Tuesday, September 30, 2014

Section 201 (c) of the JOBS Act: Uniform Media Broker Exemption Rules For Internet, Radio, Television, Newspapers and Telephones in Rule 506 Offerings (Article 5 in a series of 14 articles about Deal-Makers)

By Jim Verdonik
I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals , have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at JFV@WardandSmith.com.
Or you can check out my eLearning course at www.YouTube.com/eLearnSuccess
or read my newspaper articles at
This article is one of 14 articles in a series of articles about Deal-Makers called:

In Article (4) of this series of articles, we discussed the exemption from registration as a broker afforded by Section 201 (c) of the JOBS Act and the SEC's narrow interpretation of this exemption and how the SEC's views fit with the SEC's prior interpretation of the broker registration provisions of Section 15 (a) (1) of the Securities Exchange Act of 1934, which we discussed in articles (2) and (3) of this series of articles.
These articles involved very closely scrutinizing the language of both Section 15 (a) (1) of the Securities Exchange Act of 1934 and Section 201 (c) of the JOBS Act and then examining whether the SEC of the courts had more reasonable interpretations of the statutes' language.
When you are always closely examining details though, you sometimes lose sight of the big picture.  Digging into the details sometimes causes you to dig a pit so deep you can no longer see the sky.
So, let's take a break from digging through the details of statutory interpretation and begin talking about some big picture issues about how technology and media trends apply to broker registration rules.

When Section 201 (c) talks about "platforms and mechanisms" most people automatically assume we are talking about an Internet website enabled by software or some type of "app" or other new platform or mechanism.
But Section 201 (c) does not state that it covers only new platforms and mechanisms.  To be covered by Section 201 (c), the platform or mechanism need only "permit the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person, or through any other means."

There are two important things in Section 201 (c):
·         Section 201 (c) does not exempt anyone who is conducting an offering of securities.  It merely exempts people who provide platforms or mechanisms that permit other people to conduct securities offerings.
·         The statute specifically states to it is not limited to online offerings and covers platforms and mechanisms that use "any other means."
Understanding both of these facts is fundamental to interpreting Section 201 (c).
Let's first talk about the scope of the technology Section 201 © covers.
What are Platforms and Mechanisms?
Technology wasn't invented yesterday.  We have long had many types of "platforms and mechanisms" that permit issuers to offer and sell and negotiate.  Television, radio, newspapers and telephones all permit issuers to offer, sell and negotiate.  So do devices like telegraphs, teletypes and faxes. 
The only thing new about combining platforms and mechanisms is that you previously had to be conducting a registered public offering to fully utilize these older technologies, although telephones have been extensively used in private placements for decades as long as you complied with limits in who you could call about the offering. 
Reminding ourselves that securities offering have always used whatever is state of the art technology at the time of the offering places Section 201 (c) of the JOBS Act in its proper context.

Technology Platforms and Devices Relationship with Traditional Media

Since technology is so important to securities offerings, let's consider some basic questions about technology platforms and mechanisms used to showcase investment offerings:

  • What is a "technology platform or mechanism" that Section 506 (c) refers to?
  • Are "technology platforms and mechanisms" more like media and communications systems?
  • Or are "technology platforms and mechanisms" more like Merrill Lynch and other registered broker-dealers?
  • If "technology platforms and mechanisms" that showcase businesses that are trying to raise capital have elements of both depending on what services they perform, then where do you draw the line on what activity keeps them in the media/communications system side of the line and what activities push them into Merrill Lynch territory?
  • What do investors who use "technology platforms and mechanisms" think?  When people use a "technology platform or mechanism" to find an investment opportunity on the Internet, are they really relying on the platform operator to vouch for the value of the businesses that are showcased on the platform?  If an investor sees a TV commercial or newspaper advertisement for an investment product, does the investor automatically think the TV station or newspaper is recommending an investment?  Or do investors understand that the TV station or newspaper is just transmitting a message for someone else?
  • Should it matter whether the operator of the "technology platform or mechanism" holds itself out to investors in ways that are likely to cause investors to rely on the operator as a source of investment advice?
  • If causing investors to rely on the platform or mechanism operator as a source of investment advice is relevant to whether the technology platform operator should register as a broker, why would the SEC think venture capital funds that operate "technology platforms and mechanisms" are protected from registration by Section 201 (c) and other operators who do not have expertise in investments are not protected by Section 201 (c)?  Aren't investors more likely to rely on what a venture capital fund says about an investment than on someone who just operates a technology platform who has no investment business?
  • Are the terms "technology platforms and mechanisms" limited to Internet based software systems?  Or are TV, cell phones and other traditional media and communications platforms also "technology platforms and mechanisms?"
  • If traditional media and communications systems are no longer cutting edge, do they cease to be a "technology platform or mechanism"?
  • If traditional media and communications systems add features, would they become a "technology platform or mechanism?"  Should we retain a distinction between traditional media like TV and technology platforms as TV becomes more interactive?  What about TV shows that encourage viewers to tweet about the show or to "like" the show on Facebook?  Should a combination of technologies be treated the same as single "technology platform or mechanism"?
  • Does the revenue model for the platform, mechanism, media or system matter?  What if there are multiple operators of different platforms or mechanisms involved with different revenue models?
Our answers to these questions will help us decide what Section 201 (c) of the JOBS Act means and beyond that what regulatory policies make sense for technology platform operators.

