Private Equity Alert - Unregistered Finders - The Last Chapter?

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP

The old adage, "finders keepers," may no longer apply to the thousands of individuals and firms across the country that perform functions as finders and help arrange placements in order to earn success fees. As a result of a combination of a tighter enforcement of the previously broadly interpreted language in Section 3(a)(4)(A) of the Securities Act Exchange Act of 1934 as well as a push for transparency at all costs, we may be extinguishing a segment of the business community that we really need right now.

A legal issue, which has (at least potentially) wide spread economic ramifications, stems from a broad interpretation by the SEC and the Staff of the language in Section 3(a)(4)(A) of the Securities Act Exchange Act of 1934 (the "`34 Act") which requires registration by any person or any entity "engaged in the business of effecting transactions in securities for the account of others." There is a long history to this issue, going back to the early days of securities regulation when the authoritative guide was Professor Loss's treatise on the Securities Regulation.. Loss took the view that "finders," meaning agents who were paid to assist in private placements and who did not engage in any of the other usual business activities of a broker-dealer (retail sales; custody of customer capital; underwriting; etc.), were not required to register under Section 3(a)(4)(A).

Relying (either consciously or unconsciously) on Loss's point of view, literally thousands of organizations have sprung up in this country, firms which perform functions as finders and help arrange placements, typically in consideration of a success fee. Several years ago, however, the Staff announced, in a series of no-action letters, that it did not believe there was a so-called 'finders exception' to Section 3(a)(4)(A) and the Staff has stuck to that point of view ever since, despite a good deal of public criticism that the position went too far. The objection was, and is, that pure finders, who do not engage in any of the other traditional activities of brokers/investment bankers should be exempt, or at least treated differently. Were they all required to register, they would be undergoing unnecessary administrative and legal expense in complying with a complex set of rules and guidelines.

The issue is discussed in a number of forums, culminating in a report by the American Bar Association Task Force (, a Task Force of which I was a member. The proposal emanating from the Task Force, which I continue to think is eminently sensible, is for the SEC to adopt a standard entitled, in slang terms, "Broker-Dealer Lite," which would require finders to register in accordance with the current position of the Staff but would lighten the load considerably, assuming that none of the other attributes were present in the finder's business model.

Up until recently, the landscape did not change all that much, at least as I have viewed it. Finders have continued to operate without registration, encouraged by the fact that the SEC rarely brought enforcement proceedings against an unregistered finder based, and only based, on the failure to register. The finders who were gutting it out in this department were taking a chance that the principal employing them as an agent, typically the issuer, might renege once the success fee was earned even though it was and is likely (in my view, based on experience) that the principal would win, if taken to court, on the basis that the finder was violating the `34 Act.

The times may, however, be changing: The firestorm in the placement business accompanying New York Attorney General Cuomo's indictment of Hank Morris for alleged shabby practices has had a ripple effect in this area. The media has piled on placement agents alleged to have engaged in "pay to play" practices with political appointees like Hevesi, frequently pointing out that not only was there alleged bribery involved but also that Morris et al. were not in fact registered as broker/dealers.

The link between those two alleged offenses is not clear; but no one is surprised that the latter issue has popped up. When you are accusing somebody of illegal conduct, in the media or in court, there is nothing like a multi-count complaint to solidify your argument that the respondent/defendant must be guilty of something. Of interest for present purposes is the coincident, on May 11, 2009, announcement by CALPers, the nation's largest public pension fund, that it was adopting a placement agent policy which focuses on transparency as opposed to an outright ban as in Cuomo's Code. The CALPers Code requires that any placement agent used in connection with CALPers investments must be registered with the SEC or with FINRA, the Financial Industry Regulatory Authority.

The substance of all this activity is that it may be 'game over' for unregistered finders. If so, and if the SEC refuses to authorize Broker Dealer Lite, the venture industry will take another blow to the solar plexus. In fact if it is 'game over' for unregistered finders, this heightens my concern on the widened gap between (a) the initial funding resources of start ups . the friends and family round, the founders round, and support from SBIR grants, for example, and other civic and non-governmental organizations on the one hand and (b) the first venture capital, or Series A, round. A sharp reduction in the roster of placement agents simply exacerbates an already difficult problem. What worries me is that the popular anger at decimated jobs and 401(k) retirements account has persuaded the politicians, with their notorious shallow keels, to position themselves as avengers: 'Let's wipe out unregistered finders, along with everybody else!"

