Tag Archives: Crowdfunding Portals

Are Crowdfunding Portals Investment Advisers?

Looking for the solution of the mazeInvestment advisers are regulated by the Investment Advisers Act of 1940 – another of those old laws that govern today’s securities markets – and by also by the states. Do these laws apply to Crowdfunding portals?

It depends.

The IAA generally applies to anyone who:

  • “[E]ngage[s] in the business of advising others. . . .as to the value of securities or as to the advisability of investing in securities. . . .” or
  • “[I]ssues or promulgates analyses or reports concerning securities.”

On the other hand, the IAA generally does not apply to “the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation,” a term broad enough to include websites.

Not surprisingly, neither the SEC nor any court has yet applied those definitions to a Crowdfunding portal. The best sources of information are no-action letters issued by the SEC to electronic “matching” services and a handful of court decisions. Under these authorities:

  • A portal that merely posts investment opportunities using information provided by the issuer is probably not an investment adviser.
  • A portal that explains why every investor should have a portion of her portfolio in real estate, or in startups, is moving toward investment adviser territory.
  • A portal that advertises its industry experience and its expertise in “vetting” deals is moving toward investment adviser territory.
  • A portal that assigns ratings to investment opportunities or otherwise provides investors with the tools to select one opportunity over another is very close to the line.
  • A portal that seeks to match an investor’s personal investment preferences to opportunities on the site is an investment adviser.
  • A portal that collects money from investors and uses its own discretion in selecting investment opportunities is an investment advisor.

A portal that doesn’t want to register as an investment adviser faces a dilemma: no matter how many disclaimers the portal posts on its site, users might view the portal as an investment adviser anyway. For example, a user might decide to invest $5,000 in every deal listed by Fundrise and Patch of Land, believing she’s creating her own Fundrise and Patch of Land “mutual funds” and leaving it to her “advisers” at the portals to select individual securities. On one hand, you spend every hour of every day developing a brand that’s based on finding great deals for your registered users. On the other hand, the more successful your brand the more you look like an investment adviser.

Why not just bite the bullet and register as an investment adviser? Three primary reasons:

  • Paperwork and Cost. Unsurprisingly, investment advisers are subject to lots of regulation and oversight. It’s nothing like registering as a broker-dealer, but it’s plenty cumbersome.
  • Additional Liability. An investment adviser owes statutory and fiduciary duties to its clients.
  • Disruption of Business Model. A Crowdfunding portal that is also an investment adviser might not be able to operate the way it wants to operate. For example, an investment adviser registered with the SEC generally may not receive compensation in the form of a carried interest. 

I believe the future of Crowdfunding involves pools of assets rather than individual assets. Many portals have already moved in that direction. On FundersClub, for example, investors can choose to invest in funds that select individual securities after the fact, agnostic as to industry, i.e., a Crowdfunded venture capital fund.

Once a portal takes that step – accepting investor dollars and deciding how to invest them – the portal has stepped decisively across the line into investment adviser territory. Ideally you take that step rationally, having decided that the benefits, meaning primarily the ability to attract additional capital, outweigh the costs.

Questions? Contact Mark Roderick.

Why Delaware?

Why are most Crowdfunding entities formed in Delaware? Two reasons.

First, Delaware has very good business laws and a very good system for adjudicating business disputes. Here’s what I mean:

  • Delaware’s business laws – and by that I mean the laws governing limited liability companies and corporations – are very flexible. In the hands of a capable corporate lawyer, Delaware’s laws can be used to do just about anything you want to do, i.e., can implement just about any business deal.Delaware_CF State
  • For better or worse, Delaware’s laws are tilted in favor of management. That means those running the show – and those running the show pick where the entity is incorporated – can get more or less what they want. As an example, Delaware allows the manager of a limited liability company to disclaim all fiduciary responsibilities to the members. Most states do not.
  • Delaware has a whole court system devoted to adjudicating disputes among business entities and their owners and managers. In most states, the judge hearing a business dispute in the morning is hearing auto accident cases all afternoon and is probably a former personal injury lawyer herself. First among the country’s business-only courts, Delaware’s Court of Chancery enjoys a deserved reputation for professionalism.

