Category Archives: Legal Issues and Regulation

Is the SEC About to Crack Down on ICOs?

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CrowdfundInsider | By Jonathan Nieh | June 17, 2017

The exponential growth of Initial Coin Offerings (ICOs), which are being used to raise huge amounts of money using blockchain based tokens, have been increasingly scrutinized. According to a recent report on Reuters, regulators within the SEC are taking a hard look at the use of ICOs and how they might be a tool to circumvent securities laws.

ICO vs IPO

ICOs are similar to IPOs in that a company raises capital from the public. However, instead of receiving a share in the company, investors who participate in an ICO instead receive a cryptographic token, like Bitcoin, although the companies conducting an ICO create their own unique token. The token usually does not give the purchaser a share of ownership in the company, but oftentimes the token can be redeemed later for cash.  Because of that distinction from IPOs, ICOs are not technically a “security” and thus not officially regulated by the SEC. However, ICOs can very much be characterized as the offering of securities in some situations. For an in-depth analysis of when an ICO counts as a security, here’s a great blog post by senior contributor Amy Wan.

SEC Concerns

Obviously, if companies are using ICOs as a way to circumvent securities regulations, the SEC will want to get involved. That’s why, as an anonymous source quoted by Reuters put it, ICOs are “high on [the] radar” at the SEC. The SEC notably hasn’t made any official statements on its position as to ICO’s, however. There were a couple ETFdenials related to cryptocoins a few months ago, but those were based on companies trying to create Bitcoin-based listings on different exchanges, the most famous being one funded by the Winklevoss twins
of Facebook fame. The denials of the ETFs do imply that the SEC is concerned about the inherent risks of cryptocurrencies. In fact, the SEC laid out their chief concerns in the letters explaining each denial. Still, ICOs present a different and unique problem in that the SEC has to balance two competing interests: capital formation for emerging companies and investor protection.

See: COMMENTARY: SEC rightly concerned about 'so-called SAFE' securities in crowdfunding

With many experts questioning the absurdity of the speed at which ICOs can raise huge amounts of capital and some even asking for the SEC give some guidance at the very least, the question isn’t whether the SEC will do anything to regulate ICOs, but when. Hopefully, when they do, the regulations put in place will be congruent with crowdfunding’s inherent goal of helping small businesses grow.

 

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

 

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There are Now 29 FINRA Regulated Reg CF Crowdfunding Portals

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CrowdfundInsider | By

The number of FINRA approved and regulated crowdfunding portals has been inching higher. Today, there are 29 different Reg CF crowdfunding platforms each targeting the new securities exemption created under the JOBS Act 0f 2012. At the beginning of 2017, that number stood at 22 approved Reg CF platforms with a single entity, Ufundingportal losing it license after FINRA took action after it determined there was significant potential for fraud emanating from the site.

About a year ago, there was less than have this number so interest in launching a Reg CF platform has remained fairly robust.

See:  Is Your Crowdfunding Portal Ready for Your First FINRA Exam?

Some interesting new additions to the list include “Good Capital Ventures” based in Massillon, Ohio. According to the SEC filing, Good Capital Ventures was founded by Justin Jeffrey Gantz who is an architect by education. The site is apparently not yet live.

EquityBender, based in Newport Beach, California, is another new platform. Their website indicates their team has experience in raising more than $250 million for early stage and growth companies in the past years.

Sprowtt Crowdfunding in Tampa, Florida, was founded by Mark Robert Jones. Affiliated with Sprowtt Services, Jones is said to have been “asked to actively participate in crafting the JOBS Act, including the equity crowdfunding laws and regulations.”

Title3Funds, operated by Fundivations, is another new addition. Based in Irving, California, this platform was founded by Ronald Hirsch.

To date, over $36.6 million has been successfully raised for Reg CF issuers. The top four platforms lead the way:

  • Wefunder – $20.4 million
  • StartEngine – $7.9 million
  • Indiegogo (Microventures) – $3.2 million
  • NextSeed – $2.8 million

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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Ask An Investor: Where Should I Incorporate My Startup?

