Use of Finders in Securities Offerings

In private securities offerings where the company does not engage an investment banker who is a registered broker-dealer to market the offering to investors, companies will often seek the assistance of so-called “finders,” who are not registered as broker-dealers, to connect the company with potential investors.  These finders are often paid a pre-determined percentage of the amount ultimately raised by the company from the investors introduced by the finder.  Though this practice is extremely common, this area of the law is very much a gray area, and there are significant risks to both the finder and the company that should be considered.

The SEC’s position on finders has hardened over the years.  In 1991, the SEC permitted an arrangement where Paul Anka (yes, that Paul Anka) would receive 10% of proceeds from investors in the Ottawa Senators hockey team introduced by him.  At the time the SEC viewed the fact that he was receiving “transaction-based compensation” (i.e., payment contingent on the amount ultimately raised) as only one of many factors that determine whether he was engaging in behavior requiring broker-dealer registration.  However, the SEC has more recently stated that transaction-based compensation paid to a non-broker-dealer is impermissible, regardless of countervailing factors.  A federal court recently rejected the SEC’s new position, saying a multi-factor test is the correct approach, but with the regulation in this area up in the air, there is significant risk in paying transaction-based compensation to finders.

The risks of violation of broker-dealer regulation do not only apply to the finder, but also to the company.  Aside from regulatory actions brought against the company, investors who purchased securities in these offerings can have the right to seek rescission, i.e., get their money back.  Needless to say, this is a problem if the company has already spent the investor’s money.