Tag: Legal

Private Capital Market Regulations – 10 RegA+ Issuers Penalized for SEC Violation: What Can We Learn?

Posted on by Oscar Jofre

The Importance of Compliance in Private Capital Market Regulations

We’ve discussed compliance at length and how it’s essential for building trust within the private capital markets. But what happens when you’re not compliant?

The SEC will eventually find out and impose penalties to issuers that fail to meet securities regulations, as ten Regulation A+ (RegA+) issuers recently learned.

These recent violations can serve as a cautionary tale to issuers about the importance of adhering to Private Capital Market Regulations.

Regulation A+ and the SEC’s Oversight

Companies selling securities to raise capital generally have to register with the SEC and comply with other rules that can be expensive and onerous for smaller companies, so RegA+ allows exemptions from registration, provided certain other conditions are met. In its press release, the SEC announced that 10 RegA+ issuers failed to comply with these conditions, highlighting the challenges within Private Capital Market Regulations. The SEC reported that each issuer was previously qualified to sell securities under RegA+, but subsequently made significant changes to the offering so that it no longer met exemption requirements. These changes included “improperly increasing the number of shares offered, improperly increasing or decreasing the price of shares offered, failing to file updated financial statements at least annually for ongoing offerings, engaging in prohibited at the market offerings, or engaging in prohibited delayed offerings.”

Private Capital Market Regulations: Protecting Investors and Market Integrity

These regulations are not just arbitrary demands by the SEC; they exist to protect investors and the integrity of the system as a whole. For example, changing the offering price without getting those changes cleared by the SEC is a concern because it could be a vector for fraud or money laundering; issuing securities for a different price conceals the actual amount of money changing hands. Similarly, making unsanctioned changes to offering terms can erode investor confidence. Ideally, each investor conducted their own due diligence before investing – they felt comfortable with the terms listed in offering documents qualified by the SEC. Changing these terms without notifying investors and having changes approved by the SEC just isn’t fair play, and underscores the critical role of Private Capital Market Regulations.

The Consequences of Non-Compliance

The ten issuers cited by the SEC violated these principles, and got caught. Each company agreed to stop violating the Securities Act, and to pay civil penalties that ranged from $5,000 to $90,000. In the press release, Daniel R. Gregus, Director of the SEC’s Chicago Regional Office was quoted saying: “Companies that choose to benefit from Regulation A as a cost-effective way to raise capital must meet its requirements,” reinforcing the significance of compliance with Private Capital Market Regulations.

These penalties serve as a reminder that issuers must be careful when making changes to their offering after qualification. Working with an experienced team can help to mitigate some of this risk, but ultimately, it is the issuer’s responsibility to meet all securities regulations, including those pertaining to Private Capital Market Regulations. And as with most things, 90% of the job is preparation.

How not to fall into the wrong with the regulators checklist

  • Always check with your securities lawyer and FINRA Broker-Dealer who did your RegA+ filing before making any public statements, news releases, or announcements related to investment in your company, as these might be construed as offerings subject to SEC rules and Private Capital Market Regulations;
  • Track all your activities date, time, where distributed
  • Be thoroughly familiar with your company, its business, and how it is structured.
  • Have a clear idea of your company’s funding needs, how much capital you need to raise, what kind of equity or control you are prepared to give up in return
  • Seek advice from qualified experts: securities lawyers, broker-dealers, accountants; being familiar with your own company will help you answer their questions and get better advice.
  • Choose the right capital-raising route for your needs, whether it be a bank loan, remortgaging your house, or using one of the JOBS Act exemptions.
  • READ THE REGULATIONS! Seriously, read the regulations, and any explanatory notes from the SEC on how they apply and what you need to do to comply.
  • Make notes about the parts you’re not sure about, and ask your experts how they apply to you.

It may turn out that the exemption you initially chose isn’t the right one for your needs, so be prepared to go back and change your plans. It’s much easier to change plans before they’re implemented than it is to have to fix something that’s gone wrong with the implementation.

Once you’re satisfied with the regulation you’ve chosen, make a list of all the things you’ll need to do to carry out a compliant and successful raise. You might do this yourself, or with the assistance of your experts, but in any event you should have your experts review it to see if you’ve got anything wrong or left anything out. Execute the plan. You may need to delegate some of the items on the list to others, but ensure that there is always someone accountable to sign off on the completion of every requirement. Maintain a paper trail of who did what and when, not so much to know whom to blame but to be able to identify where something went wrong and how to fix it. Don’t panic. Mistakes happen.

What is Rule 145?

Posted on by Oscar Jofre

The Securities Act, passed in 1933, was created to protect investors following the stock market crash in 1929. It offers protection by ensuring more transparency and creating laws against fraud in the capital market. The Securities Act also requires companies to be registered with the SEC to sell securities to investors. At the same time, the SEC has introduced certain exemptions like Regulation A+ and Regulation CF, which allow private companies to raise capital without having to go through the process of SEC registration.

 

Another exemption is Rule 145, which “registered transactions in connection with reclassifications of securities, mergers or consolidations, or transfers of assets”. This is an especially important rule to be aware of for startups, as possible exit opportunities could include an acquisition. 

 

Ultimately, the rule says that if shareholders vote to accept or reject a merger proposal, it is considered an investment decision with respect to the offer of the acquiring company’s shares. When a company wants to purchase another company that has investors from previous rounds of crowdfunding, it must register its offering under the Securities Act or comply with one of its exemptions such as Regulation A, Regulation D, or Regulation CF. 

 

In addition, Rule 145 requires that all shareholders must approve the merger and receive full disclosure about the terms of the deal before they vote. Some states may also require shareholders with non-voting rights to cast their votes, as they are awarded certain inalienable voting rights in some scenarios. 

