The Broker-Dealer’s Guide to Due Diligence process

In the realm of private capital markets, due diligence is not just a procedure but a pledge—a commitment to uphold integrity, trust, and compliance.  This guide serves as a beacon for Chief Compliance Officers (CCOs) and their compliance teams, guiding them through the complexities of due diligence process in private company capital raises. From leveraging technology to navigating an ever-evolving regulatory landscape, to understanding the nuanced roles of FINRA Broker-Dealers, we delve into how these crucial processes safeguard the private capital markets, ensuring a secure and transparent investment environment for all parties involved.

Due Diligence by Chief Compliance Officers

Imagine a world where investments flow seamlessly, underpinned by an unshakeable trust between investors and companies raising capital. This is the reality that CCOs strive to create through meticulous process of due diligence on companies and investors. Through their diligent efforts, such as scrutinizing a company’s financial health, operational strategies, and leadership integrity, CCOs not only protect investors from unforeseen risks but also build a foundation of trust that is paramount for successful capital raises.

Empowering CCOs with Technology

The digital age has revolutionized due diligence process, providing CCOs with tools to gather and analyze vast amounts of data efficiently. Technologies tailored to regulations like RegCF, RegD, and RegA+ enable CCOs to customize and have still best practices in due diligence processes. Therefore, ensuring that each investigation meets specific regulatory standards. This not only streamlines compliance but also allows CCOs to allocate their resources more effectively, focusing on strategic decision-making rather than getting lost in a sea of paperwork.  CCO’s are the backbone of the firm, and as such technology needs to be part of their overall strategy for the firm to be successful, tools such as Compliance Desk provide the necessary and regulatory requirements of making sure data is collected, tracked, and maintained for CCOs. 

Navigating Challenges of due diligence process in a Dynamic Regulatory Environment

The landscape for FINRA Broker-Dealers is fraught with challenges, from navigating a complex web of regulations to ensuring that compliance teams are equipped with the necessary tools. The advent of technologies like the Compliance Desk represents a significant leap forward, enabling CCOs to maintain organized records in a FINRA-approved facility to meet Rule 17a-4 requirements. This capability is crucial for broker-dealers to manage their compliance efficiently, allowing them to focus on expanding their business while maintaining strict regulatory adherence.

The Critical Role of FINRA Broker-Dealers

FINRA Broker-Dealers are the guardians of the private capital markets, and their role extends beyond initial best practices on the due diligence process; they help to ensure the safety and integrity of transactions for investors, companies, and intermediaries alike. Once an offering goes live, they are responsible for continuous oversight, including KYC, AML, suitability, and investor verification. This dual focus on company and investor due diligence is essential for preventing bad actors from entering the market, thereby protecting the investment ecosystem.

7 Steps for Effective Due Diligence on Private Companies

For those aiming to enhance their due diligence processes or embarking on the journey to become a FINRA Broker-Dealer,  consider the following steps:

  1. Comprehensive Regulatory Understanding: Gain a deep understanding of the relevant regulations (RegCF, RegD, RegA+) and their implications for your due diligence process.
  2. Robust Data Collection and Analysis: Leverage technology to efficiently collect and analyze company data, focusing on financials, management, and operational integrity.
  3. Risk Assessment: Develop a framework for assessing and categorizing potential risks, including financial, legal, and operational risks.
  4. Management and Operational Evaluation: Conduct thorough evaluations of the company’s management team and operational capabilities to ensure they have the necessary expertise and resources.  Always do bad actor checks on the company and the principles of the company.
  5. Legal Compliance Verification: Verify the company’s compliance with all applicable laws and regulations, including securities laws and industry-specific regulations.
  6. Continuous Monitoring: Establish processes for ongoing monitoring of the company’s performance and compliance post-investment.
  7. Record Keeping and Reporting: Implement systems for maintaining detailed records of your due diligence process, ensuring they meet FINRA’s Rule 17a-4 requirements for record-keeping.

Best practices on due diligence for broker-dealers

In the rapidly evolving landscape of private capital markets, the importance best practices on due diligence for broker-dealers cannot be overstated.

It is the bedrock upon which trust and compliance are built, safeguarding the interests of investors and ensuring the integrity of the market. For FINRA Broker-Dealers and their compliance teams, staying abreast of regulatory changes and leveraging technology are key to navigating this complex environment effectively.

So, by creating a comprehensive guide of due diligence best practices that align with current regulations and anticipate future shifts, firms can not only comply with today’s standards but also set a benchmark for excellence in compliance and investor protection. As we move forward, education and adaptability will remain crucial for all stakeholders in the private capital markets, ensuring that they can meet today’s challenges and seize tomorrow’s opportunities.

Raising capital for startups: 3 red flags for not being tricked

Can a startup pay a transaction-based fee for capital raising assistance? This is a very common question. For the most part, the answer is a clear “no,” but why is that? 

