Several recent enforcement actions from the U.S. Securities and Exchange Commission (SEC or Commission) reaffirm that “finders” involved in soliciting investors on behalf of private companies are, in the SEC’s view, required to register and be regulated as brokers. The actions reinforce, in particular, that the SEC views transaction-based compensation—compensation tied to the size or success of a securities transaction—as a hallmark of broker-dealer status that triggers a broker-dealer registration requirement.
Hallmarks of Broker Status
The recent actions involve settlements imposing penalties for alleged unregistered broker-dealer activity with respect to investments in private companies.1 The firms and individuals involved engaged in a range of broker-dealer activities, many of which at their core involved sales—among others, actively identifying and soliciting investors, providing investors with marketing materials, and connecting investors with companies that were raising financing. This is consistent with the SEC’s historical approach, which has emphasized that engaging in activities designed to induce or facilitate securities transactions—such as soliciting investors, negotiating deals, or promoting investment opportunities—is fundamentally broker behavior that should be regulated, in part to protect potential investors.2
The recent actions also reinforce the view of the staff of the SEC (Staff) that any type of transaction-based compensation triggers a broker-dealer registration requirement. Each settlement order calls out transaction-based compensation as a key element of the violations involved.
Prior to 2000, the SEC had recognized an exemption from broker registration for “finders” whose activities were limited to providing services matching investors with investment opportunities, even if they received transaction-based compensation.3 In 2000, however, key precedent outlining the terms of the exemption was rescinded,4 and in 2010, the Staff stated clearly that “receipt of transaction-based compensation in connection with [finders’] activities is a hallmark of broker-dealer activity.”5 The Staff’s view is that this form of compensation creates a “salesman’s stake” in a transaction—that is, it incentivizes the “finder” to promote securities transactions that may not be in the best interest of the investor or seller and can encourage aggressive, fraudulent, or misleading sales tactics. These are risks that, in the Staff’s view, broker regulation is designed to prevent.
Importantly, in the recent orders, the SEC also took an expansive view of what transaction-based compensation can involve: In one case, that compensation took the form of “heavily discounted shares” of a company’s stock rather than cash payments or even a grant of the stock. In other words, the SEC looks broadly at whether compensation create a “salesman’s stake,” regardless of the form of payment involved.
Additional Takeaways
The recent orders involve a few additional interesting features. First, at least one involved an allegedly unregistered broker who was at the time employed by a registered investment adviser.6 The order asserts that the alleged broker activity occurred outside his employment with the adviser, in part because the finder was paid transaction-based compensation and the adviser did not receive a management fee based on the investments.
In addition, it is notable that in one instance, the SEC alleged that a finder not only acted as an unregistered broker himself, but also aided and abetted and caused the unregistered broker activity of two other individuals he had solicited to invest, through his involvement in their solicitation of additional investors. These individuals also received transaction-based compensation.
It is also interesting that not all the orders alleged fraud against the unregistered broker. Although this is not unheard of, it is more typical for actions involving allegations of unregistered broker activity to also implicate fraudulent activity.
Finally, the orders, which were issued during the prior presidential administration, seem to suggest that the SEC was not on track to approve a proposed exemptive order that would create a safe harbor from broker registration for finders performing certain limited services under specified conditions.7 As of the date of this alert, the proposed order has not been formally adopted, and the enforcement orders discussed above could suggest it may not be adopted anytime soon. It is possible, however, that the current SEC will reconsider adopting the proposal under the new administration.
[1] PMAC Consulting, LLC, Exchange Act Release No. 102230 (Jan. 17, 2025); Tamir Shabat, Exchange Act Release No.102174 (Jan. 14, 2025); Danny Z. Spiegel, Exchange Act Release No. 102175 (Jan. 14, 2025); Joseph J. Orlando Jr., Exchange Act Release No. 102176 (Jan. 14, 2025). The investments involved both direct investments in private companies and indirect investments in them through pass-through fund structures. As background, Section 15(a) of the Securities Exchange Act of 1934 generally requires a person who meets the definition of a broker or dealer to register with the SEC. Broker entities must also become members of the Financial Industry Regulatory Authority (FINRA); individuals must be supervised by a FINRA member as registered representatives.
[2] See, e.g. BondGlobe, Inc., SEC Staff No-Action Letter (Feb. 6, 2001), quoting from Massachusetts Financial Servs., Inc. v. Securities Investor Protection Corp., 411 F. Supp. 411, 415 (D. Mass. 1976), aff'd, 545 F.2d 754 (1st Cir. 1976), cert. denied, 431 U.S. 904 (1977). The consequences of engaging in unregistered broker-dealer activity can be severe. If an illegal broker-dealer is involved in a securities transaction, the Exchange Act allows for rescission of the transactions in which the broker was involved, essentially giving investors a “put” right. In addition, the SEC may impose civil money penalties, disgorgement of all ill-gotten gains (including commissions and fees earned), and prejudgment interest payments—forcing violators to return all profits made from the illegal activity with added interest. Individuals and firms involved in unregistered broker-dealer activity may also face industry suspensions, censure, and lifetime bans from participating in the securities industry. Although these ramifications primarily fall on the unregistered broker, it is possible for a company paying a finder to be held responsible for aiding and abetting or causing the violation.
[3] Dominion Resources, Inc., SEC Staff No-Action Letter (July 23, 1985).
[4] Revocation of Prior No-Action Relief Granted to Dominion Resources, Inc., Staff of the SEC Division of Market Regulation (March 7, 2000).
[5] Brumberg, Mackey & Wall, SEC Staff Denial of No-Action Request (May 17, 2010).
[6] In a related action, the adviser settled with the SEC based on alleged violations of its fiduciary duties because it disclaimed responsibility for providing investment advice, among other things. VCP Financial LLC, Investment Advisers Act Release No. 6819 (Jan. 14, 2025).
[7] For more information, please see our alert here.
