How to Distinguish Funding Portals from Broker-Dealers
The JOBS Act distinguishes between two types of crowdfund investment platforms: online funding portals and broker-dealers. Here’s why: Prior to the legalization of crowdfund investing, anyone seeking to raise capital needed to do so under the guidance of a broker-dealer.
Broker-dealers are individuals or businesses registered with agencies including the Financial Industry Regulatory Authority (FINRA) and North American Securities Administrators Association (NASAA). Broker-dealers pay compliance and oversight costs that can exceed $100,000 each year, and they pass such costs on to consumers in every transaction.
This situation isn’t so bad when a broker-dealer is handling very large and complex offerings because prudent oversight does prevent fraud. However, these compliance and oversight costs are the same for a $10,000 offering as for a $100 million offering.
For this reason, most broker-dealers won’t bother with capital raises of less than $1 million; working with smaller amounts doesn’t make financial sense based on their cost structures because they can’t pass on all the associated costs in small deals.
That’s where online funding portals come in. The JOBS Act allows such portals to support smaller capital raises without being able to perform all the duties that a broker-dealer performs. For example, a funding platform isn’t allowed to analyze a business opportunity, conduct business valuation, or find investors — duties that cost a lot of money.
Allowing funding portals to exist, and offering their use to small businesses and entrepreneurs that don’t necessarily require the full-service package that a broker-dealer provides, creates a simpler cost structure with lower fees associated with an equity investment offering.
A funding portal doesn’t have to register as a broker-dealer as long as it doesn’t perform any of these duties:
Offer investment advice or recommendations
Find investors on behalf of the issuer
Compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal
Hold, manage, possess, or otherwise handle investor funds or securities
Engage in any other activities that the SEC determines to be inappropriate
If the online platform just lists an entrepreneur’s or company’s pitch, uses a third party to manage the transfer of both cash and stock, and offers general support services that don’t fall into these categories of activities, it can register as a crowdfund investment portal. If it conducts any of these activities, it must register as a full broker-dealer.