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Finders May Finally Be Keepers: SEC Proposes Rules Allowing for Unregistered Broker-Dealers to Participate in Capital-Raising Transactions Under Certain Circumstances

Corporate and Securities Alert | October 19, 2020
By: Alexandria E. Kane and Jamie Wang

The ability to raise capital is one of the most critical challenges facing small businesses in the U.S. today. Capital can allow for exponential growth of a well-run startup with a good idea, but the lack of capital is the death knell for many others. While many small companies initially rely on friends and family for funding, there has perennially been a gap between raising money from those in your immediate circle and working with investment bankers who are registered broker-dealers for larger rounds of funding. In years past, unregistered finders stepped in to fill this gap despite the legal challenges involved. The role and responsibilities that a finder can legally undertake is a gray area. To the chagrin of their lawyers, companies often “looked the other way” and risked sanctions, possible rescission of offerings and other penalties in order to get the capital they so desperately sought. The problem of unregistered finders has been discussed by the Securities and Exchange Commission (SEC) for decades but, until the new rules proposed by the SEC on October 7, 2020, they did little to provide relief to small companies seeking to raise private placement funds through the use of finders.

Securities Laws Regarding Finders

Section 15(a) of the Securities Exchange Act of 1934 (the Exchange Act) requires that persons engaged in “broker” or “dealer” activity must register with the SEC unless an exemption is available. Section 3(a)(4) of the Exchange Act defines a broker as “any person engaged in the business of effecting transactions in securities for the accounts of others.” In Section 3(a)(5), a dealer is defined as a person that is “engaged in the business of buying and selling securities ... for such person’s own account.” Federal securities laws do not define the term “finder” and do not address a finder’s permitted activities. Instead finders must scrupulously avoid being classified as a broker-dealer unless they actually register with FINRA, which serves as the primary regulator for broker-dealers. The broker-dealer registration process and ongoing regulatory requirements are cumbersome and cost prohibitive for many small finders who engage in capital-raising transactions. These requirements include minimum net capital requirements, audited financials and maintenance of a complete compliance infrastructure in accordance with FINRA regulations.

Section 29(b) of the Exchange Act provides that:

“every contract made in violation of any provision of this title or any rule or regulation thereunder, and every contract … the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of [the Exchange Act] or any rule or regulation thereunder, shall be void: (1) as regards the rights of any persons who, in violation of any provision, rule or regulation, shall have made or engaged in the performance of any such contracts.”

Under this provision, an investor can seek rescission of the purchase of securities from an issuer, which also includes the return of commissions and fees paid to the finder. Additionally, the SEC can bring an enforcement action against an unregistered broker for violating Section 15(a) of the Exchange Act for failure to register and also against an issuer who hired the finder for aiding and abetting in such violation.

Most states have securities laws similar to those at the federal level which allow for rescission of transactions involving unregistered broker-dealers and also provide local authorities with the ability to take enforcement actions against unregistered broker dealers and companies who hire them. Notably, this past spring, the New York Attorney General unveiled a package of reform proposals relating to the offering and sale of securities which included registration and exam requirements for those meeting its new definition of finder.

Prior SEC "No-Action" Relief for Finders

Over the years, many have sought no-action relief from SEC staff regarding whether certain described activities fall within the definition of a broker or dealer. No-action letters allow SEC staff, in the absence of rulemaking to the contrary, to evaluate a specific fact pattern of proposed activities and determine if registration as broker-dealer is required. Through the years, the SEC has cited certain activities which traditionally were performed by registered broker-dealers including solicitation of investors to purchase securities, involvement in negotiations between the issuer and the investor and, most critically, receipt of transaction-based compensation, as opposed to a mere passive introduction of an investor to an issuer which is within the permissive scope of activities of a finder.

In 1991, the SEC granted no-action relief to the singer Paul Anka related to a securities offering involving the Ottawa Senators hockey team, in which he agreed to give the team names and phone numbers of those who might be interested in purchasing limited partnership units in exchange for a referral fee of 10 percent of related sales. Based upon the fact pattern, including the very limited involvement by Anka, the SEC agreed that Anka would not be deemed an unregistered broker-dealer, but stressed that that this relief was given since it was a one-time referral event and not a regular activity for Anka.

However, in recent years, the SEC indicated that it would no longer grant such relief for one-time transactions similar to Anka. In 2000, in revoking the no-action assurance it had granted to Dominion Resources, Inc., the SEC noted it had recently taken a more restrictive view of the finders’ exemption and denied relief in a number of more recent no-action requests. In 2010, the SEC denied the request of Brumberg, Mackey & Wall, a Virginia-based law firm, for no-action relief related to finder activities. In its discussion, the SEC noted that “a person's receipt of transaction based compensation…is a hallmark of broker-dealer activity,” and that transaction-based compensation would give the firm a “saleman’s stake” in the transaction. In light of the scrutiny that the SEC has given in the no-action letters through the years and the denial of many such requests, there are very few situations in which finders can clearly conduct capital-raising activities without the concern of running afoul of registered broker-dealer activities.

