Firms may regret their decision to hire finders that are not registered Broker-Dealers, or individuals that are not associated with registered Broker-Dealers, to connect them with potential investors. Section 15(a)(1) of the Securities and Exchange Act of 1934 states that non-registered persons who use any “instrumentality” to “induce” the purchase or sale of a security is unlawful.

It may seem a fine line between finding individuals or companies to purchase a security as opposed to actually selling the security. Courts will look at the following factors to determine whether the party is a seller and not just a finder:

  • The involvement the finder has with the negotiations of the security sale.
  • Discussing details and making recommendations.
  • Compensation based on the amount of securities sold, or other structures which appear to be more of a transactional compensation.
  • The finder’s previous history with effecting security sales.

A recent settlement between the SEC and a private equity firm demonstrated this fine line being crossed by non-registered finder.[1] The firm’s senior managing director hired his friend to find potential investors. This friend was not registered as a broker-dealer or associated with one; he was also barred from association with any investment advisor. The firm agreed to pay a fee of 1% of the commitments that came from his efforts. This finder was instructed by the director to not discuss his views of investments or to circulate fund documents to the potential investors. Despite these instructions, the finder did circulate fund materials and made recommendations to potential investors. These discussions with the investors also included information on other investor’s proposed commitments and his analysis of the fund strategy and track record.

Because of his efforts, the finder solicited over $550 million and was compensated with $2.4 million. The SEC, however, found that he effected the transactions and therefore violated Section 15(a)(1) because he was not registered as a broker-dealer. He settled with the SEC and agreed to be barred from the securities industry.

Sadly, the firm was considered responsible for the finder’s violations because it failed to adequately oversee his activities. It settled and paid a $375,000 civil penalty while also agreeing to modify its policies to only hire a registered broker-dealer to market securities. The senior managing director, the finder’s friend, was found to have aided and abetted the finder’s violations by failing to monitor and limit his activities and providing him with key fund information. The director paid a $75,000 civil penalty and was suspended from acting in a supervisory capacity for nine months.

Investment executives may want to weigh what advantages they see in hiring non-registered finders against the risks they pose for both their firms and themselves.


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