At least one high-volume Crowdfunding portal once used a “series LLC” for each crowdfunding vehicle and used a crowdfunding vehicle for almost every offering. Maybe that portal and others still do.
In a post that has yet to be picked up by the Associated Press, this blog once explained why that was a bad idea from a legal liability point of view. Now FINRA has chimed in.
The Series LLC
Some states, notably Delaware, allow a single limited liability company to be divided into “series,” the way an auditorium could be physically divided into cubicles. If operated correctly, Delaware provides that the creditors of one series can’t get at the assets of another series. So if one series of the LLC operates an asbestos plant and is hit with a giant lawsuit, the plaintiffs can’t get at the assets of the real estate owned by a different series of the same LLC.
Why Not to Use a Series LLC
I argued that it would be foolish to use a series LLC as a crowdfunding vehicle because:
- The series LLC concept has never been tested in a bankruptcy court, so we’re still not 100% sure the walls between cubicles will hold up.
- Some states, like Arizona, don’t even recognize the series LLC concept. So if an Arizona resident invests in a series LLC that goes bad, she can theoretically get to the assets owned by every other series of the same LLC. When you have a high-volume portal using a new series over and over, that could be a nightmare.
- Using a series LLC rather than a brand new LLC saves less than $200.
FINRA Chimes In
According to a recent statement by FINRA, a series LLC would not satisfy 17 CFR §270.3a-9(a)(6), which requires a crowdfunding vehicle to “Maintain a one-to-one relationship between the number, denomination, type and rights of crowdfunding issuer securities it owns and the number, denomination, type and rights of its securities outstanding.”
FINRA is saying, in effect, that while one series of an LLC might be protected from the liabilities of a different series under Delaware law, the series is not itself an “issuer.” The “issuer” is the LLC itself, i.e., the “parent” limited liability company formed by the portal. Because the securities of that parent do not reflect a one-to-one correspondence with the securities of any particular company raising money on the platform, it doesn’t qualify as a crowdfunding vehicle – it’s a plain vanilla investment company. And investments companies aren’t allowed to use Reg CF (they’re also subject to a bunch of other rules).
For what it’s worth, FINRA’s position about who can be an “issuer” is consistent with SEC practice.
If FINRA is right, it probably means that every offering that used a series LLC as a crowdfunding vehicle was illegal.
Some possible ramifications:
- Any investor who lost money can sue the issuer and the funding portal, and possibly their principals.
- Every issuer can sue the funding portal.
- Funding portals might be sanctioned by FINRA.
In short, a bonanza for plaintiffs’ lawyers and a black eye for the Crowdfunding industry.
Questions? Let me know.