Permitted Finder Activities: SEC Proposes Long-Awaited Exemption

Finders seeking to assist companies in raising capital are required to navigate an often cloudy path to determine whether the finder's activities and any compensation the finder would receive for its services would run afoul of the federal securities law prohibition on the conduct of broker-dealer activities by a person who is not registered with the Securities and Exchange Commission ("SEC") in that capacity. Following a decades-long period in which outside legal experts, the Treasury Department and the SEC's own advisory committees have recommended that the status of finders be clarified in some manner, the SEC has at long last proposed an exemptive order ("Proposed Exemption") that would permit natural persons to act as finders in assisting non-public issuers in raising capital in private placements without being required to register as broker-dealers.¹

This Alert provides some context and background on the SEC staff's historical view on permitted finder activities, the scope of the Proposed Exemption and considerations for unregistered persons seeking to conduct finder activities.

Context and Background

Albeit limited to natural person finders introducing accredited investors to non-public companies in connection with a private placement of securities, the Proposed Exemption may indicate a shift from the previous positions taken by the SEC staff and perhaps help to pave a clearer path for all finders to play a defined role in helping companies to raise capital.

If adopted, the Proposed Exemption would provide substantial relief and legal certainty for persons engaged in finder activities for issuers. The Proposed Exemption also would provide certainty for issuers that utilize the services of finders in raising capital, which have had to be concerned about the possibility that investors could have a rescission right under the Securities Exchange Act ("Exchange Act") if the finder's role in the company's securities offering were deemed to constitute a violation of the Exchange Act's broker-dealer registration requirement. Additionally, the Proposed Exemption, if adopted in final form, would be the second major liberalization by the SEC in recent years for unregistered persons acting as intermediaries in the sale of securities, following the position announced by the SEC staff in a 2014 no-action letter that staff would not recommend SEC enforcement action against an unregistered party effecting M&A transactions structured as stock deals in connection with the transfer of ownership of a privately held company, provided a number of conditions were satisfied.²

However, the fact that the SEC Commissioners were sharply divided on the merits of the Proposed Exemption and went so far as to issue separate statements explaining their votes on the proposal and the bases for their positions, as well as the likelihood that the Proposed Exemption will attract extensive public comment from both supporters and critics of the proposal, suggests that any relief that the SEC may end up adopting in final form could well differ materially from the approach taken in the Proposed Exemption.

The idea that there is a need for persons other than registered broker-dealers to play a role in helping companies to find and raise capital is not new. It has been fairly commonplace for various unregistered persons and parties to provide those types of services, particularly for issuers that are smaller or start-up companies, in reliance on what is often referred to as the "finder's exemption" from the Exchange Act's broker-dealer registration requirement, notwithstanding the fact that no actual exemption of that type is set forth in the Exchange Act itself nor in the SEC's related rules or interpretations. A number of no-action letters issued by SEC staff in the past have provided very limited no-action relief from the broker-dealer registration requirement in particular situations and subject to very restrictive conditions. What is new about the proposal is that the SEC for the first time is proposing to formally adopt a general framework that identifies the circumstances under which a person other than a registered broker-dealer may engage in a broader range of activities on behalf of an issuer in raising capital. In proposing a formal solution, the SEC is seeking to reconcile the general view that a finder exemption is needed to assist small issuers in raising capital with its historical view that many finder activities, if not appropriately limited, would run afoul of Exchange Act broker-dealer registration requirements.

The emerging consensus in favor of finders

There appears to be general agreement that access to capital needed to grow a business is difficult for all but well-established public companies and the handful of new companies that are able to draw public attention and interest and that finders can play an important role in bridging the gap between small businesses that need capital and potential investors. The SEC in putting forth the Proposed Exemption recognizes that finders "may play an important role in facilitating capital formation, particularly for small issuers." As indicated in the table below, that view echoes the findings and recommendations based on industry, legal and federal government reviews of the state of permitted finder activities.

