Special Projects Segment: An Overview of the Proposed Crowdfunding Rules

We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.

On October 23, 2013 the Securities and Exchange Commission (“SEC”) unanimously voted to propose a set of crowdfunding rules under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Title III of the JOBS Act created an exemption under the securities laws to allow for crowdfunding and directed the SEC to create a set of rules implementing that exemption. The ultimate goal of the proposed rules is to provide a method whereby an issuer can offer and sell securities to both accredited and unaccredited investors pursuant to Section 4(a)(6) of the Securities Act of 1933 (the “Securities Act”), which acts as an exemption from the registration requirements.

Under the proposed rules, an issuer must comply with four main requirements in order to undertake a Section 4(a)(6) offering. Those requirements are as follows: (i) the issuer can only sell an aggregate of $1 million pursuant to the exemption during a twelve month period; (ii) an investor, during a 12 month period, can only invest (a) the greater of $2,000 or 5% of his annual income or net worth if both annual income and net worth are less than $100,000 or (b) the greater of 10% of his annual income or net worth not to exceed $100,000 if either his annual income or net worth equals or exceeds $100,000; (iii) the sale is conducted through a regulation compliant intermediary and that intermediary’s platform; and (iv) the issuer complies with Section 4A(b) of the Securities Act.

Pursuant to Section 4A(b), only certain issuers can take advantage of the 4(a)(6) exempt offering. The issuer must be a company organized under the laws of a state or territory of the U.S. or the District of Columbia. Additionally, the issuer cannot utilize the exemption if it is required to file reports under the Securities Exchange Act of 1934, is an investment company, is otherwise disqualified, has not met previous 4(a)(6) filing requirements, or has no specific business plan.

In order to utilize the 4(a)(6) exemption, the issuer must file a Form C: Offering Statement with the SEC that provides various disclosures to investors and relevant intermediaries. The issuer must also make those same disclosures available to potential investors. Some of the significant disclosures include the names of those persons who own 20% or more of the issuer’s equity voting securities; a description of the business and its proposed business plan; material factors that may cause the investment to be risky; the targeted offering amount, subscription deadline, plans for oversubscriptions, and use of the proceeds; the underlying terms and rights of the offered securities; and a description of the issuer’s financial condition. In the case of an offering that is less than $100,000, the issuer must provide tax returns for the most recent year certified by its principle executive officer. Where the offering exceeds $100,000, but is less than $500,000, the issuer must provide financial statements reviewed by an outside public accountant. An issuer must provide audited financial statements when the offering exceeds $500,000.

A key component of the proposed rules is that the crowdfunding offering must occur through the use of an intermediary and its online platform. The intermediary must be registered with the SEC as a broker or as a funding portal. Additionally, the intermediary must be a member of FINRA or another registered national securities association. Intermediaries must undertake measures to reduce the risk of fraud such as having a reasonable belief that the issuer is complying with 4(a)(6) and that the issuer is maintaining accurate records of holders of its securities, as well as denying access to its platform to any issuer that it believes presents the potential for fraud. Intermediaries are responsible for making information about the offering available to investors, qualifying investors, creating communication channels, and providing investors with educational materials. Funding portals acting as intermediaries are prohibited from offering investment advice or recommendations, soliciting purchases, and handling the investors’ funds, which must be handled through a qualified third party.

The proposed rules also address such issues as the early completion of an offering, investor cancellation of a subscription, reconfirmations of subscriptions as a result of material changes, uncompleted offerings, advertising restrictions, promoter compensation, and funding portal regulations.

As of the date of this posting, the proposed crowdfunding rules are still just that – proposed. To date, the SEC has not finalized the crowdfunding rules and recently indicated that it will not finalize the rules until at least October 2015. 

Stacey Bowers