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Using Finders to Raise Capital in Private Placements and Fund Investments: Navigating SEC Broker-Dealer Rules

Avoiding the Pitfalls of Using Unregistered Finders, Lessons from Recent SEC Enforcement Actions

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific MONDAY, DECEMBER 21, 2015

David H. Pankey, Partner, McGuireWoods, Washington, D.C. Anitra T . Cassas, Partner, McGuireWoods, Richmond, Va. Presenting a 90-Minute Encore Presentation of the Webinar with Live, Interactive Q&A

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Using Finders to Raise Capital in Private Placements and Fund Investments

Presented by: Anitra T. Cassas, Partner acassas@mcguirewoods.com David Pankey, Partner dpankey@mcguirewoods.com December 21, 2015

6 | McGuireWoods

CONFIDENTIAL

Overview of “Broker” Status

Section 15(a) of the Securities Exchange Act of 1934 (“Exchange Act”) makes it unlawful for a “broker” or “dealer” to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security (other than an exempted security) unless such broker or dealer is registered with the SEC. States have similar laws on their books.

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CONFIDENTIAL

“Broker” Defined

• Section 3(a)(4)(A) of the Exchange Act defines the term “broker”

as “any person engaged in the business of effecting transactions in securities for the account of others.” (emphasis added)

• The terms “engaged in the business” and “effecting transactions”

are not defined in the Exchange Act.

• Instead, through a series of releases and no-action letters, the

SEC and its staff have listed a number of factors they look at in determining whether a market participant is required to register as a B/D.

• Through this process, the SEC staff has created a limited

exception from broker-dealer registration for “finders.”

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CONFIDENTIAL

Common Factors

There is no bright-line test. The determination is necessarily based on all of the relevant facts and circumstances. But the most common factors are:

• Receiving transaction-related compensation;
• Holding oneself out as a broker;
• Participating in the securities business with some degree of regularity;
• Assisting an issuer to structure prospective securities transactions;
• Helping an issuer to identify potential purchasers;
• Soliciting securities transactions (significant investor contact;

negotiation);

• Participating in order-taking; and
• Previous securities registration and/or disciplinary actions.

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CONFIDENTIAL

Transaction-Based Compensation

• Any compensation “directly related to the success of the sale of

the subject securities.”

• It is the single most important hallmark of broker status. The

SEC wants to ensure that individuals and entities with a “salesman’s stake” in the transaction are regulated.

• From the SEC staff’s unspoken view-point– this factor alone is

sufficient to require registration.

• There is no comfort in the no-action letters.

– Paul Anka (1991) – the “one and done” rule. – Brumberg, Mackey & Wall (2010)– if transaction-based compensation is present, SEC staff will most likely find other factors.

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CONFIDENTIAL

Transaction Based Compensation (cont.)

• At least one court has rejected the SEC staff’s position concerning the

mere introduction of parties in connection with a securities transaction.

• In SEC v. Kramer (M.D. Fla. 2011), the District Court noted that “merely

bringing together the parties to transactions, even those involving the purchase and sale of securities” is not enough to compel broker registration, even if the finder receives a fee “in proportion to the amount

• f the sale.”
• After acknowledging and then dismissing the staff’s position in

Brumberg, the Court concluded that “[i]n this instance, [finder’s] conduct consisted of nothing more than bringing together the parties to a

• transaction. The commission presented no evidence that [the finder]

either participated in the negotiation, discussed the detail of the transaction, analyzed the financial status of [the issuer], or promoted an investment in [the issuer] to [the investors].”

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CONFIDENTIAL

Significant Contacts with Investors

Even in the absence of transaction-based compensation, there are certain activities that raise such serious public protection concerns that the SEC would most likely require registration. In particular, the SEC will look at nature of the finder’s relationship and contacts with the investor:

• Providing PPMs, other offering documents, and marketing

materials to investors.

• Participation in the negotiations between the potential investor

and the issuer.

• Making recommendations to potential investors regarding an

investment in the issuer, or advising potential investors on the merits of any investment opportunity.

