Those brokers are breaking securities laws
Article By Canna Law Blogof
Startups in the cannabis space have few options when looking to raise funds– almost all banks, venture capital (VC) firms, and other institutional funds are off limits. Suitable private investors are few and far between. This situation is unfortunately leading to a proliferation of unscrupulous individuals that offer their “services” or “connections” to help companies meet investors and bring in dollars, for a fee. We’ve referenced on a few occasions (see here and here) that these investment “finders”, as well as any type of commission on dollars raised or other transaction-based fee, is 100% illegal (unless they hold a FINRA license to serve as a securities broker, and as I’m seeing, nearly all do not). Engaging an “unlicensed broker-dealer” can have serious consequences for the company. Even a dollar raised in this way puts all other company funds and assets at risk.
The frequency with which these issues are raised by clients and others makes me believe that 1) some companies are engaging unlicensed brokers without thinking to run this by their attorney, and 2) some of these unlicensed brokers are aware they are breaking securities laws, while others are simply ignorant and trying to capitalize on their “connections”, not knowing their business model is illegal.
So clearly this topic deserves its own post and its own bolded and underlined warning: Don’t sign any engagement with an advisor / consultant / snake oil salesperson that offers to raise funds for your company, in exchange for a fee. If anyone approaches you, run it by your business attorney right away, and keep them involved throughout the process.
Section 3(a)(4)(A) of the Securities Exchange Act of 1934 generally defines a “broker” as “any person engaged in the business of effecting transactions in securities for the account of others.” Pursuant to that law the SEC has laid put extensive regulations and guidance to further define “broker activities” and prohibited fee structures.
Assuming the individual is not a registered broker-dealer (which you can confirm on the FINRA site here) then here’s what you certainly cannot do:
- Engage an advisor, agent, or anyone describe their role or duties in terms that touch broker activities. At the most basic level, you should avoid any engagement that calls out “introducing” or “finding” or “bringing in” investors. If an engagement calls out “fundraising advice” or “investor relations” as a euphemism for broker activities, you’re walking a fine line. Best to reword your engagement and make no references to broker activities.
- Tie any compensation to funds raised. This includes the obvious “transaction-based” fee of a percentage of funds raised, or fees scaled to milestones. This includes “fees” paid as equity grants. It also includes any fee contingent on a fundraising round – such as a retainer charged when funds arrive.
As a startup you often feel stretched thin, and in need of any help you can get. But in this case, this is not the help you want. Accepting any funds raised through an unregistered broker-dealer, or another performing broker activities for a fee, is worse than not having funds at all. The risk is then to the entire company, and in turn all the investors and employees current and future. Don’t do it!
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