New California Laws Restricting Unlicensed Securities Brokers.

This is a Legal Alert--Not to be construed by any Reader as legal advice.

The California legislature has passed laws that completely change the risks and problems that arise when an unlicensed securities broker (often referred to as a "finder") sells securities to California residents or on behalf of California entities. Both the Company whose securities are sold and the broker now face what can be serious consequences. Because of this, we are "recalling" all prior discussions and advice regarding the limited risks arising out of transactions where a Company uses a "finder" to assist in the sale of its securities.

Until now, most placements of securities by unlicensed persons ran little risk to the "finder" or the issuer of the securities. In 2004, California enacted legislation that effected two major changes in the prior law, and which now make the use of "finders" extremely risky:

A) New Section 25501.5 was added to the Corporations Code. It gives any person who purchases a security from, or sells a security to, an individual/entity that is required to be licensed, but is not, the right to bring an action for rescission of the purchase or sale, or if the security was already disposed of, the right to sue for damages. The statute of limitations is five years, or two years from discovery of the facts by the plaintiff, whichever occurs first.

B) Section 1029.8 of the Code of Civil Procedure was amended to expand its application to persons who should be licensed as a broker-dealer, but are not, and who take a commission (or "finders fee") for selling securities. This section provides that the purchaser can sue the "finder" for damages, and may recover treble damages (limited to $10,000 above the purchase price), and may be awarded attorneys fees and costs.

Existing California authority, as well as authority under Federal securities laws, fairly well establish that a person may not receive transaction-based compensation more than once or twice without being classified as "being engaged in the business of effecting transactions in securities", which classification, under the securities laws, requires one to be licensed as a broker-dealer. It should also be noted that persons who arrange merger and acquisition transactions where securities are exchanged, issued or otherwise involved in the transaction are most likely to be considered to fall into the above classification if their compensation is in any way conditioned upon the closing of the arranged transaction.

If a Company sells its securities in a transaction where an unlicensed broker-dealer is involved, the new law appears to put at risk, for at least two years, the Company's right to retain those funds, since the purchasers have the right of rescission described above. This may not only jeopardize the Company's current financial condition, it may make it much more difficult or impossible for the Company to raise subsequent rounds of financing. Thus, Companies may find unacceptable this new long-term risk to capital raised in this fashion.

In the past, unlicensed California broker-dealers were faced with the highly unlikely potential that the California Department of Corporations or the Securities and Exchange Commission might institute some form of action against them. They ran the more realistic risk that their commission arrangement was not enforceable in a Court. However, both of these risks were largely academic. Now, an unlicensed broker-dealer may face financial ruin, as he or she is essentially providing a guarantee to the investors of the investment that they make. Under these circumstances, many "finders" may find it too risky to continue to participate in securities transactions without a proper license.

For more information, please refer to Assembly Bill No. 2167.


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Niesar & Vestal LLC is a San Francisco Business Law Firm with a diverse transactional and litigation practice. Our clients include individuals, emerging businesses, government entities and publicly held companies. 



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