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Op Ed: Know your online securities intermediary (or lack thereof)

The market for online alternative investments has been growing at a steady pace the past few years. Issuers of private placements have realized that they have the opportunity to reach a larger number of accredited investors by using third-party internet platforms. As an investor, it is important to know what distinguishes each type of platform out there, and what to watch out for when considering an online alternative investment. (Read this article for the most recent news from the SEC about how accredited investors are defined.)

There are three ways in which an issuer can market its securities to accredited investors online: on its own, by use of a passive bulletin board, and through a broker-dealer platform.

1. Direct Marketing

The issuer advertises that it is seeking investments through its own website. There is no intermediary in the offering, and the issuer is making itself available to investors directly.

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

The disadvantage is that no third-party has reviewed the deal to substantiate the statements and assertions by the issuer, or confirm that the investment is legally valid and binding. Additionally, the issuer is taking it entirely upon itself to ensure compliance with the exemption from securities registration with the Securities and Exchange Commission (“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 issuer to raise funds in the future if additional capital is necessary.

2. Third Party Announcements

The second option is through the use of a passive bulletin board. Passive bulletin boards are third-parties that assist in the sale of securities by hosting the issuer’s 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. One such requirement is that bulletin boards may not offer investment advice.

Investment advice is a very broad concept and essentially prohibits passive bulletin boards from vetting or curating issuers in order to present investors with “good” deals.  As a result, if a passive bulletin board uses any kind of subjective language to talk about the quality of the issuers on its site, that bulletin board may have engaged in investment advice and may be required to register as a broker.

Why does this matter for investors? Under some state laws, investors who invest in an issuer that has used an unregistered broker-dealer may have a private right of rescission. So, even if investors are happy with the status of their investment, another investor may decide to demand return of his principal, potentially leading to insufficient capital for the issuer to continue operations. This is a risk that is not typically disclosed prior to investment. (Read here about watching out for issuers who may offer advice outside of SEC regulations.)

3. Broker-Dealer Platforms

The third option available to issuers, to reach investors online are platforms backed by registered broker-dealers.

Brokered 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.

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 uncover any problems that could jeopardize the investment. Brokers are also able to vet deals and solicit investors on behalf of the issuer—meaning that the deals are more likely to be of better quality. Brokered platforms may also be able to help the issuer fill out its investment round so that the issuer receives enough capital to operate as planned. (What is “due diligence”? Read more here.)

Additionally, there is information available on registered brokers through FINRA’s BrokerCheck service. This gives investors the opportunity to review the credentials of investment professionals participating in the offering.

In any scenario, it is important to think critically and determine if there is enough information to make an informed investment decision.

About Andrew Stephenson

Andrew D. Stephenson, VP of Product Management and Strategy for CrowdCheck, has a wealth of experience assisting small and early stage companies with online offerings of securities. Since joining CrowdCheck in January 2013, Andrew has conducted numerous due diligence reviews, drafted disclosure materials, and helped companies identify and work through issues for securities offerings under…

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