Equity Capital Markets Blog

U.S. Crowdfunding: Tips to navigate the regulatory framework when starting your own platform


Crowdfunding platforms in the US are providing entrepreneurs and innovative companies with a new way of raising capital, though the number of companies that take advantage of it is still relatively small. The main reason is the legislation process and different regulations surrounding the crowdfunding platform registration.

This webinar will provide you with actionable tips on registering your crowdfunding platform in the US, and navigating Title III and FINRA.

We joined with Scott Andersen and George S. Georgiades, leading crowdfunding legal experts in the US, to help you learn:

  • What is the difference between Title III registered crowdfunding platform and non-registered crowdfunding portal
  • Benefits of being a registered crowdfunding platform
  • What do you need to become a Title III registered crowdfunding platform
  • Best practices for navigating Title III registration process
  • Actionable advice on successfully going through FINRA process - an actual client case study
  • What’s the hype behind Initial Coin Offerings (ICOs), cryptocurrency, and blockchain and what it means for crowdfunding

Who are the presenters:

Scott Andersen is principal at finLawyer.com. 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. In these roles, he has investigated, prosecuted and supervised 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, as well as working with crowdfunding portals, funding platforms, broker-dealers and fintech providers on regulatory compliance matters.

George S. Georgiades, of counsel to Ellenoff Grossman & Schole LLP, focuses his practice on capital formation transactions and providing regulatory compliance advice to broker-dealers, investment advisors, exchanges and crowdfunding portals. He has extensive experience in structuring, negotiating and consummating initial and other public and private securities offerings with a particular focus on technology driven finance, including Crowdfunding, Regulation A+ and Initial Coin Offerings. He has been meaningfully involved in crowdfunding since its inception working cooperatively with regulators, industry associations, funding portals and other interested parties to fashion the crowdfunding regulations and develop fundraising strategies. He routinely speaks at national conference on topics ranging from crowdfunding, broker-dealer compliance, blockchain technology, cryptocurrencies to securities reforms.  He can be reached at ggeorgiades@egsllp.com


Full transcript:

Katipult: Hello everyone, this is Brian from Katipult here on episode two of our webinars. Today I brought Scott and George that have been helping one of our clients apply for the license for the Title III platform. They were approved Friday and got their welcome letter actually 2 hours ago, so it’s a good success story we have here. It has been great working with both you.

- Hi Brian, thank you so much, happy to be here today.

Katipult: Happy to have you. Today’s topic is Title III. We could start by talking about differences in platform types, for example a funding platform, broker- dealer portal and crowdfunding platform.

Scott: There are a lot of titles in the JOBS Act which allow people to raise capital in a lot of different ways, revolutionary ways that had never been available until very recently. Essentially what the JOBS Act has allowed people to do is to raise capital by posting their offerings over the internet.

Title II was Reg D general solicitation allowing Reg D offerings to be run from a funding platform.

Title IV is Regulation A allowing individuals to raise up to 50 million dollars.

Title III is regulation crowdfunding which enables non accredited investors to invest in offerings on the internet. What makes Title III offerings different from Title II and Title IV is that the SEC made a determination that platform posting in Title III offerings had to be either a registered broker dealer or a funding portal. 

So a question arises, what is a funding portal? It is essentially a miniature broker dealer but it can’t do all the things a broker can do, like securities recommendations  or providing investment advice. On the flipside it is not subject to all the rules and requirements as a registered broker dealer.

So, when we look at things and we think about what the landscape looks like in the U.S. we see a lot of different things. We see broker dealers of course, we see funding portals which have the power the essentially act as broker dealers at Title III offerings that appear on the site. Then we have other types of offerings which occur on other types of sites.

Katipult: That is interesting. This whole approval process, which is one of the big differences from the other regulations, there are of course some best practices regarding that. What is actually needed to start the application for this license?

George: The seal of securities in the U.S. is highly regulated. 

First step is you need to have a meaningful analysis on how you intend to be involved on the offer and sales of securities. So under the JOBS Act is the Title III where a new intermediary was created called the crowdfunding portal. It is unique in a way that it’s able to execute the offer and sale of securities but with certain limitations. It is a registered entity which means that you have to file with the Securities and Exchange Commission as well as new membership application with financial industry regulatory authorities.

