SEC Proposes Conditional Broker Registration Exemptions for 'Finders'

Nelson Mullins Riley & Scarborough LLP

[co-author: Benjamin Betik]

Earlier this month, the SEC proposed an order that would exempt “Finders” — individuals who connect private issuers with accredited investors — from federal broker registration requirements, provided that certain conditions are met. The proposed exemption would allow private issuers to more easily identify potential investors, reducing capital-raising costs for smaller private businesses.

To help emerging companies and other private businesses that are poised to take advantage of the proposed exemption, here are some of the details and conditions of the proposal.

What is a Finder?

Finders are individuals who identify and, in certain cases, solicit potential investors for private issuers. Private issuers that are too small to attract a registered broker-dealer, but too large to rely on personal financing, often turn to Finders to attract investors.

Finders are particularly common in areas that lack robust venture capital and angel investor networks. Finders can also help connect historically under-represented founders, such as women and minorities, with accredited investors.

For years, Finders have existed in a regulatory gray area. Due to this legal uncertainty and lack of guidance, Finders have been unable to adequately serve the private capital market or have found themselves unknowingly engaging in unregistered broker activity. The proposed exemption is intended to bridge the gap and clarify the regulatory status of Finders.

Who Qualifies as an Exempt Finder?

To qualify for the proposed exemption, the Finder:

  • Must be a natural person, rather than an entity (such as a crowdfunding service);
  • Must not be an “associated person” (i.e., a partner, manager, or non-clerical employee) of a broker-dealer;
  • Must not be statutorily disqualified under the Exchange Act;
  • Must not engage in general solicitation; and
  • Must enter into a written agreement with the issuer that describes the services provided and the Finder’s compensation.

What Transactions by a Finder are Exempt from Federal Broker Registration Requirements?

To prevent broad circumvention of federal broker registration requirements, the proposed exemption applies only if the following conditions are met:

  • The issuer must not be a public company (i.e., a company that is required to file reports with the SEC);
  • The issuer is seeking to conduct the private offering in reliance on an applicable exemption from registration under the Securities Act of 1933, as amended; and
  • The potential investor is an “accredited investor” under Rule 501 of Regulation D, or the Finder reasonably believes that the investor is an “accredited investor.”

In sum, the proposed exemption does not apply to (a) a registered offering, (b) the resale of securities, or (c) the sale of securities to investors that are not accredited investors.

What Activities May a Finder Engage in?

The SEC’s proposed order would create two tiers of Finders. These tiers determine the scope of a Finder’s exempt activities and the disclosures that a Finder seeking exemption must make.

Tier 1 Finders may only provide the contact information of potential investors to an issuer in connection with a single capital raising transaction by a single issuer within a 12-month period. Tier 1 Finders may not have any contact with an investor regarding an issuer.

Tier 2 Finders may provide the contact information of potential investors to an issuer, as well as these additional activities:

  • Identifying, screening, and contacting potential investors on behalf of an issuer;
  • Distributing issuer offering materials to potential investors;
  • Discussing information included in an issuer’s offering materials, provided that a Tier 2 Finder does not provide advice about the valuation or advisability of the investment; and
  • Arranging or participating in meetings with the issuer and potential investor.

Under the proposed rule, Tier 2 Finders must also make certain disclosures to potential investors, including:

  • The name of the Finder, and the name of the issuer that has engaged the Finder;
  • A description of the relationship between the Finder and the issuer;
  • A description of the terms of the compensation arrangement between the issuer and the Finder;
  • A description of any material conflicts of interest resulting from the relationship between the Finder and the issuer; and
  • A statement that the Finder is acting as an agent of the issuer, is not acting as a broker-dealer or an associated person of a broker-dealer, and is not assuming a role to act in an investor’s best interest.

A Tier 2 Finder must also obtain written acknowledgement that an investor has received these disclosures either prior or at the time of an investment.

Both Tier 1 and Tier 2 Finders would be permitted to receive transaction-based compensation, such as a commission, provided that they comply with all of the applicable requirements.

Conclusion

As the SEC considers implementation of the proposed Finder exemption rule over the coming months, we will provide additional guidance on the effects of the proposed rule.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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