Frequently Asked Questions Regarding Regulation Crowdfunding and Intermediary Requirements
Sept. 25, 2018
September 25, 2018
The following answers to frequently asked questions were prepared by and represent the views of the staff of the Division of Trading and Markets (“staff”). They are not rules, regulations or statements of the Securities and Exchange Commission (“SEC” or “Commission”). Further, the SEC has neither approved nor disapproved these answers.
The staff may update these questions and answers periodically. In each update, the questions added after publication of the last version will be marked with “MODIFIED” or “NEW” after the answer.
For Further Information Contact: Office of Chief Counsel, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, N.E., Washington, DC 20549, at (202) 551-5550.
In 2015, the Commission adopted new rules and forms, collectively known as Regulation Crowdfunding, to permit companies to offer and sell securities to retail investors in reliance on the exemption under Section 4(a)(6) of the Securities Act of 1933 (“Securities Act”). These rules and forms implement the requirements of Title III of the Jumpstart Our Business Startup Act (“JOBS Act”), which added Sections 4(a)(6) and 4A to the Securities Act and Sections 3(h) and 12(g)(6) to the Securities Exchange Act of 1934 (“Exchange Act”).
For more information, please refer to the Regulation Crowdfunding adopting release available at https://www.sec.gov/rules/final/2015/33-9974.pdf.
There is a small entity compliance guide concerning registration of funding portals, which is available at http://www.sec.gov/divisions/marketreg/tmcompliance/fpregistrationguide.htm.
For more information related to Regulation Crowdfunding, please visit https://www.sec.gov/smallbusiness/exemptofferings/regcrowdfunding. In addition, the staff of the Division of Corporation Finance has issued Compliance and Disclosure Interpretations related to issuer requirements available at https://www.sec.gov/divisions/corpfin/guidance/reg-crowdfunding-interps.htm.
Answers to Frequently Asked Questions:
Requirements for Intermediaries
The Rule 300 series of Regulation Crowdfunding contains rules applicable to broker-dealers and funding portals (“intermediaries”).
Intermediaries (Rule 300 of Regulation Crowdfunding)
Question 300.1: Can an intermediary have a financial interest in an issuer?
Answer: Yes. Rule 300(b) permits an intermediary to receive a financial interest in an issuer that is offering or selling securities in reliance on Securities Act Section 4(a)(6) (“Section 4(a)(6)”) through the intermediary’s platform, provided that: (1) the intermediary receives the financial interest from the issuer as compensation for services provided to, or for the benefit of, the issuer in connection with the offer or sale of such securities being offered or sold in reliance on Section 4(a)(6) through the intermediary’s platform; and (2) the financial interest consists of securities of the same class and having the same terms, conditions, and rights as the securities being offered or sold in reliance on Section 4(a)(6) through the intermediary’s platform. However, Rule 300(b) prohibits the directors, officers, or partners of an intermediary, or any person occupying a similar status or performing a similar function, from having any financial interest in an issuer that uses the services of the intermediary.
Question 300.2: Can the intermediary receive the financial interest in the form of warrants in connection with an offering of common stock?
Answer: No. As explained above in Question 300.1, an intermediary is not permitted to have a financial interest in an issuer that is offering or selling securities on its platform unless the intermediary receives the financial interest as compensation for the services provided to or for the benefit of the issuer in connection with the offer or sale of securities in a crowdfunding offering and the financial interest consists of securities of the same class and having the same terms, conditions and rights as the securities being offered or sold in the crowdfunding offering through the intermediary’s platform. The staff does not believe that the exception in Rule 300(b)(2) covers warrants in connection with an offering for common stock, since by definition, a warrant is a right to purchase, for example, common stock in the future and therefore is not of the same class and does not have the same terms, conditions and rights as the underlying common stock available to investors.
Measures to Reduce Risk of Fraud (Rule 301 of Regulation Crowdfunding)
Question 301.1: Do intermediaries have due diligence requirements?