SEC Enforcement

In 2013, the SEC brought an enforcement action against private equity firm Ranieri Partners, its managing partner and a consultant of the firm who solicited $500 million in capital commitments despite not being registered as broker-dealer. The SECs order found that the consultant solicited investments in exchange for transaction-based compensation. The consultant’s role went beyond a mere introduction and included sending private placement memoranda, subscription documents and due diligence materials to potential investors and urging at least one investor to consider adjusting portfolio allocations to accommodate an investment with Ranieri Partners. The SEC found that the firm aided and abetted the violations by providing the consultant with key documents and information while ignoring red flags indicating that the consultant had gone well beyond the limited role of a finder and was actively soliciting investments. Since the Ranieri enforcement action, the SEC has made examples of numerous other unregistered broker dealers for exceeding their authority and engaging in broker-dealer activities.

The M&A Broker No-Action Letter

One area in which the SEC did provide clarity for finders in recent years, is in the M&A arena. In a no-action letter released on January 31, 2014, the SEC provided guidance and granted relief to unregistered M&A brokers in connection with the transfer of ownership of a privately held company as long as the transaction complies with the terms detailed in the no-action letter including:

  1. the transfer of ownership and control to a buyer who will actively operate the business as opposed to a passive buyer;
  2. the M&A Broker will have no ability to bind a party;
  3. the M&A Broker will not provide financing directly or indirectly;
  4. the M&A Broker will not have custody, control or possession of securities or funds;
  5. the transaction is exempt from registration and not a public offering;
  6. no party to the transaction is a shell company (other than a business combination related shell);
  7. clear disclosure is provided and consent is obtained with respect to any joint representation;
  8. the M&A Broker and its officers, directors and employees have not been barred or suspended from association with a broker-dealer;
  9. the securities sold in the transaction will be restricted securities; and
  10. the M&A Broker will not assist in the formation of a group of buyers.

In response to the M&A Broker no-action letter, many states also adopted similar laws at the state level to enable capital-raising transactions in M&A contexts. Congress has also introduced legislation to codify the exemption but such legislation has not been passed to date.

The M&A Broker exemption has been extremely helpful to companies seeking exit strategies for their businesses since it has opened up new opportunities to seek capital outside of the traditional investment banking route. However, challenges have remained for those who merely want a capital infusion for their existing business and do not want to give up control. As noted below, the SEC has also attempted to facilitate capital raising for these companies through other means.

Other Capital-Raising Relief Granted to Small Business

In 2012 the Jumpstart Our Business Startups Act (Jobs Act), was enacted by Congress, in part to assist companies in capital raising transactions. Included in the Jobs Act was the ability to raise money from “crowdfunding” sources under the following circumstances:

  1. permits sales of up to $1,000,000 of securities (including all other securities sold through similar offerings in the preceding 12 months); and
  2. investors may only purchase:
    1. the greater of $2,000 or 5 percent of their annual income or net worth, if annual income is less than $100,000; and
    2. 10 percent of the annual income or net worth up to $100,000, if income or net worth exceeds $100,000;
    3. transaction must be conducted by a broker or through a funding portal which is registered and complies with requirements to be set by the SEC; and
    4. issuers must comply with Section 4A(b) of the Securities Act.

As part of the crowdfunding rules, the SEC created a new exemption from the broker-dealer registration for Funding Portals. The term “Funding Portal” is defined in Section 3(a)(80) of the Exchange Act as "any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to section 4(a)(6) of the Securities Act." Fund portals are required to refrain from certain activities including offering investment advice, soliciting purchases of securities, holding investor funds or securities and other traditional broker-dealer activities.

In addition, the Jobs Act also created the “4(c) exemption” from broker-dealer registration pursuant to which a person may maintain a platform or mechanism to offer and sell securities in compliance with Rule 506 of Regulation D without registering under Section 15(a)(1) as long as they meet certain requirements including not receiving any compensation in connection with the offering.

In March 2013, the SEC issued two important no-action letter exempting AngelList and FundersClub from the requirement to register as broker-dealers related to their operation of investment platforms for angel and venture capital investing despite the fact that affiliates currently or in the future would be receiving compensation in the form of carried interest. The two letters confirm that those maintaining a platform introducing investors to funds and private placements will not need to register as broker-dealers, as long as they do not engage in other broker-dealer activities. Significantly, in these letters, carried interest was not deemed to be transaction-based compensation since it is not necessarily tied to a transaction, but instead to ongoing advisory and consulting services.