The SEC view on finders

While recognizing the general view that finders play a value-added role, the rulemaking release cites long-standing interpretations of SEC staff and the courts in great detail. That seeming deference to SEC precedent in this area appears to have informed the limited scope of the Proposed Exemption.

Court interpretations cited by the SEC

The SEC points to a number of court decisions that support the application of the Exchange Act broker-dealer registration requirement to all but a very limited scope of intermediary activities conducted in connection with the offer or sale of securities. The issue is that the Exchange Act makes it unlawful for anyone other than a registered broker to "effect any transactions in, or to induce or attempt to induce the purchase of sale of, any security" and defines a broker to mean "any person engaged in the business of effecting transactions in securities for the account of others." While the SEC recognizes that a determination of whether the Exchange Act registration requirement would apply to an unregistered finder turns on the particular facts and circumstances, the rulemaking release identifies the various indicators that the courts have found to implicate broker or dealer status under the Exchange Act, including the following:

• Actively soliciting or recruiting investors
• Participating in negotiations between the issuer and the investor
• Advising investors as to the merits of an investment or opining on its merits
• Handling customer funds and securities
• Having a history of selling securities of other issuers
• Receiving commissions, transaction-based compensation (i.e., compensation that is based or contingent in some manner on transactions in securities) or payment other than a salary for selling investments

While the SEC recognizes that no single factor is dispositive, the SEC does not provide a clear view on which of the indicators it finds to more clearly fall within the Exchange Act broker definition and prohibition and those that would be permitted for a finder. Perhaps indicating that it continues to take a narrow view, the SEC makes the point that a person who identifies and solicits potential investors for an issuer or other party could be viewed as being required to register under the Exchange Act even if the solicitation is limited to a single securities transaction and does not involve the receipt of transaction-based compensation.

SEC staff precedents

Over the years the SEC staff has issued a number of no-action letters on the limited scope of activities that unregistered individuals and entities would be permitted to play in helping companies to find capital. However, the SEC staff view may have become less clear over time as at least one more recent no-action letter appears to have narrowed the scope of permitted finder activities and the SEC staff has in some cases declined to take a position on certain aspects of finder activities. The resulting murky waters seem to have worked to limit the availability and willingness of finders to assist companies, in particular, small and nascent companies, in their capital raising efforts and also limited the interest of issuers in using the services of finders for raising capital.

The SEC acknowledges that the no-action letter issued by the SEC staff to Paul Anka in 1991 ("Paul Anka Letter") has come to serve as a guideline for the range of activities permitted for an unregistered finder.⁷ The SEC staff concluded in the Paul Anka Letter that it would not recommend enforcement action against an individual who limited his activities to: (1) entering into an agreement with the issuer to provide a list of names and phone numbers of potential investors believed to be accredited investors with whom the finder has a pre-existing relationship; (2) not engaging in any further contact with the potential investors about the issuer or the offering; and (3) receiving a finder's fee for the specified activities. The staff decision was based in good part on what the individual said he would not do, including: (i) soliciting the proposed investors; (ii) participating in any advertisement, endorsement or general solicitation; (iii) helping to prepare any sales materials; (iv) performing any analysis of the offering; (v) providing advice as to the valuation or financial advisability of the investment; or (vi) handling any funds or securities in connection with the offering.

The SEC staff, however, has in most instances declined to provide no-action relief where a finder's involvement differs significantly from that contemplated in the Paul Anka Letter. For instance, the SEC staff declined to provide any comfort where the finder planned to pre-screen investors for their eligibility to purchase the securities being offered and would receive transaction-based compensation, finding that the receipt of compensation directly tied to the investors introduced would give the finder a "salesman's stake" in the offering and would create a heightened incentive to engage in sales efforts.⁸

The Proposed Exemption

The Proposed Exemption would be issued by the SEC pursuant to Sections 15(a)(2) and 36(a)(1) of the Exchange Act, under which the SEC is authorized to grant exemptions from the Exchange Act's broker-dealer registration requirement and from any other provision of that Act when the SEC determines that the exemption is consistent with or necessary and appropriate in the public interest and also consistent with the protection of investors.

