US-Non Licenced Financial Brokers

[Sapphire Capital]

Private Placement Finders
After a recent action by the Securities and Exchange Commission ("SEC") and a New York state court ruling, the status of individuals who have not registered with the federal and state governments as brokers and who arrange private placements has become more costly. These individuals, sometimes referred to as "finders," are intermediaries who contract to find and bring parties together, but leave the ultimate transaction to the principals. (See Rogers v. Ellsworth, 501 S.W.2d 756, 757 (Tex.App. - Houston 1973). After the recent actions discussed below, finders face more uncertainty about how the SEC, the Financial Industry Regulatory Authority (formerly NASD) ("FINRA") and the courts will view their services.
In the past, finders functioned in a mostly unregulated area where they often provided broker-like services, but chose not to register — although the SEC, FINRA and the state securities commissions have always believed that a person or firm that receives commission-based compensation with regard to the sale of securities must be registered as a broker.
Recent activities of the SEC and the New York court illustrate, that the issue of registration by finders is actively being considered by regulatory authorities and the judiciary — increasing the importance for finders to decide on whether they need to register as brokers.
On April 11, 2008, the SEC sanctioned a finder for violating registration requirements of the Securities Exchange Act of 1934. (see attachment 1: . Securities and Exchange Commission v. Michael W. Crow, et al., 07-Civ-3814 (CM) (S.D.N.Y.), public enforcement notice and link to complaint).
The SEC raised no other legal issue but the matter of registration. In the action, the SEC charged Robert MacGregor for acting as a broker-dealer without registering with FINRA. MacGregor was an employee of Duncan Capital, a registered broker-dealer whose sole business was arranging private investments in public equity ("PIPEs") for small cap companies. MacGregor allegedly conducted brokerage activities on many of these PIPE offerings, including negotiating the terms of the offerings with issuers and regularly soliciting investors for the offerings. MacGregor received a fee based on the dollar amount of the placement as compensation for his activities. Although MacGregor knew of the requirement to be registered with FINRA and knew that he had not passed the required examinations in order to conduct his brokerage activities, he had not registered. The SEC's order bars MacGregor from association with any broker or dealer for at least one year as well as requiring disgorgement of "ill-gotten gains" derived from violations of the registration requirement.
Also in April 2008, the Supreme Court of New York County in New York ruled against an unregistered broker that brought suit to collect an unpaid fee. (Torsiello Capital Partners LLC v. Sunshine State Holding Corp., 600397/06) In the suit, Sunshine State Holding Corp. ("Sunshine") entered into an agreement with an affiliate of Torsiello Capital Partners LLC ("Torsiello") to render financial advisory and investment banking services and to act as the sole agent for the private placement of Sunshine's securities. Although Torsiello never secured any funding for Sunshine, Torsiello sought to enforce the agreement, claiming Sunshine owed Torsiello a fee based upon a percentage of the amount that Sunshine later successfully raised without Torsiello's assistance. The court held that because Torsiello was not a registered broker, but its proposed service was interpreted by the court to fall under the SEC's definition of brokerage services, (. The SEC defines a "broker" to include "any person engaged in the business of effecting transactions in securities for the account of others." 15 U.S.C. § 78(c)(4) (2000).) the agreement was void and rescindable. Furthermore, the court found that Torsiello had intentionally misrepresented its registration status to Sunshine (which believed that Torsiello was registered as a broker) and ordered Torsiello to repay the retainer fee it had previously received from Sunshine.
Both the SEC action and the New York state court ruling show the high price unregistered "brokers" may pay for arranging private placements for a fee based on the amount of the placement.5 (As noted in the American Bar Association's Report and Recommendations of the Task Force on Private Placement Broker-Dealers from June 2, 2005 ("Report"), the SEC generally disapproves of compensation to unregistered broker-dealers based upon the amount of the transaction. However, the Report suggests that unregistered finders that charge a fixed fee for their services will face less scrutiny by the SEC.) As illustrated in Crow, the SEC is more likely to consider individuals performing private placement activities to be brokers if they receive compensation via a commission- or success-based fee, while individuals who receive a fixed fee for their services are less likely to be considered brokers. In Torsiello, the court raised the stakes further for unregistered brokers by holding that the unregistered broker was in violation of Section 29(b) of the Exchange Act due to the broker's failure to register. As remedy, the court took the unusual step of rescinding the parties' agreement, thereby making the broker potentially liable and preventing the broker from being able to sue for his fee.
The recent actions demonstrate regulators' interest in defining this area of the private placement market. SEC plans to draft a registration policy for private placement brokers in the near future were revealed at an American Bar Association spring meeting this year. Taken together, the activities of the SEC and the New York court suggest that finders may face a high price for arranging private placements while not being registered as broker-dealers.

[Sapphire Capital]

Attachment 1:

U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20535 / April 23, 2008
Securities and Exchange Commission v. Michael W. Crow, Duncan Capital LLC, Duncan Capital Group LLC, Robert David Fuchs, and Robert MacGregor, 07-Civ-3814 (CM)(S.D.N.Y.)
Robert MacGregor Ordered to Pay $655,115 to Settle Charges of Violating the Broker-Dealer Registration Requirements
The Commission announced today that on April 11, 2008, a final judgment was entered by consent against Robert MacGregor, permanently enjoining him from aiding and abetting future violations of Section 15(b)(7) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 15b7-1 thereunder, in the civil action entitled Securities and Exchange Commission v. Michael W. Crow, et al., Civil Action Number 07 Civ. 3814 (CM), in the United States District Court for the Southern District of New York. The final judgment also orders MacGregor to disgorge $480,563 in ill-gotten gains, together with prejudgment interest of $114,552, and to pay a civil penalty in the amount of $60,000, for total monetary relief of $655,115, plus postjudgment interest. MacGregor, 42 years old, is a resident of New York, New York.
The Commission's first amended complaint (complaint) alleges that from November 2003 through at least January 2005, MacGregor was an employee of, and associated with, Duncan Capital LLC, a broker-dealer registered with the Commission, while MacGregor was not registered with the National Association of Securities Dealers (NASD). The complaint further alleges that, during the relevant period, Duncan Capital's sole business was arranging private investment in public equity (PIPE) offerings for small cap companies. As the placement agent, Duncan Capital solicited investors and received a fee from the issuers based on the amounts it raised. MacGregor allegedly conducted brokerage activities for Duncan Capital on many of these PIPE offerings, even though he knew that he was not registered with, and that he was required to be registered with, the NASD, and knew that he had not passed the examinations required in order to conduct his activities. The complaint further alleges that MacGregor received hundreds of thousands of dollars in commissions as a result of his brokerage activities.
In related administrative proceedings, MacGregor agreed to be barred from association with any broker or dealer with the right to reapply for association after one year to the appropriate self-regulatory organization, or if there is none, to the Commission. MacGregor consented to the entry of the final judgment in the civil action without admitting or denying any of the allegations in the complaint.
The action was commenced on May 15, 2007, and is continuing against the other defendants.
Source: www.sec.gov/litigation/litreleases/2008/lr20535.htm

Prior Litigation Release from the SEC :

