Introduction 

In a three to two vote, the commissioners of the Securities and Exchange Commission (“SEC”) recently approved a proposed exemptive order (the “proposed exemption”) that would permit, subject to certain conditions, a natural person to engage in certain defined activities on behalf of an issuer (a “Finder”) without registering as a broker under Section 15(a) of the Securities Exchange Act of 1934 (the “Exchange Act”). Under the proposed exemption, a Finder would be able to engage in the defined activities (described below), including, for example, introducing accredited investors to private issuers and receive transaction-based compensation without being registered as a representative of a broker.

The proposed exemption would be limited and conditional, but will likely have an impact on the private fund industry. The significance of the impact will depend on the limitations and conditions included in the final exemption.

The proposed exemption represents a significant development as the SEC has not previously recognized a Finders exemption from the requirement that such persons be registered as brokers under Section 15(a) of the Exchange Act.

The Proposed Exemption

The SEC proposed to exempt two categories of Finders, Tier I Finders and Tier II Finders. The proposed exemption for Tier I and Tier II Finders would be available only when:

• The issuer is not required to file reports under Section 13 or Section 15(d) of the Exchange Act;
• The issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act of 1933 the “Securities Act”;
• The Finder does not engage in general solicitation;
• The potential investor is an “accredited investor” as defined in Rule 501 of Regulation D under the Securities Act or the Finder has a reasonable belief that the potential investor is an “accredited investor”;
• The Finder has a written agreement with the issuer that covers services and compensation;
• The Finder is not an associated person of a broker-dealer; and
• The Finder is not subject to “statutory disqualification”, as defined in Section 3(a)(39) of the Exchange Act, at the time of Finder’s participation.

Tier I Finders:

In addition to satisfying the conditions above, the proposed exemption for a Tier I Finder would limit the Finder to providing contact information of potential accredited investors in one capital raising transaction by a single issuer in a twelve-month period. Therefore, a Tier I Finder can introduce multiple potential investors but only to one issuer in a 12-month period. A Tier I Finder may not have any contact with potential investors about the issuer.

The proposed exemption for Tier I Finders follows the approach taken in the Paul Anka no-action letter (Paul Anka, SEC Staff No-Action Letter, July 24, 1991. In the Paul Anka no-action letter, the SEC staff stated that it would not recommend enforcement action against the entertainer, Paul Anka, who was not registered with a broker-dealer, for entering into an agreement with an issuer (a hockey team) to provide to the issuer a list of names and telephone numbers of potential investors he reasonably believed to be accredited investors with whom he had pre-existing relationships. The SEC staff acknowledged he had no further contact with potential investors concerning the issuer. Mr. Anka received a finder’s fee for providing the list.

Tier II Finders:

Provided a Tier II Finder satisfies the conditions bulleted above to comply with the proposed exemption, the Tier II Finder would be permitted to engage in the following solicitation activities on behalf of an issuer:

• Identifying, screening, and contacting potential investors;
• Distributing offering materials to investors;
• Discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice regarding the valuation or advisability of the potential investment; and
• Arranging or participating in meetings with the issuer and investor.

What Finders Can’t Do

The proposed exemption for Tier 1 and Tier II Finders is a safe harbor; neither type of Finder could engage in the following activities:

• Structuring or negotiating the terms of the offering;
• Handling funds or securities related to the offering;
• Binding or obligating the issuer or investor;
• Preparing sales materials;
• Performing any independent analysis of the sale;
• Engaging in “due diligence” activities;
• Assisting or providing financing for the offering;
• Providing advice as to the valuation or financial advisability of the investment; or
• Engaging in any other activity requiring broker-dealer registration.

What Issues Does the Current Proposal Raise 

Below is a discussion of certain potential issues related to the SEC’s proposed exemption.

No State Consideration. The SEC stated in its Notice addressing the proposed exemption that “…this exemption would not affect a Finder’s obligation to continue to comply with all other applicable laws, including the antifraud provisions of the Securities Act and the Exchange Act, such as the obligations under Section 10(b) and Rule 10b-5 under the Exchange Act, and state law.” The potential benefits of the proposed exemption could be limited or mitigated if states do not provide similar exemptive relief or if the adopted exemption Order does not preempt state regulation of Finders. In either case, anyone seeking to rely on the proposed exemption would have to analyze state regulation and, in many instances, become registered as a representative or “associated person” of a broker-dealer in the states in which they are active, which would disqualify such person from relying on the proposed exemption.

The SEC may adopt an approach similar to the one that Congress did when it passed the National Securities Market Improvement Act (“NSMIA”) of 1996. NSMIA harmonized federal and state securities law and regulation by preempting state securities offering registration requirements when an issuer relies on Rule 506 of Regulation D, while allowing states to require notice filings of securities offerings in their jurisdictions. This balance between federal and state regulation allows for greater access to capital formation, while giving the states the ability to detect unregistered offerings in their jurisdiction that may be fraudulent. A similar registration preemption coupled with a notice filing approach to a Finders exemption could achieve the same goals.

Tier I Finders are limited to one capital raising transaction by a single issuer in a twelve-month period. This condition is likely so narrow because the Tier I exemption is intended for people that the SEC believes are not actually “engaged in the business of effecting securities transactions for the accounts of others” and, therefore, not a broker. However, the people most likely to benefit from the proposed Tier I exemption, such as private fund investors who provide contact information on other potential investors to a fund manager, would be more likely to rely on the Exemption Order if it allowed them to engage in more than one capital raising transaction per 12-month period. As the SEC receives comments on the current draft of the Exemption Order, it may consider less restrictive alternative conditions for meeting the Tier I exemption. One promising alternative may be to permit more than one transaction in a 12-month period, with a dollar limit on the amount earned in that 12-month period.

Natural persons. The proposed exemption for Tier I and Tier II Finders would be available only to natural persons. This limitation may be reasonable for Tier I Finders, but if a person is going to regularly solicit investors, they most likely want to form a legal entity to do so. It is unlikely that many people would want to engage in the more active solicitation role permitted under the Tier II exemption without the benefit of the legal separation of a company’s activities, assets and liabilities.

Conclusion

By proposing the exemption, the SEC is acknowledging that Finders can play an important role in facilitating capital formation for smaller issuers and private funds. An exemption from full broker registration for Finders assisting small businesses is long overdue. While allowing some Finders to forego broker registration may raise investor protection concerns, a notice filing requirement for such persons (to the SEC and states) may help mitigate this concern.

Please contact Seward & Kissel’s Investment Management Group to assist you with any questions about the proposed exemption.