The short answer is that—except under certain limited circumstances—it is illegal. Regulatory protections provide investors with the right to their money back with interest and attorney fees, and it may result in, among other things, the founders not only being held personally liable to investors but also getting listed on a  bad-actor list. 

Finding investors is one of the biggest challenges that  companies face. This is especially true for startups because most founders don’t have an established network of investors ready to invest capital. 

Often, founders who are seeking to expand their network of investors will run into someone who would be happy to make a few introductions … for a fee. RUN AWAY!!

Here are 3 Red Flags while raising capital for your company.

Red Flag #1: Transaction-based compensation

Most often, someone who wants a fee for helping to raise capital (often referred to as a “finder”) is not licensed to do so, and generally speaking, use of a finder who is not a licensed broker-dealer is a violation of federal and state securities laws. Below we summarize how to identify a broker-dealer and then look at the potential negative consequences of using an unlicensed broker-dealer.

What is an unlicensed broker-dealer?

The answer is simple: Just ask the finder, “Are you a registered FINRA Broker-Dealer?” The answer is either yes or no.

For decades, the SEC & FINRA have defined a four-factor test to determine when a “finder” is required to register as a broker-dealer. The SEC’s position is that these 4 factors will be analyzed in determining when someone is acting as a broker-dealer, with no one factor being dispositive:

  1. Whether the person receives commissions or other transaction-based compensation;
  2. Whether the person makes buy/sell recommendations and provides investment details;
  3. Whether the person has a history of selling securities (regular activity); and
  4. Whether the person takes an active role in negotiations between the investor and the issuer.

“What if a finder receives a percentage of the money raised through finder introductions, but does not make recommendations, does not have a history of selling securities, and does not take an active role in negotiations between the investor and the issuer?” 

Despite its emphasis on four factors, the SEC has stated in several no-action letters that transaction-based compensation represents a hallmark of being a broker-dealer, even when the other three factors are absent. Consequently, an individual or company that receives a commission substantially increases the risk that the party receiving the commission will be considered a broker-dealer. For decades, the best advice has been that in view of the risks involved, issuers should typically not engage finders on a percentage-based compensation basis.

Red Flag #2: Reliance on No-Action Letters

On several occasions, we have come across finders who refer to a no-action letter issued by the SEC in 2014 as evidence they can receive a commission despite not being a licensed broker-dealer.

The problem with that position is that the letter has several conditions, including that the buyer of the securities being sold has, following the sale of the securities, (i) control of the company, and (ii) must actively operate the company.

Nearly all startup financings do not fit into this scenario, so the no-action letter does not apply.2

Finders will also often attempt to find (and share with the startup’s leaders) comfort by relying on the 1991 SEC No-Action Letter involving the singer Paul Anka. While often cited by finders, the SEC staff’s decision to not recommend enforcement against Mr. Anka—if, without registering as a broker-dealer, he provided the company a list of potential investors in exchange for a commission—is of limited relevance and utility.

The SEC staff noted its no-action decision was conditioned on several factors, including that Mr. Anka was not engaging in the following activities: soliciting the prospective investors, participating in any general solicitation, assisting in the preparation of sales materials, performing independent analysis, engaging in “due diligence,” assisting or providing financing, providing valuation or investment advice, and handling any funds or securities.

Red Flag #3: Liability for using an unlicensed broker-dealer in capital raise

What Possible Liability Is There for Using an Unlicensed Broker-Dealer to Raise Capital? 

Using a finder will create liability under federal and state law. Agreements for the sale of securities made in violation of federal securities law may be held void.4 This would certainly apply to the agreement with the unregistered broker who attempts to collect a fee for assisting in the sale of the securities.

While the startup may feel that this is not such a bad thing, a violation of federal securities laws also will void (or make voidable) the agreement between the startup and investors under which the startup raised the funds. If the agreements are held void by a court, then all parties to those agreements would have a right of rescission that would last for the later of three years from the transaction or one year from the date the violation is discovered.

A right of rescission is simply a right to cancel the agreement and return each party to its original position, which means returning investments back to investors. In other words, the use of a finder who is not but should be a registered broker-dealer in effect gives the investors a multi-year redemption right.

Are There Other Potential Consequences of Engaging an Unlicensed Broker-Dealer to Raise Capital?
Yes, otherwise we would not have posed the question. Founders who engage unregistered broker-dealers to raise capital may:

  1. SEC Enforcement Actions: Face enforcement actions from the SEC as an aider and abettor8;
  2. State Regulatory Actions: Face enforcement actions from state securities regulators; and
  3. Prohibition and Labeling: Be labeled a “bad actor” and prohibited from participating in or being involved with companies that do securities offerings made under commonly used securities exemptions.9

Additionally, the startup and its principles may be prohibited from using the updated JOBS Act regulations such as Rule 506, Regulation CF, and Regulation A+ securities offering, which is the most commonly relied-upon securities exemption for startups and emerging growth companies. And, just because the list goes on, the use of an unlicensed broker-dealer could impact the ability to close future rounds of financing because of the contingent liability associated with the initial violation, which is likely to come up in investor due diligence.

