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DULR Online Proudly Presents the Proxy Plumbing Issue

DULR Online's Proxy Plumbing Issue features five student articles covering different aspects of the SEC's Concept Release on the U.S. Proxy System and a call for a version 2.0 to address certain shortcomings of the Release. The Proxy Plumbing Issue represents the continued collaboration between the Denver University Law Review, DULR Online, and Professor J. Robert Brown, Jr. Please explore the full issue here, including a thoughtful introduction to the issue by Professor Brown.

Emerging Scholar Award Recipient: Goldburn P. Maynard, Jr.

The Denver University Law Review is pleased to announce that it has selected the recipient of the Emerging Scholar Award.  Click here for details!


Emerging Scholar Award: Exclusive Spring Opportunity for Publication in Volume 92

The Denver University Law Review is pleased to announce the Emerging Scholar Award. This exclusive opportunity is for all scholars who have received their J.D. as of March 1, 2014 and have not yet accepted a tenure-track teaching position nor held a full-time teaching position for more than three years. The selected recipient will receive an award of $500 and publication in Issue 1, Volume 92, scheduled for early 2015.

We will accept submissions for the Emerging Scholar Award from March 24, 2014, until March 31, 2014. Our Articles Committee will review all submitted articles and respond to authors by April 14, 2014. Please click here to view submission details.

Volume 92 Board of Editors Announced

Denver University Law Review is excited to announce the Volume 92 Board of Editors.  Please join us in congratulating them in this accomplishment and supporting them in continuing the fine tradition of the Denver University Law Review. Please click here to view the masthead.


Revisiting Sex: Gender & Sex Discrimination Fifty Years After the Civil Rights Act

On January 31 and February 1, 2014,  the Denver University Law Review will present its annual symposium: “Revisiting Sex: Gender & Sex Discrimination Fifty Years After the Civil Rights Act.” The Civil Rights Act of 1964 represents one of the most significant milestones of the twentieth century. Title VII of the Civil Rights Act protects individuals against employment discrimination on the bases of race, color, national origin, sex, and religion.

The Symposium will explore the meaning of “sex” under Title VII, present the role gender plays in the workplace, and review the shortcomings of the fifty-year-old Title VII framework. Panel topics include Caregiving in 2014; Intersectionalities; Access to Work, Pay Inequality, and Discrimination; Sexuality and Gender Issues; and Biases in Litigation and Amongst the Judiciary.

All are welcome, and CLE credit will be available.

For more information about the Symposium, please visit our Revisiting Sex page.

The final agenda for the Symposium is available for download here.

For any other questions, please contact LaLonnie Villa-Martinez.


DULR Online Presents the JOBS Act Issue

DULR Online is proud to present its JOBS Act Issue. This issue features eight student articles covering different aspects of the Jumpstart Our Business Startups Act, the landmark legislation passed by Congress in 2012 "[t]o increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies." The JOBS Act Issue represents a unique collaboration between the Denver University Law Review, DULR Online, and Professor J. Robert Brown, Jr. Please explore the full issue here.

DU Community Outreach: Student Leaders Develop Program to Connect Diverse High School Students to the Law

On April 20, 2013, the University of Denver Sturm College of Law will host forty-five high school students to participate in Spring Training for Youth and Legal Education (STYLE). STYLE was developed by student leaders of diversity programs at DU Law to connect high school students with the legal profession. The program targets high school students who would not normally have access to the legal community because of their socioeconomic background. The students were nominated by a teacher, counselor, or other community member based on level of motivation and promise. STYLE will introduce the nominated high school students to diverse legal professionals and law students. Students will engage in seminar discussions and participate in a mock trial. The DU Law Review will post select STYLE articles in April.
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For the guidelines on how to submit an article to Denver University Law Review, please click here. If you would like to submit a shorter piece to DULR Online, please contact the Online Editor, Jonathan Coppom, at jcoppom15@law.du.edu.

