BILL ANALYSIS �
SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE
Senator Noreen Evans, Chair
2013-2014 Regular Session
AB 713 (Wagner) Hearing Date: June 4,
2014
As Amended: May 23, 2014
Fiscal: Yes
Urgency: No
SUMMARY Would provide that any person who meets the definition
of a finder, and who satisfies all of the conditions established
for finders, is deemed to be a finder and not a broker-dealer.
DESCRIPTION
1. Would provide that a finder who satisfies all of the
conditions listed in Numbers 2 through 6 below is not a
broker-dealer.
2. Would define a finder as follows: a natural person who,
for direct or indirect compensation, introduces or refers
one or more accredited investors, as defined, to an issuer,
or an issuer to one or more accredited investors, solely for
the purpose of a potential offer or sale of securities of
the issuer in an issuer transaction in this state, and as
someone who does not do any of the following:
a. Participate in negotiating any of the terms of the
offer or sale of the securities.
b. Advise any party to the transaction regarding the
value of the securities or the advisability of investing
in, purchasing, or selling the securities.
c. Conduct any due diligence on the part of any party
to the transaction.
d. Sell or offer for sale in connection with the issuer
transaction any securities of the issuer that are owned,
directly or indirectly, by the finder.
e. Receive, directly or indirectly, possession or
custody of any funds in connection with the issuer
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transaction.
f. Knowingly receive compensation in connection with
any offer or sale of securities, unless the sale is
qualified by the Commissioner of Business Oversight
(commissioner) or the security or transaction is exempt
or not otherwise subject to qualification.
g. Make any disclosure other than the following limited
disclosures: the name, address, and contact information
of the issuer; the name, type, price, and aggregate
amount of any securities being offered in the issuer
transaction; and the issuer's industry, location, and
years in business.
3. Would require each finder to file a statement of
information about him or herself and pay a filing fee of up
to $25 with the Department of Business Oversight (DBO)
before engaging in any authorized finder activities.
4. Would also require each finder to file a notice with DBO
for each issuer transaction for which the finder performs
finding activities, within 20 business days following the
first sale of securities. In that notice, the finder must
affirmatively represent that he or she has complied and will
continue to comply with the provisions described in Number 2
above, has not performed any acts or satisfied any
circumstances prohibited by Corporations Code Section 25212
(the so-called "bad boy" provisions), has not been
sanctioned by the commissioner pursuant to Section 25212,
and has obtained the informed, written consent of each
person introduced or referred by the finder to an issuer, as
specified below. DBO would be authorized to require a
finder to pay a filing fee of up to $25 in connection with
this notice.
5. Concurrent with each introduction or referral of a
potential investor to an issuer, would require each finder
to obtain the informed, written consent of the person
introduced or referred, on an agreement that discloses all
of the following:
a. The type and amount of compensation that has been or
will be paid to the finder in connection with the
introduction or referral, and the conditions for payment
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of that compensation.
b. That the finder is not providing advice to the
issuer or any person introduced or referred by the finder
to an issuer regarding the value of the securities or the
advisability of investing in, purchasing, or selling the
securities.
c. Whether the finder is also an owner, directly or
indirectly, of the securities being offered or sold.
d. Any actual or potential conflict of interest in
connection with the finder's activities related to the
issuer transaction.
e. That the parties to the agreement have the right to
pursue any available remedies at law or otherwise for any
breach of the agreement.
To satisfy the requirements of the bill, this signed,
written agreement must also contain a representation by the
potential investor that he or she is an accredited investor
and that he or she knowingly consents to the payment of the
compensation described in the agreement.
6. Would require each finder to maintain and preserve, for a
period of at least five years, all notices, agreements, and
other records relating to any offer or sale of securities in
connection with which the finder received compensation, and
would require each finder to furnish those documents to the
commissioner upon written request by the commissioner.
7. Would provide that a natural person who does not meet the
definition of a finder as set forth in the bill and who does
not satisfy all of the requirements applicable to finders,
as set forth in the bill, may be determined to be a
broker-dealer by the commissioner.
8. Would further provide that in the event a natural person
does not meet the definition of a finder, as set forth in
the bill, and does not satisfy all of the requirements
applicable to finders, as set forth in the bill, an investor
that is introduced or referred by that natural person to an
issuer, and who purchases securities of that issuer
following that introduction or referral, shall have the
right to pursue any applicable remedy afforded under state
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law, including, without limitation, any applicable remedies
available pursuant to Corporations Code Section 25501.5.
EXISTING FEDERAL LAW AND REGULATION
1. Provides for the Securities Act of 1933, and for its
implementing regulation, Regulation D, which provide a
regulatory framework for the qualification and sale of
securities and for the protection of investors that purchase
those securities. Generally speaking, the Securities Act of
1933 and Regulation D require the sale of all securities to be
registered with the Securities and Exchange Commission (SEC) and
to be structured as prescribed in federal law and regulation,
unless the solicitation is covered by an exemption. They also
require those who offer (i.e., market) and sell securities to be
licensed as investment advisers or broker-dealers, unless either
the transaction or the activity being undertaken is exempt.