What is an Escrow Provider’s Role in RegA+?

An escrow provider is a neutral party that handles financial transactions between two or more parties. They are often used in the securities industry to ensure that all parties involved in trade receive their agreed-upon share of the investment. Escrow providers in RegA+ play an essential role, securely holding funds investors have paid until those investors can be verified. This article will explain what an escrow provider is, their importance in RegA+, and some of the benefits they offer companies.


An escrow provider is a financial institution or company that holds funds on behalf of two other parties until their agreement has been met. In the context of securities offerings, escrow providers are often used in Regulation A+ transactions to hold funds invested by investors until the broker-dealer has completed their due diligence on those investors. This due diligence includes verifying the investor’s identity and ensuring that the investment is legitimate.


The escrow provider plays an important role in protecting both the investor and issuer in a Reg A+ transaction. Holding the funds until the completion of the broker-dealer’s due diligence protects the issuer from fraud and also ensures that the buyer receives their money back if the deal falls through. 


Escrow providers help to make sure that all of the necessary steps are taken to complete the transaction and that everyone involved is satisfied with the outcome. Part of this process includes making sure that the correct paperwork is filed and that all of the right people have signed off on it and everyone involved is legitimate. 


Beyond using an escrow provider to ensure that your Reg A+ transactions are completed smoothly and efficiently, it is also required for companies utilizing equity crowdfunding. Therefore, choosing an experienced escrow provider can provide valuable assistance and peace of mind throughout the process. 


Escrow providers play an essential role in Reg A+ transactions by holding and managing the funds until the necessary due diligence has been completed. They also ensure that all parties involved in the transaction comply with securities laws. These factors make escrow providers in RegA+ a necessary component of a successful offering. 

What Does Direct Listing Mean?

Recently, we received a question from an issuer wondering what “direct listing” means. In short, a direct listing, also sometimes referred to as a direct public offering, is an offering in which an issuer raises capital directly from investors without a third-party intermediary like a broker-dealer or funding platform. 


Direct listings can occur in both the public and private markets. In the private market, companies raising capital often do so under JOBS Act exemptions for SEC registration, such as RegA+ or RegD. Companies may opt for a direct listing because it lowers the costs of capital as there are often fewer fees that would otherwise be paid to an intermediary. Issuers can also use a direct listing to allow investors to invest through the issuer’s website, which can prevent investors from being directed to other offerings. This often gives issuers more control over the investment. In contrast, RegCF offerings cannot be conducted without using an SEC-registered intermediary.


However, there are significant downsides to opting for a direct listing. Some states require issuers to utilize an intermediary like a broker-dealer or funding portal to sell securities. Additionally, some Tier I RegA+ direct listings require the issuer to register the security in every state that it intends to sell the security, making the offering more burdensome and costly. Additionally, a direct listing can make it easier for companies to miss essential aspects of regulatory compliance, creating additional risks for themselves and investors. This, offerings made via a direct listing require a higher level of due diligence from investors to ensure they aren’t falling victim to fraud.


When using a registered intermediary like a broker-dealer or a funding portal, these entities often have defined processes and compliance requirements that ensure capital is being raised in accordance with securities regulations, protecting both issuers and investors. An SEC-registered intermediary ensures that an issuer has gone through due diligence like bad actor checks to validate that it is eligible to be listed on a portal.


Ultimately, any company seeking to raise capital through a JOBS Act exemption should talk to a broker-dealer and a securities lawyer to understand how they can compliantly and successfully raise the capital they need to grow in the private market. 

Can I Trade Private Shares?

Think of buying a traditional stock, listed on a public exchange like the New York Stock Exchange or NASDAQ. You can buy and sell these stocks freely; you can do so through a broker-dealer, online, or even through an app on your smartphone. You can sell it almost immediately, although there can be some limitations.

Can I trade private shares? The answer is yes. Similar to the public market, you can invest in private companies through three common types of capital raises and trade your securities on a secondary market.


To sum these exemptions up, they allow private companies to sell securities to US investors without going through the SEC’s registration process. They each vary as to how much capital can be raised. These exemptions include:


  • RegA+ is a securities exemption that allows companies to offer and sell securities to US investors and raise up to $75 million in a 12-month period through Reg A+.
  • RegCF allows companies to offer and sell securities to US investors and raise up to $5 million through online marketplaces and crowdfunding sources in a 12-month period.
  • RegD is a securities exemption that allows companies to raise capital from accredited investors (and a limited number of nonaccredited investors) without limit within a 12-month period.


