On October 30, 2015, the Securities and Exchange Commission (SEC) adopted new Regulation Crowdfunding to implement the requirements of the Jumpstart Our Business Startups Act. Regulation Crowdfunding prescribes rules governing the offer and sale of securities under Section 4(a)(6) of the Securities Act and provides a framework for the regulation of registered funding portals and broker-dealers that issuers are required to use as intermediaries in the offer and sale of securities in reliance on Section 4(a)(6). Regulation Crowdfunding is generally effective May 16, 2016, except for rules related to the registration of funding portals and amendments to Form ID, which became effective on January 29, 2016.
The SEC issued an Investor Bulletin, Crowdfunding for Investors on February 16, 2016 to educate investors about Regulation Crowdfunding and to explain this new investing opportunity — securities–based crowdfunding, which is different from websites raising funds and offering in-kind consideration for financial contributions. Starting May 16, 2016, the general public will have an opportunity to invest in start-ups and early stage companies and receive equity consideration for their investments. Continue reading “Crowdfunding Is Something Worth Explaining to Investors”
The SEC will hold its 2013 SEC Government-Business Forum on Small Business Capital Formation on November 21, 2013. A major purpose of the Forum is to provide a platform to highlight perceived unnecessary impediments to small business capital formation and address whether they can be eliminated or reduced. Each Forum seeks to develop recommendations for government and private action to improve the environment for small business capital formation, consistent with other public policy goals, including investor protection. Participants in the Forum typically have included small business executives, venture capitalists, government officials, trade association representatives, lawyers, accountants, academics and small business advocates. In recent years, the format of the Forum typically has emphasized small interactive breakout groups developing recommendations for governmental action
This year’s topics include:
• Panel discussion: Evolving practices in the new world of Regulation D offerings;
• Panel discussion Crystal ball: Now that you raised the money, what’s next for the company and the markets;
• Breakout session: Development of recommendations for securities-based crowdfunding offerings;
• Breakout session: Exempt securities offerings; and
• Breakout session: Securities regulation of smaller public companies.
The panel sessions will be webcast live on the SEC’s home page at http://www.SEC.gov beginning at 9:00 a.m. The afternoon breakout groups will not be webcast. We will post on the results of the Forum when available.
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.
The JOBS Act continues to be a hot topic. Yesterday, the Practicing Law Institute presented its continuing legal education seminar on the JOBS Act. Some discussion highlights from the seminar include:
- Under Section 105(c) of the JOBS Act, an issuer that qualifies as an emerging growth company can engage in oral or written communications, prior to or after filing the registration statement with the SEC, with qualified institutional buyers and institutional accredited investors to determine whether they might have an interest in a contemplated securities offering, also known as “testing the waters.” The panel discussed the SEC’s recent requests, in connection with reviews of issuers’ registration statements, that the issuers provided on a supplemental basis any written materials used by issuers in connection with such testing the waters. It appears that the SEC is requesting these materials to determine if the materials are consistent with the issuer’s registration statement. The fact that the SEC is requesting copies of such materials, combined with the general reluctance on the part of issuers and investment bankers to engage in testing the waters process due to liability concerns, probably means that most issuers and investment bankers will not be using written materials to test the waters, at least in the near term.
- The SEC is asking emerging growth companies to indicate on the cover of their registration statements that they are an emerging growth company and to include in the registration statement disclosure regarding how and when emerging growth company status may be lost, the various exemptions available to the issuer as an emerging growth company, such as exemptions from Section 404(b) of the Sarbanes-Oxley Act, and the issuer’s election under Section 107(b) of the JOBS Act. Unless an issuer that is an emerging growth company opts out, under Section 107(b) of the JOBS Act, the issuer will be subject to any new or revised financial accounting standards on the effective dates applicable to private companies, rather than the effective dates applicable to public companies. Historically, the effective dates for private companies have been later than the effective dates for public companies. If the emerging growth company elects to opt out of the extended transition period, the SEC requests the issuer to state that such election is irrevocable. If the emerging growth company chooses to be subject to the later effective dates for new or revised financial accounting standards, the SEC is requesting issuers to include a risk factor (as well as disclosure in the critical accounting policies section of the MD&A) explaining that the issuer’s financial statements may not be comparable to companies that comply with the public company effective dates. There are at least a few SEC comments letters publicly available requesting this information.
- Under the JOBS Act, once SEC rules are in place, general solicitation or advertising will be permitted in connection with Rule 506 offerings so long as the issuer sells securities only to accredited investors. Interestingly, the definition of the term “accredited investor” provides that an accredited investor is not only someone that is actually an accredited investor, but also someone the issuer “reasonably believes” is an accredited investor. The general consensus was that the SEC will likely not seek to change the definition of “accredited investor,” but will seek to provide for fairly stringent steps issuers will have to take in order to satisfy the JOBS Act requirement that an issuer take “reasonable steps to verify” accredited investor status in connection with Rule 506 offerings that use general solicitation or advertising.
On April 23, 2012, the SEC posed a release reminding issuers that capital raising via crowdfunding is not yet a reality:
On April 5, 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law. The Act requires the Commission to adopt rules to implement a new exemption that will allow crowdfunding. Until then, we are reminding issuers that any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws.
There is a lot of excitement in the securities and business worlds about the potential for crowdfunding to allow smaller companies to raise capital. But, I think much of that excitement is premature.
First, under Section 301(c) of the JOBS Act, the SEC has 270 days (yes, about 9 months) to issue rules implementing the crowdfunding provisions of the JOBS Act and the SEC may be unable to meet that deadline. Wave after wave of regulatory reform hitting the SEC has resulted in the SEC falling behind on its rule making activities under the Dodd-Frank Act. In addition, the JOBS Act requires the SEC to consult with any state securities commission and national securities association that that wants to provide input, which has the potential to consume a lot of time.
Second, the JOBS Act provides the SEC with a great deal of discretion on how to implement the crowdfunding provisions. While the JOBS Act received broad bipartisan and Presidential support, it is no secret that the SEC is not a fan of the crowdfunding. As such, it is difficult to predict the ultimate outcome of the SEC’s rulemaking activities with respect to crowdfunding or how those rules will be perceived by companies and the securities industry.