Staying the Course with Broker-Dealer Registration: The SEC's Impending Regulation of Crowdfunding Portals under the JOBS Act

By Shah, Raxit | Journal of Corporation Law, October 1, 2014 | Go to article overview

Staying the Course with Broker-Dealer Registration: The SEC's Impending Regulation of Crowdfunding Portals under the JOBS Act


Shah, Raxit, Journal of Corporation Law


I. INTRODUCTION

Collecting donations to run a political campaign, fundraising to support an artistic project, and contributing towards a charitable cause or foundation's funding goal; these examples illustrate diverse yet successful applications of crowdfunding. Investors' rewards for these commonplace transactions include sponsor recognition, a prototype or memorabilia from the launch of a product or project, and personal gratification. None of these circumstances, however, involve investor donations in exchange for ownership - otherwise known as securities-until now.

In 2012, the Jumpstart Our Business Startups Act (JOBS Act) created a broker-dealer registration exemption for crowdfunding portals under Title III, allowing these security intermediaries to raise capital in exchange for securities.1 The Securities Exchange Act of 1934 (Exchange Act) charges the Securities and Exchange Commission (SEC) to govern the securities market to protect investors.2 Save for a few exceptions, the SEC requires those buying and selling securities, or doing so on behalf of others, to register as a broker-dealer.3 The JOBS Act creates another exception to broker-dealer registration for crowdfunding portals and suggests guidelines for the SEC to adopt in order to regulate the intermediaries.4

The guidelines the JOBS Act suggests, however, meaningfully stray and conflict with the SEC's history of broker-dealer regulation.5 The SEC currently recognizes three exceptions: an issuer,6 finder,7 and investment advisor exception.8 These exceptions, however, are narrow. None of the exceptions allow a person to exchange securities if he exhibits hallmark broker-dealer activity, including, but not limited to, receiving transaction-based compensation, possessing investor funds, participating in negotiations of the sale of securities, or even providing certain types of information about the securities.9 Although the SEC has yet to issue formal guidelines for the JOBS Act's crowdfunding exception to broker-dealer registration, the public commenting period is underway and the SEC addressed the issue in two no-action letters.10

This Note reviews the Exchange Act and its underlying policy objectives, focusing on the Act's regulation of the securities market and broker-dealer registration. This Note first explores the SEC's past regulation of broker-dealer registration and continues with a summary and analysis of two SEC no-action letters addressing the proposed crowdfunding exception. The analysis concludes by comparing and contrasting the existing exceptions with the proposed guidelines for the new crowdfunding exception from both the JOBS Act and SEC no-action letters.

This Note contends that the JOBS Act's crowdfunding portal guidelines are too liberal and do not adhere to previous SEC precedent. As a result, this Note argues that crowdfunding portals would participate in hallmark broker-dealer activities if the SEC adopts Congress's JOBS Act guidelines. Moreover, recent SEC no-action letters regarding the regulation of crowdfunding portals do not align with past SEC rulings and exceptions. This Note argues that the SEC must take a more conservative approach in requiring crowdfunding portals to register as a broker-dealer when formally issuing guidelines than it took in its recent no-action letters or the guidelines under the JOBS Act. If it is impractical to create another exception without conflicting with the guidelines set forth for other exceptions, then the SEC should disallow a crowdfunding portal exception altogether, rather than straying from its course of 80 years.

II. BACKGROUND

In an effort to combat securities trading abuses in the American securities markets, the Exchange Act authorized a commission to adopt rules to "protect[] the public . . . with respect to trading in securities, through . . . the regulation of brokers and dealers and the securities markets."11 Congress codified the Commission's rules into law two years later. …

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