The Securities and Exchange Commission has published its long-awaited rules under Title III of the Jumpstart Our Business Startups (JOBS) Act.
As described in the nearly 700-page release, “Regulation Crowdfunding” under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, will permit companies to offer and sell securities through the highly popular but still evolving method of Internet-based fundraising known generally as crowdfunding.
Although offers and sales of securities pursuant to Regulation Crowdfunding will be subject to a number of significant requirements and limitations, they will not be subject to many of the limitations imposed on other exempt offerings, such as the general solicitation restriction of Securities Act Rule 506(b) or the “accredited investor” requirements of Securities Act Rule 506(c).
While crowdfunding has been used in many contexts to raise money via the Internet, companies generally have been prevented from using this technique to offer and sell securities because such activities trigger the federal securities laws, including those generally requiring the offer or sale of securities to be registered (unless a specific exemption is available) and those generally requiring persons or entities intermediating such offers and sales to register as broker-dealers.
Title III of the JOBS Act created a federal exemption under the securities laws to facilitate this type of fundraising for small, emerging companies. It included an exemption from the registration requirements of the Securities Act to permit securities-based crowdfunding and created a new form of intermediary, a “funding portal,” that will be permitted to facilitate such offers and sales without registration under the Exchange Act as a broker-dealer (although broker-dealers also will be able to engage in crowdfunding transactions).
The SEC designed Regulation Crowdfunding to facilitate the capital formation efforts of emerging companies while, at the same time, providing investors with certain protections.
Regulation Crowdfunding allows investments in securities through crowdfunding transactions, subject to certain limitations. At the same time, it limits the amount of money an issuer can raise using this method. It requires issuers to make certain disclosures about their businesses and the securities being offered, and provides a regulatory framework for funding portals (and broker-dealers) that will facilitate securities transactions through crowdfunding.
Regulation Crowdfunding will:
- Permit eligible companies to raise a maximum of $1 million through crowdfunding offerings in any 12-month period and
- Permit individual investors, over a 12-month period, to invest in the aggregate, across all crowdfunding offerings, up to:
- the greater of $2,000 or 5 percent of the lesser of annual income or net worth if either annual income or net worth is less than $100,000 or
- 10 percent of the lesser of annual income or net worth if both annual income and net worth are equal to or greater than $100,000.
During the 12-month period, the aggregate amount of securities that may be sold to an investor through all crowdfunding offerings may not exceed $100,000.
Certain companies would not be eligible to use Regulation Crowdfunding, including non-US companies, Exchange Act reporting companies, certain investment companies, companies subject to Regulation Crowdfunding’s disqualification provisions, companies that have failed to comply with Regulation Crowdfunding’s annual reporting requirements for two years, and companies with no specific business plan or whose plan is to engage in a merger or acquisition with an unidentified company or companies.
A company offering securities in reliance on Regulation Crowdfunding will be permitted to concurrently effect another exempt offering, provided that each offering complies with the requirements of the applicable exemption. Thus, an issuer conducting a concurrent exempt offering for which general solicitation is not permitted will need to confirm that purchasers in that offering were not solicited through the Regulation Crowdfunding offering, and an issuer conducting a concurrent exempt offering for which general solicitation is permitted may not include in its solicitation the terms of the Regulation Crowdfunding offering unless the solicitation otherwise complies with Regulation Crowdfunding.
Holding period for Regulation Crowdfunding securities
Securities purchased through crowdfunding generally will not be permitted to be resold for one year, and holders will not count toward the threshold requiring registration of securities under Exchange Act Section 12(g) if the company is current in its annual reporting obligations, retains a registered transfer agent and has less than $25 million in total assets as of its most recent fiscal year-end.