With all of these exemptions, investors can share the securities they’ve invested in. However, there are some key differences pertaining to the length of time an investor is required to hold the security before selling it on a secondary trading platform. Reg A+ is the closest to an IPO, assets can be sold the next day, and there is no lockout period. On the other hand, securities sold under RegCF cannot be sold for the first 12 months after buying it unless it’s sold to an accredited investor, back to the issuing company, or a family member. With Reg D, investors can not sell these assets for six months to a year unless they are registered with the SEC.

Once you can trade your securities, the transaction will be carried on an alternative trading system or ATS. An ATS is much like a traditional exchange, the only difference is that they do not take on regulatory responsibilities. They are also operated by a FINRA-registered broker-dealer.

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Before you make an investment decision, be sure to understand the limitations of secondary trading. If you’re unsure of what the limitations are, please reach out to a transfer agent or broker-dealer for additional information.

SEC Amends Broker-Dealer Record-keeping Requirements

The SEC’s long-time policy for broker-dealers is to keep records of their business activities in a non-rewritable, non-erasable format – otherwise known as WORM (Write Once Read Many). But with new amendments to Rule 17a-4, broker-dealers are provided an audit trail alternative to keeping data in WORM format. Beginning May 3, 2023, firms will be required to comply with the new record-keeping regulations.


The final amendments grant flexibility to broker-dealers when meeting these requirements. They can choose to either: (1) preserve documents in WORM format, or (2) preserve electronic records in a system that maintains a timestamped audit trail. These can take the form of cloud-based systems, distributed ledger technology, or other emerging technologies.


This rule can be interpreted in a few different ways. First, firms can retain some electronic records with an audit trail and preserve other records with the WORM requirement. Second, firms may use an electronic recordkeeping system that meets the audit trail and WORM requirements. Either way, broker-dealers should ensure their programs are compliant as of May 3rd, 2023, or face the stiff penalties associated with non-compliance.


With the compliance date approaching, broker-dealers should review their record retention practices and expand the review beyond WORM vs Audit Trail alternatives. By proactively evaluating existing record retention practices and identifying any gaps before the compliance date, broker-dealers can ensure that their records are up-to-date and compliant with the new regulations.


Who Does Due Diligence on Companies Using RegCF?

When it comes to raising capital using Regulation Crowdfunding (RegCF), due diligence is an essential part of the process. Due diligence helps ensure that the company offering securities complies with all applicable laws and regulations and that investors are fully informed about the risks that come with investing. We are going through who does due diligence on companies using RegCF


Conducting Due Diligence for Reg CF


The responsibility for conducting due diligence on companies using RegCF lies with a variety of parties. To offer securities through a RegCF raise, companies must use an SEC and FINRA-registered Broker-Dealer or crowdfunding platform. The broker-dealer or crowdfunding platform needs to ensure that the issuer provides accurate company information and complies with securities regulations at both the federal and state levels. These parties also ensure that any investors pass KYC and AML checks to ensure they are not bad actors or other people unable to invest.


The issuers themselves also have responsibilities when it comes to due diligence. They must provide investors with accurate and complete information about the company, its securities offering, and the risks associated with investing. Investors also have an obligation to thoroughly review any information regarding the investment opportunity so that they can understand its potential risk and determine if it is an appropriate investment.


Types of Information Gathered During Due Diligence


When conducting due diligence on companies using RegCF, there is an information-gathering process, notably from your Form C, such as:


  • Business plans
  • Background checks on key officers
  • Financial statements and tax returns
  • Intellectual property registration filings
  • Proof of ownership in any subsidiaries of the company
  • Legal documents related to the business, such as contracts and bylaws


This information provided during the due diligence process allows investors to better understand the company and its business operations. 


Protecting Investors and Issuers 


Performing due diligence on companies using RegCF is an important part of protecting investors. It helps ensure that only qualified and legitimate businesses can raise capital. It also provides investors with the information they need to make informed decisions about their investments.


Due diligence is important for companies raising funds through RegCF because of the number of new-to-the-space investors. Issuers will demand their broker-dealer to complete all due dilligence. Raises can be successful and investors need to be sure of that, as well. Additionally, platforms should also have procedures in place to collect information from companies and investors before they are allowed to raise funds, such as background checks. By doing so, platforms ensure that investors are protected and companies meet all necessary criteria before raising funds.


Proper due diligence has clear roles: From broker-dealers and the platforms that facilitate the RegCF transactions to issuers and investors themselves. Accurate and complete information about companies using RegCF protects issuers and investors. For investors, it allows them to make better-informed decisions about their investments. For issuers, it provides an opportunity to demonstrate commitment to compliance and build credibility with investors for a successful raise.

Who Does Due Diligence on Companies using RegA+?

Due diligence is an essential part of the investment process. Especially following the passage of the JOBS Act in 2012, which expanded Regulation A+ (RegA+), companies now have additional opportunities to seek capital from investors. This has created a need for due diligence on these companies that is both thorough and efficient. In this blog post, we will discuss who does due diligence on companies using RegA+ and who does due diligence on companies using RegA+.