Answer: Yes. Rule 301(a) requires that intermediaries must have a reasonable basis to believe that an issuer seeking to rely on the crowdfunding exemption complies with the requirements of Section 4A(b) and Regulation Crowdfunding, and has established means to keep accurate records of the holders of securities. The rule allows an intermediary to rely on issuer representations unless the intermediary has reason to question the reliability of those representations. The Commission in the Regulation Crowdfunding adopting release stated that the specific steps an intermediary should take to determine whether it can rely on an issuer’s representation may vary but should be influenced by and tailored according to the intermediary’s knowledge and comfort with each particular issuer. The Commission also stated that when an intermediary seeks to rely on representations to form a reasonable basis, it should have policies and procedures regarding the circumstances under which it can reasonably rely on such representations and when additional investigative steps may be appropriate.
Rule 301(c)(1) also imposes important anti-fraud responsibilities, requiring an intermediary to conduct a background and securities enforcement regulatory history check on each issuer and its officers, directors and beneficial owners of 20 percent or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power. If the intermediary has a reasonable basis for believing that any of those persons are subject to disqualification under Rule 503, it must deny access to its platform to the issuer.
Rule 301(c)(2) requires that an intermediary must also deny access if it has a reasonable basis for believing that an issuer or offering presents the potential for fraud or otherwise raises investor protection concerns. If the intermediary reasonably believes it is unable to adequately or effectively assess the risk of fraud of the issuer or its potential offering, it also must deny the issuer access to its platform. Further, if an intermediary becomes aware of information after it has granted access that causes it to reasonably believe that the issuer or offering presents the potential for fraud or otherwise raises investor protection concerns, the intermediary must promptly remove the offering, cancel it, and return or direct the return of any committed funds.
Question 301.2: When must an intermediary cancel an offering?
Answer: As discussed above in Question 301.1, Rule 301(c)(2) requires an intermediary to cancel an offering if it has a reasonable basis for believing that the issuer or the offering presents the potential for fraud or otherwise raises concerns about investor protection. The conditional safe harbor in Rule 402(b)(10) also permits a funding portal to deny access to its platform to, or cancel an offering of an issuer, pursuant to Rule 301(c)(2), if the funding portal has a reasonable basis for believing that the issuer or the offering presents the potential for fraud or otherwise raises concerns about investor protection. In addition, an intermediary may cancel the offering at any time in accordance with Rules 301 and 402, regardless of the status of the offering.
Question 301.3: What are the requirements for intermediaries with respect to records of securities holders?
Answer: An intermediary is required under Rule 301(b) to have a reasonable basis for believing that an issuer has established means to keep accurate records of the holders of the securities it offers and sells through the intermediary’s platform. In satisfying this requirement, an intermediary may rely on the representations of the issuer concerning its means of recordkeeping unless the intermediary has reason to question the reliability of those representations. Rule 301(b) also provides that an intermediary will be deemed to have satisfied this requirement if the issuer has engaged the services of a transfer agent that is registered under Section 17A of the Exchange Act.
Account Opening (Rule 302 of Regulation Crowdfunding)
Question 302.1: What are the requirements for educational materials?
Answer: Under Rule 302(b)(1), the intermediary must deliver educational materials to investors that explain, among other things, the process for investing on the platform and the risks associated with purchasing securities in a crowdfunding offering, the types of securities being offered and the risks associated with each type of security, information an issuer is required to provide to investors in annual reports, resale restrictions and investment limits. Outside of the minimum information required to be disclosed, each intermediary has flexibility to determine the content of the educational materials, and the overall format and manner of presentation of the materials, subject to the limitations on what activities funding portals can engage in pursuant to the rules. The flexibility allows the intermediary to prepare and present the educational materials in a manner reasonably tailored to the type of offerings on the intermediary’s platform and the types of investors accessing its platform. We also note that The Financial Industry Regulatory Authority, Inc. (“FINRA”) Funding Portal Rule 200 and FINRA Rule 2210 include certain content standards with respect to communications with the public for funding portals and broker-dealers, respectively.
While an intermediary has flexibility with regard to the content and format of educational materials, Rule 302(b)(2) requires that educational materials be accurate, requiring an intermediary to update them as necessary to keep them accurate. Rule 302(b)(2) also requires that the intermediary make the revised educational materials available to all investors before accepting any additional investment commitments or effecting any further crowdfunding transactions.
