Updated: Oct 25, 2022
FINRA is cracking down on Equity Crowdfunding portals as Wefunder gets hit with a massive fine.
As an investor, it’s good to see FINRA being vigilant in the space. Equity Crowdfunding has the potential to revolutionize the startup investing landscape by lowering the burdens to invest. However, like any place where money is involved, it also has the potential to be ripe with scams. The optimistic in me likes to think the majority of companies on these sites are on it with good intentions, but we shall see. Don’t get me wrong, I have done extremely well in the area thus far, so I can’t complain.
However, that doesn’t mean companies can circumvent the law. This is especially true when Nicholas Tommarello, the CEO of Wefunder, was the one who helped write and push the equity crowdfunding laws through congress. This fine handed down to Wefunder is the largest in the space by a rather wide margin, and one of three to be handed down in the space thus far. The first being, under rather egregious facts, truCrowd who was basically just completely scamming people:
Despite being, in my opinion, incredibly egregious, truCrowds fine only amounted to $243,747. This is significantly less than Wefunder’s, granted Wefunders violations have been way more, over way longer, and significantly more broad. Handed down simultaneously was a fine for StartEngine, amounting to $350,000. This is a much smaller fine that I will break down in my next article (so make sure to follow and stay tuned!). StartEngine was fined for a few raises that occurred in 2017 and 2018 mainly.
There are 5 alleged violations with *millions* of instances of breaking laws related to the crowdfunding rules. These violations include:
Exceeding Reg CF maximums, then diverting investor's funds in 39 offerings
Failing to promptly return investor's funds
Millions of emails of Wefunder offering investment advice and soliciting investments
Using the “lead investors” testimony to post misleading communications on their site
Completely failing to establish ANY supervisory procedures of its payments, banking, and investment management systems from 2016 to 2018, and several other violations for failing to implement proper procedures relating to emails, investor complaint reporting, facilitating offerings, and more.
There are several other violations within each of these categories, but all around it’s not a great look. After reading through these, it seems incredibly clear to me that the SEC and FINRA want to make sure portals are taking investor complaints incredibly seriously. The SEC fine in the case of truCrowd actually wasn’t for fraud, but for failing to follow up on investors' complaints. While the facts surrounding it are terrible, it does show that FINRA is going to be taking these laws seriously.
Exceeding Reg CF maximums and diverting investor's funds
This one is pretty bad because it’s just blatantly skirting the rules. Currently, companies are not allowed to raise more than $5 million in a rolling 12-month period under Reg CF. That limit used to be $1.07m but changed to more favorable laws in March of 2021. While $1m is not a small amount of money, it’s not hard to exceed that, and many companies do. In fact, 39 companies exceeded that from May 2016 until October 2021.
Rather than capping out the investment at that $1m, they would identify investors in that offering that qualified as accredited investors, open up a separate Reg D offering then notify the investors their investments were now being sold under Reg D. Wefunder then directed the escrow agent to transfer the funds to the Reg D offering. This happened to a total of 39 offerings. This process violated several laws under the Securities Act and Reg CF rules. FINRA says the money should have been promptly returned to investors.
Failing to promptly transmit or return investor's funds
Losing investors' money is… not good. Along with the violations in the previous section, where the money should have been returned to investors and not directed to a different escrow account, there are other issues of not promptly returning investors' funds.
Most notably, Wefunder apparently has two dormant escrow accounts collectively holding $290,000. These accounts were last used in March of 2018, and Wefunder is not able to identify the source or intended destination of these funds, and as such has failed to properly and promptly direct the funds to issuers as required.
This is one of the more egregious offenses in my opinion because there's literally just hundreds of thousands of dollars of investors' money sitting there in bank accounts. This is money belongs to investors and companies, and was given to them for a purpose, and not only has it been sitting there for over 3 years, but they also don’t know where it is supposed to go?
