Payment of finders fees has long been a grey area of the law. Because the receipt of a fee or commission on the sale of property is a key element in the definition of a broker, the widespread practice of paying finder’s fees to unlicensed persons has always had a whiff of illegitimacy. In the context of real estate transactions, some courts have made a distinction between a finder and a broker, holding that if a finder merely introduces the two parties to a transaction, and does not participate in the negotiations or structuring of the transaction, then the finder is not a broker and therefore does not need to be licensed.
In the context of securities transactions, the Securities and Exchange Commission (SEC) and the state securities regulators have not always taken consistent positions, and the ability of an unlicensed finder who introduces an investor to receive a commission has not always been clear. In a 1991 no-action letter (Paul Anka, July 24, 1991), the SEC allowed a finders’ exception where the finder only supplies his contact list., or makes an introduction, but does not participate in the negotiations. However, the scope of this position is unclear, where, say, the finder makes a regular business of introducing investors for a fee.
California law was similarly uncertain, in that the definition of a securities “broker” covers any person “engaged in the business of effecting transactions in securities.” Finders have usually taken the position that they do not “effect” transactions in securities if they merely make introductions, but the issue has never been definitively addressed b the courts.
Starting January 1, 2016, California has a new statute which allows the payment of finders fees by businesses raising investment capital. A “finder” is defined as a natural person who, for direct or indirect compensation, introduces or refers one or more accredited investors, as that term is defined in Rule 501(a) of Regulation D under the Securities Act of 1933 , to an issuer or an issuer to one or more accredited investors, solely for the purpose of a potential offer or sale of securities of the issuer in an issuer transaction in California. The statute imposes a number of conditions:
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the finder must be a natural person, not an entity;
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the transaction must be a sale of securities by an issuer of the securities in California;
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the size of the transactions for which the finder is engaged must not exceed a purchase price of $15 million in the aggregate;
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the finder must not: (a) participate in negotiating any of the terms of the transaction, (b) advise any party regarding the value of the securities or the advisability of purchasing or selling in the securities; (c) conduct any due diligence for any party to the transaction; (d) sell any securities that are owned directly or indirectly by the finder; (e) receive possession or custody of any funds in the transaction; (f) participate in the transaction unless it is qualified by permit or exempt from qualification under California law; (g) make any disclosure to any potential purchaser of securities other than: (i) the name, address and contact information of the issuer; (ii) the name, type, price and aggregate amount of the securities offered; (iii) the issuer’s industry, location and years in business.
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the finder must file, in advance of taking any finder’s fees, a statement of information with the finder’s name and address, together with a $300 filing fee, with the California Bureau of Business Oversight, and thereafter file annual renewal statements with a $275 filing fee and representations that the finder has complied with the exemption conditions.
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the finder must obtain a written agreement signed by the finder, the issuer and the person introduced by the finder, disclosing: (a) the type and amount of compensation that has been or will be paid to the finder; (b) that the finder is not providing advice to the issuer or any person introduced to the issuer as to the value of the securities or advisability of purchasing or selling them; (c) whether the finder is also an owner of the securities being sold; (d) any conflict of interest in connection with the finder’s activities; (e) that the parties have the right to pursue any available remedies for breach of the agreement; and (f) a representation by the investor that the investor is an “accredited investor” as defined in SEC Regulation D and consents to the payment of the finder’s fee.
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the finder must preserve copies of the notice, the written agreement and all other records relating to the transactions for a period of five years.
While the statute does not apply to Federal law, it still should bring considerable clarity to the area, as the SEC is unlikely to take action where a transaction takes place in California and is governed by the statute.