By Lara L. Hjortsberg, Esq.
Being a transactional attorney, it is common to come across individuals and companies that characterize themselves as finders or business brokers. They reason that since they are “only finders,” they do not need to register as brokers under the federal securities laws. The problem is, this assumption is not necessarily true. This article seeks to provide an explanation of when finders step into dangerous territory and become brokers requiring registration under federal securities laws.
Definition of Broker under the 1934 Act
Section 3(a)(4)(A) of the Securities Exchange Act of 1934 (the “1934 Act”) defines a broker as “any person engaged in the business of effecting transactions in securities for the account of others.” A finder cannot escape categorization as a broker by designating itself as a “finder” or a “business broker” and its compensation a “finder’s fee.” Rather, the SEC has taken a substance-over-form approach in its No-Action Letters with respect to broker registration and looks at the activities the finder performs and the basis for its compensation.
In recent years, the SEC has expanded the definition of broker by expressly limiting permissible finder activities. Most notable in this regard is the SEC’s 2000 Dominion Resources, Inc. No-Action Letter, in which the SEC withdrew its 1985 Dominion Resources No-Action Letter.1 The 1985 letter had allowed a variety of activities in which a finder could participate without fear of being characterized as a broker, including analyzing the financial needs of an issuer, recommending or designing financing methods and securities to fit the issuer’s needs, recommending the lawyers to prepare documentation and underwriters and broker-dealers to distribute the securities, participating in negotiations and introducing the issuer to a commercial bank to act as the initial purchaser and as a standby purchaser if the securities could not be readily marketed. Now the SEC’s Guide to Broker-Dealer Registration and the Broker-Dealer Report make it quite clear that anything beyond “finding” can throw a finder squarely into the definition of a broker.
Many a finder has argued that he is not a broker because he did not “effect” a transaction in securities. The SEC has roundly rejected this argument, reading “effecting” in the definition of a broker ever more broadly to include all actions beyond introducing the parties in a securities transaction.2 The SEC has stated that finders that: (1) find investors for issuers, even in a consultant capacity; (2) engage, or find investors for, venture capital or angel financings, including private placements; or (3) find buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions where securities are involved) may need to register as a broker, depending on a number of factors. These factors include: (1) whether the finder participates in important parts of a securities transaction, including solicitation, negotiation, or execution of the transaction; and (2) whether the finder’s compensation for participation in the transaction depends upon, or is related to, the outcome or size of the transaction or deal. According to the SEC, the presence of any of these factors indicates that a person may need to register as a broker.3
The SEC has traditionally indicated that individuals who “do nothing more than bring merger and acquisition-minded persons or entities together and who do not participate in negotiating the sale of securities, engage in any due diligence or share in any profits realized, are probably not brokers and would not be required to register as such.”4 In contrast, the SEC has also said that a professional who brings together potential buyers and sellers and advises the parties on questions of value, plays an integral role in negotiating the transaction or provides other services designed to facilitate the transaction, is a broker.5
The SEC has also looked askance at the presence of transaction-based compensation in its inquiry into whether a person is a broker, stating that “the receipt of compensation related to securities transactions is a key factor that may require an entity to register as a broker-dealer. Absent an exemption, an entity that receives securities commissions or other transaction-based compensation in connection with securities-based activities that fall within the definition of “broker” or “dealer” generally is itself required to register as a broker-dealer.” 6
The SEC appears to be moving closer to the conclusion that the mere presence of transaction-based compensation, where a finder engages in anything other than an introduction, indicates that a person is a broker. For instance, those No-Action Letters that do not require registration where transaction-based compensation is present can be distinguished from those that do by the fact that in the former situations, and consistent with the SEC’s overall position on the matter, the finder’s activities were generally limited to making an introduction of the parties to the ensuing securities transaction.7
Section 15(a) of the 1934 Act prohibits a broker from effecting transactions in, or inducing or attempting to induce, the purchase or sale of, any security other than exempted securities (as defined in § 3(a)(12) of the Securities Act of 1933 and including government and municipal securities and other similar securities) unless it is registered under § 15(b) of the 1934 Act. Section 29(b) of the 1934 Act provides that failure to register as a broker voids any contract for the performance of services in violation of the provisions of the 1934 Act. This includes a violation of the broker registration requirements. The Supreme Court stated in Mills v. Electric Auto-Lite Co.8 that § 29(b) implies a private right of action and that “[t]he interests of the victim are sufficiently protected by giving him the right to rescind…” Two other courts have reached the same result as it applies specifically to unregistered brokers even where the services under the illegal contract had already been performed.9 Noting that the result may be harsh and even draconian, the Regional Properties court stated.
