FINRA Issues Crowdfunding Portal Regulatory Notice and Proposed Rules | Practical Law

FINRA Issues Crowdfunding Portal Regulatory Notice and Proposed Rules | Practical Law

FINRA issued a regulatory notice soliciting comments on proposed rules and forms that would govern SEC-registered crowdfunding portals.

FINRA Issues Crowdfunding Portal Regulatory Notice and Proposed Rules

Practical Law Legal Update 6-546-6806 (Approx. 5 pages)

FINRA Issues Crowdfunding Portal Regulatory Notice and Proposed Rules

by Practical Law Corporate & Securities
Published on 24 Oct 2013 • USA (National/Federal)
FINRA issued a regulatory notice soliciting comments on proposed rules and forms that would govern SEC-registered crowdfunding portals.
On October 23, 2013, FINRA issued Regulatory Notice 13-34 soliciting comments on proposed FINRA rules (Funding Portal Rules) and forms that would govern funding portals operating under the crowdfunding provisions of the JOBS Act. The notice comes on the same day the SEC proposed long-awaited rules that, if adopted, would implement the JOBS Act's exemption for crowdfunding offerings meeting certain requirements (see Legal Update, SEC Proposes Crowdfunding Rules).
Title III of the JOBS Act amended the Securities Act by adding a new registration exemption (Section 4(a)(6)) for crowdfunding offerings. The exemption, which is not available until the SEC adopts implementing rules, is intended to allow capital raising from a large number of people, including non-accredited investors, in relatively small amounts using the internet and social media.
To qualify for the exemption, crowdfunding offerings must be made through a broker or funding portal that is registered with the SEC for this purpose and complies with a set of conditions, including that it is a member of a registered national securities association. Currently, FINRA is the only registered national securities association.

General Standards

Proposed Funding Portal Rule 100 provides that all funding portal members (which includes both funding portals and their associated persons) would be subject to FINRA's by-laws, unless the situation requires otherwise, and the Funding Portal Rules. The rule also provides basic definitions that have been modified to apply to funding portal members.

Funding Portal Application

Proposed Funding Portal Rule 110 sets out the membership application process for funding portals, which is based on the current NASD Rule Series membership rules for broker-dealers. Because the scope of activity of funding portals is limited, the Funding Portal Rules would tailor the NASD Rule 1010 Series by:
  • Shortening the time frames for key events. For example, the time frame for receiving a decision on a funding portal application would be 60 days after the application is filed (as opposed to 180 days under the broker-dealer rules).
  • Streamlining and consolidating the standards for granting or denying an application. Five standards would address a funding portal's:
    • ability to comply with applicable federal securities laws, rules and regulations and the Funding Portal Rules;
    • contractual or other arrangements and business relationships necessary to initiate operations;
    • supervisory system;
    • direct and indirect funding sources; and
    • recordkeeping system.
  • Providing that the membership interview may take place by video conference (or any other way specified by FINRA).
  • Streamlining the process for appealing a decision by:
    • reducing filing and response time frames from 25 days for broker-dealers to 14 days for funding portals; and
    • eliminating provisions requiring an appellate hearing.
  • Narrowing the scope of changes in control and ownership that would require an application for approval of the change.
Funding portals would apply for membership using proposed Form FP-NMA and would apply for approval of a change in control and ownership using proposed Form FP-CMA. Statutory disqualification information would be submitted using the FP-SD Schedule.
Proposed Funding Portal Rule 110(b) would require funding portal members to maintain a minimum level of fidelity bond coverage.

Funding Portal Conduct

The Funding Portal Rules would:
  • Require a funding portal member to observe high standards of commercial honor and just and equitable principles of trade when conducting its business (proposed Funding Portal Rule 200(a)). This rule is based largely on FINRA Rule 2010.
  • Prohibit a funding portal member from effecting any transaction in, or inducing the purchase or sale of, any security by means of, or by aiding or abetting, any manipulative, deceptive or other fraudulent device or contrivance (proposed Funding Portal Rule 200(b)). This rule is based largely on FINRA Rule 2020.
  • Prohibit false and misleading statements (proposed Funding Portal Rule 200(c)). This rule is based largely on FINRA Rule 2210.

Funding Portal Compliance

The Funding Portal Rules would require funding portal members to:
  • Establish and maintain a system to supervise the activities of all associated persons of the funding portal member (proposed Funding Portal Rule 300(a)). The rule, which is a streamlined version of current NASD Rule 3010, would require systems to be reasonably designed to achieve compliance with applicable securities laws and regulations and with the Funding Portal Rules. It would give flexibility to funding portal members to tailor their supervisory system to their business model.
  • Implement a written anti-money laundering program (proposed Funding Portal Rule 300(b)). The rule is similar to current FINRA Rule 3310 but provides that the program must require independent testing for compliance every two years.
  • Report to FINRA regulatory proceedings and disciplinary and other events of the funding portal member and of any of its associated persons (proposed Funding Portal Rule 300(c)). The rule is largely based on current FINRA Rule 4530. These events would be reported on the Funding Portal Rule 300(c) Form.
  • Report, and promptly update, all contact information required by FINRA through means specified by FINRA.

Investigations and Sanctions

Proposed Funding Portal Rule 800(a) would subject funding portal members to the FINRA Rule 8000 Series (Investigations and Sanctions), unless the situation requires otherwise. Among other things, the rule provides that:
  • FINRA must make publicly available information filed by funding portal members that are currently or were previously registered with FINRA. Except as otherwise provided by the rules, FINRA must make available information contained in the funding portal's most recent SEC registration forms.
  • FINRA must make available any information filed by a funding portal member indicating whether the member or any of its associated persons is subject to a statutory disqualification.

Code of Procedure

Proposed Funding Portal Rule 900(a) would subject funding portal members to the FINRA Rule 9000 Series (Code of Procedure), unless the situation requires otherwise. Among other things, the rule sets out procedures for:
  • A person to become or remain associated with a funding portal member despite being subject to a statutory disqualification.
  • A funding portal member or associated person to receive relief from the eligibility or qualification requirements of FINRA's by-laws or the Funding Portal Rules.

Arbitration and Mediation

Proposed Funding Portal Rule 1200(a) would subject funding portal members to the FINRA Rule 12000 Series (Code of Arbitration Procedure for Customer Disputes), the FINRA Rule 13000 Series (Code of Arbitration Procedure for Industry Disputes) and the FINRA Rule 14000 Series (Code of Mediation Procedure), unless the situation requires otherwise. The rule is a streamlined version of current FINRA Rule 2268.

Public Comment

FINRA is accepting comments on the Funding Portal Rules and related forms until February 3, 2014.
To learn more about Title III of the JOBS Act, see Practice Note, JOBS Act: Crowdfunding Summary.