By Erwin J. Shustak, Esq.  of Shustak Reynolds & Partners, P.C. posted on Thursday, January 28, 2016.

Erwin J. Shustak

Managing Partner

Location: San Diego, California
New York, New York
Phone: (619) 696-9500 (Ext. 109)
(800) 496-5900 (Ext. 109)
Email: [email protected]

Effective January 1, 2016, California has adopted a sweeping change to its laws on payment of finder’s fees to unregistered persons in connection with securities’ offerings.  This major change effectively reverses a 2005 law that had prohibited payment of finder’s fees to anyone other than a registered broker-dealer firm.  The new law, however, is contrary to existing SEC policy and great care must be exercised to ensure compliance with the California law and avoid falling into quicksand under the SEC guidelines.

The Prior Law-

In 2005, the California In 2005, however, the Californialegislature enacted a statute that drastically altered the risk exposure for companies andfinders in transactions involving California residents or California issuers. The legislature adopted Corporations Code section 25501.5 which gave investors the right to rescind atransaction when an unregistered broker-dealer procures the investment. If the investorno longer holds the securities, he or she may sue for damages. Pursuant to its authorityunder an amendment to Code of Civil Procedure section 1029.8, the court had the power to award attorney’s fees, costs and treble damages up to $10,000 in the event of any violation of the law.

The effect of that 2005 statute was dramatic.  In one quick brushstroke, California essentially eliminated an entire world of “finder’s” and “placement agents”.  Only registered broker-dealer firms could receive compensation for putting a California investor into a California based investment.

New Section 25206.1 Effective January 1, 2016-

Now, eleven years later, California has reversed course.  Effective January 1, 2016, California has adopted new Section 25206.1 of the California Corporation’s Code, which created a major change in California securities laws.

The new law was proposed by the Business Law Section of the California State Bar in 2012, for the purpose of legalizing what was determined to be an already wide-spread practice in California of payment of finder’s fees by businesses seeking to raise capital.  The Business Law Section commented that oftentimes, the only way small businesses could raise capital was to pay finders a percentage-based compensation.  The proposal found that legalizing the payment of percentage based compensation was necessary to promote capital formation for small businesses in California and eliminate the risk of those businesses not being able to raise capital by virtue of the 2005 law that made the practice illegal in California.

The California Exemption Requires Numerous Conditions Be Met-

New Section 25206.1 has a number of requirements that must be met for the exemption to apply.  Those are:

1. The finder must be a natural person, not an entity;

2. The transaction must involve a sale of securities by a California issuer of securities;

3. The size of the entire transaction (not just the portion raised by a particular finder) may not exceed an aggregate of $15 million;

4. The finder may not:  negotiate the terms of the transaction; advise any party regarding the value of the securities or the advisability of purchasing them; sell any securities that are owned directly or indirectly by the finder; receive possession or custody of the actual funds in the transaction; participate in the transaction unless the transaction itself is permitted or exempt from California qualification; make any disclosure to any potential purchaser other than the name and contact information of the issuer, the name, type, price and aggregate amount of the securities offered and the issuer’s industry, location and years in business.

5. In advance of taking a finder’s fee, the finder must file a statement of information with the California Bureau of Business Oversight and pay a $300 fee confirming the finder has complied with the exemption conditions;

6. The Finder must obtain a written agreement signed by the finder, the issuer and the person introduced by the finder disclosing: the type and amount of compensation the finder will be paid; confirming the finder has not and is not providing the investor with advice regarding the investment; disclosing whether the finder also owns the securities; disclosing any conflict of interest; advising that the parties have the right to pursue legal remedies for breach of the agreement; and a representation that the investor is an accredited investor as defined in SEC Regulation D and consents to the payment of the finder’s fee.

Essentially, total and full disclosure to the investor.  The finder must, in essence, be a true “finder” and just a finder and may not be a salesman for the investment.

The Conflict between New California Law and the SEC Current Policy-

The new California law only permits the payment of finder’s fees in transactions involving California based issuers, finders and investors, for transactions conducted exclusively within California.  Transactions conducted outside of California, however, are subject to a conflicting SEC policy.

Currently, the SEC treats such transactions involving payment of finder’s fees to non-registered persons as violations of Section 15(a) of the Exchange Act, which carries with it potential fines and disciplinary actions.  Until the SEC changes its current policies, therefore, any transactions conducted outside of California and not involving California based investors, issuers and finders are at risk of SEC enforcement actions.

Shustak Reynolds & Partners, P.C. has extensive experience in the area of securities and financial services law and routinely counsel’s investors, brokers, broker-dealers and registered investment advisors.For more information contact Erwin J. Shustak, Esq., Managing Partner, at 619.696.9500 or via email at [email protected] or visit our web site at www.shufirm.com

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