Reg CF Funding Portals: 50 in Total with Several Exits and Several Additions. Is Reg CF Ready to Scale?

Periodically, Crowdfund Insider revisits the Reg CF sector of online capital formation. Reg CF or “Regulation Crowdfunding” may have garnered most of the attention from popular media but really there are three individual crowdfunding exemptions including Reg A+ and Reg D 506c.

Under Reg A+ you must file an extensive offering circular with the entire offering process costing around $300,000, according to one estimate. But Reg A+ enables an issuer to raise up to $50 million from both accredited and non-accredited investors.

Under Reg D 506c, you may raise an unlimited amount of money but only from accredited investors. This is the most popular crowdfunding exemption and Reg D (5o6c and 5o06b) is a trillion-dollar market.

Issuers using Reg CF may only raise $1.07 million and must utilize a FINRA regulated Funding Portal or a broker-dealer. Due to the low cap on funding, frequently issuers will do a side-by-side Reg D 506c offering to circumvent the extremely low amount you may raise.

Last time CI revisited the number of approved Funding Portals was in July. Since that time, several new funding portals have joined the approved list and several have exited.

Regarding Reg CF funding portal exits – two more have departed this sector of crowdfunding.

EquityBender based in Charleston, South Carolina, is no more. The domain just indicates a private site.

Seeding VR is the other exit. As the name indicates, Seeding VR was targeting the virtual reality sector. Apparently, it even attempted to launch a crowdfunding platform in the UK. Today, both domains simply time out.

This brings the total of funding portal exits to 12 with at least two the direct result of some time of enforcement action: UFP LLC and DreamFunding Marketplace.

The three additions to the list bring the total to 50 FINRA approved funding portals with one in question as Fundpaas has long been on the suspended list and is expected to join the exits.

The three recent additions include:

Fundopolis has yet to list its first offering but appears ready to launch its first issuer. According to its website, Fundopolis expects to also enable issuers to raise capital under both Reg A+ and Reg D as well.

Infrashares is described as follows:

“InfraShares is a crowdfunding platform that pools investment from individuals into large sums of development capital for critical infrastructure projects (roads, bridges, airports, mass transit, water systems, renewable energy and schools).”

This platform is utilizing Reg D as well. Currently, there are two issuers posted on the site -both under Reg D 506c.

Prospect Equity does not appear to have a live site as of yet.

As Crowdfund Insider reported in October, Reg CF has raised over $300 million in securities offerings since the exemption became actionable in May of 2016, providing capital to over 2000 campaigns. This is according to a report by Crowdfund Capital Advisors.

Overall, Reg CF can be called a success as it has helped smaller companies raise much-needed growth capital while creating new jobs. But multiple shortcomings hobble the exemption thus undermining its potential success.

First, the fund cap is widely recognized as far too low.

Average seed rounds in the US stand at about $2.2 million – typically using Reg D. A good number raise much more.

In the UK, the most robust crowdfunding market in the world, issuers may raise as much money as they want. A prospectus requirement at €8 million creates a virtual speedbump for issuers looking to raise more than that amount.

The most successful Reg CF Funding Portal, Wefunder, stated earlier this year that limitations to the exemption may make the exemption an option of last resort.

Republic, another leader in the Reg CF sector, published a letter providing the perspective from issuers that have utilized Reg CF to raise growth capital. The letter, signed by 23 different founders and CEOs of early-stage firms, indicated that Reg CF has its benefits but suffers from serious limitations.

Every industry participant has voiced their concerns to both Congress and the Securities and Exchange Commission (SEC). While some policymakers have supported common-sense updates, since 2016, little has been accomplished.

And it is not just the funding cap that undermines Reg CF.

A report by the SEC from this past summer touched upon many of the issues.

Common sense changes that allow for special purpose vehicles (SPVs) that safeguard smaller investors while making it simpler to gain access to higher-quality deals is a no brainer.

There is also the 12g trap that may compel a company to become a reporting company once it has 500 investors. A problem that is antithetical to investment crowdfunding.

The Association of Online Investment Platforms (AOIP), an advocacy group for online capital formation, has posted a position paper with its goals.

So is Reg CF ready to scale? Probably not without some changes to the rules. Many of the larger platforms now have broker dealer licenses and offer other services. Doing enough $1 million deals in a year to cover your costs can be quite difficult.

The SEC is currently going through a regulatory review, as defined by a concept release, which seeks to improve the exemption ecosystem while harmonizing the alphabet soup of rules. This may be the best opportunity the industry has to see some impactful improvements. If not, it will be up to Congress to step up and do the job. Don’t hold your breath.


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Grayscale Receives Regulatory Clearance from FINRA to Offer Publicly-Traded Digital Currency Fund

New York-based Grayscale Investments has obtained regulatory approval from the Financial Industry Regulatory Authority (FINRA) to list the first publicly-traded digital currency index fund.

According to a press release, the company’s Digital Large Cap Fund (DLC) will be listed on over-the-counter (OTC) markets and trade under the ticker GDLCF. 

In addition to DLC, Grayscale offers the Bitcoin Trust (OTCQX: GBTC), Ethereum Trust (OTCQX: ETHE), and Ethereum Classic Trust (OTCQX: ETCG). The company says it’s planning to list all of its crypto investment products on the public market. 

Grayscale’s products are open to accredited investors. DLC is only available to investors that can access US financial securities. 

The DLC gives investors broad-based exposure to crypto-assets. The fund has provided a year-to-date return of 74.8%.

The DLC gives investors exposure to the largest digital assets based on market capitalization. The fund targets more than 70% of the cryptocurrency market, which includes Bitcoin (BTC), Ether (ETH), XRP, Bitcoin Cash (BCH), and Litecoin (LTC). 

The fund adjusts to changes in crypto market prices by rebalancing itself every quarter. This allows underperforming assets to be removed while also adding digital assets that are performing well. The fund is a passive investment vehicle, as it’s not actively managed.

Other factors including liquidity, operational requirements, and the availability of custodial solutions are evaluated when selecting crypto assets for the new fund.

A subsidiary of the Digital Currency Group, Grayscale is the oldest and largest digital asset manager with more than $2.2 billion of assets under management. The company began offering its products to accredited investors in Feb 2018. There were around 3.2 million outstanding DLC shares as of September 30, 2019.

Investors can acquire shares in the private placement investment vehicle, which is backed by digital currency. The valuation is made at 4:00 PM EST each day and is based on TradeBlock’s Digital Asset Reference Rate.

IOICM Receives Approval From the FINRA For Membership Application

IOI Capital and Markets, LLC (IOICM), an SEC registered broker-dealer and a wholly-owned subsidiary of iownit capital and markets, Inc. recently announced the Financial Industry Regulatory Authority (FINRA) has approved its membership application. IOICM reported that the approval allows it to be a placement agent for digital private securities issued on the blockchain-based platform developed and operated by its parent company.

Founded in 2017, IOICM describes itself as a financial services and technology firm focusing on developing and implementing blockchain-based capital-raising platform. The company noted it is dedicated to building a regulatory compliant solution that brings 21st-century technology to new segments of capital markets. While sharing more details about the platform,  IOICM CEO, Rashad Kurbanov, stated:

“Our platform has been built from the ground up over the past two years to completely digitize the securities issuance, asset lifecycle management and secondary trading processes to create a more efficient market. It is targeted for institutional and accredited investors only, providing tools to facilitate a seamless investment process, information sharing and ongoing portfolio management. We believe our platform will reduce friction in the market and reduce costs for all market participants, while importantly providing appropriate investor protections.”

Kurbanov added:

“We spent a significant amount of time with FINRA and SEC staff on productive discussions working through the use of distributed ledger technology and how it can be implemented to provide a convenient yet secure platform. We are very grateful to the Staff for their patience, input and diligence throughout our membership application process. We are not here to ‘revolutionize’ investing, but we do intend to make it vastly more modern and less complicated for both issuers and investors to engage and transact.”

FINRA Posts Regulatory Notice on Digital Assets

FINRA, the regulator of broker-dealer in the US, has posted a notice on digital assets encouraging firms to “notify FINRA if they engage in activities related to digital assets.”

The notice appears to be more of an extension to en existing request. FINRA states:

“Last year, FINRA took several steps to engage with members regarding their current and planned activities relating to digital assets. These efforts included the issuance of Regulatory Notice 18-20, which encouraged firms to keep their Regulatory Coordinator informed if the firm, or its associated persons or affiliates, engaged, or intended to engage, in activities related to digital assets, including digital assets that are non-securities.1 Regulatory Notice 18-20 requested that firms provide these updates to Regulatory Coordinators until July 31, 2019. FINRA appreciates members’ cooperation over the past year and is encouraging firms to continue keeping their Regulatory Coordinators abreast of their activities related to digital assets until July 31, 2020.”

FINRA asks members firms keep them abreast of activity such as the sales and issuance of digital assets as well as any advisory roles. Additionally, firms are asked to notify of any pooled funds, custody, mining and other participatory roles.

FINRA works in concert with the Securities and Exchange Commission (SEC) on much of these issues. Recently, FINRA and the SEC issued a joint statement regarding custody of digital assets.


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Securities and Exchange Commission Issues Statement on Custody of Digital Assets

The Securities and Exchange Commission (SEC), Division of Trading and Markets, has joined with the Financial Industry Regulatory Authority (FINRA) in issuing a statement regarding the custody of digital assets and broker-dealers.

Custody of digital assets is a pressing concern for industry participants. Similar to traditional securities, digital security issuers and platforms providing digital asset services seek to remain compliant under the law but using distributed ledger technology creates new and untested challenges.

Both FINRA and the SEC said they are aware of, and encourage and support, efforts to address these issues such that compliance with the Customer Protection Rule and other federal securities laws and FINRA rules is reasonably practicable.

The two Staffs said that in recent months they have been engaged with industry participants regarding how industry participants believe a particular custody solution for digital asset securities would meet the possession or control standards prescribed in the SEC’s Customer Protection Rule.

Both the SEC and FINRA “have found these discussions to be very informative and appreciate market participants’ ongoing engagement on these issues.” The two agencies said they look forward to continuing the dialogue as the industry evolves.