• Type of investor generally is not relevant (but see Rule 506

exception regarding accredited investor status).

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CONFIDENTIAL

True Consultants/Pure Referrals Potentially OK Under Finder Exception

Provided that a finder neither receives transaction-based compensation nor has significant contacts with investors, the no-action letters indicate that an unaffiliated finder may engage in the following activities without registering as a broker:

• refer the names and contact information of potential investors to the issuer;
• assist the issuer in determining the terms of the offering;
• help prepare materials (including private placement memorandums, financial data,

sales literature or other offering materials);

• provide market and financial analyses;
• prepare feasibility studies;
• advise issuer on its financial potential and recommend methods of financing; &
• advise on the administrative work involved in an offering.
• fixed fees or hourly rates that are reasonably related to the services

provided, and get paid regardless of the outcome of the deal (true consulting fees).

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CONFIDENTIAL

Safe Harbor for “Associated Persons of Issuers”

• Rule 3a4-1 of the Exchange Act provides a non-exclusive safe

harbor from the broker-dealer registration provisions for an "associated person of an issuer."

• Defined as any natural person who is a partner, officer, director,
• r employee of

– (i) the issuer; – (ii) a corporate general partner of a limited partnership that is the issuer; – (iii) a company or partnership that controls, is controlled by, or is under common control with, the issuer; or – (iv) an investment adviser registered under the Investment Advisers Act of 1940 (“Advisers Act”) to an investment company registered under the Investment Company Act of 1940 (“Investment Company Act”) which is the issuer

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CONFIDENTIAL

Preliminary Conditions

To qualify for the safe harbor, the individual must meet all 3 of the preliminary conditions: (1) Statutory Disqualification: Not subject to a statutory disqualification; (2) Compensation: Does not direct or indirect compensation tied to securities transactions. Whether this condition is met will depend on all the facts and circumstances. For example, in looking at bonuses, factors considered are: (1) when the offering begins and ends; (2) when the bonus is paid; (3) when issuer determines bonus will be paid; (4) when associated persons are informed of the issuer's determination; and (5) whether the bonus paid varies with the success in selling the issuer's securities. (3) Broker-Dealer Association: Not, at the time of his participation, an associated person of a broker or dealer.

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CONFIDENTIAL

Meet 1 of 3 Alternative Conditions

(1) Active Solicitation Activities: – primarily performs (or intends to) at the end of the offering, substantial duties for or on behalf of the issuer besides offerings. Will be measured in terms of volume and percentage of work performed apart from securities transactions. – (ii) not a broker or dealer, or an associated person, in last 12 months. – (iii) only participates in an offering once every 12 months other than in reliance on another alternative (except certain shelf offerings. (2) Certain Types of Investors – Limited in the rule. Does not depend on accredited, qualified purchaser or qualified client status. (3) Passive Solicitation Activities: – Preparing and deliver written communications to potential investors (no

• ral solicitation);

– Responding to inquiries of a potential purchaser if he/she initiated (response limited to information in offering document); and – Performing ministerial and clerical work involved in effecting any transaction.

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CONFIDENTIAL

Blass Speech – Safe Harbor Not a Silver Bullet

In April 2013, the then Chief Counsel of the SEC’s Division of Trading and Markets spoke specifically on broker-dealer concerns in the private fund space. Blass outlined some questions fund managers should be asking, particularly with respect to their employees and those of affiliates:

• How do you solicit and retain investors?
• What are the duties and responsibilities of personnel performing such solicitation or

marketing efforts?

– A dedicated sales force of employees working within a “marketing” department may strongly indicate that they are in the business of effecting transactions in the private fund, regardless of how the personnel are compensated.

• Do employees who solicit investors have other responsibilities? If so, consider what those

responsibilities are (i.e., are the primary functions of these employees to solicit investors?).

• How are personnel who solicit investors for a private fund compensated? Do those

individuals receive bonuses or other types of compensation that are linked to successful investments?

