Legal Issues Can Arise When a Start-up Uses Own Employees or Third-Party Finders To Aid in Startup Funding
Legal issues can arise when a start-up company or private investment fund uses its own employees or other third party “finders” to identify and solicit investors to provide capital via a private securities offering. In many cases, these individuals perform activities that require registration with the Financial Industry Regulatory Authority (FINRA) and the Securities & Exchange Commission (SEC).
Using an unregistered person or entity to find funding creates risk for issuers in securities offerings, including aiding and abetting liability for violating federal or state securities laws. Investors can seek the return of their invested funds via claims for rescission.
Who is required to register as a broker-dealer?
The Exchange Act prohibits a person from engaging in the business of effecting transactions in securities without a license. As set forth in SEC guidance, registration as a broker-dealer is generally required if a person (1) actively solicited investors, (2) advised investors as to the merits of an investment, (3) regularly participated in securities transactions, and (4) received commissions or transaction-based remuneration. If the SEC finds that an individual satisfies any of the above factors, registration may be required. Accordingly, true “finders” should not do more than make introductions in exchange for a fee. For issuers, that means contracts should be structured so that the finder gets paid regardless of whether or not any securities are sold.
Are there any exemptions to registration as a broker-dealer?
Of course, as with many securities laws, there are a number of exemptions. Most notably, the JOBS Act contains an exception from broker registration for a distinct class of intermediaries assisting in securities offerings who are exempt under Rule 506 of Regulation D. This narrow exemption applies to online intermediaries used in connection with Rule 506 offerings. To qualify for the exemption, the “finder” must (1) maintain a platform or mechanism that permits the offer, sale, purchase, negotiation, general solicitations, general advertisements, or similar activities by issuers, whether online, in person, or through other means, (2) co-invest in the offering, and (3) provide ancillary services with respect to the offering.
This exemption further requires that the online platform (1) may not receive any compensation in connection the purchase or sale of the security; and (2) may not have possession of customer funds or securities in connection with the purchase or sale of the security, and (3) may not receive separate compensation in connection with providing investment advice to the issuers or to investors.
What penalties do issuers face in using unregistered brokers to raise capital?
While there are legal pitfalls for securities issuers who utilize unregistered “finders” to solicit investors, that practice continues, with issuers, “finders” and brokers seeking to act, knowing or unknowing, under the radar. However, should an unhappy investor seek resolution, by lawsuit or complaint to a regulatory body (SEC, FINRA, State Blue Sky regulator), the radar can be aroused and the regulators may take a look, whether or not rescission is granted by the issuer in a settlement, or ordered by a court.
Issuers and unregistered finders are not the only ones subject to legal pitfalls here. The SEC is increasingly aggressive in bringing enforcement actions and imposing sanctions on private equity firms, fund managers and brokerage firms who aid or abet finders’ violations of broker-dealer registration requirements. The SEC also looks at unregistered broker-dealer issues in its compliance exams of private investment funds. While there is SEC guidance available from no-action letters, rules and interpretations for brokers, investment platforms and crowdfunding, there is not sufficient public awareness of issues involving unregistered finders. Further regulatory actions and pronouncements can be anticipated.
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Dan Brecher, at 201-806-3364.
“No Comment” Culture: Why Silence Is Often the Riskiest Legal Strategy
A “no comment” response is sometimes the right call when a legal problem arises. As a blanket policy, however, it lets allegations go unanswered, deadlines pass, evidence disappear, and manageable disputes grow into expensive litigation. The businesses that fare best are usually the ones that say little publicly while acting decisively behind the scenes. When […]
Utility-Scale Battery Storage Projects: A Legal Roadmap for Developers, Property Owners and Other Stakeholders
Utility-scale battery energy storage systems (BESS) are becoming an increasingly important component of the electric grid throughout New Jersey, New York, and Pennsylvania. As renewable generation expands, electricity demand increases and grid operators seek greater flexibility, battery storage can help balance supply and demand while providing additional capacity and reliability. For developers, battery storage presents […]
Navigating Disputes: Hire a Partnership Dispute Lawyer
A falling out between partners can be disastrous for any business. In many cases, the partnership will not survive. If you are in an unworkable situation with your partners, it may be time to consult a partnership dispute lawyer experienced in handling partnership breakups and dissolutions before the situation deteriorates any further. It is easy […]
Section 363 Sales in Bankruptcy: What Businesses, Lenders, and Buyers Need to Know
When a company enters Chapter 11 bankruptcy, many assume the process will culminate in a lengthy reorganization plan. However, distressed businesses are increasingly being sold through a different mechanism — a sale under Section 363 of the United States Bankruptcy Code. A Section 363 sale allows a company, as a debtor-in-possession in bankruptcy, to sell […]
Zoning Laws Explained: What You Need to Know Before Buying Property
Before buying property, it is critical to determine whether local zoning laws may affect your plans. If you plan to redevelop the property, you will want to confirm that local zoning regulations permit development as intended. If acquiring property that is already developed, you must verify that the use is permitted in the underlying zoning […]
Special Needs Trusts in New Jersey: Planning for Your Loved One’s Future
For parents of a child with a disability, estate planning raises concerns that go well beyond deciding who will inherit their assets. Parents may spend years making sure their child has the right care, services, and support. Eventually, they must also confront a difficult question: Who will take over when they can no longer do […]
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Sign up to get the latest from our attorneys!
Explore What Matters Most to You.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!
