SEC Proposes Exemptive Relief for Finders

At its October 7, 2020 open meeting, the Securities and Exchange Commission (the “SEC”) voted to propose exemptive relief for certain finders engaged in raising capital  from accredited investors. If the proposal is adopted, it would allow them to receive commissions and other transaction-based compensation without registration as a broker-dealer under Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”).

The measure will apply only to finders who wish to assist issuers engaged in offerings that rely on exemptions from registration under the Securities Act of 1933 (the “Securities Act”) such as Regulation A, Regulation D, or Regulation Crowdfunding. In all cases, the finders must deal only with individuals or entities they reasonably believe to be accredited investors.

The proposed finder’s  exemption creates two categories of finders: Tier I and Tier II. Finders who qualify for either Tier 1 or Tier 2 can avoid registering as a registered representative of a broker dealer and still receive transaction-based compensation. The SEC has prepared a concise chart that outlines the activities Tier I Finders, Tier II Finders, and FINRA broker dealers are permitted to perform.

Only a Natural Person is a Finder

Under the SEC’s proposed exemption, only a natural person can be a finder.  An entity such as a corporation or limited liability company is not eligible. This is consistent with the SEC’s position in recent enforcement actions against toxic funders in which it distinguishes between the activities of natural persons and entities engaged in dealer activity. Individuals buying and selling securities for their own accounts qualify as “traders,” while entities engaging in the same activity must register.

Finders May Only Solicit Accredited Investors

The SEC proposal also requires that the finder know or have a reasonable belief that the person being solicited is an accredited investor as defined by Rule 501 of Regulation D of the Securities Act. It requires the finder to follow traditional paths to form that reasonable belief before undertaking a solicitation.

The SEC proposal recognizes that accredited investors are an important source of growth capital for small businesses, and small businesses often find it difficult to locate them without the help of a finder practiced in making introductions between them and potential investors.

Conditions for Tier I and Tier II Finders

The proposed finders’ exemption is available only if: 

• The issuer is not subject to SEC reporting requirements under Section 13 or Section 15(d) of the Exchange Act;
• The issuer aims to conduct the securities offering relying on an applicable exemption from registration under the Securities Act such as Rule 506(b), Rule 506(c) and Rule 504 of Regulation D, Regulation A and Regulation CF;
• The finder does not engage in general solicitation Rule 506(c);
• The potential investor must be an “accredited investor” as defined in Rule 501 of Regulation D, or the Finder must have a reasonable belief that the potential investor is an “accredited investor”;
• The finder must provide services pursuant to a written agreement with the issuer and the agreement must describe the Finder’s services and his or her compensation;
• The finder cannot be an associated person of a broker-dealer and
• Thef finder must not be subject to statutory disqualification, as defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation in the offering.

Tier I Finders

A finder will qualify as a “Tier I Finder” if he or she meets the requirements above if his or her activity is limited to solely providing the issuer with contact information of potential accredited investors and engages in only one transaction with a single issuer within a 12-month period. Tier 1 Finders cannot have any contact with the potential investors about the issuer. The contact information provided by the Tier 1 Finder may include, among other things, name, telephone number, email address, and social media information. A Tier I Finder can receive transaction-based compensation for introducing the investor to the company without registration as a broker under Section 15(a) of the Exchange Act.  The Tier 1 Finder’s exemption is effectively a codification of the Paul Anka no-action letter (1991 SEC No-Act Lexis 925 (July 24, 1991)).

Tier II Finders

A Tier II Finder is a Finder who meets the above conditions, and who also engages in solicitation-related activities that are limited to: (1) identifying, screening, and contacting potential investors; (2) providing issuer offering materials to potential investors; (3) discussing issuer information included in any offering documents, provided that the Tier II Finder does not provide advice about the valuation or advisability of the investment; and (4) arranging or participating in meetings with the issuer and investor.

Under the proposal, so-called Tier II Finders could identify, screen, and contact potential investors; distribute issuer offering materials to investors; discuss issuer information included in offering materials; arrange or participate in meetings with the issuer and the investor; and participate in more than one capital raising transaction within a 12-month period.

Tier II Finders must satisfy certain additional written disclosure obligations. Prior to or at the time of the solicitation, Tier II Finders would be required to provide potential investors with disclosures that include: (1) the name of the Tier II Finder; (2) the name of the issuer; (3) the description of the relationship between the Tier II Finder and the issuer, including any affiliation; (4) a statement that the issuer will compensate the Tier II Finder for his/her solicitation activities, and a description of the compensation arrangement terms; (5) any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and (6) 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 to act in the best interest of the potential investor. The finder may initially provide the disclosure orally, so long as it provides written disclosure soon after and before the investor purchases the issuer’s securities.

Lastly, the Tier II Finder must obtain a written acknowledgement from each investor confirming that the investor has received the required disclosure.

Conclusion

The new SEC proposal is long overdue, and will be welcomed by issuers, investors, and potential finders alike. Management of startups and development stage companies is often uncertain how to go about conducting the capital raises so important to their companies’ growth. They’re likely to have limited resources, and may find hiring a broker-dealer prohibitively expensive. In the past, they may also not have understood what they were permitted to do to find investors, and what was not allowed.

The SEC’s proposal should answer any questions they may have had, and should also afford young companies and the finders they work with opportunities for attracting investors they lacked in the past. Especially in these challenging times, small businesses are the lifeblood of our economy. As SEC Chairman Jay Clayton said, “If adopted, the proposed relief will bring clarity to finders’ regulatory status in a tailored manner that addresses the capital formation needs of certain smaller issuers while preserving investor protections.”

This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes. For more information about going public with Form S-1, Form F-1 and Regulation A Securities Offerings, Rule 506 and Regulation CF crowdfunding,  sponsoring market makers and Form 211,  dual listings and foreign issuer listings and public company SEC reporting requirements, please contact Hamilton & Associates Law Group.

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