United States: What You Need To Know About The New SEC Rules On Crowdfunding

Last Updated: December 22 2015
Article by Josef Volman and Andrew J. Merken

On Oct. 30, 2015, the Securities and Exchange Commission ("SEC") adopted new rules that will enable some private companies to use the Internet for crowdfunding campaigns seeking up to $1 million per 12-month period.

The rules exempt crowdfunding offerings from traditional securities registration requirements under specific conditions to facilitate capital formation by smaller and startup companies. The SEC adopted the rules pursuant to the requirements of the Jumpstart Our Business Startups Act ("JOBS Act"). The SEC previously proposed crowdfunding rules in October 2013 as outlined in our advisory.

The aptly named "Regulation Crowdfunding" rules will be effective May 16, 2016, but forms for registration of funding portals will be effective Jan. 29, 2016. The SEC published the lengthy (685 pages) rules and related analyses in SEC Release No. 33-9974; 34-76324.

PRACTICAL IMPACT

The new crowdfunding rules place significant SEC and FINRA filing and compliance requirements on companies looking to raise a relatively small amount of funding, and on the funding portals/broker-dealers through which the offerings will be conducted.

When the rules were first proposed in 2013, questions arose as to how many companies would avail themselves on the new rules once they were issued and effective. It may be that the burdens are too significant for many companies who could choose to utilize the traditional Regulation D Rule 506 private placements, including the newer Rule 506(c), which does allow certain types of general solicitation and advertising but for sales to accredited investors only.

Continue reading for a deeper look at some of the key provisions.

INTERMEDIARIES ARE REQUIRED

For any exempt crowdfunding transaction, an issuer must use an intermediary – either a registered broker-dealer or funding portal – and can use only one intermediary at a time. The transaction will have to be conducted exclusively on the intermediary's online platform.

SOME ISSUERS ARE NOT ELIGIBLE

Many issuers are excluded from utilizing Regulation Crowdfunding, including the following issuers:

  • Non-U.S. companies.
  • Public companies subject to reporting requirements of the Securities Exchange Act of 1934.
  • Investment companies or companies excluded from the definition of "investment company" only by Section 3(b) or 3(c) of the Investment Company Act of 1940.
  • Companies that have failed to file required annual Regulation Crowdfunding reports during the two years preceding the filing of an offering statement.
  • Companies subject to "bad actor" or other disqualification under Regulation Crowdfunding.
  • Companies without a specific business plan or a plan to merge with unknown companies.

LIMITS ON CAPITAL-RAISING BY ISSUERS

Rule 100(a) of Regulation Crowdfunding limits the aggregate amount sold by an issuer to all investors in reliance on the new exemption (in one or more offerings) to not more than $1 million in the 12-month period preceding the date of sale. Any capital the issuer raises through other exempt transactions, such as Regulation A or Regulation D offerings, will not be counted in determining the aggregate amount sold.

LIMITS ON INVESTMENTS BY INVESTORS

Under the final rules, an investor's maximum purchase in a crowdfunding offering will be the greater of:

  • $2,000 or five percent of the lesser of the investor's annual income or net worth for investors whose annual income or net worth is less than $100,000.
  • 10 percent of the lesser of the investor's annual income or net worth, but not more than $100,000 in purchases for investors with annual incomes and net worth each or $100,000 or more.
  • No investor may invest more than $100,000 in any 12-month period across all such offerings.

For example, under this approach, an investor with annual income of $50,000 and a net worth of $105,000 is subject to an investment limit of $2,500 (five percent of annual income). The existing Securities Act Rule 501(a) applicable to determining accredited investor status will govern the calculation of net worth and annual income.

DISCLOSURE REQUIREMENTS FOR ISSUERS

The final rules require crowdfunding issuers to file certain information with the SEC and provide it to investors and the relevant intermediary for an offering. The required disclosures include, among other things:

  • A description of the issuer's business, number of employees and use of offering proceeds.
  • Information about the issuer's officers, directors and certain beneficial owners.
  • Information about the offering and the securities being offered, including the price (or the method for determining the price).
  • A description of related-party transactions and risk factors.
  • A description of the issuer's financial condition and current debt structure (similar to management's discussion and analysis of financial condition and results of operations – MD&A) accompanied by specified U.S. GAAP compliant financial statements.

An issuer is required to amend its offering documents within five (5) business days of any material change to disclose material changes that occurred during the offering period and to provide specified updates regarding progress (including 50 percent and 100 percent commitments) toward reaching the target offering amount.

The issuer's information must be posted on the intermediary's platform for at least 21 days prior the sale of any securities (though investment commitments can be accepted) and throughout the entire offering period.

FILING AND REPORTING REQUIREMENTS FOR ISSUERS

The final rules also require issuers to file with the SEC and electronically deliver to investors ongoing annual reports (Form C-AR) of the results of operations and relevant financial statements. The level of review of the financial statements will depend on the aggregate amount of securities offered by the issuer during the prior 12 months, including the current offering. They will have to be either certified by the issuer's principal executive officer or prepared, reviewed or audited by an independent public accountant and filed no later than 120 days after the fiscal year covered by each report. However, quarterly reports or current reports as would be reported on an 8-K are not required.