So you have two regulators here. A common misconception by many is how detailed your application has to be and how prepared the portal, along with the internal infrastructure for compliance, has to be before actually submitting your applications.

I like to divide the general application process in two categories: first is the pre application work and the second is the formal application process. Before we even get to the application process it is important to have a fully functioning technology platform, not only in terms of technology, but also in complying in regulations in crowdfunding.

Crowdfunding regulation is very detailed in what it requires a funding portal to do, both in the offer and sales of securities. Through that it’s not only the technology and the process that that’s required to be completed but also your internal compliance infrastructure. 

So, as counsel to crowdfunding portals in the registration process we prepare a supervisor procedures which is a detailed compliance procedure which governs your day to day operations to ensure you comply with regulation crowdfunding and articulates the daily obligations that need to be executed depending on what the portal is doing.

With written supervisory procedures many make mistakes with how detailed and how tailored they need to be. It’s not something that can be taken off the shelf or just generally applied to every portal. It is important that it is specific to your business and to the rest of your business and operations.

Katipult: What are some of the common mistakes that people make? Is it for example that they don’t have their platform when they start applying for the license?

Scott: I think that’s correct. One of the biggest errors and misconceptions we have seen is people applying for FINRA membership before getting their ‘’ducks in order’’.

Before doing your filing you want to make sure you have an operating platform that meets the regulatory requirements. The regulators view a funding portal like a broker dealer, obligated to protect the investors. Essentially a gatekeeper. 

In order to establish to the regulator that the funding portal is capable of doing that you need to demonstrate to FINRA that the portal is already designed and able to operate in a manner that meets all the legal requirements.

Katipult: I actually like that they are required to have a fully functioning platform.  I know that in other jurisdictions, Katipult is a global product so we can work in any jurisdiction, you need to apply for a license and the regulators there actually do not require that, at least not  in many cases. I think it’s a good idea because that technology is going to be a really central peace in your business and it needs to be evaluated, as well as your business model.

Scott: For regulation crowdfunding the offerings must appear on the website. They must appear on the portal. It is designed that way because there are very specific disclosures and operations that have to occur on the site so that the investor receives all the material facts related to the specific offering.

George: Keep in mind that when you file with FINRA for new membership application the process moves very intense and very quickly. From the moment you apply FINRA begins reviewing your application and bringing in the different apartments from FINRA. From marketing to corporate finance, they will be doing their respective reviews of the portal for its compliance.

I think it’s a mistake when they think they can file and it’s a work in progress. When you file with FINRA it should be the final portal as if you are ready to launch business.  You must be ready to launch next day, because that is what FINRA will be looking at and that’s how FINRA will be accessing it’s review process.

Katipult: That is very interesting. Definitely they are moving pretty quick because you told me the general time for approving and actually getting an answer or earning an approval is about 60 days and client were working with took 58 days. Of course it can take longer than 60 days but that is the general time from what I understood there.

George: Correct. The preparation is key and insuring that you have all of your documents ready.

I think that the applications are a little bit misleading in a way that it looks simple, but the requests and the documents you need to provide are very detailed, both looking into how the portal was capitalized, who the shareholders are, down to making sure your compliance process and procedures meet regulation crowdfunding.

So that is kind of FINRA’s first label review, now if the application is incomplete, substantially incomplete, it might be rejected. Once you get through the initial review, you get to the interview process and that is the opportunity for the portal sponsor management team to not only present the team and the structure, but also walk FINRA and it’s different departments through how you comply with regulation crowdfunding, such as going through the investor onboarding process, the issuer onboarding process, how offering deals will be presented on the portal, all the way down to the back office and how you are monitoring trades, how you set up your escrow relationships.

It is important to have thought about this way in advance to make sure that the infrastructure, both the compliance and the technology comply with the rules.

Scott: Generally, there are 3 criteria that need to be met.

Number one is that you need to have the portal functioning in a manner that complies with the rules and regulations because again, we’ve been discussing on this most recent and newest member of crowdfunding portal community that we had the privilege of working with, we worked with an excellent FINRA examiner who just did a great job and was pushing the application fully at all times in order to identify what information was required to be provided so we could get that information to him as quickly as possible so we could move forward and get the portal approved. It was an excellent working experience, FINRA really did a great job working with us on that particular application.

