LEGAL ALERT: New Law Could Bankrupt Companies Issuing Securities

Governor Schwarzenegger signed Assembly Bill 2167 into law effective creating what could be the single greatest threat to your business in its history. Understanding this issue could save your business.

The law is aimed at deterring individuals and entities from operating as unlicensed securities broker/dealers.  Unfortunately, the law could yield dangerous and un-intended consequences for you as the business owner.

Privately-held, middle-market companies seeking to raise capital or sell their entity generally cannot access traditional investment banks or qualified private equity groups, thus they use ãintermediariesä or ãfindersä who are wired-into networks of investment groups and understand the process.  If the company seeking capital deals directly with the investors without an intermediary thereâs no problem.  If the ãfinderä limits his behavior strictly to ãfindingä, then thereâs no problem either.  That is rarely done, however, and the results can be devastating under the new law.

What is a finder?  A finder, within the meaning of the law, is an individual or entity that merely introduces a company to an investor or visa versa.  Period.  Thatâs it.  The finder may not convey any information about the company either in writing or verbally, with the exception of the contact information.  The moment a finder behaves in a manner inconsistent with this definition, he or she has acted as an unlicensed securities broker/dealer, thus invoking the nastiness of the new law.  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 broker-dealers if their compensation is in any way conditioned upon the closing of the arranged transaction.

Until recently, most placements of securities by unlicensed persons ran little risk to the "finder" or the issuer of the securities.  It used to be that the worst that could happen if a finderâs behavior bled off into the gray area of unlicensed securities selling, ( i.e. conveying the Private Placement Memorandum and ãpitchingä investors with the story) was the finder couldnât enforce his fee payment from the company issuing the securities.  Now the table is turned on the company selling the security.

Implications of the Law:  If it is found that the finder behaved outside the parameters of ãfindingä then the company selling the security (through the unlicensed broker/dealer) is subject to a ãright of rescissionä for five years from the transaction date.  That means that the investor has a five-year look back on his investment in your business and if he doesnât like how itâs going he can demand his money back.  Think about what it would mean to the working capital and capital structure of your business to have to return the amount of money you raise in a private placement at any given time in the five years following the capital raise.  Most companies would not be able to do it and thus would seek protection and file bankruptcy.  What would happen if you had to return your retirement ãnest eggä because you used an unlicensed broker-dealer when you sold your company?

This right of rescission also threatens the financial position of a company hampering its ability to raise capital in the future, including its ability to undertake an initial public offering and complicating, materially, the ability to sell the company in the future, given the contingent liabilities.  Given the rampant activity of unlicensed intermediaries, it is just a matter of time until this law is fully tested in court.

Recommendations:  As suggested above, given the risks associated with this new law, and until we receive guidance from California courts to the contrary, we would strongly advise issuers to only used licensed broker/dealers when recapitalizing or selling securities in their company.

Contact us for information on how to arrange a presentation to your firm.