Over 3½ years after Title III of the JOBS Act created a federal exemption under the securities laws permitting securities-based crowdfunding transactions, on October 30, 2015 the SEC adopted final rules implementing the exemption and setting the stage for these crowdfunding offerings to take place once the rules become effective 180 days after they are published in the Federal Register. While the final rules largely track the proposed rules the SEC issued two years ago, they do address some of the concerns raised in the comment process by both potential issuers and investor advocates.
The final rules, collectively known as "Regulation Crowdfunding," permit companies to raise funds in securities-based crowdfunding offerings through the Internet from an unlimited number of accredited and/or non-accredited investors pursuant to Section 4(a)(6) of the Securities Act. The rules allow a company to raise up to $1 million through crowdfunding offerings in a 12-month period. The rules also cap the amount that individuals can invest into such offerings over a 12-month period (all crowdfunding offerings, not just a specific offering). An individual investor's total investment in crowdfunding offerings in any 12-month period is limited to: (a) the greater of $2,000 or 5% of the lesser of an investor's annual income or net worth, if annual income or net worth of the investor is less than $100,000; or (b) 10% of the lesser of an investor's annual income or net worth, not to exceed $100,000, if both the investor's annual income and net worth are equal to or more than $100,000. The final rules addressed the concern of the SEC's investor advisory committee under the proposed rules, which would have allowed investors to invest based on either their personal income or their net worth, whichever was larger, that people who make very little money but have a large net worth could invest large sums in inherently risky and illiquid securities.
Taking into account some issuer concerns, the final rules tweak some of the proposed issuer requirements providing issuers with greater flexibility. The SEC relaxed its requirements on when issuers must provide audited financial statements to investors. Under the proposed rules, a company offering more than $500,000 of securities in a crowdfunding offering would have to provide audited financial statements to investors. That's still true under the final rules, but the final rules allow companies offering more than $500,000 of securities but not more than $1 million of securities to skip that requirement for their first crowdfunding offering, and provide reviewed financial statements rather than audited (unless audited financial statements are otherwise available). If a company offers $100,000 or less of securities, then the financial statements must be reviewed and certified by the company's chief financial officer (but not reviewed or audited). If a company offers more than $100,000 but not more than $500,000 of securities, then the financial statements must be reviewed by an independent accountant (but not audited).
The final rules require companies conducting a crowdfunding offering to file certain information with the SEC on the specified SEC form before the commencement of the offering and to provide certain information to actual and prospective investors and the intermediary facilitating the crowdfunding offering. In its offering documents, the company would be required to disclose certain information such as:
- A description of the business and the use of proceeds from the offering;
- Information about officers and directors of the company as well as owners of 20 percent or more of the company;
- The price to the public of the securities or the method for determining the price, 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;
- A discussion of the company's financial condition;
- Certain related-party transactions; and
- Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company's tax returns, reviewed by an independent public accountant, or audited by an independent auditor.
There will however be a new optional Q&A option for these disclosure requirements, which may help reduce costs and be easier to navigate for first-time issuers. Companies relying on the crowdfunding exemption would also be required to file an annual report (containing the same information required in the offering statement) with the SEC and provide it to investors until its filing obligation is terminated in accordance with the rules.
Regulation Crowdfunding offerings must be conducted exclusively through one intermediary platform which is registered with the SEC and FINRA either as a broker-dealer or a funding portal. The final rules address the registration and regulation of these intermediaries. These intermediaries will have a number of operational requirements, including that they offer educational materials to prospective investors, open an account for each investor before an investor makes an investment commitment, make company information available throughout the offering period and for the required 21-day public offering period, conduct background checks and regulatory checks on companies looking to be on their platform and their officers and directors, provide communication channels to permit discussions about offerings on the platform, and obtain information from each investor sufficient to provide a reasonable basis for compliance with the individual investment limitations. In a change from the proposed rules, the final rules allow intermediaries to accept shares of a crowdfunding offering as payment for services. Funding portals may file with the SEC and FINRA beginning on January 26, 2016, with the application and approval process expected to take two to four months.
At the same meeting, the SEC also issued proposed rules to amend Securities Act Rule 147 and Rule 504 of Regulation D. The proposed amendments to Rule 504 would increase the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million and disqualify certain bad actors from participating in Rule 504 offerings. The proposed amendments to Rule 147 would modernize the rule, which currently provides a safe harbor for compliance with the intrastate exemption provided for in Section 3(a)(11) of the Securities Act, by easing the restriction on offers and issuer eligibility requirements.
Currently, Rule 147 restricts issuers from offering and selling securities to out-of-state residents, hampering a company's ability to use the Internet to solicit investors and raise capital. If a company is located in Indiana and wants to sell to Indiana residents, but Illinois residents can read the offer on the Internet, the company likely just made an offer to Illinois residents in violation of the rule. The proposed rules would eliminate the restriction on offers, while continuing to require that sales be made only to residents of the issuer's state. Accordingly, companies would be able to advertise their offerings on the Internet via unrestricted, publicly available websites (or any form of mass media), so long as they sell only to residents of the state in which they are based or principally operate. The proposed rules would also ease some of the issuer eligibility requirements to utilize the rule. Currently, issuers must be incorporated in the state in which the intrastate offering is conducted. The proposed rules would eliminate this requirement, requiring only that issuers have a sufficient in-state presence determined by the location of the issuer's principal place of business. While Rule 147 does not have an offering amount limitation or an individual investment amount limitation, the proposed rules would limit the availability of the Rule 147 exemption to offerings that are registered in-state or conducted under an exemption from state law registration that limits the amount an issuer can raise in a 12-month period to no more than $5 million and imposes an investment limitation on investors (consistent with existing state law crowdfunding statutes). Unlike the Regulation Crowdfunding rules discussed above, the proposed rules to amend Securities Act Rule 147 and Rule 504 of Regulation D are not final yet, and cannot yet be relied upon by companies raising capital. The SEC is currently seeking public comment on these rules.
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