Five Key Take-Aways from FINRA’s Expulsion of Crowdfunding Portal UFP

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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.   

 

  • Doom Ride Mortals DangerOverly-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
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 sandersen@finLawyer.com

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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.

 

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  • oldprof101

    The author’s reading of the FINRA order is myopic. All Jobs Act intermediaries, Title II platforms and Title III portals are subject to the anti-fraud provisions of both state and federal law. Nothing in the JOBS Act exempts them. The FINRA settlement specifically calls out the offerings in question for “impractical business plans” a fact that the author omits. Nowhere do the rules say that “a portal may generally rely on an issuer’s representations concerning compliance.” Title II portals are specifically permitted to charge for due diligence investigations and FINRA members are required to conduct them.

    • Samuel S. Guzik

      “Impractical Business Plans” – Definitely a Red Flag worthy of noting – NB

      • oldprof101

        Frustrating that the author failed to mention them because it is hard to find a portal that doesn’t have several listed. If I wanted to raise $100,000 or $1 million to “cure cancer” most of the portals would take the offering. It does not seem that the industry will wise up until a regulator does something draconian.

    • Scott Andersen

      The decision references “impracticable business plans” as one of many factors that should have led the portal UFP to deny access to suspicious issuers and offerings, a topic well covered in the article. Gatekeeper responsibilities are very different from the general applicability of the antifraud provisions of the securities laws, and Rule 301 of Reg CF sets forth when a portal may rely on an issuer’s representations — despite what oldprof101 may mistakenly believe to the contrary.

      • oldprof101

        Actually Reg CF requires a portal “to have a reasonable basis for believing that an issuer seeking to offer and sell securities in reliance on Section 4(a)(6) through the intermediary’s platform complies with the requirements in Securities Act Section 4A(b) and the related requirements in Regulation Crowdfunding.” You can’t have a reasonable basis without some investigation. FINRA’s action is a pretty clear indication that companies with “impractical business plans” have no business on a FINRA portal. In addition, joining FINRA creates an affirmative obligation NOT to participate in a fraudulent offering. The anti-fraud provisions do not define a “gatekeeper”. They speak of the disclosure of all material facts and the case law creates joint and several liability to all parties who participate in the offering. The UFP action should cause all intermediaries to up their game. I assume that is what you are advising your clients.