The SEC and FINRA “encourage and support innovation in the securities markets and look forward to continuing to engage with investors and industry participants as the marketplace for digital asset securities develops.”

The original statement by the SEC and FINRA is available here.


Importance of the Customer Protection Rule

Entities seeking to participate in the marketplace for digital asset securities must comply with the relevant securities laws.  An entity that buys, sells, or otherwise transacts or is involved in effecting transactions in digital asset securities for customers or its own account is subject to the federal securities laws, and may be required to register with the Commission as a broker-dealer and become a member of and comply with the rules of a self-regulatory organization (“SRO”), which in most cases is FINRA.  Importantly, if the entity is a broker-dealer, it must comply with broker-dealer financial responsibility rules, including, as applicable, custodial requirements under Rule 15c3-3 under the Securities Exchange Act of 1934 (the “Exchange Act”), which is known as the Customer Protection Rule.

The purpose of the Customer Protection Rule is to safeguard customer securities and funds held by a broker-dealer, to prevent investor loss or harm in the event of a broker-dealer’s failure, and to enhance the Commission’s ability to monitor and prevent unsound business practices.  Put simply, the Customer Protection Rule requires broker-dealers to safeguard customer assets and to keep customer assets separate from the firm’s assets, thus increasing the likelihood that customers’ securities and cash can be returned to them in the event of the broker-dealer’s failure.  The requirements of the Customer Protection Rule have produced a nearly fifty year track record of recovery for investors when their broker-dealers have failed.  This record of protecting customer assets held in custody by broker-dealers stands in contrast to recent reports of cybertheft, and underscores the need to ensure broker-dealers’ robust protection of customer assets, including digital asset securities.

Various unregistered entities that intend to engage in broker-dealer activities involving digital asset securities are seeking to register with the Commission and have submitted New Membership Applications (“NMAs”) to FINRA.  Additionally, various entities that are already registered broker-dealers and FINRA members are seeking to expand their businesses to include digital asset securities services and activities.  Under FINRA rules, a firm is prohibited from materially changing its business operations (e.g., engaging in material digital asset securities activities for the first time) without FINRA’s prior approval of a Continuing Membership Application (“CMA”).

The NMAs and CMAs currently before FINRA are diverse:  Some of the NMAs and CMAs cover proposed business models that would not involve the broker-dealer engaging in custody of digital asset securities.  On the other hand, some NMAs and CMAs include the custodying of digital asset securities, and therefore implicate the Customer Protection Rule, among other requirements.

Some of these entities have met with the Staffs to discuss how they propose to custody digital asset securities in order to comply with the broker-dealer financial responsibility rules.  These discussions have been informative.  The specific circumstances where a broker-dealer could custody digital asset securities in a manner that the Staffs believe would comply with the Customer Protection Rule remain under discussion, and the Staffs stand ready to continue to engage with entities pursuing this line of business.

Noncustodial Broker-Dealer Models for Digital Asset Securities

As noted, some entities contemplate engaging in broker-dealer activities involving digital asset securities that would not involve the broker-dealer engaging in custody functions.  Generally speaking, noncustodial activities involving digital asset securities do not raise the same level of concern among the Staffs, provided that the relevant securities laws, SRO rules, and other legal and regulatory requirements are followed.  The following are examples of some of the business activities of this type that have been presented or described to the Staffs.

  • One example is where the broker-dealer sends the trade-matching details (e.g., identity of the parties, price, and quantity) to the buyer and issuer of a digital asset security—similar to a traditional private placement—and the issuer settles the transaction bilaterally between the buyer and issuer, away from the broker-dealer.  In this case, the broker-dealer instructs the customer to pay the issuer directly and instructs the issuer to issue the digital asset security to the customer directly (e.g., the customer’s “digital wallet”).
  • A second example is where a broker-dealer facilitates “over-the counter” secondary market transactions in digital asset securities without taking custody of or exercising control over the digital asset securities.  In this example, the buyer and seller complete the transaction directly and, therefore, the securities do not pass through the broker-dealer facilitating the transaction.
  • Another example is where a secondary market transaction involves a broker-dealer introducing a buyer to a seller of digital asset securities through a trading platform where the trade is settled directly between the buyer and seller.  For instance, a broker-dealer that operates an alternative trading system (“ATS”) could match buyers and sellers of digital asset securities and the trades would either be settled directly between the buyer and seller, or the buyer and seller would give instructions to their respective custodians to settle the transactions.  In either case, the ATS would not guarantee or otherwise have responsibility for settling the trades and would not at any time exercise any level of control over the digital asset securities being sold or the cash being used to make the purchase (e.g., the ATS would not place a temporary hold on the seller’s wallet or on the buyer’s cash to ensure the transaction is completed).

Considerations for Broker-Dealer Custody of Digital Asset Securities

Whether a security is paper or digital, the same fundamental elements of the broker-dealer financial responsibility rules apply.  The Staffs acknowledge that market participants wishing to custody digital asset securities may find it challenging to comply with the broker-dealer financial responsibility rules without putting in place significant technological enhancements and solutions unique to digital asset securities.  As the market, infrastructure, and law applicable to digital asset securities continue to develop, the Staffs will continue their constructive engagement with market participants and to gather additional information so that they may better respond to developments in the market while advancing the missions of our respective organizations: for the SEC, to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation; and for FINRA, to provide investor protection and promote market integrity.

The Customer Protection Rule

Overview

A broker-dealer seeking to custody digital asset securities must comply with the Customer Protection Rule.  As noted, the rule is designed principally to protect customers of a registered broker-dealer from losses and delays in accessing their securities and cash that can occur if the firm fails.  The rule requires the broker-dealer to safeguard customer securities and cash entrusted to the firm, as discussed below.  If the broker-dealer fails, customer securities and cash should be readily available to be returned to customers.  In the event the broker-dealer were to be liquidated under SIPA, the SIPA trustee would be expected to step into the shoes of the broker-dealer and expected to be able to transfer, sell, or otherwise dispose of assets in accordance with SIPA.

Among its core protections for customers, Rule 15c3-3 requires a broker-dealer to physically hold customers’ fully paid and excess margin securities or maintain them free of lien at a good control location.  Generally, a broker-dealer may custody customer securities with a third-party custodian (e.g., the Depository Trust Company or a clearing bank), and uncertificated securities, such as mutual funds, may be held at the issuer or at the issuer’s transfer agent.  In either case, there is a third party that controls the transfer of the securities.  This traditional securities infrastructure (including, for example, related laws of property and security) also has processes to reverse or cancel mistaken or unauthorized transactions.

Considerations for Digital Asset Securities

There are many significant differences in the mechanics and risks associated with custodying traditional securities and digital asset securities.  For instance, the manner in which digital asset securities are issued, held, and transferred may create greater risk that a broker-dealer maintaining custody of them could be victimized by fraud or theft, could lose a “private key” necessary to transfer a client’s digital asset securities, or could transfer a client’s digital asset securities to an unknown or unintended address without meaningful recourse to invalidate fraudulent transactions, recover or replace lost property, or correct errors.  Consequently, a broker-dealer must consider how it can, in conformance with Rule 15c3-3, hold in possession or control digital asset securities.

In particular, a broker-dealer may face challenges in determining that it, or its third-party custodian, maintains custody of digital asset securities.  If, for example, the broker-dealer holds a private key, it may be able to transfer such securities reflected on the blockchain or distributed ledger.  However, the fact that a broker-dealer (or its third party custodian) maintains the private key may not be sufficient evidence by itself that the broker-dealer has exclusive control of the digital asset security (e.g., it may not be able to demonstrate that no other party has a copy of the private key and could transfer the digital asset security without the broker-dealer’s consent).  In addition, the fact that the broker-dealer (or custodian) holds the private key may not be sufficient to allow it to reverse or cancel mistaken or unauthorized transactions.  These risks could cause securities customers to suffer losses, with corresponding liabilities for the broker-dealer, imperiling the firm, its customers, and other creditors.

The Books and Records and Financial Reporting Rules

Overview

The broker-dealer recordkeeping and reporting rules require a broker-dealer, among other things, to make and keep current ledgers reflecting all assets and liabilities, as well as a securities record reflecting each security carried by the broker-dealer for its customers and all differences determined by the count of customer securities in the broker-dealer’s possession or control compared to the result of the count with the broker-dealer’s existing books and records.  The financial responsibility rules also require that broker-dealers routinely prepare financial statements, including various supporting schedules particular to broker-dealers, such as Computation of Net Capital under Rule 15c3-1 and Information Relating to the Possession or Control Requirements under Rule 15c3-3 under the Exchange Act.

The books, records, and financial reporting requirements are designed to ensure that a broker-dealer makes and maintains certain business records to assist the firm in accounting for its activities.  These rules also assist securities regulators in examining for compliance with the federal securities laws and as such are an integral part of the financial responsibility program for broker-dealers.

Considerations for Digital Asset Securities

The nature of distributed ledger technology, as well as the characteristics associated with digital asset securities, may make it difficult for a broker-dealer to evidence the existence of digital asset securities for the purposes of the broker-dealer’s regulatory books, records, and financial statements, including supporting schedules.  The broker-dealer’s difficulties in evidencing the existence of these digital asset securities may, in turn, create challenges for the broker-dealer’s independent auditor seeking to obtain sufficient appropriate audit evidence when testing management’s assertions in the financial statements during the annual broker-dealer audit.  We understand that some firms are considering the use of distributed ledger technology with features designed to enable firms to meet recordkeeping obligations and facilitate prompt verification of digital asset security positions (e.g., regulatory nodes or permissioned distributed ledger technologies).  Broker-dealers should consider how the nature of the technology may impact their ability to comply with the broker-dealer recordkeeping and reporting rules.

Securities Investor Protection Act of 1970

Overview

Generally, a broker-dealer that fails and is unable to return the customer property that it holds would be liquidated in accordance with SIPA.  Under SIPA, securities customers have a first priority claim to cash and securities held by the firm for securities customers.  Customers also are eligible for up to $500,000 in protection (of which up to $250,000 can be used for cash claims) if the broker-dealer is missing customer assets.  These SIPA protections apply to a “security” as defined in SIPA and cash deposited with the broker-dealer for the purpose of purchasing securities. They do not apply to other types of assets, including, importantly, assets that are securities under the federal securities laws but are excluded from the definition of “security” under SIPA.

