May 9, 2024
Finders’ Fees: Not Just the Broker’s Problem
Issuers of securities in private offerings are sometimes inclined to downplay the risk of paying fees to unlicensed “finders” in connection with those deals, because they view the failure to appropriately register as a broker-dealer under federal or state law as being the finder’s problem. That’s not the case, and this Dorsey blog provides a reminder of the potentially calamitous consequences to the issuer associated with paying an unlicensed finder:
The Securities and Exchange Commission (SEC) has taken the position that a person receiving a finder’s fee with respect to a purchase of securities by a U.S. investor will, in many cases, be treated as having acted as a “broker” within the meaning of federal securities laws.[1] In those cases, the unregistered finder has violated the federal securities laws. Similarly, the issuer may have violated the federal securities laws (under an agency theory, or otherwise) by having paid such fee. In many states, state regulators take similar positions under applicable state law.
The filing of post-closing notices of sale with the SEC and the states disclosing such a fee may result in federal and state regulatory enforcement actions to seek injunctions, monetary penalties or criminal sanctions against the issuer and/or finder. Perhaps more importantly, the payment of the fee may provide the relevant investor(s) with a right to rescind their investment, and create uncertainty about whether and the extent to which such rights should be reflected in the issuer’s financial statements. Such disclosures may adversely affect the issuer’s ability to raise funds, and may further increase the risk of such a rescission claim or regulatory enforcement action.
The blog goes on to recount the story of a company that paid finders fees to unlicensed brokers in a series of offerings. After the SEC came knocking, the uncertainties concerning recission rights led the company’s auditors to withhold their opinion on its financial statements, which precluded it from obtaining further financing and ultimately led to its bankruptcy. Yikes!
– John Jenkins