By: Justin Banford  [6/20/22]

We’re occasionally asked if it’s a good idea for issuers to pay unregistered “finders” fees in exchange for connecting potential investors in conjunction with private securities offerings. “No,” is the short answer.

The majority of finders are hired by issuers under finder’s, advisory, or other agreements that often involve payment of “success fees” when a finance transaction is completed. Payment of transaction-based compensation is treated by US securities regulators as a nearly-conclusive indication that a person is engaged in the securities business and should be registered as a broker-dealer, despite the fact that these arrangements are sometimes structured to try to hide or disguise the true intent of the arrangement.

The following are the key federal broker-dealer statutes that an issuer (or company) using an unregistered finder should be aware of:

  • Section 15(a)(1) of the Securities Exchange Act of 1934 (Exchange Act) prohibits anyone from “effecting a transaction in securities” or “attempt to induce the purchase or sale of any security” unless they are registered as a broker or dealer under the Financial Industry Regulatory Authority, Inc.’s rules and regulations (FINRA). The Securities and Exchange Commission (SEC) has selected FINRA as the regulating entity to license and regulate broker-dealers.
  • Section 29(b) of the Exchange Act. Every contract executed in violation of any part of the broker-dealer registration requirements “must be void” as to the rights of persons who created or engaged in the performance of such contract. As a result, the underlying securities acquisition becomes a voidable transaction, allowing the investor a right of rescission and effectively awarding the investor or purchaser a put right.
  • Section 20(e) of the Exchange Act, which allows the SEC to hold anybody who knowingly or carelessly offers substantial assistance in a violation of the Exchange Act liable for aiding and abetting.

Broker-dealer registration is intended to act as a gatekeeper to protect investors in the marketplace. In the course of their business, FINRA members must “observe high standards of commercial honor and just and equitable principles of trade,” which includes deciding if an investment is “appropriate” for their customers. Finders who assist in transactions rarely make such decisions and instead see themselves as intermediaries who make introductions to possible investors.

Because unregistered broker-dealers may not comply to these high business criteria, the SEC interprets broker-dealer rules broadly while interpreting the few exceptions narrowly. Subject to a few limited exceptions, all intermediates performing securities transactions must be licensed, according to SEC guidance developed from no-action letters. Receiving transaction-based compensation, recommending a company or the purchase of its securities, negotiating terms of a securities offering or purchase, attending meetings or presentations where the investment merits are discussed, performing or accommodating due diligence efforts, providing valuations or estimates of value, and other activities that facilitate a securities transaction are all examples of how to effect a securities transaction.

Engaging an unauthorized finder can have a number of negative consequences:

  1. Finder’s Risks: Any unlicensed person participating in activities aimed to effect a securities transaction may be breaking broker-dealer laws. The SEC or state securities regulators may seek an injunction, as well as monetary penalties or criminal consequences, to stop the illegal activity.
  2. Issuer’s Risks: Keeping and allowing an unlicensed intermediary to effect a securities transaction could be a violation of federal and state laws, exposing the issuer to civil and criminal fines. Aiding-and-abetting liability may apply to anyone who intentionally or recklessly gives substantial assistance in a violation of the Exchange Act.
  3. Rescission: Under federal and/or state securities law, a violation of broker-dealer laws gives rise to a right of rescission. The issuer may be required by the SEC or state securities regulators to provide investors with rescission rights, and the issuer may be required to repay the investment.
  4. State Securities Laws: Many states have begun investigating state Form D notice filings (which identify transactions exempt from registration under Regulation D) and carefully monitoring finder’s fees paid in connection with securities transactions. Select jurisdictions have compelled issuers to submit extra information about unregistered broker-dealers, as well as to certify that finder’s fees or commissions were only paid in accordance with broker-dealer legislation in some situations.
  5. Consequences of Bad Actors: An issuer or finder who has been convicted of a felony or misdemeanor, is subject to any court order, judgment, or decree, or is subject to any order of certain regulators may be ineligible to participate in certain types of securities offerings, such as Rule 506 Regulation D offerings and Regulation A offerings.

Broker-dealer laws can be broken if you use an unauthorized finder. When finder’s fees or commissions are paid in conjunction with an offering, the problem frequently arises in the context of state notice filings and direct questions from state securities regulators. They may also develop as a result of a failed investment, in which case the investor may pursue claims for broker-dealer law violations in order to establish a right of rescission. When deciding whether to hire a finder to assist with financing transactions, issuers should proceed with caution.

What can you do? Using finders to raise funds is not the simple answer it appears to be on the surface. Worse yet, it has the potential to cause serious issues. Nothing worthwhile comes easily, as the adage goes. If you don’t have a VC-backed business, you may have an even more difficult time raising funds than the average entrepreneur. Regardless, you may need to be your own “finder” when it comes to obtaining funds for your firm. Make connections, hustle, and share your story. No one can describe your business and investment opportunity better than you, so consider critically and consult your lawyer before allowing an intermediary to stand between you and your possible investors.

This article is not legal advice. The above is general information not applicable to specific matters. No attorney-client relationship has been established by reason of reading this article. 

For more information on how Dunlap Bennett & Ludwig can help you with your legal needs, contact us by calling 800-747-9354 or emailing clientservices@dbllawyers.com.


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