• Unregistered Broker-Dealer has Engagement Letter Voided
  • June 14, 2008 | Authors: Daniel G. Berick; Robert B. Webb
  • Law Firms: Squire, Sanders & Dempsey L.L.P. - Cleveland Office ; Squire, Sanders & Dempsey L.L.P. - Tysons Corner Office
  • The Ruling

    On April 1, 2008, the Supreme Court of New York issued its opinion in Torsiello Capital Partners LLC v. Sunshine State Holding Corp., a case arising out of the non-payment of a commission to a financial advisory firm in connection with the sale of a business.

    In April 2002 Sunshine State retained First International Capital LLC, a predecessor firm of Torsiello Capital, to render financial advisory and investment banking services and to act as the sole agent for the private placement of Sunshine State's securities. The engagement agreement provided that Sunshine State would pay First International a US$50,000 retainer and a fee of 3.5 percent of the total purchase price paid on a sale of Sunshine State, with an 18-month "tail" provision. In January 2003, after months of fruitless marketing efforts, Sunshine State terminated First International's engagement and, in May 2004, the outstanding stock of Sunshine State was acquired by a third party. Upon learning of the sale, First International demanded payment of its 3.5 percent fee. Sunshine State rejected the payment demand, and this litigation was the result. Among Sunshine State's defenses was a claim that its engagement agreement with First International was unenforceable and void under Sections 15(a) and 29 of the Securities Exchange Act of 1934 because First International was not a registered securities broker.

    Section 15 of the Exchange Act prohibits a securities broker from using interstate commerce to effect a securities transaction, or to attempt to induce the purchase or sale of any securities, unless the broker is registered with the Securities and Exchange Commission. Section 29 of the Exchange Act provides that every contract entered into in violation of the Exchange Act, or the performance of which involves a violation of the Exchange Act, is void. Sunshine State asserted that, because First Interstate was not registered with the SEC as a "broker," it could not legally perform its obligations under the engagement agreement, and that the agreement therefore was void and unenforceable.

    The Supreme Court of New York reviewed the Exchange Act definition of "broker" and the case law and no-action guidance interpreting the broker registration requirement, and concluded that First International was retained to act, and did act, as a securities broker in connection with the marketing and proposed sale of Sunshine State's securities. As First Interstate was required under the engagement agreement to perform the types of services that would require SEC licensure as a broker, and in fact performed such services without being so licensed, the court held that the engagement letter was void and that Sunshine State was entitled to have the contract rescinded. The court further held that the contract was unenforceable under the common law doctrine of illegality, which holds that a party to an illegal agreement may not ask a court to enforce it. Based on these holdings, the court not only held that Sunshine State did not owe First International the 3.5 percent transaction fee, but also ordered First International to refund the US$50,000 retainer Sunshine State had paid upon execution of the engagement agreement.

    Useful Judicial Guidance and Evidence of Continued Scrutiny

    Sunshine State is a significant decision for investment bankers, financial advisors and business brokers. Unlike the November 2005 Meteor Motors decision in Florida (described in our December 2005 Securities Update), in which an investment banker's engagement letter was voided based on a relatively obscure state real estate broker licensure requirement, the Sunshine State decision illuminates the ill-defined and perennially troublesome boundary between "broker" and "finder" under federal law, and continues the recent trend of increased judicial and regulatory scrutiny of unregistered securities intermediaries whether labeled "finders," "business brokers," "financial advisors" or otherwise. This case underscores the increasing scrutiny on unregistered broker-dealers also evidenced by the SEC's recent release of a lengthy Q&A-style "Guide to Broker-Dealer Registration"