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CONFIDENTIAL

Blass Speech (cont.) – Focus on Fees

Blass also cautioned managers to consider fees they charge and in what way, if any, they are linked to a security transaction.

• Need to consider fees tied to both possible entry points:

(1) fees tied to capital raising (2) fees tied to fund transactions

• Example: Fees the manager directs a portfolio company of the fund to pay

directly or indirectly to the adviser or one of its affiliates in connection with the acquisition or disposition (including an initial public offering) of a portfolio company or a recapitalization of the portfolio company.

– Fees described as compensation for manager, affiliates or personnel for “investment banking activity,” including negotiating transactions, identifying and soliciting purchasers

• r sellers of the securities of the company, or structuring transactions.
• The general partner will NOT be be viewed as the same person as the fund --

transactions will be for the account of others.

• To the extent the advisory fee is wholly reduced or offset by the amount of the

transaction fee, should be OK.

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CONFIDENTIAL

OCIE Exams

• In examinations by the SEC’s Office of Compliance Inspections

and Examinations, the staff has been laser focused on fees being received by fund managers (the registered investment advisers) and fund affiliates.

• Anything beyond the advisory/management fee and the carry will

most likely be questioned by the staff.

• In examinations of fund clients where these additional fees are

being received, the staff has asked for a written legal analysis conducted by, or on behalf of, the specific client in determining whether broker-dealer registration is appropriate, including any legal basis or authority on which the client has relied.

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CONFIDENTIAL

So What? Consequences of Not Registering

Finder/Consultant – primary liability under Section 15(b) of the Exchange Act Issuer/Fund Manager - secondary liability under Section 20 of the Exchange Act for aiding and abetting. Sanctions and Effect of Unregistered Broker Activity:

– cease-and-desist orders from the SEC or relevant state regulator or court injunctions – civil penalties including fines and disgorgement – criminal liabilities – potential rescission rights of investors under federal or state law, which could have a domino effect for the issuer – reputational harm

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CONFIDENTIAL

Ram Capital Case – Signal of Change

• Administrative proceedings against Ram and two individuals,

Fein and Saltzstein, in June 2009.

• Well-known in the PIPEs market– offerings often brought to

them.

• Identified and solicited investors for PIPEs from 2001-2005
• Also advised on structure of offerings (incl. drafting initial term

sheet, securities purchase agreement) and negotiated with investors and issuers.

• Majority of investors were hedge funds
• Typical Compensation: 3.5% of gross amount invested by each

solicited investor, and 25% of all warrants allocated to the investors.

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CONFIDENTIAL

Ram (cont.)

• SEC: “knew or were reckless in not knowing that Ram’s

compensation structure for its services required Ram to register as a broker-dealer. In fact, others in the industry questioned Fein about whether Ram should be registered based on the services Ram was providing and how it was compensated for such services.”

• Penalties: (1) cease and desist order; (2) suspended from

association with any broker-dealer for 6-12 months; and (3) disgorgement, prejudgment interest and civil penalties ($60-90k). (approx. total - $500k each)

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CONFIDENTIAL

Ranieri Partners – SEC Unrelenting In Its Position

• In March 2013, SEC brought companion cases against a

consultant who acted as an unregistered broker for a private equity fund, and against the fund manager and one of its principals for aiding and abetting.

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CONFIDENTIAL

In the Matter of William M. Stephens – The Unregistered Broker

The SEC alleged that, while working as an independent consultant, Stephens actively solicited investors on behalf of private funds managed by Ranieri Partners’ affiliates and, in return, received transaction-based compensation totaling approximately $2.4 million. While typically the SEC staff focuses on the compensation, this case centered around Stephens’ solicitation efforts:

• sending private placement memoranda, subscription documents, and due

diligence materials to potential investors;

• urging at least one investor to consider adjusting its portfolio allocations to

accommodate an investment with Ranieri Partners;

• providing potential investors with his analysis of Ranieri Partners’ funds’ strategy

and performance track record; and

• Providing potential investors with confidential information relating to the identity of
• ther investors and their capital commitments.