Second, because Delaware entities are used so widely, lawyers across the country are familiar with Delaware law. If two real estate investments are offered on a Crowdfunding portal, one incorporated under Delaware law and the other incorporated under Missouri law, the Delaware company has a head start in attracting investors solely on the basis of familiarity, at least outside Missouri.

There is one important exception. Under Federal Rule 147, an entity raising money through the intrastate Crowdfunding exemption of State X must be incorporated in State X, not in Delaware.

Questions? Contact Mark Roderick.

Crowdfunding and the Trust Indenture Act of 1939

Handing over moneyThe Securities Act of 1933. The Exchange Act of 1934. The Investment Company Act of 1940. Those are the pillars of the U.S. securities laws, as relevant today as they were 80 years ago. And here’s one more old law relevant to Crowdfunding: the Trust Indenture Act of 1939.

Here’s the idea. A company issues its promissory notes (obligations) to a large group of investors. If the company defaults on one or two notes, it might not be financially feasible for those particular investors to take legal action. Even if the company defaults on all the notes it will be a mess sorting out the competing claims. Which investor goes first? If there is collateral, which investor has priority? At best it’s highly inefficient, economically.

The Trust Indenture Act of 1939 imposes order and economic efficiency. It provides that where a company issues debt securities, like promissory notes, it must do so pursuant to a legal document called an “indenture” and, most important, with a trustee, normally a bank, to represent the interests of all the investors together. The TIA goes farther:

  • It provides that the indenture document must be reviewed and approved by the SEC in advance.
  • It ensures that the trustee is independent of the issuer.
  • It requires certain information to be provided to investors.
  • It prohibits the trustee from limiting its own liability.

Why don’t Patch of Land and other Crowdfunding portals that issue debt securities comply with the TIA? Because offerings under Rule 506 are not generally covered by the law. Conversely, because Lending Club and Prosper sell publicly-registered securities (their “platform notes”), they are covered, and have filed lengthy indenture documents with the SEC.

The real surprise is with Regulation A+. If a Regulation A+ issuer uses an indenture instrument to protect the interests of investors then it will be subject to the TIA and its extensive investor-protection requirements. If the issuer does not use an indenture, on the other hand hand, it will not be subject to the TIA as long as it has outstanding less than $50 million of debt. That’s a strange result – giving issuers an incentive not to use an indenture even though indentures protect investors.

That’s what happens sometimes when you apply very old laws to very new forms of economic activity. Welcome to Crowdfunding.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

INTEGRATION OF REGULATION A+ OFFERINGS WITH OTHER OFFERINGS

Yesterday I spoke about Regulation A+ on a panel at the National Press Club in Washington, D.C. One topic was whether offerings under Regulation A+ would be “integrated” with other offerings, including offerings under Title II.

The word “integration” describes a legal concept in U.S. securities laws, where two offerings that the issuer intends to keep separate are treated as one offering instead. For example, I raise $1 million in an offering under Rule 506(b), where I admit 19 non-accredited investors. Needing more money, I start another offering under Rule 506(b) a month later – and for the same project – and admit 23 more non-accredited investors. Wrong! The SEC says those two offerings are “integrated” and now I’ve exceeded the limit of 35 non-accredited investors.growth captial summit

Today, entrepreneurs can raise money under Title II Crowdfunding only from accredited investors. Under Regulation A+ they’ll be able to raise money from non-accredited investors as well, vastly expanding the potential investor base. Unlike a Title II offering, however, where accredited investors can invest an unlimited amount, an investor in a Regulation A+ offering, accredited or non-accredited, will be limited to investing 10% of his or her income or net worth.

The question naturally arises, why not do a Regulation A+ offering for non-accredited investors while at the same time doing a Title II offering for accredited investors, thus maximizing the amount raised from everyone?

The answer, unfortunately, is integration. The two offerings would be treated as one, and they would both fail as a result.

