SEC Proposes Broker Registration Exemption for Finders
Miller & Martin PLLC Alerts | October 12, 2020
Author: Scott McGinness
On October 7, 2020, the Securities and Exchange Commission (“SEC”) announced that it would propose a limited, conditional exemption from broker registration for “finders” who assist non-publicly traded issuers of securities with capital raising activities in private markets from accredited investors.
For decades, finders, not registered as, or affiliated with, registered broker-dealers have assisted issuers in capital raising efforts, being compensated based on their capital raising success. The SEC has taken an increasingly restrictive view with regard to the activities of such unregistered finders, generally taking the position that such finders must be registered or affiliated with registered broker-dealers. The consequences for issuers dealing with unregistered finders can be severe, i.e., loss of their private placement exemption (generally pursuant to Regulation D), potentially triggering rescission rights for investors and aiding and abetting liability for the issuer with respect to the unregistered finder’s violation of the relevant registration provisions of the securities laws.
The SEC has, to some extent, reversed course with the proposed safe harbor exemption (the “Proposed Exemption”) which would create two classes of finders:
- Tier 1 finders would be limited to providing contact information of potential investors in connection with a single capital raising transaction by a single issuer within a twelve-month period and could not have direct contact with any potential investor.
- Tier 2 finders could directly solicit investors on behalf of an issuer but the finder’s solicitation activities would be limited to (1) identifying, screening and contacting investors, (2) distributing offering materials, (3) discussing information concerning the issuer included in the offering materials (but not providing advice as to valuation or advisability of the investment), and (4) arranging or participating in meetings with the issuer and prospective investors.
The safe harbor for both Tier 1 and Tier 2 finders is subject to the following additional conditions:
- The issuer is not required to file reports under Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”);
- The issuer is making a private offering in reliance upon applicable exemptions from registration;
- The finder does not engage in a general solicitation;
- The potential investor is an “accredited investor”;
- The finder’s services are governed by a written agreement with the issuer describing the services to be provided and the finder’s compensation;
- The finder is an individual and not an associated person of a broker-dealer;
- The finder is not subject to statutory disqualification under Section 3(a) (39) of the Exchange Act.
Additionally, finders cannot (1) be involved in the structuring, or negotiating the terms of the offering, (2) handle investor funds or securities or bind the investor or the issuer, (3) participate in the preparation of sales or offering materials, (4) perform independent analysis of the offering, (5) engage in due diligence activities, or (6) assist or provide financing for purchases of securities.
Finally, Tier 2 finders must provide prospective investors with disclosures with respect to the finder’s role and compensation, which the investor must acknowledge in writing prior to making the investment.
The Proposed Exemption will be published in the Federal Register after which there will be a thirty-day comment period.
If adopted in substantially the form of the Proposed Exemption, the SEC could clarify the manner in which finders can assist in the capital raising efforts of privately held companies. However, issuers must await adoption of the final exemptive order in order to deal with finders with any degree of certainty. Additionally, issuers must still be cognizant of state laws governing the role of finders.