Requirements with Respect to Transactions (Rule 303 of Regulation Crowdfunding)
Question 303.1: Can intermediaries require investors to establish an account to gain access to issuer offering information available on the intermediary’s platform?
Answer: No. Rule 303(a)(4) prohibits an intermediary from requiring any person to establish an account with an intermediary to access information required to be provided by the issuer under Rules 201 and 203(a). Although “establish” is not defined for purposes of Regulation Crowdfunding, the staff does not believe that it is consistent with the intention of Rule 303, to promote a transparent information sharing process, for an intermediary to require an investor to provide information as a condition of accessing these required issuer offering materials.
Question 303.2: What steps must an intermediary take to determine if an investor has reached his or her investment limit?
Answer: Rule 303(b)(1) requires that, each time before accepting any investment commitment (including any additional investment commitment from the same person), an intermediary must have a reasonable basis for believing that the investor satisfies the investment limitations. The rule provides that an intermediary may rely on an investor’s representations regarding compliance with the investment limitation requirements concerning the investor’s annual income, net worth, and the amount of the investor’s other investments made, unless the intermediary has reason to question the reliability of the investor’s representations. Intermediaries can, in their discretion, take additional measures for evaluating investor compliance, such as: using a centralized data repository (to the extent that one is created); requiring verification of income or net worth by uploading financial documents; or creating a tool for investors to use, such as a questionnaire, to assemble to underlying data.
Question 303.3: Who can participate in communication channels on an intermediary’s platform?
Answer: Under Rule 303(c), an intermediary must provide on its platform communication channels by which persons can communicate with one another and with representatives of the issuer about offerings made available on the intermediary’s platform but the intermediary is required to restrict posting of comments to those persons who have opened an account with the intermediary on its platform. Specifically, under Rule 303(c)(4), an intermediary must require that any person posting comments disclose whether he or she is a founder or an employee of an issuer engaging in promotional activities on behalf of the issuer, or is otherwise compensated, whether in the past or prospectively, to promote the issuer’s offering. Rule 204(c) permits an issuer to communicate with investors about the terms of an offering through the communication channels provided by the intermediary on the intermediary’s platform so long as the issuer identifies itself as the issuer in all communications. Rule 303(c) further provides that if the intermediary is a funding portal, it cannot participate in the communications channel, apart from establishing guidelines for communication and removing potentially abusive or fraudulent communications. The prohibition on more active participation follows from the definition of funding portal, which as stated in Rule 300(c)(2)(i) does not allow a funding portal to offer investment advice or recommendations.
Question 303.4: What are the requirements for intermediaries with respect to maintenance and transmission of investor funds?
Answer: Rule 303(e)(1) requires an intermediary that is a registered broker-dealer to comply with the established requirements in Exchange Act Rule 15c2-4 for the maintenance and transmission of investor funds. With respect to an intermediary that is a funding portal, Rule 303(e)(2) requires a funding portal to direct investors to transmit the money or other consideration directly to a “qualified third party” that has agreed in writing to hold the funds for the benefit of, and to promptly transmit or return the funds to, the persons entitled thereto. Further, Rule 303(e)(3) provides that the funding portal must promptly direct the qualified third party to, among other things, (i) transmit funds from the qualified third party to the issuer when the aggregate amount of investment commitments is equal to or greater than the target amount of the offering and the cancellation period has elapsed, subject to conditions; (ii) return funds to an investor when an investment commitment has been cancelled; and (iii) return funds to investors when an issuer does not complete the offering.
Question 303.5: What types of entities may funding portals use as “qualified third parties” for the maintenance and transmission of investor funds?
Answer: Rule 303(e)(2) defines the following types of entities as “qualified third parties”: (1) a registered broker or dealer that carries customer or broker or dealer accounts and holds funds or securities for those persons; or (2) a bank or a credit union (insured by the National Credit Union Administration) subject to certain additional conditions enumerated in Rule 303(e)(2)(ii).
Question 303.6: What are the requirements for the funding portal agreements with qualified third parties that are banks or credit unions?