By these actions, engaged in effecting securities transactions. Sanctions incl. disgorgement and prejudgment interest of $410k and barred from the securities industry.

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CONFIDENTIAL

In the Matter of Ranieri Partners LLC and Donald

• W. Phillips -- Aiding and Abetting
• SEC alleged that Ranieri Partners and its then Senior Managing

Partner, Donald Phillips, provided Stephens with key documents and information related to Ranieri Partners’ private equity funds and did not take adequate steps to prevent Stephens from having substantive contacts with potential investors.

• According to Phillips, he informed Stephens that Stephens’

activities on behalf of Ranieri Partners were limited to contacting potential investors to arrange meetings for the principals of and that he specifically informed Stephens that he was not permitted to provide PPMs directly to potential investors.

• Phillips also argued that he informed Stephens that Stephens

was not permitted to contact investors directly to discuss his views of the merits and strategies of the funds.

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CONFIDENTIAL

Aiding and Abetting (cont.)

• In contrast to the claims by Donald Phillips, the SEC alleged that

Phillips failed to limit Stephens’ access to key documents, by providing many copies of the PPM and other offering documents to Stephens. In addition, Phillips received Stephens’ requests for expense reimbursements, which reflected extensive contact with potential investors.

• Ranieri Partners therefore caused Stephens’ violations of

Section 15(a) of the Exchange Act, and willfully aided and abetted the violation.

• Sanctions – Civil penalties of $375k for Ranieri Partners; Phillips

was suspending from associating with securities industry for 9 months and fined $75k.

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CONFIDENTIAL

How Are the Regulators Going to Know?

• SEC Examination of Fund Mangers– SEC is looking at every dollar going into and out of

the fund, fund manager, portfolio companies, affiliates, etc.

• Form D: Item 12 on Form D requires the issuer to identify the name, address and

registration number (if applicable) of any person that “has been or will be paid directly or indirectly any commission or similar compensation in cash or other consideration in connection with sales of securities in the offering, including finders.” – An amendment to Form D: required if 10% increase in the amount of sales commissions, finders’ fees or use of proceeds for payments – Failure to disclose will most likely be considered a material non-disclosure, subjecting issuers to a potential fraud claim – More than a 1/3 of the states are routinely reviewing these forms to try and catch unregistered brokers.

• Litigation: Civil litigation between parties
• FINRA: FINRA application requires a statement confirming that “the applicant has not

previously conducted a securities business, is not currently engaged in the conduct of a securities business, and will refrain from conducing a securities business until it has received approval from FINRA.” (similar to many state requirements)

• Whistleblower: Disgruntled investor/competitor/employee.
• Also may come up in the registration process.

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CONFIDENTIAL

M&A Brokers – One Area OK to Receive Transaction-Based Compensation

• In a January 2014 M&A Broker no-action letter, the SEC clarified

and expanded its guidance concerning “broker” activity in the M&A space.

• SEC staff stated that it would not recommend enforcement action

to the SEC under section 15(a) of the Exchange Act if an individual or firm meeting the definition of an “M&A Broker” were to effect securities transactions (“M&A Transactions”) in connection with the transfer of ownership of a privately held company (“Privately Held Company”) under the terms and conditions described in the letter without registering as a broker- dealer pursuant to section 15(b) of the Exchange Act, subject to certain conditions (“conditions”).

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CONFIDENTIAL

Definition of M&A Broker

• M&A Broker: For purposes of this no action letter, an M&A

Broker is a person engaged in the business of effecting securities transactions solely in connection with the transfer of

• wnership and control of a Privately Held Company (see

below), through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will control and actively operate the company or the business conducted with the assets of the company.

• Active Operation: A buyer could actively operate the company

through, among other things, the power to elect executive

• fficers and approve the annual budget or by serving as an

executive or other manager.

