The Securities and Exchange Commission (“SEC”) has proposed a conditional exemption from broker registration requirements for certain “finders” who assist issuers with raising capital in private markets from accredited investors. If adopted, the proposed exemption would permit natural persons to engage in certain limited securities activities involving accredited investors, without registering with the SEC as brokers, and to accept transaction-based compensation, provided the finder complies with all of the conditions set forth in the proposed exemption.
Ultimately, the SEC intends the exemption to be narrowly tailored, and while seeking to address the capital formation needs of certain smaller issuers, it intends to preserve appropriate investor protections. To this end, the SEC is proposing to exempt two classes of finders, Tier I Finders and Tier II Finders (collectively sometimes referred to as a “Finder”), that would be subject to conditions tailored to the scope of their respective securities activities. Tier I and Tier II Finders activities are described below:
Tier I Finders
The activities of a Tier I Finder would be limited to providing contact information of potential investors in connection with only single capital raising transaction by a single issuer, in any 12-month period. Additionally, a Tier I Finder could not have any contact with a potential investor about the issuer.
Tier II Finders
The activities of a Tier II Finder are somewhat broader in that the Tier II Finder could engage in certain solicitation activities on behalf of an issuer. However, the proposed solicitation-related activities would be 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.
Conditions Applicable to Both Tier I and Tier II Finders
The proposed exemption for Tier I and Tier II Finders would be subject to certain conditions. As such, 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 a 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, as that term is defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation.
Additional Requirements for Tier II Finders
Since Tier II Finders would be allowed to participate in a wider range of securities related activities and have the potential to engage in more offerings with issuers and investors, the proposed exemption includes additional conditions for Tier II Finders. Thus, a Tier II Finder would also need to satisfy certain disclosure and acknowledgements requirements.
The disclosure obligation includes a requirement that the Tier II Finder provide a potential investor with disclosures of the Tier II Finder’s role, compensation and conflicts of interest. The disclosure would also include an affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not an associated person of a broker dealer, and is not undertaking a role to act in the investor’s best interest. That disclosure must be made prior to or at the time of the solicitation. Additionally, 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 all of the required disclosures.
Limitations on Finder Activities
Consistent with the narrow scope of activities contemplated by the proposed exemption, the SEC has noted that Finder could not:
- Be involved in structuring the transaction or negotiating the terms of the offering.
- Handle customer funds or securities or bind the issuer or investor.
- Participate in the preparation of any sales materials.
- Perform any independent analysis of the sale.
- Engage in any “due diligence” activities.
- Assist or provide financing for such purchases.
- Provide advice as to the valuation or financial advisability of the investment.
Finally, the proposed exemption would apply only with respect to the defined activities for each tier of Finder and would be limited to activities solely in connection with primary offerings.
Cautionary Note From the SEC
The SEC noted that the exemption does not affect two important principles embodied in the regulatory framework structured to protect investors. First , the exemption would not affect a Finder’s obligation to continue to comply with all other applicable laws, including the antifraud provisions of the Securities Act and the Exchange Act, such as the obligations under Section 10(b) and Rule 10b-5 under the Exchange Act, and state law. Second, regardless of whether or not a Finder complies with this exemption, the finder may need to consider whether it is acting as another regulated entity, such as an investment adviser or a municipal advisor. An exemption from the obligation to register as a broker-dealer does not insulate a person from the registration requirements of the Advisers Act if such person is acting as an investment adviser.
Requests for Comment
The Commission is seeking comment on all aspects of the proposed exemption. Should you have thoughts on this proposed exemption, you should act quickly, as the comment period is only 30 days following publication in the Federal Register, and as such, the Comment Period ends November 11, 2020.