So, when you are thinking about doing this, you need to get your technology provider lined up because the portal has to do certain things. It has to be able to obtain certain information, convey certain information through confirmation notifications, things of that nature about the investment process. It needs to share information to educate investors, that has to be done in a very certain and distinct way so you really need to line up who is going to be providing your technology and how to make that technology work in a way that meets the standards.

It’s great working with Katipult on this last portal, to get the portal through quickly. It is absolutely required to have a good working relationship between legal consult and the technology provider.

The second thing that you need is to have very detailed written supervisory procedures. Keep in mind that  we are talking about broker-dealer regulation here, about rule based regulations and the written supervisory procedures have to address and certain circumstances will be addressed by supervisors of the portal and these are very detailed.

It has to cover the business practice and operation of the funding portal and detail who the supervisor of doing certain things is, when certain things will be performed and how they will be performed, all with the ultimate goal of making sure that the investors are protected.

The third piece that you really need to put together upfront is the people who own the portal, who are going to be operating this portal. They need to become very educated in how portals are required to operate, what are the rules, what is necessary to do to comply with the rules.

Again, FINRA in accessing whether to accept somebody for membership is going to be making primarily a determination on whether it’s comfortable that the individuals who own the portal are going to be compliant with the federal securities laws and federal rules. A big part of this is that a portal has ample written supervisory procedures outlining how the portal will be complying with those rules and laws.

Those are things that you really need to keep your mind on and work through upfront.

Katipult: So, if we should set up a list of three items that you need to actually start a crowdfunding platform from scratch, it would be a technology provider that you can actually communicate with and have a good working relationship with, then of course you need to have your business model ready, so you need to have decided what you want to do with it, and third, you have to be investing some time and actually knowing a technology as well as the rules that you need to follow so you can make sure that even though you have the technology that stays in the rules, you don’t post anything or do anything that not in the regulations.

George: Correct. We’ve also done the regulatory registration for the only two non-resident portals.

It’s a unique characteristic of the JOBS Act that you can be non-resident, for example the team is based in a foreign jurisdiction and operating a U.S. funding portal. We did the registration to the only two, one in Hong Kong and one in Canada, that are registered as of today, so if you were a non resident portal there is a little bit more information that you have to give, or a little bit more hoops that you have to jump through.

First there needs to be information sharing agreement between the Securities Exchange Commission and the securities regulator at your jurisdiction, and you also need to obtain an opinion of counsel from local counsel with jurisdiction abroad on certain items that specify you would not be restricted from providing certain information to a U.S. regulator if requested.

Katipult: Even though you are not a U.S. company, you can actually set up a Title III platform in the U.S. Are there any countries that are not allowed to apply or is it basically worldwide?

George:  We’d have to go back and look what agreements are there between the U.S. regulator and the regulator of your jurisdictions, and there is a long list countries which have agreements to cooperate in certain respect.

Katipult: Now we know a bit about what you need to prepare to get something like this started. So, how much does this typically cost? And, of course, you can give a legal point of view how you set it up and what the approval process actually costs and I can talk about the technology here.

Scott: I believe that the application fee with FINRA is $2700.

When you are breaking out what your costs are going to be I think your largest cost that you will have to consider is your technology provider and your legal provider. 

George and I have generally structured our conversation on a flat fee basis and we’ve done it in that way because we find it is helpful to the clients to be able to reach to both of us on kind of an unlimited basis as they are learning the ropes on what it means to be gatekeeper and what  obligations and responsibilities they will have with respect to that.

Again ,I mean, one of the things that George and I emphasize is, when we represent people in this space is that you know you are becoming a regulated entity and there are expectations that you, just like a broker-dealer, need to take steps that will protect investors. What we have done in the past is, we've worked out flat fees for our clients in order to spend the requisite amount of time with them to explain what they are required to do. That way they are able to meet the regulatory requirements when they launch.

George:  Let me go through education. It’s educating and sharing our experience or knowledge and best practices in the industry so I’ve been involved in crowdfunding really since the JOBS Act was just making its way through congress, really since inception. I

have been working on the adopting regulations with the SEC, FINRA and industry associations on developing best practices and fashioning this new industry with our clients. I think that in between our two firms we probably registered eight or nine portals so we went through the process many, many times and represented most of the major registered portals out there.