The SEC acknowledges that the Proposed Exemption is "narrowly drawn" and purposefully so to permit only a limited set of activities that could be conducted by an unregistered finder without compromising investor protection. In so doing, the SEC is seeking to maintain a balance between finding a way to assist small companies to raise needed capital and protecting investors against potentially unscrupulous sales activities.

What is covered

The Proposed Exemption would apply only to natural persons assisting private companies (i.e., companies that are not required to file reports under Section 13 or 15(d) of the Exchange Act) in raising capital pursuant to a private placement that is conducted in reliance on an exemption from the securities registration requirements of the Securities Act of 1933 ("Securities Act").

The Proposed Exemption would establish two tiers of finders and related permitted activities:

• Tier I Finders, who would be limited to the same types of activities permitted by the SEC staff in the Paul Anka Letter—i.e., providing investor contact information to the issuer—with no further involvement in any securities transactions that might result. That aspect of the Proposed Exemption is largely a formalization of the SEC staff's Paul Anka Letter.
• Tier II Finders, as a new class of finders who would be permitted, subject to a number of conditions and disclosure requirements, to conduct a broader range of activities on behalf of issuers raising capital that are of a type that the SEC staff has previously found to involve a "salesman's stake" and that would have previously required broker-dealer registration.

Both tiers of finders contemplated by the Proposed Exemption would be permitted to receive transaction-based compensation for their involvement in identifying and, in the case of Tier II Finders, "soliciting" prospective investors. In all cases, permitted finder activities are limited to seeking accredited investors or investors reasonably believed by the finder to be accredited investors to invest in securities being issued by a privately held company.

Tier I Finders

Along the lines of the activities permitted by the Paul Anka Letter, a Tier I Finder would be limited to providing contact information to an issuer about prospective investors that the finder reasonably believes to be accredited investors. A Tier 1 Finder would only be able to provide a list of prospective investors to a single issuer once in any 12-month period. The SEC envisions that the prospective investor list would be limited to the names and contact information for the prospective investors identified.

Tier II Finders

A Tier II Finder would be permitted to have a somewhat greater involvement in a private placement provided that specified disclosures are made to the prospective investors contacted. As noted, the SEC staff previously has taken the position that certain of the activities that would be permitted for Tier II Finders, such as pre-screening investors, could give rise to the Exchange Act broker-dealer registration requirements, particularly when the finder would receive transaction-based compensation for its services. In proposing to allow such activities for Tier II Finders, the Proposed Exemption relies on the fact that all prospective investors would have to be accredited investors (which are presumed to be in a position to make their own investment decisions) and would be provided with and acknowledge receipt of specified disclosures prior to or at the time the investors were solicited by the Tier II Finder.

It should be noted that notwithstanding the disclosure requirements for Tier II Finders, the Proposed Exemption does not allow a Tier II Finder to contact and solicit a broader range of prospective investors than those for whom a Tier I Finder could provide investor contact information to the issuer. For each category of finder, the Proposed Exemption relates only to activities with "accredited investors."

The Expanded Types of Activities Permitted for Tier II Finders

In addition to providing investor contact information to an issuer as permitted for a Tier I Finder, a Tier II Finder would also be permitted to engage in activities that the SEC considers to involve solicitation, meaning any affirmative effort to induce or attempt to induce a securities transaction. Such broader range of permitted finder activities would include:

• Identifying, screening and contacting prospective investors
• Distributing offering materials to prospective investors
• Discussing the information in the offering materials with prospective investors
• Arranging and participating in meetings between the issuer and prospective investors

The Required Disclosures

In order to engage in the expanded permitted finder activities permitted for a Tier II Finder, the finder would have to provide each investor with disclosure that includes:

• The name of the finder
• The name of the issuer
• A description of the relationship between the finder and the issuer, including any affiliations
• A statement that the finder will be compensated by the issuer for his or her solicitation activities and a description of the terms of the compensation arrangement
• Disclosure of any material conflicts of interest that could result from the arrangement or relationship between the finder and the issuer
• An affirmative statement that the finder is acting as an agent of the issuer and is not acting as an associated person of a broker-dealer or undertaking any role to act in the investor's best interests

A Tier II Finder would be required to provide a prospective investor with the disclosure at the time the investor is initially solicited, but could do so orally, so long as written disclosure that includes the above provisions is provided to the investor no later than the time any investment is made and the investor provides a written acknowledgement that the disclosure was received.

