The Securities and Exchange Commission (SEC), on October 7, 2020, proposed an exemption to the broker-dealer registration requirements of Section 15(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that is intended to assist small businesses and private funds, including private equity, venture capital and hedge funds, in raising investment capital. If adopted, the exemption would allow unregistered “finders” to provide, and be compensated for providing, limited assistance to issuers seeking to raise capital from accredited investors in non-public offerings.
Finders have long been at risk of running afoul of Exchange Act requirements. Under the Exchange Act, persons who are “engaged in the business of effecting transactions in securities for the account of others” are generally deemed to be brokers, and broker-dealers are generally required to register with the SEC. The SEC considers the solicitation of investors to be activity that is effecting transactions in securities. Further, the SEC considers the receipt of transaction-based compensation to be indicative of the need to register as a broker-dealer.
While the SEC staff historically provided some limited relief to unregistered finders through no-action letters, more recently the scope
of permissible activities has been narrowed, and the availability of no-action relief has become less clear. The proposed exemption would both clarify and expand the scope of permitted activity by finders.
The proposal would establish two categories of individuals whom it calls “Tier I Finders” and “Tier II Finders.” Finders who meet the conditions of the proposal would be exempt from registration as broker-dealers under the Exchange Act and could receive transaction-based compensation.
Both Tier I and Tier II Finders must satisfy certain minimum conditions in order to qualify for the proposed exemption. As currently proposed, the exemption would be available only where:
- The finder is a natural person;
- The issuer is not required to file Exchange Act reports;
- The offering is exempt from the registration requirements of the Securities Act;
- The finder does not engage in a general solicitation of investors;
- A potential investor is an “accredited investor” as defined in Securities Act Regulation D, Rule 501, or the finder reasonably believes that the potential investor is an accredited investor;
- The finder has a written agreement with the issuer that includes a description of the services to be provided and the finder’s compensation;
- The finder is not associated with a broker-dealer; and
- The finder is not subject to statutory disqualification, as defined in Section 3(a)(39) of the Exchange Act, at the time of the finder’s participation.
The proposed exemption would not be available to facilitate a registered offering, resale of securities, or sale of securities to unaccredited investors. Further, a finder is not permitted to:
- Be involved in structuring the transaction or negotiating the terms of the offering;
- Handle customer funds or securities or bind the issuer or investor;
- Participate in the preparation of any sales materials;
- Perform any independent analysis of the sale;
- Engage in any “due diligence” activities;
- Assist or provide financing for such purchases; or
- Provide advice as to the valuation or financial advisability of the investment.
Tier I Finders
Tier I Finders must meet the above conditions and limit their activity to furnishing the issuer with the names and contact information of potential investors. Tier I Finders may not contact the potential investor regarding the issuer, the offering or to arrange an introduction. In addition, a Tier I Finder may assist an issuer with only one capital raising transaction in any 12-month period.
Tier II Finders
Tier II Finders that meet the minimum conditions described above and the additional conditions discussed below would be permitted to:
- Identify, screen and contact potential investors;
- Distribute issuer offering materials to potential investors;
- Discuss issuer information included in any offering materials; and
- Arrange or participate in meetings with the issuer and potential investor.
In addition to the conditions described above, Tier II Finders would be required to disclose to potential investors the finder’s role and compensation terms, any material conflicts of interest, and a disclosure that the finder is acting as an agent of the issuer and is not undertaking to act in the investor’s best interest. The required disclosures must be made at or prior to the time of solicitation. The Tier II Finder must also obtain from the prospective investor prior to their completion of the investment a dated written acknowledgement that the investor received the Tier II Finder’s disclosures.
Even if the exemption is adopted, finders will remain obligated to comply with all other applicable laws, including the antifraud provisions of the Securities Act and the Exchange Act, and state law. The proposed order does not address separate broker-dealer requirements that could arise under applicable states’ securities laws. Further, a finder may need to consider whether it is acting as another regulated person such as an investment adviser or a municipal adviser, as the proposal does not exempt a person from the registration requirements of the Advisers Act if such person is acting as an investment adviser (or as an investment adviser
representative in certain states where solicitation activities require registration as such).
A 30-day period for interested parties to comment on the proposal will conclude on November 12, 2020. In addition to requesting general comments on the proposed exemption, the SEC has posed 45 specific questions relating to the proposal for which responses are requested. The proposed order may be found here.
Adoption of the proposal is uncertain, and it may change based on comments. The outcome of the November 2020 election also may impact the proposal, as it was passed by a 3-to-2 vote of the current SEC commissioners. A new administration could result in changes at the SEC, which may in turn influence adoption of the proposed exemption.