Regulation Crowdfund provides for two types of intermediaries, the registered broker-dealer and the funding portal. Broker-dealers do not need to register in order to engage in crowdfunding offerings, but their activities in this area are governed by Regulation Crowdfunding. Funding portals must register with the Securities and Exchange Commission and the Financial Industry Regulatory Authority.
Issuer Interests By Intermediaries
Regulation Crowdfunding as proposed prohibits any intermediary from holding a direct or indirect ownership of the issuer in the crowdfunded offering.
The prohibition would include any interest in the issuer that is purely economic or financial in nature.. As such, the intermediary is prohibited from receiving an ownership interest of the issuer including shares as compensation.
Transaction Based Compensation
Regulation Crowdfund will allow broker-dealers as well as funding portals to receive transaction based compensation. While funding portals are brokers under the Securities Exchange Act, they are not required to register as such because they can register as funding portals.
Obligations of Intermediaries
Whether the intermediary is a broker-dealer or a funding portal, its obligations in a crowdfunded offering are to:
♦ Provide the issuer with an internet platform to facilitate the offering, that includes required disclosures, and a communication channel pursuant to which potential investors and others may discuss the offering;
♦ Take measures to reduce the risk to investors and reduce fraud, including conducting appropriate due diligence about the issuer and its offering and denying access to issuers who are disqualified or present a potential for fraud;
♦ Open accounts for each investor;
♦ Provide investors with educational materials, confirmations of investment commitments and purchases, and notifications of various events such as cancellation of the offering; and
♦ Arrange for the delivery of funds by investors to an escrow agent or trustee.
Liability of Intermediaries Proposed Rule 502 provides a safe harbor to issuers in the event of failures by the intermediary, so long as the issuer was not aware of such non-compliance or the failure occurred with respect to the offering of another issuer.
Rule 301 of Regulation Crowdfund requires that funding portals have a reasonable basis for believing that an issuer seeking to offer and sell securities in reliance on the crowdfunding exemption through the funding portal’s platform complies with the requirements of the exemption. The rule also requires funding portals deny access to its platforms to issuers when the platform believes that the issuer or the offering presents the potential for fraud or otherwise raises concerns regarding investor protection. Additionally, should a funding portal becomes aware of information that causes it to believe that the issuer or the offering presents the potential for fraud or otherwise raises concerns regarding investor protection, the funding portal must remove the offering from its platform.
The SEC has proposed a safe harbor for issuers for, among other things, insignificant failures to comply with Regulation Crowdfund and good faith attempts to comply that fall short. While the safe harbor protects the offering (i.e., the issuer would not be required to become a public company), it does not protect the intermediary. As such, Intermediaries should exercise extreme caution to ensure compliance with Regulation Crowdfund.
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