BizTech Law Blog

The SEC Proposed Crowdfunding Regulations: Permitted and Prohibited Funding Portal Activities

The role of a funding portal is to facilitate a crowdfunded transaction involving a sale from the issuer (the company raising capital) to the investor. A funding portal does not have the legal authority to facilitate secondary market activity, i.e., bringing together a seller and buyer in a transaction in which the seller is an investor who previously acquired the security either from the issuer or from another investor. In order to legally facilitate secondary market transactions, the intermediary would have to register as an exchange or alternative trading system. A funding portal registration does not grant this authority.

A registered funding portal has limited authority that is far less comprehensive than that granted to a registered broker. A funding portal may not:

• offer investment advice or recommendations
• solicit purchases, sales or offers to buy securities displayed or referenced on its platform or compensate employees, agents or other persons for engaging in solicitation of this type
• hold, manage, possess or otherwise handle investor funds or securities

In light of the foregoing, and in order to provide greater clarity about what a funding portal may do, the SEC is proposing to include in the regulations a safe-harbor list of activities that a funding portal may engage in without being at risk of engaging in a prohibited activity, subject to numerous limitations. The permitted activities are as follows:

• Develop a set of objective criteria to limit the securities offered on the platform
• Apply objective criteria to highlight offerings on the platform
• Provide search functions or other tools that investors can use to search, sort or categorize the offerings available on the platform according to objective criteria
• Provide communication channels through the platform by which investors can communicate with one another and representatives of the issuer about offerings on the platform
• Advise an issuer about the structure or content of the issuer’s offering, including assisting in preparing offering documentation
• Advertise the existence of the portal and identify one or more issuers or offerings available on the portal on the basis of objective criteria. There is no limitation on the advertising medium a funding portal may use. Social media and Internet advertisements are permissible as are print and broadcast media.
• Deny access to the platform, or cancel an offering of an issuer, if the funding portal believes the issuer or offering may present the potential for fraud or otherwise raise investor protection concerns.
• Accept, on behalf of an issuer, an investment commitment for securities offered on the platform.
• Direct investors where to transmit funds or remit payment to purchase a security offered on the platform.
• Direct a third party escrow agent to release proceeds to an issuer upon completion of a crowdfunding offering, or to return proceeds to investors if an investment commitment or offering is canceled.

Where objective criteria are required, they must generally meet the following:

• Reasonably designed to result in a broad selection of issuers offering securities through the platform or highlighted on the platform
• Applied consistently to all issuers and offerings who potentially may, or actually have, offerings posted on the platform
• Are clearly displayed on the platform

In general, objective criteria are permitted to be based on:

• The type of security offered (e.g. common stock, preferred stock, debt securities)
• The geographic location of the issuer
• The industry or business segment of the issuer

And, if applicable:

• The number of investment commitments made
• Progress in meeting the issuer’s target or maximum offering amount
• The minimum or maximum investment amount

In no circumstances may the objective criteria be based on the advisability of investing in the issuer or its offering, or an assessment of any characteristic of the issuer, its business plan, its key management, or the risks associated with an investment.

Requirements for platform communication channels are as follows:

• The funding portal may not participate in communications, except to establish guidelines and remove abusive or potentially fraudulent communications
• The platform must permit public access to view the discussions made in the communication channels
• Posting privileges must be limited to persons who have opened an account on the platform
• Each poster must clearly disclose whether the poster is a founder or employee of the issuer or is otherwise compensated to promote the issuer’s offering

As the foregoing discussion reveals, the SEC has devoted much thought to how it would like the funding portal platforms to operate. These standards seem reasonable and the clarity of the guidance they offer is useful.

Please contact Iris Linder (517-371-8127 or ilinder@fosterswift.com) for more information.

Categories: Crowdfunding, Venture Capital/Funding