There has been a consistent gray area and longstanding confusion in securities law when it comes to unregistered intermediaries, commonly known as Finders, receiving commissions for soliciting investors on behalf of companies. The U.S Securities and Exchange Commission (SEC) has recently proposed a conditional exemption to the broker registration rules that would permit these intermediaries to find investors for small companies who face limited financing options. This conditional exemption was proposed by a 3-2 vote on October 7, 2020, after many years of industry participants calling for clarity regarding Finders’s ability to receive compensation for securities and sales. Previously, the SEC decided whether a Finder crossed into unregistered broker-dealer territory (and this violated securities laws) on a case-by-case basis.
The exemption proposed by the SEC would create two new classes of Finders: Tier I Finders and Tier II Finders. These tiers will be differentiated by the level, extent, and frequency of their activities on behalf of the issuer. Tier I Finders and Tier II Finders would both be permitted to accept compensation based on their transactions. To qualify for the proposed exemption, however, each tier of Finder would need to comply with certain conditions associated with their tier. Tier II Finders will have to comply with more stringent conditions.
As determined by the SEC, the exemption would only apply to certain private offerings of securities (Permitted Offerings). The activities of both Tier I and Tier II Finders would only be considered exempt if in connection with offerings that meet the following conditions:
Tier II Finders will also be required to provide specific information to a potential investor, before or at the time of the solicitation, including:
The disclosure should be provided in writing but can be provided orally at the time of the solicitation if it is supplemented in writing. The Tier II Finder must then obtain a written acknowledgement of the disclosures from the issuer. The written disclosure and acknowledgement can be provided in physical paper form or electronically.
Both Tier I and Tier II Finders will have to deal with several restrictions, and neither will be able to rely on this proposed exemption to engage in broker activity beyond the scope of the exemption. A Finder cannot use this proposed exemption to facilitate a registered offering, a resale of securities, or the sale of securities to unaccredited investors.
Further, according to the SEC proposed exemption, a Finder could not (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 with or provide financing for such purchases; or (vii) provide advice as to the valuation or financial advisability of the investment.
Two SEC commissioners dissented due to their concern that these conditional exemptions would increase activity in murky private markets that may be prone to fraud. Commissioner Caroline A. Crenshaw expressed concern that the exemption may erode existing investor protections while Commissioner Allison Herren Lee called for a scaled registration model. Both commissioners criticized the exemption’s lack of strict requirements for recordkeeping and inspection by the SEC. Their dissent does call into question the validity of these exemptions and whether the proposed exemptions will be passed.