A significant challenge facing many companies seeking to raise capital is finding and connecting with potential investors. Most commonly, registered broker-dealers assist companies in overcoming this challenge by introducing companies to potential investors. However, we are increasingly seeing unregistered individuals who identify themselves as “finders,” “consultants,” “agents,” or in other similar ways (each, a Finder), claiming they are legally permitted to assist companies in raising capital. These Finders are not registered as broker-dealers with the Securities and Exchange Commission (the SEC) or the Financial Industry Regulatory Authority (FINRA) and also do not comply with state law applicable to broker-dealer activities. Indeed, they often claim that they are exempt from such requirements. Despite these claims, depending on the nature and extent of the services provided, many Finders may be providing broker-dealer services that require registration. Providing such services while not properly registered not only creates potential liability for the Finders, but also for the companies who engage them.
In this legal alert, we provide a high-level overview of the legal and regulatory framework governing Finders and broker-dealer activities, including the activities that trigger registration requirements, two commonly cited exemptions and their narrow applicability, and the severe potential consequences for non-compliance.
Identifying When a Finder’s Activities Require Broker-Dealer Registration
Broker-dealers and Finders play a pivotal role in securities transactions by introducing investors to the securities market. However, broker-dealer activities are subject to extensive regulation by federal and state agencies whose mission is to protect investors and maintain market integrity.[1] The Securities Exchange Act of 1934 (the Exchange Act) requires any individual or entity that meets the definition of “broker” or “dealer” to register with the SEC, absent an available exemption from registration.[2] The Exchange Act defines a broker-dealer as “any person engaged in the business of effecting transactions in securities for the account of others … or for his own account.” [3]
Typically, a Finder introduces financing and investing opportunities to a third party for a fixed fee per introduction.[4] However, in providing these services, Finders frequently engage in activities that place them within the definition of a broker-dealer and subject them to registration requirements.[5] Accordingly, it is crucial that Finders analyze whether their current and planned activities require registration, and develop policies and procedures to mitigate potential legal and regulatory risks inherent in their activities.[6]
The SEC generally applies the following four-factor analysis for purposes of determining whether a person is required to register as a broker-dealer:[7]
- Transaction-Based Compensation: Receiving transaction-related compensation for facilitating securities deals.[8] While no single factor is necessarily dispositive, identifying transaction-related compensation, such as a commission, weighs heavily in favor of determining that such individual or entity is subject to broker-dealer registration, even absent other factors.[9] Said differently, to avoid registration, a Finder’s compensation generally should be limited to the receipt of a fixed “finders fee” per introduction that is not based on the success of such introductions or the ultimate investments made.[10]
- Transaction Facilitation: Actively participating in the solicitation, negotiation, or execution of securities transactions.[11] Whereas Finders step away from the transaction after making the introduction,[12] broker-dealers take an active role in effecting the securities transaction.[13] The SEC has stated that the following activities may indicate that a person is engaged in transaction facilitation:[14]
- Engaging in negotiations for a securities transaction, including discussing the terms of a securities transaction between a company and potential investors[15]
- Soliciting “investors and customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies,” hedge funds, or other securities industry participants[16]
- Identifying potential buyers or sellers of businesses, especially relating to mergers and acquisitions involving securities[17]
- Finding investors for issuers or venture capital financing, even as a consultant[18]
- Facilitating credit extension in connection with a securities transaction[19]
- Handling customer funds and securities[20]
- Assessing investment potential or recommending an investment[21]
- Regularity: Engaging in securities-related activities on a consistent or recurring basis.[22] Broker-dealer activity may include regularly engaging in deals, determined by the number of transactions and clients[23] as well as by the value of the transactions.[24] In contrast, a Finder’s activity is generally infrequent or intermittent.[25]
- Holding Out: Representing oneself as a broker-dealer.[26] A Finder must not hold themself out as a broker-dealer and, instead, generally must limit their role to introductions by providing a list of names, rather than actively participating in offering or effecting the transaction.[27]
Each of the above factors requires a fact-specific analysis of the nature of each transaction and the roles performed by the individual or entity involved.[28]
Limitations of Commonly Relied Upon Exemptions
While the Exchange Act generally requires persons engaged in broker-dealer activities to register as such, certain exemptions from registration are available, provided that all necessary conditions are met. The applicable conditions of such exemptions are intentionally stringent. As a result, many Finders falls outside of these exemptions.
