Funding portal registration is now available through FINRA.
This LawFlash discusses funding portals, which are the intermediariesthrough which crowdfunding will occur, specifically regarding the registration process prior to intermediating crowdfunding transactions, as well as the Financial Industry Regulatory Authority’s (FINRA’s) rules governing funding portals. Crowdfunding is permissible beginning on May 16, and prospective funding portal registrants can and should begin the process as soon as possible to secure the registrations mandated by the SEC.
A series of recent approvals by the US Securities and Exchange Commission (SEC) have paved the way for equity crowdfunding in the United States, as mandated by Title III of the Jumpstart Our Business Startups (JOBS) Act. Crowdfunding is generally considered to be the use of the Internet by small businesses to raise capital through small investments by large numbers of investors.
The novel aspect of equity crowdfunding is the ability to offer and sell securities to the public. This is a vast differentiator compared to donation- or purchase-based methods of crowdfunding that have developed in recent years in which an entrepreneur or artist typically seeks to launch a project by requesting donations or advance purchase orders (often through a third-party website) from supporters who are eager to see the project succeed. Donation- or purchase-based crowdfunding projects often promise an incentive to help with funding, like an early spot in the purchase queue if the product reaches market, or VIP shows or viewings by the artist.
Equity crowdfunding creates an opportunity for enthusiasts to have real “skin in the game” through actual ownership in the venture.
PLATFORM FOR CROWDFUNDING
Anyone can invest in a crowdfunded securities offerings beginning on May 16, 2016, subject to certain limitations on the amounts invested. However, companies are not permitted to offer equity crowdfunding opportunities directly to investors. All equity crowdfunding must occur through a registered broker-dealer or a funding portal. A funding portal is any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to the “crowdfunding exemption” (Section 4(a)(6) of the Securities Act of 1933 (Securities Act)), that does not (a) offer investment advice or recommendations; (b) solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal; (c) compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; (d) hold, manage, possess, or otherwise handle investor funds or securities; or (e) engage in such other activities as the SEC, by rule, determines appropriate.
For an existing broker-dealer FINRA member that maintains certain approved business lines, engaging in equity crowdfunding can be as simple as checking a box in FINRA’s Firm Gateway. For other broker-dealer FINRA members, before intermediating a crowdfunding transaction, FINRA’s approval could be required via a full-fledged continuing membership application (CMA) pursuant to NASD Rule 1017. For non-broker-dealers, a funding portal must become a member of a national securities association registered under Section 15A of the Exchange Act. FINRA is currently the only registered national securities association, and therefore all funding portal membership currently goes through FINRA.
FINRA has modeled the process and requirements for funding portal registration on the existing infrastructure for broker-dealer member registration. Currently, a broker-dealer applicant is required to submit SEC Form BD for registration, submit several “entitlement” materials to gain access to FINRA’s Firm Gateway, and complete FINRA’s Form NMA (New Membership Application), which is subject to up to 180 days of FINRA review before approval. Subsequent to FINRA’s approval, changes of ownership or control and material changes in business activities require broker-dealer members to submit Form CMA and related materials in order to maintain good standing.
We have successfully helped hundreds of broker-dealers navigate the FINRA membership and registration process, which can be less than intuitive. Applicants must comply with specific standards and reply to FINRA within specific time periods. Even the process of gaining access to the Firm Gateway to begin Form NMA can be confusing. Leveraging the existing broker-dealer registration process for the funding portal registration process is a logical approach, and one that FINRA was presumably able to roll out more rapidly than starting from scratch. However, the process carries with it many of the same idiosyncrasies, some of which we highlight below.
SUBPART D OF REGULATION CROWDFUNDING
Form Funding Portal
A funding portal must register with the SEC by electronically filing a complete Form Funding Portal through EDGAR. Form Funding Portal is not unlike Form BD for broker-dealer registration with the SEC and solicits similar categories of information, such as identifying and organizational information, Tax ID number, and contact information; information relating to control relationships; information relating to the disciplinary history of the funding portal applicant, its associated persons and any control affiliates; information relating to any non-securities related business of the funding portal applicant; and information relating to any qualified third party arrangements or compensation arrangements.
