Private Placement Brokers Await Attention by SEC

As previously noted in this firm’s sister blog (see “Private Placement Brokers Should be Legalized along with M&A Brokers” in the RIA Compliance Blog, Jan. 21, 2015), there has long been a large gray market of unregistered private placement brokers. Also see “Report and Recommendations of the Task Force on Private Placement Broker-Dealers” (American Bar Association Business Law Task Force, 2005). This cadre, often calling themselves “finders,” have continued to operate in plain sight, with little response from the SEC other than the issuance of a few inconsistent no-action letters and an occasional enforcement action against such brokers whose conduct was egregious in other ways.

The SEC’s Advisory Committee on Small and Emerging Companies (the “Committee”) has twice weighed-in on this subject urging SEC action.

The Committee first reported on this subject September 23, 2015, noting that:

• Small businesses account for the creation of two thirds of all new jobs;
• Early stage capital for these small businesses is raised principally through Regulation D private placements;
• Only 13% of Regulation D placements are conducted by registered broker/dealers. Many of the remaining 87% of placements involve unregistered and unregulated intermediaries;
• The failure to address the regulatory issues surrounding unregistered private placement intermediaries impedes capital formation for smaller companies (This author hastens to note that it also leaves a wide open and unguarded door for both investors and issuers to be defrauded and otherwise abused. This market is populated by more than a few disbarred lawyers and former securities professionals who have been barred from the industry).

On May 15, 2017, the Committee again addressed this subject noting:

• Identifying potential investors is one of the most difficult challenges for small businesses trying to raise capital (We observe here that structuring an investment opportunity that is a win-win for both an investor and the company and assembling a legal and persuasive deal book to describe the potential investment is a closely-related challenge that requires both a skillful securities and corporate attorney and an experienced financial intermediary);
• There is significant uncertainty as to when a finder or other financial intermediary is required to be registered as a broker/dealer (We further observe that making a wrong decision on this issue can have a disastrous impact, not only on the intermediary, but also on the issuer and the investors);
• The Committee then proceeds to express its disappointment at the failure of the SEC to address this issue, and recommends that the SEC adopt rules in the near future to legalize, rationalize and clarify this gray market.

The fact that this market continues to exist despite its perils to all participants speaks volumes as to how desperately it is needed. The SEC in all of its wisdom and with all of its experience can surely develop a regulatory regime for private placement brokers that brings order and lawfulness to this gray market. The burdens of complying with this regulatory system must be scaled to the size of the offering, of the issuer and of the intermediaries that inhabit this market.

FINRA’s new Capital Acquisition Broker Rules (see “SEC Approves FINRA’s Capital Acquisition Broker Rules” in the RIA Compliance Blog, Nov. 7, 2016) fall far short of meeting this need. Most notably they severely limit the potential investors that may be sought by a Capital Acquisition Broker to Qualified Purchasers (not Accredited Investors). However there are few if any Qualified Purchasers who are interested in investing their time or money in such small investments as are needed by many small businesses seeking capital.

One of the SEC’s primary missions is to promote capital formation. If small businesses could access this market with confidence, this country could experience significant growth in jobs, innovation and overall economic activity and prosperity. With a new Chair and a potentially two other new Commissioners, and with the SEC’s new focus on enhancing capital formation, now is the time to address the legalization and regulation of private placement brokers.

Parker MacIntyre provides legal and compliance services to securities issuers, including small businesses, investment advisers, broker-dealers, registered representatives and hedge funds, among others. Our capital formation practice group assists businesses with the complex issues that arise in the course of raising capital for at various stages of their formation, operation and growth, including compliance with federal and state laws and rules. Please visit our website for more information.

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