Name
Global FinTech Guide
Country _ Name
United States
SectionTitle
Crowdfunding / crowdinvesting / crowdlending
Body
FinTechs belonging to this category operate crowdfunding, crowdinvesting and crowdlending platforms on which money is raised to invest in various projects, mainly start-up companies and real estate projects.

Crowdfunding is not a defined financial service, but generally used to describe donation-based crowdfunding (the investor donates the money to the project), reward-based crowdfunding (the investor receives an often symbolic consideration for his investment), equity-based crowdfunding (crowdinvesting: the investor participates in the profits of the financed project or acquires shares or debt instruments) or lending-based crowdfunding (crowdlending: the investor is reimbursed at the end of the project with or without interest).

Introduction

Attitude of the country towards crowdfunding, crowdinvesting and crowdlending platforms

The general rule in the United States is that any offer or sale of securities must be either registered or exempt from registration under both federal and state laws. In addition, the general rule is that persons who are engaged in the business of effecting transactions in securities for the account of others must register as broker-dealers or be exempt from such registration.

Regulator and public sentiment towards crowdfunding platforms have mostly been positive, and even encouraging. In 2010, the JOBS Act introduced three (3) new forms of legal “crowdfunding” means of offering and selling securities:

  • Regulation CF, which permitted small-scale crowdfunding to issuers raising up to $1.0 million per year as long as they complied with certain disclosure requirements;
  • Rule 506(c), similar to a traditional private placement of securities that instead permits the use of general advertising and general solicitation so long as the issuer takes reasonable steps to verify (i.e., self-certification not permitted) that all purchasers in the offering are “accredited investors”; and 
  • Tier 2 of Regulation A, also known as “Regulation A+”, where an issuer could sell up to $50 million of securities annually to nearly anyone so long as the issuer goes through an “IPO-lite” qualification process of its offering documents with the SEC and complies with ongoing reporting requirements.

In 2020, the SEC passed several reforms to further liberalise the ability of issuers to use these crowdfunding mechanisms. For example, the maximum annual limit for sales under Regulation CF was increased from $1 million to $5 million, the maximum annual limit for sales under Regulation A+ was increased from $50 million to $75 million, a number of new categories were added to the definition of the term “accredited investor,” additional means of verifying accredited investor status were added, and the test to analyse under which multiple securities offerings might be deemed integrated into a single securities offering (and thus potentially causing those offerings when viewed together to run afoul of any single registration exemption) was modernised.

On the other hand, the current administration has approached crowdfunding with far greater scepticism and has signalled that as a means of promoting investor protection it may roll back some of the liberalisations that were recently approved, including possibly making it more difficult for a person or entity to qualify as an “accredited investor.” In general, offers and sales of securities under registration exemptions are less burdensome to an issuer if the offering only involves persons deemed an “accredited investor” – which includes certain persons of high net worth, high income earners, persons with certain professional designations, and various forms of entitie
s that are essentially deemed “sophisticated” by their nature, business, or composition and able to fend for themselves.  

Donative crowdfunding and rewards-based crowdfunding generally are not regulated, though may be subject to a host of other issues, including consumer protection laws, requirements in order to take tax deductions, state sweepstakes laws etc. In addition, it often is not clear when a reward might be deemed a security. Under the Howey test, an instrument or arrangement may be deemed an investment contract that is a security if the arrangement or instrument involves an investment of money into a “common enterprise” with an expectation of profits from the efforts of others. The SEC has used this test to find that, in some instances, the promise of a reward is indeed an investment contract that is a security, the offering and sale of which must be registered or exempt from registration, particularly if the reward comes in the form of a digital asset. 

The attitude towards crowdlending is not as clear. While non-bank lending is largely unregulated, peer-to-peer lending generally has also been deemed an offering and sale of securities. Under the Reves test, courts look at (1) motivations that would prompt a reasonable seller and buyer to enter in the transaction; (2) plan of distribution of the instrument; (3) reasonable expectations of the investing public; (4) existence of another regulatory scheme significantly reduces the risk of the instrument, thereby rendering application of the Securities Act unnecessary. Thus, most peer-to-peer lending platforms have been required to register with the SEC or operate under exemptions from registration. 

