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SEC Proposes Conditional Exemption from Broker-Dealer Registration for Finders

In Short

The Situation: For many years, various groups have urged the Securities and Exchange Commission ("SEC" or "Commission") to clarify the activities that so-called "finders," who act as intermediaries between investors and issuers seeking to raise capital, may engage in without having to register as brokers. 

The Result: On October 7, 2020, the SEC published for comment a proposed conditional exemptive order that will provide a safe harbor from the broker registration requirements for certain finders acting as intermediaries between certain issuers and accredited investors in private placement transactions.

Looking Ahead: The 30-day comment period is relatively short and the proposal is likely to generate significant public comment. If adopted, this proposal would significantly change longstanding SEC and staff positions relating to the registration requirements for finders in connection with private placements. 

In order to facilitate capital formation for small issuers, the SEC has proposed for comment an exemption from the broker registration provisions of Section 15(a) of the Securities Exchange Act of 1934 ("Exchange Act") for certain natural persons acting as finders in connection with private securities transactions. These finders would be permitted to help private issuers identify potential investors, provided that they meet the conditions in the exemption.

Under current regulatory guidance, if a person solicits investors to enter into securities transactions with issuers and receives transaction-based compensation, he or she has a "salesman's stake" in the transaction and generally must register as a broker or become an associated person of a registered broker-dealer firm. If adopted, the SEC's proposal would create a significant exception to this general rule. 

Conditions for Both Tier I and Tier II Finders

The proposed exemption would be a non-exclusive safe harbor for finders involved in primary offerings for private issuers who meet the conditions for being a Tier I or Tier II Finder. To fall within either category, the following conditions (the "Common Conditions") must be met:

  • The issuer is not required to file reports under Sections 13 or 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, or the finder has a reasonable belief that it is, an "accredited investor" as defined in Rule 501 of Regulation D;
  • 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 Exchange Act Section 3(a)(39), at the time of his or her participation.

Tier I Finders

In addition to the Common Conditions, a Tier I Finder's activities must be limited solely to providing the issuer with the contact information of potential investors (i.e., the finder may not have any contact with the potential investors about the issuer) in connection with only one capital raising transaction by a single issuer within a 12-month period. A Tier I Finder meeting these conditions would not be required to register as a broker even if it receives transaction-based compensation.

Tier II Finders

A Tier II Finder would be able to engage in more solicitation-related activities for issuers than a Tier I Finder and still not be required to register as a broker if it meets the Common Conditions and it limits its activities 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 that 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. Furthermore, a Tier II Finder, at the time of the solicitation, would be required to provide each prospective investor with disclosures including descriptions of the relationship between the finder and the issuer, the compensation arrangement and material conflicts of interest resulting from the arrangement or their relationship, and an affirmative statement that the 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 may be oral, but any oral disclosure must be supplemented by written disclosure meeting the exemption's requirements, and the Tier II Finder must obtain from the investor a dated written acknowledgement of receipt of the required disclosures, no later than the time of any related investment in the issuer's securities. If the Tier II Finder complies with all of the conditions of the exemption, he or she may receive transaction-based compensation.

A Tier II Finder would not, however, be permitted to do any of the following in connection with a transaction: (a) handle customer funds or securities; (b) have the power to bind the issuer or the investor; (c) be involved in structuring the transaction or negotiating the terms of the offering; (d) participate in the preparation of any sales material; (e) perform any independent analysis of the sale; (f) engage in any "due diligence" activities; (g) assist or provide financing for purchases; or (h) provide advice as to the valuation or financial advisability of the investment.

A Divided Commission

As expressed during the Commission meeting at which the proposal was considered, the Commissioners are divided (3-2) on the appropriateness of the proposed exemption. Among other reasons, those supporting the proposal argue that the relief would enable small businesses to find cost-efficient ways to raise funds and provide clear guidelines to finders, while those opposing the proposal argue that it encourages the growth of opaque private markets and does not adequately protect investors. The Commission has asked for public comment on all aspects of the proposal, including on the costs and benefits of the proposed exemption, within 30 days of the proposal's publication.

Three Key Takeaways

  1. If the proposed exemption is adopted, individuals will be permitted to solicit investors in connection with private placement transactions and receive transaction-based compensation without broker registration.
  2. Under the proposal, to be exempt from broker registration, individuals soliciting accredited investors for private placement transactions must limit their role to qualifying activities, investor disclosures will be required prior to or at the time of the solicitation, and investors will be required to provide a dated written acknowledgement of the solicitation disclosures.
  3. Since its adoption as proposed would result in a significant shift in the existing broker regulatory scheme, the proposal is likely to generate considerable public comment. Because of the short comment period, interested persons should submit comments soon.

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