SEC Proposes New Rules that would Exempt Certain “Finders” from Registration as Brokers

Seyfarth Synopsis: The Securities and Exchange Commission currently takes the view that "finders" who introduce potential investors to a company must register as brokers if they receive compensation based on the amount of securities sold by the company to the investors. However, in a move that reverses course on restrictive SEC guidance issued since 2010, the SEC has recently proposed an exemption, which if ultimately adopted, would exempt finders satisfying easily-attainable conditions from registration as brokers.

On October 7, the Securities and Exchange Commission (“SEC”) released a notice of proposed exemptive order to exempt “finders” meeting certain criteria from registration as brokers under the Securities Exchange Act of 1934 (the “Exchange Act”). The proposed order includes as a stated purpose enhancing capital formation resources for smaller companies and private funds which lack the ability and size to readily attract cost-effective placement services from registered broker-dealers, without at the same time creating undue risk for investors. The proposed exemptions would apply to two classes of finders defined in the proposed exemptive order, Tier I Finders and Tier II Finders.

Past SEC guidance regarding exemption from broker-dealer registration for “finders”—persons who introduce potential investors to issuers and engage in other limited activities for a fee—has come in the form of no-action letters. The first notable no action letter on the topic was the 1991 Paul Anka no-action letter[1] in which the SEC indicated that it would take no action if a person who merely provided a list of investor names and contact information to an issuer in exchange for a fee but was not otherwise involved in the offering did not register as a broker. Subsequent no action letters expanded the range of activities in which finders could be involved without being required to register even though they received a fee based on a percentage of securities sold. In the 2010 Brumberg no-action letter[2] the SEC significantly revised and narrowed its position and took the view that the sole factor determining whether a finder would be required to register as a broker is whether the finder was receiving compensation based on a percentage of securities sold. In subsequent court cases, some courts have declined to adopt the SEC’s view in Brumberg, opting instead for a multi-factor test in which the nature of the compensation was one factor to be taken into account along with the activities of the finder rather than being the dispositive factor.[3] The lack of definitive guidance or a clear regulatory “safe-harbor” has often left enterprises seeking capital, particularly smaller companies or private funds without access to larger capital market intermediaries, relying on “finders” whose lack of either broker-dealer registration or a clear exemptive basis from such registration can create substantial compliance and legal liability risks for both issuers and the finder. Lack of broker-dealer registration where required can expose the issuer, among other matters, to rescission claims from investors under both federal and applicable state securities law.

The SEC’s proposal would allow finders to receive transaction-based compensation without registration as a broker under certain conditions. The following conditions would apply to securities transactions involving both Tier I and Tier II Finders:

• The issuer in the transaction is not required to file reports under Section 13 or Section 15(d) of the Exchange Act;
• The offering is conducted under an exemption from registration under the Securities Act of 1933;
• The finder is not engaged in general solicitation;
• All of the investors referred by the finder either are “accredited investors” or are reasonably believed by the finder to be accredited investors;
• The finder provides services under a written agreement describing both the services to be provided by the finder and the compensation to be paid for such services;
• The finder is not an associated person of a broker-dealer; and
• The finder is not subject to statutory disqualification, as that term is defined in Section 3(a)(39) of the Exchange Act, at the time of the finder’s participation. This would include, among other things, being expelled or suspended from membership in an SRO or denying, suspending for a period not exceeding 12 months, or revoking a finder’s registration in various securities capacities or being associated with various regulated entities.

Tier I Finders would be subject to the following additional restrictions:

• The finder only provides contact information about potential investors (including names, telephone numbers, e-mail addresses and social media information) to an issuer and does not have any further contact with the investors; and
• The finder provides such information in connection with only one capital raising transaction by a single issuer within a 12-month period.

The foregoing restrictions are likely to be unduly limiting for most finders and for issuers seeking their services; hence Tier II Finders are likely to be the most practicable category for both finders and companies.

Tier II Finders would be subject to the following additional restrictions:

• The finder may engage in the following additional activities:
  • Identifying, screening, and contacting potential investors;
  • Distributing offering materials prepared by the issuer to investors;
  • Discussing the information contained in the offering materials but not advising as to the valuation of the offering or the advisability of investing in the offering; and
  • Arranging and participating in meetings with investors and issuers.
• The finder must make certain disclosures to the investor at or prior to the time of solicitation, which disclosures may initially be made orally provided that written disclosure follow no later than at the time of investment. The information to be disclosed includes:
  • The names of the finder and issuer;
  • The nature of the relationship, if any between the finder and the issuer;
  • A statement that the finder is being compensated for its services and a description of the compensation;
  • Any material conflicts of interest arising from the relationship between the issuer and the finder; and
  • An affirmative statement that the finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest.
• The finder must receive written acknowledgement from the investor of receipt of the disclosure no later than at the time of investment.

A useful comparison of current broker-dealer, and proposed Tier I and Tier II Finder requirements can be found at: https://www.sec.gov/files/overview-chart-of-finders.pdf. 

The prohibition on advising as to valuation or advisability of investing of course creates potential concerns for an issuer paying and a finder receiving transaction-based compensation. The proposal specifies that finder participation in structuring or negotiating terms of a transaction, due diligence activities or preparing offering materials would also be precluded.

The proposal is structured as a non-exclusive “safe-harbor” from broker-dealer registration if the conditions are met, such that failure to meet one or more conditions would not necessarily mean that broker-dealer registration was required.

The SEC noted that finders qualifying for the finder exemption still would be required to comply with all other securities laws, including anti-fraud provisions.[4] The SEC added that the exemption would not preclude finders from being to require to register in another capacity, such as an investment adviser, to the extent warranted by the facts.[5]

The SEC is currently soliciting comments on the proposed exemption. It should be noted that the proposal in its current form garnered support from only three of five SEC Commissioners, and has been criticized for not subjecting finders to any level of ongoing broker-dealer-type of regulation. If the proposal is ultimately adopted in something similar to its current form it will provide some much-needed certainty to smaller issuers who wish to engage finders and to persons seeking to provide services as finders. The proposed requirements for the exemptions are reasonably consistent with practice prior to the Brumberg letter, do not create undue burdens either for issuers or finders, and provide a relatively bright-line test that, if adopted as proposed should reduce the uncertainty and sometimes confusion faced by smaller seekers of capital and their legal and financial advisors when evaluating the permissible use of unregistered “finders.”

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[1] Paul Anka, SEC Staff No-Action Letter (July 24, 1991)

[2] Brumberg, Mackey & Wall, PLC Staff No-Action Letter (May 17, 2010)

[3] See, e.g., SEC v. Kramer, 778 F.Supp.2d 1320 (M.D. Fla. 2011)

[4] The SEC did not address the nature of the legal source of a finder’s potential liability under the anti-fraud provisions.

[5] It is noteworthy that the proposed exemption does not indicate that SEC Form D would be revised to require disclosure of use of Tier I or Tier II finders, but such a future such revision, as an information-gathering and compliance measure, would not be unexpected. Among the questions on which comment was solicited is whether a finder filing requirement should be imposed.