The two most commonly claimed exemptions are: (i) the statutory exemption included in Section 15(b)(13) of the Exchange Act (the M&A Exemption) and (ii) the position taken by SEC Staff in a 1991 no-action letter (the Finders Exemption). We discuss each such exemption in turn below.
The M&A Exemption
Pursuant to the M&A Exemption, individuals or entities involved in securities transactions solely in connection with certain mergers and acquisition activities (collectively, M&A Brokers) may be exempt from broker-dealer registration.[29] However, the conditions of this exemption limit its application to a very narrow group of unregistered broker-dealers.
M&A Brokers are prohibited from relying on the M&A Exemption if they engage in any of the following activities:
- In connection with the transfer of ownership of an eligible privately held company, having custody or holding funds or securities for exchange in the transaction[30]
- Participating in public offerings of registered securities as part of the transaction[31]
- Dealing with shell companies, except certain business combination-related shell companies[32]
- Providing financing for the transaction related to the transfer of ownership of an eligible privately held company[33]
- Assisting in financing with unaffiliated third parties without complying with applicable laws and disclosing compensation in writing[34]
- Representing both buyer and seller in the same transaction without clear written disclosure and consent[35]
- Facilitating transactions with groups of buyers formed by the M&A Broker to acquire the eligible privately held company[36]
- Engaging in transactions involving the transfer of ownership of an eligible privately held company with passive buyers[37]
- Binding parties to a transfer of ownership of an eligible privately held company[38]
Additionally, an M&A Broker’s services must be limited to “eligible privately held companies” that meet the following criteria:
- The company does not have any class of securities on a national securities exchange that is registered,[39] or required to be registered, with the SEC, nor does it file, or is required to file, periodic information, documents, and reports,[40] and
- In the fiscal year immediately preceding the fiscal year in which the M&A Broker’s services are first engaged for the securities transaction, the company satisfies one or both of the following conditions (determined based on the historical financial records of the company):[41]
Further, an M&A Broker is disqualified from the exemption if either the broker or its affiliates have been barred or suspended from association with a broker or dealer.[44] Thus, while the M&A Exemption offers flexibility for certain activities, most individuals who are actively engaged in “finder-like” activities will find compliance with its conditions concerning their activities difficult, particularly because they will have to carefully analyze all of their activities for compliance.
The Finders Exemption
Unlike the M&A Exemption, the Finders Exemption is not a statutory exemption from registration included in the Exchange Act, but instead comes from exemptive relief granted by the SEC pursuant to a 1991 no-action letter (the Paul Anka No-Action Letter).[45] In the Paul Anka No-Action Letter, the SEC Staff stated that it would not recommend enforcement action where an unregistered broker-dealer provided a company with a list of potential investors in exchange for a transaction-related commission.[46] However, in explaining the decision, the SEC Staff noted that its position was based on the satisfaction of the following conditions: (i) he would maintain a “limited role in the negotiations between the purchaser and seller”; (ii) the relevant businesses were going concerns and not “shell” organizations; (iii) the Finder would refrain from “advis[ing] the parties whether to issue securities or assess[ing] the value of any securities sold”; (iv) the Finder would not assist with obtaining financing; (v) the Finder would abstain from preparing and distributing transaction materials; and (vi) the Finder would avoid conducting due diligence or transaction analysis.[47]
The SEC Staff has since moved away from the Paul Anka No-Action Letter,[48] and the Eighth Circuit has rejected the argument that there is a Finders Exemption without the need to register as a broker-dealer.[49] In 2010, the SEC Staff denied a no-action request from Brumberg, Mackey & Wall, P.L.C., requesting no-action relief for receiving a transaction-based fee, and stated that any person receiving transaction-based compensation in connection with another person’s purchase or sale of securities typically must register as a broker-dealer or be an associated person of a registered broker-dealer.[50] In 2020, the SEC, under its previous chairman, proposed a limited, conditional exemption from broker-dealer registration requirements for “finders” who assist issuers with raising capital in private markets from accredited investors.[51] To date, the SEC has not finalized this exemptive relief, [52] and such relief is not included in the SEC’s 2024 list of priorities.[53]
Notwithstanding the fact that the Finders Exemption may not even be available today, the conditions that must be satisfied to rely on the Finders Exemption significantly limit the activities in which a Finder may engage. In practice, Finders typically go beyond merely introducing potential investors to companies and instead seek to provide additional value by offering services that arguably violate the Finders Exemption conditions, such as conducting due diligence with respect to the investment, making recommendations with respect to the transaction, or otherwise being involved in negotiating the transaction or providing the transaction documents. Given the reluctance of the SEC and the courts to support the Finders Exemption, Finders seeking to rely on the Finders Exemption must understand the risks and take great care to avoid engaging in any activities prohibited by the relevant conditions, including by developing and adopting robust policies and procedures to limit their activities.