What is clear from the outset of our exploration of how Section 201 (c) of the JOBS Act applies to changing media and communications tools is that the SEC has not adequately explained:

  • How does the SEC's interpretation of Section 201 (c) applies to all media and communications tools?
  • Why does the SEC's position makes legal, economic and technology sense?
Entertainment vs Business Opportunity

Let's begin exploring the answers to these questions by asking a question:  "Have you ever seen reality TV shows like "Shark Tank?" 
These TV programs showcase companies that are raising capital talking to investors in a speed dating format (several companies per show).  Companies that want to raise capital make presentations, are peppered with questions by investors and negotiate deals with investors during the program.  These TV programs bridge the gap that used to separate investments from entertainment.  On the technology platform side, video is replacing written materials at a rapid pace.  Many issuers already use You Tube and other video on their own websites to attract investor interest. 

The changing roles different media are playing in our lives (including in investments) justify asking:
  • Are software platforms that showcase videos about companies that are raising capital different from TV programs like Shark Tank or other programs or commercials related to securities transactions? 
  • How different are they? 
  • Do these differences justify different legal treatment of different media?
To help answer these questions, let's consider four factors:
  • When does an investment transaction occur?
  • How does the TV station or network profit?
  • What services does the TV station or network offer issuers that facilitate the investment transaction other than attracting viewers?
  • How is the TV station shaping investor perception
Applying these questions to TV stations and other media is a good first step to determining what the rules should be for Internet based technology platforms.
Investment Transactions - You might say that Shark Tank should not be required to register as a broker-dealer, because issuers that appear on Shark Tank do not accept money from viewers during the show.  But the Shark Tank investors who appear on the show negotiate with issuers about value and other deal terms during the show.  The whole premise of the show is that you are watching a real investment situation and that money will actually change hands as a result of the negotiation.  Some viewers undoubtedly contact Shark Tank participants after the show and make their own deals.  How does that differ from technology platforms that merely introduce issuers and investors and do not participate in negotiations?
Monetization Model (Fees).  You might say that Shark Tank does not charge businesses or investors a fee.  But TV networks are paid by advertisers and cable TV operators charge subscription fees.  Somehow, people are being paid for their efforts.  Networks and TV stations charge businesses for infomercials that advertise (800) numbers where people place orders.  Let's examine several different scenarios to explore how the details about fees might affect our analysis:
·         Should the media's revenue model really matter?
·         Would a TV station or network have to register as a broker under the Exchange Act, if it broadcasts an infomercial that sells securities instead of a reality TV show? 
·         Or are viewers/investors adequately protected, if the issuer that sells securities has to comply with the Securities Act? 
·         Would it matter, if the TV station charges a commission on sales or whether the issuer just pays the TV station for advertising time? 
·         Would it matter, if the TV station's advertising fees are higher, if there are more viewers?
·         Would it matter, if the TV station's fees are higher, if the issuer is successful in selling securities?
No media or communication system is free.  Someone somewhere has to pay for it.  Securities laws should not assume that any technology or communication or media service is free and should not require all service providers who are paid for service to register as brokers. 
Types of Services.  Now, let's switch from different types of fees to different types of services.  If a TV station broadcasts infomercials, in which issuers sell securities:
  • Would it matter, if the TV station provides issuers with a telephone answering service? 
  • Would it matter, if the TV station's telephone answering staff takes orders from investors? 
  • Would it matter, if the TV station writes the script for the commercial or edits the commercial?
  • Would it matter, if the actors in the infomercials are employees of the TV station or employees of the issuer? 
  • Would it matter, if the TV station sets the investment terms or participates in negotiations?
Investor Perceptions.  Now, let's consider how investors and other viewers perceive the service and what steps the TV station takes to shape that perception:
·         Would it matter, if the TV station advertises the time slot as a place to find good investments?
·         Would it matter, if the TV station issues a statement that it does not endorse any investment opportunity it broadcasts? 
·         Would it matter, if the TV station screens issuers who it allows to broadcast their infomercials? 
Given the major changes in all types of media, the basic question to consider is:  Where do entertainment or education end and the investing business begin?
When we define the dividing line in one form of media or technology, we should then apply that same dividing line to all media and technologies.
