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The SEC Proposed Crowdfunding Regulations: Required Intermediary Measures to Reduce Fraud

required intermediary measuresThe SEC's proposed crowdfunding regulations include a number of specific steps that an intermediary is required to take in order to reduce the risk that an issuer (the company raising capital) does not use the intermediary's platform to engage in fraud. The intermediary is viewed as a check and balance on the crowdfunding marketplace. Among an intermediary's responsibilities are the following:

  • An intermediary must have a reasonable basis for believing that the issuer is following all legal requirements imposed on an issuer in a crowdfunding offering. The intermediary may rely on a compliance representation from the issuer unless the intermediary has reason to question the reliability of an issuer's representation. So in most cases, this requirement comes down to requiring the issuer to sign a form attesting to compliance with all legal requirements.
  • An intermediary must have a reasonable basis for believing that the issuer has established an effective recordkeeping system to keep track of who owns the securities issued in a crowdfunded offering. Once again, the SEC would permit the intermediary to rely on representations from the issuer unless the intermediary has reason to question the reliability of an issuer's representation. The SEC declined to impose any specific method for maintaining investor records, such as requiring the issuer to hire a registered transfer agent, opting instead for flexibility.
  • An intermediary is required, at a minimum, to conduct a background and securities enforcement regulatory check on each issuer whose securities are offered by the intermediary, and on each of the issuer's officers, directors and holders of 20 percent or more of the issuer's outstanding voting equity securities. The SEC has elected not to impose any specific procedures for conducting the background checks, preferring to allow intermediaries to use their experience and judgment to determine the preferred procedures. Based on the background check information, as well as any other information the intermediary has, if the intermediary has a reasonable basis for believing that the issuer is disqualified from participating in a crowdfunded offering, the intermediary is required to deny access to the intermediary's platform. Click here to read our blog post on disqualified issuers.
  • An intermediary is required to deny access to its platform if the intermediary believes that the issuer or the offering presents the potential for fraud or otherwise raises concerns regarding investor protection. If an intermediary learns new information after an offering is already posted on the platform that raises these concerns, the intermediary must remove the offering from the platform. An intermediary is not required to have a reasonable basis for its decision to deny access. Rather, the SEC wants to empower intermediaries with discretion to take steps to reduce the risk of fraud. If an intermediary believes that it is unable to adequately or effectively assess a risk of fraud, access to the platform must be denied. For example, if the officers of an issuer reside in a jurisdiction where background checks and securities regulatory history checks are not readily available, access to the platform should be denied.

In short, the SEC is placing considerable responsibility on the intermediary to mitigate the risk of fraud. As stated in prior blog posts, I believe it makes good business sense for intermediaries to mitigate fraud risks, anyway. Investors are not likely to participate in platforms that get a reputation for allowing access to fraudulent issuers. The most successful intermediaries will likely find ways to automate mitigation of the risk of fraud.

Please contact Iris Linder (517-371-8127 or for more information.

Categories: Crowdfunding, Venture Capital/Funding

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