Answer: Regulation Crowdfunding does not specify the content of agreements with qualified third parties that are banks or credit unions, but Rule 303(e)(2) requires that the agreement must be in writing and a qualified third party must agree to hold funds for the benefit of, and to promptly transmit or return the funds to, the persons entitled to those funds. The funding portal is required to maintain the written agreement pursuant to Rule 404(a)(5) and (a)(7). Additionally, the funding portal is required to file on Form Funding Portal information about the qualified third party, including the name and address of the qualified third party.
Completion of Offerings, Cancellations and Reconfirmations (Rule 304 of Regulation Crowdfunding)
Question 304.2: Can an intermediary charge investors cancellation fees?
Answer: Regulation Crowdfunding does not directly address the question of cancellation fees. However, Rule 304(a) requires that an investor be able to cancel an investment commitment for “any reason” until 48 hours prior to the deadline identified in the issuer’s offering materials. While the rules do not address whether intermediaries may charge a cancellation fee, an intermediary should consider whether a cancellation fee is consistent with an investors’ right to cancel for “any reason” under Rule 304(a).
Question 304.3: What obligations do intermediaries have if the issuer chooses to engage in a rolling close?
Answer: Regulation Crowdfunding does not specify the type of offering in which an issuer may choose to engage. If an issuer decides to do a “min/max” offering in which offered securities will be sold if a minimum is met, but subject to a cap on the overall amount sold, it may wish as well to engage in a “rolling close” in which, once a specified minimum threshold is met, investors are notified by the intermediary that that minimum portion of the issue will be closed and funds are released to the issuer. After this initial close, the issuer may make additional closes until the maximum offering amount is received. the applicable requirements of Regulation Crowdfunding must be met at the time of each closing. For example, Rule 304(b) requires, among other things, that if an offering is closed prior to the deadline identified in offering materials, the intermediary must provide notice to any potential investors, and give or send notice to investors that have made investment commitments, of: at least five business days’ notice of the new deadline, an investor’s right to cancel commitments for any reason until 48 hours prior to the new offering deadline, and whether the issuer will continue to accept investments during the 48 hour period prior to the new offering deadline.
Question 304.4: What happens if the offering changes?
Answer: If there is a material change to the terms of an offering or to the information provided by the issuer, Rule 304(c) requires the intermediary to give or send to any investor who has made an investment commitment notice of the material change and state that the investor’s commitment will be canceled unless the investor reconfirms his or her investment commitment within five business days of receipt of notice.
Payments to Third Parties (Rule 305 of Regulation Crowdfunding)
Question 305.1: Can an intermediary compensate third parties for directing investors to its platform?
Answer: Rule 305(a) provides that an intermediary may not compensate any person for providing the intermediary with the personally identifiable information of any investor or potential investor in securities offered and sold in reliance on Section 4(a)(6). For purposes of Rule 305, Rule 305(b) defines personally identifiable information to mean information that can be used to distinguish or trace an individual’s identity, either alone or when combined with other personal or identifying information that is linked or linkable to a specific individual.
However, as permitted under the conditional safe harbor provided by Rule 402(b)(6), a funding portal may compensate a third party for referring a person to the funding portal, if it acts in accordance with Rule 305(a) and the compensation, other than that paid to a registered broker or dealer, is not based, directly or indirectly, on the purchase or sale of a security in reliance on Section 4(a)(6) offered on or through the funding portal’s platform. Further, the Commission stated in the Regulation Crowdfunding adopting release that intermediaries should be permitted to compensate third parties for general business advertising, so long as the compensation is not based, directly or indirectly, on the purchase or sale of a security offered in reliance on Section 4(a)(6).
Funding Portal Regulation
The Rule 400 series of Regulation Crowdfunding contains rules specifically applicable to funding portals. In addition, FINRA has a set of rules that apply specifically to funding portals, available at www.finra.org.
Registration of Funding Portals (Rule 400 of Regulation Crowdfunding)
Question 400.1: How do I register as a funding portal?
Answer: Funding portals register by filing an application on Form Funding Portal through the SEC’s Electronic Data Gathering, Analysis and Retrieval (“EDGAR”) system. Form Funding Portal requires information from the funding portal applicant, including information about the funding portal’s business, principals, control relationships, and employees. Required information for registration, amendments, and withdrawal is set out in Instructions to Form Funding Portal, available at http://www.sec.gov/forms and in the text of the rules, available at http://www.sec.gov/about/laws/secrulesregs.htm#sea34.
