A: Hi everybody, its Amy Wan from Bootstrap Legal. I’m here with Scott Anderson today because we are going to talk about capital raisers and raising money. Scott is the perfect guy to talk to you guys about all of this, so, Scott thanks for joining me.
S: Yeah, thanks for having me.
A: So the reason why I wanted to do this session is because ever since I published my article on capital raisers, I’ve just been inundated with calls and questions and people coming up to me at events asking all these questions. I feel like there’s a lot of confusion out there in the industry and at some point I thought, they don’t want to hear it from me, but they should hear it from you. For those of you who don’t know, Scott has his own law firm now, but he was the former deputy chief counsel at FINRA–the financial regulatory authority–the agency that regulates broker-dealers. Before that, he has led complex criminal prosecutions in the New York State Attorney General’s office and New York Stock Exchange and FINRA, so he brings a very unique prosecutorial perspective. A couple of years ago, Scott would have probably been the one on the enforcement side against capital raisers. Did I do your background justice, Scott?
S: Yeah, they did a great job. Thank you very much.
A: I want to clarify what all the regulations and laws are for capital raisers in the real estate syndication business. Let’s start with defining transaction-based compensation. What is it?
S: Sure, So, you know, the biggest thing people have to be concerned about is whether their activities are going to be deemed to be acting as broker-dealer. A broker is any person it’s engaged in the business of effecting a transaction in the securities for the account of another–so when you think about that and you think about what it means, it essentially means that if you are getting paid for being involved in the securities transaction, then very likely you may be acting as an unregistered broker-dealer. We care about that because the SEC has been very clear both in speech as well as enforcement actions. If you follow SEC enforcement actions, every month or so, there’s another action on an unregistered-broker dealer case. They are very actively pursuing these cases because they believe its the best way to protect investors.
A: If people do not have a broker-dealer license, is there any way they can charge transactions to be as compensation?
S: Just to be clear, transaction-based compensation is if you bring a securities transaction to another party and you only get paid if that person invests or your pay is conditioned on or subject to the amount of money that individual invests– that’s transaction-based compensation. Another way to refer to it more commonly is just “commission.” So, if you are receiving transaction-based compensation by bringing a securities transaction to another party, the SEC has been very clear that they view that as a hallmark that you are engaged in an unregistered broker-dealer activity. So, to answer your question, the answer is ‘no’–if you’re engaging those transactions you cannot do that absent either being registered as a broker-dealer being an associated person of a broker-dealer.
A: Let’s talk about compensation really quickly because I think when people hear commissions, they think ‘cash.’ I have been hearing folks say that they’re giving a piece of the equity as the general partner, or giving part of an acquisition fee or asset management fee. Does that count as compensation?
S: If it’s tied to the Securities transaction, yes, and that’s the problem. And by the way, when the SEC investigates these things, they take a very close look at how compensation was determined, how it’s calculated, and how it was paid. They take a very deep dive and look into it to make an assessment as to whether the compensation that was paid does, in fact, constitute transaction-based compensation.
A: What if someone is helping to raise money but is not charging for it. They’re not getting paid at all. Is that okay?
S: Traditionally the SEC primarily focused on whether somebody was receiving transaction-based compensation. That was the most important criteria for determining kind of a client’s risk, whether they had the risk of an enforcement action, but the SEC has taken broader perspective. When you consider whether you may need to be registered as a broker-dealer or an associate of a registered person with a broker-dealer, the SEC looks at other criteria. In addition to that, for example, are you involved in the solicitation of a securities offering? Are you involved in negotiating a securities transaction? Are you involved in executing a securities transaction? Are you receiving customer funds or holding customer securities? There is more, but those are examples of things that SEC will look at in making its assessment as to whether you should be registered as a broker-dealer. They should consult securities counsel–they don’t have to call me, but they should consult somebody who has some knowledge in the area to get some advice because you know, there could be significant consequences if they do this incorrectly.