In addition, FINRA now has a more limited registration application available for capital acquisition brokers (CABs). CABs are firms engaged in more limited activities such as serving as the placement agent in an offering, but are still not able to handle funds or securities or engage in certain other broker-dealer activities. Due to the restrictions imposed, there is a more streamlined registration process and CABs do not have to meet all of the onerous registration and compliance requirements typically associated with a full-fledged broker-dealer.

These changes have made it easier for certain parties to register as broker-dealers and have also enabled issuers to raise money on crowdfunding platforms and other portals in recent years. While all of these new rules have certainly assisted in capital raising, questions about unregistered finders still frequently occur and the need for clarity regarding the permitted activities of a finder who is not registered still exists.

Proposed Exemption for Finders

On October 7, 2020, the SEC proposed rules which would exempt certain categories of finders and provide greater clarity regarding the permissible activities of finders who are not registered broker dealers. This new exemption would create two classes of natural person finders, Tier I Finders and Tier II Finders, which would both be permitted, without broker registration, to engage in certain capital-raising activities and accept transaction-based compensation if they each meet conditions and limitations tailored to the scope of their respective activities.

Tier I Finders

A Tier I Finder would be limited to providing contact information of potential investors in connection with only a single capital-raising transaction by a single issuer in a 12 month period. A Tier I Finder may not have any contact with a potential investor about the issuer.

Tier II Finders

A Tier II Finder could solicit investors on behalf of an issuer, but the solicitation-related activities would be limited to:

  1. identifying, screening and contacting potential investors;
  2. distributing issuer offering materials to investors;
  3. 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
  4. arranging or participating in meetings with the issuer and investor. 
Conditions for Both Tier I and Tier II Finders

The proposed exemption for Tier I and Tier II Finders 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 under Section 3(a)(39) of the Exchange Act, at the time of his or her participation.

Further, a finder could not:

  1. be involved in structuring the transaction or negotiating the terms of the offering;
  2. handle customer funds or securities or bind the issuer or investor;
  3. participate in the preparation of any sales materials;
  4. perform any independent analysis of the sale;
  5. engage in any “due diligence” activities;
  6. assist or provide financing for such purchases; or
  7. provide advice as to the valuation or financial advisability of the investment.
Additional Conditions for Tier II Finders

Because Tier II Finders could participate in a wider range of activity and have the potential to engage in more offerings with issuers and investors, additional, heightened requirements have been proposed. A Tier II Finder wishing to rely on the proposed exemption would need to satisfy certain disclosure requirements and other conditions. These disclosure requirements include providing appropriate disclosures of the Tier II Finder’s role and compensation prior to or at the time of the solicitation. Further, the Tier II Finder must obtain from the investor, prior to or at the time of any investment in the issuer’s securities, a dated written acknowledgment of receipt of the required disclosures.

Note that the Finders Exemption would not alter a finder’s obligation to comply with all other applicable laws, including the antifraud provisions of the Securities Act and the Exchange Act and state law.

Potential Implication Beyond Small Businesses

While the SEC states that the proposed Finders Exemption is intended to help small businesses raise capital, the Finders Exemption Proposal does not materially limit the issuers or size of offerings that may use finders relying on the proposed Finders Exemption. Specifically, although the proposed Finders Exemption is limited to accredited investors and private transactions, there was no discussion in the proposal regarding an overall cap on funds raised, making possible for larger issuers or larger offerings to use a finder under the proposed Finders Exemption. Furthermore, the proposed Finders Exemption would be available to private, non-reporting companies. This could potentially extend the benefit of the proposed Finders Exemption to private equity and venture funds raising capital.

Next Steps

The SEC has requested public comment on the proposed exemption. Specifically, the SEC provided 45 questions at the end of the proposed exemption for comment. The comment period will run 30 days after the proposed exemption appears in the Federal Register.

The proposal was issued by a 3-2 vote of the commissioners. Commissioners Allison Herren Lee and Caroline A. Crenshaw offered strong dissents to the proposal, stating that it lacks requirements for recordkeeping or periodic inspection by the SEC. While the need for regulatory clarity around finders is commonly acknowledged, the commissioners’ divided views on the proposal likely foreshadow a wide range of public comments and further discussions at the SEC. After the comment period, the SEC will consider the comments and may issue the exemption as proposed or in modified form,or withdraw the proposal.

Long Term Implication of the Finders Exemption

The Finders Exemption at last appears as if it will provide issuers with the certainty they need to use finders without fear of subjecting themselves to rescission and penalties. While there are many questions and open issues that will need to be resolved in the final rules, creating bright line rules and guidance for finders to follow takes them out of the shadows and legitimizes their existence as an important resource for private capital-raising transactions.

If you have questions or would like more information, please contact Alexandria Kane (; 212.631.4409), Jamie Wang (; 646.766.1350) or another member of our Corporate and Securities Group.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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