U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20117 / May 15, 2007
SEC v. Michael W. Crow, Duncan Capital LLC, Duncan Capital Group LLC, Robert David Fuchs, and Robert MacGregor, 07-Civ-3814 (CM)(S.D.N.Y.)
SEC Charges Michael W. Crow, an Undisclosed Control Person of a Registered Broker-Dealer, and Others With Violating the Broker-Dealer Registration and Reporting Requirements
On May 15, 2007, the Commission filed a civil injunctive action in United States District Court for the Southern District of New York charging Michael W. Crow, Duncan Capital LLC, Duncan Capital Group LLC ("DC Group"), Robert David Fuchs, and Robert MacGregor with violations of the broker-dealer registration and reporting requirements.
The Commission's complaint alleges that, from November 2003 through at least December 2004, defendant Crow, who had been previously enjoined by the United States District Court for the Southern District of California from future violations of the anti-fraud provisions of the federal securities laws and sanctioned by the Commission, acted as an unregistered principal of defendant Duncan Capital, a registered broker-dealer. The complaint alleges that Crow controlled virtually every significant aspect of Duncan Capital's operations and received the vast majority of the firm's profits. Yet Duncan Capital's regulatory filings failed to identify Crow as an officer, director or "control affiliate" of the firm, and falsely stated that: (1) no court had ever enjoined any of Duncan Capital's control affiliates in connection with an investment-related activity; and (2) the Commission had never entered an order against any of the firm's control affiliates in connection with an investment-related activity.
The Commission's complaint also alleges that defendant Fuchs, the owner and nominal president of defendant Duncan Capital and the person who filed the false regulatory filings on behalf of Duncan Capital, acquiesced in Crow's undisclosed control of Duncan Capital and helped facilitate it by, among other things, transferring Duncan Capital's profits to other entities Crow controlled.
The complaint further alleges that, with the knowledge and substantial assistance of Fuchs, defendant Duncan Capital also failed to register several associated persons, including Crow and defendant MacGregor, Duncan Capital's senior managing director in charge of private placements.
The Commission's complaint alleges that by engaging in this conduct, the defendants violated the broker dealer registration and reporting requirements of the federal securities laws. Specifically, the complaint alleges that: (1) Duncan Capital violated Sections 15(b)(1), 15(b)(7) and 17(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 15b3-1, 15b7-1 and 17a-3(a)(12) thereunder; (2) Crow violated Section 15(a) of the Exchange Act and aided and abetted Duncan Capital's violations of Section 15(b)(1) of the Exchange Act and Rule 15b3-1; (3) MacGregor and DC Group violated Section 15(a) of the Exchange Act; and (4) Fuchs aided and abetted Crow, MacGregor and DC Group's violations of Section 15(a) of the Exchange Act and Duncan Capital's violations of Sections 15(b)(1), 15(b)(7) and 17(a) of the Exchange Act and Rules 15b3-1, 15b7-1 and 17a-3(a)(12) thereunder.
In its enforcement action the Commission seeks permanent injunctions against Crow, Fuchs, MacGregor, Duncan Capital and DC Group from future violations of the foregoing securities laws, the disgorgement of all ill-gotten gains and civil penalties. The Commission also named the following individual and entities as relief defendants and seeks disgorgement from them: Trevor Crow, Santal Holdings LLC, M.W. Crow Family LP, Crow 2001 Children's Trust FBO Michelle Lee Crow, Crow 2001 Children's Trust FBO Spencer Michael Crow, Crow 2001 Children's Trust FBO Duncan Crow, and Crow 2001 Children's Trust FBO Olivia Trevor Crow.
Source: www.sec.gov/litigation/litreleases/2007/lr20117.htm

See full complaint at : www.sec.gov/litigation/complaints/2008/comp20535.pdf

[Sapphire Capital]

Attachment 2:
ABA related details:
American Bar Association's Report and Recommendations of the Task Force on Private Placement

Law Offices
KARRVTUTTLE.CAMPBELL
1201 Third Avenue, Suite 2900, Seattle, Washington 98101 Telephone [phone], Facsimile [phone]
Portland Office Pioneer Tower, Suite 650,888 S.W. Fifth Avenue, Portland, Oregon 97204 Telephone [phone], Facsimile [phone]
Please reply to Seattle Office
Mike Lies, Jr.
[phone] [e-mail]
April 11, 2006
Ms. Nancy M. Morris, Federal Advisory Committee Management Officer Securities and Exchange Commission
100 F Street NE Washington, DC 20549-1090
RE: Exposure Draft of Final Report of Advisory Committee on Smaller Public
Companies (the "Advisory Committee Report")
Release Nos. 33-8666, 34-53385; File No. 265-23
Recommendation IV.P.6: Spearhead a multi-agency effort to create a
streamlined NASD registration process for finders, M&A advisors and
institutional private placement practitioners
Dear Ms. Morris:
Although I serve as Co-Chair of the NSMIA Subcommittee of the Committee on State Regulation of Securities of the Business Law Section of the American Bar Association and on the Private Placement Broker-Dealer Task Force of that Section (the "PPBD Task Force"), these comments are not submitted on behalf of any Committee of the ABA but solely on behalf of myself and this law firm.
Over a decade ago I served on the ABA Task Force that drafted what is now Form U-7 for the Small Company Offering Registration adopted by the North American Securities Association and subsequently adopted by the Commission as Offering Circular A of the Form 1-A Offering Statement under the Securities Act of 1933. In part as a result of this effort, both I and this firm have over the years represented many emerging small businesses in the Pacific Northwest in private financings. Many of these small businesses have desired to use wealthy individuals in our technology community as intermediaries in seeking to raise
equity capital and to compensate those individual intermediaries with transaction-based fees, although they are not registered as broker-dealers with either federal or state securities regulators.
This comment letter relates solely to Recommendation IV.P.6: Spearhead a multi- agency effort to create a streamlined NASD registration process for finders, M&A advisors and institutional private placement practitioners of the Advisory Committee Report. We recommend that the Commission consider an alternative approach to the recommendations set forth in the Report and Recommendations of the Task Force on Private Placement Broker-Dealers, 60 Bus. Law. 959-1028 (May 2005) (the "PPBD Report"), which was cited with approval in Recommendation IV.P.6 of the Advisory Committee Report.
Dialogues by members of the PPBD Task Force with the NASD staff concerning registration of Private Placement Broker-Dealers with the NASD as a separate category of broker-dealer has met with some resistance by the NASD staff, and for good reason. The NASD is apparently disinclined to create more categories of broker-dealers within its membership to which separate regulatory criteria would apply, and in any event the cost to the NASD of regulating small firms and individuals as Private Placement Broker-Dealers is anticipated to be significantly in excess of the dues that those small firms and individuals would generate as NASD members. This would create an issue of internal fairness within the NASD, as the larger member firms would in all probability be subsidizing the memberships of the small Private Placement Broker-Dealers.
It is anticipated that the activities of Private Placement Broker-Dealers would continue to focus largely upon the placement of securities offered and sold in reliance upon Regulation D under the Securities Act of 1933, and particularly upon the placement of those securities offered and sold in reliance upon the safe harbor afforded by Rule 506 of Regulation D. Regulation D was largely promulgated on the assumption that the regulation of the capital raising efforts of small emerging companies is to be undertaken at the outset by the several state Blue Sky administrators rather than by the Commission. This assumption underlies the operation of Rules 504 and 505 of Regulation D. The division of responsibilities under Section 203A of the Investment Advisers Act of 1940 between state and federal securities regulators reflects a similar policy -the Commission regulates the large multi-state operations, and the Blue Sky administrators regulate the smaller, more local operators.
We submit that the regulation of Private Placement Broker-Dealers raises comparable issues and evokes the same sorts of policies, and we suggest that the Commission consider relegating to state securities administrators the regulation of Private Placement Broker-Dealers in a manner similar to the delegation by the Commission to state securities regulators the registration of small securities registrations under Rule 504. Indeed, we suggest that the same disqualifying criteria be applied to the registration of Private Placement Broker-Dealers as is presently applied to the registration of small offerings under Rule 504(a) and that the state registration requirement applicable to Private Placement Broker-Dealers be conditioned upon a requirement of taking an examination by securities salespersons in a manner analogous to the requirement of delivery of a substantive disclosure document before sale that currently serves as a condition to the exemption to securities registration under Rule 504(b)(l).
We also suggest that for clarity (in the spirit of the use of Plain English in Commission regulations) any new rule exempting Private Placement Broker-Dealers from registration under the Securities Exchange Act of 1934 expressly indicate that membership in the NASD is not required for those relying upon that exemption. An express statement to that effect should aid the use of the exemption by those individuals and small firms that undertake to serve as Private Placement Broker-Dealers in raising capital on behalf of the small business community.
One final suggestion: Rule 504 contemplates that persons with regulatory histories ("Bad Boys") will be disqualified from registration under state Blue Sky registration regulations, as indeed they are (see, e.g., Section IV of SCOR Statement of Policy, adopted April 28, 1996), and there would be every reason for the Commission to assume that a similar disqualifying criterion would be embodied in any state registration procedure for the registration of Private Placement Broker-Dealers. Nevertheless, should the Commission pursue the suggestions of this letter, it may wish to include a separate Bad Boy disqualification provision akin to that set forth in Rule 262(b) of Regulation A in any Private Placement Broker-Dealer exemption Rule under the Securities Exchange Act of 1934.
We hope these suggestions prove helpful to the Commission in considering action in response to Recommendation IV.P.6 of the Advisory Committee Report.
Very truly yours,
KARR TUTTLE CAMPBELL
Mike Liles, J!.

