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Crowdfunding intermediaries- Hurry Up and Wait

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”.  I think the acronym came first, but applaud the creativity.

I have been blogging extensively on the JOBS Act and Crowdfunding Act.  My last blog addressed Herculean effort the SEC must undertake to write the laws and rules which will bring the Crowdfunding Act to fruition by early 2013.  In addition to fashioning the exemption that will allow companies to raise funds using the Crowdfunding Act, the SEC must also fashion rules to govern the funding portals that companies will be required to use in the process.

Funding Portals are popping up everywhere, at least in name and concept.  All of these portals are busy putting together systems internally, but all of those systems are subject to the SEC rules that have yet to be drafted.  Funding portals are hurrying up to be ready to implement rules that will be enacted in early 2013 while at the same time, waiting to find out what those rules will be.


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.  As of today, all entities that effect small transactions in securities between an investor and Issuer company (Issuer) must be licensed broker dealers, registered with the SEC and members of a self regulatory organization (SRO) that is a national securities association.  Currently that SRO is 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.  As with other aspects of the new law, these rules and ongoing reporting requirements have yet to be drafted.   In accordance with Section 304, Funding Portals must be “subject to the examination, enforcement and other rulemaking authority” of the SEC and must be a member of an SRO, such as FINRA.



Shortly after the signing of the JOBS Act, The Crowdfunding Intermediary Regulatory Association (CFIRA) was created to act as an SRO for Funding Portals.  However, the SEC has yet to decide if CFIRA will be the sole Funding Portal SRO body or whether it will be FINRA.  Moreover, FINRA, who opposed the JOBS Act and Crowdfunding Act, has yet to decide if it is willing to take on the role and responsibility of the Funding Portals new master and chief.


Funding Portal Requirements

Whether ultimately a Funding Portal becomes a member of FINRA or the CFIRA, they will have to follow rules and regulation, meet reporting requirements, and impose requirements on Issuers seeking to use their intermediary services. The Crowdfunding Act creates a new Section 4A of the Securities Act of 1933, entitled “Requirements with Respect to Certain Small Transactions.”  New Section 4A(a) sets forth the requirements for Funding Portals.  Each of the requirements is subject to the more detailed rules that will be drafted by the SEC and for which we are all waiting.

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

Portal must:

1)    Provide disclosures, including disclosures related to risks;

2)    Ensure that each investor reviews investor education information and positively affirms that they understand that they risk losing their entire investment and can afford such loss;

3)    Ensure that each investor answers questions demonstrating an understanding of the level of risk generally applicable to investments in startups; emerging businesses, and small issuers;

4)    Ensure that each investor answers questions demonstrating an understanding of the risk of illiquidity;

5)    Take measures to reduce the risk of fraud by establishing rules and procedures including obtaining background and securities enforcement history checks on each officer, director and person holding more than 20% of the outstanding equity of an Issuer;

6)    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

7)    Ensure that no offering proceeds are given or available to the Issuer until the target offering amount has been raised and allow investors to cancel their investment during that time;

8)    Make efforts to ensure that no investor exceeds its allowable investment amount in any 12 month period, including from all Issuers, and all Funding Portals (i.e. $2,000 or 5% of annual net income or net worth if net income or net worth is less than $100,000 or 10% of annual income or net worth up to $100,000 if annual income or net worth is over $100,000)

9)    Take steps to protect the privacy of information collected from investors;

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

11) Prohibit its directors, officers or partners from having any financial interest in any Issuer using its service.


Funding Portal Fees

It is undisputed that a Funding Portal will be able to charge a fee to an Issuer for using its service.  However, how that fee will be determined and how much that fee can be is currently unknown.  Only licensed registered broker dealers can charge a commission for raising money.  Moreover, Section 304 of the Crowdfunding Act defines a Funding Portal as “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to Section 4(6) of the Securities Act of 1933” (i..e the new Crowdfunding section).

Moreover, Section 304 continues, specifically excluding from the definition of a Funding Portal any entity that (i) offers investment advice or recommendations; (ii) solicits purchases, sales, or offers to buy the securities offered or displayed on its website or portal; (iii) compensates employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; or (iv) holds, manages, possesses, or otherwise handles investor funds or securities.

Clearly only licensed registered broker dealers will be able to offer the foregoing services and charge fees for same.  Moreover, I note that a Funding Portal has to ensure that Issuers do not receive money until a target offering is made, but at the same time can’t hold the investors money during that time.   It seems the SEC will have to require the use of a broker dealer or clearing firm by Funding Portals to address this quandary.

In addition to all of the above, each of the rules and requirements set forth in the Crowdfunding Act contains language to the extent that the SEC shall determine, by rule, other rules and practices that are appropriate.  No one outside the SEC (and perhaps inside) knows what these are yet.



Funding Portals will have to meet a plethora of requirements, including registration with the SEC and at least one SRO.  They will have to have websites that operate proficiently and meet all these requirements.  However, other than broad strokes, they don’t know what these rules and requirements will be.  They must hurry up, and wait….


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.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

© Legal & Compliance, LLC 2012

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