- Regulation Crowdfunding
- December 2, 2015 | Author: Frederick C. Leech
- Law Firm: Leech Tishman - Pittsburgh Office
- On Friday, October 30, 2015, the Securities and Exchange Commission (“SEC”) adopted new Regulation Crowdfunding under the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Securities Exchange Act”) to implement the requirements of Title III of the Jumpstart Our Business Startups Act (the “JOBS Act”) (1). The crowdfunding provisions of the JOBS Act were intended to help provide startups and small businesses with capital by making relatively low dollar offerings of securities less costly. Regulation Crowdfunding establishes the regulatory framework around the Congressional intent of Title III of the JOBS Act. Regulation Crowdfunding will become effective 180 days after publication in the Federal Register. (2) This Leech Tishman Client Alert provides an overview of Regulation Crowdfunding.
Crowdfunding is a relatively new and evolving method of using the Internet to raise capital to support a wide range of ideas and ventures. An entity or individual raising funds through crowdfunding typically seeks small individual contributions from a large number of people. Individuals interested in the crowdfunding campaign - members of the “crowd” - may share information about the project, cause, idea or business with each other and use the information to decide whether to fund the campaign based on the collective “wisdom of the crowd.”
In the United States, due largely to certain features of the Securities Act and the Securities Exchange Act, crowdfunding generally has not involved the offer of a share in any financial returns or profits that the fundraiser may expect to generate from business activities financed through crowdfunding. These features include the following -
- First. Such a profit or revenue-sharing model could trigger the application of the Securities Act because it likely would involve the offer and sale of a security. Under the Securities Act, the offer and sale of securities is required to be registered unless an exemption is available. Limitations under existing private placement regulations, including purchaser qualification requirements for offering exemptions that permit general solicitation and general advertising, have made private placement exemptions generally unavailable for crowdfunding transactions, which are intended to involve a large number of investors.
- Second. In addition to the costs of conducting a registered offering, registered offerings are not feasible for raising smaller amounts of capital, as is done in a typical crowdfunding transaction, because of the resulting ongoing reporting obligations under the Securities Exchange Act that may arise as a result of the offering
- Third. Someone who operates a website to effect the purchase and sale of securities for the account of others generally would, under existing Securities Exchange Act regulations, be required to register with the SEC as a broker-dealer and comply with the laws and regulations applicable to broker-dealers. A person that operates such a website only for the purchase of securities of startups and small businesses would find it impractical in view of the limited nature of that person’s activities and business to register as a broker-dealer and operate under the full set of regulatory obligations that apply to broker-dealers.
Main Elements of the Final Rules under Regulation Crowdfunding
Title III of the JOBS Act and Regulation Crowdfunding are intended to ease the burdens on capital-raising efforts of start-ups and small businesses by addressing the existing regulatory impediments described above, while retaining - in a more facilitative manner - fundamental investor-protection aspects of the Securities Act and the Securities Exchange Act. Regulation Crowdfunding, among other things: permits individuals to invest in securities-based crowdfunding transactions subject to certain thresholds; limits the amount of money an issuer can raise under the crowdfunding exemption; requires issuers to disclose certain information about their offers; and creates a regulatory framework for the intermediaries that facilitate the crowdfunding transactions. The following is a summary of the main elements of the final rules under Regulation Crowdfunding.
A. Limits on Capital Raised. Regulation Crowdfunding imposes capital-raising limits on issuers and investors -
- An issuer is permitted to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
- Individual investors, over the course of a 12-month period, are permitted to invest in the aggregate across all crowdfunding offerings up to:
- If either their annual income or net worth is less than $100,000, then the greater of (x) $2,000; or (y) 5 percent of the lesser of their annual income or net worth.
- If both their annual income and net worth are equal to or more than $100,000, then 10 percent of the lesser of their annual income or net worth.
- During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
B. Eligibility. Certain companies are not eligible to use the Regulation Crowdfunding exemption. Ineligible companies include -
- Non-U.S. companies;
- Companies that already are reporting companies under the Securities Exchange Act;
- Certain investment companies;
- Companies that are disqualified under Regulation Crowdfunding’s disqualification rules;
- 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; and
- Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.
D. Disclosure Obligations Imposed on Issuers. Issuers conducting an offering under Regulation Crowdfunding must file certain information with the SEC and provide this information to investors and the relevant intermediary facilitating the crowdfunding offering. Among other things, in its offering documents, the issuer is required to disclose the following -
- Information about officers and directors as well as owners of 20 percent or more of the issuer;
- A description of the issuer’s business and the use of proceeds from the offering;
- 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 issuer will accept investments in excess of the target offering amount;
- Certain related-party transactions;
- A discussion of the issuer’s financial condition; and
- Financial statements of the issuer that are, depending on the amount offered and sold during a 12-month period, accompanied by information from the issuer’s tax returns, reviewed by an independent public accountant or audited by an independent auditor.(3)
E. Crowdfunding Platforms. Under Regulation Crowdfunding, offerings must be conducted exclusively through a platform operated by a registered broker or a “funding portal”, which is a new type of SEC registrant. The rules require these intermediaries to -
- Provide investors with educational materials;
- Take measures to reduce the risk of fraud;
- Make available information about the issuer and the offering;
- Provide communication channels to permit discussions about offerings on the platform; and
- Facilitate the offer and sale of crowdfunded securities.
- Offering investment advice or making recommendations;
- Soliciting purchases, sales or offers to buy securities offered or displayed on its platform;
- Compensating promoters and others for solicitations or based on the sale of securities; and
- Holding, possessing or handling investor funds or securities.
The rules provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.
(1) Release Nos. 33-9974; 34-76324 (October 30, 2015). The JOBS Act was enacted on April 5, 2012 (Pub. L. No. 112-106, 126 Stat. 306 (2012). The SEC’s proposed rules and forms to implement Title III of the JOBS Act were issued in 2013 (Release No. 33-9470 (Oct. 23, 2013) [78 FR 66427 (Nov. 5, 2013)].
(2) The effective date of the introduction of Form Funding Portal and the amendments to Form ID is earlier - January 29, 2016.
(3) An issuer relying on the crowdfunding rules for the first time will be permitted to provide reviewed rather than audited financial statements, unless financial statements of the issuer are available that have been audited by an independent auditor.