Submission of Form Funding Portal is only one piece of the application process. Prospective funding portals should first reserve the funding portal’s name, which will be vetted by FINRA to confirm that the name is not already reserved or too similar to an existing name such that it might confuse or mislead users. Upon submission of Form Funding Portal, the SEC will assign the funding portal applicant an SEC file number that can be used to start the FINRA entitlement program. Again, much like the process for broker-dealer registration, a funding portal applicant must designate a Super Account Administrator (SAA) by completing the Funding Portal Organization Super Account Administrator Entitlement Form. The SAA will be the person entitled as an administrator to the funding portal applicant’s application materials. The funding portal applicant will use the entitlement forms to gain access to FINRA’s Funding Portal Registration Depository (FPRD) for completion of additional application materials.
Fingerprints are generally required for each person who will be a partner, director, officer, or employee of the funding portal (see Exchange Act Rule 17f-2). A funding portal applicant can submit fingerprints for its associated persons after FINRA has generated an organizational ID for the funding portal applicant. Fingerprint submissions to FINRA can be made electronically through the Electronic Fingerprint Submission (EFS) Program by contracting with a certified vendor.
A funding portal applicant will also be subject to fees, which must be sent to FINRA via electronic wire. FINRA will assess a $2,700 application fee upon submission of Form FP-NMA, which is discussed below. FINRA will also assess a $500 fee for submission of Form FP-CMA for a proposed change in ownership or control, as discussed below. These funding portal fees are significantly less than corresponding fees for broker-dealer membership applications (fees for new broker-dealer FINRA member applications range from $7,500 to $55,000, and fees for broker-dealer FINRA member changes in ownership or control range from $5,000 to $15,000).
As it does with its broker-dealer members, FINRA also will levy on each funding portal member an annual gross income assessment (as reported on Form FP—Statement of Revenue). This annual assessment is $1,200 on the first $1 million of the funding portal’s annual gross revenue and then certain percentages of annual gross revenue for certain tiers above $1 million.
FUNDING PORTAL MEMBER APPLICATION FORMS
FINRA Funding Portal Rule 110 describes the requirements and process for seeking funding portal membership with FINRA via Form FP-NMA. The “NMA” refers to “new membership application,” as with FINRA membership as a broker-dealer via Form NMA. Form FP-NMA is a streamlined version of broker-dealer Form NMA, given the limited nature of a funding portal’s business as compared to a broker-dealer. Streamlining is a consistent theme that runs throughout the funding portal application process. For example, FINRA must respond to the initial submission of Form FP-NMA with follow up questions or requests within 14 days, whereas FINRA has 30 days to respond to a broker-dealer Form NMA submission. A funding portal applicant also has up to 14 days to respond to FINRA’s initial request for additional information or documentation, whereas a broker-dealer applicant has up to 30 days to respond. FINRA is able to make follow up requests of the funding portal applicant at any time during the application process, just like the process for broker-dealer applications. However, whereas a broker-dealer applicant would have up to 30 days to respond to any follow up requests, a funding portal applicant will only have up to 7 days. This is similar to FINRA’s “fast track” review process introduced in 2013 for low-risk, low-complexity applications that require only minimal additional information that can be completed in an expedited manner. If “fast tracked,” a broker-dealer applicant typically must agree to response times within approximately one week, which is significantly shorter than the 30-day period specified in NASD Rule 1017. Finally, FINRA generally must issue its decision on the funding portal application within 60 days of submission (the broker-dealer NMA process can take up to 180 days).
Form FP-NMA requires a funding portal applicant to provide several categories of information and documentation, including, but by no means limited to the following:
- A description of the applicant’s ownership (including an ownership organizational chart identifying direct and indirect owners, ownership percentages, and any subsidiaries of the applicant).
- A list of the applicant’s associated persons (including C-suite executives).
