The Securities and Exchange Commission has proposed loosening the restrictions on finders —people who, for a fee, introduce potential investors to securities issuers— in a move that could have a significant impact on capital formation strategies for many smaller businesses.
On Oct. 7, the commission voted to propose a new limited, conditional exemption from broker registration requirements for finders, who assist issuers in raising capital in private markets from accredited investors.
If adopted, the SEC has said the proposed exemption would allow finders to engage in certain limited activities involving accredited investors without registering as brokers. “The proposed exemption,” the agency said, “seeks to assist small businesses to raise capital and to provide regulatory clarity to investors, issuers, and the finders who assist them.”
Since 2010, the SEC has taken a restrictive approach to finder activities. The commission, in the Brumberg, Mackey & Wall, PLC Staff No-Action Letter (May 17, 2010), said that anyone accepting a fee to assist in the sale or purchase of securities is, in essence, a broker and must register as required by the Securities and Exchange Act of 1934.
The new proposal would explicitly allow some finders to act without registering, which would provide greater flexibility to smaller companies and funds that may not have the size and budget to attract the services of registered broker-dealers but who may benefit from issuing securities to investors.
Two Tiers of Finders
Under the plan, the SEC would create two classes of finders, Tier I and Tier II finders, who would be subject to conditions depending on their activities.
Tier I finders would be limited to providing contact information of potential investors in connection with one capital-raising transaction by a single issuer during a 12-month period. A Tier I finder would not be allowed contact with a potential investor about the issuer, according to the SEC.
Tier II finders would be allowed to participate in a wider range of activities. A Tier II finder is able to solicit investors on an issuer’s behalf. Solicitation activities would be limited to: identifying, screening and contacting potential investors; distributing issuer offering materials to investors; arranging or participating in meetings with the issuer and investor; discussing issuer information included in any offering materials, so long as the finder does not provide advice on the valuation or advisability of the investment.
Certain conditions are proposed for both tiers. The proposed exemptions would be available only where:
- the issuer is not required to file reports under Section 13 or Section 15(d) of the Exchange Act.
- the issuer is seeking to conduct the securities 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 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 associated compensation.
- 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.
Tier II finders would also be required to make disclosures to investors about their role and compensation prior to or at the time of a solicitation. And they must obtain a dated, written acknowledgement from investors that they have received the required disclosures.
The SEC has created a chart that provides an overview of the proposed requirements for Tier I and Tier II finders and registered brokers. It can be found here.
A 30-day comment period will open after the proposed exemptions are published in the Federal Register.
In a statement released following the vote, the SEC said plan would establish “clear lanes for both registered broker activity and limited activity by finders that would be exempt from registration.” SEC Chairman Jay Clayton said in a news release that capital formation law for finders has been uncertain for years. The commission’s action, he said, “will bring clarity to finders’ regulatory status in a tailored manner” that addresses the capital formation strategies of smaller issuers while preserving investor protections.
The vote for the proposal was 3-2 along party lines, which could mean an uncertain road ahead for the plan. According to The DI Wire, SEC Commissioner Caroline Crenshaw called the proposal “a radical departure from established registration requirements.”
The experts on capital formation law at KVCF will be closely monitoring developments on our clients’ behalf. Contact us to learn more about how we assist businesses with their capital formation strategies.