In late-March 2013, the staff of the SEC’s Division of Trading and Markets issued two no-action letters related to online platforms involved in private placements. Although the facts presented by the two letters differ, both involve platforms that use a “venture fund” model to facilitate investments, and permit an investment advisor affiliated with the platform to receive incentive compensation (i.e., compensation tied to increases in the value of the investment) and reimbursement of actual expenses. In the first letter, dated March 26, 2013, the staff indicated that they would not recommend action against the operators of the FundersClub website for failing to register as a broker-dealer under the Exchange Act. The staff issued a similar letter to AngelList on March 28, 2013.
FundersClub Letter. The FundersClub request for no-action relief explains that FundersClub Inc. is a venture capital fund adviser that operates a web portal that includes information on selected start-up companies. FundersClub enters into a non-binding agreement with each start-up company, specifying a target amount of funding the start-up is seeking. Potential investors must have their accredited investor status verified by FundersClub, after which they become “members” of the portal. Thereafter, members may make non-binding indications of interest in the start-ups. If there is enough interest in a particular start-up, following a process of additional confirmations and negotiations, members invest in a fund managed by FundersClub (FC) Management. That fund in turn invests in the start-up. Investments in the fund are intended to qualify for an exemption from registration under Rule 506 of Regulation D. All cash and securities are handled by a bank or financial institution and neither FundersClub Inc. nor FC Management handles customer funds or securities.
Citing guidance included in Question 5 of the SEC Division of Trading and Market’s February 2013 FAQs, the staff noted that FundersClub’s current activities appear to comply with the Securities Act Section 4(b) exemption from broker-dealer registration FundersClub does not receive any “compensation (or the promise of future compensation) in connection with the purchase and sale of securities.” The request for no-action relief describes FundersClub’s future plans to receive reimbursement for actual expenses and compensation in the form of a carried interest, and discusses principles from existing investment adviser and broker-dealer interpretations to support FundersClub’s view that its proposed compensation model is consistent with typical advisor compensation and does not constitute transaction-based compensation associated with broker-dealer activities. In granting the requested relief, the staff took special note that both FundersClub and FC Management are advisers solely to venture capital funds defined in Rule 203(l)-1 under the Investment Advisers Act. Advisers that qualify as “venture capital fund advisers” are exempt from registration under the Act, but are subject to recordkeeping and reporting requirements under Investment Advisers Act Rule 204-4.
AngelList Letter. On March 28, 2013, the SEC’s Division of Trading and Markets granted no-action relief to a second “accredited crowdfunding” operator, AngelList LLC, a membership-only web portal limited to accredited investors, and AngelList Advisors LLC, the manager of investment funds formed to invest in start-up companies. Both of these entities intend to register as investment advisors with the SEC or one or more states. The letter advises that, subject to certain conditions, the staff of the Division will not recommend enforcement action against the AngelList entities for failure to register as broker-dealers.
The no-action request explains that AngelList plans to form a new, separate platform (through AngelList Advisors LLC) designed to provide accredited investors with the opportunity to invest in early-stage companies alongside investors identified by AngelList Advisors as experienced angel investors (referred to as lead angels). AngelList Advisors would require companies seeking funding through the new platform to undergo a diligence and approval process and meet certain established guidelines. Accredited investors on the AngelList Advisors platform would have the opportunity to invest alongside lead angels through private investment funds. Investments in the funds would be structured as private placements exempt from registration under Rule 506. AngelList Advisors would provide investment advice and administrative services to the investment funds under an agreement in exchange for a right to receive carried interest and reimbursement of expenses.
Proceed with Caution. Neither the requests for relief nor the staff’s no-action letter responses suggests that the relief provided to AngelList or FundersClub is premised on the exemption from broker-dealer registration provided by section 201(c) of the JOBS Act and codified in section 4(b) of the Securities Act. Instead, the requests for relief discuss SEC guidance on broker-dealer registration pre-dating the JOBS Act. Trading platforms or other entities that rely on the AngelList and FundersClub no-action letters need to consider a number of regulatory issues, 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. It is also important to note that neither letter addresses the general solicitation and investor accreditation issues raised by the operation of the platforms to conduct private placements under Rule 506. Nonetheless, the letters represent a significant opportunity for trading platforms and other entities to facilitate capital formation without the need for broker-dealer registration.