An Appraisal of the SEC Proposed Rules on Crowdfunding and its impact on the Fintech Ecosystem in Nigeria | Olisa Agbakoba Legal

The Securities and Exchange Commission’s (SEC) proposed rules on Crowdfunding have elicited different reactions from stakeholders, it has rattled the cage of most businesses that leverage on the internet to access credit to finance their business, businesses that create an opportunity for other businesses to access credit on their platforms and operators of financial portals.

There is no gainsaying that the initiative is laudable and this is because of the three-way regulatory oversight and protection which the SEC seeks to administer on the issuers, the investors and the Crowdfunding Intermediary that operates the Crowdfunding Portal, where the credits/funds are accessed. 

The intendment of the proposed rules is to solely cater to investment-based/equity crowdfunding thereby alienating other forms of Crowdfunding, such as debt-based crowdfunding and donation-based crowdfunding in Nigeria, from its control. However, this is not to say that debt-based crowdfunding or donation-based crowdfunding are alien to our laws in Nigeria, as Section 58 (1) of the Banks and other Financial Institutions Act has put any form of debt-based crowdfunding under the purview of the Central Bank of Nigeria, as it reads as follows;

• Without prejudice to the provisions of Part I of this Act, no person shall carry on other financial business in Nigeria other than insurance and stockbroking except it is a company duly incorporated in Nigeria and holds a valid license granted under section 59 of this Act. 

On the other hand, donation-based crowdfunding which is a vehicle for philanthropic causes is spearheaded by NGO’s registerable under the Companies and Allied Matters Act, as an Incorporated Trustee. 

The purpose of this article is to essentially comb through some of the provisions of the Rules, put them through a viable or non-viability test and then assist the fintech companies in making informed decisions, as a result of this exposition. 

An Overview of the Rules

Eligibility to Raise Funds

SEC, through these rules, has set eligibility parameters for MSMEs (Medium, Small and Micro Enterprises) who seek to raise funds to finance a project, business or venture on a Crowdfunding portal, as it posited that any such MSME must present a minimum of two (2) years’ operating track record to the Crowdfunding Intermediary before it can utilize the Crowdfunding Portal. The rationale behind this parameter is not far-fetched, as it ultimately seeks to sift through companies that might be set up as shell companies for Ponzi schemes, in pursuance of its Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) outlook.

Nature of the Investment Instruments issued on a Crowdfunding Portal by an Issuer

A point worthy of deliberation in the Rules is the type of investment instruments that issuers, being MSMEs and unlisted public companies, can offer to investors in exchange for funds raised on the portal. The Rules specifies which instruments are permissible and they are as follows-Ordinary shares, plain vanilla bonds/debentures and simple investment contracts. However, the confusion that is likely to arise from these investment instruments takes root in the features of a private company limited by shares vis-à-vis a public company limited by shares, as encapsulated in the Companies and Allied Matters Act; To wit, Section 22 (5) of CAMA prevents a private company from inviting the public to subscribe for any shares or debentures of the company while a public company is authorized to issue shares and other debt securities to the public. 

The import of the foregoing is that a private company limited by shares, cannot issue shares or other debt securities on a Crowdfunding Portal, but can enter into a simple investment contract between itself and the investors, insofar as the salient clauses regulating the investment are properly constituted in the agreement. Investment contracts are transactions whereby one or more parties, agree to invest or shell out a specific amount of money, to a particular business or company, with the expectation of getting returns from the income or profit generated by the business or company, as and when due.

Certain Exemptions to the Provisions of the Investment and Securities Act

The Rules also hint at a departure from the requirement of registration of Securities under the provisions of Section 54 of the Investment and Securities Act, as it stipulates that an issuer may offer or sell securities or other investment instruments, without the need for prior registration pursuant to the Act, provided the issuer is an entity incorporated in Nigeria and has been accredited/approved by the Crowdfunding Portal to utilize its platform. Furthermore, it states that the issuer will be exempted from registering its securities or other investment instruments, if the aggregate amount of shares and investment instruments offered and sold by the issuer within a twelve (12)-month period, complies with the following thresholds-

1. The maximum amount that a Medium Enterprise may raise will not exceed N100 million.
2. The maximum amount that a Small Enterprise may raise will not exceed N70 million.
3. The maximum amount that a Micro-Enterprise may raise will not exceed N50 million.

However, the above limits do not apply to Digital Commodities Investment Platform which are companies who leverage on an online electronic platform to offer agricultural produce, livestock and its derivative products and all other goods and articles to investors.

It is noteworthy to state that the Commission in calculating the maximum amount of shares or investment instruments offered and sold by an issuer, within the thresholds and time limit, will take into account entities controlled by or under common control with the issuer and any predecessors of the issuer. This means that the Commission will take into account, any Holding Company and its subsidiaries, any Group Company and its sister companies, as well as companies under new management as a result of a merger or acquisition, in determining whether an issuer is keeping or has kept with the conditions set in the Rules for the utilization of any Crowdfunding Portal.

