An SEC enforcement order came across my desk that illustrates how to operate a Crowdfunding portal if you want to meet people who work for the government. The order, with names removed, is available here.
As a preface, everything I know about this portal comes from the SEC’s enforcement order. It is possible that the SEC’s allegations are false – even though the portal agreed to a settlement, without admitting wrongdoing – and that the portal actually was in full compliance with all applicable laws.
With that said, here’s what the portal did, or is alleged to have done:
- In May 2013, before “general solicitation” was legal, it established a website that listed investments for anyone to see, i.e., not behind a firewall.
- Although the site included a disclaimer that investments were not available to U.S. persons, the portal did not take steps – for example, using IP addresses – to enforce this rule. In fact, more than 50 individuals who listed the U.S. as their place of residence were allowed to register, and several actually invested.
- The portal allowed at least some of the U.S. investors to self-certify that they were “accredited investors,” without even explaining what that meant.
- The portal charged a commission for raising capital without being registered as a broker-dealer.
The violations alleged by the SEC do not fall within an ambiguous gray area. They are just flat-out over the line. And note the timing: May 2013, after the no-action letters to FundersClub and AngelList, in which the SEC gave the world a road map for legal Crowdfunding.
I can only guess this portal was represented by one of my competitors. 🙂
That’s a joke, of course. Much more likely, the company wasn’t represented by anybody and just did what seemed to make sense, without knowing they were violating anything.
The portal was incorporated and operated offshore. Nevertheless, it was subject to U.S. securities laws because it solicited U.S. investors.
Fortunately, everything this company wanted to do can be done legally and at a very low cost. If you want to raise money exclusively offshore, then exclude U.S. investors. If you want to raise money from the U.S. and offshore, use Regulation S. If you’re raising money from U.S. investors use VerifyInvestor.com or Crowdentials to verify they’re accredited. If you’re going to charge a commission use an online broker-dealer. If you want to allow investors to self-certify, then use Rule 506(b) and hide your deals behind a firewall. Spend just a little money on a lawyer and stay off the SEC’s Christmas card list.
Questions? Let me know.
Great article, using the enforcement order to illustrate some important nuances of equity crowdfunding. I was curious about one part of the complaint:
“The portal allowed at least some of the U.S. investors to self-certify that they were “accredited investors,” without even explaining what that meant.”
So if the portal had included the standard wording from the SEC regs on top of the self-certification page or document – then this would not have been an issue, right?
I only ask, because so many portals (including several very prominent ones, have pretty superficial (or straightforward, depending on your perspective) self-certification methods – and would be just as guilty.
Insights?
It depends. If they had been doing Rule 506(b) deals, they could have used self-certification. But they were using general solicitation, which meant they had to do Rule 506(c) deals, which means self-certification is not enough. Where you see portals using self-certification it should mean that they’re not doing general solicitation, i.e., they’re hiding their deals behind a registration firewall. I wrote a blog post a while ago called something like What Can I Show Investors, and When? If you’d like to discuss call me at (856) 661-2265.
Thanks for clarifying. The gray area is whether or not the deals/offerings are truly private (behind a registration wall). And the other (huge) side-issue is that the most of the 506c certification criteria/options are ridiculous for any one portal (or offerer) to comply. Asking each angel for tax returns? Maybe an aunt and uncle, but not accredited angels.
That’s exactly why people use VerifyInvestor and Crowdentials – so the angel investor doesn’t have to give the portal or issuer his or her tax returns.
In my opinion Rule 506(b) deals are pretty much a historical anachronism, created by the 2013 no-action letters. It won’t be long before they disappear, except where you’re looking for non-accredited investors.