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Why do I need a FINRA Broker-Dealer?

Posted on by Oscar Jofre Tags: , , , , , ,

Broker-dealers are an essential part of the fundraising process. These entities can be small, independent firms or part of a large investment bank. However, regardless of a broker-dealer’s size, they are in the business of buying or selling securities. In this sense, whenever a broker-dealer executes orders for clients, they act as a broker, while trading for its own account means they are acting as a dealer. 

 

In the United States, Congress has granted the Financial Industry Regulatory Authority (FINRA) authorization to protect American investors by ensuring that brokers operate fairly and honestly. The organization is non-governmental and non-profit, acting independently to ensure that the rules governing brokers are adhered to. The organization states: “Every investor in America relies on one thing: fair financial markets.” FINRA oversees over 624,000 brokers across the country, ensuring that their activities adhere to all necessary rules. 

 

As a company engaged in capital market activities, choosing a broker-dealer to work with is critical to your success. For example, under Regulation A+, some states require issuers to work with a broker-dealer to offer securities in that jurisdiction. This allows issuers to maintain compliance with the SEC and other regulatory entities. Additionally, working with a FINRA-registered broker-dealer will give potential investors more confidence in the compliance of your operations. FINRA registration ensures that your broker-dealer partner has:

 

  • Been tested, qualified, and licensed;
  • Every securities product is listed truthfully;
  • Securities are suitable for an investor;
  • And investors receive complete disclosure.

 

This information ensures that broker-dealers are operating in the best interests of the investors, ensuring that the issuer provides all necessary and required information to make good investment decisions. In addition, investors (and issuers) can verify a broker-dealer’s status through BrokerCheck, a service provided by FINRA. BrokerCheck gives information on a broker-dealer’s licensing status, whether they are registered to give investment advice or registered to sell securities. Additionally, the service allows people to see regulatory actions against brokers, complaints, and employment history. Through this information, investors can validate the status of a broker to ensure they are dealing with legitimate firms. 

 

As an issuer, a FINRA broker-dealer improves compliance measures. The broker-dealer will be required to perform regulatory checks on investors such as KYC, AML, and investor suitability to ensure investors are appropriate for the company. Additionally, they will perform due diligence on you so that they can be assured that your company is operating in a manner compliant with securities laws so that they do not present false information to investors. Failing to meet compliance standards can result in the issuer being left responsible for severe penalties, such as returning all money raised to investors. 

 

Working with a FINRA-registered broker-dealer ensures that, as a company, you are meeting all legal requirements when offering securities for sales. FINRA makes sure that broker-dealers, and the issuers they work with, act transparently and honestly to keep the private capital market fair for investors.

 

KorePartner Spotlight: Steve Distante, Founder and Chairman of Vanderbilt Financial Group

Posted on by Oscar Jofre Tags: , , , ,

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

 

Steve Distante is an entrepreneur and has been his entire life. As a graduate of St. Johns University with a degree in accounting and finance, he intimately knows their struggles and success. Before starting his own business, Steve ran an Office of Supervisory Jurisdiction (OSJ), where he learned the experience from the regulatory side. It was a great use of his degree and his intrinsic skill for planning. 

 

Steve’s journey began when his father told him to look at financial services as a career path. What he found was the rewarding business of empowering entrepreneurs to create impactful products and services for good. That is at the core of the business he founded and is the CEO, Vanderbilt Financial Group, “an investment firm disrupting traditional finance by focusing on socially and environmentally responsible, ethical, and impactful investments.” With Steve at the helm, the ship is set up to ensure that entrepreneurs do not have to go through the same struggles he did as he grew his business. 

 

As if it was not already clear that helping entrepreneurs is a driving factor in his life, Steve is also the CDO for Impact U, an educational community for students, investors, and financial advisors on impact investing. He has made two documentary films for it and is currently writing a book about Impact Investing. In addition, Steve is a former president of the Entrepreneurs’ Organization and served as the UN Ambassador for EO for nearly three years. He is very passionate about helping entrepreneurs building impactful companies with missions to better the world. 

 

Steve is thrilled about the partnership with KoreConX to streamline business processes so he can continue his excellent work for the community of entrepreneurs around the world. 

How Does RegA+ Impact the Life Sciences Industry?

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Since dramatic improvements to Regulation A that went into effect in 2015, the exemption has become a tremendous tool allowing private companies to raise significant capital. Unlike other funding methods, RegA+ allows companies to raise capital more efficiently with less hassle at a lower cost. 

