Companies Seeking Capital—Be Wary of “Consultants” and “Finders”
For smaller companies and startups seeking to raise capital, encountering consultants or “finders” who promise to connect them with potential investors is common. While these individuals may offer valuable introductions, companies must carefully consider the legal framework surrounding these services. Engaging unregistered individuals in capital-raising activities can lead to regulatory and legal consequences that can jeopardize the success of the funding round and the company’s future growth. However, a legally compliant path exists for certain “finders” to operate without triggering registration as a broker-dealer.
Understanding Broker-Dealer Registration and the Finder Distinction
Federal securities laws, particularly the Securities Act of 1933 and the Securities Exchange Act of 1934, regulate the activities of individuals and firms who raise capital. Broker-dealers, defined as individuals or entities “engaged in the business of effecting transactions in securities for the account of others,” are required to be registered with the SEC and FINRA. The primary indicator of broker-dealer activity is the receipt of transaction-based compensation, such as commissions, which the SEC views as the “hallmark of a salesman” and an activity closely tied to facilitating securities transactions. Consequently, anyone receiving compensation for actively participating in capital-raising activities is presumed to require broker-dealer registration.
Finders, however, occupy a gray area in the regulatory landscape. The SEC has provided limited guidance for “pure finders” who only introduce potential investors to issuers without further involvement in the transaction. Unlike broker-dealers, finders are not defined in federal securities law and are instead characterized by what they do not do. The distinction primarily hinges on a finder’s lack of involvement in negotiating terms, providing advice, or otherwise facilitating the transaction beyond the initial introduction.
Legal Risks and Enforcement Actions Against Unregistered Broker-Dealers
The SEC has increased its scrutiny of unregistered individuals acting as brokers in capital raises, with several enforcement actions highlighting the severe consequences of engaging in these activities without proper registration. Noteworthy cases include:
SEC v. Sky Group USA, LLC: In this case, the SEC pursued charges against sales agents of a payday loan firm for promoting promissory notes without broker-dealer registration. The agents marketed and closed deals on behalf of Sky Group while receiving commissions. Each agent faced disgorgement of earnings, civil penalties, and injunctions.
SEC v. Richard Eden: Richard Eden, who engaged in securities offerings for multiple companies, accepted success-based compensation without being a registered broker. His judgment included disgorgement and penalties exceeding $1 million and a permanent ban on engaging in securities transactions.
Ranieri Partners Enforcement: The SEC targeted a private equity firm’s consultant who marketed fund interests, negotiated with investors, and received transaction-based compensation despite lacking broker-dealer registration. The consultant faced a significant disgorgement penalty and a permanent industry ban.
These cases demonstrate that even peripheral involvement in capital-raising activities can prompt severe SEC enforcement if the individual or entity is unregistered. Regulatory consequences may include disgorgement of earnings, civil penalties, permanent injunctions, and industry bans. For the issuing companies, relying on unregistered brokers can lead to rescission rights for investors, potential liabilities, and reputational damage.
Factors Distinguishing Broker-Dealer Activity from Finder Services
The SEC evaluates various factors to determine whether an individual’s activities trigger the need for broker-dealer registration:
Participation in Negotiations: Brokers typically play a role in negotiating terms, facilitating the transaction, or advising on deal structure. A finder must not engage in these activities to avoid broker-dealer classification.
Transaction-Based Compensation: The most critical factor, transaction-based compensation, such as success fees or commissions, strongly indicates broker activity. A finder paid purely for introductions, without contingency on deal success, is less likely to require registration.
Ongoing Business Engagement: If an individual regularly engages in securities-related introductions, especially with a success fee, they may be deemed “in the business” of selling securities, necessitating broker registration.
The Legally Compliant Path for Finders
Though limited, legally compliant options exist for certain “finder” services:
M&A Broker Exemptions: Recent developments have clarified rules for M&A brokers. The Federal Exemption, effective in March 2023, provides a safe harbor for M&A brokers facilitating private company transactions involving a transfer of ownership and control without needing broker-dealer registration, provided certain conditions are met. This exemption is limited to brokers who do not have custody of securities, provide financing, or represent both parties without explicit consent.
No-Action Letters: The SEC has issued no-action letters that offer guidance on permissible finder activities, allowing individuals to make introductions without triggering registration if they do not participate in negotiations, structuring, or provide securities-related advice. While no-action letters are not binding, they offer insights into the SEC’s enforcement priorities.
State Regulation and Practical Considerations for Companies
While federal exemptions exist, companies should also account for state regulations, which vary significantly. States like California and Texas have crafted exemptions, but these must be verified and followed on a state-by-state basis. Furthermore, foreign intermediaries and unregistered consultants should be cautious when approaching U.S. investors, as such activities may still fall under U.S. broker-dealer registration requirements.
Engaging with an unregistered broker carries significant risks, and issuers may inadvertently expose themselves to regulatory scrutiny. It’s essential to verify the credentials and registration status of any consultant, ensuring their compensation structure aligns with permitted activities. Companies can avoid pitfalls by consulting legal counsel to evaluate any involvement of unregistered individuals in their capital-raising processes.
* * *
Attorney Advertising—Anderson P.C. is a U.S. law firm and provides this information as a service to clients, prospective clients, and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.
Anderson P.C. is a boutique law firm dedicated to defending clients in government investigations and securities enforcement actions initiated by the SEC, FINRA, DOJ, and other regulatory bodies. We provide focused, strategic counsel and regulatory guidance across the full spectrum of federal laws and regulations affecting broker-dealers, investment advisers, banks, asset managers, private funds, public companies, senior executives, and digital assets. Our deep expertise allows us to navigate complex legal challenges and deliver results-driven solutions tailored to our clients' unique needs.
If you have any questions or need legal assistance related to government investigations, securities enforcement actions, or regulatory compliance, please don't hesitate to contact us. Our team at Anderson P.C. is here to provide the expert guidance and support you need to navigate these complex challenges.
