On October 7, 2020, the Securities and Exchange Commission (the “Commission”) issued a proposed exemptive order granting a conditional exemption from broker registration requirements for “finders” who assist issuers with raising capital in private markets from accredited investors. If adopted, this exemption would provide a non-exclusive safe harbor from broker registration requirements, allowing natural persons1 to engage in activities, subject to specific limitations and conditions, involving accredited investors without registering as a broker under the Exchange Act of 1934, as amended (the “Exchange Act”). The proposed exemption is intended to clearly delineate between registered broker activity and limited activity by finders that would be exempt from registration. The proposed exemption will be open for public comment for thirty (30) days after publication in the Federal Register. The Commission’s release is available here.
Section 15(a) of the Exchange Act requires that any individual or entity acting as a broker or dealer register with the Commission as a broker-dealer, unless an exemption from registration is available. A “broker” is defined in the Exchange Act as a “person engaged in the business of effecting transactions in securities for the account of others.” The Commission has historically looked at a number of characteristics in determining whether a person qualifies as a “broker,” including whether the person participates in the securities business with some degree of regularity or receives transaction-based compensation.2
As the Commission acknowledged in its proposing release, many small businesses face challenges in raising capital they need to grow. Persons playing the role of intermediary between small businesses seeking capital and small business investors, or “finders,” can help issuers connect with potential investors and “may play an important role in facilitating capital formation for smaller issuers.”
Historically there has been significant uncertainty in the market as to how finders should be treated and what activities should require broker-dealer registration. According to the Commission’s past no-action letters and other guidance and case law, the Commission would consider certain factors in determining whether a finder violated the securities laws by failing to register as a broker-dealer, creating a so-called “finder exemption” for certain limited activities (for example, non-transaction based introductions without further involvement). However, the Commission guidance did not have the weight of Commission action and was limited in scope, which limited its usefulness and did not alleviate the uncertainty. In its release, the Commission highlights that this lack of certainty has created an environment in which some individuals engage in unregistered brokerage activity, while others opt-out of soliciting investors for small businesses to avoid potentially running afoul of broker-dealer registration requirements.
For years, various financial industry advisory groups have advocated for the Commission to provide more certainty for finders and others involved in private capital raising who are not registered as broker-dealers through a revised regulatory framework. In May 2017, the Commission’s Advisory Committee on Small and Emerging Companies issued a recommendation that the Commission address the application of the broker registration requirements for “finders” involved in small business capital formation transactions. Most recently, in May 2020, the Commission’s Small Business Capital Formation Advisory Committee noted the importance of “finders” in “fostering capital formation for smaller businesses” in calling for the Commission to adopt a clear framework for regulating “finders.”
The proposed exemptive order classifies “finders” into two tiers: Tier I Finders and Tier II Finders. Each of the tiers would be subject to conditions tailored to the scope of their respective activities. Notably, the exemption as proposed would allow both Tier I and Tier II Finders to accept transaction-based compensation, provided they comply with all applicable conditions.
General Conditions. The proposed exemption would only be available to Tier I and Tier II Finders if the following general conditions are met:
- Non-reporting (private) company: the issuer is not required to file reports under Section 13 or Section 15(d) of the Exchange Act;
- Primary exempt offering: the issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”);
- No general solicitation: the finder does not engage in general solicitation3;
- Accredited investors: each potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the finder has a reasonable belief that each potential investor is an “accredited investor”;
- Written agreement with issuer: the finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation;
- Natural person/not associated person of broker-dealer: the finder is not an associated person of a broker-dealer; and
- No statutory disqualification: 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.
Prohibited Activities. Tier I and Tier II Finders would also be prohibited from:
- being involved in structuring the transaction or negotiating the terms of the offering;
- handling customer funds or securities;
- binding the issuer or any investor;
- participating in the preparation of any sales materials;
- performing any independent analysis of the sale;
- engaging in any “due diligence” activities;
- assisting or providing financing for such purchases; and
- providing advice as to the valuation or financial advisability of the investment.
In addition to the above conditions that are applicable to both Tier I and Tier II Finders, there are specific conditions for each tier.
Tier I Finders
Limited to providing investor contact information to issuer in one transaction within a 12-month period. Tier I Finders would be limited to providing contact information (such as name, telephone number, e-mail address and social media information) of potential investors in connection with only a single capital raising transaction by a single issuer within a 12-month period. Further, a Tier I Finder would be prohibited from having any contact with a potential investor about the issuer.
Tier II Finders
A Tier II Finder can engage in the following additional activities:
- identifying, screening, and contacting potential investors;
- distributing issuer offering materials to investors;
- discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice as to the valuation or advisability of the investment; and
- arranging or participating in meetings with the issuer and investor.
In addition, a Tier II Finder may participate in more than one capital raising transaction within a 12-month period. In order to take advantage of the proposed exemption, a Tier II Finder would need to provide a potential investor, prior to or at the time of the solicitation, as part of the investor making an informed investment decision, disclosures that include:
- the name of the Tier II Finder;
- the name of the issuer;
- the description of the relationship between the Tier II finder and the issuer, including any affiliation;
- a statement that the Tier II Finder will be compensated for his or her solicitation activities by the issuer and a description of the terms of such compensation arrangement;
- any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and
- an affirmative statement that the Tier II 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.
Under the proposed exemption, the Tier II Finder can provide this required disclosure orally, so long as it is supplemented by written disclosure meeting the above disclosure requirements no later than the time of the investment. The Tier II Finder will be required to obtain from the potential investor, at or prior to the time of the investment, a dated written acknowledgment that the investor has received the required disclosures.
In support of the proposed exemption, the Commission stated that “if adopted, the proposed relief will bring clarity to finders’ regulatory status in a tailored manner that addresses the capital formation needs of certain small issuers while preserving investor protections.”
The Commission highlights in its proposing release that the exemptive order would not affect a finder’s obligation to comply with all applicable laws (including antifraud provisions of the Securities Act and the Exchange Act, such as those under Section 10(b) and Rule 10b-5 under the Exchange Act, and state law) and would not disturb the rights of the Commission or any other party to bring antifraud or regulatory enforcement actions for violations of other applicable laws. The Commission further notes that the proposed exemption from broker registration requirements would not impact a person’s duty to register under any other applicable regulations, such as the Investment Advisers Act of 1940.
Finders may not rely on the proposed conditional exemption until such time as it is included in a final operative exemptive order, if any, issued by the Commission.
1The Commission’s proposing release specifically requests public comment on the question of whether the exemption should be limited to natural persons.
2See BondGlobe, Inc., SEC No-Action Letter (February 6, 2001).
3The Commission has not explicitly defined the term “general solicitation.” However, it has listed examples of general solicitation and has provided guidance, including through no-action letters and Compliance and Disclosure Interpretations, to clarify what constitutes general solicitation. The determination of whether a communication with a potential investor constitutes general solicitation requires a facts and circumstances analysis.
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