Finder’s Fees For Raising Capital
A Comparison of the Approaches Made By the DRE, DBO & SEC

Dennis DossBy:

By: Dennis H. Doss and Christopher J. Donovan

                                     DOSS LAW, LLP

We are frequently asked about the legality of finder’s fees paid to raise capital for mortgage transactions and pool investments.  A finder’s fee is compensation to someone who finds money for an investment.  It provides an incentive to the finder to refer prospective investors to the investment sponsor.  The legal issue finders’ fees pose is whether or not the finder must be licensed as a broker under state and federal securities laws.  As we will see, the regulators have different viewpoints.

Department of Real Estate

California law requires that real estate brokers be licensed by the DRE.  The licensing statute defines a “real estate broker” to include any person who “for compensation … solicits ….lenders … in connection with loans secured … by liens on real property.”  Business and Professions Code 10131(d). However, the courts and the DRE acknowledge that a person who merely introduces a prospective lender to a broker is not required to be licensed.

See, See.eg.,http://www.dre.ca.gov/files/pdf/reb/rebwinter_16.pdf

and Tyrone v. Kelley, 9 Cal. 3d 1 (1973); Queen of Angels Hosp. v. Younger, 66 Cal. App. 3d 359 (1977).  This exception does not apply if the finder performs any act requiring a license, regardless of how minor the act may be.  Tyrone, 9 Cal. 3d at 9; McConnell v. Cowan, 44 Cal. 2d 805, 811 (1955).  If the finder happens to be a real estate salesperson, his or her broker must receive the fee. Bus. and Prof. Code §10137.

Department of Business Oversight

It is well settled that the sale of promissory notes to private investors is the sale of securities governed by California securities laws enforced by the Department of Business Oversight.  See, e.g., People v. Schock, 152 Cal.App.3d 379, 199 Cal.Rptr. 327 (1984).  California securities law requires that brokers that sell investments be registered as broker-dealers.  Real estate brokers selling mortgage interests are exempt. However, as to unlicensed finders, by AB 667 effective January 1, 2016, California created a special exemption for finders who raise capital for any type of securities offering.  But, they must follow a set of rules in California Corporations Code §25206.1:

  1. The finder must be a natural person, not an entity.
  2. The finder must only introduce “accredited investors” (as defined in Regulation D under the Securities Exchange Act of 1933)
  3. The transaction must involve the sale of securities by a California issuer to California investors only.
  4. The size of the transaction must not exceed an aggregate purchase price of $15 million.
  5. The transaction must be qualified under the California securities laws or exempt from such qualification.
  6. The finder must not: (a) participate in negotiating any of the terms of the transaction, (b) advise any party to the transaction regarding the value of the securities or the advisability of purchasing or selling the securities, (c) conduct any due diligence for any party to the transaction, (d) sell any securities owned by the finder in the transaction, (e) receive possession or custody of funds in connection with the transaction, or (f) make any disclosure to a potential purchaser of securities other than the name, address and contact information of the issuer, the name, type, price and aggregate amount of securities offered in the transaction, and the issuer’s industry, location and years in business.
  7. Before taking any finder’s fees, the finder must file a statement of information containing the finder’s name and address with the DBO, accompanied by a $300 filing fee. Then the finder must file an annual renewal statement of information containing representations that the finder has complied with these exemption conditions, accompanied by a $275 filing fee.
  8. The finder must obtain written agreements signed by the finder, the issuer and each person introduced by the finder, disclosing: (a) the type and amount of compensation that has been or will be paid to the finder, (b) that the finder is not providing advice to the issuer or any person introduced to the issuer as to the value of the securities or advisability of purchasing or selling them, (c) whether the finder is also an owner of the securities being sold, (d) any conflict of interest in connection with the finder’s activities, (e) that the parties have the right to pursue any available remedies for breach of the agreement, and (f) a representation by the person introduced by the finder that such person is an accredited investor and consents to the payment of the finder’s fee.
  9. The finder must preserve copies of the annual renewal statements of information, written agreements and all other records relating to the transaction for a period of five (5) years.

Thus, with simple registration with the DBO, finders of all sorts can raise capital for mortgage investments from accredited investors.  Parties that pay or receive compensation without following these rules are doing so at their own risk.

Securities and Exchange Commission

The SEC takes a similar view of this topic.  According to it, a broker is “any person engaged in the business of effecting transactions in securities for the accounts of others.” The federal securities laws have no formal definition of a “finder.”

But, the SEC offers a much narrower path of safety for finders.  It has said that, “[merely bringing together the parties to transactions, even those involving the purchase and sale of securities, is not enough to warrant broker-dealer (BD) registration.”  Apex Global Partners, Inc. v. Kaye/Bassman Intern. Corp.,2009 WL 2777869, *3 (N.D. Tex. 2009).  In determining whether a person has crossed the line into broker-dealer territory, the courts will apply the multi-factor test from S.E.C. v. Hansen, 1984 WL 2413, *10 (S.D.N.Y. 1984).  In the context of a mortgage offering, the six factors the courts will consider are whether the finder does the typical things a BD does:

  1. Works as an employee of the mortgage company
  2. Is paid a commission rather than salary from the mortgage company
  3. Sells mortgage investments for another mortgage company
  4. Participates in negotiations
  5. Provides advice about the mortgage investment
  6. Actively (rather than passively) finds mortgage investors

No single factor is determinative; most courts do not require the SEC to establish all six factors to prove that a party is acting as an unregistered BD.

Take Aways

There are a few things we can learn from this discussion. First, if you pay finders for raising capital for a mortgage pool, require them to register with the DBO and follow the DBO’s rules.  Second, in all cases use a written agreement that confirms the finder’s limited role of introducing the parties.  Third, caution finders not to actively solicit investors for you.  Lastly, don’t keep the finder in the communication loop while you deal with the new investor because that could be viewed as illegal co-brokering.

© Doss Law, LLP. Attorney advertising materials. These materials have been prepared for educational purposes only and are not legal advice.  This information is not intended to create an attorney-client relationship.  Consult a knowledgeable lawyer before implementing any of the ideas in this publication.

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