On Tuesday, Andrew Dowell reported in The Wall Street Journal that a “computer attack” breached the crowdfunding site Kickstarter Inc. According to Dowell, Kickstarter was founded about five years ago and has raised US$850 million in pledges from five million people. Kickstarter retains 5 percent of the funds raised by projects that meet their funding goals. The article describes Kickstarter’s platform as an “exchange in which people can contribute often small amounts of money to fund projects.”
Crowdfunding generally refers to the process by which capital is raised from numerous, typically small, financial contributions to fund a project or enterprise and, unfortunately, a great deal of confusion remains regarding its regulatory status. Kickstarter is the leading example of donation-based crowdfunding. Contributors do not receive any equity or any financial return in the projects or enterprises that they finance. The Jumpstart Our Business Startups Act (JOBS Act) does not directly affect this form of crowdfunding.
As we discussed in this space in September 2013, the 80-year-old prohibition on general solicitation ended on Monday, September 23, 2013. This means that it is now legal for companies to solicit accredited investors and advertise that they are seeking to raise capital. This change was mandated under Title II of the JOBS Act.
The rules for crowdfunding with respect to ordinary or “retail” investors, however, were not even proposed until October 23, 2013, and the comment period for the proposed crowdfunding rules ended earlier this month. So crowdfunding rules have not yet been adopted. The mandate for crowdfunding is set forth in a different section, Title III of the JOBS Act, than the lifting of the ban on general solicitation.
It is possible that the confusion regarding the regulatory status of crowdfunding is due to the long wait for the SEC to propose and adopt rules for this potential new market. The JOBS Act had set the end of 2012 as the deadline for final rules on crowdfunding, a deadline which clearly has been missed.
In May 2013, the SEC’s Division of Trading and Markets published guidance referred to as “Frequently Asked Questions About Crowdfunding Intermediaries.” Since then, those FAQs have not been updated. The FAQ guidance indicates that Title III of the JOBS Act creates a new exemption for offerings of crowdfunded securities. Specifically, the JOBS Act amends the Securities Act to exempt issuers from the registration requirements of that Act when they offer and sell up to US$1 million in securities, provided that individual investments do not exceed certain thresholds and the issuer satisfies other conditions in the JOBS Act, most of which still require rulemaking by the SEC before they are operational.
One of the conditions that will be required for crowdfunding is that issuers will need to use the services of an intermediary that is either a broker registered with the SEC or a “funding portal” registered with the SEC. Title III of the JOBS Act adds a new provision to the Securities Exchange Act which requires the SEC to exempt, conditionally or unconditionally, an intermediary operating a funding portal from the requirement to register with the SEC as a broker. The intermediary, though, would need to register with the SEC as a funding portal and would be subject to the SEC’s examination, enforcement and rulemaking authority. The funding portal also must become a member of a national securities association that is registered under the Securities Exchange Act.
There is little doubt that donation-based platforms like Kickstarter hope to become “funding portals” for equity or financial-return based crowdfunding if and when the rulemaking under Title III of the JOBS Act becomes final. It will be interesting to see if donation-based platforms’ apparent vulnerability to computer attacks and data breaches will further stall the rulemaking necessary to implement true return-based crowdfunding. We will continue to monitor these important crowdfunding regulatory developments.