Securities Regulation Daily Advisory committee endorses SEC’s proposed finders exemption
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Monday, November 9, 2020

Advisory committee endorses SEC’s proposed finders exemption

By Amanda Maine, J.D.

While the committee spoke favorably of the proposed exemption, it also made suggestions for the Commission to keep in mind as it drafts a final exemptive order.

The SEC’s Small Business Capital Formation Advisory Committee met to discuss the Commission’s proposed exemptive order that would permit natural persons to engage in certain limited activities on behalf of issuers ("finders") without registering as brokers under Section 15 of the Exchange Act. The purpose of the proposed exemption is to help small businesses raise capital and to provide regulatory clarity to investors, issuers, and the finders who assist them. Most committee members voiced their approval of the proposed exemption but sought clarification on some matters. The committee approved a draft of recommendations for the Commission to consider before it acts on the proposed finders exemption.

Tiers. Under the proposed exemption, which the Commission approved for comment on a 3-to-2 vote last month, two classes of finders would be created: Tier I and Tier II. A Tier I finder would be limited to providing contact information of potential investors in connection with only a single capital-raising transaction by a single issuer in a 12-month period and could not have any contact with a potential investor about the issuer. A Tier II finder could solicit investors on behalf of an issuer with limitations on the solicitation-activity: (1) identifying, screening, and contacting potential investors; (2) distributing issuer offering materials to investors; (3) 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 (4) arranging or participating in meetings with the issuer and investor. Both tiers of finders would be subject to additional restrictions, such as not engaging in general solicitation, having a reasonable belief that the investor is an accredited investor, and limitations on participating in the offering itself.

Committee member Youngro Lee, CEO of NextSeed, said he sees the two tiers fitting two types of finders. One type includes "good-intentioned people and organizations" such as nonprofits, local professionals, and community leaders. These finders are not trying to make a living by being a finder but do want to help businesses in their communities raise capital. Having a rule that allows these types of reasonable conversations can benefit local small businesses, Lee explained, stating that these would probably fit under Tier I.

The second type includes individuals who do want to make a living as a finder but do not want to register as a broker-dealer, either because they don’t want to get a broker-dealer license or they can’t due to disciplinary history, Lee advised. In order to discourage bad actors from taking advantage of this exemption (which would most likely fall under Tier II), the SEC could require these finders to make certain disclosures and to keep records and documentation of communications that they must produce to the SEC if asked. This approach would result in lower costs compared to those of a broker-dealer, but would still be in the "spirit" of broker-dealer regulation when it comes to transparency, according to Lee. Jeff Solomon, CEO of Cowen, Inc., agreed with Lee’s assessment, suggesting that the "specter of an SEC audit" could help deter bad actors.

Need for clarification. Other committee members asked that the Commission clarify some aspects of the proposed exemption. Sara Hanks, CEO of CrowdCheck, had concerns about what the SEC means by "one capital-raising transaction in a 12-month period." Greg Yadley of Shumaker, Loop & Kendrick echoed Hanks’ concerns, stating that it would unnecessarily restrict finders if they are only allowed to work with one issuer on one offering in one year. "That’s not how the real world works," he commented.

Yadley also suggested that a simple notice filing could go a long way to making sure that the new regime works. Such a filing would name the offering, the finder’s contact information, the amount being raised, and the finder’s compensation, he said. The filing should be filed both with the Commission and with the relevant state regulator. This would give the states the opportunity to investigate the activities of finders and give the SEC the ability to gather data to analyze how the rule is working and to determine if it is being abused, Yadley advised.

Catherine Mott, CEO of BlueTree Capital Group, asked if the SEC would clarify that finders would be limited to natural persons rather than creating a business that will turn around and sell names to desperate people looking for money. She also inquired whether the prohibition on general solicitation means that a person cannot advertise their services as a finder. Mott would also like the SEC to provide some structure around what is considered "reasonable" compensation and fees. The SEC should also make clear whether the exemption would preempt state securities exemptions, she said, calling for consistency.

View from the states. Maryland Securities Commissioner Melanie Senter Lubin, who represents the North American Securities Administrators Association (NASAA) on the committee, said that state securities regulators oppose the proposed exemption for finders, calling it another instance where the Commission is seeking to facilitate capital formation at the expense of investor protection. According to Lubin, there are a lot of bad actors and that giving a pass to finders gets rid of the gatekeeper function for catching them. She echoed the dissents of Commissioners Lee and Crenshaw, who said that the proposed exemption would undermine longstanding staff interpretations about when broker-dealer obligations would apply to finders.

If the Commission does move forward with the exemption, Lubin said it should only apply to natural persons because permitting entities to come into this space opens the door to boiler rooms and other fraudsters acting under the imprimatur of an SEC exemption. In addition, finders should be required to do their own due diligence before making a recommendation, particularly if being a finder is their career. Only persons in the U.S. should be able to use the exemption so regulators can reach the wrongdoers through enforcement actions, she added. The exemptive order should also include guidance on conflicts of interest that need to be disclosed. Lubin concluded her remarks by stating that the SEC should not move forward on the proposal until it engages with the states and other SROs to hash out the various issues she raised.

Recommendation. Committee Chair Carla Garrett of Potomac Law Group presented a draft of the committee’s recommendations, which was approved unanimously. The recommendation, which Garrett said would be refined, states that in order to promote small business capital formation, especially for underrepresented businesses (such as minority- and women-owned businesses) and businesses that are not in regions with robust capital-raising networks, the committee supports a framework to permit certain finders to engage in limited capital-raising activities involving accredited investors with the following principles in mind:

  • The framework should be kept simple.
  • The framework should keep out bad actors.
  • The Commission should consider requiring a notice filing for all finders.
  • The Commission should work with state securities regulators to provide additional certainty for market participants.
  • The Commission should consider a blanket exemption for finders for offerings under a certain size.
  • The Commission should consider the issue of fees to finders, including the reasonableness of finders’ fees and/or limits on the amount of fees.
  • The Commission should add clarity on prohibited and permissible activities, such as the one-time per year requirement, the natural persons requirement, and whether broker-dealers are allowed to pay Tier II finders that are non-associated persons.

MainStory: TopStory BrokerDealers FederalPreemption FinancialIntermediaries FraudManipulation GCNNews PrivatePlacements SECNewsSpeeches SecuritiesOfferings

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