But along with that bad news, the integration rules under the proposed-but-not-adopted Regulation A+ regulations offer good news as well:

  • A Regulation A+ offering will not be integrated with an offering that came first. Thus, I can raise money in a Title II offering, accepting an unlimited amount from accredited investors, and the day after that offering ends conduct a Regulation A+ offering for non-accredited investors.
  • A Regulation A+ offering will not be integrated with an offering to foreign investors under Regulation S. The two can happen simultaneously.
  • A Regulation A+ offering will not be integrated with an offering that begins more than six months after the Regulation A+ offering ends.
  • A Regulation A+ offering will not be integrated with a Title III offering, even if they happen at the same time.

Another takeaway from the conference is that the SEC plans to finalize the proposed regulations under Regulation A+ by the end of the year (this year). Issuers and portals, get ready.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

CFGE CROWDFUND BANKING AND LENDING SUMMIT IN SAN FRANCISCO

Roderick CFGE

Since Labor Day, I’ve spoken at half a dozen events: for entrepreneurs, for intellectual property lawyers, for finance professionals, for digital marketing groups. This week I’ll be speaking at one of the premier Crowdfunding events in country, the CFGE Crowdfund Banking and Lending Summit on the 16th and 17th in San Francisco.

The conference features some of the leaders in the industry, including:

  • Richard Swart, Director of Research for Innovation in Entrepreneur and Social Finance, Colman Fung Institute for Engineering Leadership at UC Berkeley.
  • Ron Suber, the President of Prosper.
  • Jason Fritton, the Founder and CEO of Patch of Land.
  • Tom Lockard, the Vice President for Real Estate Investment and Institutional Sales of Fundrise.
  • Nikul Patel, the Chief Lending Officer of LendingTree.
  • Jesse Clem, the Co-Founder of LOQUIDITY, LLC.
  • Joy Schoffler, the CEO of Leverage PR.

Whether you’re new to Crowdfunding or an industry veteran, I’d strongly suggest you attend. I’m always amazed how much more there is to learn.

To register, click here. Make sure to use my promo code and receive a 25% discount! Promo code: Roderick

And while you’re there, please stop by and say hello. Crowdfunding and skiing – those are my two favorite topics.

NEW DOMAIN EXTENSIONS BECOME AVAILABLE

Crowdfunding Image - XXXL - iStock_000037694192XXXLargeWe started with .COM. Then .NET, .EDU, .INFO, .ORG, and a handful of others. But we’re about to be flooded with new domain extensions, more than a thousand of them.

In the world of finance, we’re going to have .BANK, .BROKER, .CAPITAL, .FUND, .INVESTMENTS, and .FINANCE. In the world of food we’re about to have .FOOD, .EAT, .GROCERY and .KITCHEN. You get the idea.

The flood of new extensions offers opportunity and challenge. Maybe the .FUND extension would work great for your new Crowdfunding portal. On the other hand, maybe you’re already using portal.com and now you have to worry about a competitor using portal.fund (Hint: a different domain extension doesn’t give a competitor the right to violate your trademark).

Some of the new extensions are already available, while the rest are coming soon. For a complete list and to register, go to a registrar website such as www.Godaddy.com.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

CHOOSING AND PROTECTING A NAME FOR YOUR CROWDFUNDING BUSINESS

Names matter, even for a local business, but they matter a great deal for a Crowdfunding business, where your customers know you only from a distance.

Generally speaking you can choose three kinds of names:

  • A name that describes what you do, e.g., Real Estate Crowdfunding Portal, LLC.
  • A name with no inherent meaning, e.g., Xeta, LLC.
  • A name somewhere in between, e.g., Lifelong Investments, LLC.

Each category has advantages and disadvantages:

  • A name that describes what you do…well, it describes what you do. When a consumer sees the name she knows what you’re selling. On the other hand, a name that describes what you do is often not very memorable.
  • The strongest names are those that start out with no inherent meaning. Amazon, Starbucks, E-Bay. When consumers think of Amazon they think about the gigantic online retailer, nothing else. The name is worth a billion dollars! On the other hand, Amazon had to spend more than a billion marketing dollars to give meaning to a name that otherwise belonged to a river.
  • A name somewhere in between is somewhere in between. It might be sexier than a name that is merely descriptive and require a lot less marketing fuel than a name with no meaning, but with the associated disadvantages as well.

