Happy Friday, Funds Family!

Today we’re diving into the wild world of broker-dealer laws—yes, those ever-present rules that can make or break your fund’s investor-sourcing strategy.

Understanding these regulations is crucial. So, grab your coffee ☕ and let’s break it down in plain English!

But first…

We’re about to release the results of our 2025 Market Sentiment Survey — a snapshot of how GPs and LPs are thinking about the year ahead.

If you’d like early access, here’s how it works:

Just share Fundamentals with a friend using the link below. 👇️ Once they subscribe, we’ll add you to the early access list and notify you as soon as the report is ready.

Thanks for reading! Now let’s get back to the article 😃 

📜 What are Broker-Dealer Laws?

Under the Securities Exchange Act of 1934 (Exchange Act), a 🔗 broker is generally defined as any person engaged in the business of buying and selling securities for the account of others. A 🔗 dealer is someone who is engaged in the business of buying and selling securities, but for their own account.

⚠️ Warning: The Securities and Exchange Commission (SEC) interprets what it means to be “🔗 engaged in the business” of buying and selling securities quite broadly.

So, someone who trades securities for others is clearly a broker-dealer, but you may also be considered to be acting as a broker-dealer if you engage in any of the following activities:

• Finding investors for funding rounds or capital raises

• Finding buyers or sellers of businesses

• Operating a platform enabling the trading of securities

• Providing services to registered broker-dealers

In general, the SEC applies a four-factor test to determine if someone who engages in the above activities would need to register as a broker-dealer:

1. Transaction-Based Compensation: Receiving commissions or fees tied to deal success.

2. Transaction Facilitation: Participating in solicitation, negotiation, or execution of securities transactions.

3. Regularity: Engaging in these activities on a recurring or sustained basis.

4. Public Representation: Marketing oneself as being in the business of raising capital or facilitating securities transactions.

Some SEC guidance also highlights handling investor funds or securities as an additional factor.

By far, the biggest issue is when someone’s compensation is tied to the success or size of a deal. The SEC has long treated transaction-based fees as a hallmark of broker-dealer activity—even if the other factors aren’t present (more on this below).

If you’re getting paid for making introductions, handling deals, or connecting investors with funds, that’s when these rules start waving a big red flag at you. 🚩

🏛️ What Requirements Apply to Broker-Dealers?

You can’t legally act as a broker-dealer without registering with the SEC and becoming a member of the Financial Industry Regulatory Authority (FINRA). On top of that, you may also need to register in each state where you operate.

Here’s what else applies:

• Anti-Fraud Rules:
  Broker-dealers must comply with strict anti-fraud laws, including 🔗 Section 10(b) of the Exchange Act and 🔗 Rule 10b-5. There’s zero tolerance for deceptive practices.

• Conduct Standards:
  Broker-dealers are held to a suitability standard—making sure recommendations fit the investor’s profile—but since 2020, they’re also subject to🔗 Regulation Best Interest (Reg BI), which requires them to act in retail investors’ best interest when making recommendations.

Bottom line: Broker-dealers face real regulatory obligations, both federally and at the state level.

🚨 What’s the Risk of Using an Unregistered Broker-Dealer?

Companies that use unregistered brokers—or individuals acting as brokers without proper registration—can face serious legal and financial consequences. These include:

• Lawsuits & Enforcement Actions: Both the company and its leadership may face civil or criminal penalties from regulators or private lawsuits from investors. Penalties can range from fines to, in severe cases, criminal charges.

• “Bad Actor” Disqualification: Violations can trigger disqualification from relying on common private offering exemptions (like 🛠️ Rule 506(b) and 🛠️ 506(c)), restricting future fundraising options.

• Rescission Risk: Investors may have the right to demand their money back, plus interest. If the company has already used the funds, this can create significant financial strain.

• Future Fundraising Barriers: Noncompliance in earlier rounds may scare off future investors, who often require proof of past compliance before committing capital.

🤔 Why Should Private Funds Care?

How you source investors matters (a lot). Many private funds lean on third parties—like finders, placement agents, or even friends in the ecosystem—to help bring in capital.

But there’s a fine line between lawful capital raising and broker-dealer activity, and private funds often find themselves somewhere along that spectrum.

🚦 The Broker-Dealer Continuum

Think of this as a sliding scale:

🟢 Low Risk:

At one end, you may have, for example, a fund-of-funds raising capital from its own investors to deploy into other funds. In that case, the fund is raising money for itself—it’s not being paid to introduce investors to someone else’s offering.

That activity generally doesn’t trigger broker-dealer concerns.

🔴 High Risk:

At the other end of the spectrum, you have a person or entity being directly compensated—whether through fees, carry, or other economic benefits—for connecting investors to a specific fund or deal.

