Intermediaries.
All crowdfunding must be done through an intermediary. No issuer can do crowdfunding directly without hiring one. The Act imposes various requirements on crowdfunding intermediaries.[1] For starters, intermediaries have to register with the SEC as a broker or as a funding portal and become a member of a national securities association.[2] Under the final rules, intermediaries would also have to provide risk disclosures or other investor education materials and ensure that each investor reviews such information and understands the risks.[3] Intermediaries would also need to take measures to reduce the risk of fraud by obtaining a background check on certain key persons of every issuer and providing such information to potential investors.[4]
The final rules prohibit any director, officer, or partner of an intermediary from having a financial interest in a crowdfunding issuer, except for compensation in connection with the crowdfunding intermediary services and in securities of the same class, terms, conditions, and rights as those being offered on the intermediary’s platform.[5] The final rules also provide that a funding portal cannot: (i) offer investment advice or recommendations; (ii) compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its platform; or (iii) hold, manage, possess, or otherwise handle investor funds or securities.[6]
Measures To Reduce Risk of Fraud
An intermediary must have a reasonable basis for believing that an issuer complies with all applicable requirements and that the issuer has established means to keep accurate records of the holders of the securities it would offer and sell; in doing so, an intermediary may rely on the issuer’s representations concerning compliance, unless the intermediary has reason to question the reliability of those representations.[7] An intermediary must deny access to its platform to an issuer if the intermediary has a reasonable basis for believing that the issuer or any of its officers, directors, or certain beneficial owners is subject to a disqualification or that the issuer or the offering presents the potential for fraud or otherwise raises concerns about investor protection.[8] In satisfying the requirements, the intermediary must, at a minimum, conduct a background and securities enforcement regulatory history check, deny access if it reasonably believes that it is unable to adequately assess the risk of fraud, or promptly remove the offering from its platform, cancel the offering, and return any funds to investors, as appropriate.[9]
Education Materials
An intermediary must provide certain educational materials to investors, in their most current form on its platform at all times, including: (i) the process for the offer, purchase, and issuance of securities through the intermediary and the associated risks; (ii) the types of crowdfunded securities available for purchase on the intermediary’s platform and the risks associated with each type of security, including the risk of having limited voting power as a result of dilution; (iii) the resale restrictions; (iv) the offering statement; (v) the investment limitations; (vi) the limitations on an investor’s right to cancel an investment commitment and the circumstances in which an investment commitment may be cancelled by the issuer; (vii) the need for the investor to consider whether investing in a crowdfunded security is appropriate for that investor; (viii) that following the completion of the offering, there may or may not be any ongoing relationship between the issuer and the intermediary; and (ix) that under certain circumstances an issuer may cease to publish annual reports and, thus, an investor may not continually have current financial information about the issuer.[10]
An intermediary must provide all the required information through electronic means, i.e., electronic message (e.g., e-mail, social media messages, instant messages) that contains either the information or a specific link to the information as posted on the intermediary’s platform or that provides notice of what the information is and that it is located on the intermediary’s platform or on the issuer’s website.[11] In doing so, an intermediary must first let the investor open an account with the intermediary and obtain the investor consent to electronic delivery of materials before it can accept an investment commitment.[12] An intermediary must also provide the SEC and investors with any required information provided by the issuer on the intermediary’s platform, in a manner that reasonably permits saving, downloading, or otherwise storing the information, for a minimum of 21 days before any securities are sold and until the offer and sale of crowdfunded securities is completed or canceled.[13] An intermediary may not require any person to establish an account with the intermediary to access this information.[14]
In our next post, we will discuss the requirements for funding portals under the final rules.
This post was a part of a multi-part series on the SEC final rules on the crowdfunding exemption. You can find the other posts by searching our blogs at www.mcbrideattorneys.com.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C., which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] See generally 15 U.S.C. § 77d-1(a).
[2] 17 C.F.R. § 227.300(a).
[3] Id.
[4] Id.
[5] Id. § 227.300(b).
[6] Id. § 227.300(c).
[7] Id. § 227.301(a), (b).
[8] Id. § 227.301(c).
[9] Id.
[10] Id. § 227.302(b).
[11] Id. § 227.302(a).
[12] Id.
[13] Id. § 227.303(a).
[14] Id.