UNDERSTANDING THE DIFFERENCES BETWEEN BROKER-DEALERS AND FINDERS IN CALIFORNIA

For companies seeking capital, finding potential investors can be challenging. Many companies turn to “finders”—individuals or entities that introduce and negotiate with potential investors—to facilitate the capital-raising process. However, both federal and state securities laws regulate these activities, and companies must be mindful of compliance risks associated with engaging unlicensed individuals commonly known as "finders".

Federal and California Broker-Dealer Regulations

Under federal law, it is unlawful for any broker or dealer to induce or attempt to induce the purchase or sale of any security unless registered with the Securities and Exchange Commission (“SEC”). A “broker” is defined as any person engaged in the business of effecting securities transactions for the account of others. Accepting transaction-based compensation can trigger broker-dealer registration requirements under federal law.

Similarly, California law prohibits a person from “being engaged in the business of effecting transactions in securities” unless licensed as a broker-dealer. However, the law does not clearly define what activities trigger the broker-dealer designation. This ambiguity has led to inadvertent violations, particularly by individuals acting as finders without proper registration.

Key Factors in Determining Broker vs. Finder Status

The SEC and California regulators consider multiple factors (although not one would be determinative) when determining whether a person is acting as a broker-dealer or a finder:

1. Participation in the Transaction – If the individual is involved in solicitation, negotiation, or execution of a transaction, they may be deemed a broker.

2. Compensation Structure – Transaction-based compensation (e.g., commissions or percentage-based fees) strongly suggests broker activity.

3. Regularity of Activities – If the individual routinely participates in securities transactions, they may be considered a broker.

4. Handling of Funds – Managing investor funds or securities is a strong indicator of broker status.

   
   

A company that engages an unregistered broker-dealer may expose itself to significant risks, including investor rescission rights, fraud liability, and potential SEC enforcement actions.

California’s Finder Exemption – Section 25206.1

To address the regulatory gray area surrounding finders, California enacted Section 25206.1 of the California Corporations Code in 2015. This provision provides a limited exemption from broker-dealer registration requirements for qualifying finders who comply with specific conditions.

Eligibility Requirements for Finders under Section 25206.1

A finder operating under Section 25206.1 must meet the following criteria:

1. Must be a natural person (not a corporate entity).

2. Can only introduce accredited investors to a company.

3. The transaction must not exceed an aggregate securities purchase price of $15 million.

4. Cannot engage in activities beyond introductions, such as negotiating terms, advising investors, selling securities, or handling funds.

5. Cannot receive compensation in connection with unregistered securities transactions.

   
   

Disclosure and Record-Keeping Requirements

To qualify for the exemption, finders must comply with the following regulatory requirements:

1. Initial Statement of Information: Before engaging in any finder activity, an individual must file a Statement of Information with the California Department of Financial Protection and Innovation (“DFPI”) and pay a $300 filing fee.

2. Annual Renewal: Finders must file an annual renewal statement with the DFPI, along with a $275 fee, affirming continued compliance with Section 25206.1.

3. Written Agreements: Finders must obtain a written agreement with each investor, detailing compensation, conflicts of interest, and confirming that the investor is accredited.

4. Record Retention: Finders must maintain all disclosure documents and transaction records for a minimum of five (5) years.

   
   

Limitations of the California Finder Exemption

While Section 25206.1 provides a pathway for finders to operate legally in California, it does not exempt them from federal broker-dealer registration requirements. Thus, individuals acting as finders should carefully evaluate whether their activities comply with both California and federal laws.

Conclusion

The use of finders can be an helpful strategy for companies seeking investors, but both companies and finders must navigate complex regulatory requirements to avoid potential legal risks. Companies should be cautious when engaging finders and ensure that they comply with California’s Section 25206.1 and federal securities laws. Given the nuances of securities regulations, consulting with experienced legal counsel is strongly recommended to mitigate risks and ensure compliance with applicable laws.

For more information about the distinctions between finders and brokers, please contact Mason Goodman at Fonss & Estigarribia LLP at mng@fellplaw.com or (858) 746-6497.

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