The New Texas “Finder” Securities Broker Registration

by

John R. Fahy

Texas entrepreneurs looking for investors seek referrals from their mentors, athletic coaches, physicians, professors, and successful businesspersons. But, what if that entrepreneur tried to give that person a piece of the business or the financing raised in payment for the referral? Are there any legal considerations? On July 25, 2006, the Texas State Securities Board passed a new rule allowing investor finders to legally receive such compensation if they register with the State as a finder, a “light” version of broker-dealer registration.

Persons who received transaction-based compensation relating to the sale of securities might be securities brokers who would be required to be registered under Texas law. If the transaction crosses interstate boundaries, the broker may need to be registered under federal law as well. The State Securities Board has long interpreted the definitions of “sale” broadly to capture everyone involved in the sale process.¹ And, Texas law explicitly states that unregistered persons cannot enforce commission contracts relating to the sale of securities.² Registering as a securities broker requires paying fees, passing a test, and, typically, affiliating with a registered broker-dealer.

Last year the Texas State Securities Board exempted those who sell securities to certain institutional investors from the broker-dealer registration requirements. These institutional investors must meet certain asset and income levels which allow them to be called “accredited investors.” But, it did not exempt those involved in sales to wealthy individuals.³ So, for example, the person selling to a Texas billionaire would need to register as a securities broker, but the person selling to that billionaire’s children’s trust would not.

On July 25, 2006, the Texas State Securities Board took the next step by creating a limited broker-dealer registration for “finders,” that is individuals who refer accredited investors, whether individual or institutional, to an investment, and are compensated if their referral makes a purchase.⁴ But the finders may not be involved in negotiating the sale, advising about the investment, or performing due diligence.⁵ This finder broker-dealer registration is available only to individuals, and dispenses with the exam requirement and the need to affiliate with a registered broker-dealer.⁶ It requires that finders keep certain records and not commingle the finder-related records with other records.⁷ It also requires that finders disclose in writing that the issuer pays them and their potential conflicts of interest, and provide a statement that the finder can neither recommend, nor advise, the accredited investor about the investment.⁸ The finder registration protects finders against unenforceable commission contracts and penalties for non-registration, including criminal penalties. The Texas Finder Rule should be effective sometime in September, 2006.

If a finder works on interstate deals, federal law may apply and the SEC has not exempted finders from federal broker-dealer law requirements. Federal law requires that persons “engaging in the business of effecting transactions in securities for the accounts of others” in interstate commerce must register as a broker with the SEC.⁹ Texas finders will likely ask SEC staff for No-Action Letter consideration if the finder is Texas-registered, but not SEC-registered. A No-Action Letter is a statement by the SEC staff that under a defined set of circumstances that the SEC Staff will not recommend to the SEC’s Commission members to approve an enforcement action. There can be no assurance that the SEC Staff will grant No-Action Letter relief to Texas-registered finders.

The table below describes the broker-dealer registration scheme in Texas after the effective date of the Finder Rule.

Texas case law indicates that business brokers who introduce parties that lead to the sale of the whole business in a transaction effected through a one-hundred percent (100%) stock sale may not have to register as finders.¹⁰

The Texas Finder Rule imposes some burdens. First, finders must complete an application and pay a fee (currently $275) to the Texas State Securities Board.¹¹ No exam will be required.¹² A link to the application form, “Form BD,” can be found on the Board’s website (www.ssb.state.tx.us) under “Forms and Fees.” Board examiners will review the application for possibly disqualifying events such as criminal fraud convictions, securities industry bars, and court-issued securities fraud injunctions, and then grant or deny registration.¹³ Denials would likely be rare and may be appealed to the State Office of Administrative Hearings for review.¹⁴

Second, the Texas Finder Rule requires that the finder provide prospective accredited investors a written disclosure statement that says that the finder will receive compensation, can neither recommend, nor advise, about the securities offering, and discloses the specific potential conflicts of interest with the prospective accredited investor.¹⁵ The State Securities Board did not describe how to measure the potential conflict of interest. But, a likely disclosure should include a statement that the finder’s compensation relies on making the sale, and the finder has incentives to hope the transaction closes.

