May 11, 2012
In regards to Sec. 4A(a)(10): not compensate promoters, finders, or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor
Neither the purpose, nor the meaning of this provision is clear. None of the terms are defined. Said differently, promoters, finders, and lead generators could provide a broker or funding portal with personal identifying information of potential investors as long as the broker or funding portal does not compensate them. This leaves the door open for investment advisors, aggregation websites, or anyone else who might be compensated by the investor, to provide information to brokers or funding portals. For example, an aggregation website might aggregate all the offerings from many different brokers or websites and make those available to investors for a monthly fee. This would be similar to job aggregation websites such as Monster.com or TheLadders. When an investor signs up and pays a fee to search offerings, the aggregator could provide personal identifying information to all the brokers and funding portals affiliated with that aggregator.
Said in another way, brokers and funding portals can compensate promoters, finders, and lead generators as long as no personal identifying information of any investors is provided to the broker or funding portal. So in this case, a broker or funding portal could compensate promoters, finders, and lead generators for directing potential investors to their platform. Once the investor registers on that platform however, personal identifying information will be provided by the investor and that appears to be allowable under this provision. In the case of an aggregation site, the broker or funding portal could compensate the aggregator for directing traffic to its platform, where again, the investor could register and provide personal identifying information.
There could also be the case in which a 3rd party who stands to gain in some way by a successful crowdfunding effort. This person or entity might not be compensated by anyone, but might gain from driving potential investors to a particular broker or funding portal or providing personal identifying information for potential investors to the broker or funding portal. Since there would be no direct compensation by the broker or funding portal, the personal identifying information could be provided.
Along the same lines, the definition of funding portal states that funding portals cannot solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal. This seems to presume that funding portals, and NOT broker/dealers, must literally exist in a vacuum waiting to be discovered by both issuers and investors. As discussed above, broker/dealers and funding portals cannot compensate anyone for finding investors under the law. But this definition also seems to prohibit funding portals from advertising their services altogether depending on how the terms are defined. It says that funding portals cannot solicit purchases of securities, or offers to buy both of these would appear to mean soliciting people to purchase (investors)? They also cannot solicit sales of securities which could mean they cannot solicit people to sell (issuers). Essentially, just the act of having a web platform available to the public on which issuers can list their offerings and investors can be find them is tantamount to soliciting those things. Depending on how things are defined, it appears that the new law actually flies in the face of the old definition of funding portal which did not anticipate sales of unregistered securities to the general public on the Internet.
What should be defined is solicit, compensation, promoters, finders, lead generators, and personal identifying information. Also, it should be clarified specifically what funding portals are allowed to do with respect to promoting their platform and the individual offering presented consistent with the generally accepted crowdfunding models. Possibly, funding portal should be redefined for this new activity, or these facilities should be renamed and defined anew.
HR 2930: The first bill, HR 2930, contained the following language under the section on intermediaries: outsources cash-management functions to a qualified third party custodian, such as a broker or dealer registered under section 15(b)(1) of the Securities Exchange Act of 1934 or an insured depository institution.
There is no similar provision in the law. It is likely that this provision was stricken because the definition of a funding portal specifically states that funding portals cannot hold, manage, possess, or otherwise handle investor funds or securities. What this does not say that HR 2930 said is just what type of entity must hold, manage, possess, or otherwise handle funds and securities. The Commission should clarify in the rules exactly what type of institution can hold these funds.
Further, it is clear that these funds being held by some fiduciary are held in trust to either be returned to the investor or disbursed to the issuer upon closing the sale of the securities. The fiduciary holding the funds likely will not be in a position to determine the disposition of these funds at the end of the offering period and especially whether a particular investor has cancelled his commitment to invest as allowed under the law. The fiduciary merely holds the funds for disposition as instructed by the funding portal. If this instruction constitutes managing the funds and is not allowed, it is unclear what the role of the funding portal would be at any point after the funds have been invested. Clearly this is a role that fiduciaries, insured depository institutions for example, are not preparing to assume.
Lastly, these depository institutions have concerns regarding their liability with regard to the disposition of these funds, particularly if they are charged with managing the funds. Specifically, questions have been posed as to the liability of the fiduciary in the event that funds are disbursed to what might later turn out to be a fraudulent business. Or liability in disbursing investor funds when that investor had cancelled her commitment to invest and the fiduciary was not properly notified by the intermediary.
We believe the rules should clarify the meaning of manage in this context, and because third party custodians are required for funding portals, some effort should be made to limit the liability of these institutions if they perform their duties as required and as instructed by the intermediary. These institutions will potentially be handling hundreds of millions of dollars of investor funds and should be given some protection absent any breach of duty on their part.
In regards to Sec. 4A(b)(1): file with the Commission and provide to investors and the relevant broker or funding portal, and make available to potential investor
Sec. 4A(a)(6) above requires that brokers or funding portals provide all this information to the Commission and to potential investors. This section states that the issuer is required to provide this information to the Commission and the broker or funding portal. The issue raised by this conflict is one of consistency, completeness, control, form and format. In other words, which entity (the Commission or the broker or funding portal) will determine whether all the required information has been provided, completely, correctly, and in an acceptable form or format? If this falls upon the broker or funding portal, then very specific rules or guidelines should be promulgated such that brokers and funding portals will know when they have sufficient information to pass muster with the Commission and they can list the offering. The problem here is not with the demographic information of the issuer and its principals or the details on the offering itself. The real potential for what might be determined to be an incomplete, vague, misleading, or unsatisfactory offering package comes in laypeople addressing the securities issues such as required by (H)(i) through (H)(v) below. For example, what constitutes an adequate explanation of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers or the risks to purchasers of the securities relating to minority ownership? If the issuer merely states that they anticipate no additional risk to the investor in the event that the principal shareholders exercise certain rights, is that good enough? Is it misleading? Intentionally misleading? Is it an untrue statement of a material fact that results in liability? Is the broker or funding portal required to question any of this or deny a listing if it doesnt look right? And on what basis would a broker or funding portal know to challenge a response to one of these questions?
The back-and-forth should be between the issuer and the broker or funding portal and not the funding portal and the Commission or the Commission and the issuer. But the rules must be such that the broker or funding portal does not have to send a potential listing to the Commission to wait for clearance to list it, or list an offering, send the information to the Commission, and learn at some point in the future that the offering is not complete.
In regards to Sec. 4A(b)(1)(G): the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities
It is imperative that funding portals be allowed to have an open and closed period for rescinding commitment to an issue. This option is necessary in the event someone removes their offer during the waiting period. Under one scenario, a competitor could invest and then rescind at a critical moment, which would cause the offering to fall short of the funding restriction.
We might recommend that a grace period or waiting period be allowed to begin on the day the offering has been fully funded and run for 10 days after which commitments become final and the transaction is executed.