THE SEC AND FINRA ISSUE PROPOSED CROWDFUNDING RULES
On October 23, 2013, the Securities and Exchange Commission released the long-awaited proposed crowdfunding rules necessary to implement Title III of the JOBS Act. The proposed rules are subject to a 90 day comment period , and the floodgates to crowdfunding will probably not be open until the middle of 2014.
The SEC provided a fact sheet highlighting some of the requirements under the proposed rules. Under the proposed rules,
- A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
- Investors, over the course of a 12-month period, would be permitted to invest up to:
- $2,000 or 5% of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000, or
- 10% of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.
Thankfully, the rules as proposed would allow companies to rely on an intermediary to determine that the aggregate amount of securities purchased by an investor will not cause the investor to exceed the investor limits, provided that the company does not have knowledge that the investor had exceeded, or would exceed, the investor limits as a result of purchasing securities in the company’s offering.
- Both initial and subsequent holders of securities sold in a crowdfunding transaction under the proposed rule will not be counted toward the threshold that requires a company to register with the SEC under Section 12(g) of the Securities Exchange Act. Under Section 12(g), as amended by the JOBS Act, once a company has total assets exceeding $10,000,000 and a class of securities held of record by either 2,000 persons, or 500 persons who are not accredited investors, registration with the SEC is required.
- The proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the intermediary facilitating the crowdfunding offering, and make it available to potential investors. Companies seeking to use the crowdfunding exemption would have to disclose in their offering documents, among other things:
- Information about officers and directors as well as owners of 20% or more of the company,
- A description of the company’s business and the use of proceeds from the offering,
- The price to the public of the securities being offered, 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,
- Certain related-party transactions,
- A description of the financial condition of the company, and
- Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.
- Companies would be required to amend their offering documents to reflect material changes and provide updates on the company’s progress toward reaching the target offering amount.
- Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.
- Consistent with the requirements of the JOBS Act, the proposed rules require that crowdfunding transactions take place exclusively through an online platform operated by an SEC-registered broker-dealer or funding portal. The proposed rules set forth various requirements for the operation of the funding portals. Funding portals will have to be registered with both the SEC and FINRA (or another national securities association). On October 23, 2013, FINRA released its own set of proposed rules for the registration and operation of funding portals.
Without a doubt, equity crowdfunding has the potential to dramatically alter the way companies raise capital in the United States. However, whether that potential is realized will depend heavily upon various factors, including whether start up companies will consider crowdfunding to be an efficient and cost-effective manner to raise funds, given various disclosure obligations proposed by the SEC.