We have all heard the stories about small or startup companies looking to raise capital and being approached by “finders” offering to help them to meet their goals. In exchange for such services, they only request 3% of the money raised by their investors. That’s not bad, right? Wrong. The company has now violated securities laws and opened themselves up to a whole new world of repercussions.
So, let’s examine this scenario from the start. Is the “finder” actually engaging in activities that would require registration with a broker-dealer? Engaging in the business of effecting a securities transaction requires registration. That’s pretty cut and dry. But, is “finding” potential investors construed as being in the business of effecting “securities transactions?”
The SEC has previously held that not only does the execution of a securities transaction require registration, but also the negotiation and solicitation of a securities transaction. In addition, this standard has been held as applicable to both privately-issued securities as well as publicly-traded securities. So, taking this into account, does solicitation equal finding investors? That could be hard to determine with any certainty.
Merriam-Webster defines solicitation as “the practice or act of an instance of soliciting”. Solicit is defined as “to make petition to; to approach with a request or plea; to urge (as one’s cause) strongly”.
So, taking this into account – does solicitation equal finding investors? I think we would all agree that it likely does.
Another triggering point of scrutiny in the above example, is the payment of transaction-based compensation. This element is one on which both the SEC and FINRA are highly focused. The presence of transaction-based compensation or success fees tied to a securities transaction is a strong indication that the person receiving the compensation is registered with a broker-dealer – or at least should be. In our example, the finder requesting and receiving 3% of the money raised is spot on transaction-based compensation. This payment equals sales commissions and requires registration with a broker-dealer.
So, what happens to the finder and the company in this scenario? In 2013, the SEC brought charges against a New York-based private equity firm, Ranieri Partners LLC, after determining that a close friend of the firm’s managing director, who had been acting as a “finder” for the firm, was an unregistered broker. The settlement required the finder to pay approximately $2.83 million in disgorgement and prejudgment interest. Additionally, the fund manager and the fund’s managing director agreed to pay $375,000 and $75,000 in penalties, respectively. In addition, the finder agreed to be barred from the securities industry.
The distinction between a broker and a finder is important. A “broker” is any person engaged in the business of effecting transactions in securities for the account of others. Someone who takes steps to induce or bring about a transaction is a broker. A “finder” is someone who finds, introduces, and brings parties together for a transaction. A finder leaves the negotiation and consummation of the transaction to the parties themselves.
A finder cannot “induce or attempt to induce the purchase or sale” of any security without being registered with a broker-dealer. To avoid such registration, a finder should receive a flat fee and restrict their activities to introducing issuers and potential investors. If a company wants the finder to solicit investors, perform analysis of either potential investors and/or the company, or provide potential investors with information regarding the company, it should retain a registered broker-dealer.