GENERAL RULES FOR INTERMEDIARIES

By statute and rule, all crowdfunding transactions will need to be conducted through a broker or funding portal. To be exempt from broker registration, funding portals must register with the SEC and FINRA. To maintain exempt status, funding portals must refrain from offering investment advice, soliciting transactions on the portal, handling investor funds or engaging in other activities proscribed by the SEC.

The final rules, unlike the proposed rules, will permit an intermediary to take a financial interest in a crowdfunding issuer but only if the interest is a form of compensation for crowdfunding services to the issuer and consists of the same securities being offered to others. Intermediaries will not be allowed to compensate any person for providing personally identifiable information about crowdfunding investors.

INTERMEDIARY MEASURES TO PREVENT FRAUD

Rule 301(a) will require an intermediary to have a reasonable basis for believing that a crowdfunding issuer is in compliance with statutory and regulatory mandates associated with Regulation Crowdfunding, including record-keeping requirements.

An intermediary will be allowed to reasonably rely on representations of compliance from the issuer, unless the intermediary has reason to question the reliability of those representations. If an issuer has engaged the services of a transfer agent in an offering, the intermediary will be deemed to have a reasonable basis for assuming that adequate recordkeeping compliance measures were taken.

If an intermediary has a reasonable basis for believing that an issuer or certain affiliated persons are subject to disqualification, the intermediary must deny the issuer access to its crowdfunding platform.

TRANSACTIONAL REQUIREMENTS FOR INTERMEDIARIES

The rules will also require an intermediary to perform certain account opening duties, supply the SEC and investors with offering statement and disclosure information via electronic delivery, and provide on its platform effective channels for communication among investors and representatives of the issuer. An intermediary will also be required to give investors specific types of notices about an offering and a purchaser's rights in association with confirmations, cancellations and reconfirmations of securities purchases. Certain record-keeping and compliance rules will apply to an intermediary as well.

INTERMEDIARY REGISTRATION RULES

An intermediary for a crowdfunding offering will have to register with the SEC as either a broker or a funding portal. The SEC is providing a streamlined process for registration of funding portals that is consistent with but less extensive than the process for broker-dealer registration.

A new Form Funding Portal will require information related to ownership and control of the portal, escrow and compensation arrangements, prior litigation, disciplinary history and other specified items. But unlike the proposed rules, the final rules will not require funding portals to have a fidelity bond.

SAFE HARBORS FOR FUNDING PORTALS

Rule 402 of Regulation Crowdfunding provides a nonexclusive conditional safe harbor for certain specified activities of funding portals in connection with crowdfunding offerings.

For example, the safe harbor rule will allow funding portals to highlight multiple offerings according to specified objective and searchable criteria. The search criteria specifically cannot include any kind of investment opinion or analysis, management assessment or risk analysis. Funding portals will also be allowed to supply but not participate in channels for investor and issuer communications under specified conditions that will insure fair, open and transparent communications.

The SEC will provide a safe harbor for a funding portal to advertise its existence and identify its offerings under specified conditions, and it will allow a portal to advise issuers about the structure or content of an offering, and help issuers prepare offering documents.

Portals will also be allowed to pay third parties for referring a person to them, so long as the third parties do not provide personally identifiable information and the compensation is not based on a security transaction being completed. Under specified circumstances, a funding portal can pay for the services of registered broker or dealer in connection with a crowdfunding offering.

RESTRICTIONS ON RESALES AND TRADING

Securities issued in a crowdfunding transaction will not be transferable by an original purchaser for a one-year period unless transferred to the issuer, an accredited investor, a family member, certain related trusts, or as part of a registered offering.

ADVERTISING RESTRICTIONS

Advertising the terms of the offering is not permitted, except for limited tombstone-type ad notices that direct potential investors to more information about the offering on the funding portal/broker-dealer's platform. These are similar to the tombstones permitted under Securities Act Rule 134. However, the rules do not prohibit how the notices can be distributed, so an issuer could place its notice in newspapers, as well as on social media sites and its own website.

DISQUALIFICATION PROVISIONS

The rules will impose "bad actor" disqualifications that are aligned with the disqualifications applicable under other exempt offerings. Legal persons covered by the bad actor rules include the issuer and its predecessors or affiliates, the intermediary, specified control persons, certain promoters, compensated solicitors and their control persons ("Covered Persons").

Covered Persons involved in a disqualifying event, such as securities fraud or postal fraud, will not be allowed to play a role in, benefit from or conduct a crowdfunding offering. Though an issuer will not lose the benefit of a crowdfunding exemption if it is able to show that it did not know and with reasonable diligence could not have known of the existence of a disqualification. Disqualified persons can also seek a waiver of disqualification for equitable reasons.

STATE BLUE SKY LAWS

Crowdfunding offerings are not required to conform to state registration/"blue sky" requirements, which are preempted by the SEC rules.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.