Further, an entity registering as a funding portal must also become a member of a registered national securities association. FINRA is currently the only registered national securities association. Additional information regarding FINRA membership is available at http://www.finra.org/industry/funding-portals.
Question 400.2: When do I have to file an amendment to my funding portal registration?
Answer: Rule 400(b) requires a funding portal to file an amendment to Form Funding Portal within 30 days of when any of the information previously submitted on the form becomes inaccurate for any reason.
Nonresident Funding Portals: In addition, under Rule 400(f)(2)(iii), a nonresident funding portal firm must promptly file an amendment to Schedule C to Form Funding Portal for any change in the funding portal’s agent for service of process or in the name or address of the existing agent for service of process. A nonresident funding portal is required under Rule 400(f)(3)(ii) to re-certify on Schedule C within 90 days after any changes in the legal or regulatory framework that would impact the nonresident funding portal’s ability to provide, or the manner in which it provides, the Commission or any registered national securities association of which it is a member, with prompt access to its books and records or that would impact the Commission’s or such registered national securities association’s ability to inspect and examine the nonresident funding portal. The re-certification is required to be accompanied by a revised opinion of counsel.
Question 400.3: Where can I find a list of registered funding portals?
Answer: You may search the EDGAR system for any funding portal that has an effective registration with the Commission. FINRA also maintains a list of all FINRA funding portal members on its website.
When searching EDGAR, there are multiple ways to find funding portal filings:
By Filing Type. To search the EDGAR System, please take the following steps:
- Go to the public EDGAR website, at http://www.sec.gov/edgar/searchedgar/companysearch.html.
- On the left search option, choose “Full Text (Past 4 Years)” and then click on “Advanced Search” next to the search box.
- Under the “In Form Type” dropdown menu, select:
- CFPortal – For Form Funding Portals that have been made effective;
- CFPortal/A – For amendments to a Form Funding Portal;
- CFPortal/W – For withdrawals of active funding portal registrations.
- Then click “Search.”
By Company Name. If you know the name of the funding portal, you can also search for filings by its name by going to http://www.sec.gov/edgar/searchedgar/companysearch.html.
Exemption (Rule 401 of Regulation Crowdfunding)
Question 401.1: Can a funding portal host a live event with an issuer?
Answer: Under Rule 401, a funding portal is exempt from the broker-dealer registration requirements of Section 15(a) in connection with its activities as a funding portal. However, as noted above, funding portals are prohibited from engaging in certain activities pursuant to the rules. The Commission in the Regulation Crowdfunding adopting release stated that it did not believe a funding portal should be permitted to physically meet with investors to solicit investments or offerings on its platform or host launch parties because those activities likely violate the statutory prohibition on funding portals soliciting and providing investment advice and recommendations.
A registered broker-dealer can engage in a broader range of activities than a funding portal, including providing recommendations and soliciting investors. However, registered broker-dealers need to comply with all applicable requirements, including the requirement to make only suitable recommendations.
Conditional Safe Harbor (Rule 402 of Regulation Crowdfunding)
Question 402.1: Rule 402(b)(2) of the conditional safe harbor states that funding portals may highlight particular issuers or offerings of securities made in reliance on Section 4(a)(6) on their platforms based on objective criteria. Does the rule contain a comprehensive list of such criteria?
Answer: The criteria listed in Rule 402(b)(2) are examples of objective criteria, but are not an exhaustive list. As stated in Rule 402(b)(2), the criteria must be designed to highlight a broad selection of issuers offering securities through the funding portal’s platform, be applied consistently to all issuers and offerings and be clearly displayed on the platform. However, as stated in the Regulation Crowdfunding adopting release, consistent with the statutory restrictions on funding portal activities, the objective criteria may not include the advisability of investing in the issuer or its offering or give the impression that the funding portal is providing an explicit (or implicit) recommendation on whether to invest in the issuer or the offering.
Question 402.2: Are funding portals permitted to pay transaction-based compensation to any persons?