Considerations for Digital Asset Securities

In the case of a digital asset security that does not meet the definition of “security” under SIPA, and in the event of the failure of a carrying broker-dealer, SIPA protection likely would not apply and holders of those digital asset securities would have only unsecured general creditor claims against the broker-dealer’s estate.  Further, uncertainty regarding when and whether a broker-dealer holds a digital asset security in its possession or control creates greater risk for customers that their securities will not be able to be returned in the event of a broker-dealer failure.  The Staffs believe that such potential outcomes are likely to be inconsistent with the expectations of persons who would use a broker-dealer to custody their digital asset securities.

Control Location Applications

As a related matter, the Staffs have received inquiries from broker-dealers, including ATSs, wishing to utilize an issuer or transfer agent as a proposed “control location” for purposes of the possession or control requirements under the Customer Protection Rule.  As described to the Staffs, this would involve uncertificated securities where the issuer or a transfer agent maintains a traditional single master security holder list, but also publishes as a courtesy the ownership record using distributed ledger technology.  While the issuer or transfer agent may publish the distributed ledger, in these examples, the broker-dealers have asserted that the distributed ledger is not the authoritative record of share ownership.  To the extent a broker-dealer contemplates an arrangement of this type, the Division will consider whether the issuer or the transfer agent can be considered a satisfactory control location pursuant to an application under paragraph (c)(7) of Rule 15c3-3.


To contact Commission staff for assistance, please visit the Commission’s FinHub webpage or contact Thomas K. McGowan, Associate Director, at (202) 551-5521 or Raymond Lombardo, Assistant Director, at (202) 551-5755.  To contact FINRA staff for assistance, please visit FINRA’s FinTech webpage or contact Kosha Dalal, Associate General Counsel, at (202) 728-6903.

Reg CF Update: Three New FINRA Regulated Portals Enter – One is Blockchain Based, One is Canadian & One to Finance Videos

Reg CF (Regulation Crowdfunding) is a unique securities rule that allows companies to raise up to $1.07 million from both accredited or non-accredited investors. Created by the JOBS Act of 2012, Reg CF is the smallest of the three online capital formation exemptions.

Reg D 506c allows issuers to raise as much money as they want online from accredited investors.

Reg A+ requires a company to file an extensive offering circular which must be qualified (approved) by the Securities and Exchange Commission (SEC) – thus some people call it a “mini-IPO” exemption. These issuers may raise up to $50 million from both accredited and non-accredited investors.

Reg CF was, ostensibly, designed to help very small companies across the country gain access to capital to finance their growth. Opinions are mixed as to how successful Reg CF has been since it became actionable in 2016. It is this publication’s opinion that the security exemption suffers from multiple flaws which need to be fixed. A recent report published by the SEC described Reg CF as having funded a “modest” amount. If policymakers decide to act and address these shortcomings, Reg CF may turn into a funding path with far greater potential and success.

One of the unique characteristics of Reg CF is that the statute created a new type of entity as an intermediary. “Funding Portals” are FINRA regulated online platforms where companies may pitch their business to investors. Crowdfund Insider has periodically updated our readers on the status of the Reg CF sector and the active funding portals. In May, the 3rd anniversary of the exemption kicking in, CI noted that 44 Funding Portals were in operation and 9 portals had exited the space. A single platform had been suspended. During the past three years since Reg CF became an option to raise capital, $200 million has been funded for a wide variety of firms.

So what has changed since last May? 47 Reg CF Portals and Counting.

There have been no new exits from the list of FINRA regulated funding portals since May. And Fundpaas remains suspended due to the fact the company has not paid their FINRA fees (FINRA Rule 9553). Not a good sign for the platform so it would come as no surprise if Fundpaas (DBA custvestor) ends up being added to the departed list soon.

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But since May, there have been three new additions to the roster of Reg CF crowdfunding platforms – each with an interesting story.

First, there is the “SMBX” or small business exchange – a bank replacement platform.

The SMBX is a true marketplace for businesses to issue a “small business bond” which can be traded on the platform thus providing a degree of liquidity. The bonds may be purchased in increments of $1- and generate a fixed rate of return. The price of the bond is apparently determined by an auction process. SMBX makes their money by charging a 3.5% service fee on the total amount of debt raised.

In a blog post, the company explained its vision:

“The SMBX is a smart contract-driven mobile app that allows people to buy and sell small business financial securities –especially Small Business Bonds, so that now their unused money can be lent out to local small businesses as they wish, and now we the people, instead of our banks, can keep the profits earned.”

Like a growing number of funding platforms, SMBX is leveraging blockchain technology to remove some of the friction in the primary issuance and secondary trading of these securities.

The company was founded by a “team of recovering bankers, financial engineers and technologists, and accountants.”

As of today, the SMBX is just getting started as there is a single issuer, Bernal Cutlery, raising capital on the platform.

Currently, there is very little information for Flair Exchange, or Flair Portal, as its website still says coming soon. What is interesting about Flair Exchange is the fact it is a “non-resident funding portal” and based in Vancouver, Canada. To be approved, Flair needed an opinion of counsel regarding its status as a Canadian operation and you may read it here. Originally, Flair first filed as a resident of the state of Washington.

Finally, there is Vid Angels Studios, a funding portal that is probably the most unique.

Vid Angel, a video streaming service, was one of the most successful Reg A+ issuers we have seen. Vid Angel raised $5 million from a dedicated community in less than 2 days using the exemption. The company went on to raise about $10 million before receiving a court order telling them to shut down.

Long story – short, Vid Angel was using an interesting process for providing their video streaming services that the big studios did not appreciate. Vid Angel went on to file for Chapter 11 – and bankruptcy proceedings are ongoing with the company providing periodic updates.

But Vid Angel did not let a mere legal battle against major film studios stand in the way of launching a Reg CF platform.

Today, Vid Angel Studios is crowdfunding videos that appear to have a religious leaning. Currently, there are two active campaigns. One, The Chosen, has raised over $830,000 from more than 1500 investors. The first four episodes are available now. The next four are in production.

So what’s next for Reg CF? Excellent question…

As we mentioned above, the rules are overly restrictive. The funding cap is painfully low and there are other multiple flaws – most of which were recently outlined by the Association of Online Investment Platforms.

The good news is that the SEC is in the midst of a regulatory “harmonization” review process where some of these shortcomings may be addressed – like the much-maligned “accredited investor” definition which is pretty much panned by everyone except the extreme few.

We suggest that any and all industry members take a moment and make suggestions to the SEC on Reg CF, and all of the other security exemptions. You may see the current comments to the SEC here and submit your own via a link.


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Has the SEC Slammed the Brakes on Blockchain Innovation?

The Securities and Exchange Commission (SEC) has talked up their innovation cred and support of Fintech for years. Under previous Chair Mary Jo White, the SEC held the very first Fintech Forum which saw both industry participants and policymakers engage with each other in collaborative discussion.

Back in 2016, Valerie Szczepanik, currently the head of the SEC’s FinHub and then Head of  Distributed Ledger Technology, moderated a panel on the impact of innovations on trading, settlement, and clearance activities – an important topic that continues to be relevant for the blockchain sector.

SEC officials are regularly in attendance at Fintech focused events telling the audience to stop by and chat with them as they are anxious to learn more about emerging innovations in financial services.

Any Fintech or crypto focused firm worth its salt has visited with SEC staff to pitch and discuss their concepts at the F Street Headquarters.

Several weeks back, the SEC “approved” a non-security, utility token from Turnkey Jet while providing guidance on the issuance of security tokens. Certainly progress of sorts, but critics groaned there was little new revealed by the Commission. The no-action letter on the utility token garnered this ironic response:

“In other words; [a] Laundromat token deemed to be laundromat token.”

But chatter outside the beltway has been growing in criticism. Recently, Scott Purcell, CEO and founder of PrimeTrust – a crypto friendly escrow and custody platform, made the following statement:

“Jay Clayton, Chairman of the SEC, is, I’ve heard, holding the line that no new alternative trading system (“ATS”, aka “exchange”) will be approved on his watch if it intends to trade tokens.”

Crowdfund Insider has heard similar comments from other insiders.

Not very encouraging words for people dedicating their careers to improving the financial ecosystem by enabling the digitization of finance.

Last month, FINRA and the SEC jointly announced a Broker-Dealer “Outreach Program,” scheduled to take place this coming June. Currently scheduled for the agenda will be “regulatory hot topics such as digital assets and cyber-security.”

One blockchain industry insider made the following somber comment on the FINRA-SEC event:

“If they limit this event to existing BDs, no one in the [blockchain] industry will be able to attend…”

Even worse, the event was capped at only 250 broker-dealers. That’s one way to mitigate extensive debate and discussion.

CI recently was informed there have been over 40 applications submitted by blockchain focused firms to become a Broker-Dealer. Apparently, none have been approved and multiple applications allegedly have gone far beyond the statutory deadline for a decision to approve (or not). So the Feds are allegedly bending their own rules.

Some of these applicants also want to become alternative trading systems (ATSs) which can trade in digital assets thus enabling secondary transactions for security tokens. But receiving regulatory approval as a Broker-Dealer must come first before receiving an ATS license.

One frustrated insider stated simply, “it is totally f****d.”

Ironically, blockchain industry participants want regulation. They recognize the importance of setting high standards and allowing only compliant firms to operate. People who want to tokenize assets are saying “fine these are securities let us treat them as such and broker the deals.”

FINRA is part of the broker-dealer equation as well.

Apparently, FINRA continues to ask for extensions as an approval deadlock continues. Meanwhile … unregulated exchanges carry on outside US borders.

One individual said, “they [the SEC and FINRA] are each finger pointing but ultimately it is the SEC…” that is the source of any delay.

It is no secret that many potential digital asset issuers have filed for a Reg A+ qualification to sell security tokens, yet none have been approved.