 

If the acquirer is not a public company, registration of securities is typically a costly process. However, they can utilize Reg A+ if they have an offering active that can be amended. Regulation D is typically not utilized because investors from a Reg CF raise are likely to include many nonaccredited investors. Alternatively, some companies may opt to use Regulation CF. However, this option will not work if there are already more than $5 million worth of crowdfunding investments from previous rounds. Ultimately, these considerations must be made well in advance so that all shareholders are given proper notice and have enough time to make an informed decision about whether or not to approve the merger agreement before it takes effect.

 

And in some cases, the acquiring company was unable to offer shares to crowdfunding investors, requiring them to cash out these investors. However, many investors believed in the company’s vision and were interested in the long-term progress of the company, so a cash-out can be disappointing. At the same time, a cash-out may be difficult for companies without the available funds. 

 

For companies exploring an acquisition for a potential exit after previous rounds of crowdfunding, these are some of the things that need to be taken into consideration. Just as a securities lawyer can help with initial offerings, they can also help you navigate these types of exits so you can do so compliantly. 

How Can a Foreign Company use RegA+

Posted on by Oscar Jofre

For many issuers outside of the United States, the ability to raise capital from a wide pool of investors, including “the crowd” is immensely compelling. However, for foreign issuers to be able to use RegA+, there are some important considerations to keep in mind.

 

First and foremost is whether the company would be eligible to offer securities to U.S. investors. Foreign companies should seek the advice of qualified legal counsel to ensure compliance with all applicable U.S. laws and regulations. Additionally, foreign companies should consider the costs associated with making a public offering under RegA+ and the ongoing reporting requirements imposed on the company if it elects to use this securities exemption.

 

Benefit from RegA+ as a Foreign Company

 

The benefits of using Reg A+ for foreign companies are tremendous. Perhaps most importantly, RegA+, as a securities exemption, allows companies to raise $75 million from non-accredited investors. The exemption also enables issuers to “test the waters” concerning interest in their securities before officially launching the offering

 

Using RegA+ as a Foreign Company

 

It is vital first to understand the process and what is required when looking to do a RegA+ raise. Foreign companies should be aware of the following when using RegA+:

 

  • The company must be registered as a US company with a principal place of business in the US.
  • The company must have two years of audited financial statements.

 

While RegA+ offers a foreign company a simplified path to raising capital in the United States, several requirements still need to be met for the offering to be successful. These requirements include:

 

  • Filing a Form 1-A with the SEC.
  • Passing an SEC review process.
  • Engaging a US-based registered broker-dealer.
  • Disclosing all material information about the company and the offering.

 

However, like any method of raising capital, RegA+ may not be suitable for all foreign issuers. This makes it incredibly important to engage a knowledgeable team that can guide issuers through the process.

 

Foreign Investors Key Considerations for Your Next Deal

Posted on by Nate Dodson

This post was originally written by our KorePartners at Crowdfunding Lawyers. View the original post here. 

 

When discussing fundraising for your deals, most of our attention has previously focused on U.S. citizens investing their own money. That’s to be expected, but it’s important not to overlook another potential funding source: foreign investors. This article will explore what you should know about working with foreign investors in the U.S. and their potential impact on your deal.

Foreign Investors in the U.S.

Foreign investors are those individuals or companies outside of the United States who invest their money into U.S.-based businesses. And foreign money can be great. But, of course, there are advantages and disadvantages to know here and some pretty important restrictions.

How Foreign Investments Work

Before we dive into how these investments work or the pros and cons of foreign investments, we should touch on the restrictions put in place by the U.S. government. You’ll find that they’re twofold. First, there are restrictions set out by the country’s government in which you’re raising funds that you need to consider, as well as those applied by the U.S. government. Second, there are also regulations regarding how much money can be raised from foreign investors.

Foreign Investment Regulations

Each country has its own rules regarding investments. It is your responsibility to investigate what those are and how they may impact you, your investors, and the money that you raise. Some factors to consider include how much money you’re raising and the level of involvement between citizens of foreign countries.

It’s important to stay in legal compliance within all countries, which means you need to know the true cost of remaining completely legally compliant within each’s borders. In some cases, you may find that it is simply too expensive to develop a feasible plan. For example, suppose you’re raising a small amount of capital in a foreign country to transfer to the United States, and you’re not being fraudulent. In that case, complying with local securities laws might be somewhat cumbersome.

Too often, those raising funds focus more on securities laws here in the United States rather than in the other country, but this can hamstring you.

Limitations on Who Can Invest

In addition to the laws governing investments in the other country, you’ll also need to consider our domestic Office of Foreign Assets Control, or OFAC, here in the U.S. This organization determines which foreigners can invest and which ones should be blocked. In some cases, the OFAC focuses on the individual or the nation in question. In other instances, their review centers on the foreign country and the investment amount.

For instance, if an investor has 15% of greater assets in North Korea, Iran, Syria, and some other countries, they cannot invest here in the U.S. Again, you will need to check the OFAC website to see who is on the blocked persons list.

This is all part of getting to know your investors. It’s an enormous risk, but it can be potentially rewarding. You don’t want to take any money from people that you shouldn’t be because it can lead to problems beyond the scope of securities law.

Of course, these rules are implemented with good reason. They help ensure that you’re not taking money from a terrorist, helping someone launder money, for instance.

U.S. Securities Laws

We’ve touched on these briefly, but they bear deeper scrutiny. U.S. securities laws have a significant role to play when it comes to foreign investors. For instance, we have a law called “Regulation Asks,” which states that the securities laws for foreign investors don’t apply because they’re foreigners to the SEC. Regulation S states that if you investors are outside the country, most securities laws do not apply.

With that being said, if you commit fraud in any way, dealing with foreign investors will not prevent the SEC or any other authorities from investigating you and your investors. So it’s important to avoid the assumption that Regulation S protects criminal behavior – you should always do the right thing.

