SEC’s Division of Trading and Markets Issues FAQs on Crowdfunding Intermediaries

By:  Susan Wong

(May 16) The SEC’s Division of Trading and Markets has published Frequently Asked Questions guidance on its website regarding the implementation of the crowdfunding intermediary provisions of Title III of the JOBS Act. The crowdfunding exemption will require issuers to use intermediaries – either a broker or a “funding portal” registered with the SEC – to complete crowdfunded offerings. Funding portals will also be required to become members of a national securities association registered under Section 15A of the Exchange Act. Currently, FINRA is the only such association in existence.  Intermediaries will be subject to the duties and prohibitions prescribed by the JOBS Act, the rules and regulations the SEC will adopt thereunder, as well as the rules and regulations of their applicable association.

Please note that the FAQs (i) are subject to update and revision at any time, (ii) are not rules, regulations or statements of the SEC, and (iii) have been neither approved nor disapproved by the SEC.  The crowdfunding intermediary FAQs can be found at: http://www.sec.gov/divisions/marketreg/tmjobsact-crowdfundingintermediariesfaq.htm

Currently, the FAQs provide as follows:

Responses to Frequently Asked Questions

Question 1.

I would like to operate a crowdfunding intermediary. Am I required to register with the SEC before doing so?

Answer:

Yes. You must register with the SEC either as a broker or as a funding portal.

Please keep in mind that the SEC still has to write rules to implement the crowdfunding provisions of the JOBS Act. Until the SEC has completed this rulemaking, you cannot act as a crowdfunding intermediary, even if you are already a registered broker. The Division of Corporation Finance also has reminded issuers that any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws until the SEC’s rulemaking is complete.

Question 2.

How do I register with the SEC as a funding portal?

Answer:

The SEC must adopt rules governing funding portals before permitting anyone to register with the SEC as a funding portal. These rules will address the form and process needed to register with the SEC as a funding portal.

Funding portals also must become members of a national securities association that is registered under Section 15A of the Exchange Act. Today, FINRA is the only national securities association in existence that is registered under Section 15A of the Exchange Act.

Question 3.

I would like to operate as a funding portal. Do I need to register with the Financial Industry Regulatory Authority (FINRA)?

Answer:

All funding portals must become members of a national securities association that is registered under Section 15A of the Exchange Act, in addition to registering with the SEC. Today, FINRA is the only national securities association in existence that is registered under Section 15A of the Exchange Act.

Question 4.

Are there are any limitations on what a funding portal can do?

Answer:

Among other things, the JOBS Act imposes several restrictions on the activities of a registered funding portal. A funding portal is not permitted to:

  • provide investment advice or make recommendations;
  • solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;
  • compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal;
  • hold, manage, possess, or otherwise handle investor funds or securities; or
  • engage in any other activities the SEC determines to prohibit in its crowdfunding rulemaking.

In addition, each funding portal and each crowdfunding broker is prohibited from:

  • compensating promoters, finders, or lead generators for providing the intermediary with the personal identifying information of any potential investor; or
  • allowing its directors, officers, or partners (or any person occupying a similar status or performing a similar function) to have a financial interest in any issuer using the services of the intermediary.

Question 5.

I would like to operate a crowdfunding intermediary. In addition to registering with the SEC and a national securities association, what should I know?

Answer:

There are many considerations in determining whether to operate a crowdfunding intermediary. At a minimum, you should understand the legal obligations that the JOBS Act assigned to crowdfunding intermediaries. For example, crowdfunding brokers and funding portals have significant duties under the JOBS Act to provide information to investors, reduce the risk of fraud and, where required under the Act, ensure that investors and issuers satisfy the requirements outlined in Title III of the JOBS Act.

The JOBS Act requires these intermediaries to, among other things:

  • provide disclosures that the SEC determines appropriate by rule, including regarding the risks of the transaction and investor education materials
  • ensure that each investor: (1) reviews investor education materials; (2) positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and (3) answers questions that demonstrate that the investor understands the level of risk generally applicable to investments in startups, emerging businesses, and small issuers and the risk of illiquidity;
  • take steps to protect the privacy of information collected from investors;
  • take such measures to reduce the risk of fraud with respect to such transactions, as established by the SEC, by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person;
  • make available to investors and the SEC, at least 21 days before any sale, any disclosures provided by the issuer;
  • ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest;
  • make efforts to ensure that no investor in a 12-month period has purchased crowdfunded securities that, in the aggregate, from all issuers, exceed the investment limits set forth in section Title III of the JOBS Act; and
  • any other requirements that the SEC determines are appropriate.

In addition, under the JOBS Act, an intermediary should be aware of the prohibited activities listed in response to Question 4.

For more information regarding this Alert, other provisions of the JOBS Act or crowdfunding initiatives, contact John McIlvery, Group Chair of SAM’s Public Securities practice area at (818) 444-4502.

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