McCutchen LLP

Bingham, (, has approximately 1,000 lawyers in 14 offices in the U.S., Europe and Asia and offers a broad range of market-leading practices focused on global companies. Follow the firm on Twitter @BinghamLaw.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Bingham McCutchen LLP. This work reflects the law at the time of writing.