Finder's fees and securities laws

Over the past year, I have received numerous telephone calls from clients and participated in discussions with colleagues on whether a third party may collect a finder’s fee for introducing potential investors to corporations seeking venture and/or other forms of capital financing.

These situations typically involve third parties who seek an ownership interest in the corporation, shares of the corporation’s stock or cash fees for bringing investors and their money to a corporation.

Some may attempt to rationalize what such providers or finders do by using an improper analogy: If people pay fees to accountants and lawyers for their valuable professional services, what’s wrong with giving up a piece of equity in a corporation or paying a cash fee to a third party who provides such a valuable professional service as bringing equity investors to the corporation?

The answer is simple. When corporations or individuals hire accountants or attorneys, these professionals are licensed and regulated by governing bodies that set educational, training and ethical standards. Individuals who act as promoters and/or finders and who seek finder’s fees should be held to similar standards.

Generally speaking, federal and Ohio securities laws effectively prohibit finders or promoters from engaging or professing to engage, directly or indirectly, in the purchase or sale of securities with the expectation of receiving a commission, fee or other compensation unless they are licensed.

If a promoter or finder who is not properly licensed introduces a corporation to individuals willing to make an investment, and the corporation provides that with a fee, then that individual may be subject to civil liability and/or criminal prosecution under the law. Civil damages may include fees paid for advice, any loss due to such advice, court costs and any income derived as a result of such advice.

In Ohio, an afflicted individual may bring an action for civil liability for such a violation within four years after the investment advice is rendered or two years after discovery of facts which constituted such violation, whichever is shorter.

If the promoter or finder is subject to criminal prosecution, such individual may be subject to felony charges and/or criminal fines that vary depending upon the value of the funds or securities involved.

In addition, any sale made in violation of Ohio securities laws is voidable in its entirety by the purchaser (the new equity investor). Also, the corporation, as seller of its shares of stock, and any participants involved in the sale of stock are jointly liable for the full amount paid by the investor to the corporation, along with any court costs the investor has incurred.

There are individuals who are properly licensed as securities brokers or dealers who can provide the same services as a finder or promoter. By using properly licensed individuals or entities, a corporation looking for capital can eliminate its liability.

Joel S. Heiser ([email protected]) is an attorney at Arter & Hadden LLP and is a member of the firm’s E-Group, a multidisciplinary group of attorneys who focus their practice on entrepreneurs, Internet, e-commerce and emerging growth companies. He can be reached at (216) 696-5665.

Arter & Hadden E-Group