Matchmaker, Matchmaker, Make Me a Match, Find Me a Find, Catch me a Catch – The SEC Proposes Finders’ Exemption
The U.S. Securities and Exchange Commission (“SEC”) is seeking comment on a proposed order granting exemptive relief from securities broker registration under the Securities Exchange Act of 1934 (the “Exchange Act”) to natural persons engaged in limited capital raising activities (so-called “finders”). If adopted, the exemption would permit individuals not registered with the SEC to solicit investors on behalf of operating companies and private funds, subject to certain conditions.
Section 3(a)(4)(A) of the Exchange Act defines a “broker” as “any person engaged in the business of effecting transactions in securities for the account of others.” The Exchange Act does not define what constitutes being “engaged in business” or “effecting transactions,” but the SEC has interpreted these phrases broadly to include:
- actively soliciting or recruiting investors;
- participating in negotiations between the issuer and the investor;
- advising investors as to the merits of an investment or opining on its merits;
- handling customer funds and securities;
- having a history of selling securities of other issuers; and
- receiving commissions, transaction-based compensation or payment other than a salary for selling the investments.
Against this broad backdrop, any persons assisting in even a limited way with capital raises via the issuance of securities might be considered a broker potentially subject to registration with, and extensive regulation by, the SEC. Recognizing that the prior interpretations may be over-inclusive and stifling capital raising activities, the SEC has proposed an order exempting certain individuals that are not otherwise affiliated with a registered broker-dealer—so-called, “finders,” which is not a statutorily defined term—from broker registration under the Exchange Act. As SEC guidance does not pre-empt any state-level broker licensing requirements, brokers will also need to be comply with state broker regulation.
The Proposed Order is not yet effective, and there is some uncertainty as both Democratic commissioners opposed the proposal on investor protection grounds, and their opposition to any subsequent adopting action may be strengthened if the political make-up of the five-member commission changes in the coming months.
The Proposed Order
The exemptions under the Proposed Order would only be available to natural persons and not entities. The Proposed Order would create two tiers of exemptions (as described below), with both being available only if:
- The issuer of securities for which investors are being found would not be required to file reports under Section 13 or Section 15(d) of the Exchange Act and is not relying on an exemption from registration under the Exchange Act;
- The finder does not engage in general solicitation, is not an associated person of a broker-dealer, and is not subject to statutory disqualification;
- Any “found” prospective investor is an “accredited investor” as defined by Rule 501 of the SEC’s Regulation D; and
- The services provided by the finder to the issuer are subject to a written agreement.
Tier I Finders
A Tier I finder is one who satisfies the above-listed conditions and simply provides contact information of potential investors in connection with a single capital raising transaction by a single issuer within a 12-month period. The Tier I finder may not have contact with potential investors regarding issuers. Contact information that may be provided include names, phone numbers, addresses, and social medial information. A Tier I finder may receive compensation for their services.
Tier II Finders
A Tier II finder must satisfy the above-listed predicate conditions and may directly solicit investors on behalf of multiple issuers within a given 12-month period, but the solicitation-related activities would be limited to:
- Identifying and contacting potential investors;
- Distributing and discussing the issuer’s materials to the potential investors provided that the Tier II finder does not provide advice as to the valuation or advisability of the investment; and
- Arranging for meetings between investors and the issuer(s).
Tier II finders would need to disclose to each potential investor (a) the name of the finder, (b) the name of the issuer, (c) a description of the relationship between the issuer and finder (and any material conflicts arising from this relationship), (d) a statement of an intention to seek compensation from the issuer, and (e) a dated written acknowledgment of receipt of these required disclosures.
A Tier II finder may not be involved in structuring a transaction or negotiating the terms of an offering, handling customer funds or securities, or binding the issuer or investor. The Tier II finder also may not (a) participate in the preparation of any sales materials, (b) perform any independent analysis of the sale, or (c) engage in any “due diligence” activities.
Availability for Private Funds
The Proposed Order did not include any further limitations regarding the type of issuer that may engage the services of finders or the size of the offering. Accordingly, if adopted, many privately offered collective investment vehicles (“private funds”) would be able to engage the services of unregistered individual placement agents and pay them transaction-based compensation for soliciting investors.
What Comes Next?
Unlike previous class-wide “broker” exemptions adopted by the SEC — such as Exchange Act Rule 3a4-1 for associated persons of an issuer and Exchange Rule 15a-6 for foreign brokers — the finder provisions have been proposed as an exemptive order thereby avoiding cost/benefit analysis and other administrative requirements for formal rulemaking. Without such hindrances, the SEC should have greater flexibility in acting to eventually adopt the order even before a change of administration and corresponding shakeup in the political make-up of the five-member commission.
Perhaps to blunt the criticisms of partisan action, the SEC has sought comment on the proposal. A comprehensive list of all questions raised by the SEC with respect to the Proposed Order may be found here. Comments may be submitted until November 13, 2020.