Pushing Back Against the SEC on Finders Rules

Legal Referrals | A. Abramowitz | NYC

As I’ve blogged about in the past, the SEC in recent years has taken a relatively strict position against payments to “finders” who are not registered broker-dealers, as compensation for introducing investors to companies. The SEC’s focus has primarily been on “transaction-based compensation,” i.e., payment to the finder that is contingent on investment by the introduced investor, which according to the SEC is a hallmark of broker-like activity that requires registration.

Many practitioners, along obviously with those who would like to earn a few bucks by making these introductions, have complained that the SEC’s view is too restrictive. A company proposing to do business as an unregistered finder, Platform Real Estate Inc., has now filed suit in the Southern District of New York against the SEC, seeking a declaratory judgment to the effect that broker-dealer registration is not required for the plaintiff and similar companies acting as a finder on behalf of private companies.

The essence of Platform Real Estate’s argument is that the Exchange Act generally, and Section 15(a) (the section requiring registration of those acting as broker-dealers) in particular, are intended to protect investors in the secondary market, like those purchasing shares traded on an exchange. The transactions that Platform Real Estate would be involved in, in contrast, are primary transactions, where a company issues and sells new shares to accredited investors who represent as to their intent to hold the shares potentially indefinitely.

This complaint is, as of this writing, a recent filing, and the SEC will likely respond with an answer with a different read of the Exchange Act’s statutory language and legislative history. However, I am more interested to hear the SEC’s views on the policy rationale for requiring registration in a case where someone proposes to be compensated for introducing a company to a sophisticated accredited investor in a private placement. If the answer is that the investor benefits from the securities industry know-how gained by a broker-dealer in the tests required for registration, then why is it not problematic for a company to sell directly to an accredited investor with whom it has a pre-existing, substantive relationship? In that scenario, no one is guiding the investor unless it hires legal or financial advisors, which is not required.

Ultimately, if early stage companies were able to easily hire registered broker-dealers to help raise capital, there would be less urgency around this issue, but in practice, broker-dealers do not find it worth the trouble to get involved in small deals, which makes the use of finders an attractive alternative option that is frequently pursued despite the legal uncertainty. Accordingly, it’s important that the rules relating to finders be clearly established by the courts, whether it’s ultimately the SEC’s restrictive position or something more liberal.