April 11, 2006
Sent via e-mail to [e-mail]
Advisory Committee on Smaller Public Companies
Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-3628
Attn: James C. Thyen, Co-Chair
Herbert S. Wander, Co-Chair
Re: File No. 265-23
Recommendations for Reducing Unnecessary Regulatory Burdens on
Smaller Public Companies – Advisory Committee Recommendation IV.P.6
Ladies and Gentlemen:
We are writing to express our support for Recommendation IV.P.6 included in the
exposure draft of the United States Securities and Exchange Commission Advisory Committee on Smaller Public Companies (the “Committee”), as published in Releases Nos. 33-8666 and 34-53385. The undersigned have been active participants for the past seven years as members of the
Task Force which authored the Report and Recommendation of the Task Force on Private Placement Broker-Dealers, recently published at 60 The Business Lawyer 959 (May 2005) (the “Report”). While we currently serve as the Co-Chairs of the Private Placement Broker-Dealer Task Force drawn from interested committees of the Business Law Section of the American Bar Association (“ABA”), this letter is submitted by the undersigned individually and not on behalf
of the ABA or any Committee or Section of the ABA.
We commend the Committee for its diligence in comprehensively evaluating the many issues that fell within its charter. The number of public meetings, the openness to all viewpoints, and the quality and clarity of the draft recommendations in the exposure attest to the enormity and success of the Committee’s work.
The recommendation that the Securities and Exchange Commission spearhead a multiagency effort to create a streamlined registration process for finders, mergers and acquisitions advisors and institutional private placement practitioners (collectively referred to as Private Placement Broker-Dealers or “PPBDs”) properly recognizes the impediments to small business
capital formation that could be eliminated without loss of investor protection. This is consistent with the Commission’s role as both a regulator and an agency responsible for encouraging capital formation. We urge the Committee to include this recommendation as drafted in its final Report for the following reasons:
1. The Committee’s recommendation will legitimize the activities of, and simplify
compliance procedures applicable to, persons exclusively involved in private placement of Advisory Committee on Smaller Public Companies Securities and Exchange Commission securities without compromising investor protection. To the contrary, the recommendation will bring a large number of PPBDs who currently operate in a massive “gray market” into the light.
Investors will be able to be able to access information regarding them, and the anti-fraud rules of the Commission and state regulatory agencies will be fully applicable to the activities of PPBDs.
2. As the world economy becomes more global, smaller business find it increasingly difficult to access the public markets for capital. The costs of an underwritten public offering, complying with the corporate governance and other requirements of maintaining public status, and attracting analyst coverage today make it difficult, if not impossible, to justify a small public offering. Therefore, smaller companies will continue to seek capital through private placement
of their securities. In addition, a typical growth pattern for smaller public companies is to acquire privately held complementary companies. These merger and acquisition transactions are often facilitated by persons characterized as PPBDs.
3. In each of the most recent two sessions of the SEC Government-Business Forum on Small Business Capital Formation, the number one recommendation of the Forum participants has been for the Commission, the National Association of Securities Dealers (“NASD”) and State securities regulators to enact regulations that would be consistent with the recommendations contained in the Report.
4. Because of its economic structure, it is unrealistic to believe that the NASD on its own initiative will take the lead role in implementing a limited registration procedure for private placement broker-dealers. Its organization and member fee structure reflects the tremendous amount of infrastructure necessary for the NASD properly to carry out its regulatory duties. We believe that the limited class of PPBDs easily can be fit within the self-regulatory framework, but concluding that the NASD will do so voluntarily without direction from the Commission is, we
think, naïve.
5. While several states are evaluating possible legislative and regulatory initiatives addressing some of the issues included in the Report, the result will take years long and be less efficient and less effective than if the Commission takes action to coordinate the effort and encourage some consistency.
6. While the thrust of the Report is to provide a simplified registration process and on-going regulatory oversight better adapted to the limited nature of the business of PPBDs, we believe the Commission can explore with the NASD and the States alternative regimes to accomplish the same goals. For example, the development of an exemption from the licensing requirements for persons or transactions involved in the “sale of a business” might very well be a
more logical approach than an NASD membership application. Also, an exemption from federal broker-dealer registration might be appropriate so long as there is registration in at least one state, by analogy to the structure utilized for small offerings under Rule 504 of the Commission’s Regulation D. Other s, such as the federal-state division of responsibility for investment advisors, also might similarly accommodate the needs of the Commission, the NASD and the
Advisory Committee on Smaller Public Companies Securities and Exchange Commission states. For this reason, the Committee’s recommendation that the Commission spearhead a multi-agency effort is both welcome and wise.
For the above reasons, we enthusiastically support and endorse the Committee’s
recommendation that the Commission form a multi-agency regulatory task force to create a practical set of regulations and procedures to effect a PPBD regime that will eliminate barriers to smaller public and private companies’ capital formation activities, and rationalize the applicability of the laws and regulations to persons assisting such companies in merger and acquisition activities.
Respectfully submitted,
/s/ Gregory C. Yadley
Gregory C. Yadley
Shumaker, Loop & Kendrick, LLP
101 East Kennedy Boulevard, Ste 2800
Tampa, Florida 33602
[e-mail]
/s/ Faith Colish
Faith Colish
Carter Ledyard & Milburn LLP
2 Wall Street
New York, New York 1005
[e-mail]
/s/ Gerald V. Niesar
Gerald V. Niesar
Niesar Curls Bartling LLP
90 New Montgomery Street, 9th Floor
San Francisco, California 94105
[e-mail]

[Sapphire Capital]

Attachment 3:

UTAH Bar Association Memo:

Finding a Solution to the Problem With Finders in Utah
by Brad R. Jacobsen and Olympia Z. Fay
A significant issue facing attorneys and their clients in Utah is the use of unregistered securities brokers by small businesses and start-up companies to raise investment capital. The unregistered securities brokers are commonly referred to as "finders," however, other titles exist to describe these individuals, including, unlicensed broker-dealers, intermediaries, private placement brokers, merchant bankers, investment bankers, financial public relations advisors and business consultants.1 Black's Law Dictionary, Sixth Edition, defines a finder as "an intermediary who contracts to find, introduce and bring together parties to a business opportunity, leaving ultimate negotiations and consummation of business transactions to the principals." For convenience of reference throughout this Article, these unregistered securities brokers will be referred to as "finders." Finders usually charge a transaction fee based on the amount of capital which the finders are responsible for bringing to the company. This type of compensation is commonly referred to as a "finders fee" and is usually paid in either securities or in cash (or a combination of both) as a percentage of the money raised (generally around 5-10%).
However defined, or by whatever name used, the use of a finder and the payment of a finders fee in Utah (subject to very narrow exceptions) is illegal and will likely cause a company, its officers, directors and agents to be subject to criminal sanctions and civil liability (on a personal and company level). Despite the illegal nature of using a finder in capital raising transactions, the American Bar Association (the "ABA") has recognized that in numerous instances, finders can provide beneficial services in raising capital for small businesses and start-up companies that is often not available from traditional lending sources or licensed broker dealers.2 On June 30, 2005, the ABA released a report titled "Reports and Recommendations of the Task Force on Private Placement Broker-Dealers" (the "ABA Report"), in which the ABA task force made a series of recommendations that seek to provide a uniform means by which individuals could more easily be licensed to act as finders. Such recommendations, however, will likely take years to implement due to the reviews and compromises required among many parties, including the National Association of Securities Dealers ("NASD"), the U. S. Securities and Exchange Commission ("SEC"), the North American Securities Administrators Association ("NASAA"), state regulators and others. This article discusses the current law and regulations facing finders as well as the ABA Report and recommendations for providing a reasonable solution to the current capital raising regulatory quandary facing small businesses and start-up companies.
I.SECURITIES BROKER-DEALERS vs. FINDERS

