• Steve Muehler

Common Myths about Finders, Solicitors, Unregistered Broker-Dealers, and the “Issuer Exemption”

In the financial services industry, whenever money changes hands, everyone involved in the process wants to get paid. Investors understand that registered investment advisers and broker-dealers are compensated for their role in a transaction, whether by receiving an advisory fee based on assets under management or a commission based on the sale price of the security. However, some capital raising activities in the private fund space do not fit neatly into one of these boxes, instead, falling into a murky regulatory area of finders, solicitors, issuer marketing efforts, and unregistered brokerage activity.

In 2013, former SEC Chief Counsel David W. Blass spoke to the American Bar Associations’ Trading and Markets subcommittee and warned many newly registered private fund advisers that the SEC might start going after them for failure to register as broker-dealers based on their receipt of transaction- based compensation. He had a point; Section 3(a)(4)(A) of the Securities Exchange Act of 1934 (the “Exchange Act”) generally defines a "broker" broadly as any person engaged in the business of effecting transactions in securities for the account of others.

Blass mentioned two areas where private fund managers should be careful. First, he discussed situations where advisory personnel and unaffiliated solicitors were marketing private fund interests to investors and receiving compensation based on their success. Second, he talked about advisers or their affiliates receiving fees for “investment banking activity”, such as negotiating the acquisition or disposition of a portfolio company. In the second situation, Blass made it clear that, in his view, as long as the investment banking fees were offset against the advisory fee, the SEC would not require broker- dealer registration. Further analysis of this position is beyond the scope of this article. Instead, this article focuses on whether private fund managers should register as broker-dealers when selling interests in their funds.

Blass outlined factors that “might require private fund adviser personnel to register as a broker-dealer”:

Does the employee engage in marketing the interests of the private fund to investors?

Does the employee solicit or negotiate securities transactions?

Does the employee handle customer funds and securities?

Does the employee receive compensation related to the outcome or size of the transaction?

The SEC views a “yes” answer to any of these questions as an indication that registration may be required, although the Staff weighs the receipt of transaction-based compensation most heavily.

To understand when broker-dealer registration is required, let’s explore a few commonly-asked questions from private fund advisers.

I’m selling interests in a private fund, so I don’t need to be registered.


Selling an interest in a private fund and receiving transaction-based compensation (i.e., a commission) can still require registration. The definition of “broker” under the Exchange Act is broad and includes effecting transactions in securities for the account of others. There is no distinction between registered and unregistered securities. Just because the security itself is not registered with the SEC, that does not mean you are off the hook.

I work for the private fund manager, so I can rely on the Issuer Exemption to get paid a bonus for bringing in investors without having to register.


Under the “Issuer Exemption”, a/k/a the Rule 3a4-1 safe harbor under the Exchange Act, an “associated person” of an issuer (including a private fund) is not considered to be a broker solely by reason of his or her participation in the sale of the securities of the issuer, if the associated person is not compensated based directly or indirectly on transactions in securities. Receipt of bonuses by associated persons that are directly tied to raising assets or bringing in investors would likely be deemed transaction-based compensation.

There are, however, three conditions for relying on this non-exclusive safe harbor that the firm must meet.

First, an associated person of the issuer, including a partner, officer, or employee of the fund or an affiliated person of the fund, can rely on the exemption only once in a twelve-month period. Hedge funds with continuous offerings cannot meet this condition.

Second, the associated person can only offer the securities to banks, broker-dealers, registered investment companies (mutual funds), or insurance companies.

Third, the associated person’s real job at the issuer must include “substantial duties” that are not related to fund sales. Investor relations personnel could potentially meet this condition if their job functions include activities other than marketing, such as providing client service, communicating with investors, and responding to inquiries from current and prospective clients.

The third condition of the safe harbor is that associated persons can only engage in passive sales activities, such as preparing written communications to be sent to potential investors, provided that the content is approved by a partner, officer, or director of the issuer. The associated person can respond to questions from potential investors, but the responses must be limited to information from the private placement memorandum or other offering document. Even if relying on any of the conditions above, the associated person cannot receive a commission or be compensated (directly or indirectly) based on the transaction. The safe harbor also requires that associated persons cannot be disqualified from a self- regulatory organization (like FINRA) or associated with a broker-dealer.

