- The SEC recently proposed to exempt certain finders from federal requirements to register as a broker
- Massachusetts regulators are opposed to the relief and retain state remedies for unregistered broker activity
The SEC recently proposed to grant an exemption to certain “finders” who would otherwise be required to register as brokers under the Securities Exchange Act of 1934. The relief is conditioned on compliance with
specific limits on their activities. While the proposal is undoubtedly a welcome relief to matchmakers who help companies find investors, the proposal doesn’t affect their obligations under state law. Even if the SEC grants the proposed relief, finders operating in Massachusetts must still register as brokers with the Commonwealth of Massachusetts or face the risk of enforcement action. The state official charged with enforcing Massachusetts’ securities laws, William Galvin, has taken a strong public position against the SEC’s proposed relief.
The SEC’s proposed exemption would apply to two tiers of finders. Certain requirements would apply to both tiers. As proposed, all finders must be natural persons; they may not be associated with any broker-dealer; they may only assist with private placements that do not involve any general solicitation; and they may not serve public companies. Furthermore, no person statutorily disqualified from serving as a broker (such as individuals barred from the securities industry) can rely on the exemption. All finders must enter into a written agreement with the offering company. Importantly, the relief makes clear that a finder may receive compensation based on the success of the offering, including a percentage of the funds raised.
The exemption for the first tier of finders (Tier 1) is quite narrow. Tier 1 finders may participate in only one offering every twelve months and may not contact or participate in any meetings with investors. Essentially, the Tier 1 exemption would codify, and slightly expand, the SEC’s often-misconstrued Paul Anka no-action letter, which allowed a company to pay the entertainer Paul Anka transaction-based compensation in exchange for providing a list of potential investors. Because of these restrictions, the Tier 1 exemption is unlikely to be useful to anyone proposing to act as a finder for a living; instead, it may be helpful to someone hoping to receive a payment in exchange for making referrals only on rare occasions.
The exemption for Tier 2 finders would be more useful to persons who want to make a business out of being a finder. Because the exemption is available only to individuals (but not corporations, limited liability companies or partnerships), the exemption carries enhanced risks of personal liability and limits the business’ ability to grow. Tier 2 finders can help companies identify, screen and contact investors, and they can also participate in meetings and discuss issuer information with investors. They cannot make recommendations, offer opinions on valuation, prepare offering materials or conduct due diligence. As several commenters (including industry participants FINRA and SIFMA) have noted, these limitations are perhaps unrealistic, since these activities are among the core services that many issuers would expect finders to perform. The exemption would also require Tier 2 finders to make up-front disclosures to investors about the finder’s role, including compensation and conflicts of interest, and to obtain a written acknowledgement of that disclosure before the investment is made.
Even if armed with an exemption at the federal level, finders must be mindful of applicable state law. Under Section 201(a) of the Massachusetts Uniform Securities Act, it is unlawful for any person to transact business in Massachusetts as a broker-dealer or agent unless the person is registered under the act. Other states have similar requirements. The activities that Tier 2 investors would be permitted to perform under the SEC’s proposed relief include many of the traditional hallmarks of broker-dealer activity, including receiving transaction-based compensation and soliciting investors on behalf of the issuer. The SEC’s exemptive relief would not override state-level registration requirements. As a result, any individual proposing to rely on the SEC’s relief would still need to examine state law to determine whether he or she could perform any of the permitted Tier 2 finder activities without running afoul of state law.
In Massachusetts, finders can expect a chilly reception from regulators. William Galvin, the Secretary of the Commonwealth of Massachusetts, filed a public letter opposing the proposed relief, stating that the proposal “would deregulate problematic sales practices in a high-risk segment of the market.” Secretary Galvin noted that the relief imposes no minimum qualifications, no examination or reporting requirements, and no minimum requirements of experience. Like FINRA, he expressed the view that it is unrealistic to expect unregistered finders to abide by the prohibitions on making recommendations or helping with offering materials. Finders would not be subject to any requirement to act in the best interests of investors, nor would they be held to the same high standards of commercial honor expected from registered brokers. Without registration, finders would be “invisible” to regulators until after investors have been harmed. Instead, Secretary Galvin prefers that persons receiving transaction-based compensation continue to be subject to regulatory oversight.
With the change in the Presidential administration, the recent departure of Jay Clayton, the Chairman of the SEC, and vocal opposition from some key industry participants, the proposed exemptive relief has an uncertain future. Even if the proposal is adopted in its current form, both finders and issuers wanting to engage them for fundraising should first consult with counsel about potential ramifications under state law.