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The Securities Edge Securities Blog for Middle-Market Companies

SEC curtails JOBS Act broker registration exemption in recent FAQs

Posted in Capital Raising

Businessman weary of overregulation by SECI understand that the SEC needs to balance having efficient markets and facilitating capital formation with the protection of investors, but sometimes erecting roadblocks with the intent of protecting investors is merely regulation for regulation’s sake.  On February 5, 2013, the Staff of the Division of Trading and Markets of the SEC provided guidance on Title II of the JOBS Act, specifically to help interpret the limited broker registration exemption.  While at first glance, these FAQs are not controversial, a broad interpretation by the Staff nearly eviscerates certain avenues for capital raises for small and emerging companies under Title II.  

To step back a minute, Title II of the JOBS Act exempts certain persons from having to register as a broker if that person merely “maintains a platform or mechanism” that brings together investors and issuers in a Rule 506 offering as long as the person “receives no compensation in connection with the purchase or sale of such security” and doesn’t have possession of customer funds.  Seemed simple enough.  The start-up community was excited about this exemption.  While many start-up companies struggle to raise capital after exhausting their friends and family, many people in the start-up community envisioned this to be a way for for-profit internet portals to develop where issuers could list their offering materials for a monthly subscription fee rather than a transaction-type fee. 

Unfortunately, the Staff has taken a very broad view (and in my opinion an unwarranted view) of the definition of “compensation.”  Question 6 in the FAQ states that in the Staff’s opinion, Congress did not limit the condition to transaction-based compensation (i.e., any compensation based on the actual sale of securities), but to any direct or indirect economic benefit.  Although I don’t think it is possible for anyone to ascertain what Congress’ intent is because the members all vote for different reasons, William Carlton in his Counselor@Law blog provides a nice synopsis of what the sponsor of the bill thought.  In my opinion, I think this exemption was meant to be broader to help facilitate capital raising.  

So, does this narrow exemption doom all hope for small companies raising capital?  No, of course not.  First, these are merely FAQs from the SEC, which are not necessarily the law or even the views of the Commission itself.  That said, I (nor any other prudent securities lawyer) would not recommend straying from complying with the FAQs unless you were interested in an enforcement action because the FAQs provide the Staff’s views of what they would recommend to the Commission.  Second, there are ways to achieve the same result without having to use the broker exemption.  For example, CircleUp, launched last year, is a portal that matches investors with consumer companies.  CircleUp has elected to affiliate with a registered broker-dealer.  CircleUp looks promising, but affiliating with a registered broker-dealer does make it more expensive and more selective in getting funding (both of which cut against the purpose of the JOBS Act).  Third, other organizations such as non-profit matching services like The Capital Network have relied on a series of no-action letters from the early 1990s where the SEC stated that non-profits operating passive bulletin boards (despite receiving nominal annual fees) did not meet the definition of “broker” under the securities laws and therefore were not required to register with the SEC. 

If a portal charges a fee then it won’t qualify for the broker exemption under Title II of the JOBS Act, but it may still not need to register as a broker if its activities do not arise to it being deemed a “broker” similar to the no action letters of the 1990s.  Unfortunately, what activities may deem someone to be a “broker” under the securities laws is not always as straightforward as the definition may imply: “any person engaged in the business of effecting transactions in securities for the accounts of others.”  There are several factors to consider such as whether they solicit investors, advise investors on the merits on the investment, and received commissions.  This uncertainty in whether a portal would be deemed a broker is, at least in my opinion, why Congress provided the exemption in the first place. 

Ultimately, the SEC needs to be able to balance the needs for companies to raise capital with the need to protect investors.  In this case, I think the SEC is going too far in protecting investors.  Because general solicitation would likely be involved when using a portal, the securities could only be sold to accredited investors, who presumably can fend for themselves.  Was it really necessary for the SEC to bring additional uncertainty to a promising way of start-up companies to raise capital?