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Legality of Finder's Fees in Securities Sale Transactions

Alot of money is raised every year by independent entertainment product producers utilizing sales personnel who are not licensed securities broker/dealers or licensed securities sales persons. As far as that goes, this practice is not limited just to the entertainment business.

As a matter of course, it is virtually impossible for new producers or those without a significant track record to attract licensed sales assistance from a broker or investment banking firm. As a result, producers often pay "finders fees" as compensation to those helping them raise $ for their project(s).

Finder's fees are more problematic than most producers know or want to believe. I can't really blame someone for pulling out all the stops in trying to get their project funded. What I'm attempting to do in this legal guide is share some of my insights gained through years of law practice in this area. Additionally, whether they're referred to as finder's fees, associate producer fees or executive producer fees, it's substance over style (what's in a name?) when it comes to the legality of money paid to someone assisting in the sale of a security.

For ease of analysis, we'll assume the security involved in this discussion is a percentage membership interest in a manager-managed limited liability company. The very nature of this structure places the investment transaction(s) within the purview of securities and broker/dealer regulation because the investment is "passive" and does not involve meaningful active participation by the investor in the business of the company.

First of all, most state jurisdictions do not permit finders fees. Period. What this means is if you've solicited and received investment from a person domiciled in Ohio, for example, and paid anyone other than a licensed broker or securities sales person a percentage of the investment raised, you've violated state law. If the state securities regulator finds out about it, they'll investigate and hit you with penalties and a "cease and desist" order that among other problems, you'll have to disclose to other potential investors, regardless of the state they are located in. This is called disclosure of a material fact; required by all securities regulations.

In addition, violation of broker/dealer laws provides an instant civil cause of action by any investor in your project, regardless of whether the particular investor's investment involved the illegal commission, for rescission (your money back), statutory interest and attorneys fees.

There are a few states that allow finders fees. Michigan and Texas actually have a procedure to register finders and include guidelines, of course, on what is permissable conduct and compensation for registerees. These include the basic rule of finders fee law which is a finder can only make an introduction and cannot participate in the transaction beyond that. The Texas regulation states that a fee can be paid and does not prohibit the payment of a percentage of the investment.

However, in states where finders fees are at least tolerated, such as Nevada, but not "codified" as in Michigan or Texas, the main question can often become, can I pay a percentage of the investment to a finder for a successful introduction?

The SEC has weighed in on this question by answering "no." While the SEC's policy isn't binding on the states, it certainly will be cited by any state desiring to limit how finders are paid. The SEC has promulgated a few criteria to distinguish a finders fee from a licensed broker's fee (commission). The safest course of action is to pay a flat rate or salary based on effort, not results. If you provide this in a finders contract that also is "at will," meaning the contractee's employment can be terminated with or without cause, then you have some latitude in determining who to maintain a longer relationship with. Of course, this involves a great deal of trust between the issuing company and the finder.

I encourage you to look over the regulations for finders in Michigan and Texas. Contact your legislator and see if you can get some action on similar legislation in your state. You can contact the Texas Securities Board at www.ssb.tx.us/ and in Michigan use www.michigan.gov/ofis.

Thanks for listening and keep on truckin'

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