Because of these limitations, not all fund managers take advantage of Rule 3a-4. For those that do, their internal marketing and investor relations personnel also engage in other activities and do not generally solicit investors for their private funds, nor are they compensated for bringing in new investors or increasing the investments of existing investors. Whether the issuer relies on the safe harbor or not, transaction-based compensation will always be viewed by the SEC as broker compensation. Therefore, an issuer should carefully review employment agreements and compensation arrangements of its marketing and/or investor relations personnel to ensure that the firm is not paying transaction-based compensation to avoid an SEC finding that it is acting as an unregistered broker.

That said, Rule 3a-4 is a safe harbor, which means that it is not the only way for an issuer to sell interests in a private fund without being registered as a broker-dealer. Private fund managers that engage in fund-raising activities without paying transaction-based compensation and do not use dedicated sales personnel have a better chance of avoiding being labeled as an unregistered broker-dealer.

The SEC won’t care if I pay existing investors in one of my funds a fee for passing along the names of their rich friends that might be interested in our newest fund, right?


The SEC will care. The Exchange Act defines a broker as “any person engaged in the business of effecting transactions in securities for the accounts of others.” And it’s illegal under Section 15(a)(1) of the Exchange Act to induce, or attempt to induce, the purchase or sale of security unless you are registered with the SEC as a broker. There is no statutory exemption establishing a “finder’s exemption.” Additionally, it’s not just a problem for the person receiving the fee. The person paying the fee could be considered “aiding and abetting” under Section 21 of the Exchange Act and for directly causing violations of Section 15(a), as Ranieri Partners LLC (discussed below) learned in 2013. As a practical matter, this means that a fund manager that pays an unregistered person for introducing potential investors is taking a risk.

What about the “Finder’s Exemption?”

I wouldn’t count on it.

Way back in 1991, the SEC issued the Paul Anka No-Action letter (SEC No-Action Letter (July 24, 1991)) (yes, the Paul Anka who sang “Put Your Head on My Shoulder”), which allowed Mr. Anka to introduce prospective investors and receive a transaction-based fee without having to register as a broker under the Exchange Act. In that case, Mr. Anka arranged to provide the Ottawa Senators hockey team a list of prospective investors. The hockey club would then contact the investors to gauge their interest. Anka would have no role in negotiations or any further contact with the investors. The club would then pay Anka a commission for any investment resulting from the names provided to the club.

In recent years, however, the SEC has walked back from this position, effectively shutting the door on finders. For example, in 2010, the SEC denied a no-action request from a law firm that wanted to introduce investors to an operating company that was trying to raise capital in exchange for transaction- based fees. The Staff was unpersuaded by the argument that the law firm would only be making introductions and focused on the compensation. The Staff found that “receipt of compensation directly tied to successful investments” in the company required broker-dealer registration.

Many actions brought by the SEC against firms and individuals for acting as unregistered broker-dealers involve other serious violations of the securities laws, including fraud. However, the SEC has nailed a few firms for someone acting as a broker for a private fund without being registered. In the Ranieri Partners and Stephens cases, William Stephens (“Stephens”) was hired as an independent consultant for Ranieri Partners, a holding company controlling a registered investment adviser that managed two private funds, (the “Funds”). Donald Phillips, senior managing partner at Ranieri Partners, hired Stephens to find investors for the funds, despite knowing that Stephens had been barred from the industry six years before. Phillips was responsible for supervising Stephens’ activities and told Stephens that his job was limited to setting up meetings of potential investors with the firm’s principals.

Of course, Stephens got access to private placement memoranda (“PPMs”), subscription agreements, fund marketing materials, and started wining and dining potential investors. He sent out PPMs, discussed specifics with potential investors, and raised more than $500 million in capital. Stephens received transaction-based compensation of approximately $2.4 million. Although Stephens’ agreement with Ranieri Partners prohibited him from doing anything more than make introductions, Phillips, who was responsible for supervising him, never stopped Stephens from taking on this greater role and even approved all his expenses.

The SEC entered into settlements with Ranieri Partners, Stephens, and Phillips. Stephens was, once again, barred from the securities industry and ordered to pay nearly $3 million in disgorgement and prejudgment interest (although the payment was waived because of Stephens’ financial condition). Ranieri Partners had to pay $375,000. In addition, Phillips was found personally liable for “aiding and abetting” Stephens’ violations of Section 15(a) of the Exchange Act. He was banned from the industry for nine months and required to pay a penalty of $75,000.

