Finders, Keepers, Losers, Weepers

September 29, 2008 New Jersey Law Journal

Reprinted with permission from the SEPTEMBER 29, 2008, edition of the New Jersey Law Journal. © 2008 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited. For information, call 973.854.2923 or [email protected]. ALM is now Incisive Media, .

In this unsettled economy, with news of fresh layoffs in the financial services industry becoming a daily event, many seasoned professionals are shopping their services and contacts. One lucrative avenue has been that of a finder.

A finder is “someone who finds, interests, introduces and brings parties together for a business transaction that the parties themselves negotiate and consummate.” See Northeast General Corporation v. Wellington Advertising, Inc., 82 N.Y.2d 158, 163 (1993). The American Bar Association’s (“ABA”) Task Force on Private Placement Broker-Dealers (“Task Force”) to the United States Securities and Exchange Commission (“SEC” or “Commission”) Advisory Committee on Smaller Public Companies has stated that these individuals “fill a void that is created by the lack of interest on the part of licensed brokerage firms and venture capital funds in smaller equity transactions.” See Letter from Gerald V. Niesar endorsing the “Report and Recommendations of the Task Force on Private Placement Broker-Dealers” (Sept. 12, 2005). Although these transactions might seem attractive on their face, there is the potential for significant costs and liability.

In theory, at least, a finder is merely responsible for bringing the parties to the bargaining table, but occasionally a finder’s services are utilized to aid transactions involving the purchase or sale of securities. As such, both federal and state securities laws are implicated.

Registration Statutory Basis

Under Section 15(a) (1) of the Securities Exchange Act of 1934 (“Exchange Act”), an unregistered broker or dealer may not “effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security [.]” The question is, thus, when are finders “brokers,” subject to the Exchange Act’s registration requirements. Exchange Act Section 3(a)(4) states a “broker” is “any person engaged in the business of effecting transactions in securities for the account of others.” However, ambiguity occurs when actually applied to real world situations.

To determine if finders require registration, the SEC reviews if the finders’ actions affect transactions in securities. For example, arranging meetings may possibly be appropriate, but an active role in the mechanics of the business deal involving the purchase or sale of securities is more problematic. In that vein, the SEC’s pronouncements on this area are strongly considered.

No-Action Treatment of Finders

The SEC has reviewed finder’s activities in significant detail over the last four decades through its no-action process. The Commission’s no-action procedures provide the opportunity to have the SEC staff review certain proposed conduct obtaining, essentially, clearance from the SEC for that particular conduct.

This process has been widely used in the finder’s area. For example, in a 1973 no-action letter to May-Pac Management Company of Santa Barbara, Calif., the SEC drew a distinction between mere passive intermediaries “who do nothing more than bring merger or acquisition minded persons or entities together and do not participate in negotiations or settlements” and a more active variety of such individuals or entities that “play an integral role in negotiating and effecting mergers or acquisitions that involve transactions in securities.” See Fed. Sec. L. Rep. P 79, 697 (1973). While the former variety of finder is not required to register as a broker, the latter is.

Alas, the analysis is not that simple. Indicative of the uncertain nature of a finder are two SEC no-action letters issued over a seven-month period arriving at different results. One of these no-action requests was from Hallmark Capital Corporation (“Hallmark”), a self-proclaimed “financial consultant and finder for small businesses that assists the owners of businesses in raising capital, facilitates mergers and acquisitions and provides strategic business consulting services.” See Hallmark Capital Corporation of New York, New York., 2007 WL 1879799, *2 (2007). Among the activities of Hallmark falling under the rubric of the “assistance in raising capital” was “preparing a confidential information summary describing the business, identifying broker-dealer firms that might be interested in working with the company and arranging meetings leading to the engagement of the broker-dealer by the client company to raise capital.” This conduct may appear as a passive facilitator contemplated by previous SEC pronouncements, but the company also sought to provide “assistance with mergers and acquisitions” and “strategic business consulting services.” Thus, the SEC found that Hallmark had to register as a broker-dealer if it intended to pursue these activities.

The SEC has not, however, avoided finding that no registration is required by determining that no action would be granted to Country Business, Inc. (“CBI”), that is, no requirement for broker-dealer registration. The SEC cited to several aspects of CBI’s business described below. In the SEC staff’s opinion, the nonexistence of these factors vitiated the need for CBI to register. See Country Business Inc., WL 3289777, (2006).

