One of the most heavily covered and debated-about sections of the JOBS Act is the crowdfunding exemption. The Act creates a new exemption under Section 4 of the Securities Act of 1933 through which certain crowdfunded securities issuances need not be fully registered with the Securities and Exchange Commission. Much has been written about the potential benefits that small issuers (and the American economy) will reap as well as about concerns that fraudulent internet securities offerings will reach a wide range of retail investors. Part of the success or failure of the exemption, however, depends on the strength of crowdfunding intermediaries known as “funding portals,” not just the underlying issuers.
New Section 3(a) of the Securities Exchange Act of 1934 defines the term “funding portal” as a “person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to [the crowdfunding exemption].” Importantly, the definition includes a list of five activities that a funding portal is prohibited from engaging in. The first one is “offer[ing] investment advice or recommendations.”
This prohibition is ostensibly attempting to distinguish, on the one hand, investment advisers and broker-dealers from funding portals on the other. The tension with this practical attempt at fencing off various intermediaries appears when you look at crowdfunding platforms not engaged in the offer or sale of securities. Kickstarter, one of the major crowdfunding websites, helps potential lenders link up with, among others, video game makers, authors, and fashion designers. One of the creative ways in which Kickstarter (and others) helps make these connections is to highlight certain projects; any visitor to the website can browse “Staff Picks” where they can find out, for example, how to buy into a San Francisco retail store’s plan to construct a “parklet” outside of its shop.
Would a funding portal that uses the same crowdfunding technology of its non-securities counterparts, be allowed to provide “staff picks” or “recommended companies” on its website? The success or failure of the crowdfunding model will depend heavily on funding portals being able to connect investors with companies who could use their capital. Those connections will be made far stronger if funding portals attain clear guidance on what is and is not “investment advice or recommendations.” The Securities and Exchange Commission should provide greater clarity on this issue through rulemaking so that funding portals know in advance (to the extent possible) how best to manage their communications with investors. While crowdfunding has been a darling in the world of e-commerce, the platform must fit itself into the constraints of US securities law. While the recommendation issue is but one factor that will play into the success of the crowdfunding exemption, it will be an important one to follow as crowdfunding makes the transition to securities.