On October 7, 2020, the Securities and Exchange Commission (the “SEC”) proposed a new conditional rule exempting certain “Finders” from broker registration requirements when helping issuers raise capital from accredited investors in private transactions. Exempted Finders would be permitted to receive transaction-based compensation in exchange for conducting certain limited activities without having to register with the SEC under Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”). To qualify for the proposed exemption, Finders would need to (1) meet a series of general requirements applicable to all Finders, and (2) limit the scope of their activities to comply with the restrictions applicable to whichever of the two proposed tiers they are classified within.
Current regulations do not directly address whether and under what circumstances Finders may find or solicit potential investors without being required to register as a broker and instead leave Finders and issuers to seek answers through individual no-action letters. The proposal is intended to set clear guidelines and in turn provide small businesses with easier access to external capital. SEC Chairman Jay Clayton stated that the proposal “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.” The proposal is subject to a 30-day comment period following its publication in the Federal Register.
The proposed exemption would only be available in connection with offerings made in reliance on an exemption from registration under the Securities Act of 1933 by issuers who are not required to file reports under Section 13 or Section 15(d) of the Exchange Act. Additionally, the offering must be directed at potential investors who are “accredited investors” as defined in Rule 501 of Regulation D or potential investors who the Finder reasonably believes are “accredited investors.”
The proposed exemption would only apply to the activities permitted for each tier of Finders. A Finder could not rely on this proposed exemption to engage in any other broker activity, such as facilitating a registered offering, a resale of securities, or the sale of securities to non-accredited investors, without abiding by the registration requirements applicable to such activities.
Though targeted at smaller issuers, the SEC currently has not specified a cap on the amount of funds raised under this proposal, meaning that the proposed exemption could potentially be relied on for larger transactions so long as they meet the qualifications specified below.
To qualify for the proposed exemption, a Finder must be a natural person, not an entity, and the following conditions must be met:
- the Finder and issuer must have a written agreement governing the Finder’s services that includes a description of the services provided and associated compensation;
- the Finder may not engage in general solicitation or be associated with a broker-dealer; and
- the Finder may not be subject to statutory disqualification, as that term is defined in Section 3(a)(39) of the Exchange Act, while seeking to qualify for the proposed exemption.
In addition to these general conditions, a Finder would be further bound by the conditions applicable to whichever tier that they are classified within.
Finders classified in Tier I must limit their activities to providing the contact information of potential investors to issuers, limited to a single capital raising transaction by a single issuer in a 12-month period. Notably, a Tier I Finder cannot have any contact with a potential investor about the issuer.
Finders engaging in direct solicitation of investors on behalf of an issuer would be classified in Tier II and must limit their activities 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.” Additionally, Tier II Finders would be subject to certain disclosure requirements, including specifying their relationship to the issuer and compensation prior to or at the time of solicitation, and would have to obtain a dated written acknowledgment of receipt of the required disclosures from any solicited investor prior to or at the time of their investment in the issuer’s securities.
Although Tier II Finders are permitted to engage in a broad scope of activities under the proposed exemption, no Finders would be permitted to “(i) be involved in structuring the transaction or negotiating the terms of the offering; (ii) handle customer funds or securities or bind the issuer or investor; (iii) participate in the preparation of any sales materials; (iv) perform any independent analysis of the sale; (v) engage in any “due diligence” activities; (vi) assist or provide financing for such purchases; or (vii) provide advice as to the valuation or financial advisability of the investment.”