What Is Due Diligence?


The Securities Act of 1933, a result of the stock market crash years earlier, introduced due diligence as a common practice. The purpose of the act was to create transparency into the financial statements of companies and protect investors from fraud. While the SEC requires the information provided to be accurate, it does not make any guarantees of its accuracy. However, the Securities Act of 1933 for the first time allowed investors to make informed decisions regarding their investments.  


In the context of raising capital through RegA+, due diligence means that the issuer has provided all of the necessary information to investors and securities regulators so that they comply with securities laws. This may include information like:


  • Funding: The issuer should provide a detailed plan of how the money raised through RegA+ will be used.
  • Products/Services: The issuer should provide a clear description of their products and services, as well as any potential advantages that they may have over the competition.
  • Business Plan: The issuer should provide a detailed and comprehensive business plan outlining their current and future projects, as well as realistic projections based on their financial reports.
  • Management Team: The issuer should disclose information about the company’s officers, founders, board members, and any previous experience in business that may be relevant to investors.


Issuers should also use a registered broker-dealer as an intermediary to comply with Regulation A+ (RegA+). By doing this, they will ensure that they are meeting their due diligence requirements.


Who Is Responsible for Doing Due Diligence on companies using RegA+?


When it comes to due diligence for companies using RegA+, typically, the issuer’s FINRA Broker-Dealer is responsible for conducting due diligence both on the potential investors and the company itself. 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 the issuer so that they can be assured that the 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. 


However, both investors and issuers have a responsibility for due diligence as well. Investors should research the company thoroughly and make sure they understand all details surrounding the offering before investing their money. This includes reviewing all relevant documents, such as the offering circular, stock subscription agreements, and other related materials that give them a good understanding of the investment opportunity and its potential risks.


Issuers also contribute to due diligence as they must work with their FINRA Broker-Dealer to ensure that their offering is compliant with all laws and regulations. This includes verifying all information provided in the offering materials and making sure it meets regulatory requirements. The issuer must also disclose all information that could influence an investor’s decision to purchase the securities. 


Due diligence is essential for both investors and issuers when it comes to investments under Regulation A+ (RegA+). Ensure that thorough due diligence is conducted ensures that the offering is conducted in a manner that aligns with the best interests of both investors and the issuer. Ultimately, due diligence is a key component when it comes to investments under Regulation A+ (RegA+) and should not be overlooked.


Opportunities to Invest in the Private Capital Market

The private equity market is rapidly growing, fueled by expansions to the JOBS Act exemptions in 2021. By 2030, the private capital market is anticipated to grow to a total value of $30 billion. This is largely driven by more companies seeing the potential in regulated crowdfunding through RegA+ and RegCF, and the rising interest of retail investors looking to move into the private space. Plus, research has shown that there is nearly $5 trillion in uninvested funds held by private equity firms alone. In addition, retail investors now represent 25% of the security trading volume in the public markets, a significant increase from the previous decade. According to BNY Mellon, “a new generation of younger retail investors are purchasing equities with the intention of becoming long-term market participants.” These factors have coalesced to create a favorable environment for investments in the private capital market. 


With favorable conditions to invest in public companies, there are many emerging and attractive industries for investors. Some of these include:


  • Medtech: Every day, companies are creating lifesaving technologies to improve human health and revolutionize medical care. Medtech companies often require high amounts of capital to fund clinical trials, research and development, and the many other processes they must go through. Since offerings limits for RegA+ were expanded to $75M, Medtech companies are increasingly viewing the exemption as a viable choice for raising capital.


  • Cannabis: The cannabis industry is rapidly growing, especially as public perception grows more favorable and legalization at the state level spreads across the US. However, cannabis companies are often underserved by traditional financial institutions due to the illegality at the federal level. With RegCF and RegA+, cannabis companies can tap into a vast market of retail investors who are willing to invest in an evolving industry.


  • Real Estate: Traditional real estate investments are capital intensive, making them cost prohibitive for many investors who are not high net worth individuals, private equity, or institutional investors. However, with RegA+ and RegCF, retail investors can own fractions of properties. And in, 2020, insurance, finance, and real estate accounted for 53% of qualified RegA+ offerings and 79% of the funds raised through the exemption. This indicates that real estate is an attractive investment opportunity for many investors. 


  • Franchises: JOBS Act exemptions create new opportunities for franchisees and franchisors to raise capital. These companies often have existing customers, who can become investors and brand ambassadors.


Regardless of the industry, a key component of any offering is the broker-dealer. Many states require issuers to work with a broker-dealer when selling securities in those states. A broker-dealer ensures that the issuer follows all SEC and state securities laws. More importantly, working with a FINRA-registered broker-dealer gives investors confidence by verifying that the issuer has provided all required information for the investors to make a sound investment decision. FINRA protects American investors by ensuring that brokers operate fairly and honestly. Plus, the broker-dealer also completes compliance activities, such as KYC, AML, and investor suitability and due diligence on the issuer themselves. 