However, this brings up an important point. Since securities laws may not apply the same way to foreign investors that they do to U.S. investors, are you still required to provide disclosure? Absolutely, yes. The best path forward is to comply with Reg D as much as possible because then at least you’re providing proper disclosure to your investors and not taking advantage of the vulnerable out there.

Potential U.S. Tax Implications for Foreign Investment Deals

The tax situation is never simple, and adding foreign investors to the mix can muddy the waters a great deal. The tax consequences here can be substantial because when you add foreign investors to the mix and operate as an LLC, there’s pass-through taxation.

You will also have to deal with increased IRS scrutiny. The IRS is extremely worried about what your foreign investors will do – will they take their earnings and leave without paying taxes? Ultimately, you are responsible for their actions. This can mean that if a typical deal requires approximately 30% in withholdings, you should withhold the proper amounts from your investors’ earnings and pay it to the IRS on their behalf.

We also have FIRPTA, the Foreign Investment in Real Estate Property Tax Act of 1980. It requires you to withhold 15% from investors’ returns, although you should check with your tax specialists on the sale of real estate for any distributions that will go to foreign investors.

Avoiding Tax Complications with Foreign Investors

There are a lot of potential downsides to working with foreign investors. So how can you avoid them? Just don’t take on any. How do you avoid them, though?

It just comes down to requiring foreign investors to create their corporation or LLC within the U.S. This ensures that you’re able to let them into the deal, and you no longer have to worry about taking 45% of their returns and transmitting them to the IRS. You’ll also be able to deduct all of their expenses and losses against their income since they won’t be considered “pass-through” entities.

In addition, you can set up a separate bank account for each investor, and ensure that they only receive payments through that account. That way, you can keep track of who has paid what and make sure that everyone pays their fair share.

So, while it might seem like a good idea to work with foreign investors, you need to think twice before doing so. If you do decide to go ahead with it, you’ll need to consider these issues carefully and consult with a skilled attorney.

The Canadian Exemption

While the rules we’ve discussed here apply to investors from most nations, there is an exemption for Canadian investors under certain circumstances. The U.S. maintains a treaty with Canada that states these investors are not subject to the tax withholdings we just talked about. That means Canadian investors can be taken on without too much worry, at least about tax withholdings, with one caveat – you must have a limited partnership and cannot use an LLC or C corp or any other business formation option.

If you wish to work with Canadians, you’ll need to set up a limited partnership to receive their investment. If you choose to do so, make sure you understand all the risks involved with doing so.

The Big Questions to Consider When Taking on Foreign Investors

We’ve covered a lot of ground here in a short time. So, to sum up, let’s go over the big questions you’ll need to answer when you consider taking on foreign investors within your deal.

  • Are they from a country subject to sanctions, like North Korea, Syria, Iran, or Russia? Note that this list changes from time to time as sanctions are placed and lifted. Always check the OFAC list to ensure that your investors are clear about bringing their money into the U.S.
  • Are you following the securities laws of the other country? Are you doing enough business in that country that you need to be concerned about these laws?
  • Are you complying with U.S. tax rules as they pertain to your deal? For example, are you withholding the proper amount and remitting it to the IRS? If not, you’ll be held responsible unless your partners are American entities or have an exemption.

Do you understand all the risks involved in dealing with foreign investors? Do you know where to find information about each country? Is your legal team familiar with international law? These are all things you’ll need to think through before you sign off on any deals and it’s important to consult with an experienced attorney to help guide you

How Do I Get Foreign Investors Involved in My Deal?

If you want to attract foreign investors, you’ll need to make sure that you’re meeting their needs. To start with, you’ll need to understand why they would invest in your project. What are their goals? What are their motivations?

You’ll then need to determine if you can meet those goals and motivations. Can you provide them with something unique? Something that’s hard to find elsewhere? A good place to start is by looking at what you offer and comparing it to what others offer.

Once you’ve determined that you can meet their needs, you’ll need to figure out how to get them involved. There are two ways to approach this. One is to simply ask them to invest directly. They will likely require some sort of equity stake in your company. In exchange, they’ll receive a return on investment (ROI) based on the success of your venture.

Alternatively, you may choose to take a more traditional route. You can form a limited liability company or corporation, and invite them to join as shareholders. Their shares will be treated as income-generating assets, which means they’ll pay taxes on their share of profits. This is also known as “passive” investing.

In either case, you’ll need to know the law in both countries so that you don’t run afoul of local regulations. We’ve already touched on this briefly, but it bears repeating. Be aware that you may be required to register as a broker-dealer, and comply with all applicable federal and state securities laws.

What Happens After I Take On Foreign Investors?

Now that you’ve got investors, you’ll need a plan for managing them. How do you keep them happy while still keeping your own interests protected? You’ll need to set expectations early on. Make sure everyone understands what they’re getting into.

One thing to remember is that you’re dealing with people who have different levels of experience. Some may be new to investing, while others may have been around the block many times before. It’s important to make sure that everyone understands the risks involved.

As you go through the process, you’ll also want to make sure that you have a clear understanding of the terms of the agreement. For example, you should know whether you’re going to issue stock, sell debt, or use other financing methods. As we mentioned earlier, you’ll need to be prepared to deal with taxes. If you’re issuing stock, you’ll need to decide whether you’re going to treat the shares as long-term capital gains or short-term capital losses.

Finally, you’ll want to make sure that your business plan takes these things into account. You’ll need to consider how you’re going to finance the project, how you’re going to manage risk, and how you’re going to handle any potential legal issues.

In Conclusion

In the end, working with foreign investors is a tricky situation, but with proper guidance from both experienced tax and legal professionals, it can be profitable for both you and your investors.

