On October 23, the Securities and Exchange Commission voted unanimously to propose new rules that would permit companies to offer and sell securities through “crowdfunding.” Title III of the Jumpstart Our Business Startups Act requires the SEC to adopt rules implementing the exemption from registration under the Securities Act of 1933 (Securities Act) provided by Section 4(a)(6) of the Securities Act (Crowdfunding Exemption) for offers and sales of securities through online crowdfunding platforms. Generally speaking, the Crowdfunding Exemption is intended to facilitate capital formation by startups and small businesses by allowing certain companies to raise up to $1 million in any 12-month period through online crowdfunding “portals” in exchange for securities.
The proposed rules would limit the amount a single investor could invest in crowdfunding transactions during any 12-month period. Specifically, in the case of an investor having annual income and net worth of less than $100,000, the investor would only be permitted to invest $2,000 or 5% of such investor’s annual income or net worth (whichever is greater). In the case of an investor with annual income or net worth of at least $100,000, the investor would only be permitted to invest 10% of such investor’s net worth or annual income (whichever is greater) in crowdfunding transactions. The proposed rules set forth a framework for determining an investor’s net worth and net income and would permit an issuer to rely on the applicable crowdfunding intermediary to determine the amount of securities purchased by an investor in crowdfunding transactions to ensure the investor has not exceeded his or her limit.
The proposed rules also provide a framework for disclosure in offering materials used to offer securities pursuant to the Crowdfunding Exemption and in annual reports, which an issuer would be required to file after completing an offering in reliance on the Crowdfunding Exemption. In connection with a crowdfunding offering, an issuer would be required to file with the SEC and provide to potential investors (through the issuer’s website) an offering statement on new “Form C,” which would require scaled disclosure regarding, among other things, the issuer; the issuer’s officers, directors and beneficial owners of 20% or more of its voting equity; a business plan; the use of proceeds from the offering; the target offering amount and deadline for completing the offering; the circumstances under which the issuer may close the offering prior to the stated deadline and any requirements for investors to confirm their investment commitment, as well as the fact that committed capital will be returned if the target offering amount is not reached before the offering deadline; the offering price; ownership and capital structure; risk factors; compensation paid to the intermediary; and related party transactions.
The proposal also clarifies the financial disclosure that would be required in an offering statement. In the case of offerings of more than $100,000 but less than $500,000 of securities, an issuer would be required to provide reviewed financial statements and, in the case of offerings of more than $500,000 of an issuer’s securities, the issuer would be required to provide audited financial statements. For purposes of calculating the offering amount, the proposal would require an issuer to include all offerings made in reliance on the Crowdfunding Exemption within the preceding 12-month period. In addition, an issuer would be required to include in an offering statement a discussion of the issuer’s historical results of operation, liquidity and capital resources. Once an issuer completes a crowdfunding offering, it would be subject to ongoing reporting obligations, which would require disclosure of information similar to the information regarding the issuer, its financial condition and the securities offered as would be required in the offering statement. The proposed rules specify the circumstances in which an issuer’s annual reporting obligations would terminate.
The proposed rules also provide that all crowdfunding transactions conducted in reliance on the Crowdfunding Exemption must be effected through a single online intermediary registered with the SEC as a “funding portal.” The proposed rules include various requirements for funding portals, including requirements that the portal provide communication channels to facilitate sharing of information that will allow communication among potential investors (i.e., the “crowd”), make educational materials available to potential investors, take measures to reduce fraud and make available information about issuers. Under the proposed rules, a funding portal would be prohibited from providing investment advice or recommendations, soliciting purchases or sales of securities offered or displayed on its website, handling investor funds, effecting secondary transactions in securities and engaging in certain compensation practices.
The proposal included 295 specific requests for comment, and is subject to public comment for a period of 90 days from the date the proposal is published in the Federal Register. Until the SEC adopts final rules relating to crowdfunding transactions and such rules become effective, issuers and intermediaries may not rely on the exemption provided by Section 4(a)(6) of the Securities Act.
To view the complete text of the proposal, click here.