Most aspiring token issuers have simply scrubbed any mention of blockchain, crypto, distributed ledger technology or digital assets from their filings just to get approved. Now, the strategy is to go back and tokenize the offerings once regulatory clarity emerges – whenever that is.

One recent example of Reg A+ inertia is StartEngine. To get qualified, StartEngine – a full stack crowdfunding platform, erased any mention from their Reg A+ filing regarding the tokenization of securities using ERC-1450 and the ability for investors to use Bitcoin or ETH to invest.

Another industry insider bluntly claimed they are “purposefully trying to kill the industry and doing a damn good job of it.”

So what’s going on? Aren’t these just digital securities?

Some people believe that Chair Clayton simply wants to dodge a bullet and exit before the next election cycle hits in full force. He would prefer to end his tenure at the SEC minus any major catastrophes, imaginary or not. Of course, there is always the possibility of a Twitter assault from the President. That’s no fun either – and something most people would like to avoid.

But while US policymakers pump the brakes on Fintech innovation, some other nations push forward encouraging change.

France, not really well known for its innovation chops, has concocted a system to approve initial coin offerings (ICOs) by creating a white list approved by the Autorité des Marchés Financiers (AMF). A new law has been approved (Loi Pacte) and is expected to become actionable at some point this fall.

During Paris Blockchain Week, Bruno Le Maire, the Minister of Industry for the Economy and Finance, stated:

“I believe in the blockchain, I believe in this technology.”

One observer said the is the first time that such a clear alignment has emerged between French government vision, regulation, and the promotion of innovation when it comes to digital assets.

Just this week, one of the largest banks in France, Societe Generale, issued a tokenized bond using Ethereum.

The former head of Fintech at the AMF said they are now seeing US digital asset issuers coming to France to pursue their projects.

In Germany, BaFin – a regulator notorious for its conservative stance, recently approved a tokenized bond issuance from a Fintech that offers peer to peer loans around the world.

Of course, the counter-argument is that it is wise to move cautiously in the digital asset sector.

Regulators need to gather as much information as possible before moving forward as investor protection is an ongoing pressing concern. Public officials must learn from the many mistakes of the crazed ICO marketplace – a sector of crypto that was chock full of fraud and half baked offerings. But can the regulators wait too long?

Talk is Cheap. Action Speaks Volumes.

This month, the SEC will host another Fintech Forum with much of the discussion scheduled around distributed ledger technology and the emergence of digital assets. One panel is scheduled to discuss “Distributed Ledger Technology Innovations: Industry Trends and Specific Use Cases for Financial Markets.”

But missing from the list of participants and speakers are names from some of the most innovative platforms in the blockchain space.

Why no tZero? What about Securitize and OpenFinance? And how about inviting Purcell to speak? (Perhaps they were invited and declined…).

Following the release of the Fintech forum agenda this week, CI received this snarky comment in an email:

“Oh great, so out of over 20 panelist and moderators for the Fintech forum only one actual Fintech company – makes sense…”

So when does the SEC finally accept the future and embrace the digitization of finance?

Big News: Leading Crowdfunding Platform SeedInvest Receives ATS Approval From FINRA, will Add Secondary Trading for Private Securities

SeedInvest, one of the leading US-based investment crowdfunding platforms, has received regulatory approval from FINRA to operate a secondary marketplace for securities via an alternative trading system (ATS). SeedInvest is the first traditional crowdfunding platform to receive an ATS license.

Providing liquidity for private securities in a regulated marketplace is on the list of just about every online capital formation platform. The SeedInvest news is significant for the platform as well as the industry. SeedInvest was already a registered Broker-Dealer, a requirement to receive an ATS license.

Ryan Feit, co-founder and CEO of SeedInvest, commented on the announcement:

“Liquidity remains a key missing piece towards democratizing the private capital markets. Creating a truly vibrant secondary market for private company shares has the potential to make startup investing a significantly more attractive asset class.”

Feit, in a recent interview, foreshadowed the announcement stating his ambition to launch a secondary marketplace for securities issued on their platform. Currently, SeedInvest issues securities using the full stack of exemptions including Reg A+, Reg CF and Reg D. Notably, under Reg A+, the security may trade immediately following its issuance.

Feit also mentioned his ambition to raise capital for issuers globally while accepting investors from around the world. SeedInvest has already raised capital for issuers based outside the US.

SeedInvest reports over 250,000 registered investors with approximately 50,000 of those individuals being accredited. SeedInvest also integrates with established VC firms and angel investors who participate in some of their offerings. SeedInvest is a highly selective crowdfunding platform and only accepts a small fraction of issuers who apply to raise capital on their platform.

By launching an ATS, SeedInvest will take an important next step in providing liquidity to traditionally ill-liquid securities which historically have depended on an acquisition or initial public offering to provide an exit opportunity for early investors.

SeedInvest, which was acquired by crypto-centric firm Circle last year, added that gaining the ATS license was part of “realizing Circle’s longer-term vision.”

Jeremy Allaire, co-founder and CEO of Circle, said they are empowering individuals to create and share value in ways the are more inclusive, open and efficient.

“ATS approval for SeedInvest sets us on a path to develop secondary trading marketplaces and to facilitate liquidity for private securities, which together hold the promise of significantly democratizing private capital markets,” said Allaire.

SeedInvest did not announce the launch date of the secondary marketplace but expectations are for the trading venue to go live at some point in 2019.

The most recent list of approved ATSs, minus SeedInvest, is available here.

FINRA Creates Office of Financial Innovation to Support Fintech

FINRA, the lead regulator for broker-dealers in the US, has opened up an Office of Financial Innovation in recognition of the growing importance of Fintech. Haimera Workie, currently a Senior Director at FINRA, will become its inaugural chief.

FINRA President and CEO Robert W. Cook said that innovation continues to provide new opportunities, as well as challenges, for their member firms and the industry as a whole. It incumbent upon FINRA to “keep pace.”

“Under Haime’s leadership, I am confident the Office of Financial Innovation will further FINRA’s long-standing commitment to understanding and addressing these issues through coordinated responses that foster both innovation and investor protection,” said Cook.

Cook has previously cautioned about avoiding “incrementalism or convenient compromises when bold action is required” in addressing Fintech innovation.

FINRA said the move will “further enhance” its ability to understand Fintech while fostering beneficial innovation in financial services while monitoring market integrity and investor protection. FINRA established a Fintech committee some time ago but this new Office creates a more formal recognition of the change taking place in finance due to the digitization of all financial services.

The Office is said to be an outgrowth of the Innovation Outreach Initiative under FINRA360.

FINRA360 was launched by FINRA CEO Cook when he took over the helm of the agency. Cook used the initiative to gauge the sentiment of both regulated firms and FINRA employees following a period where leadership was criticized for its sometimes ham-fisted approach to regulation. Early feedback from stakeholders has deemed the FINRA360 project a relative success.

The Fintech Office will seek to engage with industry participants, regulators, investors and other stakeholders. FINRA expects the staff to produce research on important topics of developing areas of Fintech. The team will also incorporate FINRA’s existing Office of Emerging Regulatory Issues, which focuses on analyzing new and emerging risks and trends related to the securities market.

Before joining FINRA, Workie served as Deputy Associate Director in the Division of Trading and Markets at the U.S. Securities and Exchange Commission. Workie is a graduate of the Massachusetts Institute of Technology (B.S., M.S.) and Harvard Law School (J.D.).

SEC and FINRA Schedule Broker Dealer “Outreach Program.” Will Discuss Digital Assets

The Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) have scheduled their 2019 National Compliance Outreach Program for Broker-Dealers. The event, taking place in Chicago, is designed to provide an open forum for regulators and industry professionals to discuss topics such as compliance and investor protection.

In a release, it was revealed that the program will include a discussion of “hot topics such as digital assets and cybersecurity.”

“We look forward to our continued engagement with industry professionals at this year’s National Compliance Outreach Program for Broker-Dealers,” said Peter Driscoll, Director of OCIE. “This event is a valuable opportunity for us to share our thoughts and observations from recent examinations and to listen to the insights provided by experienced industry professionals about current market and regulatory risks.”

The event is free to to attend but is capped at 250 individuals reserved on a first come basis. Those unable to attend may watch a live-stream on the SEC website.

Mike Rufino, Executive Vice President and Head of FINRA Member Regulation—Sales Practice, commented:

“As our regulatory program evolves to meet the challenges of new markets, new products and new rules, FINRA engages with member firms, compliance leaders and other regulators in meaningful discussions that enrich our regulatory efforts and provide broker-dealers with the tools and information needed to better serve investors.”

The SEC has recently issued guidance on the issuance of digital assets and the determination as to whether, or not, the asset will be considered a security. The “hot” sector of finance continues to struggle with the best path for leveraging blockchain tech.

FINRA, under the leadership of Robert Cook, has launched a FINRA 360 review of its processes – attempting to better communicate with its regulated member firms.

The program will be held at the Federal Reserve Bank of Chicago from 9 a.m. to 3 p.m. CT on June 27, 2019.

Additional information is available on the SEC’s website at http://www.sec.gov/info/complianceoutreach-bd.htm or FINRA’s website at http://www.finra.org/industry/2019-national-compliance-outreach-program-broker-dealers.

What’s the Back Story to Security Token Offerings and Regulation?

The initial coin offering (ICO) / Security Token Offering (STO) continues to endure a period of regulatory uncertainty. As things stand right now, ICOs are securities. End of story.

If you completed an ICO after the Securities and Exchange Commission (SEC) issued the DAO Report – you are probably in trouble. Hire a good securities attorney and ask the SEC for forgiveness and maybe, just maybe, you may get off with a less punitive judgment from the enforcement division.

As for utility tokens, this is a bit of a Snipe hunt, at least in the US. Do they really exist? Nope – not right now.

For utility tokens to exist and trade on an “exchange,” there will probably need to be a change in securities law. And what are the odds of that? Good question.

STOs, basically regulated securities on blockchain that leverage smart contracts, have a clearer path but there are still issues.

Currently, securities issuers are using Reg CF and Reg D to successfully sell and issue digital assets but the one exemption that many people are excited about, Reg A+, remains in regulatory purgatory.