KorePartner Spotlight: Nate Dodson, Managing Member at Crowdfunding Lawyers

Posted on by Oscar Jofre

Nate Dodson has over 15 years of experience helping clients with securities, financing, real estate, asset protection, and mergers and acquisitions. Not only has he served as an advisor in real estate transactions, financing, and investments, but he has also successfully developed ground-up commercial properties and participated on the GP side of approximately 4,000 multifamily units over the years.

Before his legal career, Nate worked as a stockbroker, giving him unique experience in investment sales, structures, and asset protection. By leveraging his industry expertise and the help from his long list of trusted connections, he has personally represented over $2 billion in real estate and business funding transactions over the years. While Nate’s full-time efforts are focused on the securities practice with and management of Crowdfunding Lawyers, he remains a partner at his diversified namesake law firm Dodson Legal Group, founded in 2007 and focusing on transactional, litigation, and family law work. Between both firms, their experienced legal teams have represented more than $5 billion in transactions.

Crowdfunding Lawyers is a boutique law firm focusing exclusively on representing securities transactions across the United States. As a specialty-focus law firm, the firm works with investment sponsors/operators and their advisors to develop capital funding strategies, investment offerings, and securities platforms. By taking a unique team-based approach to the firm’s client services, their clients work with a multitude of experienced, dedicated securities attorneys in the representation of Regulation D, Regulation A, Regulation CF, and S1/S3 public (IPO) offerings. The firm has provided services to 1,000+ clients, and its attorneys have, with CFL or through prior engagements, many billions in capital transactions over their respective careers. Because Crowdfunding Lawyers’ focus is limited to federal securities laws, they regularly coordinate with local attorneys and tax counsel to ensure well-rounded representation for clients. However, the firm’s attorneys have considerable experience in real estate, business, regulatory, and finance transactions and activities.

Nate’s experience with crowdfunding makes him a valuable addition to the KoreConX ecosystem. He is passionate about providing regulatory clarity across jurisdictions to ensure raises are compliant and efficient. His ultimate goal is to help investors and businesses succeed in the digital age.

We took some time to speak with Nate and learn more about himself, his organization, and his thoughts on the future of crowdfunding.

What services do Crowdfunding Lawyers provide for Regulation A offerings?

We handle the legal process from beginning structuring throughout the qualification process for Regulation A offerings. We never expect our clients to come to the table with anything other than their plans and ideas. After structuring, we draft all the documents and form any needed entities. Our goal is to file Form 1-A with the SEC within 45 days of engagement.

Because our services are comprehensive, we’ll start with consulting on our client’s business plans and advise the best strategies and structure for funding through a Reg A offering. We also introduce our clients to great vendor partners and team members, like KoreConx.

To meet our self-imposed 45-day timeline, we ensure that we have complete information, including broker-dealers, if involved, or financial audits and introductions are made when appropriate.

How is a partnership with KoreConX the right fit for your company?

We love working with KoreConX and refer to them regularly to serve as the transfer agent for our Reg A offerings. It is essential to have a good transfer agent system involved, as they manage your investors and investment opportunity administration.

KoreConX is not an attorney. Crowdfunding Lawyers is not a transfer agent. Both are necessary for your success with your Regulation A offering.

What excites you about this industry?

Our entire team has a passion for the investment industry, but we’re not a diversified firm. We have a team of very qualified attorneys that solely focus on securities transactions. All of our attorneys come from prestigious law schools and have worked in the legal field for years. If they are newer in the securities realm, it’s only because they have so much experience in startups, entrepreneurship, real estate, investing, and corporate law. Our attorneys have similar impressive pasts and a drive for our client’s success. 

As an example, I worked as a stockbroker until the internet stock bubble burst around 2000, selling investments on the phones before crowdfunding became available after the JOBS Act of 2012.

What services do Crowdfunding Lawyers provide that are different?

We always spend substantial time in the initial stages of representation, where we get to know our clients and their business. We strive to structure your opportunity so that you can meet both market expectations as well as investor expectations, and our client’s primary goal is to get funded faster.

While we focus heavily on real estate funds and syndications, approximately one-third of our clients are focused on business and investment funds. With our real estate fund representations, we often represent Regulation A offerings for REITs (Real Estate Investment Trusts) and series LLC offerings. Our clients can replicate their traditional syndication model with Reg A series offerings by breaking down the Regulation A offerings into unique project-specific classes. This is where our clients can continue to offer a real estate syndication model with all the benefits of placing offerings through Regulation A, which is a different twist on setting up a $75 million blind-pool fund.

 

What is KYP?

Posted on by Oscar Jofre

Previously, we have talked about KYC or Know Your Client. KYC is a rule from the non-profit Financial Industry Regulatory Authority (FINRA), created in the United States in 2007, in response to the growing fears of economic collapse that could come from underregulated securities firms. One part of the FINRA rule set created in 2012 is KYC (Rule 2090). Another is Rule 2111 (Suitability). It is important to mention both of these rules, as the topic for today, KYP, or Know Your Product, directly relates to them in their effort to protect investors. 

 

The KYC rule dictates that in the event of opening or maintaining an account for an investor, a broker-dealer is required to verify the investor’s identity by matching the provided material from the investor to government records. This aids the government in fighting money laundering and other financial crimes, as a broker-dealer must also review their finances for evidence of these types of crime. It also allows potential customers to evaluate broker-dealers as FINRA tracks the brokers in good standing with their organization. Finally, with suitability, a broker-dealer must use reasonable effort to understand the risk tolerance and facts about a potential customer’s financial position. This means understanding the types of products and plans an investor is comfortable making, as people of different ages and levels of wealth have different plans for their money. For instance, younger adults typically have a higher risk tolerance as they have a longer-term time horizon to work with their money. On the other end, older adults have lower risk tolerance. There is no one type of investing that works for every person, as each person has a different set of circumstances dependent on their life experiences. 

