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The SEC Proposes a Limited Exemption to deregulate Capital Raising Efforts

McIntyre & Lemon: > Client Alerts  > The SEC Proposes a Limited Exemption to deregulate Capital Raising Efforts

The SEC Proposes a Limited Exemption to deregulate Capital Raising Efforts

In a nod to both Wall Street and Main Street, the SEC recently proposed an order to deregulate certain capital-raising efforts for private issuers. The proposal prescribes conditions to permit natural-person finders to raise capital for issuers absent the finder submitting to the substantive broker-dealer registration and regulatory regime prescribed by the Securities Exchange Act of 1934. Notably, the proposed exemption is intended to relax a longstanding restriction generally prohibiting unregistered persons from receiving “transaction-based” compensation (e.g., commissions or other incentive-based payments) tied to securities sales.

The proposed exemption extends solely to private issuers (i.e. non-public reporting companies) engaged in an offering of securities in reliance on an exemption from the securities registration requirements of the Securities Act of 1933, such as reliance on the private offering exemption prescribed by Section 4(a)(2) of the 1933 Act. Thus, the exemption, as proposed, could extend to small operating businesses seeking to raise operating capital via small securities offerings or large, sophisticated private investment funds, such as private equity or real-estate equity funds, that engage in fund raising from sophisticated institutional investors.

The proposal divides finders into categories of Tier I and Tier II Finders. Regardless of their categorization, the proposed exemption requires the offering basically to qualify for reliance on Regulation D under the 1933 Act, meaning a finder may not generally solicit investors and is restricted to contacting investors reasonably believed to be “accredited investors” subject to the net worth and sophistication standards of Regulation D.

Other preliminary conditions require that finder services be memorialized in a written agreement, the finder not be an associated person of a broker-dealer, and the finder not be the subject of statutory disqualification, as prescribed by the express terms of the 1934 Act.

Tier I Finders

A Tier I Finder is limited to performing finder’s services once in a 12-month period and is limited to introductions of potential investors with the issuer. In short, a Tier I Finder is limited to providing contact lists or introductions and may have no other participation in the offering or ultimate investment.

Tier II Finders

In contrast to Tier I Finders, Tier II Finders are permitted to have more substantive roles, and are not limited in the frequency of their finder’s services, but are subject to greater administration in their compliance with the proposed exemption. Thus, a Tier II Finder is able to screen investors for participation, distribute offering materials, such as private placement documents, and arrange and/or participate in investment negotiations, although they may not advise about the merits of the offering or otherwise structure the offering. Borrowing from the cash solicitation rule under the Investment Advisers Act of 1940 (Rule 206(4)-3), the SEC would require a Tier II Finder to deliver at any initial contact with investors written disclosures that highlight material aspects of the finder’s activities, as follows: (i) identity of issuer and finder; (ii) relationship of the finder with the issuer (affiliated or unaffiliated); (iii) existence and terms of any compensation arrangement with the finder; (iv) any material conflicts of interest; and (v) an affirmative statement that the finder is an agent of the issuer, not associated with a broker-dealer, and not subject to act in the best interest of the investor. Prior to investment, the finder must obtain written acknowledgment from the investor of these disclosures.

Rule 3a4-1 under the Securities Exchange Act

For issuers that have previously structured distributions of privately offered securities, certain of the conditions of the SEC’s proposed exemption may be reminiscent of the safe harbor prescribed by Rule 3a4-1 under the 1934 Act, an exclusion for so-called “associated persons of an issuer” in operation since the mid-1980s. The proposed exemption is more expansive than Rule 3a-4 in narrow but important respects, most notably in its allowance of the receipt of transaction-based compensation for permissible finder’s activities. Further, Tier I and Tier II Finders are not required to have a substantive affiliation or association with the issuer. That is in contrast to Rule 3a4-1, an issuer could enlist a third-party finder having no relationship with the issuer other than finding investors.

Rule 3a4-1, on the other hand, and unlike the proposed exemption, does not restrict an issuer’s associated person from structuring and negotiating the offering, “handling” customer funds or securities (generally, an offering would be expected to receive funds by an escrow agent) or binding an issuer and/or an investor to the offering terms; participating in the preparation of any sales materials; and performing any independent analysis of the sale.

As with reliance on Rule 3a4-1, the proposed exemption only extends to the broker-dealer registration and regulatory obligations of the 1934 Act. Potential state broker-dealer registration requirements could nonetheless apply to finder’s activities.


The proposed order for exemption is open for comment until November 30. For assistance with any questions or commenting, do not hesitate to contact C. Dirk Peterson at dpeterson@mcintyrelf.com