2. Contains several exemptions from the requirement for securities
issuers to register the sale of their securities with the SEC,
and includes among those exemptions the sale of securities in
accordance with Regulation D, Rules 501 through 508. Rule 501
of Regulation D defines accredited investors as, among other
things, financial institutions, securities broker-dealers, large
pension plans, corporate entities with assets in excess of $5
million, and other large, financially sophisticated entities.
An accredited investor also includes:
a. Any natural person whose individual net worth, or joint
net worth with that person's spouse, exceeds $1 million at
the time of their purchase of securities, exclusive of their
primary residence; or
b. Any natural person with an individual income in excess
of $200,000 in each of the two most recent years, or joint
income with that person's spouse in excess of $300,000 in
each of those years, together with a reasonable expectation
of reaching the same income level in the current year.
EXISTING LAW
1. Defines "broker-dealer" as any person engaged in the
business of effecting transactions in securities in
California for the account of others or for his or her own
account (Corporations Code Section 25004).
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2. Provides that, unless otherwise exempted from the
requirement to obtain a certificate from the commissioner,
no broker-dealer may effect any transaction in or induce or
attempt to induce the purchase or sale of any security in
California unless that broker-dealer has first applied for
and secured from the commissioner a certificate authorizing
that person to act in that capacity (Corporations Code
Section 25210).
3. Authorizes several exemptions from the requirement to hold
a certificate as a broker-dealer, including persons without
a physical location in California, who sell only to
specified persons in California and only under specified
circumstances (Section 25200); real estate brokers and
financial institutions, under certain circumstances
(Sections 25206 and 25207); and persons licensed under the
Capital Access Company Law (Section 25208).
4. Further provides that "broker-dealer" does not include
several persons, including, among others, banks; trust
companies; savings and loan companies; real estate brokers;
options exchanges certified by DBO; individuals who trade
for their own accounts or in some fiduciary capacity, but
not as part of a regular business; issuers; and agents, when
they are employees of broker-dealers or issuers (Section
25004).
5. Authorizes DBO to pursue the following types of enforcement
actions against persons who are not licensed as
broker-dealers, but who are acting in a manner that requires
such licensure. DBO may:
a. Issue an order to desist and refrain from the
activity or activities that warrant licensure, until the
required license is obtained (Section 25532).
b. Levy an administrative penalty of up to $5,000 for a
first violation, up to $10,000 for a second violation,
and up to $15,000 for a third and subsequent violation
(Section 25252), and include in the administrative action
imposing such penalty a claim for ancillary relief,
including but not limited to a claim for restitution or
disgorgement or damages on behalf of persons injured by
the act or practice giving rise to the action (Section
25254).
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c. Take possession of the property, business, and
assets of such person (Section 25253).
d. Bring an action in the name of the people of the
State of California in Superior Court to enjoin the acts
or practices of the person violating the law and enforce
compliance, and, if the commissioner determines it is in
the public interest, to include in that action a claim
for ancillary relief, including but not limited to a
claim for restitution or disgorgement or damages on
behalf of persons injured by the act or practice
constituting the subject matter of the action (Section
25530).
6. Provides that a person who purchases a security from or
sells a security to a broker-dealer that is required to be
licensed and who has not, at the time of the sale or
purchase, applied for and secured from the commissioner a
certificate in effect at the time of sale or purchase, may
bring an action for rescission of the sale or purchase, or,
if the plaintiff or the defendant no longer owns the
security, for damages, as specified (Section 25501.5).
COMMENTS
1. Purpose: This bill is sponsored by the Corporations
Committee of the Business Law Section of the California
State Bar to promote and facilitate a regulatory framework
to govern the activities and accountability of finders,
provide statutory and regulatory certainty for finders and
the businesses that rely upon them, and protect investors.
2. Background: According to this bill's sponsor, "it is widely
recognized among business participants that many individuals
and entities act as 'finders' in the State of California in
connection with securities transactions. Finders -
generally viewed under California law to mean persons who
introduce issuers and investors to each other without
negotiating on behalf of either party - are often critical
to the success of capital-raising efforts by start-up
companies and other small to mid-sized companies that would
otherwise be unable to engage a broker-dealer or access
needed capital. In fact, it is believed that this is the
method by which a vast majority of capital is raised to fund
early stage businesses.
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"The vast majority of these finders are not registered as
broker-dealers, often resulting in inadvertent violations of
broker-dealer registration requirements. Thus, by relying
on finders, these companies risk severe consequences of
engaging a finder who could be viewed as having engaged in
illegal broker-dealer conduct. Furthermore, these risks are
either often not known or just ignored by issuers and
finders.
"The lack of certainty continues to jeopardize finders and the
businesses which rely upon them for crucial funding, as well
as other investors."
3. Discussion: This bill is intended to create regulatory
certainty for finders and the businesses which use them, by
codifying a set of activities that will be legal when
performed by persons without a broker-dealer license, who
meet the bill's definition of a finder, and who comply with
the bill's requirements for finders. This bill's sponsor
and supporters believe that by creating a bright-line which
clearly distinguishes allowable finder activities from those
which do not meet the bill's definition of finder
activities, the bill will encourage persons who act as
finders to comply with the bill's requirements. The value
of the bill to persons who follow it is the assurance that
they need not become licensed as broker-dealers. Persons
who do not meet the bill's finder definition may require
licensure as broker-dealers, depending on their activities.