Not a single filing submitted to the SEC has been qualified – as far as we know. Aspiring Reg A+ issuers have stopped mentioning crypto, blockchain, digital asset, etc. in their filings as it is guaranteed to slam the breaks on any progress for the offering.

And if you want to know about 12g issues – this article is a must-read.

What happens when a digital asset has more than 2000 holders (12g) and it is compelled to become a reporting company? Will the digital sky fall? Perhaps. And that’s a really big problem.

One of the reasons digital assets became popular was for their heightened liquidity. Capping the number of holders can put a damper on that.

Admirably, the SEC has opened its doors to erstwhile crypto-preneurs to stop by and chat. Many aspiring issuers and marketplaces have visited with the Commission to share their ideas and gain insight into regulatory sentiment. Sometimes the response is positive and sometimes the response is downright disheartening … Especially if you want to challenge established finance law with something based off of a distributed ledger.

As for the new SEC Fintech portal where you can submit your questions to public officials. We have heard that responses are slow to come – if they ever come at all – so don’t hold your breath on receiving any feedback. A bit of a policy black hole… that’s too bad.

Crowdfund Insider frequently speaks with crypto-insiders about what is really going on or – what is the chatter. Recently, we had the chance to speak with several industry insiders who are plugged into the inside the beltway process. We posed a series of questions on the policy backdrop which remains a bit fluid.

First, CI asked what needs to be done to get the STO market going in the US? Why have there not been any Reg A+ offerings qualified by the SEC?

More clarity on custody and secondary trading. Right now anyone who wants to do this the right way is hamstrung because the SEC and FINRA haven’t approved any custodians or exchanges for digital assets. The primary issuance part is clear but that is just the first step … the SEC seems to be having a tough time wrapping their head around blockchain projects. A few seem to be getting close to being qualified, however.

What about the concept of a “utility token?” Can this exist? Or is this just unicorns in Xanadu?

It absolutely CAN exist but until it DOES exist and it is presented to the SEC in a way they are going to be comfortable it is like a mythical creature. Also, we probably should call it something else due to the stigma of “utility token.

The SEC has moved slowly to enable blockchain based securities. Why is that? Can’t they do more?

SEC has full power in this area and does not need congressional action. All they need to do is provide guidance as to how the existing securities laws should apply to these assets specifically around custody and secondary trading as previously mentioned.

What about Congress? There is legislation pending that is ostensibly designed to facilitate digital assets. Do you believe this will be signed into law?

Several people on the hill are working on this.

Commissioner Peirce recently mentioned Representative Davidson’s Bill which is well drafted and comprehensive … Nothing will get through the Senate. Also for some reason, Democrats have been slow to get behind this despite all of the potential benefits for the underserved and society in general that blockchain technology can bring.

Is there a risk that issuers innovate outside the US (and vote with their feet) due to recalcitrant regulators/policymakers?

Yes, that is definitely happening.

Many projects are choosing to organize offshore and only offer their tokens to non-US citizens. The flip side is that many US citizens are participating in unregulated offshore offerings or on offshore exchanges and are going to get burned.

The SEC is not going to be able to do anything about that, whereas if they would just approve the intermediaries stuck in the registration process, a regulated industry could sprout up right here under their watchful eye. 

Legislative hope springs eternal.

FINRA Approves Circle’s Acquisition of SeedInvest, Continues Mission of Tokenization

FINRA has given their stamp of approval to the acquisition of SeedInvest by Circle. The crypto focused company announced the purchase of SeedInvest in October of 2018.  The acquisition of a regulated securities crowdfunding platform by the blockchain based Circle represented a seminal turning point in the crypto industry.

Circle said the acquisition will bring their company closer to “weaving crypto assets/blockchain technology and traditional forms of financial contracts such as equities and other securities.” Circle has been a vocal advocate of the tokenization of both traditional assets and non-traditional investments such as art and more.

SeedInvest, one of the larger full stack crowdfunding platforms in the US, will continue to operate as they do today but with additional support from Circle. SeedInvest will be joining Circle’s team of over 300 people and global customer base of more than 8.5 million individuals including over 1,000 institutions.

Circle said it will continue to work closely with regulators such as FINRA and the Securities and Exchange Commission as digital assets continue to evolve.

In a blog post, Circle co-founders Jeremy Allaire and Sean Neville said they intend on creating new options for both startups and growth companies while providing unique access for retail investors.

“Broadly, we aspire to bring the economic and technical breakthroughs of crypto assets and blockchain technology to traditional forms of financial contracts such as equities and other securities. We believe that the tokenization of financial assets will ultimately unlock capital for growing companies and investment opportunities for people everywhere. Over time, more functions of private equity will be tokenized — including voting and governance, dividend payouts, and other economic features. Tokenization will also create new opportunities for businesses to build better relationships with their customers by leveraging tokens linked to ecosystem behaviors,” said Allaire and Neville.

Circle has received significant venture funding – including money from Goldman Sachs. This is not the first acquisition by Circle. In February 2018, Circle acquired crypto exchange Poloniex for a reported $400 million.

There are 46 FINRA Regulated Reg CF Portals. In 2018 $109.3 Million was Raised Using this Security Exemption

Periodically, Crowdfund Insider reviews the status of Regulation Crowdfunding (Reg CF) the smallest crowdfunding exemption in the US.

Reg CF has been in use since May of 2016. According to a recent report published by Crowdfund Capital Advisors (CCA), $194 million has been raised in total using Reg CF. During 2018, $109.3 million was raised – a significant increase versus year prior.

To list a Reg CF issuer a platform must either be a FINRA regulated funding portal or a broker-dealer. Some platforms are both and some Reg CF platforms are moving forward with a BD license as it makes certain things easier to accomplish (while still being regulated by FINRA).

As of today (Valentines Day – February 14), there are now 46 FINRA regulated funding portals. This is the same number from our last report on January 6th as one portal exited the ranks of regulated platforms and another joined the list.

First, the most recent exit was Good Capital Ventures based in Massillon, Ohio. As far as we know, the site never went live. We did hear some chatter some time ago that the owner was hoping to sell the site but demand was simply not present.

Today, 7 portals have exited Reg CF in total. Of these platforms, 6 have exited by choice and one, UFP, was told to go.

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The new addition to the roster of CF portals is Bioverge, a Reg D / Reg CF platform.

Bioverge is targeting the Medtech/Healthcare industry or the “Healthcare startups of tomorrow.” Several offerings are live on the site but it appears these are only Reg D offerings.

As for all of the 46 live portals, the question remains whether or not each of these (or any of these) can be successful.

The bulk of funding under Reg CF is being delivered by just a handful of platforms. Of course, this does not mean the other portals will not succeed but this sector of securities crowdfunding has been arguably slow to grow.

Reg CF is capped at a mere $1.07 million per issuer per year. There are numerous restrictions which add cost to the issuer dimming the viability of the exemption. Additional cost means less money to the company that needs it. The law also hinders the participation of Accredited Investors by capping the amount these individuals may invest. It is perplexing to everyone as to why the Securities and Exchange Commission (SEC) did not recognize this flaw and fix it from the beginning. Most active platforms pair a Reg CF with a Reg D offering as a work around to the arbitrary limitation.

The recent report by CCA highlighted the important role of job creation Reg CF is enabling.

“Reg CF is proving to be a jobs engine (creating on average 2.9 jobs per issuer), economic generator (pumping over $289 million of revenues into local economies) and industry supporter (enabling 82 unique industries in regions across the USA),” stated a CCA spokesperson.

The CCA report said there were 221 issues in 2017 and 417 in 2018. The average raise by an issuer stood at $271,000.

The total number of investors numbered 147,448 in 2018. One would estimate these investors were largely non-accredited investors.

CCA firmly believes that Reg CF is a success but they recognize that Congress and the SEC can improve the ecosystem. CCA helped to sponsor a letter, sent to SEC Chair Jay Clayton, asking the SEC to raise the exemption cap to $20 million.

In an article last week by platform operator David Duccini, founder of Silicon Prairie – a funding portal and more, the assessment of Reg CF was grimmer. The State of Investment Crowdfunding by Duccini said the cost of capital using Reg CF is “among the highest of all the capital raising options an entrepreneur has available.”

Duccini predicts more portals will exit the sector as they “find it nearly impossible to run a sustainable business model servicing Reg CF deals alone.” Duccini believes that some intrastate crowdfunding rules are far superior to Reg CF but, of course, intrastate rules limit the potential investor audience.

So is Reg CF a success? Or not?

It is this writers opinion that Reg CF must be improved or utilization will be muted.

Policymakers started at a point of investor protection instead of beginning with the goal of sustainability and success.

For a robust ecosystem to evolve, all three constituent parties must gain. This means issuers must be able to raise the funding they need, investors must have access to quality deals, and platforms must be able to generate sufficient revenue to become profitable. Right now, that’s not happening.

The most successful sector of crowdfunding in the US is under Reg D 506c where smaller investors (accredited) can participate alongside institutional money to invest in promising firms. Unfortunately, the vast majority of the population is excluded from accessing most deals due to the exclusionary definition of an accredited investor. This is simply wrong.

There is hope on the horizon. Recently, Representative Maxine Waters, Chair of the powerful House Financial Services Committee, mentioned specifically her interest in the JOBS Act 3.0, legislation that may fix Reg CF. There could be a bipartisan path to fixing the obvious shortcomings intrinsic to the exemption.

Additionally, legislation has been crafted to address the irresponsible definition of an accredited investor which has disenfranchised the masses. One or the other bill may inevitably become law.

Hopefully, 2019 will be a good year for online capital formation. But this will mean action by both Congress and the SEC – two entities that tend to move slowly.

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Caution: Online Funding Platforms Will Encounter More Regulatory Scrutiny in 2019

On January 22, 2019, the Financial Industry Regulatory Authority (FINRA) released its examination priorities for 2019.  At the top of the list was online funding platform compliance with the securities laws.

With an uptick in the offer and sale of securities offerings online with Rule 506(c) of Regulation D and Regulation A+, FINRA intends to focus there on its core mission of investor protection.