In the Crowdfunding industry to date, most portals have chosen the more descriptive over the more powerful. Poliwogg is an exception. Fundrise might be another.

With two well-known Crowdfunding companies – Crowdentials and VerifyInvestors – we see two different approaches to choosing a name. And we can’t say for certain whether one is better than the other. That will depend on what each company does with its name.

Having chosen a name, how do you protect it?

To start with, a business acquires “common law” rights to a name merely by using it, without filing anything with the government and without involving lawyers. If another real estate Crowdfunding portal tried to use the Fundrise name today they couldn’t do it, even if the Miller brothers had never done anything to protect their name (they have).

Contrary to common belief, merely registering a company name with the state by forming a corporation or other entity provides no real protection. State filings are simply a matter of bureaucracy – the state wants to make sure that no two names are confusingly similar on its own records.

For the best protection, however, the business owner should obtain a Federal trademark from the U.S. Patent and Trademark Office. A Federal registration provides important benefits, including:

  • The registration constitutes “constructive notice” to all later users in all locations.
  • The registration permits the owner to get an injunction against a trademark infringer and sue for damages, including profits, costs, treble damages and attorneys fees.
  • The registration can strengthen the value of the name as a corporate asset.
  • The registration demonstrates your right to use the name to the owners of other websites, such as Google, Facebook, and Twitter, which are often called on to “officiate” disputes over names.

The trademark application process normally takes about a year, assuming no significant problems. Once granted, a trademark registration can last forever if continuously used and renewed.

NOTE: Not every name can be trademarked. A name like “Real Estate Crowdfunding Portal,” which merely describes the product or service, probably cannot be registered by itself. But it might be registered with a distinctive logo.

Finally, don’t forget to acquire the domain name.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

TITLE III AND THE EVOLUTION OF BUSINESS LAW

I’m not optimistic about Title III for the usual reason:  I think the cost of complying with the statute will prove too high. I’ve even proposed my own fix to the statute. But there are plenty of smart people who think otherwise, including Ron Miller of StartEngine, and ultimately opinions don’t matter. The market will decide whether Title III can work in its current form.

The SEC proposed regulations last October 23rd and the comment period ended long ago. Rather than wait for the statute to improve, I’m ready for the SEC to consider the comments, make changes to the proposed rules as it sees fit, finalize the regulations, and let the market do its job.

Whatever the defects of current Title III, and there are many, chances are they will be fixed over time. Time after time, almost from the beginning of time, the legal system has responded to the needs of the business community. Examples:

 

  • Hundreds of years ago, governments created corporations in direct response to the need of traders and investors to limit liability on foreign adventures.
  • With the advent of income taxes in the 20th century, business people had to choose between the limited liability of a corporation and the pass-thru tax treatment of a general partnership. But not for long. Soon legislatures created limited partnerships and S corporations, providing the best of both worlds.
  • When defects were discovered in limited partnerships and S corporation – for example, the risk that limited partners could face unlimited liability – legislators fixed them and fixed them until, lo and behold, Wyoming created an even better entity, the limited liability company we all know and use today (which, in turn, has already been improved).
  • Private placements have always been legal, regulated by the SEC through no-action letters and other guidance. But the private placement market needed clear rules. Hence, Regulation D in 1982. And now Title II of the JOBS Act has improved Regulation D by adding Rule 506(c).
  • Since I have been practicing law (less than a century) the corporate laws of most jurisdictions, including Delaware, have improved dramatically, as state legislatures respond to the needs of businesses large and small.

There are two things you never want to see being made:  sausage and law. But over time, commercial laws do change, usually for the better. If Wyoming can invent limited liability companies, surely we and our Federal government can improve Title III as the need becomes apparent.

So with malice toward none, with charity toward all, let’s stop debating whether Title III can work and let the market figure it out.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

CROWDFUNDING.BIZ INTERVIEW

CFBizJosef Helm runs a terrific site called crowdfunding.biz focused on the Crowdfunding industry. This week Josef interviewed me as part of his Crowdfunding Industry Spotlight series. He asked how I got into the Crowdfunding industry, my advice for those getting in today, my hopes and expectations for the future of Crowdfunding, and a bunch of other illuminating questions.