Throughout the years we’ve really learned a lot of different best practices and also nuances in the rules that are not always readily apparent.  Through the registration process in developing the portal it’s sharing our experiences, Scott as a formal regulator as well, on what are the best practices and how as gatekeepers portal sponsors should be monitoring what’s going on in their portal.

It is really the first line of defense against non-compliant offerings, fraudulent offerings or unsavory characters from accessing the capital markets.

Katipult: From a technology point of view, of course there are different ways this can be done, and it all goes into what needs you have outside of what the regulations require. So basically, what do we need to have and what would you like to have? But the actual process was like a membership and it was $2700, was that correct?

Scott: Yes, I believe that is correct. If you don’t get approved right away there are additional hurdles. For example, if your membership application doesn’t meet standards there are ways to get some of your funds refunded, but ultimately this will end up costing you more money to get through the approval process. I believe the cost is $2700 to go through this registration process.

Katipult: With most things it actually pays to be really prepared before you move into something like this. Of course, speaking of your time, the better prepared the client is, the faster you can do it. If you don’t have your branding ready for your platform, for example, it takes longer to get up your designs up and running.

Scott: We keep hitting the same point but I think it’s the most critical one and that is to spend the time you need up front before you actually file your application to become a member with FINRA.

What we’ve seen is that the federal review process has changed over time and it’s changed in part because FINRA reacted to regulatory issues that has seen out in space. There is a well publicized case dating a year or so back, where FINRA actually expelled a funding portal for not complying with the federal rules which I would essentially boil down to: it didn’t act as a gatekeeper.

That has led the membership process to be a little more detailed and intense in order that FINRA is comfortable that the applicants who become FINRA members are capable of complying with federal securities laws and will take steps to protect investors.

Katipult: It’s a lot of useful information we are getting here. One thing I would like to notice is that there are some limits of how much capital you can raise and what are the benefits to having these limits? Of course you are protecting the investors but you are also maybe ruling out others, but maybe that is going into accredited versus non-accredited investor?

Scott:That’s the big issue. When you think about raising capital and private offerings, traditionally you were always targeting the accredited investor and what the JOBS Act provided were two avenues in which you could actually raise capital from non-accredited investors.

One is a Regulation A and the other one is Regulation Crowdfunding.

Focusing on Regulation Crowdfunding, we are talking about capital raises for companies that are relatively high risk. The regulatory concern has always been, when imposing certain limits on how much capital can be raised from an individual, that somebody will invest more money than they are capable of losing. So you do have limitations on how much an individual may invest for a securities offer and under Regulation Crowdfunding.

The other limitation that you are correct on is that there is a limitation that a company during a 12 month period can only raise up to $1 070 000. There have been a lot of efforts to increase that because I think that number increased, the space becomes that more attractive.

There have been various proposals going back a year or two, I think the most recent one I heard was raising the limits to $5 000 000, which makes it much more attractive if you have the ability for an issuer who needs capital, and that’s the idea behind all of this, to help a small issuer raise capital and become successful.  If you have an issuer who could raise $5 000 000 on a Regulation CF, it just is an excellent way for them to get there, get their hands on the capital they need to make their business successful.

Katipult: Yes, I agree. You said that the current limit is $1 070 000?

Scott: That is right.

Katipult:   That is a bit of an odd number?

Scott:  It was initially $1 000 000 but it was increased very slightly.

Katipult:  Well, it’s progress.

Scott:Yes, it is incremental… We are also seeing hybrid offerings where some using crowdfunding, where in initial phase possibly doing dual offerings, one to write the offering and one to write the CF offering, allowing accredited investors to go into the right offering which allows you to raise an unlimited amount, but only to accredited investors.

We see others using crowdfunding potentially as a stepping stone to doing a Reg A. first round onto financing onto larger rounds so I think there are some interesting ways of using crowdfunding on the issuer side.

Keep in mind that there are restrictions on the crowdfunding portal side and that is important to discuss with your legal council. Crowdfunding portal has several restrictions which is important for the management to understand and it is built into your written supervisor procedure, such as limitations on marketing and solicitation and all of that is going to be included in your WSPs and built into the technology.

