Wednesday, October 1, 2014

Salesmen vs. Matchmakers: What do Deal-Makers Do? And How Should that Drive Securities Regulations? (Article 9 in a series of 14 articles about Deal-Makers)

By Jim Verdonik

I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals , have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at
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This article is one of 14 articles in a series of articles about Deal-Makers called:


One of the problems with the SEC's broad interpretation of who is required to register as a broker under Section 15 (a) (1) of the Exchange Act is that it lumps together peoples and organizations that do very different things, have very different impacts on securities markets and retain investors and utilize different skill sets.
Registered brokers have to comply with a host of requirements that add expense and do little to protect investors in deals that finders and other unregistered deal makers handle, including:
·         Expensive registration and amendments to registrations.
·         FINRA audits.
·         Salesman exams.
·         Churning and suitability requirements.
·         Record keeping.
·         Net capital requirements.
·         Customer account insurance requirements
·         Continuous education requirements.
As discussed in Article (1) and (10) in these series of articles, many issuers and investors who choose to deal with finders do not think these broker requirements are relevant to what finders do.  That's why finders choose not to register.  They would not choose to avoid registration if their customers valued these securities rules.  Even many attorneys who advise clients about the risks associated with using unregistered finders to raise capital, acknowledge that there are not better alternatives and think its bad public policy to subject finders to all rules that regulate brokers.
Let's explore the differences between finders, investment bankers and the tens of thousands of retail salesmen that work at registered broker-dealers.  We'll also compare what they do with other people who provide services in connection with securities transaction, like lawyers, accountants and other consultants, who generally are not required to register as a broker under Section 15 (a) (1) of the Exchange Act.
Let's start with talking about what retain sales brokers do.
What do Salesmen Do?
In regulating deal makers, the SEC often focuses on the role of salesmen.  The SEC's positionabout who needs ot register makes sense if you picture a room full of unlicensed finders cold calling unsophisticated innocent investors about a hot new deal. 

The reality is that most deal makers act more like match makers and marriage counsellors than sales people.

Most brokers:

·         Execute buy orders and sell orders on public securities exchanges.
·         Underwrite registered public offerings.
·         Sell mutual funds for commissions.
·         Hold money and securities for clients.
·         Trade at the broker's discretion under an agreement with the client.
·         Design retirement, education or other financial plans for clients.

Now, let's compare salesmen to dealmakers.


Deal makers identify and build on common ground between people who need capital and investors.  In some deals this is an easy process.  In other deals, middlemen add substantial value, because it is not obvious that the buyer and seller have reasons to do business with one another, it is not obvious what the best transaction structure should be to allow both buyers and sellers to achieve their goals and there are many unforeseen bumps on the road to closing the deal.

That's why it’s a mistake to lump all deal makers in with the thousands of retail securities brokers that work in the large registered broker-dealers.  A retail securities broker usually has no connection to the company whose stock he is selling.  It’s a product he sees on a computer screen. 

Deals where businesses are raising money through finders require a large amount of nurturing.  That's why registered brokers' investment banking departments don't do small deals.  SEC interpretations of the Exchange Act that prevent deal makers from adding value does substantial harm to both businesses trying to raise capital and people who would like to invest in them.  Both sides need more help than technology can provide.

New regulatory freedom and technology for issuers selling securities is useful, but the truth is that technology and regulatory change won't get deals done without a more vibrant deal-making community. 

Giving securities issuers more freedom and technology only creates minimal market change, because businesses that sell their securities to raise capital are transient players.  They enter the market and leave.  Sometimes they leave empty handed.  Other times they leave with a wheelbarrow full of money.  Either way, they have limited impact on the marketplace, because they are in the marketplace a relatively short time.

Brokers and other deal makers stay in the marketplace all the time.  So, if you want to make significant changes to the market, change should focus attention on the dynamics among the permanent players – the middlemen.

How Do Finders and Investors Work Together?
The situation is usually totally different when an individual finder calls someone about a private investment opportunity. 

  • The relationship is usually more personal.  Finders usually have had some prior business dealings with one or both the investors and the people who want to raise capital.  The investor usually talks directly with the people running the business that needs capital.
  • The investor's motives in private investment transactions are often mixed.  Investors seek profit, but they are influenced by many other factors, including interest in the industry, prior industry experience and social concerns.
  • SEC rules require that all investors in private deals have to be sophisticated, whether they are accredited or not.  Sometimes the investors are more sophisticated than either the finders or the entrepreneurs who are trying to raise capital – often for the first time.
  • Relationships are usually transparent.  Investors usually know the finder is working for the company trying to raise capital not for the investors. 
  • Investors often have opportunities to do their own due diligence.  Few investors part with their money based solely on what finders tell them.  Investors often either have industry experience or know people who do.  Investors seldom rely only on what finders say, unless the finder has established a track record in prior deals.
  • Risks are well known.  Most people avoid private placements because they are known to be risky.  People who invest in private placement deals usually make conscious decisions to take risks.
What is the primary value of finders?  Usually, the primary value a finder brings is to cause potential investors to spend the time to evaluate whether to invest in a particular issuer.  Investors are busy people.  They can't evaluate all deals in the market.  Usually, the finder is someone whose judgment the investor respects enough to spend time to read a business plan or talk to a management team.  In some cases, finders affect the decision to make an investment, but in most transactions they simply get the investor's attention and the investor makes its own decision.

Investment Bankers vs. Finders

One might argue at finders should register because they perform many of the functions performed by investment banks, which are registered as broker-dealers.

