Crowdfunding Intermediaries-Questions

On April 5, 2012 President Obama signed the JOBS Act into law. Part of the JOBS Act is the Crowdfunding Act, the full title of which is the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012”.

Intermediary Use and Registration Requirements

Section 302 of the Crowdfunding Act requires that all Crowdfunding offerings be conducted through an intermediary that is a broker dealer or funding portal that is registered with the SEC and a member of a securities organization registered under Section 15A of the Securities Exchange Act of 1934.  Currently that securities organization is the SRO, Financial Industry Regulatory Authority (FINRA).

The Crowdfunding Act carves out a new class of “broker dealer” called “Funding Portals” that can act as Crowdfunding intermediaries.  Section 304 of the Crowdfunding Act provides that Funding Portals are exempt from the broker dealer registration requirements, as long as they are registered with the SEC as Funding Portals and follow all such registration and ongoing rule and reporting requirements.  In accordance with Section 304, Funding Portals must be “subject to the examination, enforcement and other rulemaking authority” of the SEC.  The Crowdfunding Act sets forth many requirements and restrictions for funding portals.  In a previous blog I summarized these restrictions and requirements.

I have been reading all of the comments issued to the SEC in advance of rulemaking and while some offer little to the professional community, others offer a great deal.  I have already blogged on a few.  Today I read a comment letter submitted by Marshall Neel, Esquire who is affiliated with Crowdfunding Offerings, Ltd.  Mr. Neel has submitted several letters to the SEC, of which I have only read one so far.  Mr. Neel’s letter pointed out some glaring open questions and issues that will need to be resolved by the SEC rulemaking.  This blog paraphrases some of Mr. Neel’s insights.

Compensation Restrictions

In addition to being registered with the SEC and the applicable SRO, and a Funding Portal must:

(10) Not compensate promoters, finders, or lead generators for providing the broker or Funding Portal with personal indentifying information of any potential investor.

This provision is hard to interpret and leaves many loopholes that must be addressed in SEC rulemaking.  For instance, it appears that a broker or funding portal could obtain personal identifying information on potential investors as long as they do not compensate the provider.  Third parties could provide the compensation.  Investors may compensate third party aggregation websites and investment advisors to provide their information to funding portals in their search for crowdfunding investments.  The SEC needs to clarify in its rulemaking whether a funding portal or broker faces any aiding and abetting or other liability for accepting such information that they have not paid for.

Moreover, it appears brokers and funding portals can compensate promoters, finders and lead generators as long as the promoters, finders and lead generators do not provide personal identifying information.  So such entities could simply direct potential investors (through a link on the website?) to the funding portal where the investor would provide personal information directly.  The SEC needs to clarify that brokers and funding portals can indeed compensate promoters, finders and lead generators for directing traffic to their site and other outside promotional activities as long as personal identifying information is not included.  Clearly the SEC must define each of the terms, including solicitation, compensation, promoters, finders, lead generators and personal identifying information and the interactions among them.

Solicitation Prohibitions

A funding portal may not solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal.  First, broker dealers may engage in such activities, providing them with a distinct competitive advantage over non broker dealer funding portals.  Mr. Neel points out that broadly construed, a funding portal would not be able to advertise its very existence or promote any offerings on its website in any way, other than just having the website that people may stumble upon.  Moreover, the broad prohibition against solicitation of securities transactions would prevent both the solicitation of investors (purchasers) and the solicitation of Issuing companies (sellers).  Funding portals need guidance on exactly what they can do in promoting their portal and offerings listed with them.

Prohibition Against Handling Funds

A funding portal may not hold, manage, possess, or otherwise handles investor funds or securities.  The SEC needs to be clear on who exactly can hold the funds, and more importantly what is their liability.  What involves managing funds?  If a funding portal gives direction to the escrow holding the funds, are they in essence managing the funds?  How will the escrow agent be instructed to distribute the funds? On whose orders and is this act considered managing or handling funds?  From the escrow agent’s perspective, what is their liability?  Certainly, simply acting on instructions, as a normal escrow agent does, would not create excessive liability, but the tricky part is the management.  What does that mean?  Mr. Neel’s letter indicates that banks and other depository institutions have already raised concerns regarding their perspective liability under the Act.

Information Filing Requirements

A funding portal must “not later than 21 days prior to the first day securities are sold file with the SEC and make available to potential investors all disclosure information required and provided by the Issuer.”  I personally find it perplexing that the funding portal has the filing requirement.  Mr. Neel points out the obvious questions on the requirement.  Who is responsible for the accuracy of the information filed?  Will there be a review process with the SEC?  Can sales begin if there are open comments with the SEC.  Will there be a form and set format for these disclosures (I believe there will). In addition, many of the requirements will require input from professionals such as attorneys and accountants.  For example, dilution effects and share pricing determinations.  Who will be responsible for these explanations, the Issuer or the Funding Portal?

Personally, I foresee this process as being a mix between a 211 application made to FINRA by a market maker on behalf of an Issuer based on information provided by the Issuer and a short form registration process such as Regulation A.  However, that is an assumption, and the SEC needs to clarify.  If the process is too time consuming or onerous, the entire purpose of the Act will be defeated.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.

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