Working with a broker-dealer ensures that the issuer behaves compliantly and gives the investor peace of mind when investing in one of the many investment opportunities within the private capital market.


How to Manage Investment Information

For entrepreneurs, it’s crucial to understand the private capital market well. Companies no longer need to go public to raise capital, enabling entrepreneurs to maintain more control of their companies. With regulations such as RegA+ and RegCF, accredited and non-accredited investors can be part of capital raising. Plus, the available pool of capital is expected to reach up to $30 trillion by 2030, making it a promising resource for companies. At the same time, investment management has become even easier with online services and platforms coming that provide end-to-end management for private companies to streamline the process.


Understanding KYC and KYP


It is vital for investors and issuers alike to know who they are dealing with. This is where KYC (Know Your Customer) and KYP (Know Your Product) come into play. Before making any investment decisions or accepting an investment, you should always know the issuer or investor’s identity. 


KYC is an essential component of risk management. As an issuer, it can help you to understand who your investors are and determine whether they would be a risk to your company. KYC can be complicated but helps to protect against money laundering and fraud.


KYP is most applicable to broker-dealers and is all about understanding the investment products or services you are offering to your customers. This includes knowing something about the issuing company, and understanding the structure of investment products, eligibility requirements, and other information that can help a broker-dealer determine whether an investment opportunity is right for an investor.


Remain Compliant


Compliance is another crucial aspect to consider regarding private capital raising. The Securities and Exchange Commission (SEC) has enacted many rules and regulations to protect investors. These include the requirements for disclosure, registration, and filing. In addition, there are restrictions on who can invest and how much they can invest. All of these requirements are designed to protect investors and issuers from fraud.


It’s important to note that certain compliance issues must be considered when raising capital privately. For example, under RegA+, companies must file a Form 1-A with the SEC. This form provides information about the company, the offering, and the risks involved. In addition, companies must provide audited financial statements and disclose any material changes that have occurred since the last filing. Under RegCF, companies are required to file a Form C with the SEC, requiring similar information to that of Form 1-A. 


Compliance may seem like an inconvenient chore, but in fact, it offers issuers many benefits, including avoiding unnecessary costs and delays, understanding the shareholder base, identifying potential high-risk investors, and encouraging best practices in record-keeping generally. By taking a proactive and whole-hearted approach to compliance, issuers will not only have an easier time completing their raise, but lay a better foundation for more efficient and smoother operations going forward


When managing your investments and staying compliant with the law, it is important to have a solid grasp of KYC and KYP processes. KoreConX can help you with your compliance needs with our complete end-to-end solution for private companies and broker-dealers. Our platform includes a KYC/KYP tool and a compliance management system to help you efficiently and securely manage compliance activities.


What is KYC?

Each year, an estimated $2 trillion from illicit activities is laundered. This poses a significant challenge to financial institutions, requiring onerous efforts to verify that individuals involved in financial transactions are who they claim to be. This is where KYC, or Know Your Client, practices come into play. KYC compliance is at the core of any successful risk management strategy and ensures that financial institutions are not inadvertently aiding criminal activity. Let’s dive into KYC a little deeper.


What is KYC?


Regulations such as AML (anti-money-laundering), and eIDAS (electronic Identification, Authentication and Trust Services) exist to help detect and prevent financial crime, and to reduce the ability of terrorists to fund their operations.

By identifying their clients, financial institutions can help reduce the possibility of doing business with criminals or those who may be involved in criminal activity. KYC is quite complex: this means collecting various personal and professional information from their clients, verifying it, and assessing the risk the clients pose for money laundering.

There is a lot of database and document research involved in this stage, which helps assure the money is traceable: maybe dividends from investments, salaries or any other licit way of making money, with a reliable source.


How is KYC Conducted? 

The steps in a KYC procedure vary depending on the organization, but they typically include the following:


  1. Client identification: Identify the client and collect certain information, such as their name, date of birth, national identification (SSN, SIN, etc) and address.
  2. Client verification:Verify that the client is who they say they are, typically by examining documents such as a passport or driver’s license.
  3. Risk assessment: Assess the client’s risk level. This helps to determine what type of information needs to be collected from them and how often they will need to be screened. This step depends on the kind of business the client is involved in and each company can decide how much information they need.
  4. KYC compliance: Ensure that the organization complies with KYC regulations. This includes maintaining accurate records and keeping up-to-date with changes to KYC regulations.


By following these steps, organizations can effectively implement a KYC procedure.


What are the benefits of KYC? 