Katipult: Occasionally I am talking to prospects and I think that because they don’t really know what they want to do, they want to do everything. Whatever they can get their hands on, they just want to do that on a platform. I usually suggest to them to pick a direction and go that way, but these are multi jurisdiction platforms or multi regulation platforms. Is that you can recommend or do you actually recommend like me to just focus on one thing and when you get some traction and success then you could expand your business model as well?

Scott: It really depends on the business, we worked with clients who have tried to take more limited technology role, just to get their feet wet and understand how they fit into the marketplace. Keep in mind that if you are not registered broker-dealer or a registered crowdfunding portal, your role is very limited.

It is important to have a very meaningful conversation with experienced securities lawyer about what you can and can’t do, simply because if a very broad definition of what a broker or a broker-dealer is. There is no action guidance that’s available on case law dating dating back 8 years which can give guidance on what a fintech platform can do when involved in the offer and sale of securities.

Scaling up to a crowdfunding portal where you can now do a little bit more in terms of executing these transactions, but keep in mind a crowdfunding portal can’t solicit the sale of securities, cannot provide investment advice, cannot provide recommendations to invest and that is the key when you are looking at the disclosure on the platform, the marketing material to ensure that you haven’t crossed the line and that your marketing material isn’t actually a solicitation or recommendation or investment advice.

Now the next state would be a stage of becoming a fully registered broker-dealer, which gives you a lot more abilities to recommend and solicit. It is just much more advanced vehicle, but there are much more compliance obligations that go with it. It is very different than a crowdfunding portal.

Katipult: From a technology point of view, the Katipult system can actually achieve that, as we have a segmentation engine where we can go and set rules and filters for whatever users that are signing up and what categories they are being put into and then apply those rules to certain offerings and that will go back to the users so can they actually see this offering or not and do we have certain investment limits in this offering or not. So, it’s not something that technology can’t do. You need to go in one direction and get your feet wet first and then see where it takes you.

One thing I would like to make clear is that when you apply for this license, you may have the technology but you’ve gone through the actual process now, you have deals that you were waiting to put on the platform, really just trying to get approved as fast as possible. Would you be actually able to do anything on the platform before you get registered? Maybe not for yield purposes but for marketing purposes, or can you actually go live before you are registered?        

Scott: We would recommend against that. The securities laws in the U.S. are all predicated on the disclosure of all material facts.

When you are going through the process , FINRA’s regulators make the assessment that the portal is making all the legal requirements before it becomes accepted as a FINRA member and permitted to engage in general portal business.

So our general recommendation is that, when you are going through the application process you shouldn’t be engaging in any types of business that requires federal membership until you actually receive that FINRA membership. It is just better to be cautious and wait, get the approval and then start the business at that point in time.

Katipult: OK, so make sure you have everything in order before you start doing any business. That’s pretty good. Is there anything you want to share with our listeners for today’s webinar? Anything about Title III that you think everyone should know before they start something and start planning their business.

Scott: There is a lot of novel, new rules enabling capital formation in the U.S.. Regulation crowdfunding is certainly one of them. Now you are not limited to seeking investment from the accredited investor. Now non-accredited investors can also participate.

Again, there are limitations on how much they are permitted to invest in a calendar year, but they are now able to participate which is very new and very revolutionary in the United States. This enables everybody to get involved in new offerings and poses a lot of opportunity for this sector to grow.

Hopefully we will see some legislation that increasing the investment limits which will continue to make this a more attractive space.

Katipult: Maybe a bit of a random question, everybody now is watching Bitcoin, ICOs and the similar, so would you be able to use the cryptocurrency to invest in or with a Title III platform?

Scott: Cryptocurrencies have been a lot in the news. There have been some very strong statements made by the chairman of the Securities Exchange Commission about views with respect to cryptocurrencies being securities and thus being subject to securities laws.

When you look at this question fundamentally, once you reach the conclusion that this cryptocurrency or token is a security, then it opens up a host of different securities laws that are applicable. For example, if it is a token and suddenly it’s placed on some sort of internet platform where somebody from one country could trade it to somebody in another country, or the same country, it doesn’t really matter, if that touches the U.S. and it’s a security, it would require that the exchange be regulated and registered as an exchange in the United States.