 

Companies in diverse industries can benefit from the power exemptions like RegA+ give them to raise unprecedented capital in the private market. Before the JOBS Act, private investments were limited to wealthy, accredited investors, private equity firms, venture capital, and other players. However, when the legislation opened up investment opportunities to retail investors, companies were suddenly able to tap into a new pool of potential investors. In addition to making investment opportunities more accessible, the JOBS Act was also created to create jobs and foster innovation in America. 

 

These factors make RegA+ particularly well-suited for the life sciences industry. Retail investors typically make investments in companies they support and believe in. Life science companies aim to develop innovative treatments for medical conditions, make life easier for those with chronic conditions, and discover new medicines that can dramatically improve a patient’s life. Through RegA+, the ability of the everyday individual to invest in these deals is powerful. People will want to invest in a company developing treatments for conditions that have personally affected their lives or a loved one. 

 

Recent research has found that, in the post-JOBS Act economy, there has been a 219% increase in biotech companies going public in an IPO. Many of these companies are focused on developing treatments for rare conditions and cancers. Funding received through JOBS Act exemptions has significantly reduced the time to IPO after benefiting from raising earlier capital at a lower cost. Not only does this have beneficial economic implications, the advancement and funding of life sciences companies will positively impact humanity itself. Being able to identify treatments to life-threatening conditions can extend lifespans and enhance the quality of life significantly. Instead of certain conditions having terminal diagnoses, patients would have options to recover and treat their illnesses. 

 

However, companies in the life sciences space typically require significant capital to fund research and development, clinical trials, and regulatory approval. Since the increase of RegA+ to a maximum of $75 million in March 2021, even more companies will likely begin to explore this capital raising route. If companies can raise needed capital sooner and easier, they can bring their innovative medical treatments, devices, and medications to market sooner as well. This means that patients would begin to benefit from new, lifesaving options even sooner. 

 

Shareholder vs. Investor: What is the Difference?

Posted on by Oscar Jofre

When it comes to supporting a business, whether public or private, there are many ways to go about accomplishing it. There is the public stock market, common knowledge for anyone in the United States, and a central component in many discussions about the economy, and there is the private market. The private market was opened to everyday people through the JOBS Act in 2012 and its subsequent updates, allowing more and more people to invest without being accredited investors.

 

Although there are many ways to support a business, there is a difference between being a shareholder and an investor. There are cases in which a person can be both. This can best be described by a square being a rectangle, but not all rectangles are squares. A shareholder, in general, is an investor, as they are looking for their investment in their share of the company to grant them a financial gain. But, by this logic, an investor is not always a shareholder, as they can invest in a company and not gain shares. 

 

The difference has to do with the relationship between the person or entity who invests in a company. For instance, a share represents ownership of the company. The amount of ownership is dependent on how many shares are owned by the individual. The owner of a share is always invested in the company, as the financial gain that this stock represents is dependent on the company’s success or failure. The relationship between a shareholder and company also establishes rights for that shareholder to vote in meetings and the right to inspect documents, within a reasonable limit, among other rights depending on the share and company. This relationship is regulated by the United States Securities and Exchange Commission (SEC) to protect the rights of the shareholder and make sure that these owners of stock can exercise them. 

 

In this regard, an investor invests money into a company without the exchange of shares. The investor can lend money to a company that can be returned in the form of securities. However, they can remain just an investor by not receiving shares and receiving something like a bond that represents the loan. Both parties are independently regulated by the SEC, but the relationship does not guarantee shareholder rights. The relationship between an investor, like a venture capital firm, angel investor, or a private equity firm, and the corporation is determined between the two parties. 

 

Though it is subtle, and the terms investor and shareholder are often used interchangeably, there is still a difference between them. It has to do with the relationship between the two parties involved and how they handle the financial relationship.  

 

KorePartner Spotlight: Sean Levine, Managing Director and Head of Reg A & CF at Entoro

Posted on by Oscar Jofre

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

 

As an investment banker, attorney, securities analyst, entrepreneur, and consultant, Sean Levine has a wealth of experience in the private capital markets. He began his career as a lawyer, and subsequently worked with a broker-dealer until the financial crisis, earning four securities licenses during that period. Sean then transitioned to the financial publishing industry, serving as the director of research at a large publishing house. In his last year in that role, the company had launched a newsletter on private deals as Regulation A and CF grew more popular, generating massive interest from retail investors. 