FINRA, the United States regulator of broker-dealers and their associated persons, is concerned that online funding platforms owned and operated by broker-dealers -or where the platform is not registered themselves and may utilize broker-dealer affiliates as selling agents, custodians or for financial technology (Fintech) services – are not meeting suitability, supervision, and anti-money laundering (AML) requirements.

FINRA’s examination priorities letter expresses the concern that broker-dealers engaged in online securities distribution have asserted the position that they are not selling or recommending securities.

FINRA believes the evidence is to the contrary, pointing specifically to broker-dealer online funding activities that include the handling of customer accounts and funds and where the broker-dealer is paid transaction-based compensation.

While the trigger point for the suitability obligation, for example, occurs only when a securities recommendation is made, and not when custodial or Fintech services are provided or a broker-dealer is compensated, FINRA is correct that these services may reflect a larger broker-dealer involvement in online capital raising.  And, as we are aware, the Securities and Exchange Commission (SEC) and FINRA are most comfortable when a regulated entity like a broker-dealer is involved.

Examinations, registration, and FINRA regulation ensure that a broker-dealer is best equipped to protect investors.  And suitability, supervision, and AML are all pillars of broker-dealer regulatory compliance.

FINRA will explore broker-dealer reasonable basis and customer specific suitability analyses, public communications, supervision, and compliance with AML requirements.  FINRA will review offering statements to investors to evaluate whether there was full disclosure of all material facts, including compensation and whether compensation was reasonable, and whether there were misleading statements or promissory statements of a high return.

FINRA intends to probe the mechanisms of accredited investor verification in Rule 506(c) offerings and whether custodial or escrow arrangements meet the requirements of the Securities Exchange Act of 1934.   While not specifically mentioned in its examination priority letter, broker-dealers also have due diligence obligations and will be held to that responsibility.

FINRA will not be the only regulator that will probe online funding platforms and their affiliates.

The SEC will take the lead on funding platforms that are not registered to determine whether the business activities they engage in require broker-dealer registration under Section 15 of the Exchange Act.  The SEC has prioritized these cases by bringing enforcement actions in the EB-5, JOBS Act, and cryptocurrency/blockchain spaces.

The services offered by online funding platforms and their affiliated persons, including marketing services, must be carefully evaluated.  This evaluation must analyze all services provided, the content of its communications with investors, and how the online platform is compensated.

The rules are pretty clear:  if you look like, walk, and quack like a broker-dealer, you probably are one and need to be registered.  And there are state blue sky law requirements you need to comply with in the states where you do business too.

We can anticipate that 2019 regulatory inquiries will also target online offerings made under Rule 506(b) of Regulation D.  Rule 506(b), unlike its newer counterpart Rule 506(c), does not permit general solicitation.

General solicitation is the advertising of a securities offering, including any article, notice, or other published communication.

Scrutiny thus will focus on how online funding platforms and their affiliates raise capital under Rule 506(b) and whether their investment process can be reconciled with laws, regulations, and rules, including SEC no-action guidance.

Even inadvertent general solicitation eliminates Rule 506(b) as an available exemption to securities registration. Similar misunderstandings by online funding platforms and their affiliates may occur in evaluating whether there is a pre-existing, substantive relationship, a defense to general solicitation.  Mistakes here too may remove Rule 506(b) as an available exemption and your securities offering may be illegal.

While all of this is a bit more complicated than the illustrative discussion above, online funding platforms and their affiliates must navigate compliance questions to protect the integrity of the securities offerings in which they participate.

Inadvertent errors may convert good faith fundraising into an illegal securities offering.  Regulators are sticklers for compliance – good faith efforts alone that do not meet legal requirements are insufficient.  And, in 2019, one consequential U.S. securities regulator has already publicly announced that it intends to take a very close look.

[easy-tweet tweet=”Regulators are sticklers for compliance – good faith efforts alone that do not meet legal requirements are insufficient” template=”light”]


Scott Andersen is principal at finLawyer.com and concentrates his practice on SEC and FINRA regulatory defense and federal securities compliance counseling.  Scott was previously Deputy Regional Chief Counsel at FINRA, Enforcement Director the NYSE, Co-Chief of the Securities Prosecutions Unit and Assistant Attorney General at the New York Attorney General’s office.  He has investigated, prosecuted, and supervised criminal, civil and regulatory enforcement actions for over 19 years before entering private practice.


The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.

¹http://www.finra.org/industry/2019-annual-risk-monitoring-and-examination-priorities-letter .
²See, for example, In the Matter of KCD Financial Inc. , SEC Release No. 34-80340; File No. 3-17512 (March 29, 2017)(registered broker-dealer engaged in unregistered securities offering structured to meet Rule 506(b)).

FINRA’s Annual Risk Monitoring and Examination Priorities Letter Targets Online Platforms Issuing Securities

Last week, FINRA issued its annual Risk Monitoring and Examination Priorities Letter for 2019. The letter is a reference point as to what FINRA expects to target in the coming year.

The missive includes an opening by FINRA President and CEO, Robert Cook, who said the letter “describes topics that member firms should consider as they identify opportunities to improve their compliance, supervisory and risk management programs.”

Cook added that FINRA was taking a “new approach” by focusing on topics that will be “materially new areas of emphasis for [their] risk monitoring and examination programs in the coming year.”

Within the list is a section that may be of concern for crowdfunding platforms.

In the US, there are three separate federal exemptions that crowdfunding platforms utilize. These include Reg A+, Reg D 506c and Regulation CF (or Reg CF – unfortunately labeled Regulation Crowdfunding). Each of these exemptions allows the solicitation and sale of securities online. While some platforms are “full stack” using all three exemptions, others may focus on one or two.

FINRA says they are concerned regarding member firms, broker-dealers or perhaps funding portals, and how they are recommending or selling these securities. FINRA specifically references Reg A+ and Reg D 506c [accredited investors only].

While it is not entirely clear as to any possible outcome or action, the fact FINRA has brought this up will certainly give pause to online capital formation platforms.

The entire letter is available here.

The excerpt regarding Online Distribution Platforms (IE crowdfunding) is republished below.


Online Distribution Platforms

Firms increasingly are involved in the distribution of securities through online platforms in reliance on Rule 506(c) of Regulation D and Regulation A under the Securities Act of 1933 (Securities Act). While some online distribution platforms are owned and operated by broker-dealers, others are operated by unregistered entities, which may use member firms as selling agents or brokers of record, or to perform activities such as custodial, escrow, back-office and financial technology (Fintech)-related functions.

FINRA is concerned that some member firms assert they are not selling or recommending securities when involved with online distribution platforms despite evidence to the contrary, including handling customer accounts and funds, or receiving transaction-based compensation. We will evaluate how firms conduct their reasonable basis and customer-specific suitability analyses, supervise communications with the public and meet AML requirements. Further, given the broad visibility of offerings distributed through online platforms, FINRA will evaluate how firms are addressing the risk of offering documents or communications with the public that omit material information or may contain false or misleading statements, or promissory claims of high targeted returns. For offerings subject to Regulation D, we will also evaluate how firms address the risk of sales to non-accredited investors and non-compliant escrow arrangements. For offerings subject to Regulation A, FINRA will also assess the risk of excessive or undisclosed compensation arrangements between firms and the issuers.

As of January 1st, There Are 46 FINRA Approved Reg CF Crowdfunding Portals

Reg CF (or Regulation Crowdfunding as it is inconveniently called) is a securities exemption that enables companies to raise up to $1.07 million online via a regulated funding portal or broker-dealer. The concept of a funding portal was created alongside the exemption which was part of the JOBS Act of 2012 (Title III). There are three different crowdfunding exemptions, including Reg CF, in the US that enable online capital formation; Reg A+ (up to $50 million) and Reg D 506c  (unlimited funding but accredited investors only) that provide several options for firms to raise money without becoming a reporting company (IE publicly listed).

When we last visited the list of FINRA regulated funding portals there were 44 approved platforms. As of today (or according to FINRA December 13th), there are now 46 regulated funding portals able to offer Reg CF issued securities.

There have been six funding portals that have either been compelled to cease operations or have chosen to exit the sector of crowdfunding. These six former portals are:

  • Avonto, LLC
  • Crowdboarders, LLC
  • DreamFunded Marketplace, LLC
  • Neighbor Capital
  • UFP, LLC (uFundingPortal)
  • Venture Capital 500, LLC

Avonto and Venture Capital  500 are the most recent exits from the sector having departed at some point in the second half of 2018.

So which platforms are new to the list of FINRA regulated platforms as there have been four additions.

Texas-based EquityDoor is a real estate investment platform – one of just a few sites that is using (or planning to utilize) Reg CF to raise capital for real estate. EquityDoor states:

“EquityDoor was founded by a small team with a big vision. We want to make investing in the income-based real estate market a reality for every potential investor.”

The company wants to provide access to investments such as “single and multi-family residential, industrial, self-storage, retail, general office, medical office, hospitality and etc. facilities owned by a corporation’s shareholders.”

Currently, there are no investment offers listed on the EquityDoor platform.

MainVest in Massachusetts is a localized investment crowdfunding platform that is targetting main street type businesses. MainVest states:

“Find small businesses in your community. Invest as little as $100 in the ones you believe in. If your investments are successful, get quarterly returns and share in the success of the small business economy.”

There are currently five live offerings on the platform – all in Massachusetts. One, the Plan in Holyoke, has topped its minimum raise of $75,000 and is scheduled to close soon. The Plan is a beauty salon that is providing a revenue return of 20% for lenders.

Houston based Pitch Ventures Group (LetsLaunch) is another localized platform seeking to fund main street businesses.

LetsLaunch currently has three crowdfunding pitches that are live. Two are in Houston and one is in Austin. Each is seeking a relatively small amount and none of the pitches have hit their funding goals.

WWF Funding Portal is not about the World Wrestling Federation as the name may imply. WWF is about water and the need for clean water – a bit of a hot topic in Michigan. The Water Works Fund is about:

“introducing investors to water investment opportunities…Our goal is to help solve water problems … Our water problems are coming at a pace and scale we’re too often not ready for. And because of climate change, population growth, limited public dollars, and aging infrastructure – it’s going to get worse. It’s time for new ideas, technologies, partnerships, and financing.”

The site has not officially launched and is expected to kick things off in early 2019, according to their site.