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BetaKitRoger Chabra | June 2, 2017

This week on Ask An Investor, we answer a question on where should founders incorporate their company legally.

To provide a comprehensive answer, I’ve called upon Chad Bayne, partner at law firm Osler, Hoskin &; Harcourt. Chad and I have worked on many companies together over the past decade. He is a veteran of the startup ecosystem, represents many promising startups across North America, and has been involved in countless situations from incorporation, to financing, to exit and everything in-between.

I asked Chad a series of questions on the topic of company incorporation. Here’s what he had to say.


What major things should companies think about and keep in mind when they are deciding where to incorporate their company?

When forming a company, the two primary considerations are the location of the founders and the location of the team.

What are the pros and cons of incorporating in the popular regions that you recommend (e.g. Delaware)

Canada:

Pros:

  • Permits the company’s registered office to be in any Canadian province or territory.
  • Name of the company is protected across Canada.
  • Industry Canada permits electronic filing. (Certain Canadian jurisdictions, such as Ontario, still require physical copies submitted in person in duplicate.)
  • No annual filing fees.

Cons:

  • The company requires 25% of the directors to be resident Canadian directors. (Some jurisdictions in Canada, such as British Columbia, Quebec, New Brunswick, Nova Scotia, and Yukon do not have these requirements.)
  • Because the name is protected across Canada, it is often more difficult to secure a name for the company.

Delaware:

Pros:

  • The most common jurisdiction in the US for incorporation – almost all of the material corporate law related jurisprudence comes out of Delaware courts.
  • All US VC investors and their counsel are familiar with Delaware, so it presents little friction for investment.
  • No state tax payable so long as the company does not have a permanent establishment in the state of Delaware.

Cons:

  • Annual franchise tax payable on authorized capital.

See: NCFA's Annual FinTech and Funding Rooftop Networking Event

Are there specific considerations for Canada-based entrepreneurs? what about US-based entrepreneurs?

For Canada-based entrepreneurs, there are significant tax benefits that result from having a Canadian-controlled private corporation (essentially, a Canadian corporation either incorporated federally, provincially, or territorially) that is not controlled according to law, or in fact by non-Canadian resident shareholders or public companies.

These tax benefits include:

1. Access to the enhanced (i.e. refundable) scientific research and experimental development (SR&ED) tax credit regime

2. Canada-based entrepreneurs have the ability to access their lifetime capital gains exemption on the sale of shares of a qualified small business corporation (the first $800,000+ of capital gains on the same of such shares are tax-free)

3. Enhanced tax treatment for options granted to Canadian-resident employees (including a deferral of the tax payable on the employment benefit resulting from the exercise of such options until the ultimate sale of the underlying shares). In addition, there are certain additional tax savings that may be achieved upon a liquidity event. As a result, it is generally not as tax efficient for Canada-based entrepreneurs to hold shares of a US corporation.

See: For immigrant entrepreneurs, financing is a big problem

"Sophisticated legal counsel with significant cross-border experience (both from a corporate and tax perspective) is in the best position to discuss and weigh the different options with the entrepreneurs."

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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Fintech Regulation: Achieving the right balance to foster innovation

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Financial Post | Special 'Op Ed' Post, Dinaro Ly | June 4, 2017

For nine months last year, executives of Lending Loop, which describes itself as Canada’s first peer-to-peer lending market, voluntarily put the company’s ambitious growth plan on pause to spend some quality time with securities regulators. As CEO Cato Pastoll recounts, the unusual interregnum was all about figuring out how the firm could operate within a regulatory system that doesn’t really know what to do with fintech firms like his.

“The Canadian regulator’s approach is to say, `Let’s stop anything from happening until we’re 100% okay [with the business offering].’” While Lending Loop emerged from the process and is now operating, Pastoll’s frustration is evident. “You can limit everything by being super prescriptive, but if you’re not innovative, everyone’s going to fly by you.”