 

In 2019, Sean became affiliated with Entoro. At that point, Entoro had created a listing site for Regulation D 506(c) offerings that resembles a crowdfunding portal’s listing page. In part due to Sean’s leadership, the firm has since grown its practice to include Regulation A and CF clients, as well. In addition to the fact that few broker-dealers have a network of thousands of accredited investors to market their offerings, Entoro plugs its issuers into unmatched retail distribution through its ecosystem partners. The team also provides issuers access to OfferBoard, the company’s listing platform, and manages compliance efforts including KYC-AML. In addition, Entoro operates Clear Rating, a third-party valuation service that helps companies and investors understand the value of their investments. Lastly, they have established a network of preferred service providers especially suited to these exemptions, as many attorneys and other relevant professionals don’t have a comprehensive knowledge of Regulation A or CF. Entoro is registered in all 50 states and the District of Columbia.

 

Being a banker (recently earning a fifth securities license) and an attorney, Sean has the expert knowledge to efficiently navigate the complexities of capital raising. With the continued growth of investment opportunities through exemptions like Regulation A and CF, Sean is excited about the benefits to everyday investors. He said: “It’s sad that regular investors feel that the industry is so against them. These kinds of deals, A and CF, are a huge opportunity for regular investors to get in before it gets to [the point of an IPO].”

 

In working with KoreConX, Sean has seen how the company’s investor funnel streamlines the process. Plus, in some instances, it is more beneficial for issuers to offer their securities through a standalone platform, which is where KoreConX comes in. 

How the Unaccredited Investor Benefits from RegA+

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The passage of the JOBS Act in 2012 set in motion a significant change for the private capital markets. For so long, investments in private companies could only be done by wealthy accredited investors who would benefit immensely if the company was ever to go public during an IPO. While the everyday person has long been able to buy stocks of a public company, the potential for such a significant return on their investment was low. It was thought that this was to protect investors from the risk of a private company. 

However, the JOBS Act has rewritten this narrative, allowing anyone to invest in private companies raising capital through exemptions like Regulation A+. When the act was first passed into law, companies could raise up to $5 million. However, it has since undergone a few notable changes that transformed it from an infrequently used exemption to one that allows companies to raise a significant amount of capital. The first came in 2015 when Title IV amended the JOBS act to allow companies to raise up to $20 million and $50 million from tier 1 and tier 2 offerings, respectively. Again in 2020, the SEC announced further amendments allowing companies to raise up to $75 million through tier 2 offerings, which went into effect March 15, 2021. 

The amendment increased the availability of capital for private companies and created incredible investment opportunities for non-accredited investors. For investments in tier 1 offerings, there are no limits placed on investors, while tier 2 offerings limit non-accredited investors to a maxim of 10% of the greater of their net worth or annual income.

Since the change in 2015, SEC data shows the impact it has had on the number of offerings under this exemption. In 2015, only 15 companies had qualified for either tier 1 or tier 2 offerings. In 2019, this number had increased to 487 companies. With so many companies conducting offerings under Regulation A, and the number increasing year over year, there are more opportunities than ever for the non-accredited investor. They are free to research investment opportunities, deciding if the investment fits with their investment goals and risk tolerance. They are free to identify companies that align with their philosophies, values, and causes that are important to them. For example, an investor may have a strong affinity for reducing their environmental impact. They can choose to invest in a company that also upholds this same value. 

In addition, the emergence of a secondary market for private company investments opens up a new possibility for liquidity. Previously, private company shares could only be sold or traded once a company had gone public. However, now investors have the opportunity to sell their shares to other interested investors.

The JOBS Act has allowed non-accredited investors to enter the playing field in the private capital market. Just as the companies who can now use RegA+ to raise capital, investors can use the offerings as an opportunity to make a profit and support companies they believe in. 

The Role of Investor Acquisition in Capital Raising Activities

Posted on by Oscar Jofre Tags: , , , ,

The goal of any capital raising activity is to secure capital for the growth and development of the business. Without needed capital, it can often be challenging to expand; whether that means hiring more employees to keep up with demand, improving production facilities to manufacture a product, or funding research and development to bring more products or services to the market. However, in order to actually raise the capital required, potential investors need to be made aware of the offering and the opportunities becoming a shareholder entails. This requires marketing.

 

When it comes to RegA+ and RegCF offerings, the potential to sell securities to the everyday investor is powerful, opening up the market to a vast pool of potential investors not available to private companies before the 2012 JOBS Act. However, this also creates the need for companies to find the best way to reach their target audience and make them aware of the investment opportunity. Through marketing, you are able to inform prospective investors of the opportunity to invest in your company. 

