A majority of the Commission has found that Neovest, Inc. violated Section 15(a)(1) of the Exchange Act of 1934 by failing to register as a broker.

This enforcement action misapplies the statutory definition of “broker,” further muddies an already confusing landscape created by prior staff no-action letters issued to firms engaged in very similar businesses, and will likely deter technological innovation in financial services.

I respectfully dissent.

As an initial matter, Neovest, by offering its web-based order and execution management system that facilitated the exchange of information (including order messages) between customers (mostly institutional investors and asset managers) and brokers, was not engaged in broker activity.

Neovest described itself as a “technology company providing a comprehensive suite of global broker-neutral financial services to the buy- and sell-side communities.”[1]

These services were packaged in a software application that permitted asset managers and institutional investors to access data and analytical tools, connect with trading desks at their broker-dealers, and send orders to those broker-dealers, which would then execute the trades on behalf of the customer.[2]

As noted in the Order Instituting Proceedings (OIP), it was the customer, not Neovest, that “directly route[d] [its] orders to buy and sell equities and options,” and it was the customer, not Neovest, that selected the broker-dealer to which the order would be sent.[3]

Notably, the OIP makes no finding that Neovest made any recommendations regarding general trading strategies or specific securities, or that it exercised any discretion over any routing decision; it also makes no finding that Neovest held or handled customer funds in connection with any securities transactions or that it negotiated or executed trades.[4]

Essentially, Neovest appears to have provided a broker-neutral software interface that permitted transmission of information between customers and the broker-dealers they selected and provided ancillary data services and nothing more.

What then leads to the finding in the OIP that Neovest should have been registered as a broker?

The Commission OIP provides little in the way of legal analysis and never examines Neovest’s order and execution management system (OEMS) itself to determine whether it constituted broker activity.

Rather, the OIP states only that “Neovest . . . operate[d] as a broker-dealer by engaging in the business of effecting securities transactions for others through the receipt of transaction-based compensation for its OEMS services and its solicitation of customers for those services.”[5]

In other words, according to the OIP, Neovest was required to register as a broker because marketing its services to customers and accepting transaction-based compensation for those services is broker activity; however, it fails to explain how and why the particular services Neovest provided—facilitating the transmission of orders created by customers, including routing instructions, from customers to the customer’s own broker—causes Neovest to effect securities transactions in the accounts of others, which is an essential requirement to meet the statutory definition of a broker.[6]

In addition to failing to explain the basis for its implicit assertion that Neovest’s services constituted broker activity, the OIP also does not find that Neovest marketed itself as offering brokerage services.

As a legal matter, these findings are inadequate to establish a violation of Section 15(a)(1).

Receiving transaction-based compensation and soliciting customers are relevant to determining that an entity is a broker only to the extent that they occur in connection with broker activity.

That a firm receives transaction-based compensation in connection with securities-related activities may indicate that it is “engaged” in a “business,” but absent a showing that that business is the effecting of securities transactions on behalf of others, transaction-based compensation does not make a firm a broker.

In at least two cases, courts have rejected the Commission’s argument that a person who received transaction-based compensation in connection with securities transaction was a broker by virtue of that compensation.[7]

Both courts held that the defendants had merely “facilitated” securities transactions between two parties and therefore were not “performing the functions of a broker,” notwithstanding their receipt of transaction-based compensation.[8]

If the activity of the two defendants in these cases—which involved negotiating the terms of the sales and actively engaging with the parties to the transactions[9]—constitutes mere facilitation and not broker activity, Neovest’s passive facilitation of communications between customer and customer-selected broker does not fall within the statutory definition of “broker.”

Neovest’s receipt of transaction-based compensation cannot be used to bootstrap it into an otherwise inapt broker status.[10]

The Commission’s finding that Neovest engaged in solicitation is insufficient for the same reason.

The OIP nowhere finds that Neovest engaged in solicitation with respect to any securities transactions; the solicitation it describes, rather, appears consistent with the marketing activity any software firm targeted at the financial industry would perform.

“Direct outreach . . . at trade shows and industry conferences, direct marketing by Neovest employees, direct marketing by Neovest-licensed resellers, referrals from existing customers and Destination Brokers, and Neovest’s own website”[11] may all be solicitation, but these activities are the kind of solicitation that a financial data service provider, a printing service company, or an office furniture vendor might also perform in marketing its services to broker-dealers or to institutional investors.

The Commission has not established that Neovest was soliciting customers for brokerage services, so this solicitation activity is irrelevant to this analysis.[12]

The data protection issue described in the OIP was serious (even though the OIP makes no findings of harm to any customer), but mishandling of customer data—even if those customers are securities markets participants—does not make the mishandler a broker.

The OIP cites potential benefits that would have resulted had Neovest been registered—greater supervision, requirements regarding protection of customer data, and SRO and Commission examinations.[13]

Indeed, the Commission’s regulatory and supervisory talents, if applied to firms in any number of industries, could yield benefits, but until Congress directs us to apply our talents to overseeing non-securities firms, we are not permitted to do so.

