SEC Proposes Conditional Registration Exemption for Finders

The Securities and Exchange Commission voted 3-2 on October 7, 2020 to publish for comment a proposed conditional exemption (Proposed Exemption), which would allow a natural person to act as a “finder” to connect accredited investors with issuers of private securities offerings without being registered as a broker under Section 15 of the Securities Exchange Act of 1934.¹ In a significant departure from current interpretations of “broker” status in court decisions and SEC staff interpretations, finders qualifying for the Proposed Exemption would be permitted to receive securities transaction-based compensation. The Proposed Exemption was published in the Federal Register on October 13, 2020 with a comment period ending November 12, 2020.

Brief Summary of Proposal

The Proposed Exemption would create two categories of finders in the context of capital raising transactions:

• Tier I Finders could only provide the contact information of potential investors to a single issuer in connection with a single capital raising transaction within a 12 month period, and could not have any contact with the potential investors about the issuer.
   
• Tier II Finders would be allowed to engage in the following solicitation-related activities on behalf of an issuer:
   
• Identifying, screening and contacting potential investors;
   
• Distributing offering materials to potential investors;
   
• Discussing issuer information included in offering materials, but not advising as to the valuation or advisability of the investment; and
   
• Arranging or participating in meetings with the issuer and potential investors.

In order to rely on the Proposed Exemption, both Tier I and Tier II Finders would be required to comply with the following conditions:

• The issuer does not file reports with the SEC under Section 13 or 15(d) of the Exchange Act;
   
• The issuer relies on an applicable exemption from registration under the Securities Act of 1933 to conduct the securities offering;
   
• The finder does not engage in general solicitation;
   
• The potential investor is, or the finder has a reasonable belief that the potential investor is, an “accredited investor” as defined in Rule 501 of Regulation D;
   
• The issuer and finder enter into a written agreement describing the services provided by the finder and the associated compensation;
   
• The finder is not associated with a broker-dealer; and
   
• The finder is not subject to “statutory disqualification” as defined in Section 3(a)(39) of the Exchange Act.

Given their expanded range of permissible activity under the Proposed Exemption, Tier II Finders would be required to provide potential investors with certain disclosures related to a solicitation prior to or at the time of the solicitation. Additionally, Tier II Finders would be required to obtain from the investors a dated written acknowledgement of receipt of such disclosures, prior to or at the time of any investment in the issuer’s securities.

Stated Goals of Proposal

The Proposed Exemption is a response to years of industry requests for regulatory clarity regarding the scope of permissible finder activity. As noted by SEC Chairman Jay Clayton, this clarification would help facilitate capital formation for smaller issuers in particular, as private markets may be their only source of capital growth, and finders can “play an important and discrete role in bridging the gap between small businesses that need capital and investors who are interested in supporting emerging enterprises.”²

Impact of the Exemption

If adopted, the Proposed Exemption would provide a clear framework for finders to facilitate primary offerings of unregistered securities by a range of unregistered issuers without the costs of registering as or being associated with broker-dealers. Currently, finders (and the issuers engaging them) must rely on a multi-factor, facts-and-circumstances-based analysis pieced together from SEC guidance and no-action letters. Notably, the ability for both Tier I and Tier II Finders to accept transaction-based compensation is a dramatic departure from recent SEC no-action letters (and denials of no-action requests) that suggested the existence of transaction-based compensation is a convincing (if not dispositive) factor triggering a broker-dealer registration requirement.³

While the Proposed Exemption seeks to help, and is likely to have the most impact on, issuers that are too small to attract venture capital and other professional sources of capital, it includes no limits on issuer size. If adopted, the Proposed Exemption may be relied on by private funds, which are particularly well situated to take advantage of it; private funds typically rely on Regulation D to avoid registration under the Securities Act and usually sell their securities only to “accredited investors,” whether or not they engage a finder.

Effectiveness/Timing

The 30-day comment period for the Proposed Exemption expires on November 12, 2020. If there is an Administration change following the U.S. presidential election, it is not clear that the Proposed Exemption will be adopted as final, at least not without being significantly altered. Even if the Proposed Exemption is finalized, a new Administration, consistent with prior changes in control of the White House, may well stay the effectiveness of the Proposed Exemption pending review.

Footnotes

1) Notice of Proposed Exemptive Order Granting Conditional Exemption from the Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Finders, Rel. No. 34-901112 (Oct.  7, 2020).

2) SEC Chairman Jay Clayton, Public Statement on Open Meeting on Proposed Finders Exemption – Providing Regulatory Clarity to Benefit Small Businesses (Oct. 7, 2020).

3) See e.g., John Wirhlin, SEC No-Action Letter (Jan. 19, 1999); C&W Portfolio Management, Inc., SEC No-Action Letter (July 20, 1989); Dominion Resources, Inc., Revocation of Prior No-Action Relief Granted (Mar. 7, 2000).