The SEC’s Capital Raiser Proposal in Plain English

By Amy Wan, Esq and Ryan Blum

I regularly get calls from potential clients asking how they can legally raise money for others. It always goes something like this:

Me: Easy, you can 1) get a broker-dealer license or 2) form a fund-of-funds. [Explains each]
Potential Client (PC): That sounds hard and expensive. Can I just be part of the GP?
Me: Are you truly a part of the sponsor group? Are you two willing to get married and do deals together all the time and not raise for others?
PC: [silence] no… can I charge a finder’s fee?
Me: Sure! [explains parameters and that you can’t charge transaction-based compensation or a success fee and that the SEC has whittled away the finders fee exemption via case law to render it so narrow as to be useless]
PC: [silence] So… how am I supposed to make money.
Me: That’s very hard.

If you’ve read my previous blog posts about capital raisers, you already know how I view the underground capital raiser industry. And you’ve probably heard that SEC subpoenas are flying around.

Yesterday, the SEC published a proposal to open a new avenue for capital raisers that will be interesting to the real estate syndication industry. Before I dive in, keep in mind that this is a proposal and thus not yet effective. The public has 30 days to send letters for comment, suggestions, changes for the SEC’s review.

First, here’s what you’ll want read:

• Press release with summary 
• Easy to understand chart (pdf)
• Proposal text
• Video explaining the proposal

Proposal Summary in Plain English

The following proposal summary is written in plain English for lay people and is not meant to be precise. If you want the legalese version, please scroll down.

If the proposal is adopted, capital raisers who are people, not companies, can help raise capital in a limited way from accredited investors (but no non-accredited investors).

There would be two types of capital raisers: Tier I Finders and Tier II Finders. Those who follow the rules would not need a broker-dealer license and would be able to earn transaction-based compensation (or ‘success fees’) when connecting sponsors with investors.

Tier I Finders would be more limited in their activities than Tier II Finders, and consequently have to satisfy fewer requirements. Tier II Finders can do more, but must meet additional requirements.

Capital raisers (regardless of tier) would need to meet the following requirements:

• sponsor is a private, nonreporting company;
• the issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration such as Reg D, Rule 506b. Capital raisers cannot raise under the proposal for Regulation A, Regulation A+, Regulation CF, or Regulation D Rule 506(c) offerings;
• Capital raiser doesn’t publicly advertise (or generally solicit);
• The capital raiser must reasonably believe the potential investor is an accredited investor;
• The capital raiser has a written contract with the sponsor that includes a description of the services provided and associated compensation;
• the Finder is not an associated person of a broker dealer; and
• the Finder is not subject to statutory disqualification at the time.

Tier I Finders

Tier 1 Finders are limited to providing contact information of potential investors with only one capital raising transaction by a single sponsor within a 12-month period. The Tier I Finder may not have any contact with the potential investors about the issuer. The contact information the Finder may provide may include, among other things, name, phone number, email address, and social media information.

Tier II Finders

Tier II Finders must meet the general conditions above, and may engage in solicitation-related activities that are limited to:

1. identifying, screening, and contacting potential investors;
2. distributing issuer offering materials to investors;
3. discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice about the valuation or advisability of the investment; and
4. arranging or participating in meetings with the issuer and investor.

The Tier II Finder would need to provide a potential investor, prior to or at the time of the solicitation, disclosures that include:

1. the name of the Tier II Finder:
2. the name of the issuer or sponsor;
3. the description of the relationship between the Tier II Finder and the issuer, including any affiliation;
4. a statement that the Tier II Finder will be compensated for his or her solicitation activities by the issuer and a description of such compensation arrangement;
5. any material conflict of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and
6. an affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest.

This disclosure can be provided orally so long as written disclosure will follow soon after and before the investment in the issuer’s securities. The Tier II Finder must also obtain an acknowledgement, either on paper or electronically, from the investor that the investor has received the necessary disclosure.

If you’d like to comment, here’s a video on how.

Additionally, if you’d like help drafting the comment letter, you can contact our firm. As someone who used to sit on the other side and actually had to read public comment letters during the rule-making process, we have unique insight as to how the process works.

Proposal Summary in Legalese

If adopted, the proposal will grant Finders an exemption from the broker deal registration requirements of Section 15(a) of the Exchange Act by allowing natural persons to engage in certain limited capital raising activities involving accredited investors, subject to certain conditions. It is important to recognize that the proposal does not bring entity-Finders under the exemption.

The proposed exemption creates two classes of Finders: Tier I Finders and Tier II Finders. Those who tailor their activities to align with the general conditions that apply to the exemption as a whole as well as the individual requirements of one of the two Tiers can avoid registering as a registered representative of a broker dealer and still receive transaction-based compensation when connecting issuers with investors. Generally, Tier I Finders can engage in more limited activities than Tier II Finders, and consequently have to satisfy less requirements to be exempt from registration. In contrast, Tier II Finders may conduct more activities but are obligated to meet additional requirements.

Regardless of whether a Finder seeks exemption from registration as a Tier I Finder or Tier II Finder, the exemption is only available where the following conditions are present:

• the issuer is not required to file reports under Section 13 or Section 15(d) of the Exchange Act (issuer is a private, nonreporting company);
• the issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act (note that since Regulation A and Regulation A+ offerings permit some general solicitation and Regulation CF offerings require participation of a registered crowd funding portal, offerings under either of these exemptions are not eligible under this exemptive order);
• the Finder does not engage in general solicitation (note that this means a Finder cannot participate in a Rule 506(c) offering since that would involve general solicitation);
• the potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the Finder has a reasonable belief that the potential investor is an “accredited investor”;
• the Finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation (this condition is similar to that of the “third-party solicitor” under the Investment Advisers Act of 1940);
• the Finder is not an associated person of a broker dealer; and
• the Finder is not subject to statutory disqualification, as that term is defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation.

Tier I Finders

Under the exemption proposal, a “Tier I Finder” is a Finder who satisfies the above conditions, and whose activity is limited to providing contact information of potential investors with only one capital raising transaction by a single issuer within a 12-month period. The Tier I Finder may not have any contact with the potential investors about the issuer. The contact information the Finder may provide to the issuer may include, among other things, name, phone number, email address, and social media information. A Tier I finder who satisfies all of the exemption’s conditions may receive transaction-based compensation for their services without being required to register as a broker dealer.

Tier II Finders

The exemption proposal further provides that a “Tier II Finder” is permitted to engage in additional solicitation-related activities beyond those allowed for Tier I Finders if certain additional requirements are met. Under the proposal, Tier II Finders are Finders who, in addition to meeting the general conditions above, engage in solicitation-related activities for an issuer that are limited to:

1. identifying, screening, and contacting potential investors;
2. distributing issuer offering materials to investors;
3. discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice about the valuation or advisability of the investment; and
4. arranging or participating in meetings with the issuer and investor.

To become a Tier II Finder, the Finder’s additional obligations concern her written disclosure obligations. The Tier II Finder would need to provide a potential investor, prior to or at the time of the solicitation, disclosures that include:

1. the name of the Tier II Finder:
2. the name of the issuer;
3. the description of the relationship between the Tier II Finder and the issuer, including any affiliation;
4. a statement that the Tier II Finder will be compensated for his or her solicitation activities by the issuer and a description of such compensation arrangement;
5. any material conflict of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and
6. an affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest.

This disclosure can be provided orally so long as written disclosure will follow soon after and before the investment in the issuer’s securities. The Tier II Finder must also obtain an acknowledgement, either on paper or electronically, from the investor that the investor has received the necessary disclosure.