Why the Jobs Act Broker-Dealer Exception Doesn’t Matter (Much)

US CApitol Building Illuminated at Night

Under section 201(c) of the JOBS Act, an electronic platform is not required to register as a broker-dealer solely because the platform offers securities under Title II, co-invests in the securities, or provides due diligence services or standardized documents. That’s good.

What Congress giveth, however, Congress can taketh away. The exemption from broker-dealer registration is not available if:

  • The platform or anyone associated with the platform receives compensation in connection with the purchase or sale of securities; OR
  • The platform helps to negotiate deals; OR
  • The platform requires issuers to use its standardized documents; OR
  • The platform is separately compensated for giving investment advice; OR
  • The platform or anyone associated with the platform takes possession of investor funds or securities; OR
  • The platform or anyone associated with the platform is disqualified under the “bad actor” rules.

Theoretically, the JOBS Act broker-dealer exemption paved the way for Crowdfunding platforms to sell securities free from the constraints of Depression-era securities laws. In practice, however, platforms have found it very difficult, almost impossible, to build a profitable business around the exemption because of all the gaps in the exemption and the list of things you can’t do.

For example:

  • To claim the exemption, a platform may not receive any compensation in connection with the purchase or sale of securities. That doesn’t just mean “transaction-based compensation” like commissions, it means any compensation. If the platform receives a carried interest or promote, for example, the exemption disappears.
  • From a business perspective it makes sense for the platform to employ an investor-relations specialist, someone to reach out to prospective investors. But if that person receives any compensation, even a salary, the exemption disappears.
  • Suppose the platform organizes a special-purpose entity for its investors and negotiates the terms of the deal with the issuer. Buzz! The exemption disappears.
  • The exemption doesn’t even apply to employees of the platform. If they engage in activities that are not protected by SEC Rule 3a4-1, they themselves could be required to register as broker-dealers.
  • Even if you qualify for the Federal exemption, it doesn’t mean you’re exempt from state broker-dealer registration.

Here’s how the SEC answered a question about the scope of the exemption:

QUESTION

May an entity, such as a venture capital fund or its adviser, operate an Internet website where it lists offerings of securities by potential portfolio companies (in compliance with Rule 506), co-invest in those securities with other investors, and provide standardized documents for use by issuers and investors, rely on Securities Act Section 4(b) to not register as a broker-dealer?

ANSWER

Yes. These activities are permitted under Section 4(b), subject to the conditions set forth in Section 4(b)(2), including the prohibition on receiving compensation in connection with the purchase or sale of securities. As a practical matter, we believe that the prohibition on compensation makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker-dealer registration.

That’s pretty clear.

Now, the fact that a platform doesn’t qualify for the JOBS Act exemption doesn’t automatically mean the platform has to register as a broker-dealer. Whether the platform has to register as a broker-dealer would be tested under the body of laws stretching back 80 years. My point is that the JOBS Act exemption itself will be irrelevant for most platforms.

As someone once said, Crowdfunding is nothing more or less than the Internet come to the capital formation industry. Crowdfunding platforms sit astride the Internet pipeline directly connecting entrepreneurs with investors. Matching buyer to seller, they function as “brokers” in the most fundamental sense of the word.

In this sense, changing the business practices of a Crowdfunding platform to comply with the JOBS Act broker-dealer exemption is like pounding a round peg into a square hole. Pound long and hard enough and it’s possible. But it’s far better to run the platform business the way you want to run it, i.e., to make the most money. If you have to register as or affiliate with a broker-dealer, just do it.

Questions? Contact Mark Roderick.

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3 thoughts on “Why the Jobs Act Broker-Dealer Exception Doesn’t Matter (Much)

  1. Sara Hanks March 2, 2015 at 6:15 pm Reply

    Some good points there, Mark. There seem to be some platforms that think they are relying on this very limited exemption from b/d registration, when they really can’t.

    Sara

  2. Roland Wiederaenders May 20, 2016 at 9:28 pm Reply

    With respect to the definition of “ancillary services”, why does the statute say “for separate compensation, investment advice”? Does that mean that you could provide investment advice as long as it’s not for separate compensation? I know that strains credulity a little, but why was “for separate compensation” included there? I represent a client who wants to provide a platform, and provide primarily administrative services. Inevitably, those services could be classified as the rendering of investment advice under a broad construction of that term, which can include services that are more administrative in nature (preparing due diligence reports, for example).

    • crowdfundattny May 20, 2016 at 10:20 pm Reply

      I think the point of the language is exactly what you think it is, i.e., you can give some investment-related advice without losing the exemption. But that, like the rest of the exemption, is really nothing new. The same would be true under the law as it existed before the JOBS Act.

      More generally, as the blog post warns, be careful about relying on the exemption. Chances are your client will end up doing more than the exemption allows. The good news is that your client might still be exempt from broker-dealer registration under existing law.

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