If you’re interested, my interview is here. But as long as you’re at the site, take a look at the eight other people Josef has identified as industry leaders, people like Richard Swart and Joy Schoffler. Responding to the same questions, you might find their answers more interesting.

I’m honored to have been selected. Josef, thank you for what you do in this space.

OUR EXPERIENCE WITH REGULATION A – BY BEN MILLER, CO-FOUNDER OF FUNDRISE

To improve the user experience, I am inviting guest bloggers. The first is Ben Miller, a Co-Founder of Fundrise, who explains how he and his brother Dan invented Crowdfunding through Regulation A.

Please let me know if you would like to post. I’m looking for content like Ben’s – interesting, informative, educational.

-MARK RODERICK

____________________________________________________________________________________

By: Ben Miller, Co-Founder of Fundrise.

My brother Dan and I were in the real estate business for a long time, developing commercial and residential projects in the Washington, D.C. area, before we thought about crowdfunding. We got some of our capital from the same place many real estate developers get their capital: from investment funds in New York or even outside of the country.

Most of them had little connection to the places we were building and often had never even heard of the neighborhood. On the other hand, our friends and neighbors, people with real connection to the projects, couldn’t invest with us.

fundriseWe started to imagine a world where everyone could invest in high-quality real estate deals, which were then limited to professional investors. We thought about ordinary people investing in their own communities, creating a win-win for the community and business owners. Like every other developer, we’ve had our share of battles with local zoning agencies. We imagined how that process might change if actual investors from the community showed up at council meetings to support the project.

This was before crowdfunding or the JOBS Act were on the table, and every lawyer we spoke to (and we spoke to plenty) told us that our idea was impossible.

Finally we discovered SEC Regulation A. Although Regulation A had been around since 1936, before we came along it had been used very rarely, which probably explains why the lawyers hadn’t heard about it. In all of 2012 fewer than a dozen companies had used Regulation A to raise capital across the whole country, as compared to more than 7,000 Regulation D offerings.

We soon found out why. Although Regulation A allows you to raise money from anybody, including from non-accredited investors, first you have to file a disclosure document with the SEC and with the state securities regulators in any state where you offer the security, and get the regulators to approve your offering. Regulation A is nothing like the new Crowdfunding under SEC Rule 506(c), which is simple and streamlined by comparison.

Once we figured out how to file the disclosure document, which is really like a mini registration statement, we learned that neither the SEC nor the state regulators had ever seen a real estate development project offered under Regulation A. We spent hundreds of hours and way too much in legal fees working through all of the issues. We were literally doing something that had never been done in the history of the U.S. capital markets, and at the same time paving the way for everyone else.

After lots of work, lots of frustration, and lots of conversations with regulators, we succeeded. Our Regulation A filing was approved and we raised $325,000 for the project. I won’t even tell you how much it cost to raise that $325,000, but we were okay with it because we saw the experience then, and still do, as an investment in our future.

We have completed three Regulation A offerings since then. Each time we’ve gotten better and faster, not to mention that the regulators have learned along with us.

Here’s what it took to complete our most recent Regulation A offering:

reg a breakdown

Our most recent filing:

fedex

Fundrise has branched out since those early days. As the leading real estate portal in the world we offer not only Regulation A projects but Rule 506(c) investments under the JOBS Act. And we’re very excited about the new Regulation A+. Regulation A+ improves on Regulation A by allowing us to raise up to $50 million of equity from non-accredited investors (subject to a limitation on how much each person can invest) and further streamline the process by filing only with the SEC, and not with state securities regulators. Fundrise has always been a pioneer, and we expect to pioneer the possibilities of Regulation A+ as well as soon as it becomes available.

Whatever the future holds for Fundrise, and we believe our future is unlimited, we’ll always remember that Regulation A allowed us to open the door into the world of crowdfunding and give unaccredited investors the chance to invest in real estate for the first time in history.

Follow @BenMillerise and @Fundrise on Twitter.

 

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