The SEC substantially adopts prior proposed rules.
On October 30, pursuant to Title III of the Jumpstart Our Business Startups Act, which was passed in 2012, the US Securities and Exchange Commission (SEC) finally adopted rules (referred to as Regulation Crowdfunding) that permit companies to offer and sell securities through crowdfunding (essentially, through the Internet). According to the SEC, the new rules are designed to assist smaller companies with raising capital while providing investors with additional protections. These new rules and forms are expected to take effect during the second quarter of 2016 (six months after publication in the Federal Register).
Here are some quick facts about the new rules.
Companies will be allowed to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
Companies must disclose the following:
- The price to the public of the securities or the method for determining the price, 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
- A discussion of the company’s financial condition
- Reviewed or audited financial statements (see table below)
- A description of the business and the use of proceeds from the offering
- Information about officers and directors as well as owners of 20% or more of the company
- Certain related party transactions
Will a company need an audit?
Click here to view table.
Companies’ Annual Reports
- Companies must file an annual report with the SEC and provide it to investors by posting it on the company website within 120 days after the end of the fiscal year that the report covers.
- The report must include financial statements of the company that the principal executive officer of the company has certified. If the company’s financial statements have been reviewed or audited by an independent certified public accountant, the company must provide the audited statements.
- The report must also include the information required in the offering statement, limited to the information about the company and its financial condition that is required in connection with the offer and sale of the securities.
Effect on Exchange Act Section 12(g)
Holders of these securities would not count toward the threshold that requires a company to register its securities under section 12(g) of the Securities Exchange Act of 1934 (Exchange Act), as amended, if the company is current in its annual reporting obligations, retains the services of a registered transfer agent, and has less than $25 million in total assets as of the end of its most recently completed fiscal year.
Companies not eligible to use the crowdfunding exemption include the following:
- Non-US companies
- Exchange Act reporting companies
- Certain investment companies and companies subject to disqualification under Regulation Crowdfunding
- Companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement
- Companies that have no specific business plan or that have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies
No Effect on Rule 506(c)
The new crowdfunding regulation does not affect the ability to conduct general solicitation to only accredited investors pursuant to SEC Rule 506(c).
- Securities purchased in a crowdfunding transaction generally may not be resold for one year.
- The SEC has set limits on the amount that an individual may invest during a 12-month period.
Click here to view table.
Crowdfunding Platform Rules
All transactions that rely on the new rules would be required to take place through an SEC-registered intermediary—either a broker-dealer or a funding portal.
A funding portal would be required to register with the SEC on the new Form Funding Portal and become a member of a national securities association (currently, the Financial Industry Regulatory Authority). A company that relies on the rules would be required to conduct its offering exclusively through one intermediary platform at a time.
The rules would require intermediaries to, among other things,
- provide investors with educational materials that explain the process for investing on the platform, the types of securities being offered and information a company must provide to investors, resale restrictions, and investment limits;
- take certain measures to reduce the risk of fraud, including having a reasonable basis for believing that a company complies with Regulation Crowdfunding and that the company has established means to keep accurate records of securities holders;
- make information that a company is required to disclose available to the public on its platform throughout the offering period and for a minimum of 21 days before any security may be sold in the offering;
- provide communication channels to permit discussions about offerings on the platform;
- provide disclosure to investors about the compensation that the intermediary receives;
- have a reasonable basis for believing that an investor complies with the investment limitations; and
- comply with completion, cancellation, and reconfirmation of offerings requirements.
The rules also would prohibit intermediaries from engaging in certain activities, such as
- providing access to their platforms to companies that intermediaries have a reasonable basis for believing have the potential for fraud or other investor protection concerns;
- having a financial interest in a company that is offering or selling securities on its platform, unless the intermediary receives the financial interest as compensation for the services (subject to certain conditions); and
- compensating any person for providing the intermediary with personally identifiable information of any investor or potential investor.
Regulation Crowdfunding would contain certain rules specific to registered funding portals consistent with their more limited activities than that of a registered broker-dealer. The rules would prohibit funding portals from offering investment advice or making recommendations; soliciting purchases, sales, or offers to buy securities; compensating promoters and other persons for solicitations or based on the sale of securities; and holding, possessing, or handling investor funds or securities.
The rules would provide a safe harbor under which funding portals could engage in certain activities consistent with these restrictions and require funding portals to maintain certain books and records related to their transactions and business.
The forms that enable funding portals to register with the SEC will take effect January 29, 2016.
The foregoing summary was adapted from the SEC Fact Sheet on Regulation Crowdfunding published on October 30, 2015.
Impact of Regulation Crowdfunding
The long-awaited adoption of these new rules is a momentous occasion, because they have the potential to greatly facilitate raising capital through general solicitation, including through the Internet and social media platforms. However, some of the restrictions put in place to protect nonaccredited investors, such as having reviewed or audited financial statements and requiring an intermediary that will charge a fee, will make it more costly than traditional methods of raising capital from accredited investors in a private placement.
Further, companies that use the exemption must be willing to post their financial information on their websites in an annual report for the world (including competitors) to view. Last, the individual investor limitations will necessitate many more investors to have a meaningful capital raise. For example, if a company is trying to raise $1 million at $2,000 per investor, that will result in 500 new stockholders. It will be costly and/or time consuming to manage all of these new stockholders, and a variety of nonsecurities law considerations will also need to be considered in that context (such as state corporate law statutes, fiduciary duties, and flow of information to stockholders).
Alternative security provisions, such as nonvoting common stock or a voting proxy, or even new types of specialized crowdfunding securities may emerge as a way to navigate scenarios where companies have a high number of investors. That said, we stand ready to help companies, investors, and intermediaries navigate this process to facilitate a successful fundraising.