Were this not the result there would be no civil remedy for failure to register. Because fees are usually contingent, as they were here, the broker who has not performed is entitled to no fee. If the broker who has performed can recover his commission despite non-registration, then the prohibition is a toothless tiger.10
Finally, in April 2008, the New York Supreme Court held that a contract between the defendant and a now-dissolved affiliate of the plaintiffs, pursuant to which the affiliate had been retained to provide financial advisory and investment banking services and act as sole agent for the private placement of the defendant’s securities, was void ab initio and unenforceable by reason of § 29(b) of the 1934 Act. The court found that the finder had failed to register as a broker under § 15(a) of the 1934 Act.11
Keeping all of this in mind, when representing an individual or company claiming to provide only finding services, do not simply take his or its characterization at face value. You must determine what kind of services the finder is actually providing in connection with the transaction. Otherwise, you may find yourself dealing with a void finder’s fee agreement, and your client will not be entitled to remuneration under the agreement and will even have to return any payments already made by the contracting party. Further, an issuer who deals with an unregistered broker should challenge a finder straying from his or its intended purpose. Form D requires disclosure of the presence of a broker and the commission paid to such broker under a Regulation D exempt offering. Failure to disclose the use of a broker (albeit called a finder) will result in an incorrect Form D filing. The use of a broker may also affect the applicability of state law securities exemptions.
Lara L. Hjortsberg, Esq. is the founder and CEO of Corporate Governance Consultants, LLC, a law firm focusingon the corporate governance, transactional and securities law needs of small- and medium- sized businesses. She is a member of the adjunct faculty at the University of Maryland, teaching Securities Regulation and Business Planning. Ms. Hjortsberg can be reached at firstname.lastname@example.org.
1 Dominion Resources, Inc., SEC No-Action Letter, 2000 SEC No-Act. LEXIS 304 (March 7, 2000) (withdrawing
Dominion Resources, SEC No-Action Letter, 1985 SEC No-Act. LEXIS 2511 (August 22, 1985). See also, Guide
to Broker-Dealer Registration (2005) (available at http://www.sec.gov/divisions/marketreg/bdguide.htm) (hereinafter “Broker Dealer Guide”); Report and Recommendations of the Task Force on Private Placement Broker-Dealers, ABA Section of Business Law, 60 Bus. Law. 959 (2005) (hereinafter “Broker-Dealer Report”).
2 John Polanin, Jr., The “Finder’s” Exception from Federal Broker-Dealer Registration, 40 Cath. U. L. Rev. 787, 793 (1991).
3 Broker-Dealer Guide at 3-4.
4 Paul Anka, SEC No-Action Letter, 1991 SEC No-Act. LEXIS 925 (July 24, 1991); Victoria Bancroft, SEC No-Action Letter, 1987 SEC No-Act. LEXIS 2517 (August 9,1987); International Business Exchange Corporation, SEC No-Action Letter, 1986 SEC No-Act. LEXIS 3065 (December 12, 1986).
5 See Wesco Equity Funding, SEC No-Action Letter, 1985 No-Act. 2634 (August 10, 1985); Garrett Kushell Associates, SEC No-Action Letter, 1980 SEC No-Act. LEXIS 3744 (September 7, 1980); Castagana Business Brokerage, SEC No-Action Letter, 1980 SEC No-Act. LEXIS 3298 (May 15, 1980); Bay Business Service SEC No-Action Letter, 1977 SEC No-Act. LEXIS 642 (Mar. 14, 1977); Gary L. Pleger, Esq., SEC No-Action Letter, 1977 SEC No-Act. 2491 (September 9, 1977); Ruth Quigley, SEC No-Action Letter, 1973 SEC No-Act. LEXIS 3177 (June 14, 1973); May-Pac Management Co., SEC No-Action Letter, 1973 SEC No-Act. LEXIS 1117 (December 20, 1973). . See also Hallmark Capital Corporation, SEC No-Action Letter, 2007 SEC No-Act. 509 (June 11, 2007).
6 Herbruck, Alder & Co., SEC No-Action Letter, 2002 SEC No-Act. LEXIS 598 (June 4, 2002). See Richard S. Appel, SEC No-Action Letter, 1983 No Act. LEXIS 2035 (February 14, 1983); Mike Bantuveris, SEC No Action Letter, 1975 SEC No-Act. LEXIS 2158 (September 23, 1975); May-Pac No-Action Letter., Supra.
7 Paul Anka No-Action Letter, Supra; International Business Exchange Corporation No-Action Letter, Supra.
8 Mills v. Electric Auto-Lite Co., 396 U.S. 375,388 (1970).
9 Eastside Church of Christ v. Nat’l Plan, Inc., 391 F2d 357, 362 (5th Cir. Tex. 1968); Regional Properties, Inc. v. Financial and Real Estate Consulting Co., 678 F.2d 552, 561 (5th Cir. Tex. 1982).
10 Regional Properties, 678 F.2d. at 564.
11 Torsiello Capital Partners LLC v. Sunshine State Holding Corp., No. 600397/06 (N.Y. Sup. Ct. 4/1/08).