SEC ISSUES GUIDANCE ON WHETHER FINDERS NEED TO REGISTER AS BROKER-DEALERS

As the economy begins to recover, merger and acquisition transactions are bound to rebound as well.  With bank financing still hard to come by, many companies will turn to "finders" to help identify potential third-party investors. Finders are generally defined as intermediaries who help locate investors, but do not register with the SEC as broker-dealers under the Securities Exchange Act of 1934 (the "Exchange Act").  This is advantageous because registering as a broker-dealer is expensive and time-consuming.  Nonetheless, companies that use finders to assist in the sale of securities must be extremely cautious when working with a finder as they may be required to register as a broker-dealer under the Exchange Act. While the SEC has not provided a bright-line test to distinguish between a finder and a broker-dealer, it generally evaluates the following factors:

1. Whether the finders's compensation is success- or transaction-based;
2. Whether the finder participates in negotiations between the issuer and purchaser;
3. Whether the finder has a history of involvement in securities transactions; and
4. Whether the finder handles the securities of others in connection with securities
transactions.

New Guidance on Broker-Dealers vs. Finders
Recently, the SEC issued a No-Action Letter that provides additional guidance regarding the finder/broker-dealer distinction.  A prospective finder requested no action from the SEC regarding its potential engagement to assist a corporation with obtaining funding. Under the proposed fee agreement, the finder would receive success-based compensation tied to a percentage of the amounts raised from contacts identified by the firm as being interested in investing. The prospective finder stated that it would not (i) engage in negotiations on any party's behalf, (ii) provide its contacts with any information about the corporation, (iii) be involved with or make recommendations about any financing agreements reached by the parties, or (iv) assist with any transactions involving financing.

Although the finder's role was proposed to be limited, the SEC pointed to two reasons why the firm would need to register as a broker-dealer. First, the fact that the firm would only be making a limited number of introductions suggested to the SEC that the firm would be "pre-screening" potential investors and "pre-selling" the corporation's securities in an effort to make sure that the investors were both eligible for and interested in the transaction. Second, and perhaps more critically, the firm's success-based compensation arrangement suggested to the SEC that the firm would have a "heightened incentive" to engage in sales efforts. Based on those two factors, the SEC expressed its belief that the firm's activities would require it to register as a broker-dealer.

Given the SEC's guidance, both "finders" and companies that work with them must continue to be wary of SEC enforcement and the other consequences of engaging in activities related to the sale of securities without broker-dealer registration.