CAMAC's discussion paper on CSEF put forward a whole spectrum of options, and its final report is eagerly awaited.
CAMAC is shortly expected to report on possible reforms to facilitate crowd sourced equity funding (CSEF) in Australia1.
Any such proposals will take a while to get on the statute books, so this article provides a brief background to the current state of the law in Australia – and how this topic is being addressed in the United States, the United Kingdom and New Zealand.
When the CAMAC report is released, we will publish a further Insights article analysing the proposed changes.
What is crowd sourced equity funding or "CSEF"?
CSEF involves offering equity securities to the public (usually in small parcels) through internet-based intermediary platforms. This allows small companies to raise funds from, and issue securities to, a large pool of potential investors2.
Many see CSEF as a way of harnessing the power of the internet to create a new type of fundraising market – and to inject much needed capital into small and medium-sized enterprises.
However, regardless of how the investment is promoted, equity investment risk for unsophisticated investors still needs to be managed (particularly given that early-stage companies are generally riskier investments).
How does Australia currently regulate CSEF?
Small companies v large companies
A major objective of CSEF is to allow small companies to raise funds from the public. The greatest single current legal obstacle is that proprietary companies (which constitute most companies with less than 51 shareholders) are effectively prohibited from offering (or even advertising) shares to the public.
Even if small and start-up companies could raise funds in this manner, that ability comes with a number of additional regulatory requirements designed to protect "public" investors that small issuers on a CSEF platform may not be prepared to comply with, including:
- preparation of audited accounts and annual financial reporting;
- if the company has raised funds under a disclosure document from more than 100 members it must comply with continuous disclosure obligations (even if it is unlisted);
- related party transactions must be on arms' length terms or otherwise approved by members;
- potentially being subject to the takeovers laws; and
- the obligation to hold an annual general meeting and to maintain a registered office which is open during business hours.
Prospectus requirements and advertising restrictions
A prospectus (or other regulated disclosure document) is required to offer shares to the general public.
A prospectus is also necessary in order to advertise a share offer (and that advertisement must satisfy certain statutory requirements, including the well-known reference to the need to apply using the application form attached to the prospectus).
A CSEF platform would therefore be unable to advertise offers of securities to the public unless the issuer had prepared a prospectus.
As well as restrictions on the types of companies which can offer shares to the public, there are legal controls on the platforms on which such offers could be made. The operator of a CSEF platform that was a "facility where offers or invitations to acquire or dispose of securities were regularly made" would require an Australian market licence – and, therefore, be subject to similar licensing and regulatory controls as ASX for example.
Even if the operator were exempted in some way from the requirement to hold a market licence, it is likely that the operator would be carrying on a financial services business and require an Australian Financial Services Licence covering the relevant financial services.
What's happening overseas?
Several countries, including the USA, UK and NZ, have changed or are in the process of changing their securities laws to allow CSEF.
United States: In April 2012, the JOBS Act was enacted. It will allow issuers to raise up to $1 million in a 12 month period provided it is raised through a funding portal or registered broker-dealer. Investors may only invest a limited amount3 and on-sales within 12 months are prohibited.
In addition, the issuer must prepare an offering document containing specified information and lodge annual returns with the SEC. The issuer is prohibited from advertising the offer, except to direct investors to the funding portal or broker. The funding portal or broker would be required to (among other matters) provide investors with educational materials and take measures to reduce the risk of fraud.
The regime will become law when the SEC makes regulations to support the legislation.
United Kingdom: On 1 April 2014 new regulations came into effect enabling companies to issue securities through licensed crowd funding platforms4.
Investors must be: professional clients; retail clients who are advised by a regulated investment adviser; retail clients who are sophisticated or high net worth investors; or retail clients who certify that they will not invest more than 10% of their net investable financial assets in unlisted equity and debt securities.
In addition, where advice is not provided, the crowd funding platform must, before it sends the retail client an offer or promotion, assess whether the client has the necessary knowledge and experience to understand the risk involved.
New Zealand: In August 2013, New Zealand enacted broad financial reforms through the Financial Markets Conduct Act5 which included provisions which (together with recently approved regulations6) will enable CSEF in that jurisdiction from 1 April 2014. The NZ regime caps the amount an issuer may raise though CSEF in a 12 month period at $2 million but, unlike the US and UK, does not limit the amount that investors may invest in CSEF securities.
Where to from here?
CAMAC's discussion paper on CSEF put forward a whole spectrum of options, ranging from maintenance of the status quo (ie. effectively no CSEF), through modifications of the existing prospectus/fundraising law (as was done in the UK), all the way up to a completely new regulatory regime just for CSEF (as was done in the USA).
The Committee did not express any preferred option, so the release of its final report will be eagerly awaited by the markets, fundraisers (and potential fundraisers) and their advisers. Once that happens, the ball will be in the Government's court.
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1The Corporations and Markets Advisory Committee (CAMAC) released a discussion paper in September 2013 and is expected to release its report in April 2014.
2CSEF should not be confused with other forms of "crowd funding" which are now commonly used for raising funds for creative projects (such as music or films) or public-interest projects – but where the financial contributors are not issued with any rights in (or share of the profits from) the undertaking.
3In a 12 month period investors may invest up to: (1) the greater of $2,000 or 5% of their annual income or net worth (whichever is greater) if their annual income and net worth are less than $100,000 or (2) 10% of their annual income or net worth (whichever is greater) if either their annual income or net worth are greater than $100,000 – subject to a $100,000 per annum cap.
4FCA, Policy Statement PS14/4.
5Financial Markets Conduct Act 2013.
6Financial Markets Conduct (Phase 1) Regulations 2014.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.