There is an important legal distinction between securities broker-dealers and finders. "Securities brokers are required to register with the SEC pursuant to Section 15 of the Securities and Exchange Act of 1934 (15 U.S.C. 78(a)(4)), which broadly defines any person engaged in the business of effecting transactions in securities for the account of others to be within the scope of the registration mandate."3 The SEC enacted the statute to combat abusive sales tactics and to protect investors by imposing standards of professional conduct on the securities brokers which are enforced through disciplinary actions.4 The activity of a securities broker-dealer is monitored by registered national securities associations and exchanges, in which membership is compulsory for all registered brokers. Most broker-dealers belong to, and are monitored by, the NASD. Additionally, registered brokers are governed by the SEC through its enforcement of federal securities laws, educational requirements and financial responsibility rules. These registration, compliance and educational requirements are not cheap, and such costs must be passed through to the consumer of a broker-dealer's services. Therefore, many small businesses and start-ups are often priced out of using valid capital raising services or otherwise not targeted by registered broker-dealers as clients.
Unlike a registered broker-dealer, a finder is an unregistered intermediary that assists companies in raising capital. Within certain limits, a finder may operate within applicable legal requirements. The SEC has recognized that a person who only occasionally makes mere introductions of potential investors to issuers, either for free or under a non-contingent fee arrangement, and not more, is a finder who does not need to register as a broker. Through the use of No-Action letters, the SEC has attempted to promote additional standards by which finders may legally operate and, in certain circumstances, receive a transaction based fee.
In a well-known No-Action letter, the Ottawa Senators Hockey Club retained entertainer Paul Anka ("Anka") to act as a finder for purchasers of limited partnership units issued by the Senators.5 While initially proposing a much broader role, Anka eventually agreed to only furnish the Senators with the names and telephone numbers of persons in the United States and Canada who he believed might be interested in purchasing the limited partnership units. Anka additionally agreed that he would neither personally contact these persons nor make any recommendations to them regarding investments in the Senators. Anka's proposal letter to the SEC stated that he would be paid a finders fee equal to 10% of any sales traceable to his efforts. The SEC indicated that it would not recommend enforcement action if Anka engaged in the proposed activities without registering as a securities broker-dealer. The following summarizes the important factors considered by the SEC when issuing the Anka No-Action letter:
¥ Anka only provided names and contact information for prospective purchasers;
¥ The sales of the securities were to be made in compliance with the Securities Act of 1933;
¥ There was a bona fide, pre-existing relationship between Anka and his referrals;
¥ Anka would not advertise, endorse or solicit investors;
¥ Anka would not have personal contact with prospective investors regarding the investment;
¥ Only officers and directors of the Senators would contact the potential investors;
¥ Compensation paid to the Senators' officers and directors would comply with SEC Rule 3a-1, which governs compensating issuer agents;
¥ Anka would not provide financing for an investor;
¥ Anka would not perform due diligence on the SenatorÕs offering; and
¥ Anka had never been a broker-dealer or registered representative of a broker-dealer.6
While the Utah Division of Securities has stated that it will respect the Anka No-Action letter, it must be emphasized that the exception to using finders in capital raising transactions offered by such Letter is extremely narrow. It amounts to basically paying a well-connected person for a list of names and phone numbers. Rarely do finders act in such a limited capacity or are companies willing to pay such a high fee for such limited information.
II. CONSEQUENCES OF FINDERS' UNLAWFUL ACTIVITY
Federal and state securities administrators have enacted statutes detailing the consequences of finders' unlawful activities. Failure to comply with such statutes can result, in among other things: (1) a company losing its exemption for its securities offering; (2) a company, its officers, directors and agents being subject to criminal sanctions resulting from violations of applicable securities laws; and (3) company investors having the right to seek rescission of the applicable offering.7 In order to avoid the pitfalls of using a finder, it is important to understand the case law, applicable statutes and consequences of using one.
Federal Statute for Finders and Case Decisions
Section 15(a) of the 1934 Securities Act provides that "it shall be unlawful for any broker or dealer . . . to make use of mail or any means or instrumentality of interstate commerce to effect any transaction in, or induce or attempt to induce the purchase or sale of, any security . . . unless such broker or dealer is registered." As previously discussed, a finder is an unregistered party attempting to induce others to purchase or sell securities.
In SEC v. Walsh, the SEC sued former Tyco director and the chairman of its compensation committee for signing a Tyco registration statement that he knew contained a material misrepresentation regarding the payment of a finders fee. In late 2000, Frank E. Walsh ("Walsh") recommended that Tyco consider acquiring CIT Group Inc. (ÒCITÓ).8 Subsequently, L. Dennis Kozlowski ("Kozlowski"), Tyco's former Chief Executive Officer, asked Walsh to set up a meeting between Kozlowski and CIT's Chief Executive Officer. After that meeting, Kozlowski proposed to pay Walsh a finders fee for his services if the transaction was completed. When the transaction was submitted to Tyco's Board ("Tyco Board"), Walsh voted in favor of the transaction but intentionally did not disclose to the Tyco Board that he would receive a finders fee in connection with the transaction.
The terms and conditions of the Tyco/CIT merger were set forth in the Agreement and Plan of Merger dated March 12, 2001 (the "Agreement and Plan of Merger"). The Agreement and Plan of Merger contained a representation by Tyco that, other than Tyco's investment bankers for the transaction, no other investment banking or finders fees were to be paid in connection with the transaction. The Agreement and Plan of Merger was incorporated by reference in, and attached to, a registration statement (the "Tyco Registration Statement") filed by Tyco with the SEC for the securities that were issued in connection with the contemplated merger. As a director, Walsh signed the Tyco Registration Statement even though he allegedly knew that the Tyco Registration Statement contained a material misrepresentation regarding the payment of a finders fee and was aware that he would obtain a substantial fee if the transaction was completed.
After completion of the transaction Walsh received a finders fee of $20 million. The fee was paid by Tyco pursuant to the Walsh/ Kozlowski agreement. Additionally, the fee was disbursed without the knowledge of CIT's or Tyco's shareholders. Under the Agreement and Plan of Merger, the payment to Walsh was not permissible.
After investigation by the SEC, Walsh, without admitting or denying the allegations, consented to the entry of a final judgment permanently enjoining him from violations of the federal securities laws (Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Exchange Act Rule 10b-5). Consequently, Walsh was permanently barred from acting as an officer or director of a publicly held company, and ordered to pay restitution of $20 million.
Utah Rules and Penalties Concerning Finders

Issuers, due to a failure to plan in advance, often find themselves in a position of attempting to fit their offerings into the Anka No-Action letter exception after the fact. The Utah Division of Securities (the "Division") actively reviews Form Ds filed, and aggressively pursues instances where the issuer has indicated that it paid a sales commission or finders fee.9 Unless any such issuer used a licensed broker-dealer, it will need to demonstrate that it adhered to the procedures permitted by Anka (or used a licensed Issuer-Agent (discussed below)), otherwise such issuer, its officers, directors and agents will likely face significant consequences.
Described below are a number of the applicable sections of the Utah Code (the "Utah Act") that set forth certain of the consequences for using a finder in Utah.
Section 61-1-3(1) of the Utah Act provides that "t is unlawful for any person to transact business in this state as a broker-dealer or agent unless the person is licensed under the Utah Act." Section 61-1-3(2) then goes on to provide that "t is unlawful for any broker-dealer or issuer to employ or engage an agent unless the agent is licensed." The term "agent" is broadly defined as "any individual other than a broker-dealer who represents a broker-dealer or issuer in effecting or attempting to effect purchases or sales of securities."10
Section 61-1-11(11) of the Utah Act requires that if an issuer wishes to use an agent, employee or other person to effect or attempt to effect a securities transaction, such person must either (i) be licensed and associated with a licensed broker-dealers or (ii) be an officer or director of the issuer; provided, that, with respect to clause (ii), such person also (A) does not receive any commission or other remuneration; and (B) is licensed (generally as an issuer agent). While Section 61-1-11 generally applies only to registrations by qualification, coordination or notification, an aggressive view of Section 61-1-11(11), in and of itself, could be read to include any securities issuances.
Section 61-1-22(1)(a) of the Utah Act provides that " person who offers or sells a security in violation of Subsection 61-1-311 . . . is liable to the person selling the security to or buying the security from him, who may sue either at law or in equity to recover the consideration paid for the security, together with interest at 12% per year from the date of payments, costs, and reasonable attorney's fees."
Section 61-1-22(4)(a) of the Utah Act adds that "[e]very person who directly or indirectly controls a seller or buyer liable under Subsection [61-1-22(a)], every partner, officer, or director of such a seller or buyer, every person occupying a similar status or performing similar function, every employer of such a seller or buyer who materially aids in the sale or purchase, and every broker-dealer or agent who materially aids in the sale are also liable jointly and severally with and to the same extent as the seller or purchaser, unless the nonseller or nonpurchaser who is liable sustains the burden of proof that he did not know, and in exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist."
Violations of the securities laws in Utah will not only subject the issuer, its officers, directors and agents to rescission claims (e.g., return of investment, plus 12% annual return from time of investment, plus attorneys fees) described above, but also criminal sanctions, including: (1) cease and desist proceedings; (2) fines; (3) disgorgement of any fees or other profits; (4) injunction orders; and (5) the potential conviction of a third degree felony (punishable by up to two years in jail).12 The investigative proceedings and orders by any federal or state regulatory authority will also be a reportable event for any person who is a broker-dealer, investment advisor or other NASD registered individual.
Limited Exceptions Under Utah Law

Certain limited finding activities may be conducted under applicable law. The limited involvement described in the Anka No-Action letter is followed in Utah. As previously mentioned, however, few individuals can qualify for such an exemption and still effectively assist a company in obtaining financing. Additionally, Utah permits a licensed "Issuer-Agent" to represent a company in the issuance of securities. Such an Issuer-Agent, however, must first be registered and licensed with the State of Utah. The applicant must (1) file a NASD Form U-4; (2) provide proof that such applicant has passed the Series 63 or Series 66 examination; (3) pay a fee of $50; and (4) in certain circumstances post a surety bond.13 A registered Issuer-Agent, however, may not be involved in more than one offering in any twelve-month period.14 An individual who wishes to represent more than one company in any given twelve-month period must register as a licensed broker-dealer to do so. The ABA Report described below, argues that between an Issuer-Agent only being permitted to represent one company in a twelve-month period and the formal procedures of registering as a broker-dealer, there should be a middle ground (e.g., private placement broker-dealers subject to limited registration requirements that are permitted to engage in certain finding activities for a greater number of companies). The ABA Report refers to these licensed finders as "Private Placement Broker-Dealers."
III. ABA Recommendations
Registration Requirements for Finders