We know that media and technology constantly change.  If we do not apply the same rules to all media, our securities rules will become obsolete as the media changes.
Investor Motivations in Private Placement Investments
Let's explore this further by asking another question that is more basic than who performs what service and how are they paid:  Why do people invest in privately owned young companies?  It's difficult to invest in private businesses.  Why do people go to the trouble
People call their broker at Merrill Lynch or other registered brokers to buy or sell a publicly traded stock for one primary reason:  to make money.  They often delegate decision-making to their brokers about what to buy and what to sell and when to do it.  Investors often receive this information after transactions occur.  Many people don't even know what they own or what transactions are occurring.  They measure brokers based on annual rates of return on the money the brokers manage.  The number of people who have little involvement with the process of investing in publicly traded securities tells us that they are primarily interested in returns d care little about the process.
Now, let's contrast that with how people behave when they invest in private companies.  Most people are more involved in the process.  They are also choosier about the industries and geographic locations in which they invest.  Likewise, people make investments in non-public companies for many reasons.  It's not solely to obtain a return on investment. 
For many decades entrepreneurs have focused on finding angel investors who for a combination of reasons that match their businesses, including social purposes, entertainment and developing the economies of their local communities. Social Media often mixes together investing with social causes, hobbies and other interests that investors want to promote.  The most exciting thing about Social Media as a tool for raising capital is that it makes it much easier to identify large groups of people in different geographic areas who share common interests that are relevant to particular businesses.
If people are interested in combining their investments with their hobbies and charitable interests or social causes, they will need help.  Other people will find ways to help them for a fee.
Technology Platforms for Niche Investment/Lifestyle Markets
Many people who want to start and operate technology platforms want to specialize in offerings that appeal to one of more of the expanding number of online communities in which people who share common hobbies, charitable interests and social causes communicate with one another.  People are planning to build and operate funding platforms that specialize in a wide range of niche markets, including:
  • Funding orphan drug development. 
  • Others want to raise money to fund green energy projects.
  • Renovating and restoring historic buildings. 
  • Brownfield economic development projects.
  • Women owned businesses.
I can say this with confidence, because each of these types of niche platforms have been proposed by different people who have asked me about Rule 506 (c) or the crowdfunding rules.
Each of these people who want to operate technology platforms want to serve a niche of investors who invest to promote causes or other interests.  The people who want to operate these niche platforms want to make enough money to sustain their efforts, but they also want to promote these same causes that investors want to promote.
Continuing with our analogy to media like TV, these niche platforms would be similar to cable TV channels that specialize in news, business, history, real estate, travel, music videos, science fiction etc.  Investors will be attracted to the platforms that specialize in issuers that fit their interests the same way that TV viewers know which cable TV stations specialize in their interests.  This comparison of specialized Internet based technology platforms and devices to cable TV channels raises numerous questions about both the users and the operators:
  • What do these people who want to establish technology platforms that promote businesses that are important to people in these niche markets have in common with Merrill Lynch? 
  • Would Merrill Lynch be interested in these types of deals? 
  • Would investors really be protected, if we require people who operate technology platforms to register with the SEC as brokers? 
  • Should the SEC regulate people who operate technology platforms like the SEC regulates Merrill Lynch?
Section 201 (c) of the JOBS Act was an attempt to answer all these questions and to draw reasonable lines between this new type of investing and traditional broker-dealer activity. 
Any regulatory framework that tries to pound this new round way of investing into the old square broker-dealer hole will be obsolete the day it is enacted.
Now, let's explore the difference between offering or selling securities and permitting others to offer or sell securities, which is what Section 201 (c) of the JOBS Act exempts.
Having compared different media and how investors use them for different purposes, let's talk about the differences between doing something (like offering securities for sale) vs. providing technology and services that permit someone else to do something.
Permitting Others to Offer and Sell
The SEC's narrow interpretation of Section 201 (c) is based on the premise that, if you maintain a platform or mechanism that facilitates securities transactions, you are "effecting transactions" in securities for others (which is what the Exchange Act requires before you have to register as a broker) in the same way that a broker does when the broker combines:

·         Introducing investors to the issuer that is conducting a Rule 506 offering.

·         Helping to negotiate a deal.

But is that what is really happening when you maintain a platform or mechanism that "permits" others to offer securities?

 Let's examine the role of technology providers in our society.

·         When someone uses Google to search for investment information on the Internet, is Google providing investment advice?  Or is Google proving a tool that permits users to search for investment advice?  Taking it further, when someone pays Google for top position in searches, is Google recommending the investment?  Or is Google merely showcasing the investment for a fee like a newspaper sells ads for different fees based on whether the ad is placed?

·         When you make a call on your iPhone, is Apple or Verizon talking to someone, or is Apple or Verizon proving a tool that permits the user talk to someone?

·         Would either Apple, Verizon or Google be legally responsible for what the user did with the search results or what the user said on the telephone call?

It is highly unusual for people that provide technology tools that permit others to do things to be legally responsible for the actions users take.  It is a fairly general legal, business and moral principle that tool makers are not responsible for what people choose to do with their tools.  Certainly, the best way to stop people from providing tools is to make them responsible for how others use their tools. 

 So, it is fair to ask:  When Congress passed the JOBS Act, did Congress really want to discourage people from providing technology platforms that others can use to raise capital in Rule 506 offerings? 

 We think the opposite is true.  An important purpose of the JOBS Act was to promote the use of technology platforms in raising capital both in Rule 506 offerings and in crowdfunding.

As we discussed at the beginning of this article, traditional media and Internet based media are converging with one another.  Television programs promote Twitter interactions among their viewers.  Reality TV programs and You Tube are often barely distinguishable.

Now, let's examine some examples of how this convergence relates to securities offerings. 

First, let's examine traditional media like newspapers, TV or other media.  Usually, a media operator is not responsible for the content it transmits for others.  Likewise, a telephone systems operator is not required to register as a broker, because people use telephones to sell securities. 

·         The SEC does not bring enforcement actions against The Wall Street Journal for misleading advertising by issuers or by brokers. 

·         And The Wall Street Journal does not have to register with the SEC as a broker, because the advertising it carries helps to effect securities transactions.

·         The Wall Street Journal has no legal responsibility to police the content of advertisements.  But any newspaper is free ot reject advertising.  Any standards the newspaper imposes are voluntary to maintain the newspaper's reputation.  No one seriously claims that if a newspaper rejects one advertisement and accepts another advertisement that the newspaper is making a "recommendation."

Newspapers and other media that focus on investors routinely represent to investors that they provide information that is useful in making investment decisions.  Millions of people make investment decisions based on information the financial media provides.  A single article in The Wall Street Journal or other financial media can cause a significant up or down move in the market price of a publicly traded stock.  These media receive their primary financial support by selling advertising to businesses that sell securities.  Financial media are significant players in securities markets, and except for occasional insider trading issues are not regulated by the SEC.

The reason why such powerful market players are not regulated is that operating a communications media that "permits" others to sell securities is not that same as selling securities yourself. 

That is why Section 201 (c) of the JOBS Act provides an exemption for permitting others to "offer, sell, purchase or negotiate."

This same principle governs other areas of the law.  Newspapers are not liable if people advertise defective products or a reporter writes a good review of a new automobile that turns out to be a lemon.

