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SEC Proposes Exemptive Relief for Finders to Receive Transaction-Based Compensation Without Having to Register as a Broker-Dealer

On October 7, 2020, the U.S. Securities and Exchange Commission (the “SEC”) voted to propose a conditional exemption from broker registration requirements for “finders” who assist issuers with raising capital in private markets from accredited investors. If enacted, the exemption would permit individuals to engage in certain limited capital-raising activities for privately held companies and receive transaction-based compensation. The SEC has invited comments on its proposal by November 12, 2020.

Current Law
Section 15(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) requires a “broker” to be registered with the SEC and thereby comply with a labyrinth of rules and regulations. A broker is defined as “any person engaged in the business of effecting transactions in securities for the account of others.” The SEC has long cited the receipt of a transaction-based compensation (such as ‘fees’ typically paid to a finder) as a strong indicator that the recipient should be registered as a broker-dealer. Therefore, as a practical matter, a person receiving transaction-based compensation will almost always be found to have engaged in the business of “effecting transactions for … others” and thereby be unable to receive transaction-based compensation unless registered with the SEC as a broker and thus subject to strict and costly oversight.

Over the years, the SEC Staff provided some latitude for finders to operate through no-action letters. These no-action letters generally took the position that a person who did not act as finder on a regular basis and who limited his or her activity to making introductions and refrained from further involvement in the transaction could receive a finder’s fee without having to register as a broker-dealer.1 More recently, however, the availability of this no-action relief has become less and less clear, as the SEC Staff has indicated they have changed their position from prior no-action letters and narrowed the scope of permissible activities by finders. For example, in Brumberg, Mackey & Wall, P.L.C. (available May 17, 2010), the Staff declined to take a no‑action position because a finder’s commitment to refer persons “who may have an interest” in the financing implied impermissible “pre-screening” and “pre-selling.”

Proposed Non-Exclusive Safe Harbor
The SEC’s exemptive relief proposes to create two classes of finders and establish clear lanes for both registered broker activity and limited activity by finders that would be exempt from registration. The proposal would operate as a non‑exclusive safe harbor for finders. Finders that meet the terms of the exemptive order would be exempt from broker-dealer registration. Failure to meet the terms would not be dispositive, but would pose a challenge for finders who would need to prove that they are not required to register as broker-dealers.

  • Tier I Finders:
  • Tier I Finders would be limited to providing names and contact information (address, phone number, email and social media identifiers) of potential investors in connection with only a single capital raising transaction by a single issuer in a twelve (12) month period. A Tier I Finder could not have any contact with a potential investor about the issuer or the contemplated capital raise.

    Tier I Finders fit comfortably within the parameters of permissible finders delineated in SEC Staff no-action letters and are unlikely to be a source of controversy.

  • Tier II Finders:
  • Tier II Finders could engage in limited solicitation activities that exceed those historically permitted for finders, but the solicitation-related activities would be limited to:

    • identifying, screening, and contacting potential investors
    • distributing issuer offering materials to investors
    • discussing issuer information included in any offering materials
    • arranging or participating in meetings with the issuer and investor

    Tier II Finders would not be permitted to:

    • provide any investment advice or make any investment recommendation regarding the offering
    • prepare offering or sales materials
    • provide an independent analysis of the proposed transaction
    • participate in structuring or negotiating the terms of the financing
    • participate in due diligence of the issuer on behalf of investors
    • provide financing for investors or
    • handle investor funds or securities

    In addition, Tier II Finders would be required to disclose to prospective investors their role and compensation terms, any material conflicts of interest, and a disclosure that they are acting as an agent of the issuer and are not undertaking to act in the investor’s best interest. The required disclosures must be made at or prior to the time of solicitation and could be made orally if they are followed up with a written set of disclosures prior to the introduced party making the investment. The Tier II Finder must also obtain from the prospective investor prior to their completion of the investment a written acknowledgement that the investor received the Tier II Finder’s disclosures. Disclosures and acknowledgements may be furnished via email.

  • Conditions for Both Tier I and Tier II Finders:
  • The proposed exemption for both Tier I and Tier II Finders would be available only where:

    • the issuer is a private company, i.e., the issuer is not required to file reports under the Exchange Act
    • the issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act of 1933
    • the Finder is a natural person
    • the Finder does not engage in general solicitation
    • the potential investor is an “accredited investor” as defined in Rule 501 of Regulation D under the Act or the Finder has a reasonable belief that the potential investor is an “accredited investor”
    • the Finder must provide services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation
    • 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 his or her participation.

Pointers for Practitioners

  • Because the proposal is an exemptive order and not rulemaking, the order may proceed relatively quickly after the SEC receives and considers the public comments.
  • The proposed category of Tier II Finders would enable finders to function more effectively in their efforts to assist private issuers in fund raising. Given the split on the SEC (two of the five members of the SEC expressed objections and/or reservations about the proposal) and the timing (if the composition of the SEC changes next year), however, it is likely to attract concern from members of the financial community and may be modified before it is adopted (if not completely revoked), particularly with respect to the possibility that an unregulated finder may engage in inappropriate sales practices when discussing an investment opportunity with a prospective investor.
  • It is important to bear in mind that, if adopted, the exemptive relief will only apply to broker-dealer registration requirements at the federal level, and finders should evaluate what, if any, requirements may apply under applicable state law.

To read the full proposal, click here. For any questions related to the above or any other regulatory concerns, please contact Mitchell Littman, Esq. or any member of our Corporate and Securities Team.

This memorandum is for informational purposes only and not for the purpose of providing legal advice. Further, the above memorandum is not intended to be a substitute for consultation with counsel. The opinions expressed in this memorandum are the opinions of the individual author and may not reflect the opinions of Littman Krooks LLP or any other attorneys at Littman Krooks LLP. Please contact the professional listed above, or your regular Littman Krooks LLP contact.

1 See Paul Anka, SEC No-Action Letter (available July 24, 1991)