This is part six of a seven-part series on compliance with SEC and state law rules. It may sound boring, but this is really what you hire a syndication attorney for – that knowledge that you are in compliance. This way, you don’t fall victim or have the SEC come after you. Nothing could be scarier than getting a letter from the SEC saying you’re under investigation.
The point of this series is to identify and go through the main topics – the five big things that I see happening right now that the SEC and states are investigating. My prediction is that these five areas will be ratcheted up even more over the next few years.
The topic of this video is probably the most important one that’s going to be most heavily regulated: finders – paying people to help you raise money for your business or fund. We’ll go through in detail the factors the SEC uses.
The use of finders when raising capital for syndication or fund business is a big topic that I think the SEC and state regulators will be focusing on even more. Why? Because I see it being abused more and more over time. I’ve been practicing in this field for quite a while and have done a number of syndications myself. I know exactly the temptation that’s there – I’ve been tempted myself.
It would be great to just hire a broker-dealer and give the capital raising over to them. But they are often very expensive. While they deserve what they get, and the good ones earn every penny, it’s hard to meet the criteria that makes it worth their time. They need to be raising a lot of money over many deals. If that’s not there for them, other opportunities are more appealing. It’s understandable – it’s market-driven.
So we generally need to rely on raising money for ourselves. I have other videos that talk about raising money without a broker-dealer, discussing different online and offline methods, working with friends and family, etc. But let’s talk specifically about the temptation of the finder.
What is a finder? A finder is somebody who is not licensed – they don’t have a Series 7 or Series 22 securities license that allows them to sell – who would be helping you raise money. Are all finders in the world engaging in illegal activity? No, but it’s very easy to slip up, and the SEC is getting ready to regulate this area.
There are actually 16 different criteria used, but let’s start with the first case where a finder was deemed acceptable, to give you an idea of where it started and how it’s evolved since.
It began with a no-action letter from the SEC in 1991. A no-action letter is where a syndicator, fund, or business writes to the SEC asking if they would have a problem with a proposed action. The SEC then provides their general policy stance.
In 1991, the Ottawa Senators hockey team hired Paul Anka, famous for being in the Rat Pack. He was a singer with a large network of contacts. The Senators were raising money and engaged Paul Anka. Paul said he would give them his rolodex and go through name by name to identify likely investors – probably accredited investors and good prospects. He would receive a percentage of who invested.
The Senators and Paul Anka wrote to the SEC asking if this would run afoul of rules and regulations. The SEC said no, even though they were paying a percentage (which we’ll get to in a minute). The reason was that Paul Anka was just providing a rolodex – he wasn’t contacting anyone or doing anything other than providing a list of people to contact. That was deemed okay at the time, though other communications from the SEC since have suggested they probably wouldn’t allow this today.
Let’s go over the big rules, starting with the number one rule: Don’t pay anyone performance-based fees unless they’re a broker-dealer. Broker-dealers get paid on performance – they receive a brokerage fee or commission based on the amount of units sold. They may get 5-10% of the amount sold to a syndication, fund, or business. That’s a key test of how a brokerage gets paid. We’re talking about people licensed with a Series 7 or Series 22 for the sale of alternative investments.
The second rule: Are they assisting in any way with the transaction? Paul Anka just gave a list, which was barely assisting. He didn’t call anyone or help set up meetings. Broker-dealers play a very large role in facilitating the transfer of money from investors.
Third: Are they participating in discussions between the company and potential investors? If Paul Anka had set up conference calls or been part of email chains, that would count as participating in discussions.
Fourth: Are they engaging in pre-screening of potential investors? Paul Anka didn’t really pre-screen; he just went through his rolodex. He didn’t call people to ask if they’d be likely to invest or if they were accredited investors.
Fifth: Are they engaging in pre-selling activity? Contacting investors to gauge interest before an offering comes to market.
Sixth: Are they conducting or assisting with the sale itself? This is certainly a broker-dealer activity.
Seventh: Are they providing advice related to the value of the securities? Paul Anka didn’t discuss investment values or potential returns.
Eighth: Are they locating issuers of securities on behalf of investors? This is dangerous ground, especially when dealing with funds of funds.
Ninth: Are they handling customer funds and securities? If the finder is receiving money and then passing it to the fund, that’s a problem.
Tenth: Are they soliciting securities transactions? Finders can’t put up their own ads or actively solicit investments.
Eleventh: Are they disseminating quotes for securities or other pricing information? Communicating sales prices requires a license.
Twelfth: Are they actively rather than passively finding investors? Paul Anka was completely passive, just providing names from his rolodex.
Thirteenth: Are they sending private placement memos, subscription agreements, or due diligence materials? This is assisting the issuer in raising money.
Fourteenth: Are they assisting with portfolio allocations to accommodate investments? Providing investment advice like this is a broker-dealer activity.
Fifteenth: Are they providing analysis of the investment opportunity? This crosses into broker-dealer territory.
Sixteenth: Are they providing potential investors with confidential information or identifying other investors and their commitments? This is not allowed for finders.
The main question to ask yourself is: How are they getting paid? If it’s based on performance or how much is sold, it’s probably not allowed. The sponsors and officers of the sponsorship company can be paid based on performance, but bringing in outside people just to raise money won’t fly and will be quickly identified by regulators.
My name is Tilden Moschetti, and I’m a syndication attorney with the Moschetti Syndication Law Group. If we can help you navigate these areas and be in compliance with the SEC, that’s what we’re here for. We’re helping to make you successful as a syndicator, fund manager, or business trying to raise capital while staying compliant with SEC and state regulations. Regulators want you to be able to raise money and do business – they just need to ensure you’re doing it properly and within the rules. If you need help with your Regulation D Rule 506(b) or 506(c) offering, don’t hesitate to give us a call.