Lending Loop is hardly alone. Canadian banking and securities regulators, as well as innovation and competition policy-makers, have been cautiously moving ahead with the task of developing new rules for a group of startups that have little in common with the giant banking and investment entities regulated by provincial securities commissions, federal banking regulators and other agencies.

See:

Some agencies, such as the Ontario Securities Commission’s LaunchPad program, have sought to test more flexible approaches to rules, such as intensive financial reporting requirements that currently apply to relatively modest fundraising programs. “The regulator has to have the capacity to be able to help,” says Adam Spence, Associate Director, Venture & Capital Programs at the MaRS Centre for Impact Investing. “What LaunchPad is doing with intermediaries looking to expand into these new regulatory environments is key.”

In Canada, most current rules reflect more traditional ways of lending, borrowing, underwriting and selling, as well as the overlay of more recent banking regulations designed to short-circuit financial fraud. As Pastoll says, existing anti-money-laundering and know-your-customer (KYC) rules were built for an era of face-to-face contact with customers, which is not applicable with fintech offerings.

A May 2017 report on fintech regulation by the federal Competition Bureau echoes this sentiment, pointing to a “disconnect” between the expressions of enthusiasm for new fintech solutions by regulatory bodies and the rigidity of their staff tasked with the day-to-day enforcement of the rules.

“Regulation should be done in a way that encourages and enables innovative startups to offer better solutions in the marketplace,” says Dave Feller, CEO of fintech Mogo, adding that the high cost of regulation for new entrants effectively serves to protect incumbents and prevent consumers from accessing cheaper and more flexible financial services.

A case in point: when the U.K. banned embedded commissions for wealth advisors three years ago, about a quarter of the established players pulled out, leaving an opportunity for upstart “robo-advisor” firms that offer discount services at a fraction of the fee. (The Canadian Securities Administrators have taken note, and recently released a discussion paper on discontinuing embedded commissions.)

A key source of friction about the evolution of regulation has to do with the legacy of the 2008 financial crisis. Unlike many western countries, Canada didn’t experience bank collapses and its financial services regulation and oversight system was widely praised internationally. As Pastoll says, that success “has been an excuse for the last nine years as to why things are the way they are.”

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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COMMENTARY: SEC rightly concerned about ‘so-called SAFE’ securities in crowdfunding

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ReutersJoe Green | June 1, 2017

Traders work on the floor of the New York Stock Exchange (NYSE) February 24, 2016.

NEW YORK (Thomson Reuters Regulatory Intelligence) - The U.S. Securities and Exchange Commission, released an investor bulletin earlier this month (here) cautioning retail investors about the risks of purchasing a particular type of security known as a Simple Agreement for Future Equity, or SAFE, in investment crowdfunding offerings. The commission acted following concerns raised by two of its commissioners and its Office of Investor Advocacy. It was right to do so.

INVESTMENT CROWDFUNDING

Regulation Crowdfunding — the SEC's rules allowing startups and small businesses to raise just over $1 million of capital from non-accredited, retail investors through online crowdfunding portals — became effective a year ago this month. These long-awaited regulations implemented the crowdfunding provisions of Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012. Unlike popular crowdfunding platforms like Kickstarter, through which participants can make donations to for-profit businesses in exchange for rewards, investors participating in offerings under Regulation Crowdfunding receive securities (such as equity or debt) in exchange for their investments in fledgling companies.

See: SEC Approves Title III of JOBS Act, Equity Crowdfunding with Non-Accredited

The SEC's Division of Economic and Risk Analysis (DERA) has published a white paper analyzing all offerings launched under Regulation Crowdfunding from its May 16, 2016, effective date through the end of that year. To give a sense of the types of companies that have tried to raise capital using investment crowdfunding, according to DERA, the median issuer under Regulation Crowdfunding was incorporated within the last two years and had only three employees, no revenues and around $5,000 in cash and $10,000 in debt on its balance sheet. About 60 percent of crowdfunding issuers showed no revenues and 91 percent had yet to earn a profit.