« The JOBS Act: Does the Income Cap Really Protect Investors? | Main | JOBS Act Title V: Raising the Threshold for Registration »
Saturday
Apr272013

The JOBS Act: Exempting Internet Portals from the Definition of Broker-Dealer

[PDF]

Samuel Hagreen*

President Obama signed the Jumpstart Our Business Startups Act (“JOBS Act” or the “Act”) on April 5th, 2012.[1]  The Act sought to ease the regulatory burden of capital raising on startups and smaller companies to encourage economic growth.  Title II specifically included an exemption from broker-dealer registration for internet portals used to market shares sold in private placements under Rule 506 (“Portal Exemption”).

Attention has mostly focused on the JOBS Act provision that exempted crowdfunding portals from broker-dealer registration.  In fact, the exemption for portals marketing shares sold in offerings under Rule 506 may well have a broader impact.  Moreover, the regulatory requirements for the two types of portals vary considerably because of differences in the sophistication of the investors purchasing the securities. 

This paper will discuss the requirements of broker-dealer registration for online platforms that existed before the JOBS Act.  The paper will examine the changes in the JOBS Act, including the brief legislative debate regarding the exemption for platforms that market shares in offerings made under Rule 506.  Finally, the paper will discuss the effect of this framework as more of the JOBS Act is implemented. 

What is a Broker?

Section 3(a)(4) of the Securities Exchange Act of 1934 (“1934 Act”) broadly defines a broker  as “any person engaged in the business of effecting transactions in securities for the account of others.”[2]  All three elements must be present.[3]  Engaging in the business  includes “receiving transaction-related compensation; holding oneself out as a broker, as executing trades, or as assisting others in settling securities transactions; and participating in the securities business with some degree of regularity” as well as the solicitation of securities transactions.[4]  The term generally applies to activities in connection with multiple security transactions, but a single one can suffice if it was part of a larger plan.[5]

The term “effecting transaction in securities” generally means “participation at key points in the chain of distribution.”[6]  Such participation includes “assisting an issuer to structure prospective securities transactions, helping an issuer to identify potential purchasers of securities, soliciting securities transactions, and participating in the order-taking or order-routing process (for example, by taking transaction orders from customers).”[7]  This list is not comprehensive.  Additionally, participation at key points does not necessarily occur when a single factor is present but instead requires an analysis of the totality of the circumstances.  Linking factors to the receipt of transaction-based compensation strengthens the argument that the entity is acting as a broker.[8]

The fact specific nature of the test results in considerable uncertainty over the definition.  Consequently, the obligation to register can be uncertain.  The Commission staff has been unwilling to create the necessary guidance in order to provide clarity to the definition. 

The consequences of the uncertainty can be significant.  A registered broker must file a comprehensive application for Broker-Dealer Registration and comply with SEC rules.[9]  Brokers must join a self regulatory organization and comply with its detailed and complicated regulatory framework.[10]  Brokers are subject to substantial books and record-keeping requirements, as well as financial reporting to regulators and clients.[11]  Registered brokers must also comply with minimum net worth, net capital ratios and customer protections, and submit to inspection and discipline by the SEC and FINRA, adding to the costs of compliance.[12]  They must comply with additional anti-fraud provisions specific to brokers.[13]  These extensive reporting and compliance requirements effectively limit the broker to large transactions that yield a substantial return. 

The SEC’s Treatment of Online Investment Intermediaries

The uncertainty in the definition of broker was especially apparent in connection with services that sought to match buyers and sellers of privately placed securities.  In the 1990s, the SEC issued several no-action letters in an effort to provide some guidance in the area.[14]  In IPONet, the SEC discussed a proposed system for matching purchasers and sellers in offerings that were qualified under Regulation D.[15]  The letter primarily addressed whether the posting of materials involved a general solicitation.  The staff agreed that a posting would not result in a general solicitation if password protected and only made available to accredited investors.   The no-action letter, however, specified that the matching service had to be under the supervision of a registered broker-dealer or actually registered as a broker-dealer.[16] 

In a no-action letter issued just three months later, the SEC indicated that an online platform could at least sometimes avoid registration as a broker-dealer.[17]  Universities and non-profits proposed the creation of the Angel Capital Electronic Network (“ACE Network”), an online platform that would post a list of small business private offerings and allow password controlled access only to accredited investors.[18]  