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CONFIDENTIAL

Definition of Privately Held Company

• For purposes of this no action letter, a Privately Held Company is

an operating company that is a going concern (not a “shell” company) that does not have any class of securities registered or required to be registered with the SEC under the Exchange Act,

• r with respect to which the company files, or is required to file,

periodic information, documents, or reports under section 15(d)

• f the Exchange Act.

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CONFIDENTIAL

Conditions

The no action letter contains very significant limitations on the permitted activities of an M&A Broker, including the following.

• 1. The M&A Broker will not have the ability to bind a party to an M&A

Transaction.

• 2. An M&A Broker will not directly, or indirectly through any of its affiliates,

provide financing for an M&A Transaction. An M&A Broker that assists purchasers to obtain financing from unaffiliated third parties must comply with all applicable legal requirements, including, as applicable, Regulation T (12 CFR 220 et seq.), and must disclose any compensation in writing to the client.

• 3. Under no circumstances will an M&A Broker have custody, control, or

possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A Transaction or other securities transaction for the account of others.

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CONFIDENTIAL

Conditions (continued)

4. M&A Transactions cannot involve a public offering. Any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the Securities Act of 1933 (“Securities Act”). 5. To the extent an M&A Broker represents both buyers and sellers, it will provide clear written disclosure as to the parties it represents and

• btain written consent from both parties to the joint representation.
• 6. An M&A Broker will facilitate an M&A Transaction with a group of

buyers only if the group in formed without the assistance of the M&A Broker.

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CONFIDENTIAL

Conditions (continued)

7. The buyer, or group of buyers, in an M&A Transaction will, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business. – A buyer, or group of buyers collectively, would have the necessary control if it has the power, directly or indirectly, to direct the management or policies of a company, whether through ownership

• f securities, by contract, or otherwise.

– The necessary control will be presumed to exist if, upon completion

• f the transaction, the buyer or group of buyers has the right to

vote 25% or more of a class of voting securities; has the power to sell or direct the sale of 25% or more of a class of voting securities;

• r in the case of a partnership or limited liability company, has the

right to receive upon dissolution or has contributed 25% or more of the capital. – In addition, the buyer, or group of buyers, must actively operate the company.

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CONFIDENTIAL

Conditions (continued)

• 8. No M&A Transaction will result in the transfer of interests

to a passive buyer or group of passive buyers. 9. Any securities received by the buyer or M&A Broker in an M&A Transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act because the securities would have been issued in a transaction not involving a public

• ffering.
• 10. The M&A Broker (and, if the M&A Broker is an entity, each
• fficer, director or employee of the M&A Broker): (i) has not

been barred from association with a broker-dealer by the SEC, any state or any self-regulatory organization; and (ii) is not suspended from association with a broker-dealer.

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CONFIDENTIAL

FINRA

• FINRA has always deferred to the SEC in connection with determinations of

broker status.

• Nevertheless, FINRA rules previously prohibited member firms from paying or

sharing securities-related compensation with non-members.

• In recognition of the M&A Broker no-action letter, however, FINRA changed Rule

2040 regarding payments to unregistered persons.

• As noted in the FINRA Notice-to-Member 15-07, FINRA Rule 2040 is now

expressly aligned with Section 15(a) of the Securities Exchange Act and its related guidance to determine whether registration as a broker-dealer is required for persons to receive transaction-related compensation and to engage in related activities.

• FINRA has said that member firms can reasonably rely on previously published

releases, no-action letters or interpretations from the SEC staff that apply to their facts and circumstances, which would include the M&A Broker No-Action

• Letter. The rule, however, is not limited to this one letter.

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CONFIDENTIAL

State Law Issues

• This no action letter only applies at the Federal level. The states

do not have a uniform approach.

• In January, NASAA proposed a uniform state model rule

regarding the exemption of certain merger and acquisition brokers (“Merger and Acquisition Brokers”) from registration as “brokers,” “dealers,” “agents,” and/or “broker-dealers.”

• In general, except for the Excluded Activities and disqualification

provisions, a Merger and Acquisition Broker would be exempt from broker-dealer registration.