When the SEC analysts looked at the types of securities that Regulation Crowdfunding issuers chose to offer to prospective investors, they found that common and preferred equity were most frequently offered, accounting for more than a third of the offerings. However, the next most commonly offered security, accounting for just over a quarter of the offerings, was the SAFE.

THE SIMPLE AGREEMENT FOR FUTURE EQUITY

As I described at length in a 2014 Hastings Law Journal article on contractual innovation in venture capital (here) that I co-authored with John Coyle, an associate professor at the University of North Carolina at Chapel Hill, the SAFE is a relatively new startup financing instrument developed and popularized by the influential Silicon Valley startup accelerator Y Combinator. The SAFE was designed to facilitate investments by wealthy, sophisticated angel investors in early-stage technology startups that were expected to raise institutional venture capital (VC) in the near future.

A type of deferred equity contract, SAFEs entitle investors to receive a company's equity securities upon certain triggering events, such as a subsequent VC investment. Unlike their close cousins, convertible notes, SAFEs do not accrue interest while outstanding and have no maturity date. The percentage of the company's equity a SAFE investor may eventually receive upon a subsequent financing is a function of the amount invested and the valuation of the company that is negotiated by the later VC investor. Conversion of the SAFE into equity depends upon that future VC financing actually coming to fruition.

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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Canada Central Bank Votes ‘No’ On Blockchain — For Now

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PYMNTS | May 29, 2017

Reports Friday (May 26) said the central bank revealed its views in an article for The Globe and Mail publication, penned by Senior Deputy Governor Carolyn Wilkins as well as Payments Canada’s Gerry Gaetz. There are simply “too many hurdles” that must be overcome for blockchain to be integrated effectively into the nation’s interbank payment system, they said — at least for now.

The Bank of Canada, Payments Canada, top banks in the nation and blockchain consortium R3 all joined together about a year ago to explore the use of distributed ledger technology. The hurdles identified in the column include the incompatibility between blockchain and the need for privacy around some wholesale payments, as well as scalability.

See: Toronto-Based Blockchain Institute Launched

“The bottom line is that a standalone DLT wholesale system is unlikely to match the efficiency and net benefits of a centralized system,” Wilkins and Gaetz wrote. “In fact, at its heart, there exists a fundamental inconsistency or tension between a centralized wholesale interbank payment system, as we have now, and the decentralization inherent in DLT.”

The authors did agree that “one day,” perhaps, the technology could see a place in the interbank system.

“Our experiment, done in two phases, demonstrated that it’s indeed possible to settle wholesale payments on a distributed ledger,” they stated. “Our work also found that such a system could meet some, but not all, of the core international principles for financial market infrastructure.”

There is potential for distributed ledger technology to eventually generate cost savings through the reduction in back-office reconciliation costs, they said.

According to reports, Canada will continue to modernize its existing payments infrastructure and adapt ISO 20022 messaging standards to meet the financial industry’s need for privacy, scalability and greater efficiency in cross-border and domestic wholesale payments.

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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Is Your Crowdfunding Portal Ready For Your First FINRA Exam?

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Crowdfund Insider |  

With the recent one-year anniversary of Crowdfunding under Regulation Crowdfunding on May 16th, business executives and compliance officers at registered Crowdfunding Portals (CFPs) should be actively preparing for their first regulatory examination by the Financial Industry Regulatory Authority (FINRA).  

FINRA’s 2017 exam cycle will for the first time include the examination of CFPs. FINRA will conduct examinations of each CFP within the first twelve months of membership and no less than once every four years thereafter.  FINRA has considerable oversight and authority over the daily activities of its members and periodically exams its members to ensure compliance with both the FINRA rules and the federal securities laws. 

As a self-regulatory organization, FINRA has the power to take disciplinary action against its members which range from fines, censure to full expulsion. Last year, FINRA brought 1,434 disciplinary actions resulting in $176.3 million in fines, $27.9 million in restitution to harmed investors, suspended 727 individuals, barred 517 persons from the industry and either suspended or expelled 50 firms.