My view is:

(i) "No finders? O.K. that means not enough angel money for promising early stage firms (a/k/a/ gazelles), angel resource are so all over the map, it frequently takes an experienced trail guide to find them;"

(ii) "No gazelles? No U.S. innovation economy;" and

(iii) "No innovation economy? No U.S. economy to speak of."

See ("Collateral Damage: The Venture Capital Outlook and Potential "No Growth" Economic Future," and stay tuned for more thoughts on this pressing issue.


Buzz Archive:
Unregistered Finder; Can Issuer's Counsel Participate in the Deal?

by Joseph W. Bartlett, Founder of VC, 6/1/2006

Be sure to visit The Expert's Corner, a portion of VC Experts dedicated to the most advanced issues facing the Private Equity Community today. It is maintained by Joseph Bartlett, Founder of VC Experts and long-time participant in the community.


The recent issue of The Private Equity Bulletin discusses the question whether an individual or entity which is and only is, a placement agent (a "finder") must register under the '34 Act and apply for membership in the NASD. The issue is thorny, particularly now that the ABA Committee published a Task Force report, available in the current edition of The Business Lawyer, and online, which could easily be construed as the pre-cursor of an SEC proposed regulation requiring so-called "finders" to register in accordance with a regime commonly known as "Broker/Dealer Lite." Pending the resolution of this issue, which is very much in suspense, law firms have to consider the following:


What are the responsibilities of law firm professionals when representing either the investors or the issuer in a transaction which has been agented and midwived by an unregistered finder? Assume a law firm is engaged by an issuer seeking capital; the issuer coincidentally has a well known and well respected finder . which is not however, registered under the '34 Act or an NASD member. Need the law firm turn down the representation? Assuming the answer to that query is 'no,' what type of advice and/or cautions should the firm, under the applicable professional best practices, extend to its client? (Assume, as a variation on that theme, that the law firm is representing the investors . say, a professionally managed private equity fund). Herewith some suggestions for discussion . not meant as pronouncements but as items which recipients of this memorandum are invited to peruse and respond to.

My view which is personal, and does not represent the position of this law firm, is as follows:

When counsel is representing the issuer, the engagement letter should contain a warning and caveat to the following effect (target language to be shaped by the lawyers at the firm sensitive to the requirements of the local version of the Code of Professional Responsibility), viz:

"We understand that Newco Inc. has employed a placement agent, Finder Inc. ("Finder") to assist in the placement referred to in the body of this letter and proposes to compensate Finder on a basis which includes a success fee. Moreover, it is anticipated by Newco that Finder will participate in the negotiating the placement ... amount and terms ... with potential investors.

"You are hereby cautioned that, as we understand it, Finder may be required to register, but currently is not registered, as a broker/dealer under Section 15 of the Securities & Exchange Act of 1934 and to join, but has not joined, the NASD as a member [plus any requirements under State law arguably applicable]. Although there is no controlling precedent of which we are aware, at least some authorities have suggested (and there are, to be sure, opposing views) that the participation of an unregistered broker/dealer in the placement might involve legal responsibilities and consequences imposed on Newco as the issuer of the securities in question by virtue of, e.g ., Section 29(b) of the Exchange Act. We are also cognizant of the various proposals to the SEC that this issue be clarified by the promulgation of rules on the subject . but such clarification has not yet been published. In view of the lack of authority on this issue, we express no opinion on the likely outcome of any controversy involving Newco and the provisions of the '33 and '34 Acts, and/or State securities law, including but not limited to a challenge to the status of the transaction as a private offering exempt from registration under Section 5 of the Securities Act of 1933. We call the issue to your attention and will be happy to discuss it further with you."

Is this enough? Will this language adequately clue the client that the law firm may not be in a position to issue an opinion on the exempt status of the offering . which, in turn, may scare off investors?

Your views?

Joseph W. Bartlett, Special Counsel,

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