Activities that would continue to be prohibited for finders

The Proposed Exemption is noteworthy in proposing to allow a Tier II Finder to engage in active solicitation of investors, which has traditionally been cited by the SEC staff as a key factor supporting the application of the Exchange Act's broker-dealer registration requirement. In that regard, the Proposed Exemption represents a significant departure from the SEC's traditional approach in applying that registration requirement to intermediaries in securities transactions. However, the SEC emphasizes in the rulemaking release for the Proposed Exemption that the scope of permitted activities for Tier II Finders is otherwise narrow. To that end, the Proposed Exemption clearly specifies the activities that would not fall within the scope of permitted activities for an unregistered party. The list of impermissible activities for any finder, including a Tier II Finder who provides the required disclosures to investors, is consistent with past SEC interpretations on finders and broker-dealer status generally and includes:

• No involvement in structuring the transaction or negotiating the terms of the offering, including the amount of securities offered, the nature of the securities or the closing date of the offering period
• No handling of customer funds or securities
• No ability to bind the issuer or any investor
• No participation in preparing the offering materials
• No independent analysis of the securities offered
• No due diligence activities
• No provision of or assistance in providing financing for any purchase of the securities offered
• No advice on the valuation or financial advisability of the investment

Considerations

Individuals and entities engaged in or planning to engage in finder activities may wish to consider whether and how the Proposed Exemption would apply to their finder activities and whether it would be worthwhile to submit a comment to the SEC on the Proposed Exemption. Similarly, smaller companies and start-up companies and relevant industry associations should be assessing whether the Proposed Exemption and its various conditions and limitations would be likely to encourage issuers of those types to enter into arrangements with finders in order to have better access to private capital markets.

Assessing the Proposed Exemption

As noted, the Proposed Exemption is limited in scope. The following is a list of key issues that may help In determining whether its scope applies and/or whether or not to seek to submit a comment.