There are many benefits to implementing KYC compliance measures, including:


  • Prevention of financial crime: By identifying clients and understanding their financial activities, organizations can help prevent criminal activity such as money laundering.
  • Enhanced client protection: Organizations can better protect their clients from fraud and identity theft by knowing who their clients are. This is especially beneficial to banks or other institutions that are common targets of such crimes.
  • Improved client experience: By streamlining the KYC process and making it more user-friendly, organizations can improve the client experience. Clients must go through verification process with transparency and with clear goals.
  • Increased transparency: KYC compliance measures help create a more transparent environment for both organizations and their clients by sharing information.


What are the challenges of KYC? 


Despite the many benefits of KYC, there are also some challenges associated with it, such as:


  • Cost: the KYC process can be costly for organizations, particularly small businesses. This is because it requires using resources, such as staff time, to collect and verify client information.
  • Client privacy: some clients may be concerned about the amount of personal information that is required during the KYC process. This can potentially lead to identity theft or other privacy breaches.
  • Compliance: the KYC process must be followed correctly to be effective. This can be challenging for organizations, especially if they have a large number of clients.


What is the difference between KYC and AML? 


AML, or Anti-Money Laundering, is a process that is used to prevent the illicit use of financial services. This can include money laundering, terrorist financing, and other illegal activities. KYC compliance measures are a part of AML compliance, but they are not the same thing. KYC compliance measures focus specifically on the identification of clients, while AML compliance measures also include monitoring client activity to look for suspicious behavior.


KYC is a necessary process that can help to prevent financial crime. It involves collecting certain information from clients and using it to verify their identity to help protect against criminal activity. While KYC compliance measures can be costly and challenging to implement, they are essential to AML compliance, and KYC efforts can protect your company from financial crime.

Partnership Strengthens Growing Industries Raising Private Capital

In another strategic move, KoreConX All-In-One Platform announces partnership with Fundopolis, an online investment bank specializing in exempt offerings and private placement capital allocation, as a way to keep creating more opportunities for entrepreneurs.

At first, Fundopolis was a KoreClient, attracted by its industry leading state of the art platform dedicated to processing and recordkeeping issuer and investor transactions in Exempt Capital-Raising Offerings, specifically RegCF and RegA+ offerings. Fundopolis uses KoreConX´s technology for their capital market activities.

As KorePartners, Fundopolis, a FINRA Broker-dealer registered in all 50 states, is eager to make their expertise available to the whole private capital ecosystem. With expertise in sectors such as real estate and cannabis, the online bank offers experience in these ever-expanding industries, guiding private companies as they navigate the complex regulatory space while introducing them to investors who share their vision for the future. Fundopolis is also part of the ecosystem for RegD, RegCF, and RegA+ offerings providing the FINRA broker dealer services to help companies raise capital.

“Beyond that, we understand that the investment landscape is constantly changing, and we pride ourselves on approaching the entire process with an eye on what is possible. As a recordkeeping transfer agent and escrow platform, we believe KoreConX is the perfect partner for Fundopolis, providing access to a vast ecosystem of investors and issuers,” says Bert Pearsall, CEO & Managing Principal at Fundopolis.

Co-founder and CEO at KoreConX, Oscar A. Jofre, acknowledges Fundopolis as a highly rated KorePartner. “When we first met, as a KoreClient, we saw a great potential and a lot of opportunities ahead of us. Since our solution unites tools to securely and efficiently manage business data and facilitate compliance during all the capital raising process regardless of where they are in this cycle, it was only natural to add them to our valuable team of KorePartners.”

About KoreConX

Founded in 2016, KoreConX is the first secure, All-In-One platform that manages private companies’ capital market activity and stakeholder communications. With an innovative approach and to ensure compliance with securities regulations and corporate law, KoreConX offers a single environment to connect companies to the capital markets and now secondary markets. Additionally, investors, broker-dealers, law firms, accountants and investor acquisition firms, all leverage our eco-system solution. For investor relations and fundraising, the platform enables private companies to share and manage corporate records and investments: it assists with portfolio management, capitalization table and shareholder management, virtual minute book, security registration, transfer agent services, and virtual deal rooms for raising capital.

KoreConX All-In-One Platform announces partnership with Fundopolis. Read more in our blog.

Credit Cards, Escrow, and Broker-Dealers for RegA+ = $75 Million for Cannabis Companies


“It’s About Time”


Up until now, it was a real challenge for Cannabis companies to take advantage of Reg A+ exemptions that allow private companies to raise up to $75 million from the crowd; accredited and non-accredited investors alike.  So you have the investor community’s appetite, the table is set and they are ready, willing, and able; but what else do you need?


FINRA Broker-dealer


The regulation is meant to create jobs, allow private companies another way to raise capital, and allow for the investor community at large to participate. Before RegA+ exemptions, many potential investors were left looking into the candy store without any way to invest.  So with the democratization of capital and the ability of an untapped investor community to now have a seat at the table, the broker-dealer becomes an all-important intermediary.  In a highly regulated environment, the Broker-dealer takes the onerous task of KYC, ID verification, and AML ( anti-money laundering) off the issuer’s shoulder;  so you, the Issuer, can run your business without worrying about this important compliance requirement. As a result, you not only have the opportunity to gain large groups of investors but also develop brand advocates who share in your story.


