SEC Proposed Exemption to Broker Registration Rules

Originally published by Brent Perry.

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.

Details of the Proposed Exemption to Broker Registration

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:

• 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;
• 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 that term is defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation.

Tier I and II Details

• Tier I Finders:  Tier I Finders will be limited to providing only the contact information of potential investors connected with a single capital raising transaction by a single issuer over a 12-month period. A Tier I Finder is not allowed to have any contact with a potential investor about the issuer; they are only passing information. This category would codify existing no-action letter guidance from the SEC.
• Tier II Finders: Tier II Finders have a wider range of permitted activities when compared to Tier I Finders. They will also have to comply with additional conditions. A Tier II Finder would be permitted to have contact with potential investors in connection with a Permitted Offering and will be permitted to solicit investors on behalf of an issuer. Those solicitation activities would be limited to:
  • Identifying, screening, and contacting potential investors;
  • Distributing issuer offering materials to investors;
  • 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
  • Arranging or participating in meetings with the issuer and investor.

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 name of the Tier II Finder;
• The name of the issuer;
• A description of the relationship between the Tier II Finder and the issuer, including any affiliation;
• A statement that the Tier II Finder will be compensated for their solicitation activities by the issuer and a description of the terms of that compensation;
• Any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and
• An affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest.

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.

The post SEC Proposed Exemption to Broker Registration Rules appeared first on Burford Perry.

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