VideoIt's no secret that small businesses have an especially hard time raising capital. But risk-averse banks and investors don't deserve all, or perhaps even most, of the blame, according to some observers. The real culprit, they charge, is federal regulation — in particular, a 70-year-old rule that bars companies from hiring unregistered intermediaries, or "finders," to help them raise money.
The rule, part of the Securities Exchange Act of 1934, was obviously designed to keep middlemen from engaging in securities fraud and other unsavory financial activities (see "Under the Radar," at the end of this article). But critics believe the rule has outlived its usefulness. One is Bill Evers, a retired attorney in San Francisco who is trying to start a chain of weight-management clinics but is unsure where to turn for financing. Evers complains that traditional sources for start-ups, such as venture capitalists, are now more interested in providing second- or even third-round financing, or in refinancing better-established but struggling companies.
Meanwhile, says Evers, small, federally registered broker-dealers that might once have provided capital have either gone under or merged into larger investment banks that don't consider start-ups worth their time. "The system starves start-ups," he insists. While Evers says legitimate but unregistered finders are common, he complains that the rules make them publicity-shy. As a result, he says, "small-business guys can't find the finders."
Support for Evers's views comes from the CEO Council, a group representing some 200 senior executives of public companies whose stocks trade in the over-the-counter market and 150 broker-dealers that back their deals and execute their transactions. In recommendations recently delivered to the Securities and Exchange Commission, the council noted that "a major difficulty facing small business is obtaining equity capital," and that the current regulatory environment, including registration rules for broker-dealers, "unfairly restricts capital formation for small businesses."
Such groups have sought relief from the SEC for years, most recently at a forum on small-business capital formation that the commission held last September. But so far, their demands have fallen on deaf ears. Brian Bussey, assistant chief counsel for the SEC's division of market regulation, told the forum that "the possibility of lesser regulation...is a massive undertaking," and indicated that the commission has yet to receive hard evidence of how companies are being hurt by its broker-dealer registration rules.
A License to Deal
Now, however, the SEC is facing new pressure to reconsider its stance. A task force of the American Bar Association (ABA) has been studying the issue since 2002, and is expected to offer its recommendations to the SEC around the time of the ABA's spring meeting next month. Although details weren't available as this article went to press, experts familiar with the task force's deliberations expect it to recommend that the SEC ease its registration requirements under certain circumstances.
"It is time to seek out a way to permit the capable, honest financial intermediaries who are not presently registered to find a means to attain compliance," stated Hugh Makens, a former securities commissioner for the state of Michigan and a partner in law firm Warner Norcross & Judd LLP in Grand Rapids, in a report he presented at the SEC forum.
Under federal securities law, anyone can become a broker-dealer of securities by obtaining a license from the National Association of Securities Dealers (NASD) and registering with the SEC and state authorities. But because of rising costs and competition, the industry is now dominated by large investment banks.
At the minimum, Makens contends, the commission should ease the registration requirements for finders that limit their services to asset sales. "A significant number of M&A transactions [use] unregistered finders who receive transaction-based compensation," he noted in his report. Yet Makens says many of the deals are legitimate and that more would take place if finders didn't have to obtain a Series 7 license, as NASD and the SEC require, for purposes of promoting stocks. "These finders act more like business brokers" than dealers in securities, he observes.
Makens contends the test involved is essentially irrelevant to M&A transactions. Not to mention time-consuming and costly: the Series 7 exam lasts six hours and typically requires months of preparation. Also, an examinee must be sponsored by a member firm of the NASD.
Take Money, Run
But as Bussey makes clear, the SEC is unconvinced that its registration rules are overly onerous and thus hinder capital formation. Of course, the SEC's priority is to protect investors from fraud, but while it's also required by law to consider the interests of companies, the latter, too, are often victimized by unregistered brokers.
The SEC isn't alone in its defense of registering broker-dealers. In line with the 1934 act, state laws generally prohibit finders that aren't registered with the SEC from accepting payment for transactions. "It's not that difficult to find a broker-dealer willing to raise capital for small business," insists Joe Borg, director of the Alabama Securities Commission and chairman of the enforcement section of the North American Securities Administrators Association. "A lot of issuers don't want to go to the trouble of finding a licensed finder," he adds.
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