 

Where KYP comes in is a further step past just KYC and suitability. You may know the client their investment preferences, but if you do not understand the product you are investing in for your client, that information is essentially useless. Under KYP, a broker-dealer, “must understand the structure and features of each investment product they recommend. This includes costs, risks, and eligibility requirements. The KYP requirement applies to both the firm and the individual.“

 

KYP expands on the suitability requirement from FINRA by requiring a full understanding of each investment so that it fits an investor and their specific risk tolerance more effectively. This involves:

 

  • The risk level of the investment, meaning its liquidity, “price volatility, default risk, and exposure to counterparty risk” 
  • Any costs associated with fees or embedded costs
  • The financial history and reputation of the issuer or parties involved
  • Any legal and regulatory framework that applies

 

Just as it is important to know your client and understand what types of investments are suitable for regulatory and business purposes, it is important to understand the products you recommend. 

What is the Difference Between Fiduciary Responsibility and Regulatory Requirement?

Posted on by Oscar Jofre

By definition, a fiduciary is a person or an organization who holds a legal or ethical relationship of trust with another person or organization. Typically, this has to do with the responsibility or duty in a financial sense. As an adjective, it gets defined by the Oxford dictionary as “involving trust, especially with regard to the relationship between a trustee and a beneficiary.” The word gets most commonly used when stating that a company has a fiduciary duty to its shareholders. In practice, this means that the company has an ethical and legal responsibility to act in the best interest of its investors. For example, the company and its executives need to protect a shareholder’s financial investment in that company and is an example of a duty of loyalty. Included also is a duty of care, which indicates that a fiduciary will not back away from their responsibility.

 

Fiduciary duties do not just relate to the financial sector. For example, a lawyer has a fiduciary duty to their client to act in their best interest, but we will focus on the financial sector. Fiduciary responsibility in finance is a relationship between two non-governmental entities. In contrast, a regulatory requirement is a rule that a government or government-related organization imposes and enforces onto an organization.

 

Many governmental organizations impose regulations on the financial sector, like the Office of the Comptroller of the Currency or the Federal Reserve Board. The governmental-related organizations are the Financial Industry Regulatory Authority (FINRA) and Securities and Exchange Commission (SEC). We have previously discussed the regulations passed by both FINRA and the SEC in preceding blogs, which detail those processes well.

 

Both fiduciary responsibility and regulatory requirements can result in legal action if there is a breach in conduct, but the actors and stage are different. With fiduciary responsibility, the beneficiary of the fiduciary duty would file suit against the trustee in civil court who knowingly or unknowingly failed in their duty. This is a relationship between non-governmental actors, so in this case, a person litigating against an organization or vice versa.

 

On the other side, regulatory requirement gets dictated by a government entity like the SEC or OCC suing a company or individual for failing to comply with the law. This suit would land in criminal court, with punitive fines, damage to their reputation, and sanctioning. For example, in California, you need to be a registered broker-dealer for a Regulation A+ offering. If you decide as a company to ignore this law, the state regulator can, and will, require you to return all money raised, and you can get barred from raising money in the state. You will get labeled as a bad actor, which will damage the reputation of your business.

 

While fiduciary duty and regulatory requirements are different in terms of the responsibilities, actors, and negative consequences involved when failing to comply, they are critical to follow and maintain.

Why are Background Checks Important?

Posted on by Oscar Jofre

Money laundering is a global issue, with the United Nations estimating that between $800 billion and $2 Trillion are laundered each year, with 90% of this estimation remaining undetected. Money laundering is the act of taking money obtained through illegal activities and then introducing it into the system to legitimize or clean it and then make use of it. Originally, and most often, this was applied to the actions of organized crime but has expanded to included tax evasion or false accounting. 

 

The United States has multiple laws to prevent this type of activity and reclaim the illegitimate assets from criminals aiming to circumvent the system. Many of these laws directly affect the financial institutions of the nation. American banking and investment businesses need to follow compliance regulations that help in the effort to combat money laundering, including FINRA’s (Financial Industry Regulatory Authority) Rule 2090 (KYC or Know Your Client). The Know Your Client rule was introduced by FINRA to require broker-dealers to use reasonable effort to verify the identity of customers (or any other account owners) and assess their risk level. Part of this goal is to add transparency to the financial institutions in America, especially following the 2007-2008 financial crisis, and incorporate Anti-Money Laundering (or AML) compliance into the structure of our institutions.

 

AML and KYC are extensions of the Bank Secrecy Act and the CDD (Customer Due Diligence) Rule. The act, created in 1970, aims, as the Financial Crimes Enforcement Network states, “to improve financial transparency and prevent criminals and terrorists from misusing companies to disguise their illicit activities and launder their ill-gotten gains.” So, through the Know Your Client rule, broker-dealers must evaluate the information provided by a potential customer and verify their identity against government documents and assess the risk level they pose towards financial crime. 

 

This activity is a check for any indication of money laundering or terrorism financing. Part of this is a background check or a customer screening, checks beyond their identity. Using the customer’s identity, financial institutes check against various lists, like sanction lists, watch lists, and PEP lists to evaluate if the customer may be engaging in illegal activities. 

 

Background checks get followed by continuous monitoring, allowing broker-dealers to better spot irregularities in the transactions. For instance, in the event of large cash transactions, those typically over $10,000. Amount exceeding this amount must be reported and monitored. All to say that many governments and non-government institutions require compliance to defend against this issue that gets taken very seriously. Throughout 2020, there were several institutions fined for violating AML related compliance. Kyckr compiled these together and found that: 

 

  • Twenty-eight financial institutions were issued fines for AML-related violations.
  • Regulators from 14 countries issued AML-related fines.
  • Fines totaled roughly $3.2 billion USD.

