The US Securities and Exchange Commission (SEC) recently announced its latest enforcement action against a non-US bank that was providing advisory and brokerage services to US residents—In the Matter of Banco Espirito Santo S.A., Sec Rel 9270 (Oct. 24, 2011)(BES Order). The consequences of noncompliance are very costly in terms of fines for the firm and potentially for the officers, payments to the US investors, criminal penalties for the firm and officers, reputation and business disruption.  Financial service law reform in the US through the Dodd-Frank Wall Street Reform and Consumer Protection Act has focused on the need for increased regulation of investment advisers, including non-US advisers with more than a very limited US business.   Non-US banks do not have an exemption from compliance with US securities laws when providing services to US investors because they may be licensed and regulated in their home country or other non-US countries.

The Latest Development: The BES Order

From 2004 to 2010, Banco Espirito, S.A. (BES), a bank based in Portugal that is a subsidiary of a Luxembourg based financial services firm, offered investment advisory and broker-dealer services to clients based outside of Portugal, including US residents (US Clients).  BES offered securities to the US Clients that included initial securities offerings of BES affiliates, non-US mutual funds and others, as well as other non-US securities. 

Key Facts:

  • Providing Services from Non-US Office:
    • The BES International Private Banking Division, based in Portugal, provided these services to clients located outside of Portugal, including the US Clients, using telephone, fax and email to the US to the US Clients.
  • US Visits:
    • BES relationship managers visited the US twice a year to visit some of the US Clients.
  • Profile of Non-US Clients:
    • There were approximately 3,800 US Clients during this period. They were mostly individuals who had immigrated to the US from Portugal.
  • Mailing of Marketing Materials to the US:
    • BES mailed marketing materials to the US Clients, including research used for all non-US clients.
  • Non-US Call Center:
    • BES handled contact wit the US Clients through a call center located outside of the US.
    • At one point, individuals were added to the call center to focus on the US Clients.
  • Extending Securities Offerings to US Investors without SEC Registration or Exemption:
    • The BES and affiliate securities offerings allowed the purchase of securities by US investors without either registering the offerings with the SEC or meeting the terms for an exemption from registration.  
  • Failure to Organize Activities of Unlicensed Subsidiaries through US Registered Affiliates:
    • BES had a US affiliate that was registered as a broker-dealer in the US with the SEC, but excluded it from its activities.  This failure of coordination within a non-US firm to utilize its US broker and adviser license for activities of affiliates is a common source of considerable liability. 
    • BES did involve another US affiliate, a money transmitter, in its activities, using it as a point of contact in the US with the US Clients.  This affiliate was not registered with the SEC and did not have any exemption from registration for these security activities.
    • Unauthorized activities in the US or involving US investors also creates potential difficulties for US affiliates of the firm, which can range from disclosure to their customers of the SEC action against their affiliate to direct liability for involvement in the affiliate's activities.
    • Coordination will often allow the proposed new activity without the need to obtain additional licenses based on special guidance provided by the SEC for the non-US firm.

Consequences

The BES Order illustrates the potential high financial cost of non-compliance for the non-US firm.  Payments to the US Clients included interest on securities purchased plus the amount of any realized or unrealized losses to US Clients and payment to the SEC of triple the amount of commissions and fees from US Clients, plus interest and disgorgement of the fees and commissions.  In addition, in these cases there is considerable additional expense involved in handling the US Client communications and payout process required by the SEC, related legal fees and reputation fallout for the firm.  

Action Plan Now for the Non-US Bank

To address the substantial compliance risk raised by these developments, a non-US bank should carefully review its policy concerning US investors.  Key questions to consider:

  • If you have a policy that blocks these services for US investors, is it accurately identifying who is a US investor, individual or entity (as defined by the SEC)? Have exceptions been created to this policy?
  • If you have a policy of providing securities services to US investors, what type of services do you provide?  Investment advisor? Asset manager?  Broker? Dealer?  Most likely it is a combination of all of these services following the typical non-US model.  It is realistic to assume that the services are being provided through as variety of channels each creating additional US contacts.
  • If you offer investment funds to your clients, are they eligible for US investors? If you handle securities offerings of your own or third party securities, are the offerings eligible for US investors?  If not, how are they being identified and blocked?

If your business plan includes US investors, there are a number of structures and special SEC guidance for non-US firms to consider that avoid the costly compliance issues illustrated in the BES Order

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.