Financial Poise
Online Securities Intermediaries

3 Online Securities Intermediaries for Accredited Investors

From Bulletin Boards to Broker-Dealers, Accredited Investors Have Options for Finding Deals Online

The market for online alternative investments has been growing at a steady pace over the past few years. Under Rule 506(c) under Regulation D, which allows for general solicitation of private placements to reach accredited investors, companies are beginning to recognize that they have the opportunity to reach a larger number of investors. As a result, online securities intermediaries have become more popular.

Types of Online Securities Intermediaries

There are three ways in which a company can utilize Rule 506(c) to publicly market its securities to accredited investors over the internet:

  • On its own
  • A passive bulletin board
  • A broker-dealer

As an accredited investor, it is important to know what distinguishes each method and type of platform, as well as what to watch out for when considering an online alternative investment. While the risk of fraud or business failure is always present, the means by which an offering is conducted creates its own risks as well.

For instance, non-compliance with applicable federal and state laws governing the conduct of an offering may create a right of rescission for investors. So, even if you, the investor, are happy with the status of your investment, another investor may decide to demand the return of his principal. This could potentially lead to insufficient capital for the company to continue operations. This is a risk that is not typically disclosed prior to investing.

The Company Going It Alone

Under Rule 506(c), a company may advertise that it is seeking investment through its own website or through a site specifically created for the offering. There is no securities intermediary in the offering, and the company is making itself available to investors directly. Since the adoption of Rule 506(c) by the Securities and Exchange Commission (the “SEC”), a handful of technology service providers have created integrated payment processes to facilitate online investment from the company’s website.

For investors, the advantageous aspect of this arrangement is that there is no third-party intermediary that is collecting fees on the investment. Instead, all of the funds will go to the company (minus any processing, escrow costs, etc.).

The disadvantage is that no third-party has reviewed the deal to substantiate the statements and assertions by the company or confirm that the investment is legally valid and binding. Additionally, the company is taking it entirely upon itself to ensure compliance with the exemption from securities registration with the SEC. Failure to comply with its obligations may result in violations of state or federal securities laws that may make it more difficult for the company to raise funds in the future if additional capital is necessary, or could create an obligation to rescind any investments.

Passive Bulletin Boards

Passive bulletin boards are third-parties that assist in the sale of securities by hosting the company’s offering and providing technology-related services, but they do not sell on behalf of the company. Bulletin boards typically do collect transaction fees and fixed fees for the company’s use of the platform to market its offering.

One benefit of bulletin boards is that investors can review and compare a number of available offerings all in one place. Bulletin boards may also do some of their own marketing to bring deals to investor attention.

However, bulletin boards are constrained in their actions in order to avoid broker registration requirements. Unlike broker-dealers, bulletin boards cannot do the following:

  • Provide investing advice or recommendations
  • Find investors for the company issuing securities
  • Compensate its employees or agents for solicitation or sale of securities
  • Hold, manage or handle an investor’s funds or securities

Why does this matter for investors? Under some state laws, investors who invest in a company that has used an unregistered broker-dealer may have a private right of rescission, potentially leading the company to face an obligation to return investment capital that it received (and may have already spent).

Passive bulletin boards also have no obligations to undertake any sort of due diligence review of the issuer, and may be incentivized not to in order to avoid undertaking activities that would indicate the bulletin board is operating as an unregistered broker. For investors, this means that it is important to ensure they have received all the information they require to make an informed investment decision.

Broker-Dealer Platforms

The third online securities intermediary available to companies to reach investors are platforms backed by registered broker-dealers. Broker-dealer platforms have a number of obligations that work to the benefit of investors. However, this is not without cost, and brokers do take significant fees, often in the form of a fixed posting fee and percentage commissions.

One obligation, in particular, is that brokered platforms must provide investment opportunities that are “suitable” to its investors. This obliges the broker to conduct thorough due diligence on the offering and reveal any problems that could jeopardize the investment.

Broker-dealer platforms are also able to vet deals and help structure the offering—meaning that investors are provided with greater assurance that required corporate formalities have been observed and the terms are connected to the fundamentals of the company. For instance, a common transaction type for broker-dealer platforms is a company with a lead investor in place that has already negotiated the terms of the deal, but the company is seeking to raise capital in addition to that being invested by the lead investor.

With broker-dealer platforms, accredited investors also have a greater amount of publicly available information about the management and prior activities of broker-dealers through FINRA’s BrokerCheck service. This gives you as an investor the opportunity to review the credentials of investment professionals participating in the offering.

Broker-dealer platforms are often under the umbrella of equity crowdfunding, though they are not the same as funding portals and subject to different requirements.

Do Your Due Diligence

In any scenario, for accredited investors, it is important to think critically and determine if you have enough information to make an informed investment decision. Online intermediaries are evolving and changing all the time, including talk of potentially selling securities using blockchain technology. Accredited investors should educate themselves and speak to a financial advisor about their particular situation before investing.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Due Diligence Before Investing and Securities Crowdfunding for Intermediaries. This is an updated version of an article originally published on October 26, 2018.]

©All Rights Reserved. February, 2021.  DailyDACTM, LLC d/b/a/ Financial PoiseTM

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About Andrew Stephenson

Andrew D. Stephenson, Chief Product Officer for CrowdCheck and Partner with CrowdCheck Law, is an entrepreneurial attorney focused on assisting small and early stage businesses with corporate governance and securities law related matters. Prior to joining CrowdCheck, Andrew was involved with evaluating internal company communications and reports as part of complex civil litigation matters. Andrew…

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