Finder’s Fees for Securities after January 2016
by Ara A. Babaian, Esq.
For years, clients have been perplexed that they legally cannot pay finder’s fees even though, in practice, most companies raising investor funds do so in one way or another (for example, as disguised consultant fees). Relief came earlier this year when, effective January 2016, California legalized the payment of finder’s fees to persons who are not registered securities broker-dealers and who otherwise meet requirements stated in Section 25206.1 of the California Corporations Code. This legislation comes in direct opposition of Section 15(a) of the Securities Exchange Act of 1934 that requires persons to be registered as such.
This California bill was introduced by the Business Law Section of the California State Bar in 2012 in order to legalize what it recognized to be a common practice. The proposal commented that this change would promote capital formation for small businesses. Additionally, the new legislation would help protect issuers and investors from federal penalties for engaging in the practice.
While finders in limited situations do not have to be registered as brokers, both they and the issuer must meet a set of conditions set forth in Section 25206.1 of the California Corporations Cod0e.
The conditions as stated in Section 25206.1 are as follows:
1. the finder must be a natural person, not an entity;
2. the transaction must be a sale of securities by an issuer of the securities in California;
3. the size of the transactions for which the finder is engaged must not exceed a purchase price of $15 million in the aggregate;
4. the finder must not: (a) participate in negotiating any of the terms of the transaction, (b) advise any party regarding the value of the securities or the advisability of purchasing or selling in the securities; (c) conduct any due diligence for any party to the transaction; (d) sell any securities that are owned directly or indirectly by the finder; (e) receive possession or custody of any funds in the transaction; (f) participate in the transaction unless it is qualified by permit or exempt from qualification under California law; or (g) make any disclosure to any potential purchaser of securities other than: (i) the name, address and contact information of the issuer; (ii) the name, type, price and aggregate amount of the securities offered; (iii) the issuer’s industry, location and years in business;
5. the finder must file, in advance of taking any finder’s fees, a statement of information with the finder’s name and address, together with a $300 filing fee, with the California Bureau of Business Oversight, and thereafter file annual renewal statements with a $275 filing fee and representations that the finder has complied with the exemption conditions;
6. the finder must obtain a written agreement signed by the finder, the issuer and the person introduced by the finder, disclosing: (a) the type and amount of compensation that has been or will be paid to the finder; (b) that the finder is not providing advice to the issuer or any person introduced to the issuer as to the value of the securities or advisability of purchasing or selling them; (c) whether the finder is also an owner of the securities being sold; (d) any conflict of interest in connection with the finder’s activities; (e) that the parties have the right to pursue any available remedies for breach of the agreement; and (f) a representation by the investor that the investor is an “accredited investor” as defined in Regulation D and consents to the payment of the finder’s fee; and
7. the finder must preserve copies of the notice, the written agreement and all other records relating to the transactions for a period of five years.
This state legislation diverges from the federal policy of the Securities and Exchange Commission. As such, it is important to note that Section 25206.1 only permits payments to these non-registered finders in transactions occurring in the State of California involving California-based issuers, finders and purchasers. Any transactions outside of the state will be held to standards of federal law, and since the Securities and Exchange Commission still regards the payment of finder’s fees as a violation of Section 15(a) of the Securities Exchange Act of 1934, one or all parties may face penalties and/or disciplinary action, in addition to a possible rescission offer by the issuer using a non-registered broker.
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