FINRA Allegedly Warns Off Reg CF Portals on Use of Trusts for Escrow

October 20, 2016 @ 11:14 am By JD Alois

FINRA is a non-governmental entity that acts as a financial regulator over a wide swath of the financial industry. Their mission is to detect and prevent wrongdoing in the US financial markets. FINRA also has enforcement powers. Last year alone they rendered over 1500 disciplinary actions against registered individuals and firms. Investment crowdfunding is a sector of alternative finance that is part of FINRA’s portfolio. Beyond the new securities exemptions, FINRA regulates Reg CF funding portals as members of FINRA. These funding portals were created as part of the JOBS Act under Title III of the law. Today there are 18 approved and regulated portals each trying to manage a way to operational and financial success. Recently, Crowdfund Insider caught wind of a FINRA action challenging the use of trusts as escrow agents for Reg CF offers. Under Reg CF, funding portals must use an escrow agent to hold investor funds. FINRA carries a pretty big stick so when we started to ask around no-one was willing to go on the record.

Initially, we understood that a single entity, Provident Trust, was being challenged. One investment crowdfunding industry insider shared with us;

“FINRA started looking at this issue 9 weeks ago but has not put anything down in writing nor stating anything orally. They have not made any communication that Provident Trust can not be used as the QTP [Qualified Third Party] escrow agent in any offering. FINRA has requested that any trust company that acts as a QTP agent show they are a bank under 3a6 of the 34 act and they are permitted to hold funds under state law. Provident meets the definition under 3a6 and Nevada law permits Provident to hold funds. Thus Provident meets the requirements of a QTP. The other Trust Companies in the industry such as Kingdom, Goldstar, Bryn Mawr, Boston Private etc. must also meet these requirements.”

After a few more calls, we now understand that ALL trusts are being questioned by FINRA. And why is that? A bit hard to discern.

In reviewing the final rules of Title III crowdfunding, the SEC commented on use of Escrow;

“We are revising the definition of a “qualified third party” [for use as an escrow agent] to include for purposes of the final rule: a registered broker or dealer that carries customer or broker or dealer accounts and holds funds or securities for those persons, a bank, or a credit union insured by the National Credit Union Administration (“NCUA”). We had proposed to define “qualified third party” to mean a bank because investors, as well as intermediaries and issuers, would then be afforded the protections of existing regulations that apply to banks, in particular those pertaining to the safeguarding of customer funds. However, after considering the comments, we agree with those commenters who suggested that the definition of “qualified third party” should be expanded to include entities other than a bank and should include, as one commenter suggested, credit unions provided that these entities offer similar protections to banks. We also made a corresponding change to the language of the rule text to indicate that a qualified third party arrangement may involve either a bank or credit union account (or accounts) established for the exclusive benefit of investors and the issuer.”

So do Trusts, entities that typically have a relationship with bank where the funds are held, meet the standard as a “Qualified Third Party.” At least one individual who is prominent in the sector said FINRA was interpreting the rule incorrectly and that trusts are just fine.

We then decided to do the obvious and ask FINRA. Their feedback;

“No comment.”

While there are some banks directly providing escrow for Reg CF platforms we have been told the majority of platforms are using trusts. Banks are less interested in the Reg CF business. The FINRA action has been described as “frustrating”.

So is FINRA trying to undermine the young Reg CF industry with a heavy hand? Would they prefer all Reg CF portals become Broker-Dealers (a costly venture for listing platforms)? It is hard to tell, at least until FINRA decides to speak up and share their intentions.