Views on improving the integrity of global capital markets
03 December 2020

SEC’s Proposed Exemption for Finders Would Short-Change Investor Protection and Market Transparency

CFA Institute opposes the SEC’s recent proposal to exempt finders from the requirement to register as brokers and be subject to broker rules. Finders are financial intermediaries who use their contacts to help entrepreneurs and small businesses find investors. Our comment letter focuses on investor protection and market transparency.

The introduction to the SEC release begins, “The Commission’s mission includes facilitating capital formation — not only for public companies, but also for the small businesses that are active participants in our private markets.”  Absent is any affirmation of the Commission’s mission to protect investors. The proposal, like its introductory sentence, places excessive weight on the goal of facilitating transactions in private markets, at the expense of investor protection and market transparency.

Finders with the right contacts among investors can play useful roles in bridging funding gaps. Unfortunately, however, the world of finders also has a dark side of fraudsters, market manipulators, and bad actors. The proposed exemption, however, fails to address or even acknowledge these problematic practices.  Instead, by removing finders from the sunlight of registration, the exemption would likely exacerbate them. In addition, the exemption would apply only to finders in private markets, which have higher risks of fraud and adverse selection and lack the robust investor protections of public markets.

Broker registration invokes a comprehensive set of broker rules and regulations governing recordkeeping, sales practices, and other aspects of broker conduct. The proposed exemption from broker regulation would place finders in the regulatory shadows, outside the set of broker rules and the reach of SEC and Financial Industry Regulatory Authority (FINRA) compliance exams.

The proposal would create two new classes of finders, Tiers I and II. Both tiers would be allowed to receive transaction-based pay, which gives rise to conflicts of interests.

Tier I Finders would be prohibited from contacting potential investors directly. Instead, these finders could provide contact information of potential investors to the businesses seeking capital. We wonder how effective that would be. How, for example, would potential investors react to cold calls based on a referral from a finder, when the finders themselves could not speak to the investor to confirm their role?

We focused our objections on the exemption for Tier II Finders, however, because they would be allowed to engage in a wide range of solicitation activities on behalf of private issuers. They could contact accredited investors, arrange meetings with the company seeking funding, and attend those meetings.

To address investor protection concerns, the proposal sets out a series of conditions that finders would have to comply with to rely on the exemption. For example, the proposed exemption would prohibit Tier II Finders from “providing advice as to the valuation or advisability of the investment.” That seems to elevate form over substance. The finder’s presence alone — in a meeting in which the small business pitches its investment to the potential investors — would amount to an implicit but potent recommendation. Would a wink and a nod count as advice?

Another condition would require Tier II Finders to provide potential investors with a written disclosure saying, among other things, that the finder was not undertaking a role to act in the investor’s best interest. A buyer-beware statement is certainly better than no disclosure, but this is a far cry from Regulation Best Interest, which requires brokers not to place their own interests ahead of their customers.

We objected not just to the substance of this proposal but also to its form. For a proposal as far-reaching as this, the SEC should have issued a rule proposal instead of the proposed exemptive order. Rule proposals, unlike exemptive orders, must include an economic analysis. That would have subjected the proposals’ unsubstantiated claims to economic analysis, and it would have assessed the potential competitive impact of exempt finders on smaller brokers who do register. A rule proposal also would have doubled the comment period, which the exemptive proposal limited to a rushed 30 days.

As an alternative, we suggest that the SEC work with state regulators and others to design a streamlined but appropriate set of rules for finders. It may well make sense to adopt a “Broker Lite” set of rules for finders. But exempting them from the rules, and from SEC and FINRA compliance exams, is not in the interests of investor protection or market transparency.


Photo Credit @ Getty Images / boonchai wedmakawand

About the Author(s)
Stephen Deane, CFA

Stephen Deane, CFA, is Senior Director, Legislative and Regulatory Outreach, at CFA Institute. He joined CFA Institute after more than nine years at the US Securities and Exchange Commission (SEC), where he was the first staff employee in the Office of the Investor Advocate. He helped build out the office and served as principal liaison to the Investor Advisory Committee. He previously worked at Institutional Shareholders Service (ISS) and in international development. He speaks fluent Russian and has a master’s degree in Russian studies from Harvard University.

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