The Problem with Money/Investor “Finders”
The use of “finders” is common in securities offerings, particularly small business offerings. Typically, an issuing company will cross the path of a well-connected individual who promises to introduce the issuing company to prospective investors. Usually, the company is very enthusiastic about the relationship, as it will get the company in front of new prospective investors. However, the relationship and payment for services, if not structured in accordance with law, can be dangerous for both the finder and the issuing company.
With respect to these types of relationships, securities laws generally recognize two types of activities: (1) Finder activity and (2) Broker-Dealer activity. A true “finder” is one who merely introduces a potential investor to a company seeking capital and is paid only for the introduction (without regard to whether the prospective investor actually invests in the company). Broker activity, on the other hand, can include, among other things, recommending the purchase of securities, negotiating terms of the offering, attending meetings where the merits of the investment are discussed, valuing the securities, and handling funds. A broker’s compensation is typically a “transaction-based” compensation (e.g., X% of the amount invested by prospective investors introduced by the broker). Of course, to act as a broker, the person (or his/her firm) must be licensed by FINRA and must register with the SEC as a broker/dealer.
While this seems simple enough, in practice, the individual acting as the “finder” often attempts (in most cases, due to ignorance of the law) to structure his/her payment as a percentage of the amount invested by the prospective investors introduced by the finder. Even if the “finder” restricts his/her activities to introductions only, the proposed arrangement will be viewed by the SEC as unlicensed broker/dealer activity. In general, the SEC has taken the position (even as recent as July 2012) that fees based in proportion to the amount of the sale or investment suggests that the finder is acting as a broker (and therefore licensure and registration is required). Further, if the payment of the fee to the “finder” is contingent upon consummation of the transaction (i.e., “commissions” or “transaction based compensation”) the SEC has historically taken the position that the finder must register as a broker.
Engaging in unregistered broker/dealer activity (or engaging a finder that engages in broker/dealer activity) can result in serious consequences to the individual and/or firm that attempted to act as a “finder,” including, civil penalties, disgorgement of fees and commissions, and even criminal penalties. However, many issuing companies mistakenly think that it’s the “finder’s” problem. In fact, it can cause significant consequences to the company (and, therefore, it’s officers and directors), including civil and criminal liability and penalties. In addition, the re-characterization of the relationship from “finder” to “broker” can likely cause the company and its officers and directors to be in violation of state and federal securities laws (e.g., an offering that was otherwise exempt from the registration requirements of state and federal securities laws is no longer exempt). As a result of such violations, investors in such offerings may have a right to get their money back (with interest) and rescind the investment.
The bottom line is: be careful! Before entering into any relationships related to the sale of securities, be sure to seek counsel from an experienced securities lawyer.