Does a “Finder” of Corporate Financing Need to Register Under the Securities Laws to be Compensated?
When a business seeks to raise capital, many use third parties to find investors and serve as an intermediary between investors and the company, as an issuer of securities. Such intermediaries are generally referred to as “finders.” In this scenario, both the company and finder need to be wary of whether the finder meets the definition of a “broker,” such that he or she may be required to register with the U.S. Securities and Exchange Commission (“SEC”).
Section 15 of the Securities Exchange Act defines a broker as “any person engaged in the business of effecting transactions in securities for the account of others.” See 15 U.S.C. § 78c(a)(4). A so-called “finder’s exemption” has evolved out of the SEC’s “no-action letters,” generally determining that a finder is not a “broker” in certain situations. These no-action letters involve a case-by-case factual analysis involving numerous factors, including the extent of the finder’s role in setting up the transaction, how the finder was paid, and how the transaction was structured.
The factor the SEC looks most heavily towards in determining registration questions is whether the person received transaction-based compensation, i.e., a commission, in connection with the sale of securities. “[A]s a general matter, a person that receives a percentage of a commission or transaction-based compensation would be required to register as a broker-dealer.” See John M. McGivney Sec., Inc., SEC No-Action Letter (May 20, 1985). The SEC has explained that, “[t]hose persons engaged in effecting securities transactions for the account of others, and particularly those persons who receive a commission for their efforts based on the cost of the exchange of securities or the amount of securities placed, are brokers or dealers in securities.” See Securities Investor Protection Corp., SEC No-Action Letter (July 14, 1973).
Indeed, the SEC in recent years has taken a stricter approach in requiring finders to register as a broker when receiving commissions based on their role in a sale of securities. See John W. Loofbourrow Associates, Inc., SEC No-Action Letter (Jan. 29, 2006)(SEC refused to issue no-action relief when fee paid to finder would be commission-like arrangement tied to size of securities offered and then placed); Brumberg, Mackey & Wall, SEC No-Action Letter (May 17, 2010)(SEC denied finder’s no-action request, finding that the receipt of transaction-based compensation is “a hallmark of broker-dealer activity.”).
On the other hand, the SEC occasionally has found that even a commission-based fee will not require a finder to register, in particular, in the absence of any role whatsoever in the negotiations between the parties introduced by the finder. See Paul Anka, SEC No-Action Letter, 1991 WL 176891 (July 24, 1991). In this case, the SEC did not require the finder’s registration because, despite the clear use of transaction-based compensation, the finder only provided to a particular issuer the names of potential investors with whom he had a pre-existing business or personal relationship. Id. The SEC determined that the finder was not required to register as a broker-dealer because the finder did not participate in any negotiations, did not provide other services to facilitate the transactions such as underwriting or preparing sales literature, and did not make recommendations to enter into the transactions. Id.
A finder of financing for a business may also argue that he did not sell “securities,” but instead acted more like a business broker, i.e., he sold a controlling interest in an entire business as opposed to merely an issuance of securities. The SEC, however, generally finds that “business brokers” are required to register as a “broker,” unless they meet a myriad of factors beyond simply structuring the transaction as a sale of a business rather than a transfer of securities. See Victoria Bancroft, SEC No-Action Letter (Aug. 9, 1987); Int’l Business Exchange Corp., SEC No-Action Letter (Dec. 12, 1986); Country Business, Inc., SEC No-Action Letter (Nov. 8, 2006). The factors include, but are not limited to, the following:
- the finder will have a limited role in negotiations between the seller and potential purchasers;
- the finder will only advertise and/or offer for sale the business’ assets;
- the finder will not advise the two parties whether to issue securities, or otherwise to effect the transfer of the business by means of securities, or assess the value of any securities sold; and
- the finder’s compensation will be determined prior to the decision on how to effect the sale of the business and based upon the consideration received by the seller, regardless of the means used to effect the transaction and will not vary according to the form of conveyance (i.e., securities rather than assets).
In sum, a finder’s registration is largely a case-by-case, fact-specific determination that appears to involve a considerable degree of discretion by the SEC. As such, finders accepting transaction-based compensation must be wary of the above factors so that they do not unknowingly fall prey to the SEC’s registration requirements.
Evan H. Frederick is an associate with Rabin Kammerer Johnson in West Palm Beach. He practices in the areas of business, securities and whistleblower litigation.