Finding Accredited Investors Could Become Easier when Newly Proposed SEC Rules Get Adopted

Raising small business capital has never been a simple process, and smaller issuers have relied largely on their networks to make it happen. That’s why the Securities and Exchange Commission (SEC) recently proposed rules that would allow natural persons called “finders” to accept compensation from issuers of SEC registration-exempt offerings as they seek to raise funds from accredited investors. Typically, such finders need to register as brokers under Section 15(a) of the Exchange Act, but the newly proposed rules would exempt them from this requirement under certain limited circumstances.

The Finder’s Role in Capital Raising

Finders can be an important part of capital raising for smaller issuers, especially in areas without “established, robust capital raising networks,” according to SEC Chairman Jay Clayton. Accredited investors must meet certain income, net worth, or “financial sophistication” tests. Since finding accredited investors can be difficult, these finders help identify the accredited investors for the issuers. Without straightforward regulation for these finders, some small business advocates have recommended SEC action, as has the Department of the Treasury and several SEC advisory committees.

Proposed Changes Would Facilitate Finders’ Activities

 The rules under consideration were proposed on October 7. Adoption of these rules would create a two-tiered system for finders not associated with broker-dealers. In this system, Tier II finders would need to abide by more complex stipulations than Tier I finders. Notably, finders in either tier would not be allowed to conduct general solicitation in order to identify potential investors, and they must set up written agreements to provide services to specific issuers. Finders’ activities would be strictly limited to the private placement market, and finders would also be prohibited from negotiating offerings, handling the funds, preparing sales materials, offering advice, and engaging in any “due diligence” activities. Please note that this is not the complete list of restrictions.

Tier I finders would only be able to offer potential accredited investors’ contact information in connection with one single fundraising transaction by one issuer in a 12-month period. In contrast, Tier II finders’ solicitation activities, while still limited, would be more permissive. These activities would include distributing and discussing issuer materials with investors, as well as arranging meetings, provided the finder doesn’t offer any advice. Before or at the time a Tier II finder solicits an investor, the finder would also be required to disclose their role and compensation and get a written acknowledgment of these disclosures from the investor.

Opposition to the Newly Proposed Rules

Several commissioners did not approve of the proposed rules, as cited by Crowdfund Insider. For example, Commissioner Caroline Crenshaw said, “I question why the Commission is encouraging activity in these markets absent sufficient visibility into how they operate… I cannot support deliberately expanding markets that even our expert staff cannot accurately assess or analyze.” Commissioner Allison Herren Lee expressed additional concern about the effects on “the broker-dealer business model.”

The Office of the Advocate for Small Business Capital Formation has put together a video gallery with information on its proposed and recently adopted regulations. You can also follow the VerifyInvestor.com blog for more investment news and updates.