Escrow Agent 

After the broker-dealer, you need an escrow agent that can hold funds from investors in all 50 states and territories and only charge you one flat fee. 


This key intermediary holds the investors’ funds on behalf of the Issuer until the broker-dealer completes the ID, KYC, and AML verification. Once these checks are complete, the escrow agent can release the funds. Until recently, a couple of historical challenges for industry sectors such as cannabis included the inability to get Escrow for their capital raises. Not only is Escrow now available but also at a cost-effective price point and with normalized fees, which is really the way it should have always been.  


Credit Cards 


Now below 2.9%  allowing both cannabis companies and their shareholders to be fairly treated when investing in the growth of their companies;  bringing jobs to communities and opportunities to those that believe in the company. Being responsible with your credit cards is common sense. Still, the ease of use and points as an added bonus is certainly one of the nice perks and perhaps a big reason for their high usage via crowd participation in private capital raises.


If you’re part of the Cannabis ecosystem looking to learn more about how KoreConX can help you on your capital raising journey, please fill out the form here.

The 1% Broker-dealer & What you need to ask!

When working with FINRA Broker-dealer, it’s not enough that they simply have the required licenses that are necessary, so make sure to ask some questions:

  • Are you registered in all 50 states
  • Are you register for RegA+

It is also key to understand what they actually do when you are raising capital. These are some of the basic questions you need to ask of them:

  • Who contacts the investor if payment does not go through?
  • Who contacts the investor if there is a problem with KYC (Know Your Client information)?
  • Who contacts the investor for IRA payments?
  • Who contacts the joint investors?
  • Who contacts the investor if there are problems with sub agreement?
  • Who contacts the investor if there are problems during the investment process?

Bottom line:  

As a company, do you need to do anything once the investor clicks submit to make their investment?

Answers is:   NO

You should be focusing on raising capital and the FINRA Broker-dealer (who charges 1% for compliance services) is responsible for doing all of the above compliance and +.


Why do I need a FINRA Broker-Dealer?

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.


Nominee vs. Direct: How does this affect investors?

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, “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. 

What is the Difference Between Fiduciary Responsibility and Regulatory Requirement?

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.

What is KYC?

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 Alternative Finance?

By definition, alternative finance includes any financing source outside of the traditional realm of the traditional finance systems like regulated banks and stock markets. Such methods include raising seed capital from friends and family, angel investors, venture capital firms, peer-to-peer lending, or crowdfunding. In contrast, traditional finance options require companies to apply for loans from a regulated bank or publicly offer stocks for sale to the public.

For companies in their earliest stages, raising capital from family and friends is often a safe way to secure additional funding. Friend and family investors are not required to register as investors, unlike traditional investors, making it easy for them to contribute to a growing company. Often founders do not need to relinquish equity to friend and family investors, allowing founders to retain as much equity as possible through their early stages.

If a company requires more financial resources, its next options may be angel investors and venture capital firms. With angel investors, wealthy individuals invest using their own money and meet the SEC’s accredited investor requirements. It is quite common for angel investors to act as a mentor to the companies they invest in, anticipating that it will help them secure a return on their investment. Venture capital firms often invest in startup companies that display the potential for a successful return and are SEC-registered and regulated. Rather than investing their own money, they invest money from other investors to generate profits for the investor. Typically, venture capital firms request equity so that they can have a share in the company’s development.

Another alternative form of financing is through peer-to-peer lending. Typically through online platforms, applicants are matched with lenders who are typically individual people. Interest rates are usually low and are not regulated by traditional banks. Platforms assess borrowers for risk to determine if they are eligible to invest.

One of the fastest-growing forms of alternative finance is crowdfunding and can include both rewards-based and equity-based offerings. With rewards-based crowdfunding, investors invest to be compensated with products that the company offers. Equity crowdfunding allows investors to exchange their investments for equity in the company. Equity crowdfunding is supported by Regulation CF, which allows private companies to raise up to $5 million from non-accredited investors, usually done online through the various crowdfunding portals presently available or a broker-dealer. Crowdfunding is extremely valuable in that it allows avid brand supporters to become investors and become an advocate for the companies they love. For non-accredited investors, the maximum investment per year is either $2,200 or 5% of their annual income, whichever is greater.

Regulation A+ is another method allowing companies to receive investments from non-accredited investors by exempting the offering from SEC registration. Companies can secure up to $75 million annually through this method of funding. Non-accredited investors are limited to investing 10% of their annual income or net worth, whichever is greatest.

The variety of alternative finance options are attractive to companies who would like to go routes other than a traditional bank loan or those who may not be eligible for one.