Compliance Guide for Intermediaries | DART – Deloitte Accounting Research Tool

Regulation Crowdfunding: A Small Entity Compliance Guide for Crowdfunding Intermediaries[1]

Introduction

In 2015, the Securities and Exchange Commission (“SEC” or “Commission”) adopted new rules and forms to permit companies to offer and sell securities through crowdfunding2 in reliance on the exemption under Section 4(a)(6) of the Securities Act of 1933 (“Securities Act”). These new rules implement the requirements of Title III of the Jumpstart Our Business Startup (“JOBS”) Act, which added Sections 4(a)(6) and 4A to the Securities Act and Sections 3(h) and 12(g)(6) to the Securities Exchange Act of 1934 (“Exchange Act”).

This guide is only intended to summarize and explain the substantive requirements for crowdfunding intermediaries (i.e., registered broker-dealers and funding portals).

For more information on the compliance and registration requirements, you should refer to the adopting release for Regulation Crowdfunding.3 For information regarding registration of funding portals, you also may refer to the Small Entity Compliance Guide for Registration of Funding Portals. For information regarding issuer requirements, you also may refer to the Small Entity Compliance Guide for Issuers.

Who Can Act as a Crowdfunding Intermediary

To rely on the Regulation Crowdfunding exemption, a crowdfunding issuer must conduct its offering exclusively through an online platform operated by an intermediary that is registered either as a broker-dealer or as a funding portal.

a. Registration Requirements

If you are a registered broker-dealer and a member of FINRA,4 then you do not need to submit an additional registration form with the SEC to engage in crowdfunding.5

If you are not registered (and do not intend to register) as a broker-dealer but wish to act as an intermediary in crowdfunding transactions, you must register with the SEC as a funding portal on Form Funding Portal.

A funding portal is a crowdfunding intermediary that, in accordance with Section 304(b) of the JOBS Act and Exchange Act Section 3(a)(80), can engage in only limited activities. In particular, among other things, it cannot:

Offer investment advice or recommendations;
Solicit purchases, sales or offers to buy the securities offered or displayed on its platform;
Compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its platform; or
Hold, manage, possess, or otherwise handle investor funds or securities.

Therefore, if you engage in, or plan to engage in, any of these activities, you must register as a broker-dealer rather than as a funding portal to act as an intermediary in crowdfunding transactions. For information on how to register as a funding portal, please see the adopting release for Regulation Crowdfunding and the Small Entity Compliance Guide for Registration of Funding Portals.

In addition to registering with the SEC, all crowdfunding intermediaries must also become a member of a registered national securities association. FINRA is currently the only registered national securities association in existence today.6

Requirements for Intermediaries

Each crowdfunding intermediary (whether a broker-dealer or funding portal) is required to:

Provide investors with the most current and up-to-date educational materials that explain, among other things, the process for investing on the platform, the types of securities being offered and the risks associated with each type of security, the information an issuer must provide to investors, resale restrictions, investment limits, information on the restrictions for canceling an investment commitment, that the investor must consider the appropriateness of an investment in crowdfunding, that the intermediary may not have an ongoing relation with the issuer after completion of the offering, and that under certain situations the issuer may cease publishing annual financial reports;
Have a reasonable basis for believing that an issuer complies with the statutory requirements for a crowdfunding offering and Regulation Crowdfunding and that the issuer has established means to keep accurate records of securities holders;
Make information that an issuer is required to disclose available to the public on its platform throughout the offering period and for a minimum of 21 days before any security may be sold in the offering;
Provide communication channels on its platform, meeting certain conditions, which will allow investors who have opened accounts with the intermediary and representatives of the issuer to interact and exchange comments about the issuer’s offering on that intermediary’s platform; such discussions will be publicly available for viewing (i.e., by those who have not have opened accounts with the intermediary);
Require any person, when posting a comment in the communication channels, to clearly disclose with each posting whether he or she is a founder or an employee of an issuer engaging in promotional activities on behalf of the issuer or a compensated promoter;
Provide disclosures to investors about the compensation the intermediary receives;
Accept an investment commitment from an investor only after that investor has opened an account and consented to electronic delivery;
Prior to accepting each investor commitment, obtain from the investor representations that the investor has reviewed the intermediary’s educational materials, understands that the entire investment may be lost, and that the investor is in a financial condition to bear the loss; and obtain from the investor a completed questionnaire demonstrating the investor’s understanding of the restrictions on investment cancellations, potential challenges for resales, and the inherent investment risks;
Have a reasonable basis for believing an investor complies with the investment limitations in Regulation Crowdfunding;
Provide investors with certain notices once they have made investment commitments, and confirmations at or before completion of a transaction;
Comply with maintenance and transmission of funds requirements (i.e., broker-dealers must comply with Rule 15c2-4, whereas funding portals must direct investors to transmit money or other consideration directly to a qualified third party7 that has agreed in writing to hold the funds for the benefit of the investors and the issuer and to promptly transmit or return the funds to the persons entitled to such funds); and
Comply with completion, cancellation and reconfirmation of offerings requirements.

