On October 7, 2020, the Securities and Exchange Commission voted to propose a new limited, conditional exemption from broker registration requirements for “finders” who assist small business issuers in private offerings to “accredited investors.” In seeking to ensure that the “finder” concept will be within the small capital raising context, the proposed order would permit only natural persons to engage in certain limited activities involving “accredited investors” in private placements of securities. “Accredited investors” are generally individuals with net worth of greater than $1 million (exclusive of primary residence) or have gross income of $200,000 (or $300,000 with a spouse) in each of the last two years and expect such income in the current year.
Under the proposal, there would be two classes of “finders”, Tier I Finders and Tier II Finders. Tier I and Tier II Finders would both be permitted to accept transaction-based compensation. The SEC is seeking to finalize the proposed exemption that would demarcate registered broker activity and limited activity by finders that would be exempt from registration as brokers.
There has been significant uncertainty for decades about the regulatory status of finders and it is often a significant issue for smaller companies who have limited access to capital.
The SEC proposed to grant a conditional exemption from the broker registration requirements of Section 15(a) of the Securities Exchange Act of 1934 that would allow natural persons only to engage in certain limited capital raising activities involving solely “accredited investors” via two classes of exempt Finders, Tier I Finders and Tier II Finders. These finders would be subject to conditions the SEC has tailored enumerated.
A Tier I Finder would only be able to provide contact information of potential investors in connection with one single capital raising transaction by a single issuer in a 12-month period. A Tier I Finder could not have any contact with a potential investor about the issuer. This is a very limited role and meets the SEC’s prior view of a bona fide finder. It goes beyond the “one and done” concept and allows a finder to be involved in one deal per year.
A Tier II Finder would be able to solicit investors on behalf of an issuer, BUT the solicitation-related activities would be limited to:
identifying, screening, and contacting potential investors;
distributing issuer offering materials to investors;
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
arranging or participating in meetings with the issuer and investor.
We believe that as a practical matter the “discussing issuer information” requirement will be very difficult to meet. Issuers and Tier II Finders will need to document the finder’s non-advice and follow that course of action carefully. We think this requirement may negate many claims of finders seeking this exemption. Because of the peril associated with discussing information and the inevitability of communications that could lead to recommendations and associated actions, we think issuers should not allow a finder to discuss issuer information included in offering materials nor participate in substantive discussions or meetings.
The exemption for Tier I and Tier II Finders would be available only where:
Written Agreement. The finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation;
Private Company. The issuer is not required to file reports under Section 13 or Section 15(d) of the Exchange Act; in other words, the issuer is a “private” company;
Exempt Offerings. The securities offering is conducted as an offering exempt from registration (commonly referred to as a “private placement”) under the Securities Act of 1933;
No General Solicitation. The finder does not engage in “general solicitation” (in other words, no mass emails, no canvassing of people, no cold calling);
Accredited Investors Only. The potential investor introduced 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”;
No B-D Association. The finder is not an associated person of a broker-dealer; and
No Bad Boys. 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. No “bad boys.”
The SEC release provides that “A finder could not rely on this proposed exemption to engage in broker activity beyond the scope of the proposed exemption. Among other things, a finder could not rely on the exemption to facilitate a registered offering, a resale of securities, or the sale of securities to investors that are not accredited investors or that the finder does not have a reasonable belief are accredited investors. Further, 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 such purchases; or (vii) provide advice as to the valuation or financial advisability of the investment.”
These requirements must be carefully and strictly documented and observed. Because there may be telephone calls, discussions and meetings involved, this is an area where violation of the conditions may occur easily. A finder and the issuer retaining him or her must use an abundance of care and attention to detail to meet these conditions.
The SEC proposed additional requirements of Tier II Finders in that they need to make certain disclosures of the Tier II Finder’s role and compensation and the disclosure must be made prior to the time of the solicitation. This is another very important requirement to be documented and kept by the issuers and the finder. Further, a Tier II Finder must obtain from the investor, prior to or at the time of any investment in an issuer’s securities, a dated written acknowledgment of receipt of the required disclosures.
The SEC’s Office of the Advocate for Small Business Capital Formation has prepared a chart showing a comparison of some of the permissible activities, requirements and limitations for Tier I Finders, Tier II Finders, and registered brokers (see Finders Proposed Exemptive Order: Overview Chart of Tier I Finders, Tier II Finders and Registered Brokers). The proposal has a 30-day comment period and the SEC will then consider whether to adopt it. This may take several months.
Also, we will be interested to see the reactions of state regulatory authorities to the proposed order, as they may not recognized the proposed exemption from being a “broker,” thereby eviscerating the effectiveness of the proposed order.
If you have any questions concerning the above, feel free to contact us.
Reid A. Godbolt, email@example.com
Samuel E Wing, firstname.lastname@example.org
David A. Thayer, email@example.com
Brad H. Hamilton, firstname.lastname@example.org
Adam J. Fogoros, email@example.com
Melissa D. Hubbard, firstname.lastname@example.org