The Intermediary - Litigation Alert - Promoters and “Finders”
There will be no shortage of self-proclaimed crowdfunding and social-media experts who will offer to assist you with your crowdfunding offering. Similarly, securities offerings often attract unregistered “finders” who will offer to make an introduction to an investor in exchange for a finder’s fee, which usually is contingent on the sale, i.e., a commission or success fee. The activities of these persons will be deemed to be promotional activities under Regulation CF.
Investor plaintiffs will scrutinize the activities of any person promoting your crowdfunding campaign in an attempt to hold the issuer and you responsible for the actions of the third-party promoter. If you choose to work with third-party promoters, there are three issues that you must carefully monitor.
First, adopt reasonable procedures to ensure that the promoter includes in any communication the compensation disclosure required by Rule 205. You should implement procedures such as those previously described, which the SEC cites as examples in its Crowdfunding Release.
Second, in addition to this requirement under Rule 205 to take reasonable steps to ensure compliance with the promoter compensation rules, it is important to document the reasonable procedures that you have in place to ensure compliance with all aspects of Regulation CF and to document the steps you took in following those procedures. These procedures are especially important if you engage third-party promoters, as you will not have complete control over their conduct. You should have reasonable procedures to ensure that any third party speaking on the issuer’s behalf does not make any misrepresentations about the issuer or the offering.
The examples provided in the Crowdfunding Release of reasonable steps an issuer may take to ensure compliance with the compensation disclosure requirements are instructive in determining what reasonable steps you should take in ensuring compliance with all other requirements of Regulation CF. Thus, consider including provisions in the promoter’s contract, such as indemnification provisions, to provide some assurance that the promoter will comply with your instructions. You should also consider procedures to periodically monitor the promoter’s communications and to obtain confirmations from the promoter regarding compliance with your instructions and policies. Note, however, that it is imperative to follow your own procedures, as plaintiff attorneys like nothing more than to demonstrate that you violated your very own procedures!
Finally, you should not pay commissions, success fees or other transaction-based compensation to third-party promoters or to finders, even if the finder simply introduces prospective investors to the issuer and does nothing else. In the last several years the SEC staff has taken the position that a person receiving transaction-based compensation in connection with a securities transaction is an indication that the person must be registered as a broker-dealer.1 Thus, if the consultant/promoter or promoter is not a registered broker-dealer, you may pay a flat fee or other non-contingent fee for his/her promotional efforts; compensation should not be dependent on whether a sale occurs, nor may it be based on a percentage of the sales (i.e., a commission).
Written by: Mark T. Hiraide, Partner, Mitchell Silberberg & Knupp LLP. Excerpted from Crowdfunding: Practical Guide to the SEC's Final Rules for Raising Capital, available for purchase on ThomsonReuters.com. This practical guide focuses on you, the entrepreneur, and your legal counsel and the information that will help you take full and safe advantage of the crowdfunding approach to raising capital.