Additional Requirements for Funding Portals

Regulation Crowdfunding additionally requires that a funding portal:

Implement written policies and procedures, reasonably designed to achieve compliance with the federal securities laws and the rules and regulations thereunder, relating to its business as a funding portal;
Comply with certain privacy rules that are applicable to broker-dealers, such as Regulation S-P (Privacy of Consumer Financial Information and Safeguarding Personal Information), S-ID (Identity Theft Red Flags) and Regulation S-AM (Limitations on Affiliate Marketing;
Permit examinations and inspections by representatives of the SEC and the registered national securities association of which it is a member; and
Maintain and preserve certain books and records relating to its business for a period of not less than five years and in an easily accessible place for the first two years.

Prohibited Activities of Intermediaries

A crowdfunding intermediary is also prohibited from engaging in certain activities under the rules, such as:

Providing access to its platforms to an issuer if the intermediary has a reasonable basis for believing that the issuer or any of its officers, directors (or any person occupying a similar status or performing a similar function) or beneficial owners of 20 percent or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power, is subject to a disqualification. To satisfy this requirement, an intermediary must, at a minimum, conduct a background check on each issuer and those applicable persons.
Providing access to its platforms to any company that it has a reasonable basis for believing presents the potential for fraud or raises other investor protection concerns.
Having a financial interest in an issuer that is offering or selling securities on its platform unless the intermediary receives the financial interest as compensation for the services provided to or for the benefit of the issuer in connection with the offer or sale of securities in a crowdfunding offering and the financial interest consists of securities of the same class and having the same terms, conditions and rights as the securities being offered or sold in the crowdfunding offering through the intermediary’s platform.8
Compensating any person for providing the intermediary with personally identifiable information of any investor or potential investor.
If the intermediary is a funding portal, it is prohibited from participating in the communication channel on its platform, other than to establish guidelines for communication and remove abusive or potentially fraudulent communications.

Safe Harbor for Certain Funding Portal Activities

Regulation Crowdfunding also includes a safe harbor for funding portals under which certain limited activities would be deemed consistent with the prohibitions on funding portals under the Exchange Act and Regulation Crowdfunding.9 Under the safe harbor, a funding portal may:

Determine whether and under what circumstances to allow an issuer to offer and sell securities in reliance on Section 4(a)(6) through their platforms.
Subject to specified conditions, highlight particular issuers or offerings of securities made in reliance on Section 4(a)(6) on their platforms based on objective criteria, such as the type of securities being offered (e.g. common stock, preferred stock or debt securities); the geographic location of the issuer; the industry or business segment of the issuer; the number or amount of investment commitments made; the progress in meeting the target offering amount or; if applicable, the maximum offering amount, and the minimum or maximum investment amount. The funding portal may not highlight an issuer or offering based on the advisability of investing in the issuer or its offering or receive special or additional compensation for highlighting one or more issuers or offerings on its platform.
Subject to specified conditions, provide search functions or other tools that investors can use to search, sort, or categorize the offerings available through the platform according to objective criteria. The objective criteria may not include, among other things, the advisability of investing in the issuer or its offering or an assessment of any characteristic of the issuer, its business plan, its management, or risks associated with an investment.
Compensate third parties for referring persons to the funding portal in certain limited circumstances.
Pay or offer to pay compensation to a registered broker-dealer for services provided in connection with the offer or sale of securities in reliance on Section 4(a)(6), subject to certain conditions.
Receive compensation from a registered broker-dealer for services provided in connection with the offer or sale of securities by the funding portals in reliance on Section 4(a)(6), subject to specified conditions.
Advertise its existence and identify one or more issuers or offerings available through the platform, subject to certain conditions.
Accept, on behalf of issuers, investment commitments for crowdfunding offerings from investors.
Direct investors where to transmit funds or remit payments in connection with the purchase of securities offered and sold in reliance on Section 4(a)(6) or direct a qualified third party to release proceeds of a successful offering to the issuer upon completion of the offering or to return investor proceeds when investment commitments or offerings are cancelled.

