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Portals & Broker-Dealers: Comparing Types of Investment Intermediaries in Crowdfunding

Two Intermediaries and How They Conduct Crowdfunding Due Diligence

Two types of investment intermediaries may conduct Title III equity crowdfunding offerings and transactions: (1) funding portals that are not registered broker-dealers, and (2) offering platforms that are registered broker-dealers. Both kinds must be registered with the Securities and Exchange Commission (SEC), and each offers different levels of crowdfunding due diligence.

There are important distinctions between funding portals and broker-dealer platforms that feature Title III offerings. Funding portals are a newer type of investment intermediary created by Title III of the JOBS Act, while broker-dealers have been established market makers for many decades. A broker-dealer can be an individual or a company.

Being a broker permits the platform to trade securities on behalf of its customers, and being a dealer allows the platform to trade on its own account.

What Funding Portals and Broker-Dealers Can and Can’t Do

Broker-dealer platforms are authorized to do, while funding portals (which are not owned or operated by broker-dealers) are prohibited from doing, the following:

  • Offer investment advice or recommendations to investors
  • Solicit purchases, sales, or offers to buy securities offered or displayed on its website or portal
  • 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

Protecting the Investor: Crowdfunding Due Diligence and Anti-Fraud Measures

Broker-dealers are subject to strict standards of due diligence, with respect to how they select issuers and equity offerings to be listed on their platforms. Funding portals are not legally subject to any such standards, although they do have incentives to select high-quality issuers, which usually requires a respectable level of due diligence. When you visit a broker-dealer platform, though, you know exactly what its due diligence standards are, because they have been published by the SEC and the Financial Regulatory Authority (FINRA).

Acting as an intermediary, a broker-dealer must take reasonable steps to ensure that the information and disclosures that issuers post on its platform are materially accurate and complete. If the broker-dealer fails to take those steps, it will face disciplinary action, including fines and civil enforcement action by the SEC and FINRA. That means the platform’s staff has to examine carefully and in depth an applicant’s financial disclosures, perform criminal background checks on its executives, and so on. The broker-dealer is obligated to take reasonable steps to screen out dishonest issuers and fraudulent offerings.

Registered broker-dealers are subject not only to the general anti-fraud and anti-manipulation provisions of federal securities laws and regulations, but also to additional crowdfunding due diligence, anti­-money-laundering rules and other requirements specific to broker-dealers.

Two requirements are the Know Your Customer Rule (FINRA 2090) and the Suitability Rule (FINRA 2111). Together, they require broker-dealers to collect sufficient information about each investor to determine that investor’s risk profile and whether particular investments are suitable. To accomplish that, the broker-dealer operating an offering platform should review applicant companies’ business plans in order to screen out offerings that it believes are generally unsuitable for its registered investors. Broker-dealers can be found in violation of the Suitability Rule if they put their own interests (e.g., maximizing commissions) ahead of the customer’s interests by recommending one product over another.

All intermediaries—funding portals and broker-dealer platforms alike—must conduct background checks on officers, directors, and 20% equity holders of each issuer, to reduce the risk of fraud. Intermediaries must disqualify an issuer if one of its officers, directors, or “participants” (e.g., promoters) in the offering is a “bad actor,” as defined by the SEC (e.g., a convicted felon, person subject to a finance-related injunction or restraining order, person subject to SEC disciplinary action, etc.). Likewise, all funding portals and broker-dealer platforms are subject to anti-fraud and anti-manipulation provisions of federal securities laws and regulations.

Identifying Types of Investment Intermediaries and Their Websites

How can you tell funding portals and B-D platforms apart? They may be very similar in appearance, because they use the same kind of website architecture and navigation structure. You may not be able to distinguish between them readily, unless you read the “About Us” page and/or the fine print in the footer on the home page.

If you are unable to determine whether a site is operating as a broker-dealer, you can (1) contact the platform’s staff and ask about their broker-dealer status or (2) visit FINRA’s BrokerCheck page  and conduct a search to see if the platform is registered as a broker-dealer or merely as a portal.

Conducting Your Own Due Diligence is Still Important

If you consider registering as an investor on a non-broker-dealer funding portal, ask the principals exactly what kind of screening and selection process they use before they approve an issuer’s application and list an offering. Some portals use third-party services such as CrowdCheck, a Virginia-based compliance and due diligence service provider, to perform crowdfunding due diligence and/or conduct background checks on the owners and officers of issuers. If the platform claims to conduct its own due diligence in-house, make sure the principals have relevant experience in the securities or investment banking industry so that their due diligence is effective.

Keep in mind that you (along with the crowd) may still need to conduct your own due diligence before you invest, even if the platform is a broker-dealer. Do not presume that all due diligence performed by these types of investment intermediaries supports your personal objectives and risk tolerance.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Crowdfunding from the Investor’s Perspective and Securities Crowdfunding for Intermediaries. This is an updated version of an article originally published on March 30, 2016.]

©All Rights Reserved. June, 2020.  DailyDAC™, LLC d/b/a/ Financial Poise™

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About David M. Freedman

Legal and financial journalist.

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