So where does the Reg CF crowdfunding sector stand today in regards to funding raised?

StartEngine, a full stack platform (CF, A+, D & STOs), launched a crowdfunding index some time ago that does a pretty good job of tallying the number of issuers and the amount raised. While the end of the year numbers are not yet available from StartEngine, has posted numbers as of the end of November. According to StartEngine, total capital raised via Reg CF  now stands at $156.8 million since the exemption went into effect in May of 2016. Last October was the biggest month for Reg CF as issuers raised  $10.9 million.

Most of the funding to date has been dominated by just a few of the platforms: Wefunder, StartEngine, SeedInvest, NextSeed, and Republic.

While some industry insiders thought Reg CF’s success the small amount raised accompanied by criticism pertaining to the excessive degree of regulation, has caused others to wish for change.

Basic requests such as an increase to the funding cap (up to $20 million), removal on restrictions for accredited investors (everyone does a workaround now), allowing a special purpose vehicle (SPV), are frequently requested. There are others.

Hope springs eternal that either Congress or the Securities and Exchange Commission will move to fix the shortcomings intrinsic to the exemption. Meanwhile, most issuers (and money raised) continues to head straight for Regulation D (506c and 506b) and the light touch regulatory approach that enables issuers to raise as much money as they want. But only from accredited investors.


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A Potential Pathway Forward for U.S. Initial Coin Offerings

This summer, with little fanfare, the North American Securities Administrators Association (NASAA) announced some interesting and, in our view, directionally enlightened ideas on potential changes to state securities laws as they relate to secondary market trading.

If you aren’t familiar with NASAA, it is a Washington, D.C.-based association that represents the interests of state securities regulators.  If adopted, NASAA’s proposal may help provide a solution to reduce the friction typically associated with aftermarket trading at the state level of not only traditional securities but also of “tokens” or digital assets that are securities.

As has been widely reported, until recently many token issuers believed they were issuing “utility” tokens that were otherwise exempt from the application of federal and state securities laws.

With clear messaging from the Securities and Exchange Commission (SEC), most issuers in the market have come to appreciate and acknowledge that they were mistaken.

The pressing issue these days is not only how to incorporate compliance with the securities laws into token offerings prospectively, but also how to remediate potential prior non-compliance.

In fact, many issuers may have to remediate the entire chain of previously non-compliant securities activity if they want to achieve full compliance going forward.  Given the great awakening that there has yet to be such a novelty instrument as a “utility token,” issuers need to grapple with the equally true reality that they may have also facilitated unlawful aftermarket trading in such tokens.  Investors themselves may also have additional violations to contend with which will need separate attention.

[easy-tweet tweet=”Given the awakening that there has yet to be such a novelty instrument as a “utility token,” issuers need to grapple with the reality that they may have facilitated unlawful aftermarket trading in such tokens” template=”light”]

Token issuers like to insist that they aren’t responsible for policing secondary trades in their tokens and that responsibility for compliance rests solely with the selling purchaser.

While there is some truth to that, it’s not true in all instances and certainly not in the context of many of the token offerings we’ve seen conducted to date.

Distribution of Securities & Statutory Underwriting

For example, issuers of privately-placed securities generally have to exercise reasonable care to assure that they are not selling securities to persons intent on immediately reselling. It’s slightly more complicated than this, but, in general, the fundamental issue is whether the parties are participating in a distribution of securities.

Sellers involved in a distribution are considered to be statutory underwriters and sales by them are, for all intents and purposes, attributable to the issuer.

Token issuers will eventually come to appreciate this in the same way in which they are learning to accept the issuances of tokens as securities issuances.

These aren’t novel interpretations of law meant to target the token industry but established theories of law imposed on private issuers of securities for generations.

Unsolicited or Not?

The presence of an ATS (Alternative Trading System, registered with FINRA) to facilitate these secondary transactions while an important development to bringing the token industry into compliance doesn’t in and of itself solve for the specifics of state regulatory compliance by the seller of the security.

While there may be applicable exemptions available for individual sellers, we believe that a more holistic approach will be required by issuers and resellers.  A key issue will be whether the ATS is accepting unsolicited transactions.

Whether or not a sale of a token posted on a non-password protected website will be deemed to be unsolicited is an issue to be determined.  If the determination is that a posting on a publicly-available website is a solicitation then all regulatory jurisdictions (including all 50 states and international) will have enforcement authority.  Keep in mind that the ATS will be regulated by FINRA and they may very well desire to ensure that purchasers of secondary transactions have better and more meaningful access to current information about the issuers prior to facilitating any such transaction on behalf of an account holder/purchaser—similar to most other regulators.

Token issuers that either failed to comply with the securities laws at the time of the original financing, including, in our example, those that failed to exercise reasonable care to only sell to persons not involved in a distribution, may have to take affirmative corrective action in order to redress prior misconduct.

This isn’t a new concept. In fact, noncompliant securities offerings have occurred for generations and there are means by which to remediate violations and become compliant.

Offering investors their money back in a “rescission offering” may be the only way to properly proceed to clean up both the initial and subsequent sales. The rescission is predicated on the original offering.

[easy-tweet tweet=”Offering investors their money back in a “rescission offering” may be the only way to properly proceed to clean up both the initial and subsequent sales #ICOs” template=”qlite”]

If the securities were initially issued in a Rule 506 offering, then that is the offering/investment that needs to be reconfirmed.  In a rescission offer, the investors receive the option to get money back or stay in the original offering.  If the investor elects to stay, the date of rejecting the rescission offer becomes the new date of sale.  Nothing in the original offering is changed other than the deemed date of investment.  While that is clearly a painful, but not unprecedented, process, NASAA’s proposal presents a potential silver lining as described below.

The NASAA Proposal

More specifically, it may provide an incentive for token issuers to remedy previous compliance failures through the Regulation A (Reg A+) offering process. By reducing aftermarket trading friction for the securities of issuers that have previously sold securities in a Tier 2 Regulation A offering, securities token issuers will be able to enable tokens previously issued in non-compliant offerings to subsequently trade lawfully throughout the U.S., so long as the issuer has qualified a Tier 2, Regulation A offering and is current in its ongoing reporting requirement.

Implicit in the NASAA proposal, and the so-called manual exemption upon which it is based, is the notion that with the ongoing commitment to keep investors up to date on the latest company information comes greater permissibility with secondary trading.

NASAA’s proposal highlights one potential benefit of remediating past violations through the facilitation of secondary market trading of the securities of issuers that have previously sold securities in a Tier 2 Regulation A offering and that properly comply with current and ongoing disclosure requirements.   The NASAA proposal is a welcome initiative and one which the industry should vocally support and submit comment letters.

NASAA’s first proposed model rule would designate certain sources of information/data as nationally recognized securities manuals or their electronic equivalent for purposes of the so-called “manual exemption” from registration under state securities law.

This proposed model rule is intended to address issues that have arisen as a result of the discontinuation of the corporate records manual previously published by Standard & Poor’s.  NASAA’s proposed rule addresses the federal requirement and the public’s need for ongoing disclosure about the issuer and its business.

Consistent with how disclosure for public companies work, the issuer must provide investors with full and fair disclosure not only at the time of the initial issuance of the securities but then again on an ongoing basis, otherwise known as, “continuous disclosure”.  The continuous disclosure is equally important for secondary trading since, without it, investors would only have access to the information provided to investors at the time of the primary issuance of the tokens to the initial purchasers.  Quite quickly, this information would be stale and investors would be trading securities without the benefit of full and fair disclosure.

The second proposed model rule would provide two alternative options for providing an exemption for secondary trading in securities of issuers that have previously sold securities in an offering under Tier 2 of Regulation A and that remain current in their ongoing reporting requirements under federal law. The second proposal is designed to facilitate secondary trading in securities of Regulation A – Tier 2 issuers.  Coupled with the first proposed rule, we believe that NASAA is laying the proper groundwork so that any issuer of unregistered securities (including those that may need to offer rescission) be able to have those instruments included in a Regulation A+ filing, agree to provide ongoing updated disclosure (legal and accounting) in a recognized securities manual, and consequently, be permitted to have those securities trade lawfully.  This will be a costly and time-consuming endeavor but necessary for avoiding future regulatory enforcement actions.

If NASAA doesn’t enact these proposed rules, it will continue to be extremely difficult for any new issuers of restricted securities, or issuers of noncompliant tokens, to have their securities trade in secondary market transactions.

[easy-tweet tweet=”If NASAA doesn’t enact these proposed rules, it will continue to be extremely difficult for issuers of noncompliant tokens, to have their securities trade in secondary market transactions” template=”qlite”]

Without these rules, an issuer of securities in the U.S. must either:

(i) have their securities listed on NYSE or NASDAQ (and comply with their extensive listing requirements) in order for those securities to be deemed to be a “covered security”, which also requires full ongoing continuous disclosure with the SEC (10-Ks, 10-Qs and 8-Ks), thereby  pre-empting the necessity for state by state securities law compliance, which is quite expensive and difficult to achieve, or

(ii) trade Over-the-Counter and annually update your disclosure in a recognized Standard Manual but only gain clearance in 39 states for secondary trading.   Otherwise, with very limited other alternatives, a restricted security may not be publicly displayed for sale across states to solicit new investors.

The complexity of these rules may be overwhelming for the uninitiated, but while the SEC and state securities regulators may have been somewhat forgiving the first round with unknowing violators, they are creating a pathway for compliance that puts all issuers of securities fully on notice that they will need to strictly follow.

The comment process ended August 20 and there were a total of 5 letter submissions – ALL in favor of the proposals.

We also note that the OTC Markets observed in their comment letter that both the SEC’s Advisory Committee on Small and Emerging Companies (ACSEC) and the US Department of Treasury have also publicly supported these changes.

We commend NASAA for its leadership in advancing these proposals.