Last year we saw UFP, LLC, a once registered crowdfunding portal, expelled from FINRA membership. UFP’s expulsion was a decisive move by FINRA and sent a clear message to the crowdfunding industry. With upcoming examinations and a possibility of regulatory action against member firms and their associated persons, this is an important time for CFPs to ensure that they are meeting compliance standards. FINRA will assess each CFP’s business and the risks associated with those activities.  The level of risks, and the CFP’s management of those risks is an important factor in FINRA determining how frequently the CFP will be examined going forward. After the first examination, CFP’s may be examined on a one, two, three or four-year cycle. 

We expect that FINRA will be carefully examining how CFPs manage their day-to-day operations, ensure that their issuers are meeting the requirements of Regulation Crowdfunding (Reg CF), oversee issuer communications with investors on the portal, and develop their compliance infrastructure to address their specific business model and risks.  The following are some key areas where we believe FINRA will focus its efforts.   

See: Are Overseas Portals the Next Big Thing in US Equity Crowdfunding?

Gate Keeper Responsibilities

CFPs are viewed by regulators as “gate-keepers” with the primary goal of protecting investors from fraudulent and noncompliant offerings. The FINRA rules require CFPs to have a reasonable basis for believing that issuers posting offerings on their portals comply with applicable regulatory requirements, including Regulation Crowdfunding, and require CFPs to deny access to issuers that present the potential for fraud or otherwise raise investor protection concerns.

We expect extensive consideration of how CFPs are evaluating prospective issuers, and the scope and manner of detecting issuer noncompliance. There is growing industry concern that Form C filings and other offering materials being made available to investors may fall short of Regulation Crowdfunding. This ranges from offerings failing to provide the appropriate financial disclosures to offering materials appearing not to provide adequate disclosure about the business and the offering, including non-generic risk factors. One emerging trend includes issuers filing screenshots of the offering’s deal page on the CFP with the SEC as the Form C. These filings are often illegible and at times appear to be thin on disclosure of material information.  If the disclosures provided in the Form C are on their face inadequate or fail to meet basic requirements, we can expect FINRA to inquire into the effectiveness of the CFPs’ compliance procedures and controls.

Communications with the Public & Advertising

CFPs routinely communicate with the public to, among other things, market their services. All CFP communications or advertisements to the public, including written communications distributed to one or more investor, must be based on principles of fair dealing and content must be fair and balanced.

CFP communication with the public may not include false, exaggerated, unwarranted, promissory or misleading statements or claims. This may be as subtle as a slogan, graphic or eye-catching headline which is promissory in nature or hints at the potential future success of a specific offering or the offerings posted on the portal in general. Profit forecasts are prohibited, with the exception of a hypothetical illustration of mathematical principles, provided that it does not predict or project the performance of an investment. 

CFPs are not permitted to make recommendations or provide investment advice. If there are any statements which are intended to act as an endorsement or suggest that an offering is of a higher quality, safer or worthier than others, it could be deemed a recommendation and a breach of the rules.

The scope of review extends beyond just the CFP to all forms of communication. For CFPs that post article, reports and other content prepared by third-parties, your compliance team must be mindful of whether such content is one-sided. CFPs will be deemed to have adopted third-party content which may include impermissible investment advice or recommendations or contain misleading statements. Executives who choose to use the CFP to post their own blogs need to also be sensitive to this issue. Chief Compliance Officers (CCO’s) and supervisors need to carefully review all content posted on the CFP.  FINRA’s recently published Notice to Members 17-18 provides valuable guidance on digital media communications.

One of the most important compliance tools CFPs are expected to use is email surveillance which is the periodic review of communications between the issuer or its agents and the public. We expect that FINRA will be evaluating how CFPs have been monitoring these communications, including how frequently and in what manner this review is conducted. 

CFPs that include offerings outside of Title III Crowdfunding can likely expect questions and comments by FINRA staff pertaining to those offerings as well.

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support, and networking opportunities to over 1500+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at www.ncfacanada.org.

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