On October 30, 2015, the U.S. Securities and Exchange Commission (SEC) adopted final rules under Title III of the JOBS Act to enable U.S. companies to offer and sell securities through crowdfunding (Regulation Crowdfunding). This alert provides an overview of the SEC crowdfunding rules slated to become effective in early May 2016, with certain related forms, such as Form Funding Portal (which will be used to register as a funding portal), becoming effective at the end of January 2016.

Generally, Regulation Crowdfunding implements a JOBS Act exemption for certain activities related to crowdfunding from the registration requirements of the U.S. Securities Act of 1933 (Securities Act), subject to investment limitations on investors, as well as disclosure requirements for issuers and intermediaries engaged in crowdfunding transactions. The JOBS Act also exempts certain crowdfunding intermediaries (funding portals) from broker-dealer registration under the U.S. Securities Exchange Act of 1934 (Exchange Act).

“Crowdfunding” is a term for internet-based fundraising characterized by decentralized groups of donors/investors individually committing relatively modest amounts of capital to small businesses, social projects, artistic performances, etc. Popular sites such as Kickstarter and IndieGoGo already provide a crowdfunding platform for the solicitation of donations, while sites like Fundrise, CircleUp and AngelList facilitate securities offerings using existing securities registration exemptions such as Regulation A and Regulation D. However, under current federal securities laws and regulations, participation in crowdfunding offerings under Regulation D generally cannot be extended to non-accredited investors, and the use of Regulation A involves an onerous disclosure and review process at both the state and federal levels. The JOBS Act and the recently adopted final rules are intended to provide a regulatory regime that narrowly but effectively permits certain issuers, investors and intermediaries to participate in investment-based crowdfunding while limiting the potential occurrences of fraud.

Overview of Regulation Crowdfunding

For Investors/Issuers:

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For Funding Portals:

In addition to allowing registered broker-dealers to act as crowdfunding intermediaries under the JOBS Act, Regulation Crowdfunding creates a newly designated crowdfunding intermediary called a “funding portal,” facilitating primary issuances of securities on behalf of issuers without the burden of registering as a broker-dealer under the Exchange Act. While funding portals do not need to register as broker-dealers to be crowdfunding intermediaries, there are certain activities that funding portals are prohibited from engaging in.

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Because these broad prohibitions include certain activities funding portals were meant to engage in, the proposed rules include certain safe harbors.

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Marketplace Evolution

The SEC has completed its crowdfunding rulemaking process under the JOBS Act. In the coming years the interpretation and enforcement of Regulation Crowdfunding may be tested as the SEC seeks to balance the promotion of capital formation against the protection of investors. Global crowdfunding activity is expected to reach between $90 billion and $96 billion by 2025 (almost twice the size of the global venture capital industry today) according to a 2013 World Bank study. This rapid growth in funding size and the corresponding number of offerings expected to rely on Regulation Crowdfunding will likely challenge regulators and make rule enforcement difficult. In the meantime, market entrants are already quickly developing rule enforcement and fraud mitigation technology that is not possible within traditional offerings in an attempt to ensure that market participants (issuers, investors and service vendors) enjoy the rewards of an efficient, transparent crowdfunding market.