 

More than ever before, social media has become an integral part of marketing activities across all business sectors. It allows you to reach your audience where they’re at, and as nearly seven in ten Americans are on social media, that place is online. Through social media, businesses can tell their story and use that to drive investors (and even new customers) to support their brand. Beyond social media, marketing becomes a key component of investor acquisition. Through investor acquisition, a company is able to target investors based on demographics; whether that is people who exhibit similar behaviors to shareholders, by age, by location, or by any other meaningful factor that allows you to identify the right investor for your company. The methods to target these prospects are just as diverse. While we’ve already mentioned social media, email marketing is still an effective media channel, along with online advertising, and many more channels of marketing. The importance is to use whichever channels allow you to best reach your target audience. 

 

The key to marketing is that it helps publicize your offering and find the best investors for your company. Successfully marketing an offering, as long as advertisements are truthful and not misleading, can make a significant difference in the raise’s success. Similarly, finding the right investor acquisition partner with experience in marketing capital raising activities can help ensure you meet compliance and use the most effective strategies for reaching the right audience. 

KorePartner Spotlight: Jake Gallagher, Director of Business Development at North Capital

Posted on by Oscar Jofre Tags: , , , , , ,

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

 

Jake Gallagher has always been interested in business. He wanted to know how they worked and why some were sustainable while others were not. On top of that, the private market for company offerings has presented challenges to businesses entirely separate from those faced by public offerings.

 

This has no doubt been part of the reason he works with North Capital Private Securities as the Director, Business Development. There, he works directly with issuers and helps with transactional compliance, but beyond that is the use of RegTech to streamline broker-dealer processes like KYC (Know Your Client) and accredited investor verification. 

 

The difference that makes North Capital Private Securities and Jake unique is their work in both primary issuance and the secondary market for private market shares. Jake is well versed in both, having worked with many sectors and exemptions including, Reg A and D, VC, and hedge funds. In addition, PPEX, the ATS platform that North Capital Private Securities operates, makes trading on the secondary market easier for investors and provides options for liquidity in the private capital market.

 

The most exciting thing about the current climate of the private sector is that these options have provided for extreme growth, as more investors are ready and able to participate in the offerings of private companies. While it is a small ecosystem, the changes that have come in the last few years for who can participate in private market offerings are fueling the growth of many companies that would have otherwise been on the public market before they were ready. 

 

Jake is thrilled about the partnership with KoreConX. He anticipates they will work together on primary offerings and secondary trading, bringing together a significant experience that can only benefit all involved. 

Stock Options for Employees

Posted on by Oscar Jofre Tags: , , , ,

Stock exchanges have a long history within America. The first was the Philadelphia Stock Exchange, originally the Board of Brokers of Philadelphia, founded in 1790 and was followed by the New York Stock Exchange two years later. For nearly as long as the United States has been a country, they have had brokers buying and selling stocks. 

 

Since the latter half of the 20th century, however, the idea of stock options for employees has been popular as an incentive tool for employees to have a vested interest in the company’s success. For both publicly traded and private companies, offering employees the opportunity to be awarded or purchase shares is a powerful incentive. This practice has continued into the modern-day, as grantees (the employee or executive of a company) can receive the option to buy stock in the company for a fixed price in a finite time. This process also includes a vesting period, which is a period of time that a grantee will need to wait before they can exercise their stock options.

 

There are two main types of stock options, Incentive stock options (ISOs) and Non-qualified stock options (NSOs). The difference between these types is that the former is usually offered to top talent and executives while being treated as capital gains when taxed, while the latter is granted to employees of all levels and considered income when taxed after being exercised. For example, as an incentive to continue excellent performance, a company can give an employee or executive the option to buy 500 shares in the company at $5. As the name indicates, this is an option that an employee is granted the right to do, but it is not an obligation. If the employee buys the stock at $5 over the period designated by the company, the employee will then have the option to sell the share after the vesting period has passed. 

 

Most plans for employee stock options allow a percentage of stock to be sold each year. In our example, if the company allows for 20% of the stock to be vested each year, after one year, an employee will have the ability to sell the 100 shares of their stock options, and so on for each year as the stocks continue in the vesting process. The advantage for employees granted the right to exercise stock options in the company that they are working for is that they will, in most cases, receive that stock at or lower than the market price. The purpose of this is to make an employee feel like the company’s success is tied to their success as well. If they can work to further the company’s goals and raise the price of the company’s stock on the stock market, the employee can sell their stock options and make a profit. 

