SEC Urged to Make it Easier for Small Companies to Use “Finders” to Raise Capital

Small businesses seeking to raise capital in private offerings using “finders”, and firms brokering M&A deals involving private companies have faced the risk that transactions could be unwound (“rescinded”1), sometimes years later, because of the involvement of “unregistered brokers” in the transactions.


In a September 23, 2015 letter2 to the SEC, its Advisory Committee on Small and Emerging Companies made several proposals that would make it easier for small and emerging companies to raise capital using finders, rather than more costly, and often uninterested, registered broker-dealers.  Chief among the recommendations:

  • The SEC should clarify that persons receiving transaction-based compensation solely for providing names of or introductions to prospective investors are not subject to broker-dealer registration.
  • Intermediaries involved in discussions, negotiations and structuring, and solicitation of prospective investors for private financings should be exempted from federal registration as brokers provided they are registered as a broker under state law.

Section 3(a)(4)(A) of the Securities Exchange Act of 1934 defines a “broker” as “any person engaged in the business of effecting transactions in securities for the account of others.” Historically, in applying this definition to finders the SEC and its enforcement staff have focused on several factors, but particularly on whether the finder’s compensation was transaction-based or contingent on the transaction closing, and on whether the finder helped negotiate or structure the deal.

M&A Brokers

In its January 31, 2014 M&A Broker “No-Action” Letter3 the SEC (staff) permitted unregistered “brokers” to engage, under specified conditions, in effecting M&A transactions. The Letter states that the staff will not recommend enforcement action to the Commission if unlicensed M&A brokers (“finders”, “business brokers”) assist in the purchase and/or sale of businesses to persons who will be actively involved in managing those businesses, and may receive transaction-based compensation for both bringing about the sale and locating third party financing for the purchaser, whether the transaction was structured as a sale of assets or securities.

Among other limitations4, although an M&A broker may be compensated for obtaining third-party financing, this is limited to financing the M&A transaction. The M&A Broker Letter does not apply to capital formation activities,  and thus does not provide relief for:  (i) a placement agent assisting in raising capital for pooled investment vehicles such as hedge funds and private equity funds; and (ii) to finders helping to raise capital in an issuer’s private offering.

Brokers’ Transaction Fee Sharing Permitted

SEC registered brokers which are members of the Financial Industry Regulatory Authority (FINRA) are prohibited by FINRA Rule 2040(a)(1) from paying transaction based compensation to unregistered M&A Brokers that refer transactions to any person that is not registered as a broker-dealer. However, in August 2015, the SEC approved FINRA’s “Supplementary Material .01” to the rule which provides guidance in connection with a brokerage firm’s determination that the finder with whom it desires to share a fee is not required to register as a broker.5

State Regulation

In addition to the federal regulatory regime, each state regulates “brokers” under it own laws and regulations, referred to generally as “Blue Sky Laws”.  State laws vary greatly, and the laws of each state which may apply to a transaction must be reviewed and complied with.

This multi-state regulatory burden may be eased with regard to M&A brokers if states begin adopting the North American Securities Administrators Association’s (NASAA) September 29, 2015 Model State Rule, which exempts M&A brokers from having to register as securities brokers.6

On December 4, 2015, FINRA submitted to the SEC proposed rules for firms which fall within FINRA rules’ definition of “Capital Acquisition Broker” (CAB)7. Among other things, the proposed rules would permit CABs to acts as finders in private offerings to “institutional investors”8 and “qualified purchasers”, but not to investors who do not meet those definitions, for example, persons who just meet the minimum threshold test of “accredited investor”, as set forth in Rule 501 of SEC Regulation D9 .

  1. Recommendations Regarding the Regulation of Finders and Other Intermediaries in Small Business Capital Formation Transactions (September 23, 2015)

  2. Section 15(b) of the Securities Exchange Act of 1934, requires that persons “in the business of effecting securities transactions” register with the SEC as brokers. Transactions involving unregistered brokers  may be subject to rescission under Section 29(b) of the Exchange Act. Section 29(b) deems void transactions effected in violation of any other section of the Exchange Act (in this case the broker registration requirements set forth in Section 15(b)), and simultaneously leaves the business broker or “finder” vulnerable to attack on the right to collect its fee.
  3. SEC M&A Broker Letter to Faith Colish, Martin A. Hewitt, Eden L. Rohrer, Linda Lerner, Ethan L. Silver, and Stacy E. Nathanson, Jan. 31, 2014, as revised Feb. 4, 2014.  Copies of the No-Action Letter and the request letter to which it responded are available at:
  4. For the additional restrictions see M&A Broker Letter, fn 3, supra.
  5.  FINRA Regulatory Notice 15-07, “Payments to Unregistered Persons”.  Members that are uncertain as to whether an unregistered person may be required to be registered under Section 15(a) of the Exchange Act by reason of receiving payments from the member can derive support for their determination by, among other things: (1) reasonably relying on previously published releases, no-action letters or interpretations from the Commission or Commission staff that apply to their facts and circumstances; (2) seeking a no-action letter from the Commission staff; or (3) obtaining a legal opinion from independent, reputable U.S. licensed counsel knowledgeable in the area. The member’s determination must be reasonable under the circumstances and should be reviewed periodically if payments to the unregistered person are ongoing in nature. In addition, a member must maintain books and records that reflect the member’s determination.
  6. NASAA. Model Rule Exempting Certain Merger & Acquisition Brokers (“M&A Brokers”) From Registration, Adopted September 29, 2015,
  7. Sec Release No. 34-76675 FINRA Notice of Filing Proposed Rule Change to Adopt the Capital Acquisition Broker Rules, December 17, 2015.
  8. “Institutional investors” as defined under FINRA Rule 2210 (generally, certain types of institutions, registered investment advisers and persons or entities with assets of at least $50 million); or “qualified purchasers” set forth in Section 2(a)(51) of the Investment Company Act of 1940, as amended (generally a person, family investment vehicle or trust that owns assets of at least $5 million, or any person or entity acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis not less than $25,000,000 in investments.
  9. Rule 501, Regulation D. An “accredited investor”, includes anyone who: earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence). On the income test, the person must satisfy the thresholds for the three years consistently either alone or with a spouse, and cannot, for example, satisfy one year based on individual income and the next two years based on joint income with a spouse. Entities such as banks, partnerships, corporations, nonprofits and trusts may be accredited investors, including any trust, with total assets in excess of $5 million, not formed to specifically purchase the subject securities, whose purchase is directed by a sophisticated person,  or any entity in which all of the equity owners are accredited investors.