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CONFIDENTIAL

NASAA Model Rule

The term “Merger and Acquisition Broker” means any broker and any person associated with a broker engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company, regardless of whether that broker acts on behalf of a seller or buyer, through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the eligible privately held company, if the broker reasonably believes that -- (I) Upon consummation of the transaction, any person acquiring securities or assets of the eligible privately company, acting alone or in concert, will control directly or indirectly, and will be active in the management of the eligible privately held company or the business conducted with the assets of the eligible privately held company; and (II) If any person is offered securities in exchange for securities or assets of the eligible privately held company, such person will, prior to becoming legally bound to consummate the transaction, receive or have reasonable access to the most recent fiscal year-end financial statements of the issuer of the securities as customarily prepared by its management in the normal course of

• perations and, if the financial statements of the issuer are audited, reviewed, or compiled, any

related statement by the independent accountant; a balance sheet dated not more than 120 days before the date of the exchange offer; and information pertaining to the management, business, results of operations for the period covered by the foregoing financial statements, and any material loss contingencies of the issuer.

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CONFIDENTIAL

NASAA Model Rule - Definitions

• “Control” – Similar to the M&A Broker no-action letter, except

presumption is at the 20% level.

• Eligible Privately Held Company – Similar to the M&A Broker letter,

but the fiscal year ending immediately before the fiscal year in which the services of the Merger and Acquisition Broker are initially engaged with respect to the securities transaction, the company must also meet either

• r both the following conditions (determined in accordance with the

historical financial accounting records of the company):

– The earnings of the company before interest, taxes, depreciation, and amortization are less than $25,000,000; and/or – The gross revenues of the company are less than $250,000,000.

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CONFIDENTIAL

NASAA Model Rule – Excluded Activities

A Merger and Acquisition Broker would not be exempt from registration if it did any of the following: (i) Directly or indirectly, in connection with the transfer of ownership

• f an eligible privately held company, receives, holds, transmits, or has

custody of the funds or securities to be exchanged by the parties of the transaction; (ii) Engages on behalf of an issuer in a public offering of any class of securities that is registered, or is required to be registered, with the SEC under Section 12 of the Securities Exchange Act, or with respect to which the issuer files, or is required to file, periodic information, documents, and reports under Section 15(d) of the Exchange Act; or (iii) Engages on behalf of any party in a transaction involving a public shell company.

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CONFIDENTIAL

NASAA Model Rule – Disqualification Provisions

A Merger and Acquisition Broker is not exempt from registration if it is subject to –

(i) Suspension or revocation of registration under Section 15(b) of the Exchange Act of 1934; (ii) A statutory disqualification described in section 3(a)(39) of the Exchange Act of 1934; (iii) A disqualification under the rules adopted by the SEC under Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act; or (iv) A final order described in paragraph (4)(H) of Section 15(b) of the Exchange Act.

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CONFIDENTIAL

Capital Raising Issues for Small and Emerging Companies

• It is widely recognized that small business capital formation is key to

creating jobs in the US.

• The issues surrounding capital formation for small and emerging

companies are not new. These issues, however, have been severely exacerbated by the financial crisis.

• Bank funding slowed to a trickle or dried up entirely.
• And the universe of financial intermediaries who can legally raise capital

– registered broker-dealers – has been dramatically shrinking over the last 15 years, both in terms of the number of firms and the scope of services that they render.

• Quite simply put, the risk/reward ratio of smaller offerings often attract

little interest of registered broker-dealers.

• Accordingly, many companies turn to finders.

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CONFIDENTIAL

JOBS Act Change

• Section 201(a)(1) of the JOBS Act directs the SEC to revise Rule 506 of

Regulation D to provide that the prohibition against general solicitation

• r general advertising shall not apply to offers and sales of securities

provided that all purchasers of the securities are accredited investors.