1. The Proposed Exemption applies only to finders who are natural persons. The SEC is silent on whether it has considered or would consider another exemption, such as a broker-dealer-lite alternative system of registration and regulation, to permit legal entities that do not otherwise fall within an existing exemption from broker-dealer registration to act as finders and to receive transaction-based compensation for those services.
2. The Proposed Exemption does not apply to associated persons of a broker-dealer. A salesperson or other registered personnel of a registered broker-dealer cannot rely on the Proposed Exemption. That restriction is intended to prevent a registered broker-dealer from circumventing the broker-dealer sales practices regulatory regime, including SEC Regulation Best Interest, by arranging for one of its associated persons to provide services to clients in an individual capacity.
3. The Proposed Exemption applies only to private offerings by private issuers. While the SEC's stated intent is to help "small businesses," the Proposed Order would apply to issuers and offerings of any size where the finder complies with the specified criteria that is not related to offering size. Under the Proposed Exemption, a finder would not be permitted to assist a public company that is subject to Exchange Act reporting requirements with finding investors for a private placement.
4. The Proposed Exemption applies only to finder interactions with accredited investors. Despite the Proposed Exemption prohibiting any solicitation activities by a Tier I Finder and requiring a Tier II Finder to provide specific disclosures as to the finder arrangement, the Proposed Exemption would permit finders to solicit only investors that are, or are reasonably believed to be, accredited investors.
5. The Proposed Exemption would not necessarily supersede previous SEC guidance relating to finder activities. Any finder activities that did not comply with the limits of the Proposed Exemption could still be deemed to trigger the Exchange Act broker-dealer registration requirement. However, activities covered by existing SEC no-action letters granting relief from broker-dealer registration presumably could continue. It should be noted that the SEC is seeking comment on whether and to what extent existing SEC staff no-action letters in this area should be withdrawn, which could ultimately rescind any comfort afforded for finders seeking to act within the same set of facts and circumstances previously addressed in those letters.
6. The Proposed Exemption is intended to be a non-exclusive safe harbor. The SEC stated in the rulemaking release that the Proposed Exemption would serve as a non-exclusive safe harbor from broker-dealer registration for a finder and that no presumption would arise that the finder had violated the broker-dealer registration requirement of the Exchange Act if such person's activities were not squarely within the terms of the Proposed Exemption. Rather, the need for broker-dealer registration would depend on the facts and circumstances of the situation, including in particular the specific activities conducted by the finder.
7. Other federal securities law provisions would remain applicable. Finder activities conducted within the Proposed Exemption would eliminate the SEC enforcement risk for the individual engaging in the finder activities and should also eliminate the risk that the related offering could become subject to a rescission right for an investor under the Exchange Act. However, all other applicable Exchange Act provisions would apply, such as the anti-fraud provisions of the Exchange Act and SEC Rule 10b-5. In addition, relevant provisions of any applicable state securities law would continue to apply.
8. Other registration requirements may still apply. The availability of the Proposed Exemption to a finder would not eliminate the need for the finder to consider whether conducting its activities within a particular state or involving parties in that state would be permissible without the finder being registered as a broker-dealer or in a similar capacity with the state securities regulatory authority. Additionally, reliance on the Proposed Exemption would not be equivalent to meeting the Exchange Act's broker-dealer registration requirement, which in some cases could provide an exemption from other federal and state registration requirements that otherwise could be applicable. In that regard, it should be noted that a handful of states have or have proposed specific registration requirements for finders. For instance, the Texas Securities Board requires a finder to register as such in order to receive transaction-based compensation, and the New York Attorney General has proposed a rule that would require finders to become subject to registration, filing and examination requirements akin to those that apply under New York law to registered broker-dealers.⁹

Implications for Further SEC Action

The less than unanimous approval of the Proposed Exemption by the SEC Commissioners and the likelihood of extensive public comment on the Proposed Exemption could lead to a delay in the SEC taking any final action as well as final action that differs significantly in form and content from the Proposed Exemption.

Criticism of the Proposed Exemption by some SEC Commissioners

The issuance of the Proposed Exemption was not unanimously approved by the SEC Commissioners. Commissioners Crenshaw and Lee emphasized in their separate statements the need for empirical data regarding private capital markets, small issuers and finders in connection with any regulatory reform to be adopted in this area, with Commissioner Lee expressing concern that a policy shift of the significance of the Proposed Exemption should not be effected "circumventing important economic analysis" that would be required if the Proposed Exemption were issued as a rule.¹⁰ The statements of Commissioners Crenshaw and Lee also expressed concern that the active solicitation of investors that would be permitted for Tier II Finders constituted "core broker conduct" that would present the same risk of a "salesman's stake" in a securities transaction that the SEC has traditionally cited as necessitating broker-dealer registration and which the SEC's Regulation Best Interest (which applies only to registered broker-dealers and recently went into effect) is intended to address. Commissioner Lee's statement also noted that the Proposed Exemption's approach in treating accredited investors as being sufficiently sophisticated so as not to require the investor protections of the broker-dealer regulatory regime is inconsistent with—and represents a backing away from—the approach taken by the SEC in Regulation Best Interest, which imposes sales practice and disclosure requirements for broker-dealers when making securities recommendations to a "retail customer" (i.e., a natural person who uses the securities recommendation primarily for personal, family or household purposes), regardless of the retail customer’s net worth or amount of assets under management. Additionally, Commissioner Lee noted in her statement that the Treasury Report and the ABA Task Force Report, which were cited in the rulemaking release as support for the Proposed Exemption, actually recommended a "broker-dealer lite" type of tailored registration requirement and regulatory regime for finders and similar intermediaries rather than an outright exemption from broker-dealer registration and regulation.

