In theory, only broker-dealers registered under section 15 of the Exchange Act are allowed to receive compensation for connecting issuers with investors. In practice, the world of private securities includes lots of folks we refer to as “finders.” Like bumblebees, these folks should be unable to fly according to the laws of physics but many plants couldn’t survive without them.
Because of the disconnect between theory and reality, industry participants have been urging the SEC for years to develop exemptions for finders.
The SEC just proposed exemptions that would allow some finders to operate legally, i.e., to receive commissions and other transaction-based compensation from issuers.
The SEC proposes two tiers of Finders
- Tier 1 Finders would be limited to providing the contact information of potential investors to an issuer in one offering per 12 months. A Tier I Finder couldn’t even speak with potential investors about the issuer or the offering.
- Tier II Finders could participate in an unlimited number of offerings and solicit investors on behalf of an issuer, but only to the extent of:
- Identifying, screening, and contacting potential investors;
- Distributing offering materials;
- Discussing the information in the offering materials, as long as the Funder doesn’t provide investment advice or advice about the value of the investment; and
- Arranging or participating in meetings with the issuer and investor.
A Tier II Finder would be required to disclose her compensation to prospective investors up front – before the solicitation – and obtain the investor’s written consent.
The Limits to the Proposed Finders
- The Finder must be an individual, not an entity.
- The Finder must have a written agreement with the issuer.
- The proposed exemptions apply only to offerings by the issuer, not secondary sales.
- Public companies (companies required to file reports under section 13 or section 15(d) of the Exchange Act) may not use Finders.
- The offering must be exempt from registration.
- The Finder may not engage in general solicitation.
- All investors must be accredited.
- The Finder may not be an “associated person” of a broker-dealer.
- The Find may not be subject to statutory disqualification.
The SEC issued an excellent graphic summarizing the proposed exemptions
Because they are entities, the typical Crowdfunding portal can’t qualify as a Finder under the SEC’s proposals. And because the proposals don’t allow general solicitation, a Finder who is an individual can’t create a website posting individual deals.
But the no-action letters to Funders Club and AngelList that kick-started the Crowdfunding industry (no pun intended) will invite many Tier 2 Finders to take their businesses online. Under the proposals and the no-action letters, it seems that a Tier 2 Finder could legally create a website offering access to terrific-but-unnamed offerings, but give investors access to the offerings only after registering and going through a satisfactory KYC process per the CitizenVC no-action letter.
A Step Forward for Crowdfunding
Many finders and issuers will jump for joy at the new proposals, while others will be disappointed that the SEC drew the line at accredited investors. In a Regulation A offering or a Rule 506(b) offering open to non-accredited investors, the law requires very substantial disclosure, especially in Regulation A. The SEC must believe that non-accredited investors are especially vulnerable to the selling pressure that might be applied by a finder.
Nevertheless, like the SEC’s proposals to expand the definition of accredited investor, the proposals about finders are a step forward.
CAUTION: As of today these proposals are just proposals, not the law.