United States: SEC Finally Proposes The Rules To Implement The Crowdfunding Exemption

The ability of private companies to raise capital over the internet from a wide pool of investors in non-registered offerings is one step closer to realization.  On October 23, 2013, which is over 1 ½ years after passage of the JOBS Act, the SEC finally proposed rules to implement the crowdfunding provisions of the law.1  The proposed crowdfunding rules represent another significant shift in how companies can raise capital.  Recently adopted revisions to Rule 506 of Regulation D permit companies to use general advertising (including via the internet) to solicit investments in non-registered offerings, provided that all purchasers are accredited.2 The proposed crowdfunding rules would permit eligible companies to raise capital via the internet from non-accredited investors as well. 

Under the proposed rules, companies would be permitted to raise up to $1,000,000 in a 12-month period from non-accredited investors.  Individuals with a net worth and annual income of less than $100,000 could invest the greater of $2000.00 or 5% of their net worth or income.  Individuals with a net worth or income greater than $100,000 could invest the greater of 10% of their annual income or net worth.  Investors could not purchase more than $100,000 through the crowdfunding exemption in a 12-month period.  As proposed, the rules do not require companies to verify the income levels or net worth of investors.

Companies would be required to raise money through regulated broker-dealers or other newly-created and regulated crowdfunding "portals."  The portals would likely be policed through FINRA, which also has announced proposed parallel rules.  Companies would be permitted to use only one portal intermediary and the primary interface between an investor, the company and the portal would be online. This is intended to facilitate the "crowd" aspect, allowing all information to be shared from one source and creating a uniform delivery system for the securities.  The intermediaries would be required to provide potential investors with certain educational materials, take measures to reduce fraud, and make issuer information available on the online platform.  

The proposed rules contain many key restrictions and reporting requirements. For example, any securities purchased via crowdfunding could not be resold for at least one year. Advertising would be strictly prohibited except for notices directing potential investors to the funding portal.  Investors would be given guidelines for canceling investments, and possibly a reconfirmation process, so that investors are aware of their rights to rescind an investment.  The proposed rules also require issuing companies to provide certain information to the SEC, investors, potential investors and intermediaries.  

Crowdfunding offering materials would require extensive disclosure and must include, among other information, the names and prior three years' business experience of officers and directors, names of 20% of more voting equity owners, a description of the company's business, the intended use of proceeds, the offering price, the offering's targeted amount, the deadline for raising the targeted amount, risk factors, certain related-party transactions, whether the company will accept offers in excess of the targeted amount and compensation paid to intermediaries. Companies raising up to $100,000, $500,000, or more than $500,000 (including amounts sold in the preceding 12-month period) would each be required to give progressively greater disclosures about the company's past financial history, which be difficult for start-ups with a limited financial track record.  Companies seeking to raise $100,000 or less would be required to provide a tax return for the most recent year, which raises privacy concerns that the SEC intends to address by allowing redacting of person information.  Companies seeking to raise more than $500,000 would need to provide audited financial statements, which may induce companies to seek less than $500,000 in order to avoid costly audits.   Other proposed requirements include ongoing annual reporting to the SEC and investors.

Non-U.S. companies, SEC reporting companies, certain investment companies, companies disqualified under proposed disqualification rules, companies that failed to comply with their annual reporting requirements, companies that have no specific business plan or whose plan is to engage in mergers and acquisitions of unidentified companies, all would be ineligible to use the crowdfunding exemption.

The SEC initially is seeking extensive comment on the proposed rules (which are over 500 pages) for a 90-day period.  Stay tuned for further developments as the SEC continues with implementation of the crowdfunding rules.

For further information, contact Rebecca Forest, Dylan Shea or any member of the Capital Markets & Technology Group.

1. http://1.usa.gov/1cYBzsH
2. http://1.usa.gov/16rw9AB

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