 

Continuing our example, if the employee has $2500 in shares in the company and the market price increases, they will make the difference. So, if the company reaches $8 per share by the time the employees’ stock is fully vested, they can sell it for $4000, for a $1500 profit. 

 

The typical scenarios for this type of stock option are in start-up companies or as incentives to bring the best talent to a larger company. For the company, the incentive does not come from the operating budget but helps to involve employees in the company’s success. The success of the company is a success for all. 

 

How to Select a Crowdfunding Platform for Your Capital Raise

Posted on by Oscar Jofre Tags: , , ,

Introduction to the JOBS Act

One of the significant advancements brought to the financial sector in recent years was the enaction of the JOBS Act signed into law by President Obama on April 5th of 2012. Within that legislation contained a form of raising capital for private companies available to any American, whether they were accredited investors or not. This was Regulation CF or regulated crowdfunding.

Regulation CF and Investment Limits

When Reg CF was implemented, it limited the amount an unaccredited investor could invest and how much a private company could raise. In March 2021, the limit a company can raise increased to a maximum of $5 million within 12 months. Previously, before the introduction of Reg CF, it was challenging for the average investor to invest in a private company, as they did not have the capital to do so. This is now possible through Reg CF, which uses equity crowdfunding platforms to connect investors and private companies.

FINRA Regulation and Compliance

Funding portals are regulated by FINRA, which imposes compliance on the organizations that provide the service and includes regulatory oversight and reporting requirements. FINRA has a list of funding portals registered and regulated by FINRA, which is the first thing to check when considering a funding portal.

The Value of a good Crowdfunding Platform

Part of the value of crowdfunding platforms for private companies is establishing demand and proof of concept. If people are willing to invest in a Reg CF offering, it shows that people want a product or service to succeed. So, choosing the correct equity crowdfunding portal for you depends on the user base of that platform. For example, let’s look at three portals to see the differences in who is investing on those platforms.

Examples of Crowdfunding Platforms

FanVestor

FanVestor is a platform predominantly for celebrities looking to raise money for a product or a charity. If, as a private company, you are among this group of people, this would be an effective platform, as investors would look here for you.

Republic and WeFunder

In contrast, if you are a startup, you would be looking at portals like Republic or WeFunder. These two portals focus on startups, with Republic focused on real estate, video games, and crypto, and WeFunder focused on giving small businesses and startups an alternative to venture capital and banks; their focus is “fixing capitalism.”

Matching Your Goals with Investor Interests

Look at where the investors are and what they are excited about, and then match that with your goals and vision. This is the best way to choose the right funding portal. It puts your company in the best place to raise the most capital and take your vision from dream to reality, with the backing of investors that believe in you.

Evaluating Platform Benefits

Beyond that, look to see which platform is the most beneficial for your situation. Consider how much they will charge and help you with the campaign. The purpose of working with a funding portal is to put your company, product, or service in the best possible position for success. The right crowdfunding platform will balance your weaknesses with their strength.

 

Note: This information is provided for educational purposes only and should not be construed as legal or investment advice.

KorePartner Spotlight: Dean DeLisle, Founder and CEO of Forward Progress

Posted on by Oscar Jofre Tags: , , , , ,

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

Dean DeLisle has been raising capital for the past 35 years both for himself and for other companies. He has made the transition from roadshows and bound pitch decks to sophisticated online marketing funnels. Dean’s experience has resulted in a unique approach to Investor Acquisition Marketing with his firm Forward Progress.

“People know they want to invest but need to understand more, so we place a high priority on education throughout our Investor Acquisition campaigns,” says Dean. Forward Progress helps clients build the necessary digital footprint to educate prospective investors in Regulation CF, Regulation A+, and Regulation D offerings. The building of the footprint requires many of the same strategic elements you would see in a revenue-focused campaign–content, thought leadership, advertising, and marketing automation.

The Forward Progress team stays at the forefront of digital marketing trends by participating as speakers on capital raising, marketing automation, and marketing strategy. The company boasts certifications with leading platforms like Hubspot CRM, Facebook Ads, Google Analytics, and more to make sure the issuers they support are at the bleeding edge.

The partnership with KoreConX makes sense for Dean, as both companies are dedicated to investor education and businesses alike. It fits with the DNA of both companies.

Nominee vs. Direct: How does this affect investors?