As amended on May 23, 2014, the bill is also clear regarding the
remedies available to investors, issuers, and the
commissioner, if a person fails to comply with the bill's
requirements. In its current form, the bill clarifies all
of the following:
a. A person who fails to meet the definition of a
finder set forth in the bill, and who fails to satisfy
all of the conditions set forth in the bill, may be
determined to be a broker-dealer by the commissioner.
Existing State Law Number 5a through 5d above describes
the different types of enforcement actions DBO may bring
against unlicensed persons who are required to hold
broker-dealer licenses.
b. If a person who fails to meet the definition of a
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finder set forth in the bill, and who fails to satisfy
all of the conditions set forth in the bill, introduces
or refers an investor to an issuer, and that investor
purchases securities of that issuer following the
introduction or referral, the investor has the right to
pursue any applicable remedy afforded under state law,
including, without limitation, any applicable remedies
available pursuant to Section 25501.5 (i.e., rescission
or damages; see Existing State Law Number 6 above).
c. Each introduction or referral of a potential
investor to an issuer by a finder must be covered by a
written agreement that must be signed by the finder, the
issuer, and the potential investor. That agreement must
contain a provision stating that the parties to the
agreement have the right to pursue any available remedies
at law or otherwise for any breach of the agreement.
This language is intended to ensure that contractual
remedies are also available to both an issuer and an
investor, if a finder fails to comply with the provisions
of the bill.
4. On The Other Hand: Although no letters of opposition to
this bill were received by this Committee, an alternate
interpretation of its merits is possible. Under this
alternate interpretation, the bill reflects the reality that
there are too many individuals engaged in promoting
securities transactions in California for DBO to adequately
supervise and regulate, and codifies DBO's existing practice
of failing to bring enforcement actions against certain
finders who are acting as broker-dealers without being
properly licensed.
This alternate interpretation is not entirely unfounded.
California is home to approximately 3,100 licensed
broker-dealer firms, which employ approximately 285,000
agents, and to approximately 3,600 licensed investment
adviser firms, which employ just over 50,000
representatives. An unknown number of persons are
inappropriately operating as broker-dealer agents and
investment adviser representatives without a license. In
total, at least 340,000 persons and firms offer investment
advice to Californians. As described immediately below,
they do so with very little regulatory oversight.
Because of historic funding shortfalls, California does not
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perform regular, periodic regulatory examinations of its
broker-dealers, their agents, or its investment advisers or
their representatives to ensure compliance with state
securities laws and discourage misconduct. Although many
other states regularly examine their securities licensees at
least once every four years, DBO's broker-dealer and
investment adviser examination frequency averages once every
28 years. Often, it takes a complaint from an investor or
another state or federal regulator before DBO examines a
California securities licensee.
Legislation enacted last year (SB 538, Hill, Chapter 335,
Statutes of 2013) was intended to provide DBO with
sufficient securities examiners to achieve a four-year
examination frequency. However, because DBO's request to
hire more staff must be approved through the budget process,
the 2014-15 State Budget must be adopted, before DBO can
extend any job offers to new securities examiners. To date,
no additional examiners have been hired.
Should we respond to the current reality by codifying DBO's
existing practice of failing to sanction persons who are
violating certain state securities laws? Or should we,
instead, ensure that DBO has adequate staff with which to
enforce existing law?
5. Summary of Arguments in Support:
a. The Corporations Committee of the Business Law
Section of the California State Bar is sponsoring this
bill for the reasons summarized in the background and
discussion sections above. "The State Bar Corporations
Committee believes that there is a need for some form of
limited regulation of finders as an essential component
of an efficient capitals market. AB 713 effectively
addresses this need by creating a straightforward
definition of finder and clarifying the precise
activities in which a finder may or may not engage.
Moreover, we believe that the reporting and informed
consent requirements under AB 713 help ensure greater
accountability, investor protection, and regulatory
oversight."
b. Three firms and one attorney sent identical letters
of support, in which they state, "By providing clear
guidance and establishing meaningful reporting and other
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requirements for finders, AB 713 will ensure better
market transparency, proper accountability, and
additional investor protection while at the same time
facilitating capital formation for business entities in
California." Entities submitting these letters include
the Law Offices of Joseph W. Carroll, Fortis General
Counsel, Townsend & Styer Maintenance Co., and attorney
Andrew Gross, with Russ, August, & Kabat.
6. Summary of Arguments in Opposition: None received.
LIST OF REGISTERED SUPPORT/OPPOSITION
Support
Corporations Committee of the Business Law Section, California
State Bar (sponsor)
Andrew Gross
Fortis General Counsel
Law Offices of Joseph W. Carroll
Townsend & Styer Maintenance Co
Opposition
None received
Consultant: Eileen Newhall (916) 651-4102