Regulating Crowdfunding Portals
By Vela Wood
There is a lot of buzz regarding how the crowdfunding regulations are going to affect entrepreneurs and potential investors, but little has been written about how the regulations are going to affect the linchpin in this whole process: the funding portals.
It’s easy to see why the regulations are taking so long. The SEC’s regulations (which we are all patiently waiting for) must focus on investor protection while balancing the goals of crowdfunding in general – to make it easier and less burdensome for the general public to invest in startups. “Regulations” and “less burdensome” aren’t usually compatible with each other.
The requirement I want to discuss today is the one which mandates that a startup use the services of an intermediary that is either a registered broker or a registered “funding portal” with the SEC. These funding portals will have their own governing regulations, and they must become members of a national security association, also known as a self-regulatory organization (SRO), that is registered under Section 15A of the Exchange Act. Thus, the SROs will be held accountable for overseeing compliance of the crowdfunding regulations. Currently the only registered SRO is the Financial Industry Regulatory Authority (FINRA). Furthermore, there may be a required “test” that operators of funding portals must pass, such as the Series 7, 63, 64, 66, or 79 test, but this has not been confirmed.
According to the SEC’s JOBS Act “Frequently Asked Questions About Crowdfunding Intermediaries,” the JOBS Act will require funding portals to, among other requirements, do the following:
- 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 in each officer, director, and person holding more than 20% 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 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 Title III of the JOBS Act
- And any other requirements that the SEC determines are appropriate
As you can see, the requirements above could be interpreted in a wide variety of ways and make compliance very difficult. This interpretation issue is obviously a concern. Further, while potential investors and issuing startups continue to wait for the SEC to release and adopt the crowdfunding regulations, the main concerns may not be the delay in their release, but rather the risk that the regulations are too restrictive, which could potentially defeat the purpose behind the crowdfunding push.