One of the major obstacles of growth for Internet based Crowdfunding platforms in the U.S. has been the reaction of regulatory authorities.
However, two “no-action letters”, dated March 26, 2013, were sent by the SEC to online equity-based crowdfunding portals FundersClub and AngelList (the letters can be found here and here.) are required to register as a broker dealer under U.S.securities law. No-action letters can be requested from SEC staff to clarify whether a particular product, service, or action would constitute a violation of U.S. federal securities law. The letter is limited to the specific facts and circumstances in the request only.
The SEC’s Division of Trading and Markets addressed this issue based on a narrow, fact-specific interpretation in response to requests from FundersClub Inc. and AngelList LLC seeking assurances that their online investment matchmaking activities would not result in enforcement action by the SEC. The letters look to not only provide interim guidance but for the SEC’s Division of Corporation Finance to use both companies to test as to how the rules may potentially work.
The Significance of Clarification
Portals are structured as investment advisory services have the same registration requirements as investment advisors. When a company is funded by investors, the portals do not receive cash compensation but instead receive compensation known as “carried interest”, future profits from the company.
“Carried Interest” compensation seemed to one of the key factors in the determination for the SEC, along with other provisions such as the disclosure of compensation agreements and fees that advisors to the company would pay, along with the rule that the company cannot be in charge of handling any funds or securities from customers who purchase or invest.
However it should be noted that these requests were made prior to the passing of the JOBS Act, so trading platforms or other entities that rely on the AngelList and FundersClub no-action letters need to consider a number of regulatory issues specific to their own case, including the letters’ conditions that the platform operator register with the SEC or one or more states as an investment adviser (or qualify as an exempt reporting adviser), and make appropriate arrangements with a bank or other financial institution to hold all customer funds and securities.
In addition both letters fail to address the general solicitation and investor accreditation issues raised by the operation of the platforms to conduct private placements under Rule 506. Although the letters represent a significant opportunity for trading platforms and other entities to facilitate capital formation without the need for broker-dealer registration, questions still remain about other provisions that have yet to come into existence, especially with the deadline for implementation of Title III of the JOBS Act coming later this year.
Clarification also comes into question when it comes to experience; even if crowdfunding is just going to stand out as a simpler, cheaper way to raise capital, experts believe that companies will still seek capital through traditional conduits such as investment banks and venture capitalists. Many companies will seek to go the traditional route due to value added services and incentives that investors bring, such as substantial networks to facilitate recruiting and customer introductions, along with the implementation and assessment of technological innovation and the promise of potential joint venture partnerships.
Reactions and Outlooks for the Future of Crowdfunding Platforms
David Feldman, Partner at Richardson & Patel and a leading legal expert in the crowdfunding field stated that the precedence of FundersClub and AngelList is that “it’s essentially using a website to bring investors into their vehicles, and the SEC says this is ok if you limit it to accredited investors.”
Feldman also went on to add that AngelList is teaming up with SecondMarket even though it is a standalone platform. He also addressed how due diligence will be performed, saying that “they are also applying to be an investment adviser with the SEC and will require due diligence and careful review of deals before offering them to accredited investors through their site.”
Although the Letters represent only the beginning of a process in which entrepreneurs, investment managers, private companies, the Staff, the SEC and others explore and develop the rules, the timetable before full implementation of the JOBS Act allows a very low margin of error.
In a publication from law firm Goodwin Procter they concluded that “key questions, for example regarding general solicitation and the procedures by which investors may be verified as “accredited” await further guidance from the SEC. Finally, other parties such as state regulators and various self-regulatory organizations have not yet weighed-in and may have a material impact.”
It still remains to be seen however, how the market and other companies seeking crowdfunding will react to the new structures and regulations currently being developed and how it will add legitimacy and security to the crowdfunding world.