 

Failing to follow the laws and maintain compliance can have serious consequences for financial institutions. Ensuring that you do the proper level of due diligence, follow the Know Your Client rule, and perform a background check can protect your business. 

 

What is KYC?

Posted on by Oscar Jofre

In 2007, the SEC approved the founding of the non-profit Financial Industry Regulatory Authority (FINRA). FINRA was created in the wake of a failing economy to consolidate the regulation of securities firms operating in the United States. The authority’s responsibilities include “rule writing, firm examination, enforcement, arbitration, and mediation functions, plus all functions previously overseen solely by NASD, including market regulation under contract for NASDAQ, the American Stock Exchange, the International Securities Exchange, and the Chicago Climate Exchange.”

The mission is to safeguard the investing public against fraud and bad practices. To fulfill this mission, FINRA added two rules in 2012: Rule 2090 (KYC or Know Your Client) and Rule 2111 (Suitability). 

KYC works in conjunction with suitability to protect both the client and the broker-dealer and help maintain fair dealings between the parties. The Know Your Client rule is a regulatory requirement for those responsible for opening and maintaining new accounts. This rule requires broker-dealers to access the client’s finances, verify their identity, and use reasonable effort to understand the risk tolerance and facts about their financial position. 

KYC is an important rule as it governs the relationship between customer and broker-dealer and safeguards the proceedings. At the heart of this rule is the process that verifies the customer’s identity (or any other account owners) and assesses their risk level. Part of FINRA’s goal is to eliminate financial crime, which means that when a broker is accessing a potential customer, they are looking for evidence of money laundering or similar crimes. This process goes both ways as FINRA allows a customer to verify the identity of brokers in good standing with the organization.

KYC also goes hand-in-hand with the Anti-Money Laundering (AML) rule, which seeks to identify suspicious behavior, outlined under FINRA rule 3310. Crimes such as terrorist financing, market manipulation, and securities fraud are illegal acts that KYC, AML, and other rules aim to prevent.

Another part of the Know Your Client rule is the requirement of a broker-dealer to use reasonable effort to understand a client’s risk tolerance, investment knowledge, and financial position. For example, accredited investors can make Regulation CF and A+ investments without facing restrictions, while the everyday investor is limited based on their net worth and income. 

When making recommendations for a client, a broker-dealer must comply with Rule 2111, the suitability rule, which means that they must have reasonable grounds for this suggestion based on a review of the client’s financial situation.

Compliance with these rules is maintained by following policies and best practices that govern risk management, customer acceptance, and transaction monitoring. Due diligence is done to know a client needs to be recorded, retained, and maintained so that broker-dealers can continuously monitor for suspicious or illegal activity. In 2020, FINRA processed 79.7 billion market events every day and imposed $57 million in fines. 

What is RegTech?

Posted on by Oscar Jofre

In the wake of the 2008 economic crisis and the subsequent recession that followed, there was a push to create new regulations to govern financial institutions in the United States. With these regulations came requirements that businesses had to follow to be compliant with the new laws. What followed the new regulations was a rise in companies offering services to help companies manage compliance easily and efficiently, both in time and cost. This is the purpose and application of RegTech.

RegTech, or Regulatory Technology, is more specifically the use of technology to manage regulatory processes within the financial industry. The goal of companies that offer RegTech is to use cloud computing, machine learning, and big data to drive automation and lift a majority of the burden of complicated compliance requirements of the compliance teams in businesses, to reduce human error, and accomplish difficult tasks more efficiently. As regulations become more robust and regulators are demanding more transparency in the forms of auditability, traceability, and automation, a company that is required to comply with a lot of regulations cannot easily subsist without some form of RegTech to help them avoid the risk of sanctions.

RegTech services help to compile large amounts of data in secured and compliant ways, as well as comb that data for risks to the organization. While these services affect the budget of a company, it is arguably canceled out by the amount of time and energy saved by simplifying the complex processes. 

For example, let’s say a bank was previously doing all of their regulation audits manually, scanning the compliance law and solving what pertains to them, what they need to do, and how they need to do it to be compliant. While they could feasibly do this, it will take a considerable amount of time if the compliance officer tasked with this job is not a master of the laws pertaining to their enterprise. Then, following that long process, the bank will need to show the reporting, who did the reporting, when it was pulled, and keep the information secured. 

This type of manual process is solved by RegTech. Not only will your data be secured, but it will also be accessible and timestamped, so you can demonstrate who complied, how they complied, and when they complied by logging all of the actions a user takes and creating a trail.

This is one example of how RegTech helps in a compliance situation, but it is also used by regulators to help reduce the time it takes to investigate compliance issues. While these are the more well-known aspects of RegTech, it also helps in many more categories within the financial sector, such as:

  1. Reporting
  2. Anti-money Laundering 
  3. Compliance
  4. Governance
  5. Risk Management
  6. Management and Control 
  7. Transaction Monitoring

As the financial industry continues to rely more and more on data and technology, RegTech will continue to grow to keep up with the demand for more applications from companies and regulators alike. 

What is the role of a board director?

Posted on by Oscar Jofre

When thinking about corporate governance, the first roles that often come to mind are the executive officers like the CEO or CCO. These roles are often responsible for the day-to-day operations of the company, keeping things running smoothly, with other roles reporting to them. However, the board of directors is just as important as they look out for the interests of shareholders. 

The role of a board of directors is to provide company oversight, ensuring that the company is operating in the best interests of shareholders. Decisions that the board of directors is responsible for include hiring or firing company executives, creating policies for dividends and options, and determining executive compensation. The board also generally ensures that the company has the right resources in place to operate effectively. The board of directors is governed by company bylaws, which include the process for selecting directors and what their duties entail.

