Thursday, January 02, 2014

Non-Financial Companies Should Not Operate Crowdfunding Portals

I attended a holiday party last month where one of the nameless wheeler-dealer types in attendance bragged that his technology company was planning to launch a crowdfunding portal.  His logic was that developers using his startup's tech could help build their ecosystem by attracting investment partners.  He shrugged his shoulders when I told him that FINRA regulates portals and will probably mandate more formal affiliations.  I was really put off by his nonchalance.  Needless to say, he never followed up with me but eagerly took business cards from suckers in attendance.

That conversation left me wondering whether it is appropriate for a non-financial company to own and operate a crowdfunding portal independent of a broker-dealer.  I totally understand the need for technology companies to develop ecosystems of partners and developers.  That's what enables app stores' success.  The difference is that app stores merely display retail products and don't raise investment capital.  An app store is not a fundraising platform for companies offering ownership of their future revenue.

FINRA is still soliciting interim funding forms from portals.  These animals called "crowdfunding portals" still don't have the SEC's equivalent of a zoological classification.  That allows everyone and their cousin to create their own platforms from white-label technology providers like Launcht with no regulatory supervision.  The first lawsuit from a disgruntled investor who invested through an unregistered crowdfunding portal run by a non-financial company will ruin the operations of every other portal that didn't seek FINRA registration or brokerage affiliation.  The portals that don't take those steps may be ignorant of the auditing and recordkeeping requirements that come with fiduciary duties for investors.

I almost phrased the title of this article as a question:  Should non-financial companies operate crowdfunding portals?  I decided that I had to come down firmly on the "no" side of that question because that's the only way I can think of to protect investors from predators running baloney portals.  It's the Wild West out in crowdfunding land and these tumbleweed towns called portals really need a sheriff.  The SEC proposed a 585-page crowdfunding regulation last October and it is still not finalized.  Portal operators need to read the fine print of this soft law starting right now.  It currently exempts portals from registering as brokers and allows them to collect "success fees" instead of brokerage commissions.  I don't know what the final regulation will say but there's a lot of minutiae buried in those 585 pages that will trip up anyone not paying attention.

The freewheeling dude I met was with a tech startup that does not have the internal risk management and recordkeeping architecture common to financial service providers.  Anyone who thinks companies making software and hardware can run their own portals is in for a rude awakening when financial regulation compliance smacks their company hard.