Not only is the OIP legally deficient, but it further complicates an already confusing area of the law and introduces additional uncertainty.

Although the Commission has not spoken definitively on the regulatory status of this type of financial services technology product, the Division of Trading and Markets staff has repeatedly provided no-action relief under Section 15(a)(1) to firms providing services similar to those provided by Neovest.[14]

Each no-action letter addresses a somewhat different set of activities; however, the key difference between the firms to which the staff has extended relief and Neovest appears to be the presence of transaction-based compensation.

General solicitation to retain a firm’s securities-related services, even if those services involve the sending of messages (including orders) related to securities transactions, does not set Neovest apart from the firms that obtained relief.

At least one of the no-action letters extended relief to a firm that engaged in solicitation of customers for its platform, which the firm was careful to distinguish from the solicitation of securities transactions.[15]

The OIP makes no findings to suggest that Neovest did anything different here.

Although these staff letters are, of course, not binding on the Commission or the public, it is inappropriate to suggest in a settled enforcement action, with no prior notice to the market, that a factor that staff a little over a year ago publicly stated was consistent with the extension of relief is now to be given such significant weight in determining that a firm should have registered as a broker.

More concerning, however, is the apparent elevation of transaction-based compensation to a determinative factor in the analysis.

As noted above, using this factor to bootstrap non-broker activity into the broker definition is contrary to law because it reduces the broker definition to a question of form of compensation and disregards the nature of the actual business activity of the firm.

It appears that this factor may have originated as an indicator of whether a person was, in the words of the “broker” definition in Section 3 of the Exchange Act, “engaged in the business of effecting transactions in securities on behalf of others” (emphasis added).[16]

In some contexts, such as an individual who only periodically performs broker activity, compensation based on successful completion of a transaction may be an important factor in determining whether the “engaged in the business” element of the statutory definition has been satisfied.

In the case of a firm that is regularly engaged in providing broker services, however, it seems less relevant.

To the extent that we rely on transaction-based compensation to distinguish between firms that are engaged in broker activity (and therefore must register) and those that are not (and therefore need not register), we may be drawing an arbitrary line between firms simply based on their compensation model.

If transaction-based compensation becomes a “talisman” to which we feel we must turn whenever we conduct the broker analysis, it obscures far more than it clarifies.[17]

Moreover, this talisman might take us places we do not want to go. Would, for example, a retail broker that decided to forgo both commissions and payment for order flow and instead charged its customer-members an annual membership fee be permitted to operate without registering as a broker-dealer?

It appears that every firm that has received no-action relief for activity similar to Neovest’s activity here receives compensation for regularly engaging in activity that is related, in some way, to securities transactions.

Granted, it may not be transaction-based compensation (though in some cases the difference seems academic[18]), but the form of the compensation is irrelevant to the question of whether these firms, which are regularly being paid for providing an ongoing securities-related service, are “engaged in the business” of providing whatever services they are providing.

Accordingly, in the context of firms providing a fee-based service on an ongoing basis, Neovest’s receipt of transaction-based compensation does not distinguish it from other firms engaged in a similar business that are compensated differently.

The relevant question here and in the no-action letters, rather, is whether the activity that the firm is “engaged in the business of” is broker activity, in other words, whether the firm is engaged in the business of effecting transactions in securities on behalf of others.

The answer is no.

Firms that offer a service that provides information and allows customers to transmit messages (including orders) to specific brokers may be “facilitating” securities transactions, but by this measure, so is any other data services vendor, such as an internet service provider or a vendor that provides direct connectivity to an exchange.

Given the prominence accorded to the transaction-based compensation factor in the staff’s no-action relief and other guidance to date and the continued lack of clarity around what activity an OEMS needs to avoid if it does not plan to register as a broker, the public would have benefited from the Commission’s careful consideration of these issues and Commission action to clarify them.

Such consideration could have come in the form of a report under Exchange Act Section 21(a)(1) or, better yet, through a Commission rule or order.

This OIP, however, clarifies nothing (except, perhaps, that the transaction-based compensation factor has swallowed the broker definition whole) and introduces new uncertainty about whether an OEMS can market its business without the Commission determining that its marketing activity constituted solicitation.

A response to the concerns I have outlined might be—“Well, Neovest could have come in for no-action relief.”

The problem with requiring anyone whose products and services touch the financial services industry to come in for no-action relief is that it dissuades people from applying their ingenuity to serving the securities industry.

The road to no-action relief is long and costly.

If a firm does not fall within the scope of the securities laws, why should it subject itself to that process?

Because the Commission has determined to pursue an enforcement action in an area haphazardly marked out by a long line of individually-negotiated no-action letters, service providers are only going to become more hesitant to provide novel solutions to problems market participants face.

This action likely will lead would-be innovators to conclude that they cannot enter this space until they have hired counsel, spent months engaging with our staff, and signed on to a set of inflexible conditions on their activity.

Such barriers to entry are unnecessary in and unbecoming of the world’s strongest securities market.