On August 19, Nicole Strydom and I gave a 10 minute presentation on the general solicitation rules and the current status of “crowdfunding” at a ceremony to announce the finalists in the student division of the Minnesota Cup. This summary of our presentation provides brief overview of the new rules on general solicitation and the forthcoming rules on crowdfunding.
Distinction between General Solicitation and Crowdfunding
- For SEC purposes, general solicitation and crowdfunding are two distinct concepts, although in common parlance they are closely related. For example, you may think that crowdfunding by definition must include dissemination of advertisements or information to the masses. For purposes of the securities laws, though, crowdfunding has nothing to do with general solicitation.
General Solicitation and Rule 506(c)
- New SEC Rule 506(c), which allows (for the first time since the Securities Act was enacted in 1933) issuers to publicly advertise unregistered offerings of securities conducted pursuant to Regulation D.
- The new rule doesn’t replace the status quo – the “traditional” Rule 506 offering to only accredited investors and up to 35 non-accredited investors is still available (although it has been renumbered Rule 506(b)).
Rule 506(c) provides a new exemption for sales of securities that specifically allows for advertising, but there are a few caveats to keep in mind:
- Although advertising using virtually any media is permitted, the existing anti-fraud provisions still apply – so any untrue statement of a material fact or omission of a material fact can still subject an issuer to liability, which may be problematic when an issuer is trying to describe an offering in the context of an advertisement (or, say, a 140 character tweet).
- In an advertised offering under Rule 506(c), investments can only be accepted from accredited investors – the ability to accept up to 35 non-accredited investors is not available for a Rule 506(c) offering.
- In an advertised offering, the issuer is responsible for verifying the status of the accredited investors. In a plain vanilla Rule 506 offering, the issuer typically requires the investor to self-certify that they are an accredited investor. While that will continue to suffice for purposes of Rule 506(b), it will not be enough in advertised offerings under Rule 506(c). The specific steps required by an issue to verify accredited investor status will vary under the circumstances (e.g., widely advertised offerings with low minimum investments require more verification that selectively advertised offerings with high minimum investments). The SEC has established four methods of verification will be deemed to satisfy the issuer obligation, and those safe harbors are described in Rule 506(c).
The new general solicitation rule has triggered a number of additional rule proposals from the SEC, including new rules or changes to existing rules that would require:
- That issuers file the required Form D with the SEC 15 days in advance of the first use of general solicitation for the offering. Currently, the requirement is that the Form D be filed within 15 days after the date of the first sale in the offering.
- That issuers must include a legend on any written advertisement that informs people, among other things, that only accredited investors may invest and that investors have to be able to bear the loss of their investment.
- That issuers must submit any written advertising material to the SEC no later than the first day the materials are used.
- The first thing to note about crowdfunding is that it isn’t yet a permissible way to raise money in an unregistered offering – the rules that will implement the crowdfunding provisions of the JOBS Act have not yet been finalized.
- An offering pursuant to the forthcoming crowdfunding rules may not make use of advertising, other than to direct the prospective investor to visit the funding portal for the offering. This is somewhat counterintuitive, since the everyday use of the term crowdfunding almost necessarily implies widespread advertising.
- If an issuer takes part in a crowdfunding offering, it will be limited to raising $1 million in a rolling 12 month period from that particular offering or any other offering, even other non-crowdfunded offerings.
- In a crowdfunding offering, there are limitations on the amount that the issuer can accept from any investor in a rolling 12 month period. Specifically, if the investor has an annual income or net worth of less than $100,000, the issuer can only accept up to the greater of $2,000 or 5% of the investor’s income. If the investor has an annual income or net worth greater than $100,000, the issuer can accept up to 10% of the investor’s annual income, with a maximum of $100,000.
- In a crowdfunding offering, only broker-dealers or a new type of regulated entity called a funding portal can conduct an offering. This funding portal isn’t allowed to offer investment advice, solicit sales, pay compensation based on sales or handle investor funds. What can it do? It can help match investors with issuers. Funding portals will also be required to register with the SEC and FINRA and comply with appropriate rules of each regulatory body.
- Issuers who want to use the crowdfunding exemption will need to file certain financial information with the SEC – including a description of the financial condition of the issuer. Issuers will also need to provide this information to its broker-dealer or funding portal and to potential investors. The amount of financial information the issuer will have to provide depends on the target offering amount. For example, if targeted offering amount is greater than $500,000, the issuer will need to provide audited financial statements, but if it’s $100,000 or less, the issuer will just need to provide its income tax return for the most recently completed fiscal year, as certified by the issuer’s principal executive officer.
- There are lots of exciting opportunities for growing businesses as a result of the new Rule 506(c), which will allow for advertising in connection with private offerings, and the forthcoming crowdfunding rules, which will permit companies to raise money from non-accredited investor. However, there are also many caveats and pitfalls – not all of them discussed here – and kinks in the system that will need to be worked out. As a result, companies should involve their securities lawyers as early in the financing process as possible.