On June 30, 2005, the Task Force on Private Placement Broker-Dealers (the "Task Force") released the previously described ABA Report.15 The ABA Report discusses the problems that are associated with using a finder at both the state and federal level and makes recommendations for permitting expanded finders activities. The objectives of the ABA Report were:
¥ To present a comprehensive survey of the relevant issues relating to this vast gray market of securities brokerage; and
¥ To propose a solution that the Task Force believes will provide a reduced, but appropriate, level of regulation in the M&A and private placement arenas.
The ABA Report additionally set forth four critical goals for the proposed solution:
¥ To modify the amount and scope of the regulations that will apply such that they would be in proper balance with the scope of activities to those being regulated;
¥ To make possible and encourage the effective licensing of those finders who do adhere to honest and ethical business practices;
¥ To diminish the number of unlawful securities brokers to a level that will make effective enforcement actions more feasible; and
¥ To provide issuers and finders a means of distinguishing the good from the bad.
The ABA through the Task Force recommends that the SEC, NASD and state administrators work toward creating a simplified system for finders to be licensed. The system the ABA Report is proposing will permit finders to engage in activities similar to those of securities broker-dealers with a few limitations. The Task Force's new recommended limitations for finders include:16
¥ No participation in public offerings registered pursuant to the Securities Act of 1933, but with the ability to receive referral fees for introducing such offerings to full service broker-dealers.
¥ No statutory disqualification of the firms or its principals.
¥ Offerings by finders could be made only to accredited investors and other "qualified purchasers" when the SEC defines such term. Issuers, however, could separately offer to any investors qualified by the type of exemption.
¥ The finders may not handle or take possession of funds or securities.
¥ All offerings would be done on a best effort basis.
¥ All funds from offerings will be placed in escrow in an unaffiliated financial institution and in accordance with escrow requirements in SEC Rule 15c2-4.
¥ The finders may not engage in secondary market or trade activity, including assisting with maintenance of "desk drawer" markets at the issuer or the broker-dealer.
¥ Finders shall have successfully completed simplified NASD examinations appropriate to the scope of activities of the finders.
Statement of Activity and Examination Requirements

The Task Force recommends that a finder be required to file an annual statement of activity with the NASD and applicable states. The annual statements will summarize the transactions the finder has participated during the past calendar year and provide sufficient statistical information for regulators to analyze the effects of the finders program or conduct appropriate inspection.
The Task Force is proposing an examination requirement similar to that of the securities broker-dealers. Currently, examinations are not required for finders since the scope of their coverage does not exceed the knowledge required to perform obligations that the ABA anticipated for securities brokers. The Task Force recommends the securities regulators "develop new targeted examination for registered representatives and principals, such as finders, testing only relevant topics of their duties."17
Create an Environment Where Applicants Want to Register

An obvious concern for those finders who have engaged in transactions without registration in the past is that regulators, particularly state administrators, will require disclosure of past activities in their states. The Task Force recommends that states establish a period procedure under which prior activities would not require disclosure. If an applicant faces virtual certainty of a state regulatory proceeding and a demand for rescission, there is little incentive for compliance. The Task Force is urging the NASAA to promote among its members a system of encouraging, rather than discouraging, appropriate registration. Many states require letters from an applicant for securities registration stating that the entity has not engaged in securities transactions in the state in the past (often without a time limit). These letters have the effect of izing the applicant who wants to come forward and become compliant. The Task Force is recommending a one-year hiatus in the use of such letters to permit individuals or firms to come to compliance.
CONCLUSION
Small businesses and start-up companies in need of investment capital are often in a "catch 22"18 when it comes to raising funds. Without additional capital, such companies may not survive, but if they raise capital through the use of a finder, they will likely be violating the law which, in turn, may lead to their demise. Such companies, additionally, are often not large enough to draw from traditional sources of capital or do not otherwise have contacts with available investment capital. Often, through no knowing violation of the law, these companies end up using finders to obtain desperately needed capital. The ABA acknowledges the difficult position small businesses and start-ups are in when it comes to raising capital. The ABA, through the Task Force, has recommended that by permitting individuals to be licensed simply as finders, smaller businesses and start-up companies would likely have additional access to legitimate investment capital not currently available. The licensing requirements, while less stringent than that of a broker-dealer, would provide protections and regulatory oversight not currently imposed on finders operating on and beyond the grey line of legality.
Until the SEC, state administrators and NASD resolve their concerns and issues regarding the licensing on finders recommended by the Task Force, Utah companies and attorneys would do well to steer clear of their unauthorized use. While some states, such as Michigan, have chosen to license finders ahead of final federal rules, little can effectively be done at the state level until federal securities laws and regulations expand activities permitted by finders. Practitioners who believe a limited exemption and registration for finders would be a beneficial addition to the current securities regulatory environment are encouraged to work with their legislators and regulators to push such recommendations through to adoption.
The authors would like to thank Benjamin N. Johnson, Director of Corporate Finance, and George A. Robinson, Director of Licensing & Compliance, with the Utah Division of Securities for their review and comments on this article.
1. See Mary M. Sjodquist, ABA Reports and Recommendations of the Task Force on Private Placement Broker-Dealers, June 20, 2005 at 2.
2. See id.
3. See Steven M. Hecht, Securities Law: Are finders also broker-dealers? The National Law Journal, March 8, 2004.
4. See id.
5. See Paul Anka, SEC No-Action letter (July 24, 1991)
6. See id.
7. See Utah Code Ann. ¤ 61-1-22 (2005).
8. See United States Securities and Exchange Commission Litigation Release No. 17896 (Dec. 17, 2002), at www.sec.gov/litigation/litreleases/lr17896.htm
9. See Form D, Section C, Question 4a.
10. See Utah Code Ann. ¤ 61-1-13(2) (2005).
11. Utah Code Ann. ¤ 61-1-22(1)(a) (2005) provides that a violation of "Subsection 61-1-3(1), Section 61-1-7, Subsection 61-1-17(2), any rule or order under Section 61-1-15, ... Subsection 61-1-10(4) or 61-1-11(7), or offers, sells, or purchases a security in violation of Subsection 61-1-1(2) ..." subjects the issuer and certain affiliated parties to rescission liability. Note, however, that a violation of Utah Code Ann. ¤ 61-1-11 (11) referenced in the prior paragraph is not included in the litany of violations that provides grounds for a rescission offer.
12. See Utah Code Ann. ¤ 61-2-17 (2005).
13. See Utah Regulations R164-4-1(E)(4).
14. See Utah Regulations R164-4-1(E)(4)(A).
15. See ABA Report and Recommendations.
16. Id.
17. See id. at 4.
18. The phrase "Catch 22" comes from Joseph Heller's novel of the same name. The paradox that trapped members of the US military: Anyone who applied to get out of military service on the grounds of insanity was behaving rationally and thus couldn't be insane.

[Sapphire Capital]

Attachment 4:

The Texas “Finder” Securities Broker Registration
Texas entrepreneurs looking for investors seek referrals from their mentors, athletic coaches, physicians, professors, and successful businesspersons. But, what if that entrepreneur tried to give that person a piece of the business or the financing raised in payment for the referral? Are there any legal considerations? On July 25, 2006, the Texas State Securities Board passed a new rule allowing investor finders to legally receive such compensation if they register with the State as a finder, a “light” version of broker-dealer registration.
Persons who received transaction-based compensation relating to the sale of securities might be securities brokers who would be required to be registered under Texas law. If the transaction crosses interstate boundaries, the broker may need to be registered under federal law as well. The State Securities Board has long interpreted the definitions of “sale” broadly to capture everyone involved in the sale process.1 And, Texas law explicitly states that unregistered persons cannot enforce commission contracts relating to the sale of securities.2 Registering as a securities broker requires paying fees, passing a test, and, typically, affiliating with a registered broker-dealer.
Last year the Texas State Securities Board exempted those who sell securities to certain institutional investors from the broker-dealer registration requirements. These institutional investors must meet certain asset and income levels which allow them to be called “accredited investors.” But, it did not exempt those involved in sales to wealthy individuals.3 So, for example, the person selling to a Texas billionaire would need to register as a securities broker, but the person selling to that billionaire’s children’s trust would not.
On July 25, 2006, the Texas State Securities Board took the next step by creating a limited broker-dealer registration for “finders,” that is individuals who refer accredited investors, whether individual or institutional, to an investment, and are compensated if their referral makes a purchase.4 But the finders may not be involved in negotiating the sale, advising about the investment, or performing due diligence.5 This finder broker-dealer registration is available only to individuals, and dispenses with the exam requirement and the need to affiliate with a registered broker-dealer.6 It requires that finders keep certain records and not commingle the finder-related records with other records.7 It also requires that finders disclose in writing that the issuer pays them and their potential conflicts of interest, and provide a statement that the finder can neither recommend, nor advise, the accredited investor about the investment.8 The finder registration protects finders against unenforceable commission contracts and penalties for non-registration, including criminal penalties. The Texas Finder Rule should be effective sometime in September, 2006.
If a finder works on interstate deals, federal law may apply and the SEC has not exempted finders from federal broker-dealer law requirements. Federal law requires that persons “engaging in the business of effecting transactions in securities for the accounts of others” in interstate commerce must register as a broker with the SEC.9 Texas finders will likely ask SEC staff for No-Action Letter consideration if the finder is Texas-registered, but not SEC-registered. A No-Action Letter is a statement by the SEC staff that under a defined set of circumstances that the SEC Staff will not recommend to the SEC’s Commission members to approve an enforcement action. There can be no assurance that the SEC Staff will grant No-Action Letter relief to Texas-registered finders.
The table below describes the broker-dealer registration scheme in Texas after the effective date of the Finder Rule.

