What are the due diligence obligations of crowdfunding portals?

Sara Hanks
January 10,
Sara Hanks  replied:

This question has been the subject of a lot of debate over the years since the JOBS Act was enacted. Some lawyers (and many platforms) take the view that their diligence obligations are limited to those set out in Rule 301 of Reg CF (make sure the issuing company tells you it has complied with its obligations, make sure there's a record-keeping mechanism, and make sure the company isn't disqualified by reason of the bad actor prohibitions). Others point to the provisions of Section 4A(c) of the Securities Act, which says "issuers" are responsible for any misstatements unless by exercise of reasonable due diligence they couldn't have known there was a misstatement, and provides that "issuer" includes anyone "selling" the securities. People in the limited-liability camp argue the portals aren't "selling" and thus aren't "issuers". The SEC says, under certain circumstances, portals may be liable for misstatements by issuers.

This debate may have become largely moot since the 2019 Supreme Court decision in Lorenzo, which provides a separate cause of action under Rule 10b-5 for anyone who "disseminates" a misleading statement. I cannot work out why this decision does not worry portals more.

The other liability provision that should concern portals is Section 9(a)(4) of the Exchange Act, a relatively new addition to that Act, which provides that liability for misleading statements extends to anyone who "willfully participates" in an offering.

In all these cases, liability can be addressed by undertaking due diligence to ensure that the statements made by a company are not misleading.

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Sara Hanks
January 10,
Sara Hanks  replied:

This question has been the subject of a lot of debate over the years since the JOBS Act was enacted. Some lawyers (and many platforms) take the view that their diligence obligations are limited to those set out in Rule 301 of Reg CF (make sure the issuing company tells you it has complied with its obligations, make sure there's a record-keeping mechanism, and make sure the company isn't disqualified by reason of the bad actor prohibitions). Others point to the provisions of Section 4A(c) of the Securities Act, which says "issuers" are responsible for any misstatements unless by exercise of reasonable due diligence they couldn't have known there was a misstatement, and provides that "issuer" includes anyone "selling" the securities. People in the limited-liability camp argue the portals aren't "selling" and thus aren't "issuers". The SEC says, under certain circumstances, portals may be liable for misstatements by issuers.

This debate may have become largely moot since the 2019 Supreme Court decision in Lorenzo, which provides a separate cause of action under Rule 10b-5 for anyone who "disseminates" a misleading statement. I cannot work out why this decision does not worry portals more.

The other liability provision that should concern portals is Section 9(a)(4) of the Exchange Act, a relatively new addition to that Act, which provides that liability for misleading statements extends to anyone who "willfully participates" in an offering.

In all these cases, liability can be addressed by undertaking due diligence to ensure that the statements made by a company are not misleading.

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Manny Amadeo
February 2,
Manny Amadeo  replied:

In the modern age, it seems that people sometimes debate and dispute basic facts. 

How can a funding portal operator be responsible for separating what is intended to be persuasive vs. what is misleading?

Does this put the portal into the role of an independent fact checker of the issuer?

In the same way that stock buyers rely on the wisdom of the market (peers, analysts and pundits), shouldn't the platform just rely on "the crowd" to help separate fact from fiction or to help educate each other when it is more nuanced?    

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Sara Hanks
February 2,
Sara Hanks  replied:

Assuming you accept the assertion that portals are responsible for the content on their platform, yes, it follows that they would need to fact-check statements on their site. And they would have to determine whether a statement was intended as "mere puffery" ("we have the best bagels this side of the Arkansas River") as opposed to a statement of fact ("we have shipped more bagels this year than anyone in Kansas"). But that's something that securities lawyers (and indeed jurors in cases alleging misstatements) have done for aeons.

Crowd commentary is supposed to be an essential part of the process, but you can't force the crowd to review every single offering.

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