Publications

SEC Proposes New Crowdfunding Rules

November 25, 2013
Harter Secrest & Emery LLP

On October 23rd, the Securities and Exchange Commission (“SEC”) voted to propose new rules under Title III of the Jumpstart Our Business Startups Act (“JOBS Act”) related to crowdfunding (the “Proposed Rules”). Crowdfunding is described by the SEC as “an evolving method of raising money through the internet” that allows companies to raise capital by collecting small investments from multiple people. The Proposed Rules would allow individuals to invest in startup companies through the use of a registered crowdfunding intermediary, subject to certain limitations. Some of these limitations include a limit on the amount of capital a company can raise through crowdfunding, a requirement that companies disclose certain information about their offers, and development a comprehensive framework for SEC-registered crowdfunding platforms.

OVERVIEW OF PROPOSED RULES

Issuers wishing to utilize crowdfunding to raise capital under the Proposed Rules would be faced with several regulatory restrictions. Certain companies would not be eligible to crowdfund, including foreign companies, SEC reporting companies, certain investment companies, companies already disqualified under the proposed disqualification rules, companies that have failed to comply with 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.

If a company were deemed eligible to crowdfund, it would be limited to raising a maximum aggregate amount of $1 million through crowdfunding efforts over a 12-month period. This aggregate amount would include any capital raised by entities under common control with the issuer within the same 12-month period, but would not include capital raised by other means.

DISCLOSURE REQUIREMENTS

The Proposed Rules would require companies raising capital through a crowdfunding transaction to disclose the following information with the SEC:

  • 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.

The same information would have to be disclosed to investors and potential investors, as well as the crowdfund intermediary facilitating the offering.

ANNUAL REPORT

In addition to the above disclosures required for each crowdfund offering, once a company has issued securities through crowdfunding, it becomes subject to annual reporting requirements with the SEC. The annual report would have to include the same information provided for each offering, would have to be ¬led within 120 days of the end of the company’s fiscal year, and would have to be posted on the issuer’s website.

COMMUNICATION

Companies issuing securities through crowdfunding would be prohibited under the Proposed Rules to advertise the terms of the offering without also including information about the crowdfunding platform facilitating the offering. The issuer itself would be prohibited from including anything more than the following in a publicized notice of offering:

  • A statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted and a link directing the potential investor to the intermediary’s platform;
  • The terms of the offering (the amount of securities offered; the nature of the securities; the price of the securities; and the closing date of the offering period); and
  • Factual information about the legal identity and business location of the issuer, limited to the name of the issuer of the security, the address, phone number and website of the issuer, the email address of a representative of the issuer and a brief description of the business of the issuer.

INVESTORS

Not only would the Proposed Rules subject issuers to a number of restrictions, investors wishing to participate in crowdfunding efforts would also face certain limitations on how much they could invest in a company. Under the Proposed Rules, investors would be subject to the following investment restrictions within a 12-month period:

  • $2,000 or 5 percent of their annual income, 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. Investors in this category would be limited to purchasing no more than $100,000 in securities through crowdfunding within a 12-month period.

Those making investments in crowdfunding ventures would also be prohibited from re-selling their securities for a period of one year.

CROWDFUNDING INTERMEDIARIES

The SEC also created a new entity with the Proposed Rules, a funding portal, which would give internet-based platforms the opportunity to host and facilitate a crowdfund securities offering. These brokers and funding portals would become the exclusive intermediary for crowdfund offerings, and each such broker or funding portal would have to be registered with the SEC prior to any transaction. All crowdfund intermediaries would be responsible for:

  • Providing investors with educational materials,
  • Taking measures to reduce the risk of fraud,
  • Making available information about the issuer and the offering,
  • Providing communication channels to permit discussions about offerings on the platform, and
  • Facilitating the offer and sale of crowdfunded securities.

SEC-registered brokers or funding portals would not, however, be permitted under the Proposed Rules to:

  • Offer investment advice or make recommendations,
  • Solicit purchases, sales or offers to buy securities offered or displayed on its website,
  • Impose certain restrictions on compensating people for solicitations, or
  • Hold, possess, or handle investor funds or securities.

CONCLUSION

The Proposed Rules would establish a regulatory framework for an already popular method of raising capital for smaller businesses, but would offer investors more protections by requiring disclosure of specified information, restricting certain communications, and requiring the use of a registered crowdfund intermediary. It remains to be seen whether the regulations proposed on October 23rd will strike the necessary balance to make crowdfunding an effective method for raising capital, however, it is obvious that these Proposed Rules were highly anticipated by the market and could potentially mark the beginning of a new era for small business startups.

The 90-day public comment period for the proposed rules will begin after they are published in the Federal Register. After that point, the SEC will evaluate the comments and determine whether to make changes or adopt the rules as they stand currently. The 585-page SEC Release (#33-9470) is available online.

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