Legal affairs

Obligations and requirements to provide crowdfunding, crowdinvesting and crowdlending platforms described above

Regulation CF Crowdfunding Platforms: 
Regulation CF crowdfunding platforms must either qualify under Regulation CF or register as broker-dealers. Crowdfunding platforms must be approved by the SEC and have issuer due diligence requirements, must conduct background checks, must deliver educational materials to investors, must implement written policies and procedures and privacy policies, and have specific requirements as to how they can compensate employees and have restrictions on the ability to maintain investor funds and custody securities. Certain other activities of crowdfunding intermediaries are also prohibited. 

Registered Broker-Dealers Operating Crowdfunding Platforms: 
Broker-dealers who are crowdfunding intermediaries do not need to have additional registrations, but they do need to have FINRA approval to conduct crowdfunding activities. See “Asset and portfolio management” above for additional information on the requirements applicable to broker-dealers. They also need to provide investors with educational materials, make issuer information available regularly and perform diligence on the issuer, among other things. Many platforms that enable crowdfunding via Rule 506(c) or Regulation A+ are also operated by registered broker-dealers.

Technology Service Providers Operating Platforms: 
It is possible that a platform can be operated by an unregulated service provider if all the regulated activities are performed by regulated third parties. In addition, there is an exception from registration as a broker-dealer for certain Rule 506(c) crowdfunding platforms, as long as certain restrictions are followed. 

Crowdlending Platforms:
Nonbank lending is largely unregulated in the United States, but peer-to-peer loans usually are deemed securities, subjecting crowdlending platforms to all the same regulations as other platforms for the offer or sale of securities. 
Donation-based Crowdfunding and Reward-based Crowdfunding: 
Donation-based crowdfunding platforms generally are not regulated. Reward-based crowdfunding may be regulated or prohibited under state sweepstakes and gambling laws, depending on the nature of the rewards, but generally are not regulated.  

Additional comments regarding the legal situation for crowdfunding, crowdinvesting and crowdlending platforms or what FinTech’s must be aware of in this business area

Crypto lending is under the microscope. The SEC entered into a settlement with BlockFi where the SEC determined that BlockFi’s crypto lending product was an investment company, meaning any crypto lending product in the United States must be structured very carefully and that the sale of such a product may need to be further restricted. 

Issuers conducting international offerings may have problems if the international offering is deemed “integrated” with the United States offering. 

Additionally, for crowdfunding that does not involve securities, the Federal Trade Commission (FTC) has used its powers to pursue fraudulent or deceptive crowdfunding efforts. 

Securities sold under Regulation CF are subject to a one-year restriction on transfer. During the one-year restriction, the securities can only be transferred back to the company, to an accreditor investor, to family members upon death, divorce, or similar events, or in an offering registered with the SEC. Once the year has passed, the securities may be freely traded. There are also restrictions on the transfer of Regulation A+ securities by affiliates, and Rule 506(c) securities generally are restricted and cannot be resold without another exemption.

Economic conditions

Market size for crowdfunding, crowdinvesting and crowdlending platforms and biggest companies in this business area

Regulation CF crowdfunding is a tiny part of the overall market, topping $1 billion total for the first time in 2021. The only Regulation CF crowdfunding platforms with significant market share currently are WeFunder, StartEngine and Republic. Because of the recent increase of the maximum annual offering size from $1 million to $5 million, there have been quite a few new entrants to the market. Further, these platforms frequently also permit investing through Regulation A+ and Rule 506(c). Regulation A+ offerings totalled around $3 billion, while Rule 506(c) topped $200 billion, which is still just less than 1% of the overall private placement market in the United States.

Asset fractionalisation platforms are also becoming more popular, with Rally being the early market leader.

Additional comments regarding the economic situation for crowdfunding, crowdinvesting and crowdlending platforms or what FinTech’s must be aware of in this business area

Increases in fundraising thresholds means the crowdfunding market in the United States is likely to get significantly more competitive. 

Crowdfunding platforms are subject to significantly less regulatory burdens than broker-dealers performing substantially similar activities, in part because the amount one may invest through a crowdfunding platform is limited.

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