Texas case law indicates that business brokers who introduce parties that lead to the sale of the whole business in a transaction effected through a one-hundred percent (100%) stock sale may not have to register as finders.10
The Texas Finder Rule imposes some burdens. First, finders must complete an application and pay a fee (currently $275) to the Texas State Securities Board.11 No exam will be required.12 A link to the application form, “Form BD,” can be found on the Board’s website (www.ssb.state.tx.us) under “Forms and Fees.” Board examiners will review the application for possibly disqualifying events such as criminal fraud convictions, securities industry bars, and court-issued securities fraud injunctions, and then grant or deny registration.13 Denials would likely be rare and may be appealed to the State Office of Administrative Hearings for review.14
Second, the Texas Finder Rule requires that the finder provide prospective accredited investors a written disclosure statement that says that the finder will receive compensation, can neither recommend, nor advise, about the securities offering, and discloses the specific potential conflicts of interest with the prospective accredited investor.15 The State Securities Board did not describe how to measure the potential conflict of interest. But, a likely disclosure should include a statement that the finder’s compensation relies on making the sale, and the finder has incentives to hope the transaction closes.
Third, the Texas Finder Rule limits the finder to giving the issuer only the prospective accredited investor's contact information16 and providing the prospective accredited investor only the following information:
1.The name, address, and telephone number of the issuer of the securities;
2.The name, a brief description, and price (if known) of any security to be issued;
3.A brief description of the business of the issuer in 25 words or less;
4.The type, number, and aggregate amount of securities being offered; and/or
5.The name, address, and telephone number of the person to contact for additional information.17
Fourth, the Texas Finder Rule requires that certain records relating to completed transactions be maintained for five (5) years18, the first two (2) of which can be archived.19 The finder is also barred from commingling the finder records with records from the finder’s other businesses.20 The rule requires finders to keep:
1.Compensation records for acting as finder, including the name of the payor, date of payment, name of issuer, and the name of the accredited investor;
2.Copies of the information provided by the finder to the prospective accredited investors;
3.Agreements between the finder and the accredited investor and between the finder and the issuer;
4.Contact lists of prospective accredited investors and issuers; and
5.Correspondence with accredited investors and issuers, including e-mail.21
Finally, the Texas Finder Rule requires that finders provide copies of these records to the State Securities Board staff upon request22, including allowing State Securities Board examiners to inspect records.23

1 TEX. REV. CIV. STAT. ANN. Art. 581-4(e).
2 Kadane v. Clark, 43 S.W.2d 197 (Tex. 1940); TEX. REV. CIV. STAT. ANN. Art. 581-34.
3 7 Tx. Admin. Code §109.5.
4 7 Tx. Admin. Code §§115.1(a)(9), 115.11.
5 7 Tx. Admin. Code §115.11(a).
6 7 Tx. Admin. Code §115.1(a)(9).
7 7 Tx. Admin. Code §115.11(c).
8 7 Tx. Admin. Code §115.11(b).
9 15 U.S.C. 78(c)(4)(A)
10 Star Supply Co. v. Jones, 665 S.W.2d 194, 196 (Tex.App.--San Antonio 1984); Vero Group, v. ISS-International Service System, 971 F.2d 1178, 1186 (5th Cir. 1992, reh’g den’d 978 F.2d 713); see also Rogers v. Ellsworth, 501 S.W.2d 756 (Tex.App.--Houston 1973).
11 TEX. REV. CIV. STAT. ANN. Art. 581-35.A and Art. 581-41(a)(1).
12 7 Tx. Admin. Code §§115.3(c)(2)(E)
13 TEX. REV. CIV. STAT. ANN. Art. 581-4(e); 7 Tx. Admin. Code §104.5.
14 7 Tx. Admin. Code §§105.1 et seq.;.TEX. GOV’T CODE §§2001.054, 2003.058, and 2003.021.
15 7 Tx. Admin. Code §115.11(b).
16 7 Tx. Admin. Code §115.11(c)(2).
17 7 Tx. Admin. Code §115.11(c)(1).
18 7 Tx. Admin. Code §§115.11(d)(2) and 115.11(d)(3).
19 7 Tx. Admin. Code §115.11(d)(5).
20 7 Tx. Admin. Code §115.11(d)(6).
21 7 Tx. Admin. Code §115.11(d)(3).
22 7 Tx. Admin. Code §115.11(d)(7).
23 7 Tx. Admin. Code §115.7.

[Sapphire Capital]

Attachment 5:

CA: Private Offerings Using Non-Registered Broker/Dealers June 1, 2005
A new provision of the California Corporate Securities Law that became effective on January 1, 2005, raises the bar for companies raising money through equity offerings. This statute, Section 25501.5, 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 security is no longer owned by one of the parties, for damages. The statute further provides that the court in its discretion may award reasonable attorney's fees and costs to a prevailing plaintiff under the Section. The new law also provides for additional treble damages, up to a maximum of $10,000.
We anticipate that the new law, and the questions that it poses, will bring to fore an issue with which securities practitioners have long struggled " what is the exposure to the issuer of securities, if it engages a 'finder' or other financial intermediary that is not a registered broker/dealer"
I. Background
Most startups and early stage companies, in attempting to raise equity capital privately, do not have sufficient contacts themselves to find accredited or sophisticated investors, and accordingly seek the assistance of investment professionals or financial intermediaries to locate investors. These companies, however, which typically seek capital of less than $5 million, find it difficult to attract investment bankers who are registered broker/dealers, as such small offerings are not economic for the broker/dealer. Consequently, early stage companies look to financial intermediaries who refer to themselves by a number of different titles (e.g., investment bankers, merchant bankers, consultants, finders, etc.) that are not registered broker/dealers. This article addresses the risks faced by companies that use unregistered broker/dealers to access capital.
II. The Finder's Exemption from Broker/Dealer Registration
Brokers and dealers in securities are required to register with the SEC.[ii] Similarly, each state has its own requirements for broker/dealer registration. Under federal law, a 'broker' is any person engaged in the business of effecting transactions in securities for the account of others, but does not include a bank.[iii] A 'dealer' is a person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.[iv]
Section 15 of the Securities Exchange Act of 1934, as amended (the '34 Act) makes it unlawful for any broker or dealer to use the mails or any means or instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of any security.[v]
Finders maintain they are not 'effecting' transactions in securities and are not therefore broker/dealers, because they merely, for a fee, 'find' and place in contact with one another buyers and sellers of securities. Although the exemption from broker/dealer registration of a finder has been recognized by Professor Louis Loss,[vi] it is generally a narrow exemption in light of SEC interpretations.[vii]
The SEC, in one no-action letter (Paul Anka, July 24, 1991), found an exemption from broker/dealer registration for a finder who furnished, for a transaction-based fee, names of persons with whom he had had a preexisting relationship and whom he believed to be accredited investors. In finding the individual within the finder's exemption, the SEC noted that he had not previously been engaged in arranging financings and represented that he would not do so in the future.
The SEC's interpretation of the finder's exemption is predicated on the finder merely making available to the issuer, by introduction or otherwise, the identity of interested investors, and on the absence of the following factors, all of which tend to indicate broker/dealer activity:
Participation in negotiations
* Counseling investors of the merits of investing
* Recommending the investment to investors
* Receiving compensation based on a percentage of the offering proceeds
* Holding securities or cash
* Providing details of the financing to investors
* Conducting sales efforts[viii]
Most finders' activities in raising money for the issuer include one or more of the above proscribed activities.[ix] Moreover, even under the Paul Anka interpretation, if the intermediary does not engage in any of these activities, he still may be engaged in the business of effecting transactions in securities, and therefore fall outside the 'finder's exemption,' if he receives transaction-based compensation more than once or twice in his career. More recent SEC no‑action letters suggest that the staff is construing the 'engaged in the business' phrase even more narrowly than in the 1991 Paul Anka letter and may conclude that transaction-based compensation alone is sufficient to trigger the broker/dealer registration requirement.[x] In any case, it is difficult for small business issuers to be confident in obtaining private capital through the agency of non-registered finders without risk of being exposed to the consequences of using an unregistered broker/dealer. What then are the consequences to the company of using an unlicensed broker/dealer
III. Liability of Issuer for Compensating Unlicensed Broker/Dealer
Undoubtedly, under federal law, and now in California pursuant to Section 25501.5, an investor has a right of action against the unlicensed broker/dealer for violation of the broker/dealer registration requirement. An issuer may be liable on a theory of secondary liability, if the issuer knowingly assists or abets the violation of the broker/dealer registration requirement. We discuss below whether the investor may have a primary right of action for rescission or damages against the issuer for the unlicensed broker/dealer's violation of the broker/dealer registration requirements.
A. Right of Rescission: Voidability Statutes - Which Contracts May Be Rescinded
1. Federal Law Section 29(b) of the '34 Act
Section 29(b) of the '34 Act provides, in part:
(b) Every contract made in violation of any provision of this title, and every contract heretofore or hereafter made the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of this title shall be void: (1)as regards the rights of any person who, in violation of any such provision, rule, or regulation, shall have made or engaged in the performance of any such contract, and (2)as regards the rights of any person who, not being a party to such contract, shall have acquired any right thereunder with actual knowledge of the facts by reason of which the making or performance of such contract was in violation of any such provision, rule, or regulation.
Section 29(b) goes on to provide that any action brought 'by any person to or whom any broker or dealer sells or purchases, a security in violation of [the anti-fraud provisions] of Section 15(c)(1) or (2) must bring the action within one year of the discovery of such violation and within three years after the violation. Does 29 of the '34 Act invalidate a private offering arranged by a non-registered finder Section 29(b) has been interpreted to allow rescission by investors and by issuers of transactions in securities with unregistered broker/dealers.[xi] While the holding of these cases invalidated the agreement and transaction between the investor or the issuer and the non-registered finder, there is dicta in the Regional Properties case that the offering itself, as evidenced by the contract between the issuer and the investor, also could be invalidated by Section 29(b).[xii] On the other hand, it may be difficult to establish the requisite causal relationship between the injuries of the plaintiff purchaser of securities to the finder's failure to register.[xiii]
2. California Law Section 25501.5
Now, the addition of Section 25501.5 also raises the question of whether the investor who purchases a privately offered security from an issuer that pays a commission to an unregistered broker/dealer may seek rescission of his investment against the issuer under California law.
Section 25501.5 of the Corporate Securities Law of 1968 provides, in part:
(a)(1) A person who purchases a security from or sells a security to a broker/dealer that is required to be licensed and has not, at the time of the sale or purchase/secured from the commissioner a certificate authorizing that broker/dealer to act in that capacity, 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. [xiv]
Clearly, the statue provides a rescission remedy against the unregistered broker/dealer. What is not so clear is whether the investor can also seek rescission against the issuer. If the unlicensed broker/dealer acted as placement agent for the issuer, does this constitute a purchase of a security from an unlicensed broker/dealer?
In the typical corporate financing transaction, the unlicensed broker/dealer is a placement agent for the issuer, which is the principal in the sale transaction. Thus, the statute would seem ineffective, if it did not provide a remedy against the issuer. The situations in which the investor purchases securities directly from the unregistered broker/dealer acting as a principal in the transaction are few. For example, an underwriter in a public offering sells as a principal. A market maker of publicly traded securities also may sell securities as a principal from its own inventory. Lastly, there are certain securities in which the sponsor or promoter of the security is also a broker/dealer. It appears, however, that it is this last category of security that Section 25501.5 was intended to address specifically.
The Comments to the Assembly Floor Analysis to AB 2167 note that the bills sponsor, the Conference of Delegates of California Bar Associations, explained that the bill was designed to address the problem of 'bucket shops or boiler rooms' that engage in securities fraud and that, according to the Conference of Delegates, it specifically targets 'disreputable brokers who victimize consumers by operating illegally; unlicensed persons who sell products such as viaticals, mortgage pools, and pyramid or 'Ponzi' schemes; and persons licensed in a related field, like insurance, who sell securities to their existing clients without obtaining the proper securities licenses. However, except in the case of these unusual securities, where the seller of the security is the principal and falls within the definition of a broker-dealer and an issuer,[xv] most finders do not own the securities they sell they are acting as an agent of the issuer.
Nowhere in the legislative history is the issuer, or any other party other than the unregistered broker/dealer mentioned. It thus appears from this legislative history, and the plain language of the statute, that the statute was intended to provide a rescission remedy in only those few instances where the unregistered broker/dealer acts as a principal.[xvi]
This interpretation is supported by the fact that in other states that have statutes with similar rescission remedies for violation of the broker-dealer registration requirements, the statutes identify very specifically other parties, including the issuer, that are subject to rescission liability.[xvii]
B. Right of Rescission '33 Act Registration/ Blue-Sky Qualification Provisions
Aside from the issue of invalidation of the offer under Section 29(b), another issue is whether the use of unregistered broker/dealers vitiates the issuer's exemption from the registration requirements under the Securities Act of 1933, as amended (the '33 Act) and the analogous state law qualification requirements for the issuer's sale of securities. If so, using an unlicensed broker/dealer will give rise to a statutory right of rescission for such registration/qualification violations.
1. General Solicitation
Most private offerings today are made pursuant to Rule 506 of Regulation D, as state blue-sky laws regulating the sales of securities sold in such offerings are pre-empted. Regulation D under the '33 Act provides a private offering exemption from registration under the '33 Act, provided the issuer does not use means of general solicitation or advertising to find investors.[xviii] In interpreting this requirement, the SEC's staff has stated that the existence of a pre-existing and substantive relationship is important in establishing an absence of general solicitation or advertising because it ensures that, prior to any offer by the issuer or persons acting on its behalf, the offeror can determine that the proposed investor has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the proposed investment.[xix]
If the issuer cannot develop 'pre-existing substantive' relationships with qualified investors, it may seek the assistance of broker/dealers whose business it is to build a customer base of qualified investors, with whom such pre-existing relationships may be attributed to the issuer.[xx]
The SEC, in a series of no-action letters,[xxi] has stated that the issuer, or persons acting on its behalf, must have established a substantive relationship with a potential investor before a private offering is commenced in order to avoid general solicitation. Thus, a selling agent must have, prior to commencement of any private offering, a coterie of qualified investors (either accredited investors or investors meeting the sophistication test of Rule 506(b)(ii)[xxii]). But, with the exception of several matching services and networks, mostly non-profit entities,[xxiii] all of these no- broker/dealers.[xxiv]
Thus, if the issuer is relying on pre-existing relationships with potential investors established by the unregistered broker/dealer, the offering may not satisfy the requirements of Regulation D, giving rise to a federal statutory right of rescission.[xxv] Moreover, a private offering that does not satisfy the requirements of Rule 506 will be subject to state regulation, which similarly precludes general solicitation[xxvi] and may provide for longer statutes of limitation on rescission actions.[xxvii] In addition, many states' limited offering exemption expressly precludes the payment of commissions to persons who are not registered in the state as a broker/dealer.
2. Disclosure Requirements
Finally, if the issuer is deemed to have engaged in a general solicitation and violates the '33 Act registration provision, it can be subject to liability for failure to disclose the contingent liability resulting from the violation. Even if the issuer has not engaged in a general solicitation, the failure of an issuer to disclose that it is using an unregistered person might be considered a
material fact that was required to be disclosed.[xxviii] These questions may at best require embarrassing risk factor disclosures, and at worst cause delays or cancellation of the IPO.[xxix]
IV. Conclusion
Section 25501.5 does not appear to provide a rescission right against the issuer, and while it is relatively rare that an unlicensed broker/dealer sells its own security giving rise to a rescission right to its purchaser, the statute's ambiguity may discourage finders from helping small companies raise capital, and discourage issuers from using finders because of having to disclose that retaining a non‑registered person as a finder may violate California law. Many small companies in Southern California raise equity capital through non-registered broker/dealers and finders, and such companies may now find that their private placement activities may subject them to substantial liability.