 

Douglas S. Ellenoff, a member of Ellenoff Grossman & Schole LLP since its founding in 1992, is a corporate and securities attorney with a focus in business transactions, mergers and acquisitions, and corporate financings. In the last several years, he has been involved at various stages in numerous registered public offerings and hundreds of private placements into public companies. Along with other members of his Firm, Mr. Ellenoff has been involved at various stages with over 100 registered blind pool offerings (commonly referred to as “SPACs”); In addition to our IPO experience with SPACs, he has been involved with more than 30 SPAC M&A assignments. The Firm represents nearly 60 public companies with respect to their ongoing 34 Act reporting responsibilities and general corporate matters. He also provides counsel with regard to their respective ongoing (SEC, AMEX and NASD) regulatory compliance. Like the other innovative securities programs, the Firm has taken a leadership role in the emerging crowdfunding industry, which was signed into law by President Obama on April 5, 2012. The Firm actively participates in many discussions with the SEC and FINRA with respect to the proposed rules which went into effect May 16, 2016.  The Firm has sponsored conferences, webinars and has been invited to speak at numerous events on the topic. The Firm is already actively engaged with clients (funding portals, broker-dealers, technology solution providers, software developers, investors, and entrepreneurs).

Attorney on SEC & Crypto Asset Marketplaces: “By Not Allowing Intermediaries They Are Stifling Innovation”

Recently, at the StartEngine Summit during LA Blockchain Week, CI had the chance to sit down with prominent securities attorney Linda Lerner.

Lerner is Senior Counsel at Crowell Moring and a veteran lawyer with deep experience and expertise in securities issuance and regulation of stock exchanges. Lerner is currently working with Fintechs to help push the process forward when it comes to receiving an Alternative Trading System (ATS) license for trading in digital assets using the blockchain.

Many months ago, the Securities and Exchange Commission (SEC) tipped their hat that it is was inclined to accept securities trading of digital assets on ATSs. Today, multiple platforms are pursuing an ATS license, with at least one – tZero, partnering with a full-blown exchange – Box Digital Markets.

But while there are many crypto asset platforms heading down this path, these platforms must first become a registered broker-dealer. As one may expect, this process can take some time. But in Lerner’s opinion, the feds are dragging their feet for far too long, overly concerned about getting it wrong.

Meanwhile, elsewhere around the world, crypto exchanges have set up operations in jurisdictions which are blockchain friendly. Perhaps, most notably Malta where Binance, one of the largest crypto exchanges in the world, set up shop after meeting with government officials and reviewing customized legislation that was crafted to encourage blockchain innovation and Fintech entrepreneurship. France, for example, is creating an entirely new regulatory regime for crypto innovation that expects to allow ICOs without a need for a formal approval process. Think about that for a moment.

Lerner, who is knee deep in the process, says the SEC is “standing there like a roadblock because they are afraid something will blow up in their faces.”

“By not allowing the intermediaries to get registered they are stifling innovation and preventing issuers from raising capital, they are standing in the way …” states Lerner. “They are so afraid something might go wrong.”

While this fear of failure by public officials is somewhat understandable, it is still frustrating for Fintechs pushing to innovate the issuance, and management of, digital assets. The crypto ecosystem is very new and the learning curve has been fast and furious for regulators. But Lerner is of the opinion that by NOT enabling regulated entities to operate, they are pushing platforms to operate in a non-compliant manner. That’s not good.

Lerner says they punish everyone who does not pursue a compliant process but the enigma is there is no clearly defined compliant option.

FINRA has 180 days to approve broker dealer applications but apparently there is a delay in adhering to this rule, according to Lerner. While FINRA, a Self Regulatory Organization, may extend this timeframe, it appears it may be the SEC which has been slow to advance platforms pushing to get an ATS license.

Lerner acknowledgers that some broker dealer / ATS applications are complicated, but others are not so much. Some applications have been sitting in front of the regulators for months, says Lerner.

She acknowledges that some of the questions the regulators are tackling are a heavy lift. Issues regarding custody or payment in crypto are frequently mentioned. Who takes a hit if the value of crypto changes in the middle of a transaction? This must be decided.

Another hurdle, is the fact that every broker dealer must have a fidelity bond. Until recently, none of these bonds covered the issuance of digital tokens. This is another procedural change. Insurance companies had to adapt their concept of a policy when a security is tokenized. Lerner says at least on insurance company is currently ok with it.

Cybersecurity is at the top of the list of challenges for the SEC in general. The many reports of exchange hacks, and allegations of lax security protocols at crypto exchanges, does not help advance the issue.

Communication between divisions within the SEC may be a problem as well. Lerner is concerned there has been a disconnect, at times, between some of the larger segments of the securities regulator. The Commission has been slow to create an effective management and information information process for crypto asset innovation. Trading and Markets must coordinate with CorpFin and, meanwhile, Enforcement is investigating dozens or hundreds of allegations of crypto fraud. As a federal bureaucracy, the SEC can be very siloed at times.

“It would be nice if those divisions spent more time with each other,” Lerner says.

Not too long ago, the SEC appointed Valerie Szczepanik as the Associate Director of the Division of Corporation Finance and Senior Advisor for Digital Assets and Innovation. In effect, she has been tasked with managing much of the crypto innovation and channeling the various constituents at the Commission. Lerner is optimistic she will be able to “bring it all together.”

Lerner does have praise for one element of the equation. She says FINRA is really working hard to get it right.

“I applaud FINRA and what they are doing,” states Lerner.

The frustration with the pace of approval is obvious but eventually, and perhaps quite soon, regulators will have to decide how, and who, should move forward in the process.

“For this to really work, the industry, [including] FINRA, SEC, CFTC, FINCEN must be in the room hammering it out. The industry must be in the room too,” says Lerner. “Too often the regulators say they will figure it out. Look how that has worked out …”

Reg CF: 44 FINRA Approved Crowdfunding Portals and Counting

In June, we updated readers on the number of FINRA approved Reg CF portals. At that time the count stood at 41 regulated crowdfunding platforms. As of today (September 21, 2018), that number has now increased to 44 FINRA approved Reg CF platforms as three new platforms have been added to the group.

As for portals that have exited this sector of online capital formation, that number remains the same at four (Crowdboarders, DreamFunded, Neighbor Capital and UFP).

So who are the new additions to the smallest form of investment crowdfunding? They are as follows:

EnrichHER Funding is a platform that “unites founders and funders who share a vision for sustainable women-led ventures.” EnrichHER was founded by Roshawnna Novellus earlier this year to empower female founders with the capital needed to build their businesses. As of yet, there are no offerings on the platform.

MiTech, a Public Benefit Corporation, is operating the site Crowdfund Main Street. The California based platform currently has five offerings listed on the site. None of these offerings have yet met their minimum funding goal.

SeedingVR is a vertical crowdfunding platform as it is focusing on one sector of industry: Virtual Reality. The platform explains:

“We are the only equity crowdfunding portal specific to the virtual reality industry and offer exclusive access to some of the stealthiest VR tech. And yes we know virtual reality, mixed reality and augmented reality are technically different. But for simplicity sake we put them into the same bucket and just call in VR.”

Currently, there are no VR offerings listed.

As we recently reported, since the Reg CF industry went live in 2016 approximately $135.3 million has been raised under this securities exemption. A very small sum in the broader ecosystem of early stage funding. Most of the money raised to date has been with the assistance of just a handful of platforms.

Industry participants, along with this publication, are hopeful that policymakers will step up and remove some of the shortcomings intrinsic to the exemption to help foster sector growth and provide a more effective path for early stage companies to raise growth capital. While regulators, elected officials, and other prognosticators expected rampant fraud under Reg CF – the opposite has been true. The exemption was so strict it completely undermined utilization.

In July, a letter was forwarded to Securities and Exchange Commission (SEC) Chairman Jay Clayton demanding action by the regulator to fix one aspect of Reg CF. A prominent group of Fintech leaders demanded the Commission to increase Reg CF from the current $1.07 million cap to $20 million.

It was pointed out that in Europe many countries now allow issuers to raise up to €8 million (USD $9.4 million) on crowdfunding platforms. There are some advocating to push that amount higher as crowdfunding is viewed as an efficient vehicle to help fuel startups. There is also legislation being crafted to enable issuers to more easily operate on a pan-European level. This new legislation may also include rules to incorporate initial coin offerings (ICOs) as an option for issuers beyond more standard debt and equity offerings.

In the end, policymakers should focus on making Reg CF the exemption of choice for the very best firms. Today, the most promising startups use Reg D as the compliance demands are less stringent and thus presents a far lower cost for companies raising capital. Additionally, this means only VCs and the very wealthy have access to these investment opportunities and smaller investors are cut off from the opportunity.

While the changes needed to improve Reg CF may be relatively simple to fathom there is little political will to make these improvements. Either due to benign neglect, ignorance, or opposition, access to capital for smaller and early stage firms remains a problematic policy issue. Perhaps the electorate should demand business / entrepreneurship experience from our elected officials?


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FINRA Publishes Paper on Regtech, Seeks Feedback from Interested Parties

FINRA has published a white paper on regulatory technology or Regtech developments within the securities industry. Regtech is a hot sub-sector of Fintech as it has the potential to make the job of financial regulators easier while saving time (and money) for the firms they regulate. Of course, the devil is always in the details as to how Regtech is integrated into routine operations.

The white paper explains:

“As financial services firms seek to keep pace with regulatory compliance requirements, they are turning to new and innovative regulatory technology (Regtech) tools to assist them in meeting their obligations in an effective and efficient manner. These Regtech tools may facilitate the ability of firms to strengthen their compliance programs, which in turn has the potential to create safer markets and benefit investors. However, these tools may also raise new challenges and regulatory implications for firms to consider.”

FINRA recognizes that Regtech has big implications for broker dealers and thus their white paper highlights specific areas of interest. These Regtech innovations include:

  • Surveillance and monitoring
  • Customer identification (KYC) and antimoney laundering (AML) compliance
  • Regulatory intelligence
  • Reporting and risk management
  • Investor risk assessment.

FINRA says it supports innovation that contributes to both market integrity and investor protection. Of course, Regtech can perfectly align with this mission. FINRA is asking that stakeholders actively engage with FINRA on areas where additional guidance or resources may be desired to support adoption of Regtech solutions that are consistent with the principles of investor protection and market integrity.

Comments on the White Paper are requested by November 30, 2018.

The FINRA Regtech White Paper is available here.