SEC Proposes "Finders" Exemption to Help Small Businesses Raise Capital

4 min

On October 7, 2020, the Securities and Exchange Commission (SEC) issued a notice proposing a new limited, conditional exemption (the Proposed Exemption) from broker registration requirements of Section 15(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act), for finders who assist private companies or funds with raising capital from accredited investors. If adopted, the Proposed Exemption would permit natural persons to engage in certain fundraising activities, as explained further below, without registering with the SEC as brokers. In the press release announcing the Proposed Exemption, Chairman Jay Clayton expressed hope that the Proposed Exemption would help small businesses raise additional capital by clarifying the ambiguity surrounding the scope of a finder's permitted activity.

The Proposed Exemption would create two classes of finders, Tier I Finders and Tier II Finders, based on the types of activities in which they engage, and requires that the following conditions exist for both classes of finders:

  • 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 of 1933, as amended;
  • 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 (the private company or fund) 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.

Tier I Finders may only provide potential investors' contact information (including name, telephone number, e-mail address, and social media information) to a single issuer in relation to one capital-raising transaction by the issuer during a 12-month period. Tier I Finders may not participate in multiple capital-raising transactions during a 12-month period and may not provide information regarding the issuer to potential investors (or have any contact with the potential investors about the issuer).

Tier II Finders would be permitted to engage in multiple capital-raising transactions during a 12-month period and in the following additional solicitation-related activities beyond those permitted for Tier I Finders: (i) identifying, screening, and contacting potential investors; (ii) distributing issuer offering materials to investors; (iii) discussing issuer information included in any offering materials, as long as no advice regarding the valuation or advisability of the investment is provided; and (iv) arranging or participating in meetings with the issuer and investor. Tier II Finders would also need to provide potential investors with certain disclosures, including the names of the Tier II Finder and the issuer, a description of the relationship between the Tier II Finder and the issuer, a description of the compensation arrangement and any material conflicts of interest between the Tier II Finder and issuer, and a statement that the Tier II Finder is an agent of the issuer and is not undertaking to act in the investor's best interests. Tier II Finders would also need to obtain from the potential investor a written acknowledgment that such disclosures have been provided.

The Proposed Exemption notes that while other forms of solicitation exist, only the types of activities stated above are permissible under the Proposed Exemption. Finders would still not be able to participate in many activities conducted by broker-dealers, including (i) structuring the transaction, (ii) negotiating the terms of the offering, (iii) handling customer funds or securities, (iv) preparing sales materials, (v) engaging in due diligence activities, (vi) performing an independent analysis of the sale, or (vii) providing financing for the investment or advice as to the valuation or financial advisability of the investment. While the proposed rule would provide much-needed clarity and flexibility, these restrictions will continue to present challenges for finders, as many of the restricted activities are natural outgrowths of the advice sought by issuers that are not otherwise inclined (or able) to engage a registered broker-dealer.

There will be a 30-day comment period once the proposal is published in the Federal Register, which is expected to occur this month. Commissioners Lee and Crenshaw did not support the Proposed Exemption. Commissioner Lee noted that under the Proposed Exemption, Tier II Finders could participate in many activities traditionally reserved for broker-dealers without the investor protections that come with registration as a broker-dealer. Commissioner Crenshaw expressed concern that the Proposed Exemption would further the growth of opaque private markets, which are already prone to higher transaction costs, valuation errors, and fraud while eroding investor protections.

*          *          *

Anyone having questions about this client alert should contact members of our Securities Practice Group: Eric R. Smith at ersmith@Venable.com, Carmen M. Fonda at cmfonda@Venable.com, William N. Haddad at wnhaddad@Venable.com, Michael A. Leber at mleber@Venable.com, Jeffrey N. Ostrager at jnostrager@Venable.com, Gabriel M. Steele at gmsteele@Venable.com, Thomas D. Washburne, Jr. at twashburne@Venable.com, Darius Alam at dralam@Venable.com, or Mario Richards at marichards@Venable.com