Background
On October 7, 2020, the U.S. Securities and Exchange Commission (SEC) proposed an order (the “Proposed Order”)[1] that would allow natural persons to engage in limited activities assisting issuers in raising capital without registering as a broker-dealer. Currently, a person who identifies and solicits potential investors and receives transaction-based compensation in connection with such activity may be viewed as engaging in broker-dealer activity, and accordingly, would need to register as a broker-dealer with the SEC.[2]
In the Proposed Order, the SEC notes that small businesses often seek capital through securities offerings in reliance on an exemption from registration. Finders, who identify and solicit potential investors for these offerings, often operate in a regulatory gray area. The Proposed Order seeks to clarify that finders can, under certain circumstances, solicit investors without registration as a broker-dealer.
The Proposed Order creates two classes of finders: Tier I Finders and Tier II Finders. Each class of finders would be permitted to engage in solicitation of investors without registration as a broker-dealer, subject to certain conditions.[3] These tiers are discussed in turn below.
The exemptive relief of the Proposed Order would apply solely in connection with primary offerings of non-reporting companies which offerings are exempt from U.S. securities registration requirements.[4]
There is a 30-day comment period on the Proposed Order, ending on November 12, 2020.
Tier I Finders
Under the Proposed Order, a natural person may act as a Tier I Finder by providing investor contact information to an issuer in connection with one capital raising transaction within a 12-month period, if the following seven conditions are met:
- The issuer is not required to file reports under Section 13 or Section 15(d) of the U.S. Securities Exchange Act of 1934, as amended (“Exchange Act”);
- The issuer seeks to conduct the offering in reliance on an exemption from registration;
- The finder does not generally solicit investors;
- The investors are accredited investors, as that term is defined in Rule 501 of Regulation D[5], or the finder reasonably believes that the investors are accredited investors;
- The finder provides services pursuant to a written agreement with the issuer, where such an agreement sets forth the description of services provided by the finder and associated compensation the finder will receive;
- The finder is not an associated person[6] 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.[7]
The Proposed Order would limit the activities of a Tier I Finder to providing the issuer with contact information of potential investors in connection with one capital raising transaction for that issuer within a 12-month period. The Proposed Order provides that a Tier I Finder who meets the above-described conditions may receive transaction-based compensation in connection with providing this contact information to the issuer.
Tier II Finders
The Proposed Order would also create a category of Tier II Finders who would be permitted to engage in a wider range of activity than Tier I Finders. The Proposed Order would permit a Tier II Finder to engage in a broader scope of solicitation-related activities, as set forth in the chart below, including contacting potential investors, distributing offering materials and discussing the issuer information contained in the same with potential investors, and arranging or participating in meetings with the investor. The Tier II Finder may not have a role in preparing the offering materials.
However, in addition to meeting the seven criteria applicable to Tier I Finders, Tier II Finders would need to satisfy certain disclosure requirements and other conditions. For example, a Tier II Finder would be required to provide the potential investor with disclosure that describes the relationship between the Tier II Finder and the issuer, any compensation the Tier II Finder will receive, and any material conflicts of interest arising from the relationship. The Tier II Finder must also provide disclosure that it is not undertaking a role that requires it to act in the investor’s best interest.[8] The disclosure must be provided prior to or at the time of the solicitation, and the investor must provide a written acknowledgement of receipt of these disclosures.[9]
The SEC warns that neither Tier I nor Tier II Finders may provide advice as to the advisability of the investment. Further, the SEC also emphasizes that Tier I and Tier II Finders are not permitted to be involved in structuring the transaction or negotiating its terms, performing any independent analysis of the offering, engaging in due diligence or handling customer funds or securities. Tier I and Tier II Finders may not rely on the exemption set forth in the Proposed Order to engage in broker-dealer activity beyond the scope of the Proposed Order, such as facilitating a registered offering, resale of securities or an offering to unaccredited investors.[10]
Scope of Permitted Activities for Finders Under the Proposed Order
The following chart sets forth a summary of the activities in which Tier I and Tier II Finders would be permitted to engage under the Proposed Order.
|
ACTIVITY
|
TIER I FINDER
|
TIER II FINDER
|
Providing investor contact information to an issuer
|
Yes
|
Yes
|
Participating in more than one capital raising transaction within a 12-month period
|
No
|
Yes
|
Contacting potential investors
|
No
|
Yes
|
Distributing offering materials and discussing those materials with investors
|
No
|
Yes
|
Participating in meetings with both potential investors and the issuer
|
No
|
Yes
|
Structuring the transaction or negotiating its terms
|
No
|
No
|
Performing independent analysis of the transaction
|
No
|
No
|
Performing due diligence
|
No
|
No
|
Handling customer funds and securities
|
No
|
No
|
Providing financing
|
No
|
No
|
Facilitating a registered offering
|
No
|
No
|
Facilitating a resale of securities
|
No
|
No
|
Contacting non-accredited investors
|
No
|
No
|
Providing advice as to the valuation or advisability of the investment
|
No
|
No
|
Conclusion
The SEC notes that the Proposed Order would provide issuers with greater access to capital and potential investors. There is a 30-day comment period on the Proposed Order, ending on November 12, 2020. Shearman & Sterling LLP will closely monitor these developments.
Footnotes
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