The SEC agreed that the ACE Network was not required to register as a broker-dealer but imposed conditions.  The Network could not provide investment advice, make profit or charge any contingent fees, participate in negotiations between issuers and purchasers, directly assist in the transaction by providing closing documentation or paid attorney referrals, handle funds or securities, or hold itself out as providing any other securities-related services.[19]  The matching network did not intend to charge a transaction-based fee but proposed to charge a nominal flat fee to the companies and investors to cover administrative costs. [20]  The SEC emphasized that no transactions or negotiations would take place on the network and that persons associated with ACE Network would not be allowed to participate in offerings unless they were disclosed and separately conforming to securities laws.[21] 

In determining whether platforms matching buyers and sellers in private placements were required to register, subsequent pronouncements emphasized the importance of the fee structure. In one no-action letter, the SEC staff declined to give the requested relief after determining that the proposal did not rule out the possibility of a transaction-based fee.[22]  In another, the provider, in addition to actively soliciting investors and providing advice to companies preparing offering materials, provided a fee structure that at least suggested compensation would increase as the company became “more successful in "marketing" securities to potential investors.” [23]  Following this guidance, services could conclude that the fee structure was a predominant factor in determining the obligation to register.  The SEC embraced matching services when they acted as a passive conduit that did not charge transactional fees,[24] rejecting models that involved entities with a “salesman’s stake” in the outcome.[25] 

The SEC, however, denied a no-action request that closely mirrored the facts in ACE Network where the matching service left open the possibility that fees would be “contingent upon the outcome or completion of any securities transaction resulting from a listing on [the website].”[26]  A prior interpretation that suggested a different result was characterized as having “unique facts.”[27]  The letter and subsequent pronouncements suggested that the staff generally considered online platforms that matched buyers and sellers of privately placed stock as brokers that needed to register under the Exchange Act. [28]

Along with transaction-based compensation, the forbiddance of advice to issuers, or investors, by the entity has been a significant factor in the SEC’s determination.  In ACE Network, it explicitly forbade advice about “the merits of particular opportunities or ventures.” Similar to ACE Network, it allowed a matching network that charged only administrative fees and “scrupulously avoid[ed] giving any endorsement or any evaluation of any kind.”[29]  In another letter, it confirmed that a matching service was acting as a broker because actively solicited investors and provided advice to issuers.[30]     

Quick Passage of the Portal Exemption

The exemption from the broker dealer registration for online platforms in the JOBS Act arose out of the need to assist “angel” investors.  Angel investors have been described as “serial entrepreneurs” who invest their own wealth in startup companies.[31]  They often provide funding before venture capitalists are willing to invest.[32]  For-profit online matching service portals that sought to bring together angel investors with high potential growth startups confronted the constant risk of the need to register as a broker-dealer.  The President’s Council on Jobs and Competitiveness recommended in October 2011 that “experienced and active seed and angel investors (and their meeting venues)” should be given special exemption privileges because of their wealth and business acumen.[33]   

Representative McHenry of North Carolina introduced the Portal Exemption as an amendment to the JOBS Act on March 8, 2012.[34]  Reiterating the sentiment of the report from the Council on Jobs and Competitiveness, McHenry applauded the crucial role of angel financing in funding America’s startups and thought it clear that the workings of the angel financing community “should not be subject to the regulations that were designed to protect inexperienced investors.”[35]  He explained, the exemption would enable “investors to connect with start-ups” by removing “some red tape that is within securities regulations […]”[36]

The amendment was adopted with little debate.  The legislative history contains no critical comments.  Representative Barney Frank of Massachusetts used the opposition time to describe the amendment as uncontroversial, filling out the rest of the time with other matters.[37] 

Likewise the SEC failed to register any opposition.  In testimony after the adoption of the Act, SEC Chairwoman Mary Shapiro echoed the specific nature of the provision.[38]  She called it a “narrow exemption… in connection with certain limited activities.”[39]

The Effects of the Portal Exemption Amendment

The Act clarifies that in certain circumstances online platforms do not need to register as broker-dealers.  The exemption applies to platforms that: 

permit the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person, or through any other means.[40] 

