FINRA recently completed a settlement expelling from FINRA membership UFP, LLC, a registered funding portal that operated under uFundingPortal.com. The matter marks both early and decisive action by FINRA against a registered funding portal operating under Regulation Crowdfunding. It establishes that FINRA takes seriously its new regulatory beat and that the gatekeeper function that portals are required to fulfill must be satisfied.
Here are key takeaways from FINRA’s action against UFP:
- Funding portals, like broker-dealers, are gatekeepers. The FINRA action was based on the determination that UFP had no basis to believe that its issuers were in compliance with Regulation Crowdfunding. The rules require that a portal must have a reasonable basis for believing that an issuer seeking to offer or sell its shares on its platform meet the requirements of Regulation Crowdfunding. In fact, a portal is required to deny use of its platform where it reasonably believes that an offering presents a potential for fraud. While a portal may generally rely on an issuer’s representations concerning compliance, this is not true in instances where the portal has any reason to doubt the issuer’s representations.
- UFP hosted suspicious issuers and offerings. Many crowdfunding portals are understandably concerned that the initial action by FINRA against a funding portal resulted in the highest sanction — an expulsion. UFP was in many ways an anomaly, however. How often do you have sixteen issuers who omit the same specific disclosures required by Regulation Crowdfunding? Two of the issuers had identical officers and directors, but vastly different business plans. Thirteen of the issuers had identical valuations, price per share, funding targets, and no assets or history of operations before May 2016, yet each issuer was valued at $5 million.
- Overly-optimistic financial forecasts spell trouble. FINRA advertising rules have always limited its members use of forecasts and profit projections when selling securities. We continue to see in the JOBS Act space that capital raises under Title II and IV on platforms with no broker-dealer affiliation often use generous profit projection forecasts. Crowdfunding portals like broker-dealers, however, will be held to a higher standard, and thus the marketing dichotomy continues between broker-dealer and portal related offerings and those of platforms who have no FINRA affiliation.
- Are Portals responsible for an issuer’s valuation? FINRA was clear in its criticism of UFP that several issuers on its site held wholly unsupported and improbably identical $5 million valuations. The regulatory violation by FINRA was structured as an untrue or misleading statement, and FINRA’s case was relatively easy considering the identical valuations across multiple issuers on UFP’s site. A question remains how FINRA will view a portal’s responsibility for an issuer valuation on a one-off basis, looking at one issuer on a site specifically.
- Unreasonable supervision. Like the broker-dealer world, where FINRA finds violations of federal securities laws or its rules, a portal will also be hit with a failure to reasonably supervise violation. This can be challenging for some new portals whose principals have no broker-dealer experience, and FINRA does not yet require any series license to confirm a principal’s familiarity with the rules in advance of allowing them to operate a funding portal.
FINRA has established early and decisively that it will be closely monitoring its new territory, Title III crowdfunding. As has always been the case with broker-dealers, FINRA will hold funding portals responsible for troubling issuers and offerings, as FINRA correctly views the portals to be “gatekeepers” who have a responsibility to protect investors.
Scott Andersen is principal at finLawyer.com and outside General Counsel of FundAmerica. He has also been Deputy Regional Chief Counsel at FINRA, Enforcement Director at FINRA and the NYSE, Co-Chief of the Securities Prosecutions Unit of the NY Attorney General’s office, and Asst. Attorney General for the State of NY. He has been investigating, prosecuting and supervising criminal, civil and regulatory enforcement actions for over nineteen years. He concentrates his practice on SEC, FINRA and state regulatory defense and securities regulatory counseling. He can be reached at [email protected]
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.