The Securities and Exchange Commission (SEC) is proposing a new conditional exemption for “finders” who help small businesses raise capital in private markets. The exemption from the broker registration requirements of Section 15(a) of the Exchange Act would allow natural persons to engage in certain limited private security offerings involving accredited investors.  

“Many small businesses face difficulties raising the capital that they need to grow and thrive, particularly when they are located in places that lack established, robust capital raising networks,” Chairman Jay Clayton said in a press statement.  “Particularly in these ecosystems, finders may play an important role in facilitating capital formation for smaller issuers.  There has been significant uncertainty for years, however, about finders’ regulatory status, leading to many calls for Commission action, including from small business advocates, SEC advisory committees and the Department of the Treasury.  If adopted, the proposed relief will bring clarity to finders’ regulatory status in a tailored manner that addresses the capital formation needs of certain smaller issuers while preserving investor protections.”

Use of Finders

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 SEC.

The Exchange Act generally prohibits a person from engaging in the business of effecting transactions in securities without a license. Accordingly, 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. Accordingly, true “finders” can generally do little more than make introductions in exchange for a fee.

Proposed Conditional Exemption

The proposed exemption would create two classes of exempt Finders, Tier I Finders, and Tier II Finders, that would be subject to conditions tailored to the scope of their respective activities. Tier I and Tier II Finders would both be permitted to accept transaction-based compensation under the terms of the proposed exemption.

Tier I Finders

A Tier I Finder would be limited to providing contact information of potential investors in connection with only a single capital raising transaction by a single issuer in a 12-month period.  A Tier I Finder could not have any contact with a potential investor about the issuer.

Tier II Finders

A Tier II Finder could solicit investors on behalf of an issuer, but the solicitation-related activities would be limited to: (i) identifying, screening, and contacting potential investors; (ii) distributing issuer offering materials to investors; (iii) 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 (iv) arranging or participating in meetings with the issuer and investor. 

Conditions for Both Tier I and Tier II Finders

Both Tier I and Tier II Finders would be subject to certain conditions. The proposed exemption for Tier I and Tier II Finders would be available only where:

  • The issuer is not required to file reports under Section 13 or Section 15(d) of the Exchange Act;
  • The issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act;
  • The Finder does not engage in general solicitation;
  • The potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the Finder has a reasonable belief that the potential investor is an “accredited investor”;
  • The Finder provides 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.

Prohibited Activities for Finders

Finders in either tier could not rely on the proposed exemption to engage in broker activity beyond its scope. For instance, a Finder could not rely on the SEC’s proposed exemption to facilitate a registered offering, a resale of securities, or the sale of securities to investors that are not accredited investors or that the Finder does not have a reasonable belief are accredited investors. 

In addition, a Finder could not (i) be involved in structuring the transaction or negotiating the terms of the offering; (ii) handle customer funds or securities or bind the issuer or investor; (iii) participate in the preparation of any sales materials; (iv) perform any independent analysis of the sale; (v) engage in any “due diligence” activities; (vi) assist or provide financing for such purchases; or (vii) provide advice as to the valuation or financial advisability of the investment.

Additional Requirements for Tier II Finders

Given that Tier II Finders would be authorized to participate in a wider range of activity and potentially engage in more offerings, they would need to satisfy certain disclosure requirements and other conditions. These disclosure requirements, which include a requirement that the Tier II Finder provide appropriate disclosures of the Tier II Finder’s role and compensation, must be made prior to or at the time of the solicitation. Additionally, the Tier II Finder must obtain from the investor, prior to or at the time of any investment in the issuer’s securities, a dated written acknowledgment of receipt of the required disclosures. 

What’s Next?

The proposed exemption will now be subject to a 30-day comment period following publication in the Federal Register.

If you have questions, please contact us

If you have any questions or if you would like to discuss these issues further,
please contact Dan Brecher or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.