Once upon a time, in the halcyon days before markets broke down, when smaller acquisitions still were frequent and when private capital was sometimes available from individual investors, a breed of businessmen strode the earth to service these transactions. We called them "finders."
Independent consultants, or "finders," historically functioned in two modes: In an acquisition, the finder was agent for seller, seeking a buyer either for the assets or stock of the seller; and in capital formation, finders represented the issuer in locating investors.
These services typically were performed for smaller companies, be they public or private; the larger and more sophisticated businesses tended to use Securities and Exchange-registered investment banks and brokerage firms.
We exclude from discussion the employees or officers of a company seeking acquisitions or financing; where such persons are not separately compensated, based on a percentage of monies realized in the transaction, they are exempt from regulatory scrutiny under Exchange Act Rule 3a-4.
Under the Securities Exchange Act of 1934, a "broker" must be registered. (The same uniformly is true under state laws.) A broker is "any person engaged in the business of effecting transactions in securities for the account of others." Avoiding broker-dealer registration was a sine qua non of the finder's world. Registration was (and is) very expensive and time-consuming. It requires exams and licensures for supervision and for transactions (such as market-making) wholly inapplicable to selling businesses or raising capital. It is a continuous cost and burden.
receiving flat-fee payment, not a percentage of the acquisition proceeds or financing; and in M&A, selling only assets, not stock (a difficult task, as the final form of an acquisition will be controlled by tax and business matters, not the regulatory status of an intermediary).
For a while, the SEC, in a series of occasional no-action letters, condoned such approaches; states generally did not. But no governmental agencies put heavy pressure on the finders, who were filling an obvious intermediation need in the marketplace. Being a finder was like drinking a beer during Prohibition - illegal perhaps but, in reality, no problem.
Governmental permissiveness also extended to finders' actions that violated the theoretical bases of the exemption from brokerage registration. Finders typically were asked to "sell the investors" to earn their fee; their fee was always a percentage of the transaction. The finders often wrote the "book" or private placement memo, or else no rational company would agree to pay a significant fee just for "a name." A subset for finder practice also arose for lining up purchasers in the growing number of PIPE transactions for smaller public companies.
Clamping down
The law today is quite different.
In the last three years, the SEC has in effect revoked use of the "finder" status. See, for example, the SEC's "Guide to Broker-Dealer Registration," issued in April, which makes clear that registration is likely required in the presence of any one of the following facts: "finding investors for 'issuers'... even in a 'consultant' capacity"; "engaging or finding investors for venture or angel financings, including private placements"; and "finding buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions when securities are involved.)"
Lawyers now routinely advise finders that they must register and advise companies not to use unregistered finders. (It is a crime for a company to retain an unregistered broker, and the transaction that may have occurred is void as a matter of law; an acquirer or investor can rescind it and get its money returned.)
Additionally, of late we have seen those brokers serving the middle market who have gone through the pain and expense of registration, aggressively marketing to companies by highlighting the risks that will be run by retaining the services of an unregistered competitor.
Finally, in the last year, federal and state regulatory and court actions have become numerous, basing liability findings solely on the fact of non-registration, enjoining brokerage activity by finders and requiring finders to forego future fees and refund prior fee payments. Until recently, assessing liability for failure of a finder to register arose only in cases where another, perhaps more serious, violation of law also had occurred, such as fraud or misrepresentation as to the substance of the transaction.
Today's issues
Requiring full SEC registration of finders is illogical, and everyone, including the SEC, knows it.
In 2003, the SEC Government-Business Forum on Small Business recommended a vastly simplified registration procedure (complete with draft form "1010 EZ"). The 2006 final report of the SEC's Advisory Committee on Smaller Public Companies recommended adopting the simplified registration proposal of the American Bar Association, issued in May 2005 (see www.abanet.org/buslaw/tbl/tblonline/2005_060_03/home.shtml#1), and a concomitant amnesty program ("[a]n unregistered money finder will 'never come in from the cold' ... if the regulators reserve the right to institute enforcement actions"). The SEC is widely known to be working on just such a simplified registration regime.
The need in the near future will be particularly acute. Hopefully, the SEC will not be so swamped with the fallout from the "crash" as to be distracted from this task. In today's financial environment, companies will badly need financing or will need to be acquired. Many traditional, fully registered brokerages or investment banks either have crumbled or will crumble, and those that survive may well be subject to other distractions.
Investors, withdrawing from the organized markets for their investment activities, will actively seek other places to put their money to work. (Neither real estate nor overseas seem inviting as this column is going to press). Finders - those now operating and likely a large crew of newly unemployed former financial industry professionals with good Rolodexes - may be badly needed to grease the wheels of both public and private finance and M&A.
One interim solution may arise through finders affiliating with the small number of registered broker-dealers that have structured themselves, through their agreements with FINRA (the self-regulatory agency replacing the NASD), to supervise from afar the finders who agree to affiliate with and be supervised by the broker-dealer.
Even this solution is less than ideal. Aside from the resultant added transaction cost and reduced net fees to the finder, the practical task of a broker-dealer supervising a bunch of finders spread around the country doing M&A and private corporate finance cannot be simple. And, of course, the finder still must pass the Series 7 securities agent examination to be eligible to affiliate with the registered broker in the first place.
In-house counsel should not be tempted, or forced, to utilize unregistered "brokers" and be subject to risks of illegality and transactional rescission, which clearly arise under current legal interpretation. The SEC should act promptly and clean up the finders mess by instituting a highly simplified finder registration procedure, with total amnesty for past deals and amnesty for any deal pending on the date such registration becomes available, as well as pre-emption (which may require congressional action) of contrary treatment under state broker-dealer regulation.
Stephen M. Honig is a partner in the Boston office of Duane Morris. You can reach him at smhonig@duanemorris.com
Reprinted with permission from New England In-House, a bimonthly publication of Dolan Media.
© 2008 Dolan Media, All Rights Reserved.
November 2008 / NEIH