- A description of the applicant’s business model, including regarding (i) the forms of compensation that will be paid to the funding portal or its associated persons; (ii) any referral fees or transaction-based compensation that the funding portal or associated persons will pay to others; (iii) the types of securities to be presented to investors; (iv) any limitations on the types of issuers that will be presented; (v) how issuers will be presented to investors (e.g., website, social media platform); and (vi) the type and scope of any other business activities the funding portal applicant intends to conduct.
Additional information that will be required includes descriptions of contractual relationships and contracts and agreements, detailed information about source of funds for the funding portal, and disclosures regarding the applicant and all of its associated persons, to the extent that they have regulatory history.
Once approved (and much like the broker-dealer CMA process), Form FP-CMA and the related review and approval process will be required for any changes in the ownership or control of 25% or more of the equity/capital of the funding portal member. The follow up requests, responses and response times described above for Form FP-NMA also apply to Form FP-CMA. Given the limited nature of a funding portal’s business, material changes in business operations are not applicable, and therefore Form FP-CMA is not used in this manner, as is broker-dealer Form CMA.
Interestingly, a broker-dealer is able to effect a change of control within 30 days of providing notice to FINRA, whereas a funding portal requires prior approval. However, FINRA must issue a decision to the funding portal with 60 days of the proposed change of ownership or control, as compared to up to 180 days for a similar application of a broker-dealer. Nevertheless, this still seems like a peculiar result—a full-fledged broker-dealer can effect a change of control in as little as 30 days, but a funding portal could be required to wait up to 60 days.
Form FP-CMA requires a funding portal to provide several categories of information and documentation, including an explanation of the impact of the proposed ownership or control change on the following components of the business of the funding portal: (a) impact on owners or control persons of the funding portal (including identification of all new owners that will, directly or indirectly, own or control 25% or more of the funding portal or persons who will, directly or indirectly, control the funding portal); and (b) impact on supervisory structure and personnel.
NOTIFICATION TO FINRA AND POTENTIAL MEMBERSHIP IMPACT
New FINRA Rule 4518 requires that broker-dealer members notify FINRA prior to engaging for the first time in a crowdfunding transaction by updating their profile information on the “Additional Business Types” section of the “Business Activities” page. FINRA considers a broker-dealer member that is already approved to engage in private placements or underwriting to have the necessary FINRA membership approvals to intermediate crowdfunding transactions. Other broker-dealer FINRA members may need to file a CMA pursuant to NASD Rule 1017 using Form CMA if the activity would be a material change in business operations. This is a facts and circumstances analysis, and FINRA’s materiality consultation process is available to assist member firms with determining whether such activity is material and, if so, whether a CMA is required.
Broker-dealer FINRA members must also notify FINRA within 30 days of directly or indirectly controlling (or being controlled by or under common control with) a funding portal. While FINRA Rule 4518 only requires this after-the-fact notice, a funding portal itself is required to submit and have approved Form FP-CMA. FINRA’s rules are not clear with regard to how a broker-dealer FINRA member that only acquires control of, or comes under common control with, a funding portal would satisfy the notice requirement, as control would not seem to logically mean that the broker-dealer member should note “funding portal” as one of its own “business types.” Seeing as though Form FP-CMA is needed from the funding portal’s perspective, it is possible that FINRA may consider this to also serve as the broker-dealer member’s notice.
FUNDING PORTAL CONDUCT
Funding Portal Rule 200 is based on FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade). A funding portal member must observe high standards of commercial honor and just and equitable principles of trade in the conduct of its business. A funding portal member must not eﬀect any transaction in, or induce the purchase or sale of, any security by means of, or by aiding or abetting, any manipulative, deceptive, or other fraudulent device or contrivance.
