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SEC Approves FINRA's Proposed Crowdfunding Portal Rules
Practical Law Legal Update w-001-3873 (Approx. 5 pages)
SEC Approves FINRA's Proposed Crowdfunding Portal Rules
by Practical Law Corporate & Securities
| Published on 26 Jan 2016 • USA (National/Federal) |
The SEC approved FINRA's proposed rules and forms on SEC-registered crowdfunding portals.
On January 22, 2016, the SEC issued an order approving FINRA's proposed rules (Funding Portal Rules) and forms that, once effective, will govern funding portals operating under the crowdfunding provisions of the JOBS Act.
Title III of the JOBS Act amended the Securities Act by adding a new registration exemption (Section 4(a)(6)) for crowdfunding offerings. In October 2015, the SEC adopted Regulation Crowdfunding, which establishes final rules and forms implementing the crowdfunding exemption. The exemption is intended to allow capital raising from a large number of people, including non-accredited investors, in relatively small amounts using the internet and social media. To learn more about Title III of the JOBS Act, see Practice Note, Crowdfunding Offerings Under Section 4(a)(6).
To qualify for the exemption, crowdfunding offerings must be made either through a broker or a funding portal that is registered with the SEC for this purpose and complies with a set of conditions, including that it is a member of a registered national securities association. Currently, FINRA is the only registered national securities association.
The approved Funding Portal Rules are summarized below.
General Standards
Funding Portal Rule 100 will provide that all funding portal members (which includes both funding portals and their associated persons) will be subject to FINRA's by-laws, unless the situation requires otherwise, and the Funding Portal Rules. The rule also provides basic definitions that have been modified from the broker-dealer definitions to apply to funding portal members.
Funding Portal Application
Funding Portal Rule 110 sets out the membership application process for funding portals, which is based on the current NASD Rule Series membership rules for broker-dealers. Because the scope of activity of funding portals is limited, the Funding Portal Rules tailor the NASD Rule 1010 Series by:
- Shortening the time frames for key events. For example, the time frame for receiving a decision on a funding portal application will be 60 days after the application is filed (as opposed to 180 days under the broker-dealer rules).
- Streamlining and consolidating the standards for granting or denying an application. Five standards will address a funding portal's:
- ability to comply with applicable federal securities laws, rules and regulations and the Funding Portal Rules;
- contractual or other arrangements and business relationships necessary to initiate operations;
- supervisory system;
- direct and indirect funding sources; and
- recordkeeping system.
- Providing that the membership interview may take place by video conference (or any other way specified by FINRA).
- Streamlining the process for appealing a decision by:
- reducing filing and response time frames from 25 days for broker-dealers to 14 days for funding portals; and
- eliminating provisions requiring an appellate hearing.
- Narrowing the scope of changes in control and ownership that would require an application for approval of the change.
- Identifying events and timing that would cause a pending application to lapse.
Funding portals will be required to apply for membership using proposed Form FP-NMA and to apply for approval of a change in control and ownership using Form FP-CMA. Statutory disqualification information will be submitted using the FP-SD Schedule.
Funding Portal Conduct
The Funding Portal Rules will:
- Require a funding portal member to observe high standards of commercial honor and just and equitable principles of trade when conducting its business (Funding Portal Rule 200(a)). This rule is based largely on FINRA Rule 2010.
- Prohibit a funding portal member from effecting any transaction in, or inducing the purchase or sale of, any security by means of, or by aiding or abetting, any manipulative, deceptive or other fraudulent device or contrivance (Funding Portal Rule 200(b)). This rule is based largely on FINRA Rule 2020.
- Prohibit false and misleading statements (Funding Portal Rule 200(c)). This rule is based largely on FINRA Rule 2210.
Funding Portal Compliance
The Funding Portal Rules will require funding portal members to:
- Establish and maintain a system to supervise the activities of all associated persons of the funding portal member (Funding Portal Rule 300(a)). The rule, which is a streamlined version of FINRA Rule 3110, requires systems to be reasonably designed to achieve compliance with applicable securities laws and regulations, and with the Funding Portal Rules. The rule is designed to give flexibility to funding portal members to tailor their supervisory system to their business model.
- Report to FINRA regulatory proceedings and disciplinary and other events of the funding portal member and of any of its associated persons (Funding Portal Rule 300(c)). The rule is largely based on current FINRA Rule 4530. These events will be reported on the Funding Portal Rule 300(c) Form.
- Report, and promptly update, all contact information required by FINRA through means specified by FINRA.
Investigations and Sanctions
Funding Portal Rule 800(a) will subject funding portal members to the FINRA Rule 8000 Series (Investigations and Sanctions), unless the situation requires otherwise. Among other things, the rule provides that:
- FINRA must make publicly available information filed by funding portal members that are currently or were previously registered with FINRA. Except as otherwise provided by the rules, FINRA must make available information contained in the funding portal's most recent SEC registration forms.
- FINRA must make available any information filed by a funding portal member indicating whether the member or any of its associated persons is subject to a statutory disqualification.
Code of Procedure
Funding Portal Rule 900 will subject funding portal members to the FINRA Rule 9000 Series (Code of Procedure), unless the situation requires otherwise. Among other things, the rules set out procedures for:
- A person to become or remain associated with a funding portal member despite being subject to a statutory disqualification.
- A funding portal member or associated person to receive relief from the eligibility or qualification requirements of FINRA's by-laws or the Funding Portal Rules.
Funding Portal Rule 900 better aligns with existing provisions for FINRA broker-dealer members.
Arbitration and Mediation
Funding Portal Rule 1200(a) will subject funding portal members to the FINRA Rule 12000 Series (Code of Arbitration Procedure for Customer Disputes), the FINRA Rule 13000 Series (Code of Arbitration Procedure for Industry Disputes) and the FINRA Rule 14000 Series (Code of Mediation Procedure), unless the situation requires otherwise. The rule is a streamlined version of current FINRA Rule 2268.
Notifications to FINRA
New FINRA Rule 4518 contemplates that FINRA registered broker members may intend to act as intermediaries in crowdfunding transactions. The rule will require FINRA members to notify FINRA:
- Before engaging for the first time in an offer or sale of securities in reliance on Section 4(a)(6) of the Securities Act.
- Within 30 days of gaining control of, becoming controlled by, or coming under common control with, a funding portal.
Effectiveness
FINRA will announce the effective date of the rule change in a regulatory notice no later than 90 days following the SEC's approval. FINRA intends for the effective date to be no later than 365 days after SEC approval.
In addition, the SEC is accepting comments on Amendment No. 1 of the proposed rule change, which FINRA filed with the SEC on January 21, 2016. The amendment makes certain definitional and technical changes to FINRA's original proposal. The SEC will accept comments on Amendment No. 1 until February 18, 2016.