Crowdfunding Portal Requirement for Portals located Outside Nigeria

The Rules also makes provisions for a litmus test to determine when a person is said to be operating, providing or maintaining a Crowdfunding Portal in Nigeria and the main point of concern in this test, is the reference to platforms outside Nigeria, that actively targets Nigerian Investors and mandating that such platforms will be a crowdfunding portal in Nigeria. The reservation that this brings to the fore, is the issue of choice of law with respect to an investor who decides to invest in a platform outside Nigeria, knowing fully well that the choice of law as evidenced in the terms of use of that platform, will be the law of the jurisdiction of its area of operation and then proceeds to submit to the jurisdiction, by subscribing to the services of that platform outside Nigeria. The decision to make platforms outside Nigeria, that targets Nigerian Investors, subject to the Rules of the Commission, will not be a sustainable one because of the rule of party autonomy—the power enjoyed by litigants to choose the law applicable to their cross-border legal relationship.

Assuming without conceding that the decision by the Commission through the Rules, to subject Crowdfunding Portals outside Nigeria to its Rules is somehow sustained, its metrics for determining active targeting through the direct or indirect promotion of the Portal in Nigeria fails to take into consideration online/social media marketing and its borderless nature, which is the modus operandi of most businesses today. The Rules only makes provision for direct or indirect promotion in Nigeria, which connotes physicality. It is almost as if the Proposed Rules has refused to give cognizance to the impetus of online/social media marketing/promotion in this current day and age.

Registration Requirements for a Crowdfunding Portal

According to the Rules, a crowdfunding portal can only be registered and operated by a Crowdfunding intermediary and the only entities that can be licensed as a Crowdfunding Intermediary are Exchanges, Dealer, Broker, Broker/Dealer or Alternative Trading Facility as prescribed under the Act and the SEC Rules and Regulations.

The Rules also permit a category for a Restricted Dealer, which caters for Dealers who are registered by the Commission for crowdfunding activities simpliciter.

Furthermore, certain persons do not fall under the microscope of the Commission with respect to these rules on Crowdfunding and they are as follows;

1. A technology service provider who merely builds an infrastructure, software or system for an operator, being a Crowdfunding Intermediary. This encompasses tech companies who build solutions to enable Crowdfunding Intermediaries leverage on technology to reach a wider audience.
2. An operator of a Communication Infrastructure that merely routes an order to an approved stock market.
3. An operator of a financial portal that merely aggregates content and provides links to financial sites of service and information provider. This category covers fintech companies that serve as a digital investment marketplace, that connects investors to investment opportunities offered by Broker/Dealers, who are either a Crowdfunding Intermediary or a Restricted Dealer.

The Rules also prescribe the minimum paid-up capital of N100 million for any entity interested in being Crowdfunding Intermediaries, as well as a Restricted Dealer. Additionally, the Commission requires such other requirements to satisfy itself that either the Chief Executive Officer of the Crowdfunding Intermediary, its board of directors or any of its officers are not unfit to operate the Crowdfunding portal, by reason of being adjudged dishonest or fraudulent by a Court or other Self-Regulatory Organization in the Nigerian capital market; among many other requirements.

Operation of a Crowdfunding Portal

The Commission empowers the Operators of a Crowdfunding Portal, through the Rules, to take appropriate actions against any person in breach, either the issuer or any investor, by directing that such person takes the appropriate remedial measures as the circumstances require. The measures may include but not limited to suspension or expulsion of such persons after consultation with the Commission. The rules also provide for an avenue whereby such expelled or suspended persons may appeal against the decision of the operator to the Commission. This provision is especially important to ensure that issuers, who misrepresent facts or information in their offering documents, upon filing with the portal, are penalized.

Revocation of Registration

To ensure that no crowdfunding portal is redundant, the Rules have set a six (6) months period of inactivity, which will necessitate a revocation of the registration of any Crowdfunding Portal. Also, the Commission can revoke the Registration of any Crowdfunding portal on the occasion of non-payment of prescribed fees, failure to meet any requirements prescribed by the Rules or where the intermediary contravenes any of the provisions of the Act, the rules and regulations and the code of conduct for capital market operators.

Operation of a Trust Account

The Rules specifies that every crowdfunding portal shall appoint a custodian, who shall establish and maintain a separate trust account for each funding round on the portal, with a financial institution registered by the Commission as a Custodian. This presupposes the existence of a trust deed on the portal, which would essentially simplify how the funds invested will be disbursed to the issuer and the rights of the trust beneficiaries (being the investors) to the trust property (being the monies invested).