Funding portal members’ communications are subject to content standards, which are an abridged version of FINRA’s communications rules for broker-dealers under FINRA Rule 2210. A “funding portal communication” is any electronic or other written communication that is distributed or made available by a funding portal member to one or more investors. All funding portal member communications must be based on principles of fair dealing and good faith and must be fair and balanced. All funding portal member communications must also prominently disclose the name of the funding portal member, or the name under which the funding portal member primarily conducts business as disclosed on the member's Form FP-NMA. Funding Portal Rule 200(c) prohibits funding portal communications that
- include any false, exaggerated, unwarranted, promissory, or misleading statement or claim;
- omit any material fact or qualiﬁcation if the omission, in light of the context of the material presented, would cause the communication to be misleading;
- state or imply that FINRA, or any other corporate name or facility owned by FINRA, or any other regulatory organization endorses, indemniﬁes, or guarantees the funding portal member's business practices; or
- predict or project performance, imply that past performance will recur or make any exaggerated or unwarranted claim, opinion, or forecast. A hypothetical illustration of mathematical principles is permitted, provided that it does not predict or project the performance of an investment.
FUNDING PORTAL COMPLIANCE
Funding Portal Rule 300 is based on FINRA Rules 3110 (Supervision), 4530 (Reporting Requirements), and 4517(c) (Member Filing and Contact Information Requirements), as well as Exchange Act Rule 17a-3(a)(12)(ii).
Each funding portal member must satisfy certain ongoing requirements, including, but not limited to establishing and maintaining a system to supervise the activities of its associated persons that is reasonably designed to achieve compliance with applicable securities laws and regulations and with the Funding Portal Rules, including, at a minimum, (a) establishment and maintenance of written procedures to supervise the activities of the funding portal member and its associated persons; (b) designation of a person with authority to carry out the supervisory responsibilities of the funding portal member; and (c) reasonable eﬀorts to determine that all supervisory personnel are qualiﬁed by virtue of experience or training to carry out their assigned responsibilities.
INVESTIGATIONS, SANCTIONS, CODE OF PROCEDURE, AND ARBITRATION AND MEDIATION
Funding Portal Rule 800 (Investigations and Sanctions) generally subjects all funding portals to FINRA’s 8000 Series of rules (Investigations and Sanctions), including with respect to provision of information and testimony, inspection and copying of books, fines, and other sanctions. A funding portal also is subject to requirements similar to BrokerCheck for FINRA broker-dealer members. Much like FINRA Rule 8312, Funding Portal Rule 800(b) provides the following:
- FINRA may provide access to the public, via an appropriate link on the FINRA website, to a funding portal member's current SEC Form Funding Portal, including amendments and registration withdrawal requests, as ﬁled with the SEC pursuant to SEC Regulation Crowdfunding.
- FINRA will make available to the public information ﬁled by a funding portal member that indicates whether the funding portal member or any associated person of the funding portal member is subject to a “statutory disqualification” under Section 3(a)(39) of the Exchange Act. A funding portal member must keep this information current and must update such information promptly (within 10 days of any change in the information).
Funding Portal Rule 900 (Code of Procedure) generally subjects all funding portal members to the FINRA Rule 9000 Series of rules, unless the context requires otherwise, except for the FINRA Rule 9520 Series, FINRA Rule 9557, and the FINRA Rule 9700 Series of rules. Funding portal Rule 900 includes certain, specific procedural rules applicable to funding portal members, such as circumstances where a funding portal member may be subject to a ﬁne by FINRA or a “statutory disqualification.”
Funding Portal Rule 1200 (Arbitration and Mediation) generally subjects all funding portal members to the FINRA Rule 12000 Series (Code of Arbitration Procedure for Customer Disputes), FINRA Rule 13000 Series (Code of Arbitration Procedure for Industry Disputes) and FINRA Rule 14000 Series (Code of Mediation Procedure) of rules, unless the context requires otherwise. Funding portal Rule 1200 addresses the use of predispute arbitration agreements for investor accounts (similar to FINRA Rule 2268). In this regard, and like customer agreements for brokerage accounts, any predispute arbitration clause must be highlighted and must be immediately preceded by the specific language in outline form.
Investing via equity crowdfunding is permissible beginning on May 16, 2016, but only through a funding portal or a broker-dealer that intermediates crowdfunding transactions. Businesses raising capital cannot crowdfund directly with prospective investors.
With the May 16, 2016 “go-live” date for equity crowdfunding nearly upon us, those seeking to register as funding portals should begin the application process as soon as possible, be aware of the steps they will encounter throughout the process, and be mindful of the rules to which they will be bound if approved.