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SEC Proposes Exemptive Relief for Finders

After numerous calls for the U.S. Securities and Exchange Commission (SEC) to provide clarity on the role of “finders” in the capital markets ecosystem, the SEC sought to provide that clarity at a meeting held on October 7, 2020. The SEC’s proposed exemptive relief would create a nonexclusive safe harbor from broker registration for finders, which are natural persons seeking to engage in certain limited activities on behalf of issuers, subject to certain conditions and disclosure requirements.

The SEC began by stating that businesses must have access to robust capital markets to grow, and that it considered the facilitation of those markets a part of its mission. However, the SEC acknowledged that many small and emerging issuers encounter challenges accessing capital markets and connecting with interested investors due to either their size or geographic location, and thereby look to finders to bridge the gap. Finders, who facilitate connections with potential investors by offering limited and discrete services to issuers, have historically provided their services without definitive rules about when they are required to register as brokers under Section 15 of the Securities Exchange Act of 1934 (Exchange Act). This uncertainty has made it difficult for issuers looking to “play by the rules” to ascertain in what circumstances they may engage an unregistered finder. To alleviate this uncertainty, the proposed exemption would allow finders to offer certain services to certain issuers without registering as a broker, as long as they meet the conditions described below.

Availability of Exemption

The proposed exemptive relief would be available pursuant to Sections 15(a)(2) and 36(a)(1) of the Exchange Act and a “finder” would be permitted to rely on it if:

  1. The issuer is: (i) not required to file reports under Section 13 or Section 15(d) of the Exchange Act [i.e., companies that (a) are not listed on a securities exchange, (b) have not issued public equity or debt securities, and (c) do not exceed certain size thresholds] and (ii) is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act of 1933 (Securities Act);

  2. The “finder” (i) does not engage in general solicitation (the determination of which generally involves applying a variety of formal and informal tests to the specific facts and circumstances surrounding an activity or relationship); (ii) is not an associated person of a broker-dealer; (iii) 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; and (iv) provides services pursuant to a written agreement; and

  3. 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.”

Tiers of Finders

If the parties involved in the offering meet the above criteria, the exemptive relief further establishes service limitations and guidelines by dividing finders into two classes, each subject to its own conditions:

Tier I Finder

A Tier I Finder’s activity is limited to providing the contact information of potential investors for one capital-raising transaction by a single issuer in a 12-month period. A Tier I Finder may receive transaction-based compensation for its limited services but may not have any contact with a potential investor about the issuer.

Tier II Finder

A Tier II Finder is allowed to provide expanded services and may engage in solicitation activities, provided solicitation is limited to: (i) identifying, screening and contacting potential investors; (ii) distributing the issuer’s offering materials to investors; (iii) 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 (iv) arranging or participating in meetings with the issuer and investor.

However, because the SEC considers these limited activities of Tier II Finders to be solicitation activities, Tier II Finders would also be subject to certain disclosure requirements under the proposed exemptive relief. The following required disclosures may be provided to an issuer orally, but must be supplemented by written (paper or electronic) disclosure that satisfies all requirements no later than any related investment in the issuer’s securities. Furthermore, a Tier II Finder must obtain a dated, written acknowledgement from the investor that they have received:

  • the name of the Tier II Finder;

  • the name of the issuer;

  • the 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 his or her solicitation activities by the issuer and a description of the terms of such compensation arrangement;

  • 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.

Practice Points

The proposed exemptive relief will provide finders with clear lanes in which to operate. However, finders should be aware that: (i) it is only an SEC exemption and, unless relief is determined to preempt state statutes, various states may still require them to register as brokers; (ii) they are subject to all other applicable laws, including the antifraud provisions of the Securities Act and the Exchange Act and state law; and (iii) they still need to consider whether they are acting as another regulated entity that requires registration, such as an investment adviser or a municipal advisor. Additionally, the proposed exemption does not affect the rights of the SEC or any other party to enforce compliance with other applicable law, or the available remedies for violations of the law.

Issuers, on the other hand, should be aware that a Tier I or II Finder that complies with the proposed exemptive relief would not be subject to the broker/dealer sales practice rules created when the SEC passed their “Reg BI Package.” Furthermore, both finders and issuers should keep in mind that this is only a proposal; and while there appears to be added latitude to allow finders (subject to SEC standards and potentially the standards of the state in which finders and the parties they “find” are located) to provide services to foreign companies, as foreign issuers are not required to file reports under Section 13 or Section 15(d) of the Exchange Act regardless of size, there is no way to predict what the final relief will allow.

In conclusion, while the proposed exemptive relief does provide the clarity that market participants were seeking, finders and issuers should be aware of its limitations and note that the upcoming election may impact its adoption or implementation.

 

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume X, Number 295
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About this Author

Matthew Silver, Investment attorney, Drinker Biddle
Counsel

Matthew R. Silver works closely with investment management clients on broker-dealer and investment adviser regulation as well as private fund managers. He has experience counseling his clients on contractual drafting and negotiation issues; dealing directly with regulators including FINRA, the SEC, the NFA and the CFTC; advising on CFTC/NFA futures/swap issues; drafting the formation, operating and disclosure documentation for private funds; and negotiating ISDA swap documentation.

Matthew has worked on the M&A transactions...

215-988-2591
Stacie L. Lamb Financial Lawyer Drinker Biddle Law Firm
Associate

Stacie L. Lamb counsels a variety of clients in the investment management industry, including investment advisers and investment companies. Stacie advises on various fund types and structures, including exchange-traded funds (ETFs), and open-end and closed-end funds, as well as their advisers and independent trustees.

Prior to joining Drinker Biddle, Stacie was counsel for an investment management firm working with a large complex of ETFs. She also previously worked as vice president for a subsidiary of a global banking institution, where she worked...

312-569-1146
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