Friday Letter: Making sense of the SEC’s order on finders

The Securities and Exchange Commission this week adopted an exemption rule for finders.

The vote was 3-2, with the two Democratic commissioners, Allison Herren Lee and Caroline Crenshaw, dissenting.

On the surface, this might not seem to matter much to the venture community. But when you consider the role of scout programs in today’s investment scene, I’d argue you shouldn’t overlook the SEC’s decision.

Sequoia Capital is credited with starting the venture scout program. The economics of scouts and how they operate varies from firm to firm, but by and large scouts are tasked with bringing deals to the venture firms, whether they’re student interns, angel investors or portfolio company founders.

Mostly, scouts are finding seed deals, and in some instances, scouts themselves may invest on behalf of the firms or even put in some of their own capital. They could be rewarded with a commission or performance-based equity.

For the SEC, the issue of finders mostly has to deal with registered brokers, folks who help companies raise money and are often involved in the negotiations. The 3-2 vote by the SEC results in limited, conditional exemption from broker registration requirements for finders.

Essentially, the SEC is saying finders are allowed engage in broker-dealer activities, actively soliciting and recruiting investors on behalf of issuers, and receiving commissions tied to their sales activities without having to register with the SEC. Crenshaw argued that unlike registered broker-dealers, a finder would not be subject to periodic inspections or examinations, nor would they be required to maintain records of their activities or comply with basic broker-dealer requirements such as suitability or know your customer rules.

I spoke this week with Amit Singh, a partner in Stradling’s corporate law practice in San Diego, who said that scouts are a subset of finders. He told me there’s been some gray area surrounding finders and brokers in recent years.

Prior to the SEC vote on the issue, Singh said the proposal would “clarify the rules.” Depending on their arrangement with the fund managers, scouts are likely not involved with deal negotiations, but Singh said many scouts are arguably receiving success-based fees for their work of “finding portfolio investments.”

In regards to the SEC vote, Singh noted that “things are going in that direction,” and he pointed out how California has already enacted a securities law on this, which would put the SEC action in line with the state.

You read more from Singh on California’s finders fee exemption for unregistered persons on his blog.

What do you think? Do you see the SEC exemption on finders impacting scouts? And while we’re on the topic, what are your thoughts on scouts 11 years after Sequoia Capital started their own scout program?

I’m always happy to hear from you. You can reach me at agoldfisher@buyoutsinsider.com and I’m open to voice and video calls, of course.