For many small and emerging companies looking to raise capital, “finders” play a valuable role in providing access to qualified investors. In recent years, however, heightened enforcement efforts by the SEC and state securities commissioners have meant that unregistered finders – and the issuers who employ them – are facing significant penalties, including civil and criminal charges, for failing to register as broker-dealers.

In their latest article for MicroCap Review, Pryor Cashman Corporate Co-Chair Eric Hellige and Associate Francesca Djerejian discussed the risks of utilizing unregistered finders in connection with securities offerings. 

What is Unregistered Broker-Dealer Activity?

Under federal and state securities laws, any person or entity engaged in the business of effecting transactions in securities for the account of another must comply with comprehensive regulatory protocol. As Hellige and Djerejian explained: “the SEC has taken the position that finders who are engaged in such activities and fail to become associated with a registered broker-dealer have denied investors the protections of regulatory oversight and firm supervision.” And this failure can lead to damaging consequences. 

Risks Issuers Face When Employing Unregistered Finders

In addition to civil and criminal penalties and potential bars from participating in the securities industry, issuers who engage unregistered finders can face severe repercussions. For instance, federal and state securities laws may allow investors to rescind their investments in an issuer’s securities on the basis that they were materially misled by the issuer’s failure to disclose that the finder was not a registered broker-dealer.

Moreover, in some states, investors may be entitled to seek monetary damages from the issuer for not being informed that an unregistered finder was engaged.

How to Determine When a Finder Has “Effected” a Securities Transaction

While there is no bright-line test for assessing whether a finder has effected a transaction in securities – and thus acted as an unregistered broker-dealer – the SEC and state securities regulators will consider a number of factors when evaluating the possibility. Activities which have been found to create a presumption that a finder acted as a broker include, but are not limited to:

• Soliciting prospective investors for a securities offering;
• Offering or providing advice or recommendations on the merits of a securities offering, or the likelihood of success of the issuer’s business activities;
• Negotiating the price or other material terms of a securities offering;
• Assisting an issuer with the preparation of offering documents;
• Distributing offering or sales materials or other related financial data;
• The payment of transaction-based compensation; and
• Previous involvement, the frequency of involvement and possible future involvement in the sale of securities.

Advice for Issuers Considering Employing Unregistered Finders

Hellige and Djerejian advise any issuer contemplating employing an unregistered finder to assist with a private placement of securities to carefully consider the compensation scheme paid to such finder, the activities of the finder in connection with the offering, and the interactions between the finder and potential investors. “In most cases,” they cautioned, “it may be more prudent to limit the individuals or entities engaged in the solicitation of potential investors to those that are registered broker-dealers.”

For more information about employing unregistered finders in securities offerings, read Hellige and Djerejian’s full article in MicroCap Review.

More About Pryor Cashman’s Corporate Finance Group

With extensive experience representing issuers, underwriters, placement agents and investors from a broad spectrum of industries, Pryor Cashman’s Corporate Finance Group has the insight to counsel clients on all aspects of capital markets equity and debt offerings.

Our attorneys structure offerings, prepare and negotiate deal documentation, conduct due diligence, draft and review offering materials and public disclosures, and handle Financial Industry Regulatory Authority (FINRA) filings. Additionally, our familiarity with various capital markets transactions enables us to navigate issues related to federal and state securities laws, stock exchanges, the Securities and Exchange Commission (SEC) and FINRA. 

To learn more about our work in this area, visit our Securities + Corporate Finance practice page.