Answer: Yes. Rule 402(b)(7) permits a funding portal to pay or offer to pay compensation to a registered broker-dealer for services, including referrals, provided in connection with the offer or sale of securities in reliance on Section 4(a)(6), subject to certain conditions and so long as the services are not prohibited under Rule 305. As noted above in question 305.1, an intermediary, including a funding portal, may not compensate any person for providing the intermediary with the personally identifiable information of any investor or potential investor in securities offered and sold in reliance on Section 4(a)(6).
Question 402.3: Are funding portals permitted to receive commissions or other transaction-based compensation for services provided?
Answer: Yes. Funding portals are brokers, as defined under Rule 300(c)(2), and so may receive commissions or other transaction-based compensation from issuers for services provided in connection with the offer or sale of securities in reliance on Section 4(a)(6).
In addition, Rule 402(b)(8) provides a safe harbor under which a funding portal may receive compensation, including transaction-based compensation, from a broker-dealer for providing referrals to that broker-dealer relating to an offering made pursuant to Section 4(a)(6). The safe harbor, however, does not apply to a funding portal receiving transaction-based compensation for referrals of investors in other types of offerings, such as Rule 506 offerings, that are effected by a registered broker-dealer. Receipt of transaction-based compensation in connection with such referrals or in connection for services provided to issuers that are not in connection with an offering made in reliance on Section 4(a)(6) could cause a funding portal to be required to register as a broker with the Commission under Exchange Act Section 15(a)(1).
Question 402.4: Can a funding portal advertise a single issuer?
Answer: Rule 402(b)(9) permits a funding portal to identify one or more issuers or offerings available on the portal on the basis of objective criteria that are reasonably designed to identify a broad selection of issuers and offerings and are applied consistently to all potential issuers and offerings, subject to conditions. A funding portal that seeks to advertise a single issuer must consider whether it is in fact highlighting the issuer on the basis of objective criteria that are reasonably designed to identify a broad selection of issuers and offerings. As stated by the Commission in the Regulation Crowdfunding adopting release, advertisements can take many varied forms, including non-traditional means, such as blogs, e-mails through social media or other methods.
If a funding portal is unable to rely on the safe harbor, it must then consider whether advertising a single issuer is providing impermissible investment advice or a recommendation, or is otherwise an impermissible solicitation of offers to buy the securities offered or displayed on its platform. More generally, advertisements sent by a funding portal must not suggest that it is a recommendation to purchase a security or advice as to the advisability in investing in any security.
Question 402.5: What happens if a funding portal is unable to rely on the conditional safe harbor under Rule 402?
Answer: Rule 402(a) expressly provides that there is no presumption that a funding portal has violated the prohibitions under Regulation Crowdfunding or under Section 3(a)(80) of the Exchange Act solely by reason of the funding portal or its associated persons engaging in crowdfunding activities that do not meet the conditions specified in the safe harbor. However, a funding portal must analyze all of its activities to determine whether it continues to qualify for the exemption from broker-dealer registration under Rule 401 or it is acting as a broker and thus is required to register under Section 15(a) of the Exchange Act.
Compliance (Rule 403 of Regulation Crowdfunding)
Question 403.1: Do funding portals have any obligations with respect to privacy?
Answer: Yes. Because funding portals will collect and maintain sensitive personal information about the investors using their platforms, they must comply with Rule 403(b). Rule 403(b) requires funding portals to comply with the same privacy rules as those applicable to brokers, namely to comply with Regulation S-P (Privacy of Consumer Financial Information and Safeguarding Personal Information), Regulation S-AM (Limitations on Affiliate Marketing), and Regulation S-ID (Identity Theft Red Flags).
Records to Be Made and Kept by Funding Portals (Rule 404 of Regulation Crowdfunding)
Question 404.1: Do funding portals have any anti-money laundering (“AML”) requirements?
Answer: Although funding portals do not currently have AML requirements, the Financial Crimes Enforcement Network (“FinCEN”) has proposed an amendment to the rules under the Bank Secrecy Act (“BSA”) definition of “broker or dealer in securities” to include funding portals. If this amendment is adopted as proposed, funding portals would be required to implement policies and procedures reasonably designed to achieve compliance with the BSA requirements, including the filing of suspicious activity reports (“SARs”).