• Section 201(c) of the JOBS Act also added language exempting

persons from broker-dealer registration under the following conditions:

– (A) that person maintains a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitation, general advertisements, or similar or related activities by issuers of such securities, whether online, in person, or through other means (e.g., social media, websites, etc.); – (B) that person or any person associated with that person co-invests in such securities; or – (C) that person or any person associated with that person provides ancillary services with respect to such securities.

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CONFIDENTIAL

JOBS Act (cont.)

• Ancillary Services:

– Due diligence services -- so long as such services do not include, for separate compensation, investment advice or recommendations to issuers or investors; and – The provision of standardized documents to the issuers and investors, so long as such person or entity does not negotiate the terms of the issuance for and on behalf of third parties and issuers are not required to use the standardized documents as a condition of using the service.

• Other Conditions

– No compensation in connection the purchase or sale of such security (not limited to transaction based compensation; any direct or indirect economic benefit to the person or any of its associated persons) – No possession of customer funds or securities in connection with the purchase or sale of such security; and – No subject to statutory disqualification.

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CONFIDENTIAL

Little Has Changed

• The JOBS Act reform in this area changed very little with respect

to the area of unregistered finders.

• The SEC staff acknowledged that the prohibition on

compensation makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker- dealer registration.

• Also has no effect on state requirements.

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CONFIDENTIAL

SEC Advisory Committee on Small and Emerging Companies

• In 2011, the SEC formed an Advisory Committee on Small and

Emerging Companies. The current term just ended, and the SEC has renewed the charter but the members may change.

• The Committee’s objective is to provide the SEC with advice on its rules,

regulations, and policies, with regard to its mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation, as they relate to, among other things, capital raising by emerging privately held small businesses (“emerging companies”) and publicly traded companies with less than $250 million in public market capitalization (“smaller public companies”) through securities

• fferings, including private and limited offerings and initial and other

public offerings.

• The June 3, 2015 and July 15, 2015 meetings of the Committee

included discussion of finders and other financial intermediaries in small business capital formation.

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CONFIDENTIAL

Concerns

• a. The importance of Rule 506 to small companies in raising

capital.

• b. The current BD registration system, especially the FINRA

membership application process, is perceived to be disproportionately complex, and the resulting regulatory compliance is perceived to be overwhelming for a finder or smaller intermediary.

• c. Failure to provide relief impedes capital formation for smaller
• companies. Small companies have great difficulty in locating

fully licensed BDs to assist in capital raising.

• d. Appropriate regulation would enhance economic growth and job

creation

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History - 2005 ABA Task Force Report

2005 – Report and Recommendation of the ABA Task Force on Private Placement Brokers – in effect recommending a concerted effort to simplify the registration of “private placement brokers”

• Sales could only be made to “accredited investors,” and only in

limited amounts

• Sales could only be made in private placements, not public
• fferings
• Prior “bad boy” activities would disqualify a person from acting as

a finder

• Full written disclosure of the finder’s compensation would be

required

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History - 2005 ABA Task Force Report

• Finders would be exempt from the definitions of “broker” and

“dealer” and permitted to share fees with broker-dealers

• Coordinated Federal and state regulation would focus on the

above requirements and appropriate investor protections.

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History - 2006 SEC Advisory Committee on Smaller Public Companies

In 2006, the SEC Advisory Committee on Smaller Public Companies urged the SEC to “[s]pearhead a multiagency effort to create a streamlined NASD registration process for finders, M&A advisors and institutional private placement practitioners.”

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History - Small Business Forums have recommended alternatives, including that the SEC:

• a. “allow ‘private placement brokers’ to raise capital through

private placements of issuers’ securities offered solely to ‘accredited investors’ in amounts per issuer of up to 10% of the investor’s net worth (excluding his or her primary residence), with full written disclosure of the broker’s compensation and any relationship that would require disclosure under Item 404 of Regulation S-K, in aggregate amounts of up to $20 million per issuer” (2009)

• b. “adopt a financial intermediary exemption that would remove

from the scope of federal broker registration requirements persons who operate in a limited capacity to assist small issuers in raising private capital subject to investor protection safeguards” (2011)

