“Finders” vs. “Consultants”

Joseph W. Bartlett, Special Counsel, McCarter & English LLP & Co-Founder of VCExperts

Several decades ago, the Staff of the SEC publicly rejected the conclusions in the then-Bible on Securities Regulation by Professor Loss to the effect that individuals and firms classified as “finders” who were paid success fees for bringing sources of capital to the attention of capital hungry issuers were not required to register under the `34 Act as broker-dealers or to join what was then the NASD as long as their only activity of any relevance was to bring investors to the attention of the issuer and vice versa. The notion was that broker-dealers had a menu of responsibility and services if they were “engaged in the business” … retail customers, custody of securities, trading, market making, underwriting, etc.,… and participation in only such one activity did not require registration. The Staff set out publicly to disagree with Loss’s conclusion, provoking a series of articles on the subject by yours truly (see Appendix) which chronicled the various enforcement actions and public pronouncements by the Staff to the effect that transaction-related compensation was, of and by itself, enough to require registration and the activity was otherwise illegal, with a variety of consequences.

As all concerned are aware, what ensued was a period which I described in a meeting with the Staff decades ago as a “crime wave;” hundreds, perhaps thousands, of finders continued to operate as they had in the past, interrupted by occasional enforcement actions which were brought by the SEC administratively and which expanded the reach of the statute to the boundaries with which the Staff was comfortable. The occasional case in the U.S. District Court to the contrary notwithstanding, [1] the Staff has remained more or less fixed in its attitude that transaction-related compensation, at least if it is repeated more than once, requires registration and the consequences entail violation of Section 29 of the 34 Act.

At one point, in accordance with the perception of my partner and friend Ed Fleischman (a former member of the Commission), the SEC was regulating “by opinion,” meaning that its enforcement actions were designed to influence at least the White Shoe law firms to deny opinions to their clients if an unregistered finder had appeared on the scene and, indeed, to advise their clients to stay away from scenarios which involved a success fee to an unregistered individual or firm.

In 2005, the ABA Task Force (I was a member) recommended the enactment by the SEC of a clarifying regulation in this gray area which would open the door to individuals and firms to register under what is called “broker-dealer lite” procedures, meaning registration which could be afforded by the finder community versus the unsupportable expense of full dress registration. [2] However, the SEC has not launched a clarifying … purifying if you like … regulation of that sort and the situation remains confused.

In today’s environment, it looks like the capital markets are adjusting to a situation in which an individual renounces the status as a “finder” and signs up as a “consultant.” There is language lifted from the Task Force Report on the ability of consultants to go forward in these precincts.

“Consulting Activities. Individuals can have a limited role in securities transactions without being deemed to be agents. They can consult on structure, provide valuation reports, render technical advice, provide industry expertise, assist as accountants in the development of forecasts, etc. However, the SEC views transaction-based compensation for such persons as problematic and is suspicious that they really are involved in the entire transaction, including playing a role in obtaining investors. The less involved a business consultant is in the negotiation and structuring of a transaction, the less likely it will be that the staff will require the business consultant to register as a broker-dealer despite the fact that the consultant receives transaction-based compensation.” [3]

The typical defensive posture is that the consultant is hired to advise on any number of issues and raising capital is not at the top of the list; that said, it is often the case that, until capital comes in over the threshold, there isn’t any way to pay anyone other than, maybe full time employees and suppliers so, in that sense, the consultant’s pay is transaction-related … but not, at lease openly, for acting as a finder. The consulting fees, which can be incurred and accrued on a monthly basis as obligations, are only transaction-related because they have to be. To mitigate the likelihood of illegality, most consultants do, as a matter of fact, consult on business issues only tangentially related to raising capital; the company’s general health and welfare is the subject matter in question, whether it has money or not. Another good fact is a consulting arrangement which continues for six or twelve months after the funds are raised … a steady dollar amount earned and owed at the close of each month. Several months prior to the fund raise is another good fact. Since bonuses to employees tied to fund raising can be attacked, a level monthly payment is advisable.

Joseph W. Bartlett, jbarblett@mccarter.com

September 2015

[1] Bartlett, “Unregistered Finders: The Kramer Case, etc.”

[2] Bartlett, “ABA Task Force Urges the SEC to Promulgate ‘Broker Dealer Lite:’ Registration Requirements for Unregistered Finders; Many Firms Are Currently at Risk in a ‘Gray Area,’” The Journal of Private Equity, Summer 2007/

[3] American Bar Association, “Report and Recommendations On Private Placement Broker-Dealers,” June 20, 2005.

APPENDIX

Writings on Unregistered Finders by Joseph W. Bartlett (Numbers 1 through 11 are available with a subscription to VCExperts.com)

  1. “Unregistered Finders: The Kramer Case, etc.”
  2. “Finders As Broker-Dealers: The Plot Thickens.”
  3. “Consequences of Violating Section 29,”
  4. “Unregistered Finders: The SEC Begins Enforcement Actions,”
  5. “Private Equity Alert – Unregistered Finders – The Last Chapter?”
  6. “Mandatory Registration of Finders as Private Placement Brokers: SEC Action On The Way” (Part 1),
  7. “Mandatory Registration of Finders as Private Placement Brokers: SEC Action On The Way” (Part 2),
  8. “Unregistered Finder; Can Issuer’s Counsel Participate in the Deal?”
  9. “Finder’s Keepers?”
  10. “Business Brokers Not Required to Register as Brokers,”
  11. “Mandatory Registration of Finders: ABA Task Force Report,”
  12. “ABA Report and Recommendations of the Task Force on Private Placement Broker-Dealers,” 2005
  13. “ABA Task Force Urges the SEC to Promulgate ‘Broker Dealer Lite:’ Registration Requirements for Unregistered Finders: Many Firms Are Currently at Risk in a ‘Gray Area,’ The Journal of Private Equity, Summer 2007.

 

One thought on ““Finders” vs. “Consultants”

  1. Pingback: “Bird-dog Finders” vs. “ Biz development Consultants” | Finance topics, trends, & specific term sheets

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