It is important to note, as stated in the safe harbor rule – Rule 402(a) – that the antifraud provisions and all other applicable provisions of the federal securities laws continue to apply to the activities described in the safe harbor.

Disqualification Rules for Intermediaries

Regulation Crowdfunding prohibits any person subject to a statutory disqualification, as defined in Exchange Act Section 3(a)(39), from acting as, or being an associated person of, an intermediary unless permitted to do so by Commission rule or order.10 FINRA’s funding portal rules and Exchange Act Rule 19h-1 provide a process for FINRA members and their associated persons subject to a statutory disqualification to seek to become or remain a member or be associated with a member. FINRA’s funding portal rules are available at www.finra.org.

Other Resources

The adopting release for Regulation Crowdfunding can be found on the SEC’s website at http://www.sec.gov/rules/final/2015/33-9974.pdf.

Regulation Crowdfunding (17 CFR 227.100 et seq.) can be accessed through the “Corporation Finance” section of the SEC’s website at http://www.sec.gov/divisions/corpfin/ecfrlinks.shtml.

You can also submit complaints or tips about possible securities laws violations on the SEC’s questions and complaints page at http://www.sec.gov/complaint.shtml.

Contacting the SEC Staff

The SEC staff is happy to assist intermediaries with questions regarding Regulation Crowdfunding. For issuer questions, you may contact the Division of Corporation Finance’s Office of Small Business Policy via email or by telephone at (202) 551-3460. For intermediary questions, you may contact the Division of Trading and Markets, Office of Chief Counsel, via email or at (202) 551-5777.

Footnotes

[1]

This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.

Crowdfunding is a relatively new and evolving method of using the Internet to raise capital to support a wide range of ideas and ventures. An entity or individual raising funds through crowdfunding typically seeks small individual contributions from a large number of people. Individuals interested in the crowdfunding campaign – members of the “crowd” – may share information about the project, cause, idea or business with each other and use the information to decide whether to fund the campaign based on the collective “wisdom of the crowd.”

The adopting release is available at http://www.sec.gov/rules/final/2015/33-9974.pdf. See also Regulation Crowdfunding, Securities Act Release No. 33-9974, Exchange Act Release No. 34-76324 (Oct. 30, 2015), 80 FR 71387 (Nov. 16, 2015).

Registered broker-dealers seeking to serve as crowdfunding intermediaries must also be members of a registered national securities association. The Financial Industry Regulatory Authority (“FINRA”) is currently the only such association in existence. If you are a registered broker-dealer but not a member of FINRA, then you will have to obtain FINRA membership prior to engaging in crowdfunding.

FINRA members should contact FINRA to determine whether they need any further authorization from FINRA to engage in crowdfunding.

FINRA’s funding portal rules are available at www.finra.org.

A qualified third party means a registered broker or dealer that carries customer or broker or dealer accounts and holds funds or securities for those persons, a bank, or a credit union insured by the National Credit Union Administration.

The directors, officers, or partners of an intermediary, or any person occupying a similar status or performing a similar function, are statutorily prohibited from having any financial interest in an issuer that uses the services of the intermediary.

The rule expressly provides that there is no presumption that a funding portal has violated these prohibitions solely by reason of the funding portal or its associated persons engaging in crowdfunding activities that do not meet the conditions specified in the safe harbor. However, a funding portal must analyze its activities because it remains responsible for such activities and the operations of its platform and for compliance with Regulation Crowdfunding and other applicable securities laws.

Events that could result in a statutory disqualification for an associated person under Section 3(a)(39) include, but are not limited to: certain misdemeanor and all felony criminal convictions; temporary and permanent injunctions issued by a court of competent jurisdiction involving a broad range of unlawful investment activities; expulsions (and current suspensions) from membership or participation in a self-regulatory organization (“SRO”); bars (and current suspensions) ordered by the Commission or an SRO; denials or revocations of registration by the Commodity Futures Trading Commission (“CFTC”); and findings by the Commission, CFTC or an SRO that a person: (1) “willfully” violated the federal securities or commodities laws, or the Municipal Securities Rulemaking Board (“MSRB”) rules; (2) “willfully” aided, abetted, counseled, commanded, induced or procured such violations; or (3) failed to supervise another who commits violations of such laws or rules.