We note that The Wall Street Journal and other "publications of general and regular circulation" are specifically excluded from the definition of the term "investment adviser."  If a publication does not fit within the "general and regular circulation" exception, it may be treated like in a newsletter that some investment advisers circulate and may have to register as an investment adviser, because the content it creates includes investment advice. 

But merely creating content does not cause most publications to cross the line.  They have to charge a special fee that is higher than a general circulation price to buy a newspaper, except for free newsletters that some investment advisers use to promote their services.  Advertising agencies also routinely create content in advertising (including advertising that sells securities) without being required to register under securities laws.

 This establishes a useful way to look at technology platforms and mechanisms used in securities offerings and ancillary services that advertising agencies provide:

  • Technology providers and media are not responsible for the effects of what their platform permits others to communicate.
  • When the technology provider or media outlet crosses the line to creating content that contains their own recommendation and not merely reporting or transmitting what others say, under some circumstance they might have the same responsibility for the content and its effects as other content creators, if they are not of "general and regular circulation."
  • Service providers like advertising agencies and recording studios that merely provide services that help others who are selling securities to communicate more efficiently or more effectively are not regulated by securities laws.
Brokers Sell Advice

Registered broker-dealers like Merrill Lynch tell investors that they can rely on Merrill Lynch for advice.  Merrill Lynch actively promotes the impression among its customers that Merrill Lynch will help their customers achieve higher returns on their investment.  This active effort to cause investors to rely on investment advice is the primary factor that distinguishes Merrill Lynch and other brokers and investment advisers from other service providers who help issuers sell securities.  If an Internet platform promotes reliance on itself by holding out to the public that it advises which securities to purchase or that it produces higher investment returns, then the Internet platform would have crossed the line into doing what registered brokers do.

 For these reasons, we think the most reasonable way to interpret the technology platform or mechanism provision of Section 201 (c) of the JOBS Act is that permitting someone else to communicate does not require you to register as a broker.  Neither does providing a necessary or "ancillary" service, unless the service provider takes action designed to cause investors to rely on the service provider for advice about whether to buy or sell securities.

Technology platforms that do not charge investors for private access to deals or that charge only a reasonable listing fee should fit within the "general and regular circulation" exemption of the Investment Advisers Act.  That is different than an exemption from registration as a broker under the Exchange Act, but the same principles that apply to the media (including technology platforms and other digital media) under the Investment Advisers Act should apply to the broker registration provisions of the Exchange Act.. 

 Fees for Using Technology Platform or Mechanism

A corollary of this distinction between providing a platform that "permits" others to make offers and sales vs. "effecting transactions" is that the technology provider does not lose the protection of Section 201 (c) merely because the technology provider charges a reasonable fee for its services.  Continuing our analogy with The Wall Street Journal, a market rate subscription fee should not be confused with a fee for "effecting" securities transactions.  Later in this article, we will discuss the issue of the reasonableness of the fees being important to protect against using such fees to hide sales commissions for selling.

What limits does Section 201 (c) place on people trying to use the exemption to avoid registering as a "broker" or a "dealer"?  In particular, what does Section 201 (c) say about fees? 
The exemption provided in Section 201 (c) applies only if:
  • "such person and each person associated with that person receives no compensation in connection the purchase or sale of such security;"
  • "such person and each person associated with that person does not have possession of customer funds or securities in connection with the purchase or sale of such security; and"
  • "such person is not subject to a statutory disqualification as defined in section 3(a)(39) of this title and does not have any person associated with that person to such a statutory disqualification."
The limitation on receiving "compensation in connection with the purchase or sale" of securities is the primary limiting factor for Section 201 (c).  If you cannot receive compensation, then why would anyone bother to maintain a platform or provide necessary services, unless you are the issuer trying to sell securities or an investor trying to help the company grow?

The SEC contends that all compensation a technology platform provider receives would be "compensation in connection with the purchase or sale" of securities, but is that really true?
We'll discuss issues related to how Section 201 (c) of the JOBS Act deals with fees for different types of services in article (6) of this series of articles.

If you would like to learn more, you can reach me at JFV@WardandSmith.com.
Or you can check out my eLearning course at www.YouTube.com/eLearnSuccessor purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
or read my newspaper articles at




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