Posted on by Oscar Jofre Tags: , , , ,

Today, there are many ways to buy and sell securities. For publicly traded companies, 75% of Americans are familiar with investing apps or online accounts. For private companies, many investors in companies invest with a broker-dealer and or maintain their own investments. In the first situation, an investor deals with a broker-dealer who holds the investors’ assets in a nominee account, while the second is a direct investing method controlled entirely by the investor. Both accomplish the same goal, buying or selling securities for profit or dividends, but the effect on an investor varies. 

 

A nominee is an account held by a broker-dealer, and securities owned by an investor are held as a means of separation between the broker’s business and the assets owned by the nominee account. This separation established a level of protection for the investor. In the event of the broker’s business failing, the securities held in the nominee account cannot be ascertained by any creditor claiming assets. The stocks will still be the asset of the investor, regardless of what happens to the broker. 

 

The issue that comes forth in this model is that, while regulators and exchanges review these accounts periodically, they do not get checked daily, which opens the door for a bad actor to commit fraud and move the assets without permission. For example, fraud could occur if the broker-dealer ‘borrows’ a client’s assets to keep them afloat, potentially. An even more extreme example would be if a broker was to take all of the money and run, though this is less likely. 

 

The main thing to consider is that while the investor is the beneficiary of the stock, the broker has the authority to move it and sell it on the investor’s behalf. This is why it is important to look into the investor compensation programs with a broker, and for further protection, separate your assets between multiple brokers. While this option comes with risks, the broker will ultimately handle the operations of the account. If you are working through direct investing, account operations are maintained by the investor. 

 

With direct investments, the trade-off for increased security is that an investor is responsible for buying and selling decisions. A direct stock plan can allow you to buy or sell stock in some companies directly through them without using a broker. However, according to Inverstor.gov, “Direct stock plans usually will not allow you to buy or sell shares at a specific market price or at a specific time. Instead, the company will buy or sell shares for the plan at set times — such as daily, weekly, or monthly — and at an average market price.” Both options have merit, but the choice is between complete security at the cost of time and energy. 

Using RegCF to Raise Money for a Non-US Business

Posted on by Mark Roderick Tags: , ,

To use Reg CF (aka Title III Crowdfunding), an issuer must be “organized under, and subject to, the laws of a State or territory of the United States or the District of Columbia.” That means a Spanish entity cannot issue securities using Reg CF. But it doesn’t mean a Spanish business can’t use Reg CF.

First, here’s how not to do it.

A Spanish entity wants to raise money using Reg CF. Reading the regulation, the Spanish entity forms a shell Delaware corporation. All other things being equal, as an entity “organized under, and subject to, the laws of a State or territory of the United States,” the Delaware corporation is allowed to raise capital using Reg CF. But all other things are not equal. If the Delaware corporation is a shell, with no assets or business, then (i) no funding portal should allow the securities of the Delaware corporation to be listed, and (ii) even if a funding portal did allow the securities to be listed, nobody in her right mind would buy them.

Here are two structures that work:

  • The Spanish business could move its entire business and all its assets into a Delaware corporation. Even with no assets, employees, or business in the U.S., the Delaware corporation could raise capital using Reg CF, giving investors an interest in the entire business.
  • Suppose the Spanish company is in the business of developing, owning, and operating health clubs. Today all its locations are in Spain but it sees an opportunity in the U.S. The Spanish entity creates a Delaware corporation to develop, own, and operate health clubs in the U.S. The Delaware corporation could raise capital using Reg CF, giving investors an interest in the U.S. business only.

NOTE:  Those familiar with Regulation A may be excused for feeling confused. An issuer may raise capital using Regulation A only if the issuer is managed in the U.S. or Canada. For reasons that are above my pay grade, the rules for Reg CF and the rules for Regulation A are just different.

 

This blog was written by Mark Roderick of Lex Nova Law, a KorePartner. The article was originally published on Mark’s blog, The Crowdfunding Attorney.

What is KYP?

Posted on by Oscar Jofre Tags: , , , , , , 1 Comment on What is KYP?

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?

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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?

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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 are Options?

Posted on by Oscar Jofre Tags: , , , ,

Like warrants, options are a form of security called a derivative. As a derivative’s name suggests, these securities gain their value from an underlying asset. In the case of options, this is the underlying security. 