A: I want to talk to you about the issuer exemption because I think that people have been interpreting in a very creative and interesting way where they’re just adding capital raisers to the sponsor entity or GP. Do you have a reaction to that?
S: If you receive transaction-based compensation, the issuer exemption is not applicable. And by the way, bringing people into the sponsor, you know under the issuer exemption, their activity can’t just be related to raising capital. They have to have significant responsibilities after raising capital. So from my perspective, I would be at the troubled with respect to that setup.
A: What if their additional responsibility after raising capital is ‘investor relations’?
S: Look, it has to be real. I mean the person who is going into the sponsor really has to have other responsibilities and those responsibilities can’t be the solicitation of investors. It has to be broader than that for the issuer exemption to work and again, as I mentioned a moment ago, it seems the motivation would be lost apparently to even engage in this structure because they can not receive transaction-based compensation or else there’s no issuer exemption available.
A: In terms of alternatives, people are looking at the Finder’s Fee exemption. Can you explain to us the Finder’s Fee Exemption?
S: A couple of decades ago, the Commission gave some no-action guidance which became known as the Finder’s Fee Exemption. Basically the Finder’s Fee Exemption was literally just limited so that you introduce somebody to somebody else and you walk away and then you receive a Finder’s fee for that introduction and the introduction doesn’t include a discussion on the merits of the investment, it doesn’t include a recommendation, it doesn’t include involvement and negotiation, it doesn’t include involvement and helping fund the transaction. It was a very limited exemption limited solely to an introduction, which the SEC indicated in such circumstances would not require registration as a broker-dealer.
The problem now is that since the guidance came out, the SEC has largely, through cases, backed away from that guidance, specifically articulating that if you receive transaction-based compensation on a single security transaction, that may be enough to require that you be registered as broker-dealer. Anyone who is considering relying on the Finder’s fee exemption– I urge them to consult securities counsel. And when you’re getting the opinion from counsel that you can do this, ask the lawyer to put it in writing it so it’s very clear what the opinion and advice is, and so that if there’s ever an issue later with that opinion and advice, it can be shared as a mechanism for defending yourself against an SEC investigation.
But the Finder’s Fee exemption is very limited now and the SEC priority has made it very clear, even in a non-fraud situation, that unregistered broker-dealer cases are an SEC priority because they want people engaged in these activities to have a certain level of knowledge. They want individuals engaged in this business to be supervised by a supervisor–generally a Series 24 supervisor, a broker-dealer who makes sure they’re complying with certain rules, etc. And they also expect that people engaged in the business as broker-dealers are gate-keepers. They have a responsibility to protect investors. And that responsibility is supervised directly by FINRA, which is a self-regulatory organization. I believe that gives the SEC comfort knowing that people engaged in this type of activity are regulated directly by FINRA and their activities being reviewed on a regular basis.
A: Fantastic. Is there anything else you wanna add for our listeners?
S: Yeah I would just say that we’re talking about an area that the SEC cares very much about, that the SEC is consistently bringing cases on. You should be consulting legal counsel and not kind of guessing or putting patchwork together with respect to how you believe you can conduct your business. You should get an opinion from legal counsel.
A; If people have been engaged in the activities that we’ve been discussing today, and say they’re going to promise to not do that anymore or back away from it, given that they’ve already done some of these activities in the past, what should they do?
S: Well, they should consult counsel. I mean, the first thing they should do is stop engaging in the activities if they believe that their activities are illegal. Speak to legal counsel, who may confirm that you should be a broker-dealer. There’s a tremendous amount of risk for you to go forward and not be broker-dealer. People should take pause and listen to that advice and act on that advice with respect to what they should do about their previous activity. That’s a longer discussion and I think it’s a conversation they should have with legal counsel.
A: Fantastic. Scott, how can people find and follow you?
S: My website is finlawyer.com. My phone number, my e-mail address is contained there.
A: Fantastic. Awesome. Thank you so much for sharing your knowledge, Scott.
S: Yeah my pleasure. Nice seeing you
A: You too.