New Crowdfunding Broker-Dealer FAQs Published by the SEC Staff

Crowdfunding of securities offerings is continuing its inevitable emergence, albeit with the active pushback of the SEC and its staff.  As many of you who have been following the crowdfunding movement know, Section 201(c) of the JOBS Act added a new Section 4(b) to the Securities Act of 1933.  On an initial read, that new section seemed to provide crowdfunding platforms an exemption from registration as a broker-dealer solely by reason of actions to facilitate Rule 506 offerings so long as they complied with specified conditions.  Section 201 also directs the SEC to adopt rules lifting the ban on general solicitation in Rule 506 offerings to only accredited investors (provided that the issuers take reasonable steps to verify accredited investor status).  While the lift of the ban on general solicitation in certain Rule 506 offerings depends upon SEC rulemaking (the SEC proposed rules in August of 2012, and there has been no action since), the Section 4(b) exemption from broker-dealer registration supposedly was effective immediately as a statutory change.  The seeming purpose of these provisions was to permit crowdfunding portals or other platforms or mechanisms to conduct operations without becoming subject to broker-dealer registration.   The SEC, however, continues its pushback against the crowdfunding revolution. 

Further evidence for this comes as the SEC staff has now published a series of FAQs relating to this new limited exemption from broker-dealer registration for crowdfunding platforms.  The FAQs were published on February 5, 2013 by the Staff of the SEC’s Division of Trading and Markets and are available here.

These FAQs formalize the guidance that has been provided by the SEC in various no-action letters relating to the types of activities that may be conducted by finders and others without broker-dealer registration.  The FAQs clarify that the Section 4(b) does not require further rulemaking, but do make a point of noting that a crowdfunding platform cannot permit an issuer to conduct a general solicitation on its platform until the SEC issues its final rules on the general solicitation exemption.  The FAQs also note that the exemption from broker-dealer registration in this section is applicable only when securities are offered and sold pursuant to Rule 506 – which effectively means only sales to accredited investors.  Additionally, they set forth the staff's opinion that the exemption is only available if the crowdfunding platform provides only certain specified activities - basically,  operating a “platform or mechanism” to facilitate the sale of securities, co-investing with an issuer, or providing “ancillary services” such as due diligence services without investment advice.   Finally, a crowdfunding site seeking to rely on the exemption may not be subject to statutory bad-boy disqualifications, may not take possession of customer funds or securities, and, importantly, may not receive compensation – transaction based or otherwise – in connection with the purchase or sale of securities on the site.

As to this latter point, the FAQs specifically note that “Congress conditioned the exemption on a person and its associated persons not receiving any ‘compensation’ in connection with the purchase or sale of such security.”  Because the JOBS act bill did not limit the condition to transaction-based compensation, the FAQs state:

the staff interprets the term ‘compensation’ broadly, to include any direct or indirect economic benefit to the [platform] or any of its associated persons. At the same time, we recognize that Congress expressly permitted co-investment in the securities offered on the platform or mechanism. We do not believe that profits associated with these investments would be impermissible compensation for purposes of Securities Act Section 4(b).

To this end, the FAQs note that a venture fund may operate a crowdfunding platform, and in fact go further to note that “[a]s a practical matter, we believe that the prohibition on compensation makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker-dealer registration.”

The FAQs also make clear that the staff is viewing the ban on compensation condition broadly.  After positing the situation of a fund group that has an internal marketing department or investor relations department of an affiliated adviser whose staff is paid a salary to promote, offer, and sell shares of the privately offered funds and asking “Can these persons rely on the exemption from broker-dealer registration in Section 4(b) if the funds are offered and sold pursuant to Rule 506?” the FAQs answer in the negative, stating “[a]ny salary paid to a person for engaging in these activities is compensation to that person in connection with the purchase or sale of securities. As a result, that person would not be able to rely on the exemption from registration as a broker-dealer provided in Section 4(b).”

In short, while crowdfunding in coming, the SEC and its staff continue to try to do their best to make it as difficult as possible for aspiring crowd funding platforms.