 

There are typically two primary forms of options; call options and put options. Both are governed by contracts; a call option allows the holder to buy securities at a set price while a put option allows them to sell. However, options contracts do not come for free. They can be bought for a premium, which is a non-refundable payment due upfront. Once options have been purchased, the holder has a certain amount of time during which they can exercise their options. On the other hand, options do not require the holder to purchase the shares contracts allow. When options are exercised, the price paid is referred to as the strike price.

 

In buying call options, the holder is guaranteed to buy securities at a certain price, even if the underlying security significantly increases in price. A put option works more like an insurance policy, protecting the holder’s portfolio from potential downturns. If a security was to decrease in price, the shareholder would be able to sell at a set price specified by their option contract, even if the market price was to fall lower than what the option allows it to be sold at.

 

In addition to being a way to minimize investment risks and maximize profits, options are becoming a popular incentive for employees, especially in startup companies when looking to attract employees. In addition to options that can be bought, options also refer to the ones issued to employees by their employer. This gives employees the chance, but not the obligation, to buy shares within a specified time. Employee stock options either come as an Incentive Stock Option or Nonqualified Stock Options, with the difference being the tax incentives that go along with exercising the options. 

 

Whether you have call or put options, they are a useful way to protect your portfolio from downsides or benefit from being able to purchase more shares at a discounted price. They are just one of the many forms of securities available, which should be considered carefully when making investment decisions.

What is a Virtual Data Room?

Posted on by Oscar Jofre Tags: , ,

Every way that we do business is changing on what seems a daily basis. In just the last year, we have seen a public health crisis push everyone into their homes to work in the interest of public safety. Along with that change, there was also a change needed in the IT departments to ensure that remote connections were secure. What we have seen in the time of the pandemic is that cyberattacks have increased as remote access has created openings. We have seen two notable attacks already this year, one on Colonial Pipeline and another on the South Korean Nuclear institute, KAERI.

 

However, this is not to say the whole world is doom and gloom on the cybersecurity side, as there are ways to protect yourself, especially as companies continue going virtual. Previously, in the event of an M&A transaction, loan syndication, or private equity and venture capital transactions, the actors in these transactions would meet in a physical, secured room to do the due diligence process and access important documents. In this physical room, extensive surveillance and logs track who has been in and out and what they viewed, costing money and time. In addition, parties outside the company that owns the documents would need to arrive at the physical location to view them, again, costing time and money. 

 

The answer to this, as the business world tends to find, is a move towards virtual storage options called a virtual data room. Virtual data rooms have become a widespread solution to the problems detailed above. Through an extranet or a virtual private network (VPN), these systems are secure by limiting access via the internet to specific users at specific times. If a deal falls through or a specified task gets completed, access can easily be revoked.

 

Highly sensitive data usually gets stored in a Virtual Data Room, a level of protection necessary as cyber threat numbers escalate. Beyond the security, these data repositories generally include a log that details each person’s activities with the sensitive files. Like the move to remote work, which has increased the availability of skilled employees, virtual private rooms open up a business to a global market of potential deals. No longer are businesses limited by their ability to feasibly transport a person and their team to a physical room and then have a place for them to stay while discussing a deal. 

 

The main goal of a Virtual Data Room is to provide a centralized access point to a large volume of sensitive and secure documents needed for the most paperwork-intensive processes. While a physical room removes the chances of a cybersecurity attack completely, it also poses certain disadvantages that contrast the wealth of opportunity created by a Virtual Data Room.

USA vs. Canada: Who Has Better Capital Raising Rules

Posted on by Oscar Jofre

When it comes to raising capital for your business, there is some confusion between rules in the United States and Canada. Can Canadian companies file for Regulation A+ like a United States company? Yes, but with some important caveats. The important thing that separates the two North American countries are some simple but distinct differences in securities law.

With the 2012 JOBS Act (and its subsequent additions), Rule 251(b)(1) says Regulation A can only be used by: “an entity organized under the laws of the United States or Canada, or any State, Province, Territory or possession thereof, or the District of Columbia, with its principal place of business in the United States or Canada.” The United States, through the SEC regulation, has allowed Canadian companies to file the same as US companies, but the rules of law in Canada still apply. You have to follow the rules established by the SEC or any federal law, as there are significant ramifications if you are not compliant.

Broker-Dealers

The best thing about having a broker-dealer is that they can act as an insurance policy. Some companies expect that they can handle the offerings for a Reg A+ on their own, which is possible, but it will ultimately end up costing you more money in the end. This means that for several states in the US, you have to be a FINRA licensed broker-dealer, who is registered as a broker-dealer in that state, to sell securities. If you ignore this rule, it only takes one complaint to have a state securities regulator coming down on you.