The exemption applied only to platforms offering securities exempt from registration under Rule 506 of Regulation D.[41] 

As a condition of the exemption, platforms may not receive compensation in connection with the purchase or sale of the security or hold customer funds.[42]  They may, however, co-invest in an offered security or provide ancillary services.[43] The term ‘ancillary services’ is specifically defined to include due diligence or providing standardized documents, as long as there is not a separate charge for any investment advice, recommendations or negotiation.[44]  The platform also may not be statutorily disqualified because of prior bad actions.[45]

The Portal Exemption confirms the SEC’s prior stance regarding transaction-based fees.  The platform may not charge a transaction fee, eliminating some of the “salesman’s stake.”  This is consistent with one of the factors in ACE Network.[46]  Portals can, however, charge other types of fees and can provide ancillary services.  It also overturns the SEC’s specific guidance that platforms must forgo the right to provide ancillary services as a condition for avoiding registration.[47]  

At the same time, however, the exemption left a number of questions unanswered.  Guidance from ACE Network specifically prohibited the platform from providing advice as a condition of the exemption.  The JOBS Act, however, is mostly silent on its right to provide “advice.”  The language suggests that in fact platforms may be able to provide some advice without having to register.  Platforms are allowed to provide “ancillary services,” something that does not include “investment advice or recommendations” for “separate compensation.”[48]  The language suggests that an exempt portal can provide advice but cannot charge a fee specific to that transaction.[49] 

Moreover, even if a portal cannot provide investment advice or recommendations, the boundary between this service and general solicitations will not always be clear.[50]  Advocates of crowdfunding websites have argued that portals should be able to create interest in their sites through advertising or promotional campaigns to encourage use by issuers and purchases by investors.[51]  Potential issues arise in connection with the positioning of the listing, the creation of issuer qualification standards, the deletion of online third party comments, or the creation of a portal that caters to a specific market segment of offerings.  Some flexibility may be necessary to permit portals to distinguish themselves and compete for investors.[52]

The exemption makes the economics of these platforms uncertain.  Portals can avoid the cost of broker-dealer registration, but have restrictions on the charges that they can impose.  The Portals will have to devise a compensation structure that provides sufficient profit without involving fees per transaction or separate fees for advice.  Some have read into the Act’s reference to assisting in negotiations as an opportunity to create services, further straying from the SEC’s original concept of an offerings platform on the internet from ACE Network.[53]    

The exemption ultimately clarified some uncertainties while leaving others up in the air.  Parts of the SEC’s original guidance in ACE Network were held on to.  Others, in the name of new age capital raising, were decided not to be crucial enough to investor protection.  Perhaps accelerated by recent economic conditions, the SEC’s careful oversight of the pendulum between facilitating capital raising and investor protection is swinging back a little towards the former.

 

 


       *.     J.D. Candidate 2013, University of Denver Sturm College of Law.

       [1].     Jumpstart Our Business Startups Act (JOBS Act), Pub. L. No. 112-106, 126 Stat. 306 (2012).

       [2].     15 U.S.C. § 78c(a)(4). A dealer is distinct from a broker in that they buy and sell securities on their own account. However, this distinction is often disregarded when discussing the two as a broker-dealer as they are regulated similarly.  See David A. Lipton, A Primer on Broker-Dealer Registration, 36 Cath. U. L. Rev. 899, 909 (1987).

       [3].     John L. Orcutt, Improving the Efficiency of the Angel Finance Market: A Proposal to Expand the Intermediary Role of Finders in the Private Capital Raising Setting, 37 Ariz. St. L.J. 861, 904-05 (2005).

       [4].     Oil-N-Gas, Inc. SEC No-Action Letter, 2000 WL 1119244, at *1.

       [5].     SEC v. Kenton Capital Ltd., 69 F. Supp. 2d 1 (D.D.C. 1998) (business set up to participate in securities transactions so the first one could not be called an isolated transaction).

       [6].     Oil-N-Gas, Inc. SEC No-Action Letter, 2000 WL 1119244, at *1; See also Mass. Fin. Servs., Inc. v. Securities Investor Protection Corp., 411 F. Supp. 411, 415 (D. Mass. 1976), aff'd, 545 F.2d 754 (1st Cir. 1976).

