Rules for Finders? Not So Fast…

The SEC made a splash in October 2020 when it proposed a new set of rules that would allow finders to receive transaction-based compensation for introducing investors to issuers even though they are not licensed as a securities broker-dealer. 

This proposal represented a dramatic departure from the traditional rules, and it was driven, at least in part, by concerns about equity: If the success of entrepreneurs depends more on who they know than on what they can do, then the traditional rules serve to entrench class distinctions. Those who come from money and therefore have connections to wealth become successful entrepreneurs because they can raise the needed funds. Those who lack those connections may fail for lack of capital, despite their ability and innovations. 

The role of a finder is most relevant in private offerings. In such an offering, no advertising or “general solicitation” is permitted. As a practical matter, that means the entrepreneur can only pitch the investment opportunity to investors that the entrepreneur personally knows, or those introduced to the entrepreneur by someone the entrepreneur personally knows. An entrepreneur who does not personally know any investors able to write big checks will have to rely on these introductions – which then raises the question of whether the entrepreneur can incentivize these introductions by paying some sort of compensation to finders. 

And it went… nowhere

But those who hoped the SEC’s new rules would usher in a new paradigm for capital-raising have reason to be disappointed: The proposed rules have not been finalized; and with recent changes in leadership at the SEC, it now appears unlikely that the SEC will ever adopt the proposed rules. 

To underscore this, in an annual report published in December 2021 by the SEC’s Office of the Advocate for Small Business Capital Formation, there is a reference to the proposed finder rules along with a statement that “the Commission has not taken further action on the proposal, and providing regulatory clarity for finders is not in the Commission’s current regulatory agenda.” 

However, the concept is not entirely dead yet. Senator Kevin Cramer of North Dakota has introduced a bill in the Senate (S. 3922) that would exempt finders from registration as a broker-dealer. That bill has been picked up for inclusion in a Republican-backed “JOBS Act 4.0” package of legislation. At this point it’s too early to tell whether Senator Cramer’s bill will survive the legislative process. 

So where does that leave us? For now, we’re right where we’ve been all along. 

The current law

Unfortunately, the current law for finders is a bit murky. The rule for securities broker-dealers basically says that someone may not help facilitate securities transactions for compensation without having a broker-dealer license. But keep in mind two things:

1. The idea of “facilitating” an investment is very broad and may cover any activity intended to induce or bring about a transaction between an issuer (the organization raising capital) and an investor. A finder who attends meetings with an investor or who delivers documents will likely fall within its scope. A finder who does nothing more than make an introduction may not; but SEC no-action letters have gone both ways in that situation – sometimes finding that broker-dealer laws apply, and other times finding that they do not. 
2. Similarly, the idea of “compensation” is also broad. It can include not just transaction-based cash compensation but just about any other kind of quid pro quo benefits a finder may receive from an issuer. And the closer the nexus is between a finder’s compensation and the success of the investment transaction, the more likely the finder would need to be licensed. 

But there are alternatives

So what is an entrepreneur to do? 

First, there may still be ways of paying finders without violating the broker-dealer rules. For example, a finder could be paid a flat fee for providing a list of potential investors, without any further involvement in the investment process. 

But perhaps better yet, there are several capital-raising strategies that do allow for general solicitation and advertising, which largely eliminates the need for a finder. These include: 

Rule 506(c) offerings to accredited investors (with verification of their accredited status); 

Regulation Crowdfunding; 

Offerings by charities utilizing charitable exemptions at the federal and state level; 

Direct public offerings that are registered with state securities regulators; 

Coop offerings, in states that have such an exemption; and 

Regulation A, a nation-wide offering involving a mini-registration with the SEC. 

We at CEC will keep an eye on developments in the Senate or at the SEC for finders and will provide an update to our community if things change. But entrepreneurs need not let the SEC’s inaction here stop them from raising capital. 

Naturally, this discussion should be regarded as informational only and not as legal advice. If you’d like to talk with us about capital raising strategies, don’t hesitate to reach out to us.