The board is made of elected members called board directors. The shareholders must elect directors as voting rights are generally included as part of their rights as a shareholder. Shareholders are allowed to vote on board directors during annual shareholder meetings. Generally, board director terms are staggered so that only a few are elected each year, rather than needing to elect an entirely new board whenever elections are required.

Board directors are responsible for upholding the foundational rules outlined in company bylaws. Failure to do so can result in their removal from the board. Actions that may necessitate a director’s removal may include using inside information for personal gain, making deals that are a conflict of interest to shareholders, using their powers as a director for things other than the financial benefit of the company, and other actions that would be detrimental to shareholders.

There are typically three types of directors; inside, outside, and independent directors. Inside directors are typical representatives of company management and shareholders and may include company executives or major shareholders. Outside directors are not involved in the company’s day-to-day decisions, making them more objective and help strike a balance between inside directors but are generally compensated for attending board meetings and carrying out their duties. Independent directors are required to not have any ties to the company; for example, a relative of a company executive would be ineligible for this role.

It is important to ensure that board directors diligently follow the bylaws that govern them to ensure they always are acting in the best interests of the company’s shareholders. The board serves as a check and balance with the company’s management. Shareholders should also take their right to vote seriously, executing whenever possible to ensure that they are protecting their investment in the company. 

 

Meet the KorePartners: Louis Bevilacqua of Bevilacqua PLLC

Posted on by Oscar Jofre

With the recent launch of the KoreConX all-in-one RegA+ platform, KoreConX is happy to feature the partners that contribute to the ecosystem. 

 

For the past 25 years, Louis Bevilacqua has served as a corporate and securities lawyer. After spending the majority of his time at large, international law firms, Louis discovered his passion for “representing entrepreneurs and helping them accomplish their goals.” Noticing that it was often more difficult to help small or microcap companies, Louis began his firm to eliminate the prohibitive costs typically associated with large law firms. 

 

Utilizing technology to allow lawyers to work virtually, Bevilacqua’s savings are passed onto its clients. Now, small companies can access the same top-tier resources that previously only large ones may have been able to afford. “Since most of our attorneys, like me, have decades of experience at big firms, we know how deals are supposed to be done and can provide excellent representation at lower price points,” Louis said. 

 

Not only is Bevilacqua’s team comprised of experienced lawyers, but many are also entrepreneurs. Understanding first-hand the challenges that small companies face, they are experienced problem solvers that are both flexible and proactive. Also, Louis says that “we also have a vast network of contacts with investors, broker-dealers, transfer agents, Edgar printers, audit firms and other service providers in the industry and can easily make the right referrals to anyone that the company needs.”

 

Through the JOBS Act and RegA+, investors have access to investments that they may not have had previously. Since the SEC requires substantial disclosure for RegA+ offerings, investors are provided more detailed disclosures than other private offerings. Companies also benefit from the lower costs associated with RegA+. Since it is more flexible and cheaper than a traditional IPO, the cost is not prohibitive. One of the primary reasons that Louis supports the regulations is that it “helps facilitate the raising of capital for smaller issuers, who always need capital and do not have as many avenues to obtain it.”

 

However, Louis also thinks that the resale market could be improved. Currently, companies looking to allow their shares to be traded “must identify a market maker willing to file a 211 application with FINRA”, which can be a difficult process. Making this process easier will allow more people to trade the shares purchased through a RegA+ offering. Additionally, for investors to deposit the shares they’ve purchased into a brokerage account, they typically must incur the fees associated, as the brokerage is generally required to perform their due diligence. 

 

For companies looking to raise money through RegA+, Bevilacqua provides clients with the legal services they need for a successful offering. Whether they need help “testing the waters,” filing the offering statement, drafting shareholder agreements, etc., Louis and his team provide expert guidance. Also, “ having a platform like KoreConX that brings all the components necessary to accomplish a Reg A offering in one easy to use platform is a fantastic tool to help us help entrepreneurs raise capital.” 

What is the Role of a Corporate Secretary?

Posted on by Oscar Jofre

A Corporate Secretary is a required position set forth by state corporation laws and is part of the ‘check and balance’ on board members and offers the board advice and support. While providing the company with advice on the state laws, they are also tasked with ensuring that board members maintain their fiduciary duties to shareholders. 

 

One way they do this is by accurately recording and maintaining the minutes for the board meetings they usually set up. Corporate secretaries are responsible for ensuring that an adequate number of board meetings are held and that scheduling coincides with the availability of board members. They are required to comply with meeting notices and often are responsible for other logistical arrangements. This is just one of the basic tenets of the position and typically remains a constant between companies. 

 

Corporate secretaries are essentially a compliance officer for board members, serving as a liaison between the board, officers, and shareholders while maintaining documents that are required to keep the board and company in compliance with regulations. They also direct the activities related to the annual meeting of shareholders and share transfers. As a note, while the corporate secretary does not need to be a lawyer, they need to have sufficient knowledge of corporate and securities law to ensure compliance, so a background in law can be helpful. They should also be as well-versed in the company’s business, understanding it thoroughly to be an effective corporate secretary.

 

Even though the role of the corporate secretary is dynamic and complex, varying slightly between companies, the basic function of the position can be boiled down to being responsible for providing support to the board, officers, and shareholders on business matters and the laws that apply to them. Whether it is setting up, facilitating, or creating the agenda of a board or annual shareholders meeting, a corporate secretary is an essential and mandatory part of a company’s structure in the modern world of business. 

KorePartner Spotlight: Sara Hanks, CEO of CrowdCheck

Posted on by Oscar Jofre

With the recent launch of the KoreConX all-in-one RegA+ platform, KoreConX is happy to feature the partners that contribute to its ecosystem.