Companies offering securities through crowdfunding will be required to file detailed information with the SEC and provide it to investors and the intermediary facilitating the offering, including:
- The price or method for determining price, the target offering amount, the deadline for reaching the target, and whether investments in excess of the target will be accepted
- The company’s financial condition
- Financial statements that, depending on the amount offered and sold during a 12-month period, are accompanied by information from company tax returns which must be reviewed by an independent accountant or audited by an independent auditor
- If a company offers for the first time more than $500,000 but not more than $1 million of securities in reliance on these rules, it could provide reviewed rather than audited financials, unless independently audited financial statements are available
- A description of the business and the use of proceeds
- Information about officers, directors, and owners of 20 percent or more of the company
- Certain related-party transactions and
- Material information necessary to make any statements, in light of the circumstances under which they were made, not misleading.
Issuers must amend offering documents during an offering period to reflect material changes and provide updates on progress toward reaching the target offering amount. If there is a material change to the terms of an offering or to the information provided by the issuer, the intermediary must inform any investor who has made an investment commitment about the material change and that the investor’s investment commitment will be cancelled unless the investor reconfirms it within five business days of receipt of the notice.
Companies relying on Regulation Crowdfunding would be required to file annual reports with the SEC and provide them to investors.
Transactions relying on the new rules will be required to take place through an SEC-registered intermediary – either a broker-dealer or a funding portal. Funding portals will be required to register with the SEC using “Form Funding Portal” and will be required to become members of the Financial Industry Regulatory Authority (FINRA). Companies will have to conduct Regulation Crowdfunding offerings exclusively through one platform at a time.
Crowdfunding intermediaries will be required, among other things, to:
- Provide investors with educational materials that explain, among other things, the platform’s investing process, the types of securities being offered, information a company must provide to investors, resale restrictions, and investment limits
- Take measures to reduce the risk of fraud, including having a reasonable basis for believing that an offering company complies with Regulation Crowdfunding and is able to maintain accurate records of securities holders
- Make the information a company is required to disclose available to the public on the platform throughout the offering period and for at least 21 days before securities are sold in the offering
- Provide a means to facilitate discussions about offerings on the platform
- Provide disclosure to investors about the intermediary’s compensation
- Accept an investment commitment only after the investor has opened an account
- Have a reasonable basis for believing an investor is eligible
- Provide notices to investors once they make commitments, and confirmations at or before completion of any transaction
- Comply with requirements relating to maintenance and transmission of funds, and requirements for completion of offerings and cancellation and reconfirmation of investment commitments.
Crowdfunding intermediaries will be prohibited from:
- Allowing access to companies that they reasonably believe have the potential for fraud or raise other investor protection concerns
- Having a financial interest in companies offering or selling securities on their platforms, unless the financial interest is received as compensation for the services (subject to certain conditions) and
- Compensating any person for providing personally identifiable information about an investor or potential investor.
The activities of registered funding portals are intended to be more limited than those of a registered broker-dealer, and therefore Regulation Crowdfunding will prohibit them from offering investment advice or making recommendations; soliciting purchases, sales or offers to buy securities; compensating promoters and others for soliciting purchases or compensating them based on the sale of securities; and handling or holding investor funds or securities. A safe harbor will allow funding portals to engage in certain activities consistent with these restrictions.
Funding portals will also be required to maintain certain books and records.
SEC staff report
SEC staff will study Regulation Crowdfunding and submit a report to the SEC analyzing its impact on capital formation and investor protection no later than three years after the regulation’s effective date.
Regulation Crowdfunding will become effective 180 days after the final rules are published in the Federal Register; however, the forms that will enable funding portals to register with the SEC Commission will become effective January 29, 2016.
Understanding more about Regulation Crowdfunding
As noted above, the Regulation Crowdfunding adopting release is very comprehensive. It discusses many different regulatory matters in its nearly 700 pages and covers in great detail a number of technical issues as well as the policies upon which the new rules are premised.
Parts of the regulation appear to be quite restrictive, and the cost and effort of compliance with its requirements may make capital raising pursuant to Regulation Crowdfunding prohibitively burdensome and expensive for some companies, especially smaller ones, given the limited amounts that can be raised. However, in drafting the rules, the SEC appears to have remained faithful to Congress’s mandate, and the restrictive nature of the rules is consistent with the JOBS Act provisions that gave rise to them. Of course, the ultimate success of the effort can only be judged through experience – and that will take time.