Despite the record success of many initial coin offerings (ICOs), increasing capital for ICOs is a tricky process. It is tempting to accept help anywhere one can get it, and there's absolutely no shortage of persons and companies clamoring to “find” or refer shareholders in exchange for a little commission in the form of fiat money or tokens.
These companies and persons may be required to enroll as “broker-dealers” under various federal and state laws before they may make such referrals. To avoid those headaches, this article explains the differences between broker-dealers and finders, and provides some helpful advice on how to properly utilize them. To help simplify matters, this post will only address ICOs that are securities offerings rather than comment on non-securities offerings of utility tokens.
Broker-dealers are primarily regulated under the Securities Exchange Act of 1934 (the “Exchange Act”). In addition, many countries also govern broker-dealers throughout their securities legislation, commonly known as “blue sky laws.” As an example, California law provides a right of rescission recovery of additional monetary damages, and an elongated statute of limitations for investors against an unlicensed broker-dealer.
Overseeing almost 3,800 brokerage firms and approximately 634,000 registered brokers, the Financial Industry Regulatory Authority (“FINRA”) is the largest independent regulator for all securities firms doing business in the United States.
The Exchange Act makes it unlawful for any broker or dealer to “effect any transactions in, or to induce or attempt to induce the purchase or sale of, any collateral” unless that broker or dealer is registered with the SEC. Speaking generally, ICOs raising capital, and the persons or businesses helping ICOs raise such funds, usually do not have to worry about registration issues involving traders.
However, there are a few situations which could certainly involve traders, but more frequently, the issue is whether companies or persons helping raise capital on behalf of their ICO must register as brokers. A person who refers a potential investor to a ICO and receives in return either a commission based on the trade or a finder’s fee is probably a broker within the definition of the Exchange Act.
If this is so, the failure to register as such may result in serious adverse effects to the individual termed an unregistered broker-dealer, such as injunctive or disciplinary action against the person or company, the prohibition of such person or company from registering as a broker-dealer in the future, and vulnerability to law suits, fines, and penalties, and even criminal prosecution.
The law And Broker-Dealers
The Exchange Act defines a “broker” as “any individual engaged in the business of effecting transactions in securities for the account of others,” along with a “dealer” as “any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise”.
In short, a broker sells securities for clients, even though a dealer sells securities for itself. In deciding if a person or a business is a broker or a dealer, the SEC looks at the actions in which the individual or business actually engages. Note that the SEC looks at “activities,” and not just one “activity”.
While one specific activity may not require registration as a broker or dealer, other activities may require it. ICO promoters must become sufficiently trained to at least examine on a broad basis how various activities are considered from the decisions of national courts and the SEC's no-action and interpretive laws.
ICOs utilizing finders must be careful to make sure that the claimed finder truly is a legitimate, true finder. ICO promoters should conduct due diligence to the finder's previous activities and proposed future activities adequate to identify whether the finder has conducted unregistered broker-dealer services previously, and if that finder is or isn't likely to take part in broker-dealer actions before or during the ICO.
In an engagement letter with a finder, ICO promoters should think about including indemnification clauses for any liability incurred by the ICO because of the finder's failure to enroll as a broker-dealer, if enrollment turns out to be demanded by law. Additionally, ICO promoters may consider getting representations and warranties from the finder that it is not a broker-dealer and is therefore not required to enroll as a broker-dealer.
Providing covenants that clearly spell out prohibited activities might be useful both in educating unsophisticated finders about the broker-dealer legislation, as well as devoting the ICO with a breach of contract claim against the finder for any such violations.
In analyzing whether a party is a registered broker, the first step should be to confirm registration by using the FINRA BrokerCheck tool located at: finra.org/brokercheck
Next, ICO promoters should carefully investigate the broker-dealer's credentials to ensure that the broker-dealer is capable of supplying the all of the services that you require out of it and finally increase the funds it asserts to be able to. After retaining a broker-dealer, the ICO should work in tandem with the broker-dealer to make certain that it conducts the offering from the way required to use the securities exemptions that the ICO should rely upon.
Initial Coin Offering Advisors Conclusion
All of broker-dealers are finders, but maybe not all of finders are broker-dealers. Typically, finders don't need to be registered under federal and state legislation, but broker-dealers do.
In most cases, if a person or company does anything aside from only provide an introduction of a possible investor to a ICO, or requires reimbursement that is determined by the if the investment or how much investment is made, then that person or company is a broker-dealer and must be registered with the appropriate authorities.
ICOs that opt to leverage the employment of finders or broker-dealers should take steps to minimize their legal exposure to liability against claims regarding the use of unregistered broker-dealers or illegal finders to be able to guarantee a successful and legal ICO.