In order to assist its shareholders with obtaining liquidity, many community bank organizations engage in what are often referred to as “desktop transactions.” These transactions typically involve bank personnel maintaining a list of shareholders who have expressed a desire to sell their bank or bank holding company stock. When the bank later becomes aware of potential third-party buyers, the bank then introduces such potential buyers to the selling shareholders on the list. Although a long-standing practice, these transactions pose real risks for the bank and its personnel under securities laws.
Federal and state securities laws require that broker-dealers be registered or licensed with the Securities and Exchange Commission and/or FINRA. A “broker” is generally one that participates in effecting securities transactions for the account of others; a “dealer” is one who buys and sells securities for its own account as part of its regular business. An issuer of securities (i.e., a company with respect to its own stock) is not considered a broker when selling its stock for its own account, as it would in a capital raising transaction. Also, an issuer is generally not a dealer if it does not buy or sell its own stock for its account as part of its regular business. This so-called “issuer’s exemption” generally extends to the issuer’s personnel, who are permitted to assist the issuer from time to time in selling its securities, provided certain other conditions are met. However, according to the SEC, issuers whose activities go beyond selling their own securities may need to register as broker-dealers if they effectively operate markets in their own securities.
The practice by many community bank organizations of engaging in desktop transactions may mean such organizations are participating in securities transactions for the account of others or in facilitating a market in its stock. In other words, such organizations may be deemed to be unregistered broker-dealers in violation of federal and state securities laws. The consequences to the bank organization and its personnel if found to be an unregistered broker-dealer can be significant and may include:
- enforcement actions and monetary penalties imposed by securities regulators against the bank organization and its personnel;
- lawsuits by a buyer of bank or holding company stock against both the seller and the bank organization seeking return of the purchase price;
- securities fraud claims against the bank organization if incomplete or misleading information was provided to the buyer; and
- significant reputational damage to the bank and its personnel.
To the extent bank organization officers or directors participate as buyers or sellers in desktop transactions, they may be exposing themselves to additional claims for breach of fiduciary duties relating to conflicts of interest or self-dealing.
Issuers seeking to provide shareholders with liquidity opportunities should limit their involvement in assisting third-party resales as much as possible. Bank organizations may consider establishing an online message board or similar platform where shareholders can offer their shares on their own, without bank involvement. Bank organizations may also consider engaging third-party online platforms that will maintain this service in a secure and compliant manner. While it can be difficult to balance against the desire to assist shareholders, limiting the bank organization’s involvement in facilitating desktop transactions can significantly reduce legal risks that may result from violating federal and state securities laws.
Due to the risks involved in becoming entangled in desktop transactions, bank organizations may want to take a different approach in satisfying their shareholders’ need for liquidity. One such tool is a stock buy-back program. Under a buy-back program, which must be established by the board of directors, the bank organization would periodically offer to purchase directly from its shareholders a specified number of its outstanding shares at a stated price. Buy-back programs are subject to applicable regulatory approvals and will often constitute issuer “tender offers” which are subject to regulation under federal securities laws. The tender offer rules for privately-held issuers are generally manageable, requiring among other things that the offer be open for 20 business days and that the issuer provide disclosure of material information concerning the offer and the organization. Although this additional regulation does not come without some expense to the issuer, it can be an effective tool to provide at least some liquidity for shareholders without the legal risks associated with desktop transactions. In addition, a buy-back program also has benefits to the bank organization by reducing dilution and by allowing the organization to control who its shareholders will be.