Posted October 20, 2016

Table of Contents

Introduction

The Texas intrastate crowdfunding rules permit a segregated account to be used in lieu of an escrow account when the maximum amount of the securities offering is $100,000 or less.  See Rule 139.25(f)(2).  This guidance is intended to provide some basic information and assistance in using a segregated account and to discuss the proper handling of funds required by the Board Rules.
 
As with an escrow account, the segregated account must be in a bank or other depository institution (bank) located in Texas and organized and subject to regulation under the laws of the United States or under the laws of Texas.  See Rule 139.25(f)(4).
 
The requirement to have an escrow or segregated account is to protect funds that do not belong to the registered general dealer (GD) or Texas crowdfunding portal (TCP).  The GD/TCP must treat the property of others with the highest standards of accountability. When a segregated account is used in place of an escrow account, the obligation to abide by the requirements for such an account set out in Rules 139.25 and 115.19 is absolute and is not waivable by the Issuer, prospective purchasers, investors, or the GD/TCP.  See Section 33.L of the Texas Securities Act.
 

Requirement for a Written Segregated Account Agreement (SAA)

The SAA defines the responsibilities of the parties (the GD/TCP and the Issuer) with respect to the funds in the segregated account. It must identify the bank where the funds will be held and provide the account number.  All signatories on the segregated account must be persons registered with the Securities Commissioner.  See Rule 139.25(f)(3)(B).  Although not required, a GD/TCP may consider it advisable to require two signatories on a segregated account that will or may hold a substantial amount of money. 
 
Rule 139.25(f)(3)(B) requires the SAA to be in writing, and Rule 139.25(j)(4) requires that a copy of the SAA be included in the notice filing made by the Issuer with the Securities Commissioner to claim the exemption.
 

Additional Requirements of Texas Crowdfunding Portals (TCPs)

When a segregated account will be used to hold funds raised in an offering, certain disclosures to prospective purchasers and investors are required on the TCP’s website.  The TCP must disclose that a segregated account is being used and include a statement that the TCP, in administering the segregated account:
  • is responsible for the prudent processing, safeguarding, and accounting for funds entrusted to the portal by the investors and the issuer;
  • will act to the advantage of and in the best interests of the investors and the issuer; and
  • will ensure that all requirements of the SAA between the TCP and the Issuer are met before funds are disbursed from the segregated account.
See Rule 115.19(c)(3).
 
Complete records of segregated account funds shall be kept by the TCP and shall be preserved for a period of five years after termination of the securities offering to which they relate. The TCP must maintain and preserve for a five year period: 
  • any agreements and/or contracts between it and an issuer, prospective purchaser, investor, bank or other depository institution; and 
  • ledgers (or other records) that reflect all assets and liabilities, income and expense, capital accounts, and escrow or segregated accounts.
See Rule 115.19(e)(2).
 
This recordkeeping requirement includes a copy of the SAA entered into between the TCP and the Issuer and documentation of all transactions in the segregated account.
 

Additional Requirements of Issuers

The issuer must inform all prospective purchasers that a segregated account will hold investor payments.  See Rule 139.25(f)(6).
 
When a segregated account is used for funds raised in a securities offering, the issuer must file with the Securities Commissioner a copy of the written SAA between the Issuer and the GD/TCP.  See Rule 139.25(j)(4).  This filing must be made at the same time the Issuer makes its other notice filings to claim the exemption provided by Rule 139.25.
 

General Principles for Administration of the Segregated Account

The segregated account must be in a bank or depository institution located in Texas and organized and subject to regulation under the laws of the United States or under the laws of Texas.  See Rule 139.25(f)(4).
 
In receiving monies for deposit into the segregated account, the GD/TCP may choose to accept a variety of forms of payment, including cash, check, money order, electronic funds transfer, or credit card.
 
The funds in the segregated account must be kept separate from funds in any other account used by the GD/TCP.  To prohibit commingling of funds from different offerings or other monies, a separate segregated account must be set up for each securities offering in which such an account is used.  See Rule 139.25(f)(5). These procedures are required by the Texas Securities Board to assure prospective purchasers, investors, and issuers that the funds raised will be safeguarded during the securities offering period.
 
No funds belonging to the GD/TCP (except funds reasonably sufficient to pay for account fees, obtain a waiver of account fees, or to keep the account open) may be included in the segregated account. It is the GD/TCP’s responsibility to pay for the costs of check orders, bank fees, credit card fees, insufficient fund fees and other fees that may be deducted from the account. These expenses should be anticipated in advance so a reasonable amount of money can be deposited into the account to cover the expenses prior to their deduction by the bank. 
 
Funds are held in the segregated account by the GD/TCP until all conditions to release the funds have been fulfilled.  See Rule 139.25(f)(1).  By holding funds in a segregated account, the GD/TCP assumes a heightened duty to the investors and the Issuer.
 
This heightened duty is one of trust and confidence between the parties. It obligates the GD/TCP to take care of property or money placed in the account for the benefit of the prospective purchasers, investors, and the Issuer, who have entrusted the funds to the GD/TCP for safekeeping. The GD/TCP must avoid conflicts of interest or self-dealing and remain objective and neutral and act at all times to the advantage of and in the best interests of all parties to the transaction.  Since the GD/TCP closes the offering, it is responsible for prudent processing, safeguarding, and accounting for funds raised in the offering and entrusted to them by prospective purchasers and investors, and is responsible for seeing that all requirements relating to the use of the segregated account set out in Rule 115.19 and Rule 139.25 are met, all instructions in the SAA are followed, and any other conditions met before funds are disbursed from the segregated account.  See Rule 139.25(f)(5) and Rule 115.19(c)(3).
 

