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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