The Financial Industry Regulatory Authority (FINRA) and the Securities Industry and Financial Markets Association (SIFMA) submitted comment letters to the SEC expressing their concern about the Commission’s proposed exemption from broker-dealer registration requirements for so-called "finders." Both organizations commented on the lack of oversight should the exemption be finalized, with SIFMA noting that it could affect the perception of the integrity of U.S. markets.
Proposed exemption. The Commission approved the proposed exemption for comment on a 3-to-2 vote. The exemption would create two classes of finders: Tier I and Tier II. A Tier I finder would be limited to providing contact information of potential investors in connection with only a single capital-raising transaction by a single issuer in a 12-month period and could not have any contact with a potential investor about the issuer. A Tier II finder would be permitted to solicit investors on behalf of an issuer with certain limitations on solicitation activity: (1) identifying, screening, and contacting potential investors; (2) distributing issuer offering materials to investors; (3) discussing issuer information included in any offering materials, provided that the Tier II finder does not provide advice as to the valuation or advisability of the investment; and (4) arranging or participating in meetings with the issuer and investor.
Both tiers of finders would be subject to additional restrictions, such as not engaging in general solicitation, having a reasonable belief that the investor is an accredited investor, and limitations on participating in the offering itself. At a recent meeting, the SEC’s Small Business Capital Formation Advisory Committee voted to support the proposed exemption, with enumerated qualifications it recommended that the SEC consider.
FINRA. In its letter, FINRA noted that it only regulates broker-dealers’ private placement activities, while most private placements occur either directly with investors or through other intermediaries. According to FINRA, by creating a separate category of exempt private placement brokers that would not be identified to regulators, subject to examination, or subject to broker-dealer regulatory requirements, the SEC would create significant risks to investors.
One of FINRA’s main objections to the proposed exemption concerns Tier II finders. The exemption would allow these unregistered finders to engage in capital-raising activity without the routine oversight and examination by regulatory authorities that registered brokers face, FINRA warned. Tier II finders would not have to possess any minimum knowledge or competency with respect to securities to qualify for the exemption, and there would be no assurance that such individuals have the knowledge, skills, integrity, or competency to serve investors or issuers in capital raising activities, asserted FINRA.
FINRA also expressed its concern that despite the prohibition on finder participation in the preparation of issuer sales materials, the lack of oversight could result in the preparation of sales materials by finders that are designed to maximize sales at the cost of compliance with standards requiring such communications to be fair and balanced. In addition, the prohibition on Tier II finders to make recommendations to prospective investors would be difficult to detect or enforce, FINRA said.
As an alternative to the proposed exemption, FINRA recommended a system that promotes its Capital Acquisition Brokers (CABs), which are broker-dealers that engage in a limited range of activities, including advising companies and private equity funds on capital raising and corporate restructuring and acting as placement agents for sales of unregistered securities to institutional investors. According to FINRA, CABs can act as finders or placement agents in connection with the sale of newly issued unregistered securities or in connection with a change of control of a private company and are subject to FINRA rules, which can be used to accommodate a category of brokers similar to the SEC’s proposed Tier II finders. Unlike the proposed exemption, CABs would be subject to core regulatory requirements such as having a supervisory system reasonably designed to achieve compliance with applicable laws and regulations, FINRA advised.
SIFMA. While SIFMA stated that it appreciates the SEC’s efforts to address this issue given the present lack of clarity on the topic, it advised that the proposed exemptive order may not provide an appropriate framework for finder activity. Echoing FINRA’s recommendation, SIFMA said that SEC should consider alternatives such as promoting CABs.
SIFMA also warned that the SEC should take into account the potential effects the exemption might inflict on the reputation of the U.S. capital markets, especially concerning integrity and reliability. According to SIFMA, authorizing this type of uninformed solicitation risks creating a market perception that people soliciting investments lack knowledge and information about the securities and issuers for which they are soliciting, and that such solicitations are unreliable. This perception, according to SIFMA, would undermine decades of efforts by the Commission to bolster public confidence in financial markets.
SIFMA cautioned that the framework proposed by the SEC is not tailored to the goal of promoting small business capital formation because it does not include any limit on offering size, as one transaction or in the aggregate. And while the proposed exemptive order purports to be narrowly tailored, SIFMA remarked that it does not define "smaller issuer" or limit the size of the issuer that could engage a finder, adding that there are several non-reporting companies that do not fit the commonly understood definition of "small."
Echoing concerns raised by the North American Securities Administrators Association (NASAA), SIFMA urged the SEC to work with state regulators to provide clarity and consistency regarding the types of activities in which finders and other limited purpose brokers may engage. SIFMA also cast doubt on the basis for the proposed exemptive order, stating that it does not provide economic analysis sufficient to meaningfully address the merits of the proposed framework, nor does it address reasonable alternatives.
Instead of issuing an exemptive order, SIFMA recommended that the Commission use the notice and comment rulemaking process to implement changes relating to finders. This would allow the public to provide meaningful comments and analysis to assist the SEC in:
- identifying the need for the action and explaining how the proposed framework would meet that need;
- articulating the appropriate economic baseline against which to measure the proposed framework’s likely economic impact;
- identifying and evaluating reasonable alternatives to the proposed approach; and
- assessing the potential economic impact of the proposed framework and reasonable alternatives, in light of quantitative and qualitative costs and benefits of each.