SEC Proposes Exemptive Relief for Finders to Help Private Issuers Raise Capital
For many years, small businesses and other private issuers have struggled to connect with investors when seeking to raise capital in a private offering. The amount of money being raised was sometimes too small for many investment bankers, or the associated fees were too expensive for the small business. The capital being sought often exceeded that which was available from friends and family. As a result, private companies sometimes looked to “finders” who could introduce them to prospective investors in return for a “finder’s fee” paid when the introduced persons made an investment in the company.
However, finders run the risk of being deemed unregistered broker-dealers. The Securities Exchange Act of 1934 (“Exchange Act”) generally requires all broker-dealers to register with the Securities and Exchange Commission (“SEC” or the “Commission”) and defines brokers as anyone “engaged in the business of effecting transactions in securities . . .” The SEC considers persons who solicit investors for investment in securities transactions to be engaged in effecting securities transactions. Moreover, the SEC has cited the receipt of a transaction-based fee such as the one typically paid to finders as a strong indicator that the recipient should be registered as a broker-dealer.
Nonetheless, for many years, the SEC Staff provided some latitude for finders to operate through no-action letters. These no-action letters generally took the position that a person who did not act as finder on a regular basis and who limited his or her activity to making introductions and refrained from further involvement in the transaction could receive a finder’s fee without having to register as a broker-dealer. In more recent years, the availability of this no-action relief has become less and less clear, as the SEC Staff has indicated they have changed their position from prior no-action letters and narrowed the scope of permissible activities by finders. For example, in Brumberg, Mackey & Wall, P.L.C. (available May 17, 2010), the Staff declined to take a no‑action position because a finder’s commitment to refer persons “who may have an interest” in the financing implied impermissible “pre-screening” and “pre-selling.”
The SEC is now proposing to clarify and expand the scope of permitted conduct by finders through a conditional exemptive order that would exempt from the broker-dealer registration requirements two categories of finders: Tier I Finders, who would only provide names and contact information of prospective investors, and Tier II Finders, who could engage in limited solicitation of prospective investors.  The proposed exemptive order would operate as a non‑exclusive safe harbor for finders. Finders that meet the terms of the exemptive order would be exempt from broker-dealer registration. Failure to meet the terms would not be dispositive, but would pose a challenge for finders who would need to prove that they are not required to register as broker-dealers.
In order to qualify for the exemptive relief, all finders would need to meet certain minimum conditions. Those requirements are:
Tier I Finders must limit their activity to furnishing the issuer with the names and contact information of prospective investors. The contact information may include address, phone number, email, and social media identifiers. Tier I Finders must not contact the prospective investors to arrange introductions or otherwise discuss the financing. In addition, they may only assist one capital-raising transaction in any 12-month period. There are no other requirements for Tier I Finders.
Tier I Finders fit comfortably within the parameters of permissible finders delineated in SEC Staff no-action letters and are unlikely to be a source of controversy.
Tier II Finders would be permitted to engage in limited solicitation activities that exceed those historically permitted for finders. As a result, they would also be subjected to greater disclosure requirements.
Tier II Finders would be permitted to:
Tier II Finders would not be permitted to:
In addition, Tier II Finders would be required to disclose to prospective investors the finder’s role and compensation terms, any material conflicts of interest, and a disclosure that the finder is acting as an agent of the issuer and is not undertaking to act in the investor’s best interest. The required disclosures must be made at or prior to the time of solicitation and could be made orally if they are followed up with a written set of disclosures prior to the introduced party making the investment. The Tier II Finder must also obtain from the prospective investor prior to their completion of the investment a written acknowledgement that the investor received the Tier II Finder’s disclosures. Disclosures and acknowledgements may be furnished via email.
The proposed Tier II Finder category is a welcome recognition that a finder can be most effective if he or she can furnish and discuss issuer offering materials and arrange and participate in introductory meetings. Nonetheless, this part of the proposal is likely to attract concern from some quarters, particularly with respect to the possibility that an unregulated finder may engage in inappropriate sales practices when discussing an investment opportunity with a prospective investor.
There will be a 30-day public comment period on the proposed exemptive order, commencing when the proposal is published in the Federal Register. Because the proposal is an exemptive order and not rulemaking, it may proceed relatively quickly after the SEC receives and considers the public comments.
Two of the five members of the Commission expressed objections and/or reservations about the proposed exemptive order. Their concerns may affect the timing and terms of the final exemptive order and could also foreshadow an effort to revoke or revise the order if the composition of the Commission changes next year.
The proposed exemptive order offers much-needed clarification on the role of finders. Moreover, the proposed category of Tier II Finders would enable finders to function more effectively in their efforts to assist private issuers in fund raising. There is a demonstrated need for finders in many private financings, and the SEC’s proposal seeks to find a proper balance between filling this need while protecting investors against unscrupulous sales activities. Nonetheless, given the split on the Commission and the timing, it is likely that the proposal will prove controversial in some quarters and may be modified before it is adopted. Finally, it is important to bear in mind that, if adopted, the exemptive order will only apply to broker-dealer registration requirements at the federal level, and finders should evaluate what if any requirements may apply under applicable state law.
 See Paul Anka, SEC No-Action Letter (available July 24, 1991).