FINRA Proposes Crowdfunding Portal Rules and Related Forms

by Holland & Knight LLP
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On October 23, 2013, the Financial Industry Regulatory Authority (FINRA) issued proposed rules and forms regarding crowdfunding through funding portals. The proposed rules, which reflect rules recently proposed by the SEC, are generally more simplified versions of the current rules governing FINRA members.

General Standards

Proposed Funding Portal Rule 100 provides that FINRA By-Laws and Funding Portal Rules apply to all funding portal members, including both the funding portal and all "associated persons." This rule also modifies certain definitions to apply to funding portal members.

Funding Portal Application

Proposed Funding Portal Rule 110(a) sets forth a membership application process for funding portals. The rule is a simplified version of the current National Association of Securities Dealers (NASD) Rule 1010 Series membership rules for broker-dealers.

As compared to the rules for broker-dealers, the proposed Funding Portal Rule 110(a):

  • shortens the timeframes for key events; for example, the timeframe for the Department of Member Regulation to approve or deny a funding portal membership application process (MAP) form is 60 days, as opposed to 180 days for broker-dealers
  • streamlines and consolidates the standards for granting or denying an application (from 14 standards to 5 standards); the five standards address a portal’s (1) ability to comply with the applicable federal securities laws, rules and regulations, and FINRA’s Funding Portal Rules; (2) contractual or other arrangements and business relationships necessary to initiate operations; (3) supervisory system; (4) direct and indirect funding sources; and (5) recordkeeping system
  • provides that the membership interview may be conducted by videoconference or other means as FINRA may specify
  • streamlines the process for appealing a denial of a MAP application by reducing applicable filing and response timeframes from 25 days to 14 days and eliminating provisions for an appeals hearing
  • narrows the changes in ownership or control for which a funding portal member would be required to apply for approval

The proposed forms for funding portals require significantly less information than their counterpart broker-dealer forms.

Funding Portal Conduct

Proposed Funding Portal Rule 200(a) requires a funding portal member to observe high standards of commercial honor as well as just and equitable principles of trade. The rule is based in large part on FINRA Rule 2010.

Proposed Funding Rule 200(b) prohibits a funding portal member from effecting any transaction in, or inducing the purchase or sale of, any security by means of, or aiding and abetting, any manipulative, deceptive or other fraudulent device or contrivance. The rule is based in large part on FINRA Rule 2020.

Proposed Funding Portal Rule 200(c) essentially prohibits false and misleading statements and is an abbreviated version of FINRA Rule 2210.

Funding Portal Compliance

Under proposed Funding Portal Rule 300(a), a funding portal member will be required to establish and maintain a system to supervise activities of associated persons. It must be reasonably designed so as to maintain compliance with applicable securities laws, regulations and the Funding Portal Rules. This is a streamlined version of current NASD rules regarding supervision (NASD Rule 3010).

Proposed Funding Portal Rule 300(b) contains anti-money laundering (AML) provisions consistent with the SEC’s proposed requirements and Chapter X Title 31 of the Code of Federal Regulations. The proposed rule requires funding portals to maintain a written AML program; however, the proposed rule permits funding portals to conduct the required independent testing for compliance every two years, as compared with the annual testing requirement stipulated in FINRA Rule 3310.

Proposed Funding Portal Rule 300(c) requires funding portal members (and associated persons) to report to FINRA (or to the member) regulatory proceedings, disciplinary and other events using Funding Portal Rule 300(c) Form.

Proposed Funding Portal Rule 300(d) requires funding portal members to report to FINRA all contact information required by FINRA through such means as FINRA may specify and to promptly update their required contact information.

Investigations and Sanctions

Proposed Funding Portal Rule 800(a) would subject funding portal members to FINRA rules regarding investigations and sanctions (FINRA Rule 8000 Series) unless the context requires otherwise. FINRA has the obligation to make available to the public any information filed by a funding portal member indicated whether the funding portal member or any associated person of the funding portal is subject to statutory disqualification.

Arbitration and Mediation: Funding Portal Rule 1200

Proposed Funding Portal Rule 1200(a) subjects funding portal members to FINRA code of arbitration procedures for customer disputes (FINRA Rule 12000 Series), FINRA code of arbitration procedures for industry disputes (FINRA Rule 13000 Series), and FINRA code of mediation procedures (FINRA Rule 14000 Series), unless the context requires otherwise.

Paragraph (b) of the proposed rule is a simplified version of FINRA Rule 2268, which addresses the use of pre-dispute arbitration agreements for customer agreements. The comment period on the proposed rules expires February 3, 2014.

Regulatory Notice:

http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/
p370743.pdf

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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