SEC Proposes “Finder” Exemption to U.S. Broker-Dealer Registration Requirements to Facilitate Small Business Capital Raising
On October 7, 2020, the U.S. Securities and Exchange Commission (the ”SEC”) proposed a new limited, conditional exemption (the “Proposed Exemption”) from the broker-dealer registration requirements of Section 15(a) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) for “finders” who assist issuers with raising capital in private markets from accredited investors. The Proposed Exemption would permit natural persons to engage in certain defined and limited activities involving accredited investors without registering with the SEC as brokers. There will be a 30-day comment period for the Proposed Exemption following publication in the Federal Register.
The Proposed Exemption is designed to assist small businesses in raising capital and to provide regulatory clarity to investors, issuers and the finders who assist them. As noted by SEC Chairman Jay Clayton, “Many small businesses face difficulties raising the capital that they need to grow and thrive, particularly when they are located in places that lack established, robust capital raising networks… Particularly in these ecosystems, finders may play an important role in facilitating capital formation for smaller issuers.”
Seeking to address the capital formation needs of such smaller issuers while preserving the Exchange Act’s investor protections, the Proposed Exemption would create two classes of exempt finders, Tier I Finders and Tier II Finders, each subject to restrictions and obligations tailored to the scope of the their respective activities.
Permitted Activities of Tier I and Tier II Finders
Under the Proposed Exemption, the Tier I Finder classification would be available to those finders performing only limited finding services. Importantly, Tier I Finders would be prohibited from making any contact with a potential investor about an issuer. Instead, they would be limited to sharing the contact information of potential investors in connection with a single capital raising transaction by a single issuer in a 12-month period.
Tier II Finders, in contrast, would be permitted to engage in solicitation-related activities on behalf of issuers so long as such 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 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.
Both Tier I and Tier II Finders would be permitted to accept transaction-based compensation.
The Proposed Exemption would not, however, be available to finders engaged in certain prohibited activities. Neither Tier I nor Tier II Finders seeking the Proposed Exemption could (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.
Conditions Applicable to Both Tier I and Tier II Finders
Both Tier I and Tier II finders would only be able to utilize the Proposed Exemption if the following conditions are satisfied:
- 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 U.S. Securities Act of 1933, as amended (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 associated compensation;
- The finder is not an associated person of a broker-dealer; and
- The finder is not subject to statutory disqualification, as defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation.
Failure to satisfy any of these conditions would, in the absence of an alternative exemption from the broker-dealer registration requirements of the Exchange Act, expose unregistered finders to SEC enforcement actions.
Additional Conditions Applicable to Tier II Finders
Reflecting the broader scope of Tier II Finders’ activities under the Proposed Exemption, the SEC would impose on them disclosure requirements not applicable to Tier I Finders. Specifically, Tier II Finders would need to provide potential investors with the following information:
- the name of the Tier II Finder;
- the name of the issuer;
- a description of the relationship between the Tier II Finder and the issuer, including any affiliation;
- 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;
- any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and
- 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.
Additionally, Tier II Finders would need to obtain from investors a dated written acknowledgment of receipt of the above information.
The Proposed Exemption would enable finders to leverage their capital raising networks to benefit small issuers without subjecting such finders to the Exchange Act’s broker-dealer registration requirements. The primary challenge for finders would be ensuring their compliance with the conditions of the Proposed Exemption. Helpfully, the SEC provided an overview chart comparing the permitted activities of Tier I Finders, Tier II Finders and registered broker-dealers.
Additionally, finders should note that compliance with the Proposed Exemption would not impact their obligation to comply with other appliable laws, including obligations under the Exchange Act, the Securities Act, laws concerning regulated entities such as investment advisers and state laws.