That’s classic broker-dealer activity and will almost always require registration.

🟡 Gray (Yellow?) Area:

The murky middle includes forming a special purpose vehicle (SPV) to pool investors into a single fund or deal.

On its face, forming an SPV isn’t broker activity. But the risk increases when the person organizing or managing the SPV is effectively being compensated by the underlying issuer based on the amount or success of the capital raised.

That compensation might come in the form of carried interest, transaction-based fees, or even preferential side letter terms tied to the raise. People raise these SPVs all the time, but they might not be entirely without risk.

Takeaway: The SEC doesn’t just look at the paperwork—it looks at the economic reality. If your compensation structure suggests you’re being paid to source investors (even indirectly), you may be creeping into broker-dealer territory.

✅ Exemptions & Safe Harbors: The Silver Linings

The good news is that not every investor introduction triggers broker-dealer registration. There are two common exemptions—the M&A Exemption and the Finders Exemption—but the exceptions are narrow, fact-specific, and often misunderstood.

The M&A Broker Exemption

One statutory exemption that does exist is for M&A brokers under 🔗 Section 15(b)(13) of the Exchange Act. This exemption applies to individuals or entities involved solely in facilitating the transfer of ownership of certain privately held companies. But it’s narrow and comes with detailed conditions.

For example, M&A brokers cannot:

• Handle funds or securities in the transaction;

• Participate in public offerings;

• Represent both buyer and seller without clear written disclosure and consent;

• Facilitate transactions involving passive buyers or shell companies (with limited exceptions for business combination-related shells);

• Provide financing for the deal, or assist in arranging financing with third parties without proper disclosure and compliance with applicable laws;

• Form groups of buyers to acquire the company; or

• Bind parties to the transaction.

In addition, the exemption applies only to transfers of ownership of eligible privately held companies that meet certain financial thresholds—specifically, companies with less than $25 million in EBITDA or $250 million in gross revenues in the preceding fiscal year.

The So-Called “Finders Exemption”

Unlike the M&A exemption, there is no formal exemption for finders under federal law. Instead, what’s often referred to as the “Finders Exemption” comes from a handful of narrow, fact-specific no-action letters—most notably a 🔗 1991 SEC no-action letter involving musician Paul Anka.

In the letter, the SEC staff indicated they would not pursue enforcement against Mr. Anka, who introduced potential investors to a company in exchange for a fee, so long as he played a very limited role.

That limited role came with strict conditions. Specifically, he could not:

• Participate in negotiations between the company and investors,

• Advise the parties or assess the value of the securities,

• Assist in obtaining financing,

• Prepare or distribute offering materials, or

• Conduct due diligence or provide transaction analysis.

In other words, the finder’s role was limited to making introductions—and nothing more.

Since that time, the SEC has distanced itself from the idea of a broad finders exemption. In 2010, the 🔗 SEC staff expressly declined to extend similar no-action relief to a law firm seeking to receive a transaction-based fee for capital introductions, reaffirming that receiving success-based compensation is a strong indicator of broker activity.

Courts have also rejected arguments that an unregistered finder can rely on this exemption. And while the SEC 🔗 proposed a conditional exemption for finders in 2020, that proposal was never finalized and does not appear to be moving forward.

The takeaway: The so-called Finders Exemption is, at best, a narrow and unreliable path. Anyone engaging in finder activity today—especially if they’re receiving compensation tied to capital raised—should assume they are at risk of being treated as an unregistered broker.

A Note on State Blue Sky Laws

Even if you’re compliant or are able to find an applicable exemption at the federal level, state securities laws may impose additional requirements. Many states have their own registration rules or exemptions for finders and unregistered brokers. It’s critical to check state laws before engaging any intermediary.

💪 Best Practices to Keep You in the Clear

Here’s how you can sidestep potential pitfalls and keep your fund’s investor-sourcing strategies in the green zone:

1. Clarify Roles Early:
   Clearly document who is involved in investor outreach and what their role is—from advisors to finders. This helps flag any activities that might cross into broker-dealer territory.

2. Structure Compensation Carefully:
   Avoid success-based fees or commissions tied to capital raised. Instead, consider flat fees or retainer-style payments that reflect time and effort, not outcomes.

3. Stay Informed & Get Legal Advice:
   Broker-dealer regulations evolve. Stay current with SEC and FINRA guidance, and when needed, consult experienced legal counsel for a legal opinion or, in specific cases, a no-action letter.

/ WRAPPING THE CASE

/ JURY TRIAL

Have you enjoyed this newsletter? Don’t forget to share it with your GP, Co-GP, LPs, or anyone else you think might find it valuable!

You can also propose a topic that you would like us to cover! Just reply to this email or submit your suggestions 🔗 here.

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.