On October 7, 2020, the SEC proposed a new Finders exemption that would allow commissions to be paid to certain unlicensed persons who refer Accredited investors to private securities offerings. This is a proposed rule that creates two “tiers” of Finders who can legally receive commissions for referring investors to a securities offering without having a securities license. The comment period closed for this proposed rule on November 12, 2020.
The SEC created a handy chart that describes the difference between Tier 1 and Tier 2 Finders, which can be accessed by clicking here.
If you wish to read the proposed order, you can do so by clicking here.
The proposed Finder’s exemption would only apply if all of the following conditions are met:
- A Finder would not be subject to regulatory reporting,
- A Finder must be a Natural Person,
- The offering must be exempt from registration under The Securities Act of 1933 (such as Regulation D, Rule 506) — the rule does not apply to referring investors to registered offerings (such as Reg A+ or other registered (public) companies),
- The Finder cannot engage in general solicitation — so no advertising for investors for this purpose is allowed,
- The investor must be accredited, and
- The Finder and Issuer must enter into a written agreement with respect to the services offered and the amount of compensation.
- The Finder cannot be an “associated person” of a securities broker-dealer (so it would not apply to current securities licensees, who must continue to operate within the constraints of their licenses).
The Finder cannot do any of the following things:
- Be a disqualified person or bad actor,
- Engage in resales of securities,
- Be involved in structuring the transaction or negotiating the terms of the offering,
- Handle investor funds or securities, or contractually bind the investor or Issuer,
- Participate in preparation of sales materials,
- Perform independent analysis related to the securities,
- Provide financing for the purchase of the securities,
- Opine regarding the advisability of the investment for a particular investor.
The proposed Finders are further divided into 2 categories:
Tier 1 Finders would be limited to referring investors to a single capital-raising transaction by a single Issuer within a 12-month period and would be prohibited from communicating with prospective investors about the Issuer. Introductions only.
Tier 2 Finders are allowed to:
- Solicit investors on an Issuer’s behalf,
- Identify, screen and contact potential investors,
- Distribute offering materials to prospective investors,
- Discuss information in the offering materials with investors, and
- Coordinate meetings between the Issuer and investors.
However, Tier 2 Finders are required to provide disclosures to investors, prior to or at the time of solicitation, regarding their role and compensation and conflicts of interest; and to obtain the investor’s dated written acknowledgment of having received such disclosures.
This proposed rule has not yet been approved. The public comment period ended November 12, 2020, after which the SEC will evaluate the responses and if all goes well, will issue the final rule – which could be several months away, if it happens at all.
What does this proposed Finders Rule mean for you as a Syndicator?
First, the rule-making process is underway, and until the public comments have been reviewed and assimilated and a new rule is adopted and published in the Federal Register, the new rule is just a pipe dream, and it’s not the first time it’s been proposed — so don’t hold your breath.
This means it’s still a violation of securities laws for an unlicensed “Finder” to receive “transaction-based compensation” (i.e., commissions) for referring investors to a deal, nor can you, as an Issuer of securities, legally pay any such compensation to anyone without a securities broker-dealer license until such time, if ever, that this rule is finalized and enacted.
The old rule stands: Everyone in management of a syndicate or fund should have a role other than raising money and that’s what they get compensated for; and no formula should be used to take into account how much someone has raised when determining their share of earnings.
Only people with the appropriate securities licenses can receive transaction-based compensation (commissions). For the Issuer, paying unlicensed brokers could cause you to lose your exemption at the state or federal level. For a Finder, until this rule gets enacted, acting as an unlicensed broker can get you in heaps of legal trouble and could make you liable for performance of the investment for those whom you refer for the life of the investment. So, until this rule gets hashed out and takes effect (if ever), don’t pay commissions to unlicensed Finders, and don’t act as one.