The United States Securities and Exchange Commission has issued final rules on Regulation Crowdfunding. This post analyzes the “Issuer Requirements” section of the SEC’s adopting release.
Offering Statement Disclosure Requirements
The final rules under Regulation Crowdfunding create new Form C that issuers will use to file the required disclosures and related information with the SEC. Form C itself will be filed in the standard format of eXtensible Markup Language (XML), but the SEC is not mandating any specific media format for any and all attachments or exhibits to the offering statement.
Issuer Information; Officer and Directors; and Certain 20% Beneficial Owners
The SEC has adopted the issuer, officer and director, and 20% beneficial owners disclosure requirements largely as proposed. Issuers must identify these persons “as of the most recent practicable date, but no earlier than 120 days prior to the date the offering statement or report is filed.” As opposed to Regulation A required disclosures, Regulation Crowdfunding disclosures related to the business experience of directors and officers must only cover the previous three, rather than five, years. Additionally, issuers offering securities under the Regulation Crowdfunding regime must disclose their website address. The SEC believes that given the Internet-based nature of Crowdfunding, all issuers will have websites or will be able to create them at a small cost. Business Plan and Use of Proceeds
The SEC did not modify Rule 201(d) with regard to the requirements that the issuer disclose information about its business and business plan. The final requirement, therefore, is very flexible and issuers will be allowed to tailor their disclosures according to their particular business and stage of development.
As adopted in the final rules, the use of proceeds disclosure will require issuers to provide a reasonably detailed description of the purpose of the offering, such that investors will be able to understand how the proceeds will be used by the issuer. According to the SEC, instead of providing formulaic requirements, the key for this disclosure is for issuers to provide the appropriate level of detail to potential investors so they will be able to make an informed decision.
Target Offering Amount and Deadline
The final disclosure rule related to the target offering amount is unmodified from the proposed rule. Under this rule, issuers will be required to disclose both the target offering amount as well as the total amount it will be willing to accept. Therefore, for example, if an issuer sets a target amount of $100,000 but is willing to accept up to $1,000,000, the issuer must disclose both amounts in its offering statement.
Rule 201 contains a lengthy list of additional factual and business information that must be disclosed by the issuer to the SEC and the intermediary, including information on such topics as identities of intermediaries, intermediary compensation, legends, employee statistics, risk factors, indebtedness, and related-party transactions. For the most part, the disclosure requirements detailed in the proposed rules have been adopted with minimal modifications. The most noteworthy modifications from the proposed rules are summarized below.
- An added Rule 10b-5 type requirement to “disclose any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.”
- Modification of the required disclosure of the compensation to be paid to the intermediary so that it may be disclosed either as a dollar amount, percentage of the offering amount or as a good faith estimate if the exact amount is not available at the time of the filing.
- An added requirement to disclose the location on an issuer’s website where prospective investors will be able to access the issuer’s annual report (including the date on which the report will be available).
- An added requirement to disclose whether the issuer or any of its predecessors had previously failed to comply with ongoing reporting requirements of Regulation Crowdfunding.
Discussion of Financial Condition and Financial Disclosures
The SEC has only made a few technical clarifications to the proposed rules regarding the discussion of financial condition and financial disclosures. The SEC notes that the discussion should focus, to the extent material, on the issuer’s operational history as well as its liquidity and capital resources. Additionally, issuers should explain their access to other sources of capital, such as lines of credit, to the extent these disclosures do not overlap with the discussion of business or business plan.
The SEC has modified the requirements on financial disclosures in the final rules. The disclosure requirements are based on the amount of securities offered and sold. The following list of requirements has been reproduced from the final rules release:
- For issuers offering $100,000 or less: disclosure of the amount of total income, taxable income and total tax as reflected in the issuer’s federal income tax returns certified by the principal executive officer to reflect accurately the information in the issuer’s federal income tax returns (in lieu of filing a copy of the tax returns), and financial statements certified by the principal executive officer to be true and complete in all material respects. If, however, financial statements of the issuer are available that have either been reviewed or audited by a public accountant that is independent of the issuer, the issuer must provide those financial statements instead and need not include the information reported on the federal income tax returns or the certification of the principal executive officer.
- Issuers offering more than $100,000 but not more than $500,000: financial statements reviewed by a public accountant that is independent of the issuer. If, however, financial statements of the issuer are available that have been audited by a public accountant that is independent of the issuer, the issuer must provide those financial statements instead and need not include the reviewed financial statements.
- Issuers offering more than $500,000: For issuers offering more than $500,000 but not more than $1 million of securities in reliance on Regulation Crowdfunding for the first time: financial statements reviewed by a public accountant that is independent of the issuer. If, however, financial statements of the issuer are available that have been audited by a public accountant that is independent of the issuer, the issuer must provide those financial statements instead and need not include the reviewed financial statements.
- For issuers that have previously sold securities in reliance on Regulation Crowdfunding: financial statements audited by a public accountant that is independent of the issuer.
In order for a public accountant to be “independent” from the issuer, one of two conditions must be satisfied: (a) the public accountant complies with the SEC’s independence rules set forth in Rule 2-01 of Regulation S-X, or (2) the public accountant complies with the independence standards of AICPA. Finally, it should be noted that the final rules confirm that no issuers is exempt from the financial statement requirements under any circumstances.
