A question I am often asked is what is the definition of a finder, or questions that lead to that question. The issue arises when an unregistered person or entity introduces investors to an issuer and seeks to obtain payment based on the investment made by the investor. The problem is, that in many instances, the introducing party is acting in a manner that requires registration as a broker or a dealer, and thus must be registered in order to accept compensation for the introduction to the investor.
The issues of finders and compensation are currently a “hot” topic for securities regulators, and the issue is in great flux today. It is, therefore difficult to describe finders in a general way that is helpful because the answer in a particular case will turn on the particular facts. One small factual change, and the answer changes.
General Definition of a Finder
Addressing the issue GENERALLY, he does not have to register if the finder is only a finder. Being a finder means that he only introduces; he does not discuss, negotiate, or get involved in the transaction. However, the SEC may take a different view of “discuss” or “get involved” than you do.
Statutes and Rules for Finders
The federal securities laws do not specifically define the term “finder” or detail what a finder can or cannot do. For the finder, the goal is to avoid conducting themselves as a “broker” or a “dealer” and then having an exemption from the registration requirements.
Definition of a Dealer
The “dealer” definition is a bit easier to address and to deal with. Section 2(a)(12) of the Securities Act of 1933 defines a “dealer” as “any person who engages either for all or part of his time, directly or indirectly, as an agent, broker, or principal, in the business of offering, buying, selling, or otherwise dealing or trading in securities issued by another person.” The definition excludes those buying or selling for their own account but includes someone doing so as part of a regular business.
The SEC is currently engaged in multiple lawsuits over the definition of “dealer.” Those matters deal with the “regular business” part of the definition and have little to do with the issue of a finder. The reality is that a finder introduces investors to investment and is rarely in the business of offering, dealing, or trading in securities.
Definition of a Broker
The more difficult term for a finder is “broker.” A broker is defined as “any person engaged in the business of effecting transactions in securities for the accounts of others.”15 U.S.C. § 78c(a)(4).
Section 15 of the Securities Exchange Act of 1934 requires that brokers and dealers register with the SEC. In Section 15, the phrase used to define the conduct which invokes a registration requirement is “to induce or attempt to induce the purchase or sale of any security.”
Finder Findings are Fact Based
The reason for the inconsistency is the fact that the determination of whether the finder is required to register as a broker or dealer is factually driven. The answer turns on what the finder does, whether he discusses the investment with the investor, whether he attends meetings, delivers offering material, engaged in negotiations of the investment, or engages in other conduct which would lead one to conclude that he was “inducing” the sale, or “effecting” the transaction or the type of fee for his services.
Compensation of Finders
While most finders are paid on the basis of a percentage of funds raised, some are paid by the hour, others on a flat fee. The simple answer is the more involved the finder is, and the more his compensation is based on the funds raised, the more likely the requirement that he be registered as a broker or dealer.
The SEC has traditionally focused on transaction-based compensation as a significant factor in determining whether the actor is a broker and required registration. This is not surprising since receiving transaction-based compensation is the hallmark of a salesman. Additionally, in the SEC’s view, paying someone based on the amount of the investment can create an incentive to engage in sales efforts and mislead investors.
Negotiation Often Requires Registration
Consideration of the finder’s involvement is a pivotal aspect along the registration continuum. The SEC has frequently cited the finder’s role in negotiating investment terms as a basis for requiring registration. To illustrate, a clear instance where registration isn’t necessary is when the finder simply provides a list of potential investors to the issuer without further involvement. In such cases, compensation can be offered, and registration isn’t mandated.
At the opposite end of the spectrum, consider a scenario where a firm acts as a consultant on mergers and asset sales, conducts reviews of financial reports, and provides advice to management on financial decisions. The firm receives compensation based on the transactions’ outcomes and occasionally participates in the negotiation process. In a no-action letter, the SEC stated that the firm must register as a broker-dealer due to its involvement in negotiating and planning the transactions.
SEC No-Action Letters
The SEC has issued a number of no-action letters addressing this question, and unfortunately, they have not been consistent. In a series of no-action letters, the SEC has confirmed that a person who merely makes an introduction, without more, is not required to register and in some instances, has permitted the finder to obtain compensation based on the amount of money invested. On the other hand, the SEC has also stated that other finders, who are making introductions, would require registration. Additionally, while SEC No-Action letters can sometimes be used as guidance as to how the SEC will react to a similar set of facts, SEC No-Action letters surrounding finders are getting old, and the view of finders may change in the very near future.
The reason for the inconsistency is the fact that the determination of whether the finder is required to register is factually driven. The answer turns on what the finder does, whether he discusses the investment with the investor, attends meetings, delivers offering material, or engages in other conduct which would lead one to conclude that he was “inducing” the sale or “effecting” the transaction.
Another factor is how the finder is paid. While most finders are paid on the basis of a percentage of funds raised, some are paid by the hour, others on a flat fee. The simple answer is, the more involved the finder is, and the more his compensation is based on the funds raised, the more likely the requirement that he be registered. Conversely, if the finder merely introduces the investors to the issuer, and takes a flat fee, then he probably does not have to register at all.
A key factor in the registration continuum is the negotiation aspect of the finders involvement. The SEC has often referred to the finder’s involvement in the negotiation of the terms of the investment as a reason for requiring registration. Again, the clearest example of conduct that does not require registration is where the finder provides a list of potential investors to the issuer and does nothing more. In that situation, compensation can be paid, and no registration is required.
Proposed Finder Registration Exemptions
Periodically the SEC considers providing an exemption from registration for finders. The most recent proposal was in October 2020. There, the SEC proposed a new limited, conditional exemption from broker registration requirements for “finders” who assist issuers with raising capital in private markets from accredited investors. The proposed exemption would permit natural persons to engage in certain limited activities involving accredited investors without registering with the Commission as brokers. The proposed exemption seeks to assist small businesses to raise capital and to provide regulatory clarity to investors, issuers, and the finders who assist them.
The proposal would create two classes of finders, Tier I Finders and Tier II Finders, that would be subject to conditions tailored to the scope of their respective activities. The proposed exemption would establish clear lanes for registered broker activity and limited activity by finders that would be exempt from registration.
The SEC’s release regarding the proposal is on their website at https://www.sec.gov/news/press-release/2020-248; there is an educational resource to explain the proposal at https://www.sec.gov/educational-resources-finders-proposed-exemptive-order and a chart detailing the differences and requirements for the two tiers, at https://www.sec.gov/files/overview-chart-of-finders.pdf.
Unfortunately, in the two years that have passed since that proposal, nothing has passed.
We expect the SEC to issue a new release regarding finders and will report it on the site’s main page when it is released.
If you are involved in a transaction where you are a finder or are contemplating paying a finder you need legal representation. Call Mark Astarita at 212-509-6544. Let’s see if we can help.
Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.
Mark J. Astarita, Esq. is a securities lawyer who represents investors, financial professionals and firms in litigation, arbitration and regulatory matters across the country. He is a partner in the national securities law firm of Sallah Astarita & Cox, LLC and can be reached by email at firstname.lastname@example.org or by phone at 212-509-6544.
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Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.