Management of the Segregated Account

Setting up the account

All checks and deposit tickets for the segregated account should identify the Issuer or securities offering directly on the document to provide a clear and direct connection between the document and the securities offering (Offering).  The segregated account should be styled in the name of the GD/TCP as a segregated account for the Issuer or Offering. 
 
The SAA signed by the GD/TCP and the Issuer may specify a date when the account is to be closed and must set out how the funds are to be disbursed.  A copy of the SAA must be retained in the GD/TCP’s records.
 
Although not required, the GD/TCP may want to require two signatures on all checks on a segregated account that holds a substantial amount of money.  Since the GD/TCP is potentially liable if an employee converts funds in the segregated account, adequate supervision over account signatories is essential.  All signatories on the segregated account must be persons registered with the Securities Commissioner.  See Rule 139.25(f)(3)(B).
 

Operating the account

The records for the segregated account should be reconciled every month. This could include a review of the bank statement each month and reconciliation with the check register.  A segregated account ledger may be needed for proper reconciliation. 
 
It may be desirable to have the reconciliation prepared by someone not associated with the receipt and disbursement functions and reviewed and approved by the GD/TCP’s manager or owner.
 
It is advisable for voided checks to have their signature blocks removed or otherwise rendered ineffective.
 
The GD/TCP may want to maintain a separate file (Issuer File) for each offering by an Issuer that utilizes a segregated account.
 
Closing a segregated account requires returning payments to investors (if the offering terminates early or does not reach its funding goals) or disbursing funds to an Issuer when the securities offering is fully funded.
 
Disbursements from the segregated account should be made promptly once all conditions for release of the funds have been met.  The rules do not define promptly, so a reasonableness standard is appropriate.  It is reasonable to allow adequate time for funds to clear the bank before disbursing.  The latter is especially important since a failure to do so may cause the GD/TCP financial problems. In times of economic downturn, there is a higher risk of accepting checks, money orders, or other financial instruments that may be counterfeit, written on insufficient funds, or forged. If fraud is suspected, the GD/TCP may want to take the financial instrument to the bank from which it was allegedly issued and verify its authenticity.
 
It may also be prudent for the GD/TCP to ask how much time the bank requires for local and in-state checks, money orders, and cashier’s checks to clear the payor’s bank. The payor is the prospective purchaser or investor who wrote the check or provided the cashier’s check or other financial instrument. Once the funds have cleared the bank, they are called collected funds. It is important to distinguish collected funds from available funds, which have not cleared the bank and are still prone to chargebacks to the account. A chargeback is the money disbursed from the account, but which is not available because the financial instrument never cleared the payor’s bank. In other words, the GD/TCP did not wait until the funds were collected funds before making a disbursement.  A bank may add its own fee to the amount which it charges back to the account. Wire transfers and cash are the only deposits which are generally recognized as collected funds upon deposit.
 
The funds in the segregated account can be disbursed only to those persons entitled to receive them by the SAA and Rule 139.25(f)(1). If a dispute arises concerning all or part of the funds, the portion in dispute should be kept separate by the GD/TCP until the dispute is resolved while the undisputed portion is distributed appropriately.
 

Maintaining Records

Rule 115.19(e) requires the GD/TCP to keep segregated account records for five years after termination of the securities offering.  The GD/TCP must keep records to establish how the account was used.  This information would include the records of the account or other similar records clearly reflecting the date, amount, source, and explanation for all receipts, withdrawals, deliveries, and disbursements of the funds or other property in the segregated account. Examples of such account records are checkbooks, canceled checks, check stubs, check registers, bank statements, vouchers, deposit slips, ledgers, journals, closing statements, accountings, and other statements of receipts and disbursements rendered to Issuers or others regarding the account funds.
 
It is advisable for each Issuer File to contain a current disbursement sheet which lists:
  • the date, source and type of all receipts;
  • date, check number, item description, payee and amount of all checks;
  • date, amount and type of any other disbursements (i.e.: outgoing wire-transfers); and
  • any remaining balance.
Voided checks that have been canceled or where funds have been credited back to the account can be be shown on the disbursement sheet. 
 
Documentation supporting each disbursement from the segregated account and a determination that the disbursement was made to the appropriate payee must be maintained in the Issuer File.  The Issuer File would include copies of all checks, deposit slips, and receipt items.  If the bank or depository institution does not provide a copy of cancelled checks (paper or electronic) with the month end bank statement, the GD/TCP may want to obtain a signed acknowledgment from the bank stating copies will be provided upon request.
 

Miscellaneous

The GD/TCP should be aware of any FINCEN or IRS reporting requirements applicable to the segregated account.
 
If a GD/TCP detects that funds have been misappropriated, it should immediately notify the Inspections and Compliance Division of the Texas State Securities Board.
 
Occasionally, a segregated account may include unclaimed funds because the person to whom the funds belong cannot be located. The GD/TCP should make all reasonable efforts to locate the person so that proper payment can be made, including attempting to contact the person at last known addresses and telephone numbers. When all reasonable efforts have been exhausted, the GD/TCP may be required to maintain the property in the segregated account for a period of at least three years.  Afterwards, the GD/TCP is permitted to treat the property as abandoned and may look to the abandoned property provisions in Title 6 of the Texas Property Code for instructions on how to handle disbursing these funds.