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Small Business Forums have recommended alternatives, including that the SEC:

• c. “Join with NASAA and FINRA in the effort to implement the

basic principles of the American Bar Association Task Force on Private Placement Brokers. To achieve this goal, [the Commission should] join NASAA and FINRA in developing a time frame for quarterly or other regular meetings – with specified benchmarks – until a mutually agreeable regime of finder registration and regulation is achieved” (2014)

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Advisory Committee - Decision Points

• Definition and segmentation of covered persons
• Limitation on permissible activities
• Disqualifications
• Disclosure of compensation/other relationships with issuer,

reporting, other regulatory provisions

• Legal and practical challenges and impediments
• Other issues

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Detailed List of Structural Considerations and Decision Points

a.

Definition and segmentation of covered persons – Identify the types of persons who participate in finder and other intermediary activities – Differentiate among those classes of persons – e.g.

• Finders – referrals and introductions only
• Advisors – more expansive internal activities
• Intermediaries – limited pre-selling

– Scale regulations according to the class of participants b. Limitation on permissible activities – For each covered class, provide appropriate limitations on the activities conducted – Consider limitations on size of offerings, and number of transactions or purchasers – Determine what constitutes a “small business” issuer for purposes of the rules

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Detailed List of Structural Considerations and Decision Points (continued)

• c. Threshold Restrictions

– No handling of customer funds or securities – Participation permitted only in private placements, not registered

• fferings

– Permitted transactions limited to accredited investors and other qualified purchasers

• d. Disqualifications

– Appropriate bad actor disqualifications – Not available for intermediary (and, if an entity, its officers, directors and participating employees) (i) has been barred from association with a broker dealer by the SEC, any state or any self-regulatory

• rganization; or (ii) is suspended from association with a broker-

dealer – No disqualification or other sanctions for failure to register as a broker before the effective date of the new rules

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Detailed List of Structural Considerations and Decision Points (continued)

• e. Regulation and reporting

– No-action letter approach – Self-executing status – similar to Advisers Act solicitors rule – Registration – similar to Dodd-Frank Act reporting by exempt advisors – Membership in FINRA or other self-regulatory organization – Written disclosure requirements

• Identity of the intermediary
• That the intermediary represents the issuer and not the investor
• Relationship, including any affiliation, between intermediary and issuer
• Compensation arrangements, including nature and amount of payments
• Continuing applicability of other provisions, including the anti-fraud

provisions, or the federal and state securities laws

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Detailed List of Structural Considerations and Decision Points (continued)

f. Legal and practical challenges and impediments

• g. Other issues

– Dollar thresholds on amount raised in any transaction – Annual filing or other ongoing reporting requirements – Examinations (routine, for cause) – Fee-sharing with registered broker-dealers – Escrow of funds in minimum offerings – Technical FINRA requirements relating to “recommendations,” “know your customer” and “suitability”

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Detailed List of Structural Considerations and Decision Points (continued)

On September 23, 2015, the Committee made the following recommendations to the SEC:

• The SEC should take steps to clarify the current ambiguity in

broker-dealer regulation by determining that persons that receive transaction-based compensation solely for providing names of or introductions to prospective investors are not subject to registration as a broker under the Exchange Act.

• The SEC should exempt intermediaries that are actively involved

in the discussions, negotiations and structuring, as well as the solicitation of prospective investors, for private financings on a regular basis from broker registration at the federal level, conditioned upon registration as a broker under State law.

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Detailed List of Structural Considerations and Decision Points (continued)

• The SEC should spearhead a joint effort with NASAA and FINRA

to ensure coordinated State regulation and adoption of measured regulation that is transparent, responsive to the needs of small businesses for capital, proportional to the risks to which investors in such offerings are exposed and capable of early implementation and ongoing enforcement.

• The SEC should take immediate steps to begin to address

issues regarding the regulation of intermediaries in small business capital formation transactions incrementally instead of waiting until development of a comprehensive solution.

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