Hot off the Press: SEC Proposes Conditional Exemption for Finders

It has been over three years since the SEC’s Advisory Committee on Small and Emerging Companies recommended (by a split vote) that the SEC should propose a conditional exemption for finders from the broker registration requirements of Section 15(a) of the Exchange Act for certain capital raising activities involving accredited investors. Last week, the SEC finally issued such a proposal. 

This is potentially big news! I’ve spent countless hours advising emerging companies about issues related to the retention of “finders” to assist with fundraising. For almost 30 years, these “finders” have been pointing to the Paul Anka no action letter* (from 1991) as evidence that they can be compensated for helping raise capital without being registered as brokers. 

The problem with the Paul Anka precedent is twofold. First, it is based on a very narrow situation that rarely matches the actual circumstances faced by people who regularly work to help emerging companies find capital. Mr. Anka only did it once in his life, and he never had any contact with the potential accredited investors about the investment. Second, given the SEC’s stance on the need for broker registration for anyone receiving transaction-based compensation in these situations, the SEC had essentially stated in recent times that, if it had a “do over,” even on the limited Anka facts, it likely wouldn’t have provided no action relief in the current regulatory climate. 

Given the limited potential relevance of the Anka precedent, I’ve frequently been the bad guy in these conversations. I’ve been forced to explain to my clients why they can’t legally pay “transaction-based compensation” (i.e., a commission) to people not registered as brokers in capital raising transactions. I’ve had to help clients understand the real risks involved, not just risks of enforcement actions or investor rescission rights, but also the potential impact on future capital raising and/or liquidity events. 

I won’t bore you with all the details of the proposal (I’ll save that for a post after we see what, if any, final exemption is adopted), but it includes a two-tier system of finders who can engage in limited activity with accredited investors on behalf of an issuer. The type of permitted activity, required disclosures, and frequency of engagement depends on the tier. There’s this handy chart, which shows the differences between the two tiers and registered brokers in terms of permitted activity. We’ll also have to see what types of “written disclosure to investors” is required for “Tier II Founders” before knowing the full extent of the hassle factor. 

Assuming that the SEC eventually adopts a final exemption (nothing is guaranteed and timing is unknown), I know it will be a potentially significant tool to help many entrepreneurs who have been clamoring for ways to get help to network with accredited angel investors. BTW--it is clear from the release that the exemption does NOT apply to activity before such final adoption, so don’t get too far ahead of yourselves. 

* For fans of popular music, yes that Paul Anka! The same guy who had more than 30 hits that cracked the Billboard Top 40 between the late 1950’s and mid-1970’s, including chart topping hits like “Diana,” “Lonely Boy,” and “(You’re) Having My Baby.”