Participation of the Issuer on the Crowdfunding Portal

All issuers seeking to raise funds on the portal are expected to file a standardized offering document with the Crowdfunding portal and it will essentially include details relating to the issuer, such as the use of the proceeds, the issuers business plan, the project or business to be funded, the minimum amount required, the target amount and such other salient information about the investment opportunity the issuer is offering on the portal.

Every issuer shall have its funding offer live on crowdfunding portal for not more than sixty (60) days which means at the end of the sixty (60) days, if the issuer does not raise the minimum amount it requires, it will be required to withdraw the offer and wait until after ninety (90) days from the date of such withdrawal to list a new offer.

However, in the event that the amount raised meets the minimum amount required by the issuer but not the target amount, the issuer will be required to present to the portal and the investors, a revised business plan, which will show how it intends to maximize the use of the amount raised, though falling short of its target, without negatively impacting operations of the issuer. 

Participation of the Investor

The Rules provide investors with a forty-eight (48) hours cooling off period to withdraw their investments on a Crowdfunding portal, from the date of close of an offer from an issuer. Any amount which must have been debited to the account of the investor prior to the withdrawal shall be refunded to the investor within forty-eight (48) hours of such withdrawal date.

Non-permitted Issuers 

There are certain entities that are prohibited from raising funds through a Crowdfunding Portal and they are as follows;

1. Complex structures-These are companies with no immediate transparency of the beneficial owners of the company.
2. Public listed companies and their subsidiaries- These are companies whose securities are listed and trading on the floor of the Nigerian Stock Exchange. 
3. Companies with no specific business plan or a blind pool- These are companies with business plans which are solely for merging with or acquiring unidentified entities.
4. Companies that propose to use the funds raised to provide loans or invest in other entities;
5. Such other entity as may be specified by the Commission. 

Requirements for Digital Commodities Investment Platforms (DCIP)

According to the Rules, a DCIP is a platform that connects investors to specific agricultural or commodities projects, for the purpose of sponsoring such projects in exchange for a return.

The provisions of Rules 43 (a) of the Proposed Rules, reveals that such agritech companies shall be permitted to provide crowdfunding portal services but then Rules 43 (d) contradicts with the provision, namely; DCIP shall only host commodities investment projects on crowdfunding platforms other than a platform which it controls whether directly or indirectly. The Commission with this contradiction is seen to be approbating and reprobating because if it says they are permitted to render crowdfunding portal services, why then is it saying they can only host their projects on other crowdfunding platforms that they do not control, in another breath. This contradiction needs to be resolved by the Commission.

The Way forward for Fintech Companies in view of these Rules

It appears from the Rules that Fintech Companies have only two alternatives open to them;

1. They can aggregate content from certified Crowdfunding Intermediaries and provide links to their portals on their websites, application or other similar modules, thereby making themselves out to simply provide a digital investment marketplace that connects investors to curated offerings of certain Crowdfunding Intermediaries.
2. Register a cooperative society under the Cooperative Societies Law of their respective states. For instance, the Lagos State Cooperative Federation under the Cooperative Societies Law of Lagos State 2014 makes provisions for a Cooperative Multipurpose Society (CMS). The CMS is a cooperative society that goes beyond just encouraging savings and giving out loans to members, it can buy and sell goods, venture into businesses and service members and non-members. The Director of the Cooperative Society is saddled with the responsibility of ensuring that all cooperative societies run their operations in accordance with the cooperative principles, which means the SEC does not regulate the activities of the Cooperative Society. 

Suffice to say, that the overall outlook of the SEC Rules on Crowdfunding is to give adequate protection to investors who wish to take part in the Crowdfunding Market, as it ensures that the investors have access to clear information on any investment vehicle offered by an issuer. This allows them to assess the risk and make informed decisions based on the information at their disposal. 

Furthermore, the Rule also enjoins the Crowdfunding Portals to have risks disclosures on their portals as a result of the volatility of the Nigerian financial market, whilst ensuring that they operate an orderly, fair and transparent market activity on their platforms.

The feature of MSME’s in the Rules shows that there is now a recognition of the pivotal role they play in our economy, as they are the bedrock of Nigeria’s industrialization and inclusive economic development, as once described by the Vice President, Prof. Yemi Osinbajo. The import of their inclusion guarantees their access to much-needed capital which would foster productivity and boost innovation whilst allowing the economy to tap into the entrepreneurial prowess of our youthful population. 

Sadly, the tenor of the rules foretells the exclusion of many fintech companies’ and this means that they either merge with companies with the requisite wherewithal or they reinvent themselves. The Commission has created a centralized community which would largely be filled with major players in the finance industry who have the required capital base to run a crowdfunding portal. They have failed to appreciate the ingenuity reposed in the fintech companies and their ability to foster financial inclusion through their people-centric business model.

Written By: Olaseni Aka-Bashorun (Entertainment and Technology Associate – Olisa Agbakoba Legal)

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