Louis Wharton is a Partner of the Firm. Louis’ practice focuses on advising startup, emerging growth and middle market companies across a spectrum of industries in securities compliance, corporate finance, mergers and acquisitions and general corporate matters.  He counsels clients in the technology, internet/e-commerce, pharmaceutical, apparel and entertainment industries, among others.


Q.  I’m considering engaging a finder to help me complete my capital raise.  What issues should I bear in mind when discussing the engagement?

 A.  The staff of the Securities and Exchange Commission (SEC) has stated that a proposed arrangement whereby a finder provides to an issuer services related to raising funds to finance its operations and development, including making introductions to individuals and entities interested in providing such financing, where the finder’s compensation is based on a percentage of the capital raised from such investors, requires the finder to register as a broker-dealer.  The Securities Exchange Act of 1934, as amended (Exchange Act), provides that any broker effecting transactions in securities, or inducing or attempting to induce the purchase or sale of securities, must be registered with the SEC, and defines a broker as any person engaged in the business of effecting transactions in securities for the account of others.  The staff has indicated that a person may be ‘engaged in the business’ by receiving transaction-related compensation or by holding itself out as a broker-dealer.  A person may ‘effect transactions’ by assisting an issuer to structure prospective securities transactions, by helping an issuer to identify potential purchasers of securities, or by soliciting securities transactions.

       The staff also noted that a finder’s intention to introduce only those persons with potential interest in investing in the issuer’s securities implies that the finder anticipates both pre-screening potential investors to determine their eligibility to purchase the issuer’s securities, and pre-selling the issuer’s securities to gauge the investor’s interest.  Moreover, the staff has indicated that the receipt of compensation directly tied to successful investments in the issuer’s securities by investors introduced by the finder (i.e. transaction-based compensation), would give the finder a “salesman’s stake” in the proposed transactions and would create heightened incentive for the finder to engage in sales efforts.  Pre-screening and pre-selling activities, along with the receipt of securities commissions or other transaction-based compensation, are hallmarks of broker-dealer activity, requiring registration.

       Accordingly, any person receiving transaction-based compensation in connection with another person’s purchase or sale of securities typically must register as a broker-dealer or be an associated person of a registered broker-dealer.

 Q.  What are the consequences of engaging an unregistered broker as a finder?

 A.  Engaging an unregistered broker-dealer may create a rescission right under federal and state law in favor of the purchasers of the issuer’s securities, potentially requiring the issuer to return the money it received in its capital raise.

      Section 29(b) of the Exchange Act provides that every contract made in violation of the Exchange Act and every contract the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of the Exchange Act, shall be void, as to any persons who, in violation of any such provision, rule or regulation, shall have made or engaged in the performance of any such contract, provided that that no contract shall be deemed to be void by reason of this section in any action maintained in reliance upon this section, by any person to or for whom any broker or dealer sells a security in violation of the Exchange Act’s requirements regarding registration, unless such action is brought within one year after the discovery that such sale or purchase involves such violation and within three years after such violation.

      While Section 29(b) directly applies to the finder, with the possibility of voiding the finder’s engagement agreement, the language also refers to claims maintained by investors to whom the finder sold securities in violation of the Exchange Act’s broker-dealer registration requirements, creating the possibility that an investor could assert a claim for rescission of their investment within 3 years after the date the securities are purchased by the investor and one year after discovery of the violation.

       California Corporations Code Section 25501.5 also provides that a person who purchases a security from or sells a security to an unlicensed broker-dealer may bring an action for rescission of the sale or purchase or, if the plaintiff or the defendant no longer owns the security, for damages, providing a direct right of rescission to investors.

       The use of an unregistered broker-dealer could also result in difficulties subsequently registering the issued securities for public sale.  Most registration statements require the issuance of a legal opinion indicating whether the securities being registered will, when sold, be legally issued, fully paid and non-assessable.  The issuer’s use of an unregistered broker-dealer and issuance of securities in transactions that violated the requirements of the Exchange Act will prevent the issuer’s counsel from issuing the required opinion.  In addition, the unregistered broker-dealer’s contact with unaccredited investors in violation of available federal and state securities laws could result in the loss of exemptions from registration.

       Accordingly, given the risks of rescission rights, the inability to subsequently register the issued securities and the potential loss of available securities exemptions, issuers should refrain from engaging finders for transaction-based compensation unless such finders are registered broker-dealers.


For more information on this or other related topics, contact Louis Wharton at (818) 444-4509 or lwharton@stubbsalderton.com. 

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