       [7].     Oil-N-Gas, Inc. SEC No-Action Letter, 2000 WL 1119244, at *1. See also SEC v. Hansen, 1984 WL 2413 (S.D.N.Y. 1984), at *10.

       [8].     Herbruck, Alder & Co. SEC No-Action Letter, 2002 WL 1290291, at *2 (2002) (“Receipt of compensation related to securities transactions is a key factor that may require an entity to register as a broker-dealer. Absent an exemption, an entity that receives securities commissions or other transaction-based compensation in connection with securities-based activities that fall within the definition of ’broker’ or ‘dealer’ generally is itself is required to register as a broker-dealer.”). 

       [9].     SEC Form BD, www.sec.gov/about/forms/formbd.pdf; 1934 Act 15 U.S.C. § 15(b)(7).

     [10].     1934 Act at 15 U.S.C. § 15(b)(8). In most cases this will be the Financial Industry Regulatory Authority (“FINRA”).  In addition, brokers must meet all state requirements in the states that they do business, join the Securities Investor Protection Corporation, meet associated persons requirements of FINRA’s by-laws, register with the Securities Information Center and register all branch offices with FINRA. See http://www.finra.org/Industry/Compliance/Registration/MemberApplicationProgram/HowtoBecomeaMember/P006271.

     [11].     1934 Act, 17 C.F.R. § 240.17a-3, 17a-4, 17a-5, 17a-11 (2012).

     [12].     1934 Act, § 15(c)(3-1,2,3) (Depending on the investing activities a broker participates in, they must generally have a net capital of at least $250,000 and maintain a ratio of net capital to aggregate indebtedness to all other persons of not more than 1500 percent.)

     [13].     1934 Act, 15 U.S.C. §§ 9a, 10(b), 15(c)(1)-(2).

     [14].     Orcutt, supra note 3, at 918. 

     [15].     IPONET, SEC No-Action Letter, 1996 WL 431821 (July 26, 1996), at *1.

     [16].     Id.  In a 2000 release, the SEC commented on Internet matching services.  It specifically noted that entities had substantially deviated from the guidance of the IPONet letter in creating new online matching services; See also Use of Electronic Media, Securities Act Release No. 7856, 2000 WL 502290 (2000), available at http://www.sec.gov/rules/concept/34-42728.htm.    

     [17].     Orcutt, supra note 3, at 918.

     [18].     ACE Network, SEC No-Action Letter, 1996 WL 636094, at *3-7 (1996). The letter proposed that listings would consist of offerings exempt from registration under Regulation A or Regulation D, Rule 504.  Companies would post a tombstone and an offering circular, and could post “testing the waters” documents.  Ultimately, it was up to the small company making the offering to comply with all applicable securities laws and verify that each investor is accredited before finalizing the deal.

     [19].     Id.

     [20].     Id. at *2.

     [21].     Id. at *7.

     [22].     Progressive Technology Inc. S.E.C. No-Action Letter, 2000 WL 1508655, at *2 (2000). (“The precise nature of all the fees that Progressive receives for these services from issuers and others is unclear.  Moreover, you have not clarified whether Progressive's fees will be made contingent upon the outcome or completion of any securities transaction resulting from a listing on SeekingCapital.com.”). 

     [23].     Oil-N-Gas Inc. S.E.C. No-Action Letter, 2000 WL 1119244, at *2 (2000). (“Among other things, Oil-N-Gas actively solicits investors to purchase oil and gas interests (for example, by targeting potential investors with direct mailings and follow-up e-mail) and provides advice to issuers on preparing offering materials for posting to the web site. The precise nature of all the fees that Oil-N-Gas receives for these services from issuers, investors, and others is unclear. However, information posted on the web site suggests that these fees will increase as Oil-N-Gas becomes more successful in "marketing" securities to potential investors.”). 

     [24].     Orcutt, supra note 3 at 919.

     [25].     Id. at 908.