Essentially if this were to happen, you would need to give all the money raised back and pay a fine, but most importantly, they would bar you from ever raising capital in that state. Now, as a bad actor in one state, you may not be able to raise capital in any state. There are huge repercussions to doing this wrong when you can pay a broker-dealer to handle this for you. This is the same for a US company as well as a Canadian company.

The beauty of the SEC and FINRA is that it forces transparency and accountability. While this is a safeguard for the investors more than for the company, it is still an important step to doing this process correctly.

Lawyers

As the system is created, in the United States, a lawyer can practice law in a state and federal law in all 50 states without needing a license in each state. However, if a US lawyer is licensed to practice in Florida, they cannot give legal advice in another state about state law. Instead, you would have to involve a licensed lawyer from that state if issues arise there. The difference here is that in Canada, this is not the same. If you have a lawyer in Alberta, they cannot provide you with advice in British Columbia or Ontario.

Securities

One of the many differences between the United States and Canada is the number of citizens. Within the US, the current population is nearly 333 million. In contrast, the Canadian population is just over 38 million. When you raise capital through Reg A+, you want to have access to as many potential investors as possible. You will most likely end up spending the same amount of money in either country, as the Reg A+ laws make it easier to file than it used to in the US.

The main difference you will see is in the rules about offering to US citizens and Canadian citizens. The American investor can freely trade securities in a secondary market, while the Canadian investor can do nothing but hold it. The primary raise is one set of laws, but the secondary rules in Canada are different.

Auditing

When it comes to Reg A+, the financials of a company need to be audited before filing and they need to qualify. First, an important note is every company attempting a Reg A+ needs two years of audited financials if they’ve been in business for two years. If they’ve been in business one year, they need one year. Even if they are a startup, they still need to provide audited financial statements, even if there is not much to show. The difference here comes from the agency they can file with. In the United States, it is US GAAP and US GAAS. In Canada, they have the option of using IFRS.

When it comes to raising capital in either jurisdiction, there are notable differences in securities laws that need to be met. Whether you are a US or Canadian company looking to use the exemptions like Regulation A+, building a team of experienced broker-dealer and legal partners will ensure a successful and compliant capital raise.

KorePartner Spotlight: Douglas Ruark, President of Regulation D Resources

Posted on by Oscar Jofre

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

 

For over two decades, Douglas Ruark has been involved in the corporate finance world specifically focused on SEC-exempt securities offerings.  In 1992, he co-founded Heritage Financial, a company specializing in sourcing commercial real estate and corporate debt financing for commercial borrowers, which later merged with the investment banking firm InvestCap Partners in 1994. Five years later, Douglas served as the primary founder of Regulation D Resources, a company founded to advise corporate clients on the preparation and execution of Regulation D private placement offerings. Since the company’s formation in 1999, Regulation D Resources has provided advisory services for over 5,000 securities offerings. The company currently provides securities preparation and execution services for Regulation D, Regulation CF, and Regulation A+ exempt offerings.

 

Douglas and his expert team work with their clients to structure the offering, draft offering documents and SEC filings, advise on key metrics, and in Regulation A+ offerings convert and submit such filings for SEC qualification.  The Regulation D Resources team also provides compliance support once the client is ready to market their offering to ensure the client is properly supported through the close of the offering. The firm handles offering clients across a wide array of industries including real estate (which is one of the top sectors they work with), energy, technology, and manufacturing. 

 

One of the factors setting Douglas and Regulation D Resources apart is the 22 years of experience in the securities industry, an unblemished compliance track record, and the significant transactional experience developed in that timeframe.  Beyond his experience, Douglas is genuinely excited to be in this space. He says: “I love seeing what entrepreneurs have developed. The fun deals are companies that have developed technology that can have a big impact on an industry or be a game-changer.  Assisting them in raising funding to advance their dream and capitalize future corporate success is truly rewarding.”   

 

Douglas enjoys his partnership with KoreConX, sharing the same drive and vision regarding the application of technology to streamline processes. In addition, the responsiveness of the KoreConX team, he feels, has been great.  As soon as he was interested in learning more about the KoreConX platform, “Oscar reached out and set up a call introducing the services.  We instantly connected as our firm’s focus has been furthering the ability of small and medium-sized companies to access private capital and democratizing that access via SEC-exempt offerings.  Oscar’s work in streamlining processes and keeping costs contained for entrepreneurs aligned perfectly with the mission at Regulation D Resources.”  

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