 

With over 30 years in the corporate and securities law field, Sara Hanks has a wealth of experience. Before CrowdCheck began, Sara and one of the firm’s co-founders (whose husband became the other cofounder) served on the Congressional Oversight Panel where they spent 18 months in DC investigating the Troubled Asset Relief Program. Shortly after this time, the bills that became the JOBS Act were passing through Congress and Sara’s interest in the private capital markets grew.

 

Sara and the CrowdCheck co-founders began to discuss due diligence and the implication crowdfunding would have. With their combined legal and entrepreneurial experience, they knew they could help investors make good investment decisions and walk entrepreneurs through the compliance process. These conversations led to CrowdCheck, which Sara says was “founded on the back of a cocktail napkin.”

 

CrowdCheck and its affiliated law firm, CrowdCheck Law, provides clients with a complete range of legal and compliance services for issuers and investors. As a “weapon against potential fraud,” CrowdCheck does due diligence for investors, letting them see the results themselves in a report that is easy to understand. The firm also helps entrepreneurs through the complex process of compliance, making sure that they have met all legal requirements. Sara and CrowdCheck have tremendous experience applying exciting securities laws to the online capital environment, a skillset valuable in the crowdfunding space.

 

One of the things that excites Sara most about this space is that there are “so many cases of first impressions.” Raising capital isn’t new, but with crowdfunding, new questions arise every day and there is the opportunity for innovative delivery of information.

 

A partnership with KoreConX is exciting for Sara and CrowdCheck because KoreConX values and understands how essential compliance is. “This environment won’t work without compliance,” Sara Hanks said, so it was valuable finding a partner that did not need convincing when it came to compliance.

Reg CF Investment Vehicles: What Are They Good For?

Posted on by Andrew Stephenson

In its recent rulemaking, the SEC added new Rule 3a-9 under the Investment Company Act to allow for the use of “crowdfunding vehicles” for Reg CF investments. It is important to recognize that crowdfunding vehicles are quite limited, and not at all similar to the special purpose vehicles (“SPVs”) used to aggregate accredited investors in angel or venture capital funding rounds.

In that type of SPV, there is often a lead investor or manager who may act on behalf of the investors in the SPV. Those persons could be exempt reporting advisers under the Investment Advisers Act, or even fully registered investment advisers. In this way, SPVs create real separation between the investors and the underlying issuer, with some person or entity acting as an intermediary when making decisions or providing information to investors.

For crowdfunding vehicles, on the other hand, the SEC requires that investors receive the same economic exposure, voting power, ability to assert claims under law, and receive the same disclosures as if they invested directly in the issuer itself. In particular, a crowdfunding vehicle:

  1. Is organized and operated for the sole purpose of directly acquiring, holding, and disposing of securities issued by a single Reg CF issuer;
  2. Does not borrow money and uses the proceeds from the sale of its securities solely to purchase a single class of securities of a single Reg CF issuer;
  3. Issues only one class of securities in one or more offerings under Reg CF in which the crowdfunding vehicle and the Reg CF issuer are deemed to be co-issuers;
  4. Receives a written undertaking from the Reg CF issuer to fund or reimburse the expenses associated with its formation, operation, or winding up, receives no other compensation, and any compensation paid to any person operating the vehicle is paid solely by the Reg CF issuer;
  5. Maintains the same fiscal year-end as the crowdfunding issuer;
  6. Maintains a one-to-one relationship between the number, denomination, type and rights of Reg CF issuer securities it owns and the number, denomination, type and rights of its securities outstanding;
  7. Seeks instructions from the holders of its securities with regard to:
    1. The voting of the Reg CF issuer securities it holds and votes the crowdfunding issuer securities only in accordance with such instructions; and
    2. Participating in tender or exchange offers or similar transactions conducted by the Reg CF issuer and participates in such transactions only in accordance with such instructions;
  8. Receives, from the Reg CF issuer, all disclosures and other information required under Reg CF and the crowdfunding vehicle promptly provides such disclosures and other information to the investors and potential investors in the crowdfunding vehicle’s securities and to the relevant intermediary; and
  9. Provides to each investor the right to direct the crowdfunding vehicle to assert the rights under State and Federal law that the investor would have if he or she had invested directly in the Reg CF issuer and provides to each investor any information that it receives from the Reg CF issuer as a shareholder of record of the crowdfunding issuer.

The result is that no lead investor or manager can be used, and investors will have the same rights and responsibilities as if they invested in the issuer directly.

The biggest practical effect is that Reg CF investors will appear on one line on the issuer’s cap table (addressing the “messy cap table” issue), and that line will represent the full number of beneficial owners, who each must still be notified by the issuer in the event of any decisions requiring investor action. The issuer could hire an administrator to handle communications with the investors in the crowdfunding vehicle, but there was nothing preventing an issuer from doing that previously.

However, by only existing as one line on the issuer’s cap table, and confirmed in its rulemaking, crowdfunding vehicles will count as one “holder of record” for the purposes of Section 12(g) of the Securities Exchange Act. This is the provision that says that a company has to register with the SEC and become fully-reporting when it reaches a specified asset and number-of-shareholder threshold. Up to now, crowdfunding companies have relied on a conditional exemption from Section 12(g) but some companies have worried about what will happen when they no longer comply with those conditions.

The SEC further opined that with these changes, it is possible that issuers will provide greater voting rights than has been common in Reg CF offerings. I am not sure that will be the case, as use of crowdfunding vehicles will not simplify obtaining votes for any necessary corporate consents unless the rights of investors are curtailed by the use of drag-alongs or similar provisions.

Setting up a crowdfunding vehicle will require documentation tailored to follow the terms of the securities being sold in the crowdfunding offering, and arranging for administrative tasks such as issuance of K-1s to the investors.  CrowdCheck is available to talk through the implications of using crowdfunding vehicles and whether it makes sense for your Reg CF offering.

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