The CBI Factors and Finder Determinations

While not an exhaustive list, the SEC staff seems to rely upon the factors enunciated in CBI when evaluating finder no-action requests. Different factual situations will warrant special considerations, but the SEC’s reliance on the CBI factors offers guidance to individuals or entities that may want to become finders.

Initially, the SEC determines if a finder has limited its role in negotiations between the buyer and seller, and whether it is vested with explicit or implicit power to bind any party to an agreement. If the finder has an expansive role or authority, registration may be required. A finder is also well served by dealing only with “going concerns,” and should avoid dealings with empty “shell organizations,” especially when securities are involved. Although such activity is not per se illegal, these companies almost always raise regulatory suspicions.

Further, a finder should also conduct transactions only with businesses capable of meeting the federal “small business” definition. Larger businesses tend not to use finders, and, if they do, the SEC tends to be suspicious because, quite simply, such companies are capable of courting investors on their own. At that level, chances are that the putative finder has a more involved role than may be readily apparent.

Additionally, finders should limit their roles to only transactions involving their clients’ assets. A finder should also have no role in the formation of any potential purchaser because such split loyalties may raise regulatory scrutiny. The SEC also may not require registration if the underlying transaction — covered by the finder’s agreement — is a complete transfer of all of the business’ equity to a “single purchaser or group of purchasers.” The finder must also not “advise the two parties whether to issue securities, or otherwise to affect the transfer of the business by means of securities, or assess the value of any securities sold (other than by valuing the assets of the business as a going concern).”

Critically, the SEC tends to focus on finder compensation. As such, the finder’s compensation should be predetermined well before the underlying transaction ever occurs. Thus, if compensation is deferred, the formula to compute the finder’s compensation should be established prior to both finalizing the deal structure and deal closing. Further, if the remuneration is based upon the consideration received by the seller, regardless of the means used to effect the transaction, or if compensation varies according to the form of conveyance — for instance, securities rather than assets — registration will probably be required.

Finally, a finder should not provide any sort of assistance to the purchasers “with obtaining financing, other than completing the paperwork associated with loan applications.” Where a finder attempts to facilitate several aspects of the deal, the finder blurs the distinction between a passive conduit and a more active deal “broker,” requiring registration. See Howard S. Meyers, “Finders Fee Arrangements: Potential Pitfalls and Considerations,” The Attorney – CPA (July 1, 2002).

New Finder Proposals

The apparent ambiguity and uncertainty surrounding the present state of finders’ law has led many to propose reform, and proposals abound.

The Task Force advocates the licensure of a form of private placement broker-dealers (“PPBDs”), substantially less invasive than typical Exchange Act registration procedures. See “Report and Recommendation of the Task Force on Private Placement Broker-Dealers,” 60 The Business Lawyer 959 (May 2005). However, if a new regulatory scheme is proposed, some may criticize it as an acknowledgement that the current Exchange Act registration requirements are examples of overregulation.

Nonetheless, until these proposals are actually adopted, they remain only academic constructs. However, the current law requires a factually-based analysis, warranting careful consideration by any individual or entity that provides or engages in such services because serious penalties exist for both the finder and client if the finder acted as an unregistered broker-dealer.

Enforcement actions against the finder carry, among other things, substantial monetary and professional-related penalties. Further, pursuant to Section 29(b) of the Exchange Act, the use of an unregistered broker is illegal. See See 15 USC § 78cc(b) (2008). Hence, the client employing the finder’s services also faces possible regulatory action and potential investor rescission claims. In such circumstances, the finder faces both potential regulatory liabilities, the inability to recover its fee from its client, and, in some cases, being required to re-pay any retainer previously advanced. See Torsiello Capital Partners LLC v. Sunshine State Holding Corp., (Decided: April 1, 2008).


In sum, the law governing finders’ arrangements is not a topic that should be approached lightly by finders or their clients. These arrangements — even when reduced to writing — may only confirm an unregistered broker-dealer relationship in violation of the securities laws. Given the potential for substantial liability, finders and their clients must, therefore, carefully delineate the roles, duties and compensation between the parties prior to any work on the transaction. Any other approach is simply a recipe for disaster.