     [26].     Progressive Technology Inc. S.E.C. No-Action Letter, 2000 WL 1508655, at *4 (2000)

     [27].     Id. at *2.

     [28].     See also Exchange Act Release No. 34-42728, 2000 WL 502290, at *14 (2000) (discussing online matching services and noting that “broker-dealer registration generally is required to effect transactions in securities that are exempt from registration under the Securities Act.”).

     [29].     Texas Capital Network, Inc. SEC No-Action Letter, 1994 WL 52739 (1994).

     [30].     Oil-N-Gas Inc. S.E.C. No-Action Letter, 2000 WL 1119244, at *2 (2000).

     [31].     Department of Commerce, Report to Secretary Locke: Improving Access to Capital for High-Growth Companies 7 (June 2011), available at http://www.sep.benfranklin.org/wp-content/uploads/2012/04/NACIE_Report-Access_to_Capital.pdf.

     [32].     Id.

     [33].     The President’s Council on Jobs and Competitiveness, Interim Report 20 (October 2011). 

     [34].     158 Cong. Rec. H1277-03 (daily ed. March 8, 2012) (Debate on the JOBS Act).

     [35].     Id.

     [36].     Id.

     [37].     Id.

     [38].     Testimony Concerning the "JOBS Act in Action Part II: Overseeing Effective Implementation of the JOBS Act at the SEC" Testimony to the subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs Oversight and Government Reform Committee, US House of Representatives (July 28, 2012) (testimony of SEC Chairman Mary L. Schapiro). http://www.sec.gov/news/testimony/2012/ts062812mls.htm#_ftnref1

     [39].     Id.

     [40].     15 U.S.C. § 77d(b)(1)(A) (2012).

     [41].     Id. at 77d(b)(1).

     [42].     Id. at 77d(b)(2)(A&B).

     [43].     Id. at 77d(b)(1)(B&C).

     [44].     Id. at 77d(b)(3)(A).

     [45].     Id. at 77d(b)(2)(C); 15 U.S.C.A. § 78c(a)(39) (2012).

     [46].     ACE Network SEC No-Action Letter, supra note 18 at *1 (platform agreed not to “handle funds or securities involved in completing a transaction.”). 

     [47].     Id. at *8 (platform agreed not to “directly assist investors or listing companies with the completion of any transaction, for example, through the provision of closing documentation or paid referrals to attorneys transaction, for example, through the provision of closing documentation or paid referrals to attorneys or other professional”). 

     [48].     15 U.S.C. 77d(b)(3)(A) (2012).

     [49].     The exemption for portals used in crowdfunding ventures specifically provides that the platform cannot provide advice or recommendations.  See 15 U.S.C. 78c(a)(80) (2012).  An argument could be made that, given the absence of any express language, portals in the private placement context are not subject to the same restriction. 

     [50].     The SEC has proposed a rule to allow general solicitations in certain circumstances, eliminating the prohibition against general solicitation and general advertising in rule 506 and rule 144A offerings; see Securities Act Release No. 33-9354, 2012 WL 4356706 (2012). 

     [51].     RocketHub Whitepaper, May 2012, at 18, 19 http://www.sec.gov/comments/jobs-title-iii/jobstitleiii-39.pdf; Applied Dynamite Inc. Comment Letter, May 4, 2012, at 3, 4 http://www.sec.gov/comments/jobs-title-iii/jobstitleiii-50.pdf.

     [52].     Thomas V. Powers, SEC Regulation of Crowdfunding Intermediaries Under Title III of the JOBS Act 5 (October 2012), http://m.nutter.com/files/Uploads/Documents/Banking-&-Financial-Services-Policy-Report-SEC-Regulation-of-Crowdfunding-%20Intermediaries-Under-Title-III-of-the-JOBS%20Act-October%202012.pdf.

     [53].     Kenneth Mason, New Opportunity to Participate in Capital Raises in the United States and Avoid Registration as a Broker-Dealer 11 (Summer 2012), http://www.kayescholer.com/news/client_alerts/Investment-Funds-Newsletter-Summer2012/_res/id=sa_File1/Investment-Funds-Group-Newsletter-Summer2012.pdf

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