More recently, the SEC provided no-action relief from broker-dealer registration in the M&A Brokers No-Action Letter. The Division of Trading and Markets allowed transaction-based compensation to be paid without requiring broker-dealer registration in situations where finders help identify potential buyers for privately held companies. This relief is limited to situations where the buyer intends to actively operate the acquired business. Additionally, finders in this situation cannot have the ability to bind a party to the transaction and cannot have custody, control, or possession of funds or securities related to the M&A transaction fee.

Can I have my marketing employees become registered representatives of a broker- dealer?

That’s possible, but it may not be the best solution.

A private fund adviser could find a broker-dealer that might be willing to assist in its marketing efforts and agree to take on sales staff from the adviser as registered representatives. Keep in mind, however, that the brokerage firm that takes on these registered representatives is required to supervise them, even if they are not on-site. The brokerage firm is also required to keep records of all e-mails sent by the sales staff in their capacity as registered representatives. The brokerage firm may require that the sales staff have an email address on the brokerage firm’s system to ensure that their activity can be reviewed and monitored. Similarly, the private fund firm might want to require that the sales staff also have an email address on its system for advisory business to keep the records separate. Frankly, this sounds like a supervision disaster.

What are my options?

Private fund managers have choices. If they want to hire people to find investors, then those employees must have additional job responsibilities aside from actively marketing private funds. Private fund managers can also consider either registering the firm as a broker-dealer, buying an existing brokerage firm, or hiring a placement agent to help sell fund interests. Broker-dealer registration is an extended, expensive, and complicated process, subjecting the registrant to stringent regulations and FINRA oversight. For firms that prefer to focus on the investment process, hiring a placement agent or agents might be the way to go.

For firms that prefer to stay out of the brokerage arena, here are some tips.

The “Don’t” List

Do not pay employees (or independent contractors) compensation based on a percentage of the amount invested by investors as a result of their efforts. Paying a flat fee every time a new investor is accepted based on the marketer’s efforts can also lead to trouble.

Do not do indirectly what you cannot do directly. Paying a bonus to an employee based on the amount of assets raised can be viewed as transaction-based compensation, even if that is only one factor in the bonus calculation. The same goes for compensation in the form of equity, including phantom stock. As long as the employee receives compensation that can be tied, however tenuously, to the amount of funds brought in, the SEC will view this as a commission and require broker-dealer registration.

Do not hire employees for the sole purpose of marketing fund interests to new investors. Even if the employee receives a salary instead of commissions, this person could still be found to be a broker since he or she is “engaged in the business of effecting transactions in securities.”

Do not allow employees or independent contractors for the fund to provide advice on potential investments in the fund.

The “Do” list

Do ensure that employees providing investor relations support have other non-marketing duties. These duties could include preparing written communications to and responding to questions from potential investors, assisting with RFPs, and coordinating communications with clients and investors.

Do pay employees or independent contractors involved in an offering by a private fund a salary or an agreed-upon fee that is not contingent on their success in raising capital. Similarly, any bonuses awarded should be unrelated to the amount of capital raised. A general rule of thumb is that marketing and/or investor relations personnel should be compensated with the same salary and bonus structure as the rest of the employees at the firm.

If bonuses are discretionary and vary among employees, do ensure there is backup documentation as to how the bonus was calculated and decided for each employee. Any indication that a bonus calculation included an increase in firm assets for just the marketing employee would likely be viewed as transaction-based compensation unless all employee bonus calculations included the increase in assets as a factor.

Who is going to find out anyway?

To rely on exemptions from registration available under the Securities Act of 1933, private funds must file Form D with the SEC. This form requires disclosure of any sales commissions and finders fees in connection with financings (See Items 12 and 15 on SEC Form D, "Sales Compensation” and “Sales Commissions and Finders' Fees Expenses".) The form also requires disclosure of the CRD number of the recipient of sales compensation, which is a number assigned by FINRA’s Central Registration Depository to registered representatives of broker-dealers. Failing to file the Form D can result in an SEC administrative action against the firm. Sanctions can include not being able to rely on Regulation D in the future. In a worst-case scenario, an issuer that willfully fails to file Form D can be found guilty of a felony.