Consequences of Acting As or Engaging an Unlicensed Broker-Dealer
Operating as or engaging an unregistered broker-dealer carries significant regulatory and legal risk. The SEC and FINRA have the authority to investigate and take enforcement action against unlicensed broker-dealers that can result in civil monetary penalties, injunctions, disgorgement of fees or profit, prohibition from working in the securities industry, and reputational damage.[54] Such consequences may also include criminal liability and investor remedies.[55]
The SEC has recently brought civil cases against unregistered Finders in federal courts and enforcement actions. In 2021, the SEC brought an action against a payday loan firm and some of its employees in the U.S. District Court for the Southern District of Florida alleging in part that receipt of transaction-based compensation indicated operation as an unregistered broker-dealers.[56] In 2022, the SEC brought another case in the U.S. District Court for the Central District of California Western Division alleging that an employee who acted as a “finder/closer” had violated the broker-dealer registration requirements because this employee contacted prospective investors from lead lists, provided information about investment opportunities, and was paid transaction-based compensation for his efforts.[57] Both of these cases resulted in court injunctions being entered against the defendants, along with other penalties and disgorgement.[58] The SEC also brought an enforcement action against a consultant for being an unregistered broker-dealer because he brought investors to private equity funds, distributed information and subscription documents, provided his analysis, and received transaction-based compensation for his efforts.[59] The consultant settled the matter with the SEC, which resulted in the consultant being barred from the securities industry and subject to disgorgement.[60]
Under federal law, engaging an unlicensed broker-dealer can void agreements with new investors, potentially granting investors rescission rights.[61] Similar violations under state law may also provide a basis for rescission and other remedies, exposing issuing companies and their officers to significant liabilities.[62] Further, if found non-compliant, these entities could be prohibited from participating in Regulation D securities offerings in the future.[63]
Conclusion
If a Finder’s actions place the Finder within the definition of broker-dealer without meeting an applicable exemption, they must register with the SEC and FINRA (or otherwise become a registered representative of properly registered broker-dealer) and satisfy any applicable state registration requirements. Failure to do so may result in legal penalties and reputational harm for the Finder. The entities that engage Finders may also face significant financial, legal, and reputational liability that could limit participation in future securities offerings.
For additional information please contact Paul Foley, Kiki Scarff, John Faust, James Severs, Brittany Puckett, or your typical relationship attorney at Akerman LLP to discuss this further.
[1] SEC Strategic Plan: Fiscal Years 2022-2026 14, 6-13, https://www.sec.gov/files/sec_strategic_plan_fy22-fy26.pdf; 17 C.F.R. § 240 (2011).
[2] 15 U.S.C. § 78o(a)(1) (2012).
[3] 15 U.S.C. § 78c(a)(4)(A); 15 U.S.C. § 78c(a)(5)(A).
[4] Capital Markets, Comparison Table – Finders vs. Broker-Dealers, BL, https://www.bloomberglaw.com/external/document/XB6K2QBC000000/capital-markets-comparison-table-finders-vs-broker-dealers.
[5] SEC Staff Study on Investment Advisers and Broker-Dealers 166, 50 (January 2011), https://www.sec.gov/files/913studyfinal.pdf.
[6] Bloomberg Law, supra note 5.
[7] SEC Guide to Broker-Dealer Registration, SEC Division of Trading and Markets (April 2008), https://www.sec.gov/about/reports-publications/investor-publications/guide-broker-dealer-registration.
[8] Id. at II.A.
[9] Id.
[10] Bloomberg Law, supra note 5.
[11] SEC Guide to Broker-Dealer Registration, supra note 8.
[12] Bloomberg Law, supra note 5.
[13] SEC Guide to Broker-Dealer Registration, supra note 8.
[14] Id. at II.A.-B.
