Do I Have to Disclose Payments To a Finder?
Companies seeking capital are frequently approached by intermediaries who offer to locate investors in exchange for a fee. Most intermediaries also known as “finders” are not registered as broker-dealers with the Securities and Exchange Commission (the “SEC”). These intermediaries wear many hats and may refer to themselves as fund managers, receivers, turnaround experts, investment bankers, stock promoters, placement agents, business brokers, investor relations firms or consultants. They may be attorneys, CPAs, insurance brokers, custodianship shell purveyors or other market participants. Often these intermediaries claim that they do not need to be registered with the SEC or FINRA as broker-dealers because of a “finder’s exemption”.
Criminal Actions & Finders
Criminal actions spanning a decade reflect that the finders exemption is a dangerous trap for the unwary and in fact, undisclosed payments to purported finders acting as corrupt hedge fund managers reveal a string of criminal kickback cases that started with the Bermuda Short indictments in 2002.
The possibility of receiving capital even through the efforts of a finder creates a tempting opportunity for issuers who need funding for their businesses. New companies going public are particularly vulnerable to schemes involving finders because they simply do not understanding the laws that apply to finders.
Issuers that fail to properly disclose agreements to compensate finders to investors violate the anti-fraud statutes and risk criminal prosecution by the Justice Department. This is true even where the investor is an accredited investor such as a hedge fund.
The use of unregistered finders or intermediaries to raise capital creates civil liability for both the issuer, its management and the finder.
Section 15(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) generally requires any person who effects securities transactions to register with the SEC as a broker-dealer. Finders may become involved in various securities transactions including matters other than raising capital, including reverse mergers and direct public offerings. In limited circumstances, companies may compensate a finder who is not registered without violating the federal securities laws; however, in these circumstances the public company has an absolute duty to disclose the finders agreement and compensation in its SEC filings.
The determination of whether a finder is required to be registered as a broker-dealer typically involves an analysis of several factors including:
Prior Securities Transactions
Any previous compensation or other evidence of previous involvement in securities offerings increases the likelihood that the SEC will view the finder as engaged in activities that require registration as a broker-dealer. In other words, if a purported finder has openly touted its capital raising services on the internet it is likely that they will be deemed an unregistered broker and any compensation paid to them for raising capital is illegal.
The more involved the finder is in the negotiations for the sale of the securities, the more likely the SEC is to view the finder as engaged in activities that require registration as a broker-dealer. Discussing details of the securities sold and making recommendations increases the likelihood that the SEC would require registration. Finders should avoid the following activities:
i. Actively soliciting potential investors;
ii. Advising potential Investors about the merits of an investment;
iii. Participating in the negotiations;
iv. Participating in the valuation or creating terms of the securities to be sold;
v. collecting, holding or disseminating investor funds;
vi. reviewing or drafting any agreements related to an investment;
vii. providing assistance to investors in completing the purchase agreement, subscription agreement or other documentation pertaining to an investment.
viii. providing financing to any investor;
ix. providing assistance to the Company in drafting or distributing any materials including financial data or sales materials; and
x. introducing an issuer to commercial banks, lawyers or other professionals to facilitate an investment.
Risks of Using Finders
The temptation of using a finder can lead to potential liability for the finder as well as the issuer. Failure of a finder to be properly registered as a broker-dealer may subject that person to potential liability, including criminal penalties, fines, suspension, and disbarment.
Issuers could also be subject to sanctions and penalties from federal securities regulators as aiding and abetting the unregistered broker-dealer including fines, prohibition on future securities offerings, and criminal actions where proper public disclosures are not made. The potential harm to the companies that use unregistered finders includes civil and criminal enforcement action as well as investor rescission rights and shareholder actions. Investors would have a rescission right, meaning that they could demand repayment of their entire investment without set-off or deduction.
If used, the finder should not have been involved in prior securities transactions and do no more than make introductions of investors to issuers, and should only be compensated by a flat fee which is not based upon the sale of securities. An agreement between the issuer and the finder should define the duties and compensation of the finder.
Most importantly, in order to comply with the antifraud provisions of the securities laws, the issuer and finder must disclose agreements with finders as well as all compensation paid to them in its public filings.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855