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.
Reputational Risk and Legal Exposure: Why New Jersey Businesses Must Manage Them Together
New Jersey businesses must manage legal and reputational risk together because modern disputes play out on two fronts at once: the legal proceeding itself and the court of public opinion, where customers, employees, investors, and business partners often reach conclusions long before a judge or jury has had the opportunity to evaluate the facts. Success […]
Eviction Is Not Always the End: Understanding Post-Possession Rent Claims in New Jersey and New York
No. An eviction does not automatically end a tenant’s obligation to pay rent. Post-eviction rent claims are common because recovering possession resolves who has the right to occupy the premises, but it does not extinguish the tenant’s contractual obligations under the lease. Whether unpaid or future rent remains owed depends on three factors: the lease’s […]
Company Dissolved? Legal and Financial Consequences to Expect
A company is dissolved; legally, it ceases to exist. Accordingly, dissolution results in significant legal and financial consequences. It is a process that must be properly managed to avoid continuing liability. The Corporate Dissolution Process Corporate dissolution is the legal process of formally closing a corporation, paying its debts and distributing the remaining assets. Most […]
The Legal Implications of Signing a Triple Net Lease
A triple net lease is a commercial lease in which the tenant pays the property’s real estate taxes, insurance, and maintenance costs, known as the three nets, in addition to base rent. They are most often used in freestanding retail and office buildings and in large single-tenant industrial properties, with terms that typically run 10 […]
When to Settle and When to Fight: A Litigator's Framework
Every lawsuit comes with a cost, and knowing when to settle a lawsuit is one of the most consequential decisions a business owner will face. Experienced litigators understand how to minimize cost and obtain certainty for their clients. For many business owners, the decision is viewed almost entirely through a financial lens: What will it cost […]
Types of Business Law Services Companies Actually Use
Business law services are legal services that help companies form, operate, transact, protect assets, manage risk, and resolve disputes. The phrase can sound broad because it is broad. A company may need help with entity formation one month, contract review the next, a commercial lease after that, and a business dispute later in the year. […]
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!
