On October 23, 2013, the Securities and Exchange Commission (SEC) proposed rules which would, if adopted, govern the offer and sale of securities under new Section 4(a)(6) (the “Crowdfunding Exemption”) of the Securities Act of 1933 (Securities Act), provide a framework for the regulation of registered funding portals and brokers, and exempt securities sold pursuant to the Crowdfunding Exemption from the registration requirements of Section 12(g) of the Securities Exchange Act of 1934 (Exchange Act).
On April 5, 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. The JOBS Act seeks to reduce securities law burdens on start-ups and on small businesses to make capital more accessible. In enacting the JOBS Act, Congress requires the SEC to implement rules that grant cost-effective access to capital for companies of all sizes in the form of capital formation, disclosure, and registration requirements.
Title III of the JOBS Act amends Section 4 of the Securities Act to create an exemption for crowdfunding activities. Crowdfunding is a term used to describe a network of people who pool their money, usually via the Internet, to collectively support the financing needs of another person or organization. Under Title III, crowdfunding will be exempt from securities registration subject to the following conditions:
- The aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the crowdfunding exemption during the 12-month period preceding the date of the transaction is not more than $1 million;
- The aggregate amount sold to any investor by the issuer, including any amount sold in reliance on the crowdfunding exemption during the 12-month period preceding the date of the transaction, does not exceed: (1) the greater of $2,000 or five percent of the annual income or net worth of the investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; or (2) 10 percent of the annual income or net worth of an investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000;
- The transaction is conducted through a registered broker or funding portal that complies with the requirements of the exemption; and
- The issuer complies with the disclosure requirements of the exemption.
Summary of the Proposed Crowdfunding Regulations
The proposed regulations, if enacted as approved, can be broken down as follows: (1) crowdfunding exemption; (2) requirements on issuers; (3) requirements on intermediaries; (4) additional requirements of funding portals; and (5) miscellaneous provisions.
Crowdfunding Exemption
The Crowdfunding Exemption places a limitation on the amount of capital that may be raised by an issuer. The proposed rules clarify these limitations by stating that only capital raised in reliance on the Crowdfunding Exemption apply to the $1 million annual limitation, while capital raised through other means, including other exemptions, will not be counted toward the $1 million cap. An issuer who engages in Crowdfunding Exemption offerings may draw scrutiny by the SEC for:
- Simultaneous offers in which only one offering allows for general solicitation;
- Securities sold by entities controlled by or under common control with the issuer as securities sold by controlled entities will be considered sold by the issuer themselves.
- Securities sold by a predecessor of the issuer during the preceding 12-months as securities sold by the issuer’s predecessor will be considered aggregated in enforcing the $1 million cap.
The JOBS Act excludes the following issuers from utilizing the Crowdfunding Exemption: (1) issuers not organized under the laws of a state or territory of the United States; (2) issuers that are subject to Exchange Act reporting requirements; (3) investment companies as defined in the Investment Company Act of 1940; and (4) any other issuer that the SEC deems appropriate. The SEC proposes to also exclude, by rule, the following issuers:
- Those disqualified under the provisions of Section 302(d) of the JOBS Act;
- Issuers who have failed to file and provide to investors ongoing annual reports for the two years immediately preceding the filing of the new offering statement; and
- Issuers who have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.
A single transaction in reliance on the Crowdfunding Exemption will need to be conducted through only one broker or funding portal using either an Internet website or other similar electronic medium. Additionally, the proposed rules outline an online-only platform which enables the public to access offering information and share information publicly; the effect being that such transactions will be exclusively conducted through an intermediary’s platform.
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