Under Proposed Exemptive Order, Finders Need Not Register with a Broker-Dealer to Receive Transaction-Based Compensation
On October 7, 2020, the Securities and Exchange Commission (the “Commission”) released a Notice of Proposed Exemptive Order (“Notice”) that would create a conditional exemption from the broker registration requirements for certain activities of Finders (the “Proposal”). Key take-aways are outlined below in a Question & Answer format.
Q. Under the Proposal, who can do what?
The [Proposal] would create two classes of exempt Finders, Tier I Finders and Tier II Finders, that would be subject to conditions tailored to the scope of their respective activities. Tier I and Tier II Finders would both be permitted to accept transaction-based compensation under the [Proposal].
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 could 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:
Q. The safe harbor is conditional; what are the conditions?
A. There are conditions that apply to both tiers, and then additional conditions that only apply to those seeking an exemption for the broader range of activities captured under Tier II:
Conditions for Both Tier I and Tier II Finders
Additional Conditions for Tier II Finders
Tier II Finders must meet all of the conditions set forth above, and must also:
The requisite disclosures may be made by the Finder orally prior to or at solicitation, but if made orally, then the disclosures must be made again in writing no later than the time of any related investment in the issuer’s security.
Q. What activities are prohibited for an exempt Finder under the Proposal?
A. An unregistered, exempt Finder is not permitted to:
Q. Why are associated persons of a broker-dealer precluded from relying on the Proposal’s safe harbor for Finders?
A. The Commission is concerned about investor confusion. The Notice’s specific requests for comment indicate that the Commission has similar concerns regarding investment advisers. This is particularly interesting because the Notice cautions that a Finder relying on the safe harbor to avoid registering with the Commission as a broker may nonetheless still be required to register with the Commission (or a state) as an investment adviser, depending on their conduct.
Q. What was the impetus for the Proposal?
A. In the Notice, the Commission acknowledges that there have been many calls for action in this area, with increasing insistence since at least 2005. In particular, the Commission noted that there is (1) “a broad market perception that additional clarity and possibly relief may be needed in this area”1 and (2) concerns regarding “the perceived inability of smaller companies to engage the services of a broker-dealer to assist with opportunities to raise capital in exempt [private] offerings.”2 In this regard, the Commission hopes that Finders will both identify interested investors in areas that “lack robust venture capital and angel investor networks” and also bridge the gap between issuers and venture/start-up capital.3
Q. How likely is it that this will come to fruition?
A. The Proposal is not a formal rulemaking and as such may follow a decidedly less onerous process to move from initial proposal to final order. Notwithstanding the foregoing, the Commissioners are split on the proposal (with Commissioners Crenshaw and Lee opposed) and based upon the enumerated requests for comment, it appears that there are still a broad range of particulars under consideration by the Commission. The Notice provides 30 days (from publication in the Federal Register) for receipt of public comment.
In reading the statements of the Commissioners, and consistent with existing No Action relief, there seems to be little disagreement about providing the exemption for Tier 1 Finders; the debate seems primarily focused on the breadth of proposed permitted activities for exempt Tier II Finders.
Q. What does it mean that the Proposal is a “safe harbor”?
A. If approved by the Commission, the Proposal would create a presumption that natural persons who comply with the conditions of the exemption are permitted to engage in the prescribed, limited activities on behalf of issuers, and will not be held in violation of law for failing to register as brokers with the Commission. As with all safe harbors, failure to meet the requisite conditions is not tantamount to a violation of law; instead, the Commission’s staff would evaluate the facts and circumstances of the situation to determine if a violation of the Exchange Act (Section 15(a)) had occurred.
Because those who are relying on the safe harbor, by definition, are not required to register as brokers, the recordkeeping obligations of 17a-3 and 17a-4 do not apply, nor does the Commission have examination authority over Finders. Notwithstanding the foregoing, those relying on the safe harbor will need to have created and retained the requisite documentation to evidence compliance with the safe harbor’s conditions.
Q. What areas are likely to change from the Proposal to a final order?
A. The 45 questions presented at the end of the Notice provide insight into areas of the Proposal that may change. They also make clear that a lot remains up in the air. For example, the Commission queries whether to:
As to the last question, this is presumably a reference to FINRA. But, it is important to note that a number of states (e.g., California, Michigan, South Dakota, and Texas) already have laws exempting finders, subject to various conditions. Similarly, New York has proposed registration requirements specific to finders that are not associated with FINRA member firms. The Notice includes a footnote explaining that nothing in the Proposal excuses compliance from other applicable laws, including the anti-fraud provisions of federal securities laws and all applicable state laws.
We will continue to track the Proposal as it moves through the public comment period, and possibly, beyond. In the meantime, if you have any questions regarding the Proposal, or the rules and regulations relating to broker-dealers or investment advisers, please feel free to contact us.
By the Investment Management and Broker-Dealer Team at Kilpatrick Townsend & Stockton
Jeffrey T. Skinner
Lauren C. Jackson
Lauren B. Henderson
Thomas W. Steed, III
F. Daniel Bell, III
Andrew B. Sachs
Regan K. Adamson
Katherine A. McCurry
Waylon M. Bryson
Alexandra M. Fenno
Michael MacRae Robinson
Investment Management Attorney