John Lilly - Strategic Insights
John Lilly - Strategic Insights


Raising Money For Early Stage Companies
We are frequently asked why JLSI does not engage in fundraising for Early Stage companies---either directly or as a “finder” for companies looking to raise money. The simple reason is that JLSI is not a FINRA licensed Broker/Dealer and to accept commission-based compensation without this licensure (even for “making introductions”) is simply not “legal” in the eyes of the SEC.

Unfortunately, not all business consultants play by this set of rules, even though they take great risk in doing so. We are frequently asked to make introductions to possible investors on the promise that if anything happens, JLSI will get commissions, stock or warrants in the company. We just don’t do it. For perspective on this issue, see the note below written by our lawfirm, Faegre and Benson. This suggests that the rules around “finders” are very current with the SEC and that they are serious about enforcement.

SEC Continues to Deny Finders Exemption From Broker-Dealer Registration
Authors: Matthew Kuhn

The Securities and Exchange Commission recently issued a response to a no-action request that emphasizes the SEC's narrow interpretation of the finder exception from broker-dealer registration. As discussed in this prior article, the distinction between finders and broker-dealers who are subject to additional regulation is ambiguous and involves analysis of four factors identified by the SEC. One of those factors is the receipt of transaction-based compensation, but the SEC has repeatedly stated that no one factor is determinative in the analysis.

Request for Exemption from Broker-Dealer Registration
The SEC's recent response was to a request for no-action relief from the law firm of Brumberg, Mackey & Wall, P.L.C. ("BMW"). BMW sought to assist a renewable energy company in acquiring funding. BMW's proposed arrangement provided that BMW would introduce potential investors to the company and BMW would receive a percentage of the funds raised from those investors. Under the arrangement, BMW would not (1) engage in any negotiations with investors, (2) provide potential investors any information about the energy company that could be used as the basis for funding-related negotiations, (3) be responsible for, or make any recommendation regarding, the terms, conditions or provisions of any agreement for an investment or (4) provide any assistance to any potential investor with respect to any transaction involving the financing of the energy company. In its request, BMW did not state that it would have no contact with potential investors as part of the proposed arrangement.

In denying BMW's request, the SEC focused on the role it believed BMW would have in introducing potential investors to the company seeking financing. The SEC believed that such introductions would involve BMW "pre-screening" potential investors to determine their eligibility to purchase securities and "pre-selling" the company seeking financing. The SEC emphasized that the transaction-based compensation BMW sought to receive would give BMW a strong incentive to engage "pre-selling" or other sales activities such that BMW would need to register as a broker-dealer if it proceeded with the proposed arrangement.

The BMW no-action letter is the most recent example of the SEC's trend of narrowly interpreting the finder exception. The SEC's focus on the proposed transaction-based compensation suggests that the other three factors previously identified for determining whether broker-dealer registration is required carry little (if any) weight if transaction-based compensation is involved. The SEC's 1991 no-action letter involving the entertainer Paul Anka still suggests that if there is absolutely no contact between a purported finder and potential investors, the finder may be allowed to receive transaction-based compensation without registering as a broker-dealer. However, given the SEC's increasing focus on investor protection, the age of the Paul Anka letter and the lack of recent SEC responses granting no-action relief for finders seeking to receive transaction-based compensation, the SEC seems to be taking the position that any person who receives transaction-based compensation in a securities transaction is a broker under the Securities Exchange Act. The BMW no-action letter serves as a reminder that issuers seeking financing and finders seeking to comply with the law should be aware of the laws that apply to finders and broker-dealers, the ambiguities that exist in those laws and the potential consequences of non-compliance.


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