The major change from the proposed crowdfunding rules related to progress statements is that, under the final rules, issuers may satisfy the progress updating requirements by “relying on the relevant intermediary to make publically available on the intermediary’s platform frequent updates about the issuer’s progress toward meeting the target offering amount.” When the issuer decides to close the offering, they will still be required to file Form C-U with the SEC, as contemplated in the proposed rules.
On-Going Reporting Requirements
Under the final rules, issuers will be required to file annual reports with the commission within 120 days of the end of the fiscal year covered in the report. The rules also require issuers to post these annual reports on their websites. As opposed to the high level of public accountant involvement in preparing financial statements in connection with the offering statement, the SEC has relaxed the level of involvement for financial statements included with the annual reports. The final rules only require the issuer’s principal executive officer to certify that the financial statements are true and complete in all material respects. Apart from the diminished requirements for annual report financial statements, however, all other information contained in the offering statement must be included in the crowdfunding issuer’s annual reports.
With regard to the final rules on termination of the on-going reporting requirement, the SEC adopted as proposed the three circumstances as previously drafted and added two additional circumstances that will trigger the end of the on-going reporting obligation. The circumstances that will end the on-going reporting requirement are: (a) when the issuer is required to file Exchange Act reports; (b) when the issuer has filed at least one annual report and has fewer than 300 holders of record; (c) when the issuer has filed at least three annual reports and has total assets that do not exceed $10 million; (d) when the issuer or another party purchases or repurchases all of the securities issued pursuant to the crowdfunded offering, including repayment in full of all debt securities; or (e) the issuer liquidates or dissolves in accordance with state law.
Form C and Filing Requirements
The final rules related to Form C and the related filing requirements largely parrot the proposed rules. The SEC, however, did make a few changes worth noting. First, as alluded to above, all exhibits required or permissible under the rules will be allowed to take the portable document format (“PDF”) as official filings. Second, the proposed Form C-A to be used for amendments to the offering statement has been changed in name to Form C/A in order to remain consistent with the SEC’s other form-naming conventions. Third, a new Form C-AR/A will be available for issuers when amending annual reports. Fourth, the XML-based portion of Form C will require issuers to check applicable boxes indicating the state jurisdiction in which it plans to offer securities, with the justification that including such information will aid state authorities who still maintain antifraud authority over crowdfunding offerings. Fifth, an optional Q&A section has been added to Form C that will afford issuers the option to include information not required to be included in the XML format all in one place.
Prohibition on Advertising Terms of the Offering
The final crowdfunding rules related to the prohibition on advertising the offering terms will look familiar to those who read the proposed rules carefully. Crowdfunding advertising notices may only include the following information:
- A statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted and a link directing the investor to the intermediary’s platform;
- the terms of the offering; and
- factual information about the legal identity and business location of the issuer, limited to the name of the issuer of the security, the address, phone number and website of the issuer, the e-mail address of a representative of the issuer and a brief description of the business of the issuer.Although the content of information an issuer may disseminate in a notice is admittedly limited, the SEC will not regulate the medium through which the notice is transmitted. Therefore, in the view of the SEC, “the final rules will allow issuers to leverage social media to attract investors, while at the same time protecting investors by limiting the ability of issuers to advertise the terms of the offering without directing them to the required disclosure.”
- Additionally, the final rules permit the issuer to communicate directly with investors about the terms of the offering through the channels provided on the intermediary’s platform, as long as the issuer clearly identifies itself. The SEC believes that one of the keys to crowdfunding is the ability of crowd members to communicate with each other in order to determine which ideas or companies are worth funding. According the SEC, the issuer should be given an opportunity to respond to questions about the terms of the offering as well as communicate directly with investors through the communication channels available on the intermediary’s website. All of the rules related to the prohibition on advertising the terms of the offering apply to any person acting on behalf of the issuer.
- The “terms of the offering” only include: (a) the amount of securities offered; (b) the nature of the securities; (c) the price of the securities; and (d) the closing date of the offering period. Although these are substantially similar to “tombstone ads” under Securities Act Rule 134, the permitted crowdfunding notices will require a statement (for example, a hyperlink) directing the investor to the intermediary’s online platform.
Compensation of Persons Promoting the Offering
The final rules about the compensation of persons promoting the offering were finalized as proposed with one clarification that broadens the term “acting on behalf of the issuer” to include all persons compensated by issuers for any reason (i.e. employees) regardless of whether the compensation is related to promoting the offering. Under the final rules, an issuer or a person acting on the issuer’s behalf can compensate someone for promoting the offering, but only if the promotional activities takes place through the communication channels provided by an intermediary, and only if the issuer “takes reasonable steps” to ensure that the promoter clearly discloses the receipt of such compensation along with any communication regarding the offering.
Other Issuer Requirements
Regardless of the structure of the offering, all crowdfunding issuers must describe how securities in oversubscribed offerings will be allocated. The SEC will not, on the other hand, limit the amount of nor prescribe how to allocate oversubscriptions. All that is required of issuers is to abide by the annual $1 million limit and disclose in the offering statement how much it will be willing to accept, the allocation, and intended purpose of, amounts raised in oversubscriptions.
Offering Price; Types of Securities Offered; and Valuation
Consistent with the proposed rules, the final rules about offering price will not require listing a fixed price or prohibit dynamic pricing. Additionally, the final rules do not limit the type of securities offered and do not require any specific method for valuing the securities.
You can view our complete analysis of Regulation Crowdfunding here.