SEC (Finally) Issues Crowdfunding Regs
When President Obama signed the JOBS Act into law on April 5, 2012, it included the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012″ (CROWDFUND Act) which would permit companies to raise up to $1 million in equity via crowdfunding. The Act directed the Securities and Exchange Commission (SEC) to issue implementing regulations within 270 days of passage – or December 31, 2013.
In April, SEC Chief Counsel David Blass stated that “It just is not possible for me to say a date in which it will or will not be up and running.” Mary Jo White was sworn in as the new SEC commissioner that month, while her views on thjs issue are unknown it is believed that her predecessor was somewhat hostile to the Act. The delay triggered the House of Representatives to pass H.R. 701 which set an October 31, 2013 deadline for implementation of the regs.
While H.R. 701 was never enacted, the SEC met the House deadline with room to spare when it released its 585-page proposed regs for a public comment period of 90-days, with drafting of the final rule to follow thereafter. Some speculate that the final rules will not be in place until late 2014.
In July, the SEC lifted the ban on general solicitation of non-public offerings so long as all purchasers are accredited investors and the issuing company takes steps to verify this status. An “accredited investor” includes a natural person who: earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
A summary of the CROWDFUND Act is below.
SEC Proposed Rules
The SEC’s summary of the regs:
Consistent with the JOBS Act, the proposed rules would among other things permit individuals to invest subject to certain thresholds, limit the amount of money a company can raise, require companies to disclose certain information about their offers, and create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions.
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 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
- 10 percent 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.
Certain companies would not be eligible to use the crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies, companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, 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.
As mandated by Title III of the JOBS Act, securities purchased in a crowdfunding transaction could not be resold for a period of one year. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Exchange Act.
Disclosure by Companies
Consistent with Title III of the JOBS Act, the proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.
In its offering documents, among the things the company would be required to disclose:
- Information about officers and directors as well as owners of 20 percent 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.
- 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 the offering document 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.
One of the key investor protections Title III of the JOBS Act provides for crowdfunding is the requirement that crowdfunding transactions take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.
The proposed rules would 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.
- Facilitate the offer and sale of crowdfunded securities.
The proposed rules would prohibit funding portals from:
- Offering investment advice or making recommendations.
- Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
- Imposing certain restrictions on compensating people for solicitations.
- Holding, possessing, or handling investor funds or securities.
The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.
The Commission will seek public comment on the proposed rules for 90 days. The Commission will then review the comments and determine whether to adopt the proposed rules.
More Detail on Disclosure Obligations
As discussed in the SEC summary above, a Company issuing shares via a crowd funding platform must disclose:
- Identifying information about the issuer including its name, legal status and organization type, physical address and website.
- Identifying information about its officers (president, vice president, secretary, treasurer, chief financial officer and controller) and directors, including each person’s principal occupation and employment record, and whether they are an employee of the Company along with the total number of employees.
- Shareholders holding more than 20 percent of the issuing Company’s total outstanding voting securities;
- The current business and the anticipated business plan;
- Financial condition; and indebtedness
- Use of proceeds;
- Target offering amount and deadline to reach the target offering amount,
- Price of the securities and the method used to determine the price;
- Ownership and capital structure;
- Risk factors;
- Description of related party transactions within the preceding 12 months that exceeded 5% of the aggregate amount of the capital being raised by the issuer in reliance upon the crowd funding exemption (related parties include beneficial owners of 20% or more of the outstanding voting securities, any promoter or incorporator of the issuer if it was incorporated within the last three years, and in each case immediate family members or related parties (parent, child, siblings, in-laws, and domestic partners); and
- Compensation paid to the intermediary.
The issuing company also must provide a statement that investors may cancel an investment commitment until 48 hours prior to the deadline identified in the their offering materials, and a statement that if the company reaches the target amount prior to the identified deadline, it may close the offering early if it provides notice about the new offering deadline at least five days prior to the new deadline
The level of financial disclosure depends upon the size of the offering:
- $100,000 or less: Income tax returns filed by the issuer for the most recently completed year and financial statements certified by the principal executive officer.
- More than $100,00 up to $500,000 must have a financial statement reviewed by a CPA.
- More than $500,000 : audited financial statements
More Info: Forbes’ Devon Thorpe has a good discussion with crowd funding experts at LINK