Broker-Dealers and Crowdfunding

By Mark Roderick , CrowdFunding Beat Guest Contributor, 

The most challenging legal question in Title II Crowdfunding is who is required to be a broker-dealer and under what circumstances. The question is most acute for the officers of an issuer, those who direct the issuer’s activities and put the offerings together.

Section 3(a)(4)(A) of the Securities and Exchange Act 1934 generally defines “broker” to mean “any person engaged in the business of effecting transactions in securities for others.” Section 15(a)(1) of the Exchange Act makes it illegal for any “broker. . . .to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security” unless registered with the SEC.

Simply put, anybody in the business of effecting securities transactions for others must be registered. There is a lot of law around what it means to be “engaged in the business of effecting securities transactions for others.” Based on decided cases and SEC announcements, important factors include:

  • The frequency of the transactions.
  • Whether the individual‘s responsibilities include structuring the transaction, identifying and soliciting potential investors, advising investors on the merits of the investment, participating in the order-taking process, and other services critical to the offering.
  • Whether the individual receives commissions or other transaction-based compensation for her efforts.

Perhaps the most important rule is that the issuer itself – the entity that actually issues the stock – does not have to register as a broker-dealer. The logic is that the issuer is effecting the transaction for itself, not for others.

But what about the President of the issuer, and the Vice President, and all the other employees who send the mailings and put the deal on the website and answer questions from prospective investors? Are they required to register as – or, more accurately, become affiliated with – broker-dealers?

The answer is complicated.

SEC Rule 3a4-1, issued under the Exchange Act, provides a “safe harbor” from registration. Under Rule 3a4-1, an employee of an issuer will not have to register if she is not compensated by commissions, and EITHER:

Her duties are limited to:

  • Preparing any written communication or delivering such communication through the mails or other means that does not involve oral solicitation of a potential purchaser, as long as the content of all such communications are approved by a partner, officer or director of the issuer; or
  • Responding to inquiries of a potential purchaser in a communication initiated by the potential purchaser, as long as her response is limited to providing information contained in an offering statement; or
  • Performing ministerial and clerical work.


  • She performs substantial services other than in connection with offerings; and
  • She has not been a broker-dealer within the preceding 12 months; and
  • She does not participate in more than one offering per year, except for offerings where her duties are limited as described above.

Consider the President of the typical Title II portal offering borrower-dependent notes to accredited investors. Her duties are certainly not limited as described above, and she might participate in – actually direct – dozens of offerings per year. Does that mean she has to register as a broker-dealer?

Not necessarily. Rule 3a4-1 is only a safe harbor. If you satisfy the requirements of Rule 3a4-1 then you are automatically okay, i.e., you don’t have to register. But if you don’t satisfy the requirements of Rule 3a4-1, it doesn’t automatically mean you are required to register. Instead, it means your obligation to register will be determined under the large body of law developed by the SEC and courts over the last 80 years.

Courts and the SEC have identified these primary factors among others:

  • The duties of the employee before she became affiliated with the issuer. Was she a broker-dealer?
  • Whether she was hired for the specific purpose of participating in the offerings.
  • Whether she has substantial duties other than participating in the offerings.
  • How she is paid, and in particular whether she receives commission for raising capital.
  • Whether she intends to remain employed by the portal when the offering is finished.

Within the last couple years, a high-ranking lawyer in the SEC spoke publicly but informally about broker-dealer registration in the context of private funds, an area similar to Crowdfunding in some respects. He expressed concern at the way that some funds market interests to investors and suggested that some in-house marketing personnel might be required to register. At the same time, he suggested that an “investor relations” group within a private fund – individuals who spend some of their time soliciting investors – wouldn’t necessarily be required to register if the individuals spend the majority of their time on activities that do not involve solicitation. On one point he was quite clear: the SEC believes that if an individual receives commissions for capital raised, he or she should probably be registered.

Whether an officer or other employee of a Crowdfunding issuer must register as a broker-dealer will be highly sensitive to the facts; change the facts a little and you might get a different answer. With that caveat, I offer these general guidelines:

  • If an employee receives commissions, he has to register no matter what.
  • If an employee performs solely clerical functions, he does not have to register.
  • If an employee participates in only a handful of offerings, he does not have to register.
  • If an employee spends only a small portion of his time soliciting investors, he does not have to register.
  • If an employee advises investors on the merits of an investment, he’s walking close to the line. Describing facts, especially facts that are already available in an offering document or online, in response to an investor inquiry, doesn’t count as advising investors on the merits of an investment.

Here are two corollaries to those guidelines.

  • As long as he’s not paying himself commissions, the Founder and CEO of an issuer that is a bona fide operating company (not merely a shell to raise money) doesn’t have to register.
  • If the CEO hires Janet to solicit investors, and that’s all Janet does, and she speaks regularly with investors over the phone and helps them decide between Project A and Project B, the SEC is probably going to want Janet to be registered.

Of course, the most conservative approach for Crowdfunding issuers to run every transaction through a licensed broker-dealer. However, that adds cost and most issuers are trying to keep costs down.

This area is ripe for guidance from the SEC, and maybe even a new exemption for bona fide employees of small issuers. Stay tuned.

Written by

Mark Roderick

For more information on Crowdfunding, including news, updates and links to important information pertaining to the JOBS Act and how Crowdfunding may affect your business, follow my blog, or twitter handle: @CrowdfundAttny.

This article was also publish on this site

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