The SEC’s Associated Persons Rule

Ask the owner of any startup business venture what his or her biggest hurdle is and 9 out of 10 will say “raising money.”  Even in a good economy, most lenders are hesitant to risk their capital on new ventures, which leaves most entrepreneurs scrambling for equity capital.

Raising equity capital, however, is not cheap.  It also requires compliance with some very complex laws; namely the Securities Act of 1933, the Securities Exchange Act of 1934 and the securities laws of whatever state(s) where investors are located.  Strict compliance with these laws is a must. 

Most small business startups raise equity capital through exempt offerings.   The “exempt” reference refers to the fact that these offerings are exempt from public registration with the Securities and Exchange Commission (“SEC”) .  Nonetheless, even an exempt offering takes time and money to be successful.

Due to a tight budget, most startups seek ways of minimizing the costs of a private offering.  They usually focus on what advisor(s) can be eliminated from the process.  Accountants (who have to prepare the financial projections for investors) and attorneys (who must prepare the private placement memorandum and handle Federal and state exemption filings) almost always survive the cut.  Broker-dealers, however, sometimes are supplanted for the business owner himself, who wants to tap his own network of contacts, or other officers of the business with similar connections.  These individuals do not have to be licensed broker-dealers and are able to solicit investors without a broker-dealer license under the SEC’s “Associated Persons Rule.”  

What the Associated Persons Rule says is that an associated person of an issuer of securities shall not be deemed to be a broker solely by reason of his participation in the sale of the securities of such issuer if the associated person:

(a) Is not subject to a statutory disqualification, as that term is defined in Section 3(a)(39) of the Securities Exchange Act of 1934, at the time of his participation; and

(b) Is not compensated in connection with his participation by the payment of commissions or other remuneration based either directly or indirectly on transactions in securities; and

(c) Is not at the time of his participation an associated person of a broker or dealer; and

(d) Meets certain other conditions .

Simply put, a business owner’s use of the Associated Persons Rule to save money on broker-dealer fees should only be undertaken after careful consultation with their attorney.  Securities law is complicated and the consequences for non-compliance are severe; the smart businessperson needs to be proactive and be educated about the pitfalls before wading into the pond of equity investment capital.