On Oct. 7, 2020, the Securities and Exchange Commission (SEC) proposed a limited and conditional exemption from broker registration for natural persons, referred to as “finders,” who seek to help non-reporting, private companies raise capital from accredited investors in exempt offerings, subject to certain conditions. Generally, persons who effect transactions in securities for the account of others cannot do so through interstate commerce unless the person is registered with the SEC. There has long been ambiguity about when or if finders, who seek to bridge the gap between businesses and investors by identifying potential investment opportunities, must register as broker-dealers with the SEC. The proposed exemption seeks to clarify the role and obligations of finders so that small businesses can more easily connect with the investments they need to succeed. In the current market, small businesses often struggle to identify potential investors, and few broker-dealers are willing to raise capital in the smaller transactions.
The proposal looks to create two classes of finders: Tier I Finders and Tier II Finders. These new classes of finders do not need to register as “brokers” under federal regulations if they adhere to certain requirements, including only offering exempt securities and soliciting only “accredited investors.” Tier I Finders are limited to only providing contact information of potential investors to the issuer, whereas Tier II Finders may conduct additional activities such as screening potential investors, distributing offering materials, discussing the offering generally (but without providing advice as to the investment’s value), and arranging or attending meetings between potential investors and the issuer. Because of the additional authority granted to Tier II Finders, those who wish to rely on this exemption must provide certain disclosures to potential investors, including the compensation arrangement with the issuer and a disclaimer to the investor that indicates: the finder is acting as the issuer’s agent, is not an associated person of a broker-dealer, and is not assuming a role to act in the investor’s best interest. Neither the Tier I nor Tier II Finders can structure transactions, negotiate terms, handle funds, prepare sales materials, preform analyses of the sales, engage in due diligence or provide financial support.
Currently, finders generally must comply with both state and federal registration requirements. To register with the SEC, a broker-dealer must apply to a self-regulatory organization, most commonly the Financial Industry Regulatory Authority (FINRA), and comply with any subsequent restrictions on business activities. In Ohio, dealers must be registered with the Ohio Division of Securities, and Ohio law offers very limited exemptions from such registration. Ohio Revised Code 1707.01(E) defines “dealer” as a person who engages in the business of the “purchase or sale of securities for the account of others in the reasonable expectation of receiving a commission, fee, or other remuneration.” As explained by the division in Ohio Securities Bulletin 2013:2 (May 2013), few exceptions apply to exempt finders from registration as dealers when they are receiving compensation, even indirectly, that is tied to the sale of securities. Thus, even if registration with the SEC is no longer required following adoption of the proposal, persons working as finders in Ohio likely will still need to register with the division or risk substantial penalties.
The proposed exemption has not yet been adopted, and there will be 30-day comment period for the exemption following its publication in the Federal Register. You can learn more about the types of permitted activities by the Tier I and Tier II Finders in a chart released by the SEC here, and you can read the full press release here.