These risks and the impediments they pose to early stage capital formation recently have received increased attention by the Bar and small business community. A task force formed by the Business Law Section of the American Bar Association's Committee on Small Business recently recommended that the Securities and Exchange Commission (SEC), National Association of Securities Dealers (NASD) and North American Securities Administrators Association (NASAA) establish a simplified system of registration for unregistered financial intermediaries. See, Report and Recommendations of the Task Force on Private Placement Broker/dealers, ABA Section of Business Law (March 29, 2005) (ABA Task Force Report). Earlier, in 2003, the small business community made the same recommendation to the SEC at the SEC's 22nd Annual SEC Government-Business Forum on Small Business Capital Formation (December 2003).
[ii] 15 of the '34 Act.
[iii] 3(a)(4) of the '34 Act.
[iv] 3(a)(5) of the '34 Act.
[v] 15(c)(6) of the '34 Act.
[vi] lthough a pure finder may 'induce the purchase or sale of' a security within the meaning of 15(a), he is not normally a broker because he effects no transactions. He merely brings buyer and seller together. Louis Loss, Fundamentals of Securities Regulation at 609 (1988) (emphasis added).
[vii] In numerical terms, perhaps more persons rely upon [the finder's] exception than on any other provision in the 1934 Act. It is the small businessman's exclusion and the basis upon which innumerable local consultants perform financial services for friends and associates without complying with the formal registration, record keeping [sic], and other requirements imposed upon brokers by 15 of the 1934 Act. The strict definition of a 'finder' is relatively narrow and would probably exclude, if tested, the majority who claim it as protection. Sheldon M. Jaffe, Broker‑Dealers and Securities Markets: A Guide to the Regulatory Process 2.04, at 21 (1977).

[viii] See, e.g., Richard S. Appel, SEC No-Action Letter, 1983 No-Act. LEXIS 2035 (Jan. 13, 1983); John DiMeno, SEC No-Action Letter, 1978 No-Act. LEXIS 2188 (Oct. 11, 1978).
[ix] For an excellent discussion of the finders' exemption, see "The Finders" Exception from Federal Broker/dealer Registration, by John Polanin, Jr., Catholic University Law Review, Vol. 40, No. 4 (Summer, 1991).
[x] See, Dominion Resources, Inc, SEC No-Action Letter, 2000 No-Act LEXIS 304 (March 7, 2000) (revoking its prior letter, Dominion Resources, Inc., SEC No-Action Letter, 1984 LEXIS 2511 (August 24, 1985)).

[xi] See, e.g., Regional Properties, Inc. v. Financial & Real Estate Consulting Co., 678 F.2d 552, 558 (5th Cir. 1982); Eastside Church of Christ v. National Plan. Inc. 391 F.2d 357 (5th Cir.), cert. denied sub nom. Church of Christ v. National Plan, Inc., 393 U.S. 913 (1968). See generally Samuel H. Gruenbaum & Marc I. Steinberg, Section 29(b) of the Securities Exchange Act of 1934: A Viable Remedy Awakened, 48 Geo. Wash. L. Rev. 1 (1979).
[xii] For example, in the Regional Properties case the court said: The statute does not in terms limit the class of persons who may invoke its contractual voidness provisions to investors. While the law was enacted to protect the public interest and the investor, [n17] its protection extends beyond those who buy securities. ***
Section 29(b) renders certain contracts void. It does not limit that invalidity to contracts between issuers and sellers or to those between issuers and investors. (678 F.2d at 561) (emphasis supplied); see, also, Western Fed. Corp. v. Erickson, 739 F.2d 1439, 1443-44 n.5 (9th Cir. 1984).
[xiii] See, Sheldon M. Jaffe, Broker/dealers and Securities Markets: A Guide to the Regulatory Process 2.05, at 24 (1977) (citing Hayden v. Walston & Co., Inc, 528 F.2d 901 (9th Cir. 1975)).

[xiv] Section 25501.5(b) provides that the court, in its discretion, may award reasonable attorney's fees and costs to a prevailing plaintiff under this section. Moreover, Assembly Bill 2167 stated that it extended the statute of limitations for actions under this section to within 5 years of the violation or within 2 years of the plaintiff's discovery of the violation, whichever comes first. However, Section 25506, which extended the statute of limitations for several other sections, did not include Section25501.5. Assembly Bill 2167 also extended the application of treble damages to an action under Section 25501.5 by amending Section 1029.8 of the Code of Civil Procedure to provide that any unlicensed person who causes injury or damage to another person as a result of performing services for which a license is required under, among other sections, Part 3 of Division 1 of Title 4 of the Corporations Code (Regulation and Notice Filing Requirements of Agents, Broker/dealers, Investment Adviser Representatives and Investment Advisers) shall be liable for treble the amount of damages assessed in a civil action, not to exceed $10,000.

[xv] See, Corporations Code 25010 defining 'issuer.'
[xvi] California's rescission statute (Civil Code 1691) provides that the party asserting rescission must promptly "[r]estore to the other party everything of value which he has received from him under the contract." But here the investor has not received anything from the unlicensed person, since the security purchased was from the issuer, not the unlicensed person.

[xvii] See, Louis Loss and Joel Seligman, Securities Regulation, Civil Liability, 11-B-4, Voidability Provisions (3d, 2001).

[xviii] Rule 502(c) of Regulation D provides in part: "Except as provided in Rule 504(b)(1), neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:
(1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
(2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.

[xix] J. William Hicks, Limited Offering Exemptions: Regulation D, 3.04 (West Group, 2000 2001 Edition).
[xx] See no-action letters in footnote 21, below.
[xxi] Arthur M. Borden (October 6, 1978); E.F. Hutton & Co., Inc. (December 3, 1985); Bateman, Eichler, Hill Richards, Inc. (December 3, 1985); and H. B. Shaine & Co., Inc. (May 1, 1987), in which the staff indicated tacit approval of use of an offeree questionnaire to establish a respondents sophistication and financial suitability.
[xxii] Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) [must have] such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.
[xxiii] Texas Capital Network, Inc. (Feb. 23, 1994); Colorado Capital Alliance, Inc. (May 4, 1995); Angel Capital Electronics Network (Oct. 25, 1996); Lamp Technologies, Inc. (May 29, 1997); Arizona Capital Network, Inc. (April 21, 1998); and IPONET (July 26, 1996), in which the SEC approved a procedure by a registered broker/dealer for private placements to accredited investors over the Internet whereby notice of a private offering in a password protected page of the broker/dealer's IPONET website would be accessible only to IPONET members who have previously qualified as accredited investors, where their solicitation was not linked to any pending or proposed offering and where a period of time has elapsed between member registration and participation in any private offering.

[xxiv] In the SEC Interpretation: Use of Electronic and Internet Offerings, the SEC staff noted that internet private offerings by non-registered finders may pose regulatory concerns. SEC Release Nos. 33-7856, 34-42728 (May 4, 2000) (web site operators need to consider whether the activities that they are undertaking require them to register as broker/dealers.*** In other words, third-party service providers that act as brokers in connection with securities offerings are required to register as broker/dealers, even when the securities are exempt from registration under the Securities Act.). Presumably, the staff's position that registered broker/dealers can better perform this function than non-registered finders is predicated on the greater control of registered brokers, who have been trained to determine suitability of investors, are subject to fiduciary obligations, and are regulated by the NASD and the SEC.
[xxv] See 12(a)(1) of the '33 Act.
[xxvi] For example, California Corporations Code 25102(f).
[xxvii] For example, California's 25506 which provides for a 5‑year statute of limitations on violations of 25501, 25502 and 25504 after January 1, 2005.
[xxviii] The ABA Task Force Report notes that the failure to accurately disclose compensation to an unregistered financial intermediary on Form D will almost certainly be found to be a material non-disclosure, and a fraud claim will lie for that omission. ABA Task Force Report at p. 42.
[xxix] For example, Item 26 of the SEC registration form SB-2, and by cross reference Item 701 of Regulation SB, require disclosure of all securities sold privately by the issuer within the past three years, including the names of the principal underwriters, total underwriting discounts and commissions and the section of the '33 Act or SEC rule under which the issuer claims an exemption from registration. It is here where the issue whether the underwriter or placement agent is a registered broker/dealer is likely to arise. State securities regulators also review Form Ds filed to determine whether commissions have been paid to unlicensed persons.

[Sapphire Capital]

March 28, 1997
Unlicensed Broker Sentenced
By SARAH KERSHAW
An unlicensed Haddonfield commodities broker convicted of stealing nearly $2 million from investors was sentenced in Federal District Court in Camden yesterday to five years in prison, prosecutors said.

From 1990 to mid-1993, the broker, Michael Tropiano, 36, traded on securities and commodity markets on behalf of more than 100 clients, regularly skimming from their investment pool, which grew to as much as $4 million, prosecutors said.

Mr. Tropiano then stopped trading on the markets altogether but, between June 1993 and 1995, continued to send his clients false reports stating their profits.

He supplied clients who wanted to collect their earnings with money he received from new clients. In January, the Securities and Exchange Commission and the Commodity Futures Trading Commission banned Mr. Tropiano forever from commodities trading.