Third, the Texas Finder Rule limits the finder to giving the issuer only the prospective accredited investor's contact information¹⁶ and providing the prospective accredited investor only the following information:

1. The name, address, and telephone number of the issuer of the securities;
2. The name, a brief description, and price (if known) of any security to be issued;
3. A brief description of the business of the issuer in 25 words or less;
4. The type, number, and aggregate amount of securities being offered; and/or
5. The name, address, and telephone number of the person to contact for additional information.¹⁷

Fourth, the Texas Finder Rule requires that certain records relating to completed transactions be maintained for five (5) years¹⁸, the first two (2) of which can be archived.¹⁹ The finder is also barred from commingling the finder records with records from the finder’s other businesses.²⁰ The rule requires finders to keep:

1. Compensation records for acting as finder, including the name of the payor, date of payment, name of issuer, and the name of the accredited investor;
2. Copies of the information provided by the finder to the prospective accredited investors;
3. Agreements between the finder and the accredited investor and between the finder and the issuer;
4. Contact lists of prospective accredited investors and issuers; and
5. Correspondence with accredited investors and issuers, including e-mail.²¹

Finally, the Texas Finder Rule requires that finders provide copies of these records to the State Securities Board staff upon request²², including allowing State Securities Board examiners to inspect records.²³

The Texas Finder Rule is the first such limited registration program in the United States and will act as a road map to other State Securities Administrators and the SEC should these regulators want to do something similar. It may be changes as a national consensus builds. For Texas residents it can protect against liability for acting as an unregistered broker and permit finders to enforce commission contracts with issuers.

About the Author
John R. Fahy is a securities attorney in private practice in Fort Worth, Texas with Whitaker, Chalk, Swindle & Sawyer, LLP. He has worked for the U.S. Securities and Exchange Commission’s Fort Worth District Office, managed the Texas State Securities Board’s Houston office, and served as general counsel for two NASD-registered broker-dealers. He also previously held the Series 7, 24, and 66 licenses. Mr. Fahy earned his law and masters degrees from the University of Texas and his undergraduate degree from Yale. He can be reached at (817) 878-0547 or .

DISCLAIMER
The above article is published for information purposes only and is not, nor is it intended to be, legal advice. If the reader is or may become involved in a transaction as a finder, investor, or offeror, engagement of personal counsel is strongly advised. This article is not intended to and does not create an attorney-client relationship.

                                       
¹ TEX. REV. CIV. STAT. ANN. Art. 581-4(e).
² Kadane v. Clark, 43 S.W.2d 197 (Tex. 1940); TEX. REV. CIV. STAT. ANN. Art. 581-34.
³ 7 Tx. Admin. Code §109.5.
⁴ 7 Tx. Admin. Code §§115.1(a)(9), 115.11.
⁵ 7 Tx. Admin. Code §115.11(a).
⁶ 7 Tx. Admin. Code §115.1(a)(9).
⁷ 7 Tx. Admin. Code §115.11(c).
⁸ 7 Tx. Admin. Code §115.11(b).
⁹ 15 U.S.C. 78(c)(4)(A)
¹⁰ Star Supply Co. v. Jones, 665 S.W.2d 194, 196 (Tex.App.--San Antonio 1984); Vero Group, v. ISS-International Service System, 971 F.2d 1178, 1186 (5th Cir. 1992, reh’g den’d 978 F.2d 713); see also Rogers v. Ellsworth, 501 S.W.2d 756 (Tex.App.--Houston 1973).
¹¹ TEX. REV. CIV. STAT. ANN. Art. 581-35.A and Art. 581-41(a)(1).
¹² 7 Tx. Admin. Code §§115.3(c)(2)(E)
¹³ TEX. REV. CIV. STAT. ANN. Art. 581-4(e); 7 Tx. Admin. Code §104.5.
¹⁴ 7 Tx. Admin. Code §§105.1 et seq.;.TEX. GOV’T CODE §§2001.054, 2003.058, and 2003.021.
¹⁵ 7 Tx. Admin. Code §115.11(b).
¹⁶ 7 Tx. Admin. Code §115.11(c)(2).
¹⁷ 7 Tx. Admin. Code §115.11(c)(1).
¹⁸ 7 Tx. Admin. Code §§115.11(d)(2) and 115.11(d)(3).
¹⁹ 7 Tx. Admin. Code §115.11(d)(5).
²⁰ 7 Tx. Admin. Code §115.11(d)(6).
²¹ 7 Tx. Admin. Code §115.11(d)(3).
²² 7 Tx. Admin. Code §115.11(d)(7).
²³ 7 Tx. Admin. Code §115.7.