But most investment banks deal with publicly traded companies and securities and have large retail sales forces that sell securities to retail customers.  Investment banks also issue analyst reports that make buy-sell recommendations that circulate widely among retain investors.  Finders usually deal only with private companies in private placements and usually lack a retail sales force.

The primary public policy reason it makes sense to require investment banks to register is their impact on public markets and retail investors.

Investment banks simply have a much greater impact on the investing public that finders do not have.
Differences in Many Professional Service Providers
In the world of deals, many people provide services in connection with sales of securities, including attorneys, accountants, consultants, appraisers, engineers and other professionals. 
Likewise, newspapers and other media have long provided advertising for sales of registered securities without being required to register under Section 15 (a) (1). 
Since these service providers all play important roles in securities transactions, but are not required to register as a "broker," unless they do more than provide their normal services, we logically conclude that you have to do more than provide services in a securities transaction to "effect the transaction" or to induce a purchase or sale of securities.
This poses several questions:
  • Where is the line between what brokers do and what other service providers do?
  • Can someone be acting as a broker in one transaction and not be acting as a broker in another transaction?
  • Or does acting as a broker in one transaction or many transactions pollute the service provider for all transactions? 
This last question might seem irrelevant to whether the person has violated the law.  What does it matter if there is one violation or many violations?  The answer is that is that it matters to determining the liability to investors in specific deals. 
Both companies that raise capital and the person accused of being an unregistered broker have potential civil liability to investors in to specific investors in specific transactions.  What happens on other transactions is irrelevant to determining liability to specific investors in another transaction.  The fact that you might have been speeding yesterday does not earn you a speeding ticket if you are obeying the speed limit today.  So, both the business that raised capital by selling its securities and the unregistered broker have defenses, if the unregistered broker did nothing in this transaction that required it to be registered.
But the defense that someone did not act as a broker in a single transaction does not settle the issue for the unregistered finder.  As we discuss in articles (2) and (3) of this series of articles, the Exchange Act definition of a broker requires a finding that someone is "in the business."  Some courts have indicated that a single instance of someone accepting compensation for the same thing a broker does is not enough for them to be "in the business" of effecting securities transaction.
Keep these three questions in mind as we analyze whether the SEC's treatment of different situations is consistent with the Exchange Act's language.
As we discussed, the SEC's broadly interprets these key three phrases.  But if it is more reasonable to interpret the Exchange Act's actual language more narrowly than the SEC does:
  • Courts are free to adopt a narrower interpretation of the Exchange Act's definition of broker and registration requirement, if the courts find public policy reasons to give unregistered finders greater leeway. 
  • And the SEC is free to conclude that forcing investors into the hands of large registered brokers has not produced good results for either businesses trying to raise capital or investors, which could cause the SEC to narrow its interpretation of the scope of these parts of the Exchange Act
Therefore, carefully parsing the Exchange Act's actual language helps us understand the latitude both the courts and the SEC have to change course to meet the needs of businesses that are trying to raise capital.
Rule 506 Technology Platforms

Now, let's move from fees to technology platforms.

The technology platform part of the Section 201 (c) exemption will probably be most important for Rule 506 (c) offerings that permit issuers to advertise and conduct general solicitations.  But technology platforms that restrict access to qualified accredited investors were used in Rule 506 offerings before Rule 506 (c) permitted advertising and general solicitation.  Such Rule 506 (b) platforms are just technology based implementations of the principle that it's not a general solicitation if you hire a broker-dealer to solicit the broker-dealer's customers in a private placement. 

Because these platforms were open only to persons who registered as accredited investors as customers of the platform, they did not constitute a general solicitation.  But you have to be careful about how you drive people to register at these platforms.  Issuers cannot conduct a general solicitation to ask people to register to see their offering, if they are conducting a Rule 506 (b) offering, like they can in a Rule 506 (c) offering.

Likewise, the parts of the Section 201 (c) exemption that permit intermediaries to invest in the deal and also provide ancillary services, whether or not a technology platform is used, also could apply to any traditional private offering, not just to Rule 506 (c) offerings

Platform Technology is not the Key Issue

Focusing on the technology platform being used in an offering tells us very little about the securities regulations that govern the offering.  The technology might be the same, but the most important difference between earlier Rule 506 offerings that utilized technology and new Rule 506 (c) offerings are that you do not have to restrict access to your website to registered customers and you can use Social Media, the Internet, traditional advertising and general solicitations to drive people to your technology platform.  Rule 506 (c) offerings can use websites that are open to anyone.  Rule 506 (c) requires that your buyers must be verified accredited investors, but it places no limits on who you make offers to or how you contact them.

This difference results in greater offering effectiveness and cost efficiencies.

The ability to communicate outside your technology platform is a big advantage of Rule 506 (c) offerings.  It means that non-accredited investors, who learn about your offering, can forward information to accredited investors they think might be interested in your offering.  This is important because there are many more non-accredited investors than there are accredited investors.  Each person who learns about your offering is a potential salesman, if you communicate to community members in ways that motivate them to forward your messages to others who share their interests. 

The bottom line is that "going viral" in certain target communities creates efficiencies in both the time it takes to complete an offering and marketing expenses.

For these reasons, it's important to businesses raising capital that platform operators be able to provide basic services that will enable the investor who use their platforms to efficiently make reasonable decisions that are consistent with processes investors use to make investment decisions when a technology platform is not used.
If you would like to learn more, you can reach me at
Or you can check out my eLearning course at
or read my newspaper articles at




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