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October 2020

SEC Proposes New Rules Governing "Finders" to Clarify Broker Exemption Status

On October 7, 2020, the U.S. Securities and Exchange Commission ("SEC") voted to propose a new limited, conditional exemption from registration requirements for “finders” who assist issuers with raising capital in private markets from accredited investors. The proposed exemption SEC Release No. 34-90112 is long overdue. If adopted in final form, it would permit natural persons to engage in certain limited activities involving accredited investors without registering with the SEC as brokers.  The proposed exemption seeks to assist small businesses to raise capital and to provide regulatory clarity to investors, issuers, and the finders who assist them.

The problem of how to treat unregistered finders has been brewing in the securities industry for decades. In the Release, the SEC staff pointed out that the SEC “has not previously recognized a ‘finders’ exemption or exception, nor . . . broadly addressed whether and under what circumstances a person may “find” or solicit potential investors on behalf of an issuer without being required to register as a broker, or even whether such activity implicates the . . . regulatory regime for brokers.” For decades, market participants have looked to the courts or SEC staff no-action letters when seeking to avoid registration. Different facts and circumstances have led to conflicting results, with some requests resulting in no recommendation of an enforcement action, while others failing to obtain such relief.

While the vote intends to establish helpful guidelines for both registered broker activity and limited activity by finders that would be exempt from registration, there was not unanimity on the scope of the proposal. Commissioner Lee was very critical, stating that it is “flawed in both substance and procedure.”

The proposal, as published, would create two classes of finders, Tier I Finders and Tier II Finders. The proposed exemption for both 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 (typically, Section 4(a)(2) and Regulation D);
  • The Finder does not engage in 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 defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation.

A “Tier I Finder” is defined as a Finder who meets the above conditions and whose activity is limited to providing contact information of potential investors in connection with only one capital raising transaction by a single issuer within a 12-month period, provided the Tier I Finder does not have any contact with the potential investors about the issuer. The contact information may include, among other things, name, telephone number, e-mail address, and social media information.

A “Tier II Finder” is one who engages in solicitation-related activities on behalf of an issuer, that are 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.

The SEC proposed 44 questions for interested parties to consider and is seeking comments by the 30th day following the date of publication in the Federal Register (still pending). We also note that this proposal does not resolve state securities law positions on the finder’s exemption from registration as a broker.

The Gordon & Rees team will be monitoring the status of this proposal. If you have any questions please reach out to the authors below.

Banking & Finance

Lawrence Cohen
Craig S. Heryford

Banking & Finance