It raises other issues as to whether people who are involved in facilitating the sale of these cryptocurrency transactions, whether they are acting as broker-dealers, in which case it would require broker-dealer licensing. Usually a predicate question when you are looking at this issue is whether anybody is receiving what’s known as transaction based compensation or commissions.

One of the benefits of being in a Title III funding portal is that you are able to receive transaction based compensation or a percentage of the amount raised. That is the benefit of being a licensed broker-dealer or a funding portal in the United States. Anybody who doesn’t have those licenses but is putting investment transactions together and receiving transaction based compensation should probably speak to a lawyer because they are probably violating the federal security laws by not complying with a Section 15 of the Exchange Act, requiring broker-dealer registration.

We have seen a lot of people and lot of money being raised both in the U.S. and offshore and securities regulators around the world reacted to this one way or the other. My comment on this is, what is happening in the U.S. is no surprise. You don’t have to be practicing securities law for a lengthy period of time to understand that when you are soliciting investments and one of the chief motivations of people to participate in the investment is that the token or the cryptocurrency is going to increase in value, you are not far from this being a securities transaction, so what is going to happen now with respect to this and the continuation of cryptocurrency offerings in the U.S. is they are going to have to comply with the federal securities laws or they risk being subject of investigation by the Securities and Exchange Commission.

That benefits Title III, Title II and Title IV because I think that people who want to raise capital in ICO or cryptocurrency type offerings and who wants to be in compliance with federal securities laws will look at these titles in the JOBS Act to see if any of these particular Titles work for them in order to structure a compliant offering. I mean an offering that complies with the federal securities laws.

Katipult: So essentially, if you want to do it, stick to the rules that are already there.

George: We are living a really exciting time now in capital markets. We are seeing a convergence of blockchain and different type of technologies, what’s being built on blockchain they used for virtual currencies, cryptocurrencies, coins, tokens, so we are seeing a very unique kind of development merging with the legal reforms that we saw in 2012, which themselves were historic, changing 80 years worth of legislation common practices in our capital markets.

As a crowdfunding portal, as Scott noted earlier, once you become a member of the capital markets you have certain responsibilities as a gatekeeper as an intermediary to these transactions, so whenever you are confronted with any type of offering it is imperative that you ensure that one, it complies with regulation crowdfunding and the issuer can use the exemption, and two, that you have taken measures to ensure that obvious cases of fraud are not allowed to slip by and enter capital markets.

As Scott noted there are other regulatory issues that need to be evaluated so I think that it is important for crowdfunding portals just like broker-dealers lawyers and other intermediaries in the capital markets to meaningfully evaluate these transactions and counsel whether their issuers or their clients on the whole host of regulations that apply to these transactions. Although we appreciate the enthusiasm on how we are seeing the capital markets evolve using this type of technology, it is still very important that there is a meaningful evaluation of what everyone’s responsibilities are to make sure we meet the goals of our regulatory system of transparency and investor protection.

Katipult: Yes, that makes perfect sense. I saw a Linkedin post a few days ago where the name ICO has a really negative ring to it, and I think the new term was STO, security token offer, but they should be the same I think.

Scott: People are calling it different things and proposing models to do the offerings that comply with the securities laws. It is really nothing new, there is 89 years of case law detailing what is a security.

As George mentioned, there have been a lot of positive changes to the securities laws in the last few years and what we need to do is we need to explore how this new technology blockchain, which is phenomenal as it has a lot of potential and billions of dollars are being invested in it, is developing.

It is critical that there is compliance with the federal securities laws and if there are issues the SEC will review them and make an assessment as to whether there needs to be additional guidance provided to issuers or investors with respect to these offerings.

Katipult: Any last thoughts, anything you want to share before folks say goodbye to the listeners?

George: Just want to thank you for your time. Scott and I together with Katipult put together a quick blog, I think it is posted on your website, that highlight nuances of regulation crowdfunding and things to think about when you are developing your platform, submitting your application, along with common pitfalls and best practices. It is just a high level highlight that I suggest people to have a look at if they are interested in forming a crowdfunding portal. We are always delighted to take any questions or comments.