How to be compliant when crowdfunding

By Jonathan Heymann | October 30, 2015 | Last updated on September 21, 2023
3 min read

Crowdfunding is gaining increased exposure. In simple terms, it’s a method by which issuers can raise funds from a wider array of the general population.

How? Through the use of technology that can provide the issuer or registered dealer with the ability to spread the word about the proposed investment more effectively. Firms registered as Exempt Market Dealers have always been able to get capital through crowdfunding by using their existing category of registration and relying on the Exempt Distribution rules, such as the Accredited Investor exemption and the Offering Memorandum exemption in all provinces (except Ontario). It was simply a matter of developing a portal so that a firm could see whether a client qualified, and if the investment was suitable. In the summer of 2015, B.C., Saskatchewan, Manitoba, Quebec, New Brunswick and Nova Scotia approved legislation allowing start-up and early-stage issuers to crowdfund with certain limitations. (Ontario is planning to publish crowdfunding exemption proposals in the fall of 2015.) Issuers:

  • must register their portals in each jurisdiction where they wish to raise capital;
  • may not provide advice to investors on the suitability of the investment; and
  • must decide on a minimum amount they need to raise, which must be achieved within 90 days; otherwise, all raised funds must be returned to investors.

There are also limits on how much an issuer can raise, and how much an individual may invest in each product. Under these rules, start-ups can raise up to $250,000 per distribution, up to a maximum of two distributions per year. An individual investor is limited to $1,500 per issuer. Investors also have a right to withdraw from the investment within 48 hours of subscribing.

In order to utilize crowdfunding, firms have to file Form 33-109F5 to alert regulators that they are using a new mechanism to attract investors—namely, a crowdfunding portal to raise capital. Then, regulators will look closely at the crowdfunding technology the firm is using to ensure it is reliable, secure and able to protect the integrity of the investment process. As with the distribution of all exempt products, regulators will want to know if the firm:

  • has performed the necessary due diligence on the product being promoted;
  • is asking the right questions to determine how the investor qualifies;
  • has enough information about the client’s financial picture to perform a suitability review;
  • will be able to protect the confidentiality of client information gathered over the Internet; and
  • will be able to perform the necessary client identification procedures pursuant to Anti-Money Laundering legislation.

The new rules could mean that a firm could have to process more transactions than before: instead of 10 people investing $100,000 each, for instance, you could now have 100 people investing $1,000 each. To limit the amount of paperwork, the portal must gather sufficient detail from prospects to succinctly determine which exemption the investor qualifies under and whether the investment is suitable based on their risk tolerance and time horizon. Blunt questions, such as “Are you prepared to lose all of your money?” and “Do you realize you will not get your money back, for at least five years, if at all?”, will help weed out clients who should not invest.

Registered dealers have always been able to crowdfund, but web-based technology has attracted a wider pool of investors. So ensure transactions that take place are pursuant to existing compliance obligations.

Jonathan Heymann

Jonathan Heymann is President of Wychcrest Compliance Services Inc., a consulting firm specializing in securities compliance and registration.