On October 23, 2013, the Securities and Exchange Commission (“SEC”) voted unanimously to propose rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding.
Crowdfunding describes an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects, products or artistic endeavors. Crowdfunding has generally not been used as a means to offer and sell securities because offering a share of the financial returns or profits from business activities would likely trigger the registration provisions of the federal securities laws relating to the offer or sale of securities.
Title III of the JOBS Act created an exemption under the securities laws so that this type of funding method can also be used to offer and sell securities without registration. The JOBS Act established the framework for a regulatory structure for this funding method. It also created a new entity – a funding portal – to allow Internet-based platforms or intermediaries to facilitate the offer and sale of securities without having to register with the SEC as brokers. Crowdfunding should not be confused with rules that were recently adopted under Regulation D that permits issuers of securities of private companies to engage in general solicitation or public advertising related to the sales of such securities.
The intent of the JOBS Act was to make it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. Critics, led by consumer groups and state securities administrators, have been critical of both the Regulation D amendments regarding general solicitation, as well as the crowdfunding provisions, as opening the floodgates for fraudster to prey on the financially unsophisticated. Accordingly, the challenge for the SEC is to establish a regulatory structure that both permits small companies and entrepreneurs to access investors in an efficient manner, while protecting the investors from scam artists.
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:
$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 (such as hedge funds), 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.
Securities purchased in a crowdfunding transaction cannot be resold for a 12-month period. 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 Securities Exchange Act of 1934.
Disclosure by Companies
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 are:
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.
Title III of the JOBS Act requires 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:
The proposed rules would prohibit funding portals from:
The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.
The SEC will take public comments on the proposed rules for 90 days, after which it will review the comments and determine whether to adopt the proposed rules. Depending upon the tone and substance of the comments, the SEC may move quickly to adopt the rules as proposed, adopt the rules with certain modifications based on the comments, or re-propose the rule for additional public comment. Anxious market participants should not expect to start offering their crowdfunding securities.
October 28, 2013
Jay B. Gould, Partner, firstname.lastname@example.org
Mr. Gould’s nearly 30 years of wide-ranging experience includes advising investment companies, investment advisers and broker-dealers on new funds and products, mergers and acquisitions, and governance, compliance and regulatory matters. He is leader of Pillsbury’s Investment Funds & Investment Management practice team. Under his leadership, HFM Week named Pillsbury "Best Onshore Law Firm—Client Service" in 2009, 2010 and 2011, and “Best Onshore Law Firm – Hedge Fund Startups” in 2012. He counsels clients involved in all aspects of the financial services industry, representing U.S. registered investment companies, hedge funds, offshore investment companies, investment advisers, retail and institutional broker-dealers, and municipal bond underwriters. Mr. Gould has extensive experience in structuring private fund startups and their general partners, drafting offering documents, and advising on and making introductions with respect to capital raising strategies. Mr. Gould also advises clients regarding inspections and examinations by the SEC, FINRA, the CFTC and other regulatory agencies. Mr. Gould is ranked as a leading lawyer by 2013 Legal 500 US.
Honors & Awards
Legal 500 US, Alternative/Hedge Funds—Leading Lawyer (2010-2013)
Full Bio (http://www.pillsburylaw.com/jay-gould?view=1)
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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Jay Gould. This work reflects the law at the time of writing in October 2013.