On October 7, 2020, the US Securities and Exchange Commission (SEC) proposed granting exemptive relief from the broker registration requirement in Section 15 of the Securities Exchange Act of 1934, as amended (the Exchange Act) to certain natural person “Finders” who assist issuers with raising capital in private offerings. According to the SEC’s proposed exemption (Proposed Exemption),1 the SEC seeks to facilitate capital formation, particularly for small businesses, and to provide regulatory clarity to investors, issuers, and finders while preserving appropriate investor protections.
In this Legal Alert, we provide a brief overview of the Proposed Exemption, including the relevant definitions and conditions, and a summary of the SEC’s policy rationale behind particular provisions of the Proposed Exemption.
The proposed exemption
The Proposed Exemption would grant exemptive relief from the broker registration requirement of Section 15(a) of the Exchange Act to permit natural person Finders to engage in certain limited capital raising activities on behalf of an issuer in the context of an offering not registered under the Securities Act of 1933, as amended (the Securities Act). 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. Both Tier I and Tier II Finders would be permitted to accept transaction-based compensation under the terms of the Proposed Exemption.
The Proposed Exemption would provide a non-exclusive safe harbor from broker registration; accordingly, no presumption would arise that a person has violated Section 15(a) of the Exchange Act if such person is not within the terms of the Proposed Exemption.2
Finally, the Proposed Exemption would not affect a Finder’s obligation to continue to comply with all other applicable laws, including the anti-fraud provisions of the Securities Act, the Exchange Act, and state law. In addition, the Proposed Exemption is not intended to affect the rights of the SEC or any other party to enforce compliance with applicable law or the available remedies for violations of the law.
Conditions for both Tier I and Tier II Finders
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 (i.e., it is not a reporting company);
- the issuer is conducting the 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 under the Securities Act 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 the compensation paid;
- 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.
The Proposed Exemption would be limited to Finder activities conducted in connection with primary offerings and only cover the activities defined for each tier of Finder. A Finder could not rely on the Proposed Exemption to engage in broker activity beyond the scope of the Proposed Exemption, such as to facilitate a registered offering, a resale of securities, or the sale of securities to investors that are not accredited investors (or to investors that the Finder does not have a reasonable belief are accredited investors).
Similarly, 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 an investor’s purchase of securities; or (vii) provide advice as to the valuation or financial advisability of the investment.
Tier I Finders
In addition to compliance with the general conditions for Finders set forth above, a Tier I Finder would be limited to providing contact information of potential investors in connection with a single capital raising transaction by a single issuer in a twelve-month period. Such contact information could include, among other things, name, telephone number, e-mail address, and social media information. This limited activity precludes a Tier 1 Finder from participating in continuous offerings or multiple sales of securities. In addition, 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 if the general conditions for Finders set forth above are followed and the Finder’s solicitation-related activities are 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 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. The SEC believes these limitations will appropriately narrow the role of the Tier II Finder to support the Proposed Exemption.
Because a Tier II Finder could participate in a wider range of activity and have the potential to engage in multiple offerings on behalf of issuers, these Finders would also need to satisfy certain disclosure requirements and other conditions to rely on the proposed exemption. In particular, Tier II Finders would need to provide a potential investor, prior to or at the time of the solicitation, with the following: (1) the name of the Tier II Finder; (2) the name of the issuer; (3) a description of the relationship between the Tier II Finder and the issuer, including any affiliation; (4) a statement that the Tier II Finder will be compensated for his or her solicitation activities by the issuer and a description of the terms of such compensation arrangement; (5) any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and (6) an affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest.
These disclosures could be made orally so long as the oral disclosure is supplemented by written disclosure that satisfies the above requirements no later than the time of the investment in the issuer’s securities. Finally, under the Proposed Exemption, a Tier II Finder must obtain from the investor, prior to or at the time of investment in the issuer’s securities, a dated written acknowledgment of receipt of the required disclosures.
The regulatory status of Finders engaged in capital raising activities has long been an open question. The Proposed Exemption is intended to address the capital raising needs of smaller issuers while maintaining appropriate investor protections. To encourage feedback from small business marketplace participants on the impact of the Proposed Exemption, the SEC has made available certain educational resources,3 including an overview chart that illustrates key permissible activities of Tier I and Tier II Finders.4 The SEC has requested comments on all aspects of the Proposed Exemption, including several specific items listed in the Proposed Exemption. The comment period expires on November 12, 2020.
1 SEC Release No. 34-90112 (Oct. 7, 2020), available at: https://www.sec.gov/rules/exorders/2020/34-90112.pdf.
2 Regardless of whether a Finder takes advantage of the safe harbor provided by the Proposed Exemption, it may need to consider whether it is acting as another regulated entity, such as an investment adviser or municipal advisor.
3 The educational resources are available at: https://www.sec.gov/educational-resources-finders-proposed-exemptive-order.
4 The overview chart is available at: https://www.sec.gov/files/overview-chart-of-finders.pdf.