The Citizen.vc letter provides some guidance but deal platforms are still inconsistent in how they handle investor accreditation



A couple of weeks ago, there was some notable regulatory activity in the area of marketing private placement deals online. On August 6, the SEC responded to an incoming letter seeking no-action relief from Citizen.vc, Inc. Citizen.vc is an online venture capital platform, similar to OurCrowd or FundersClub.

As a quick refresher, recall that private placements conducted under Rule 506(b) of Regulation D may not be marketed as a “general solicitation.” Generally speaking, an issuer may only offer securities to persons with whom they or their broker have a “substantive pre-existing relationship.”

The no-action letter issued by the SEC to Citizen.vc provides some helpful guidance on qualifying investors and what constitutes a pre-existing substantive relationship for purposes of determining if there has been a general solicitation in violation of Rule 506(b). Here’s the link:

http://www.sec.gov/divisions/corpfin/cf-noaction/2015/citizen-vc-inc-080615-502.htm

The SEC coordinated the issuance of the Citizen.vc letter with the release of Compliance and Disclosure Interpretations (C&DI’s) that are very relevant to private placement offerings listed on websites, and specifically, clarifying what constitutes a pre-existing substantive relationship between an issuer (or someone acting on their behalf) and an investor for purposes of determining whether the issuer has conducted a public offering. The timing of the C&DI’s suggests the SEC clearly intended to provide the market with additional clarity about various practices now taking place on online deal portals. (If you’d like me to send you the relevant C&DI’s, just email me.) From what we understand, the staff at the SEC has been increasingly concerned about suspect practices it has observed in the industry.

We’ve noticed very little consistency in how deal portals verify the accreditation status of investors and create this pre-existing substantive relationship. Some websites use only a check-the-box-hey-trust-me-I’m-accredited method while others use an extended investor questionnaire to determine the sophistication of the investor. On Monday I even received an email from Venovate that asked me which method I prefer to verify my status: Income verification filed with the IRS, a letter from my accountant, or a bank statement showing net worth over $1 million.

In many cases in reviewing the registration process of dozens of active deal portals we track at Dealflow.com, there’s at least a question about whether the portal has established a substantive pre-existing relationship with new investor sign-ups as the SEC defines it under Citizen.vc and the related CD&I’s.

Some of this can be blamed on previous lack of clarity, however, even when there was clarity (for example, the 30-day waiting period provided under the Lamp Technologies no-action letter), not all online portals followed the guidance. At the extreme I’ve been able to visit a portal for the first time and wire my money minutes later – with no “relationship” at all.

The Citizen.vc letter actually throws that 30-day standard right out the window in favor of a facts-and-circumstances approach. To wit (from the SEC’s letter): “We also agree that there is no specific duration of time or particular short from accreditation questionnaire that can be relied upon solely to create such a relationship. Whether an issuer has sufficient information to evaluate, and does in fact evaluate, a prospective offeree’s financial circumstances and sophistication will depend on the facts and circumstances.”

We talked with Dan DeWolf, partner at Mintz Levin who represented Citizen.vc. DeWolf feels that the SEC’s letter along with the CD&I’s provide more clarity in an area of online deal marketing that’s in need of better compliance. We agree with Dan. The issue of how to establish a legally meaningful relationship with an investor — whether you’re a broker-dealer, a registered investment advisor, or a deal portal — is critical to giving issuers more confidence to market deals online without worrying about blowing their Reg D exemption. There’s an obvious need for better compliance in this area.

Our sense is that it’ll take a few weeks, maybe even a few months, but in time, we’ll start seeing more consistency across deal portals in how they verify accredited status and develop a real relationship with their investors.

Steven Dresner
steven.dresner@dealflow.com

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