[15] Bloomberg Law, supra note 5.
[16] SEC Guide to Broker-Dealer Registration, supra note 8.
[17] Id.
[18] Id.
[19] Id. at II.B.
[20] Id. at II.A.
[21] Bloomberg Law, supra note 5.
[22] SEC Guide to Broker-Dealer Registration, supra note 8.
[23] Bloomberg Law, supra note 5.
[24] Id.
[25] Id.
[26] SEC Guide to Broker-Dealer Registration, supra note 8.
[27] Bloomberg Law, supra note 5.
[28] SEC Guide to Broker-Dealer Registration, supra note 8.
[29] 15 U.S.C. § 78o(b)(13)(E)(iv).
[30] 15 U.S.C. § 78o(b)(13)(B)(i).
[31] 15 U.S.C. § 78o(b)(13)(B)(ii).
[32] 15 U.S.C. § 78o(b)(13)(B)(iii).
[33] 15 U.S.C. § 78o(b)(13)(B)(iv).
[34] 15 U.S.C. § 78o(b)(13)(B)(v).
[35] 15 U.S.C. § 78o(b)(13)(B)(vi).
[36] 15 U.S.C. § 78o(b)(13)(B)(vii).
[37] 15 U.S.C. § 78o(b)(13)(B)(viii).
[38] 15 U.S.C. § 78o(b)(13)(B)(ix).
[39] 15 U.S.C. § 78l(a).
[40] 15 U.S.C. § 78o(b)(13)(E)(iii)(I).
[41] 15 U.S.C. § 78o(b)(13)(E)(iii)(II).
[42] 15 U.S.C. § 78o(b)(13)(E)(iii)(II)(aa).
[43] 15 U.S.C. § 78o(b)(13)(E)(iii)(II)(bb).
[44] 15 U.S.C. § 78o(b)(13)(C).
[45] Paul Anka, SEC No-Action Letter, 1991 WL 176891 (July 24, 1991).
[46] Id.
[47] Id.
[48] Kristina Fausti, Comments at the SEC Twenty-Seventh Annual SEC Government Business Forum on Small Business Capital Formation Program (Nov. 20, 2008) (record of proceedings on file with the SEC).
[49] Brief for Appellee at 28, SEC v. Collyard et al. 861 F.3d 760 (8th Cir. 2016).
[50] See Brumberg, Mackey & Wall, P.L.C., SEC No-Action Letter, 2010 WL 1976174 (May 17, 2010).
[51] See Notice of Proposed Exemptive Order Granting Conditional Exemption from the Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Finders, 85 Fed. Reg. 64542 (proposed Oct. 13, 2020).
[52] See generally Paul Foley et al., SEC Proposes Exemption from Registration for Certain Finders, Akerman LLP (Oct. 15, 2020), https://www.akerman.com/en/perspectives/sec-proposes-exemption-from-registration-for-certain-finders.html, for a discussion on the proposed rule.
[53] SEC Strategic Plan: Fiscal Years 2022-2026, supra note 2.
[54] Bloomberg Law, supra note 5.
[55] See State v. Casper, 297 S.W.3d 676 (Tenn. 2009) (In addition, if found to be an unregistered broker-dealer, an unregistered Finder may have its agreements voided and may be required to return all finders fees received); 15 U.S.C. § 78cc(b).
[56] See Complaint, SEC v. Sky Group et al., No. 1:21-cv-23443 (S.D. Fla. filed Sept. 29, 2021).
[57] See Complaint, SEC v. Richard Eden et al., No. 1:22-cv-004833 (C.D. Cal filed July 14, 2022).
[58] SEC v. Sky Group et al., No. 1:21-cv-23443 (S.D. Fla. June 29, 2022); SEC v. Richard Eden et al., No. 1:22-cv-004833 (C.D. Cal 2023).
[59] William M. Stephens, Exchange Act Release No. 69090 (Mar. 8, 2013), available at https://www.sec.gov/files/litigation/admin/2013/34-69090.pdf.
[60] Id.
[61] 15 U.S.C. § 78cc(b).
[62] See, e.g., RCW 21.20.430 and ORS 59.115.
[63] Report and Recommendations of the Task Force on Private Placement Broker-Dealers (Am. Bar Ass’n 2005), https://www.sec.gov/info/smallbus/2009gbforum/abareport062005.pdf.