These types of criticism by SEC Commissioners themselves of the approach reflected in the Proposed Exemption may lead the SEC to consider a different approach, which Commissioner Lee suggested could involve a scaled broker-dealer registration requirement for finders with recordkeeping requirements for the registrant and examination authority for the SEC. It is also possible that the Commissioners' criticisms will lead to a lengthy delay by the SEC in taking any formal action on the Proposed Exemption.

Public comment being requested

Additionally, public comments received could sway the SEC's decision on the form and content of a final exemptive order. The SEC is seeking comment on all aspects of the Proposed Exemption and asks 44 specific questions that request comment on all aspects of the finder activities to be covered, including:

• Whether the definition of finder should be limited to natural persons or should instead include legal entities as well as persons associated with a broker-dealer or issuer
• Whether permitted finder activities, including solicitation, are appropriately identified
• Whether the restriction for soliciting only accredited investors should be changed to a restriction imposing a limitation on the amount of an investment that could be solicited
• Whether offerings that finders may participate in should be limited to: (1) exempt offerings; (2) offerings within a specified size threshold; (3) only involving a primary capital raises; and/or (4) offering of only specified types of securities
• Whether finders should be limited to working only with privately held companies or should instead be subject to a wider or narrower range of issuers
• Whether the proposed required written disclosures should be extended to Tier I Finders in addition to Tier II Finders as currently proposed and/or require more specific disclosure or an acknowledgement of receipt from investors solicited
• Whether issuers should be required to assume any liability for Finder misstatements
• Whether there should be any limits on the form and amount of transaction-based compensation and other compensation that may be received by a finder
• Whether a finder should be required to file a notice with the SEC that it will be acting as a finder in reliance on the Proposed Exemption
• Whether the SEC, in connection with issuing a final exemption, should withdraw any of the no-action letters previously issued by the SEC staff in the area of finders and broker-dealer status
   

Comments are due to the SEC by no later than November 12, 2020. While the Proposed Exemption brings some relief for finders and those companies raising capital, we expect that there will be significant commentary to this proposal.

_{1 SEC, Notice of Proposed Exemptive Order Granting Conditional Exemption from Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Finders, 85. Fed. Reg. 64542 (Oct. 13, 2020), available at https://www.sec.gov/rules/exorders/2020/34-90112.pdf.
2 M&A Brokers, SEC Staff No-Action Letter (Jan. 31, 2014, as revised Feb. 4, 2014).
3 ABA, Report and Recommendations of the Task Force on Private Placement Broker-Dealers (Jun. 20, 2005), available at https://www.sec.gov/info/smallbus/2009gbforum/abareport062005.pdf.
4 SEC Advisory Committee on Small Business and Capital Formation, Final Report (Sept. 21, 2017), available at https://www.sec.gov/info/smallbus/acsec/acsec-final-report-2017-09.pdf.
5 Treasury Department, A Financial System That Creates Economic Opportunities Capital Markets (October 2017), available at https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf.
6 SEC Office of the Advocate for Small Business Capital Formation, Annual Report for Fiscal 2019, available at https://www.sec.gov/files/2019_OASB_Annual%20Report.pdf.
7 Paul Anka, SEC Staff No-Action Letter (July 24, 1991).
8 Brumberg, Mackey & Wall, PLC, SEC Staff No-Action Letter (May 17, 2010).
9 Texas State Securities Board, Rule 115.1(c). New York Attorney General Press Release, Attorney General James Moves to Modernize and Streamline Securities Filings in NYS (Apr. 6, 2020),available at https://ag.ny.gov/press-release/2020/attorney-general-james-moves-modernize-and-streamline-securities-filings-nys.
10 Public Statement of SEC Commissioner Allison Herren Lee, Regulating in the Dark: What We Don't Know About Finders Can Hurt Us (Oct. 7, 2020), available at https://www.sec.gov/news/public-statement/lee-proposed-finders-exemption-2020-10-07; Public Statement of SEC Commissioner Caroline A. Crenshaw on Proposed Exemptive Relief for Finders (Oct. 7, 2020), available at https://www.sec.gov/news/public-statement/crenshaw-finders-2020-10-07.}

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