Securities and Exchange Commission Proposes Regulations Authorizing the Use of Crowdfunding in Equity Offerings
On October 23, 2013, the Securities and Exchange Commission (the “Commission”) issued proposed regulations to implement Title III of the Jumpstart Our Business Startups Act (the “JOBS Act”). Regulation Crowdfunding would govern the offer and sale of securities under new Section 4(a)(6) of the Securities Act of 1933, as amended (the “Securities Act”), and would permit the offer and sale of securities over the internet to both accredited and unaccredited investors without the formal registration of such offerings with the Commission under Section 5 of the Securities Act. The goal of this Section of the JOBS Act and the proposed regulations is to allow startups and small businesses to raise capital in a cost efficient manner using the Internet.
The Commission has provided a 90-day public comment period, after which it will consider adopting final rules to regulate equity crowdfunding in the United States. The major aspects of the proposed regulations are as follows:
Offering and Participation Limits
- An issuer will be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
- Investors, over the course of a 12-month period, will be permitted to invest up to:
- $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
- 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.
- As an interesting contrast to the rules that the Commission recently adopted regarding the elimination of general solicitation in Rule 506 offerings solely to accredited investors, an issuer will not have an obligation to confirm an investor’s compliance with these limits, but rather, will be entitled to rely on representations of the investor that he or she is in compliance with these limits.
The following companies will not be eligible to use the crowdfunding exemption:
- Non-U.S. companies,
- Companies that already are public companies or otherwise obligated to file current and periodic reports with the Commission,
- Certain investment companies,
- Companies that are disqualified under the recently proposed disqualification rules under Rule 506 promulgated under the Securities Act,
- Companies that have failed to comply with the annual reporting requirements in the proposed rules, and
- Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.
As mandated by Title III of the JOBS Act, securities purchased in a crowdfunding transaction cannot be resold for a period of one year. Holders of these securities will not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended.
Disclosure by Companies
Consistent with Title III of the JOBS Act, the proposed rules would require issuers conducting a crowdfunding offering to file certain information with the Commission, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.
In its offering documents, among the items an issuer will be required to disclose:
- Information about officers and directors as well as owners of 20 percent or more of the issuer’s outstanding securities.
- A description of the issuer’s business and the proposed use of proceeds from the offering.
- The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
- Certain related-party transactions.
- A description of the issuer’s financial condition.
- Financial statements of the issuer that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the issuer’s tax returns or reviewed or audited by an independent public accountant or auditor.
Issuers would be required to amend the offering document to reflect material changes and provide updates on the issuer’s progress toward reaching the target offering amount.
An issuer relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the Commission and provide it to investors.
All crowdfunding offerings are required to be conducted exclusively online through a platform operated by an intermediary registered with the Commission. The intermediary will either be a registered broker-dealer or a funding portal, which is a new type of SEC registrant.
The proposed rules would require these intermediaries to:
- Provide investors with educational materials.
- Take measures to reduce the risk of fraud.
- Make available information about the issuer and the offering.
- Provide communication channels to permit discussions about offerings on the platform.
- Facilitate the offer and sale of crowdfunded securities.
The proposed rules would prohibit funding portals from:
- Offering investment advice or making recommendations.
- Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
- Imposing certain restrictions on compensating people for solicitations.
- Holding, possessing, or handling investor funds or securities.
The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions. The Financial Industry Regulatory Authority (“FINRA”) has also issued proposed rules, forms and a regulatory notice designed to regulate the funding portals, all of which you can access here.
You can access the 585-page regulation by clicking here. We will provide a new client alert when the Commission adopts final regulations to implement Regulation Crowdfunding. Feel free to contact the author with any questions about this important development.