Investment Recommendations and soliciting investments
This is where the “millions” of violations come in. Over the course of the past 5 years, Wefunder has sent out millions of emails to hundreds of thousands of investors recommending and soliciting investments in specific offerings on their platform. CF Rule 402(a) prohibits funding portals from offering investment advice or recommendations of securities offered.
Many of these emails were drafted by their marketing teams, interns, and specifically recommend companies with words such as:
“…You might want to check out”
“Invest in [Issuer name]”
There were over 1 million of these emails over the years with this language and recommendations despite clear guidance in 2015 stating it would be inconsistent with the above statutes. The guidance actually states very specifically that there is only certain things allowed in these emails, and everything else is not allowed. For example, a funding portal may alert investors that a new offering is open for investment and relevant details, but may not make recommendations about those companies.
Posting misleading communications on their website
Nearly every raise on Wefunder has a “lead investor.” This is partly used so companies can only have 1 spot on their cap table to under that lead investor, but it was also apparently used to mislead investors. From May 2016 to December 2021, Wefunder used these lead investors to make statements that misled investors into thinking these investors gave some sort of added security or vetting. Many said things like the lead investor had “vetted the startup” or he will “fight for you” or that they will “help the company succeed.” Despite this, Wefunder apparently made no effort to verify if these were true.
Realistically, these lead investors are just there to make money like anyone else. As well, it's often the CEO like the one above, so any claim about going above and beyond likely isn’t legitimate any more than as their capacity as that founder. It’s unclear if this was used in bad faith by attempting to get in a favorable statement to influence investors, or if it was just failing to police the statements that were being put. FINRA did note that when asked, they often did take down statements that violated the rules.
Wefunder Failed to establish and main reasonable supervisory systems
This is definitely the most extensive of all the breaches as they list a whole host of ways in which they basically failed to implement policies and supervisory systems to make sure that the business is running in compliance with the law. Here, FINRA said that Wefunder failed to establish supervisory practices for:
Completely lacked any system to track investments. Their process employed a manual, labor-intensive process that relied almost entirely on one person who had no accounting or finance training or background.
Investment payment, banking, and investment fund management systems from 2016 to 2018
Practice for facilitating Reg CF and Reg D offerings until 2021
Failed to provide clear direction for identifying and reporting investor complaints that were required to be reported to FINRA, leading to several investor complaints going unreported.
From 2016 to 2021, Wefunder failed to have any system to ensure that the content of email communications complied with applicable securities laws.
I do have some mixed feelings about these large fines, and crackdowns on portals though. On the one hand, many of these complaints are affecting retail investors and that's unacceptable. You can’t just misplace hundreds of thousands of dollars in investor funds, fail to supervise their money, and fail to put it where it needs to be. However, fining a company millions of dollars may or may not fix that because now they are out millions of dollars they could have used to hire people. $1.4 million is literally 20 salaries for well-paying jobs or money to update these processes. Not to mention, fining Wefunder for negligence but truCrowd 1/5th of that for actively attempting to defraud people seems strange.
As well, these are earlier-stage companies and startups in an evolving, extremely regulated, highly competitive industry. Much of this didn’t seem like it was done in bad faith necessarily, but rather just negligence. Wefunder is only operating on just under 10 million in revenue in 2021, and that was at a HEAVY loss and very thin margins. Realistically, they’re going to make mistakes and that’s just how it is. That being said, some of these are pretty bad, and punishing individuals for being negligent isn’t anything new.
It is a bit hard to realistically call FINRA’s actions unjustified though. Wefunder literally helped write the laws and now they are actively breaking the rules despite knowing what is and isn't right. Much of this was clarified in the SEC’s 2015 ruling, so they can’t claim ignorance. There are hundreds of thousands of dollars of investors' money sitting in escrow, going to the wrong places, being delayed, getting diverted, and they were caught skirting the limits that everyone else had to play by. Not to mention, it’s what FINRA decided was fair and Wefunder signed the settlement agreement.
If you want to read the full document, you can find it here: