On May 7, 2012, the SEC Division of Trading and Markets issued FAQs about crowdfunding intermediaries in the JOBS Act. The FAQs provide guidance on the implementation of the crowdfunding intermediary provisions of Title III of the JOBS Act. Highlights of the FAQs are set forth below.

Crowdfunding Intermediary

The JOBS Act creates a new exemption for offerings of "crowdfunded" securities. Specifically, the JOBS Act exempts companies from the requirements of Section 5 of the Securities Act when they offer and sell up to $1 million in securities, provided that individual investments do not exceed certain thresholds and the company satisfies other conditions in the JOBS Act, which will require rulemaking by the SEC within 270 days of the enactment of the JOBS Act on April 5. The SEC Division of Corporation Finance has reminded issuers that any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws until the SEC's rulemaking is complete.

One of the crowdfunding conditions is that the companies use the services of an intermediary that is either a broker or a "funding portal" registered with the SEC. A person cannot register with the SEC as a funding portal or act as a crowdfunding intermediary now even if such person is already a registered broker because the SEC must adopt rules regarding crowdfunding. These rules will address the form and process needed to register with the SEC as a funding portal. Funding portals also must become members of the Financial Industry Regulatory Authority (FINRA) in addition to registering with the SEC.

Operating Restrictions

The JOBS Act imposes several restrictions on the activities of a registered funding portal and prohibits a funding portal from:

  • providing investment advice or making recommendations;
  • soliciting purchases, sales, or offers to buy the securities offered or displayed on its website or portal;
  • compensating employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal;
  • holding, managing, possessing, or otherwise handling investor funds or securities; or
  • engaging in any other activities the SEC determines to prohibit in its crowdfunding rulemaking.

In addition, each funding portal and each crowdfunding broker is prohibited from:

  • compensating promoters, finders or lead generators for providing the intermediary with the personal identifying information of any potential investor; or
  • allowing its directors, officers or partners (or any person occupying a similar status or performing a similar function) to have a financial interest in any issuer using the services of the intermediary.

Legal Obligations

The JOBS Act requires crowdfunding brokers and funding portals to, among other things:

  • provide disclosures that the SEC determines appropriate by rule, including those regarding the risks of the transaction and investor education materials;
  • ensure that each investor: (i) reviews investor education materials; (ii) affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and (iii) answers questions that demonstrate that the investor understands the level of risk generally applicable to investments in startups, emerging businesses, and small issuers and the risk of illiquidity;
  • take steps to protect the privacy of investors' information;
  • take such measures to reduce the risk of fraud with respect to such transactions, as established by the SEC by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person;
  • make available to investors and the SEC, at least 21 days before any sale, any disclosures provided by the issuer;
  • ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest;
  • make efforts to ensure that no investor in a 12-month period has purchased crowdfunded securities that, in the aggregate, from all issuers, exceed the investment limits set forth in the JOBS Act; and
  • comply with any other requirements that the SEC determines are appropriate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.