The SEC is not the only regulator to worry about. Many states also require Form D filings when state residents purchase an issuer’s securities (unless there is an exemption available). State securities administrators can issue fines and prevent an issuer from engaging in future private placements in that state.

What the Worst That Can Happen?

There are many bad consequences for failing to register as a broker-dealer or using the services of an unregistered broker.

Negative publicity impacts the firm’s and unregistered marketer’s reputation.

Rescission: Section 29(b) of the Securities Exchange Act of 1934 provides that any contract made in violation of any provision of the Exchange Act is voidable at the option of the investor. A successful claim by an investor would require the return of funds by the issuer and

rescission of the purchase contract. Additionally, any purchaser in the transaction has the right of recission, not just those solicited by unregistered brokers.

“Aiding and Abetting” Liability: Section 20(e) of the Exchange Act grants the SEC authority to take action against any person who aids and abets violation of federal securities laws. Those parties who are found to have aided and abetted any such violation are themselves considered to have committed the underlying offense. This can lead to civil penalties and disgorgement of profits and commissions.

“Bad Actor” Triggering Event: If the SEC finds an individual guilty of, or reaches a settlement based on, a violation of the registration rule, that individual will be considered a “bad actor” under Rule 506 of Regulation D. Bad actors can no longer participate in Regulation D offerings.

Barred from Future Offerings and the Industry: Violating the broker-dealer registration rules can also result in disciplinary action by the SEC and state securities authorities against the firm and its individuals. Sanctions include cease and desist orders, fines and penalties, and bars against future participation in the securities industry. Firms and individuals can also be barred from using Regulation D exemptions from registration in the future.

Ongoing disclosure: If the outcome of using an unregistered broker includes a settlement with the SEC, this will need to be disclosed on Form ADV Part 2A and Form CRS. Individuals may also be required to include disclosures on Form ADV Part 2B.

Regulator Pile On. Once one regulator goes after a firm or individual, others may also join in.

Additional Online Resources:

About Steve Muehler Portfolio of Companies (Steve Muehler Holdings, LLC):

Steve Muehler – Paralegal:

Steve Muehler – Investment Banking:

Steve Muehler – Annuities:

Steve Muehler – Debt Capital Markets:

Steve Muehler – Equity Capital Markets:

Steve Muehler – Real Estate Loans:

Steve Muehler – Insurance:

Steve Muehler – Commercial Insurance:

Steve Muehler – EquityLock Residential:

Steve Muehler – EquityLock Commercial:

Steve Muehler – Bail Bonds & Immigration Bonds:

About Mr. Steve Muehler, Founder & Senior Managing Member:

Personal Site:

Personal Site:








STEVE MUEHLER is not a lawyer or a law firm, and Steve Muehler does not act as your attorney, and is not a substitute for advice from an attorney. Steve Muehler does not provide any legal advice, and none of the information provided herein or on any completed document should be construed as legal advice. Steve Muehler cannot provide legal advice and can only provide self-help services at your specific direction. Steve Muehler can assist you in completing legal forms when you are seeking to represent yourself in your own legal matters. If you need legal representation, are involved in litigation, or have complex legal issues that cannot be handled or dealt with on your own, you should seek competent legal advice and/or hire an attorney. Our legal documentation preparation service uses the answers you provide to automatically populate legal forms and complete them on your behalf. Our review of your answers is limited solely to completeness, spelling and grammar, internal consistency of names, addresses and the like. At no time do we review your answers for legal sufficiency, draw legal conclusions, provide advice or apply the law to the facts of your particular situation. Steve Muehler cannot provide legal advice for any situation or case. As such Steve Muehler cannot make personal recommendations as to what documents should or should not be used and cannot attempt to predict the legal impact of using any certain response or form. This document preparation service is not intended to create an attorney-client relationship, and by using Steve Muehler's services, and no attorney-client relationship will be created. You are totally and solely responsible for your own selections and actions. Again, Steve Muehler cannot make any recommendations for any corrections or changes to the documents or their application, content or use.

NEWS SOURCE: Steve Muehler Holdings, LLC

4 views0 comments