On July 13, 2017, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) issued CVM Instruction No. 588 (ICVM 588/2017) which provides for the distribution of public offering of securities of small business companies (sociedades empresárias de pequeno porte) held with CVM registry exemption and made through electronic platforms of participatory investment in the internet, hereinafter referred to as "investment-based crowdfunding".
The electronic platform of participatory investment ("platform") is the legal entity regularly constituted in Brazil and registered with CVM with authorization to exercise professionally the activity of distribution of public offerings of securities issued by small business companies held with registry exemption under ICVM 588/2017, exclusively through the internet, program, application or electronic means that provides a virtual meeting environment between investors and issuers.
- Scope of the Regulation
The new regulation is not aimed at all types of participatory financing activity, collaborative or collective held through the internet, known globally by the term "crowdfunding". For example, one of the most common modes of crowdfunding is based on donations, in which case the taxpayers get nothing in return - not even the refund of the amount donated. Such activity does not attract the jurisdiction of CVM.
Another popular mode of crowdfunding is that based on gifts, rewards, or pre-sale products (often a prototype) or services. This type of contribution offers a return that does not have a financial nature. The taxpayer's intention is to acquire the product resulting from the project funded and, therefore, the consideration will consist in receiving this product. Common examples are albums, books or other author rights' works. In general, these are innovative or even unique products and they are purchased by a value less than their future price of sale. In this case there is no public offer of securities and therefore it is not subject to the jurisdiction of CVM.
The arrangements for loans to pair carried out through the internet (P2P and P2B, peer-to-peer and peer-to-business lending) are not object of this regulation because their offer is not framed in the definition of security.
This new regulation is focused only on cases where an idea, project or business is presented by means of an internet portal to a large number of individuals as an investment opportunity that generates right of participation, of partnership or of the remuneration. Overall, this type of offer is known by the term "investment-based crowdfunding", when it involves the distribution of securities in general, or as "equity crowdfunding", when the consideration offered corresponds to equities only.
ICVM 588/2017 aims to (a) contribute to the development of innovative sectors, which may be relevant for the Brazilian economy; (b) expand and improve the quality of financing instruments for startup companies or companies with difficulties of access to credit because of its size; (c) promote adequate protection of investors who, in many cases, are not customary participants of the capital market; and (d) provide legal certainty for electronic platforms of investment-based crowdfunding and for small business companies.
The main aspects of this regulation are outlined below and comprise the following: (a) definition of eligibility criteria for issuers; (b) increase in annual funding limit; (c) imposition of investment limit on retail investors; (d) establishment of procedures to be used in the offer; (e) standardization of essential information of the offer; (f) obligation to grant broad and equitable access to information of the offer; (g) establishment of requirements for the registration and authorization for operation of platforms; (h) prohibition of certain activities and restriction on the use of advertising material; and (i) the joint offer permission for the participatory investment syndicate ("syndicate"), which can optionally have a lead investor.
This program is intended for the small business company, which is a company regularly constituted in Brazil, with annual gross revenues of up to R$ 10 million, ascertained in the fiscal year ended in the year preceding the offer and it is not registered as a securities issuer at CVM.
If the small business company is controlled, connected or subject to common control by another legal entity, individual or investment fund, the annual consolidated gross revenues of all the entities cannot exceed R$ 10 million.
With this limit CVM takes into account that the investment-based crowdfunding can contribute to the creation of businesses, and can play a strategic role for developing countries. The Brazilian regulator intends to benefit companies that are in their early stages of development of ideas, prototypes or proofs of concept, as well as varied-sized startups.
The funds raised by small business companies cannot be used for: (a) consolidation, merger, merger of shares and purchase of equity participation in other companies; (b) acquisition of securities, convertible or not, issued by other companies; or (c) granting of credit to other companies.
- Annual Funding Limit
The public distribution of securities issued by a small business company is automatically exempt from registration with CVM whenever the amount of the funding does not exceed R$ 5 million and the term of the transaction is up to 180 days, provided that both limit and term are previously defined.
In the event that the registration has already been exempt in the calendar-year, using the same or another platform, the sum of the total amount of the current offer with the amounts previously obtained by the small business company may not exceed the limit of R$ 5 million.
A new offer with registry exemption for the same small business company, through the same or another platform, cannot be carried out within 120 days from the date of closure of the previous offer.
- Investment Limit on Retail Investors
CVM adopted the same approach widely used by overseas regulators to protect retail investors by introducing an annual limit of R$ 10 thousand, which can be invested in the deals on which the investors apply their resources, considering the applications performed on all platforms. Such limitation is necessary before the high risk of failure of the entrepreneur, the lack of liquidity of the purchased securities, the absence of a full prospectus and the lack of any analysis by CVM about the information of the offer.
However, exceptions have been made for qualified investors or angel investors who act as leaders of syndicates.
Additionally, it is common for family members or friends of entrepreneurs to invest in these businesses, and thus another exception was created, allowing, for people who have proven to have annual gross income or net worth of investment of more than R$ 100 thousand, to invest up to 10% of the greater of the two values, that is, exceeding the annual general limit of R$ 10 thousand.
The platform must verify that such limits have not been exceeded, and must also request and keep the evidentiary documentation or a declaration of the investor, as the case may be. Such duties are typical of the distributor of offers.
The public offer exempt of registration must follow specific rules, in accordance with established conventions worldwide for the activity of crowdfunding, as, for example, the request for a target value, which, if by chance is not reached in a given period, leads to the closure of the offer without the transfer of resources to the issuer.
The target value is set by the entrepreneur and, in principle, corresponds to the minimum amount required for the accomplishment of the desired project. Therefore, if the amount collected does not reach the target value, it would be reckless to terminate the offer and transfer amount less than the amount sought for the offeror, since it would be unlikely that in this condition the use of resources could generate real results and gains for investors, even though the entry of any resource is always helpful for the entrepreneur.
Additionally, the manifestation of the investor of its intention to participate in the offer shall be nonbinding. Once the collected added value investment intentions exceeds the target value, investors will be notified for carrying out the deposit of amounts defined in their investment intention, and will be given a minimum period of seven days to present their submission. After the elapse of this period, the platform should consider that the investor gave up participating in the offer. If this happens, no fines or penalties will be applied.
The possibility of giving up such participation is a fundamental requirement for the offer to proceed with automatic registry exemption, taking into account the participation of the retail public.
- Standardization of Information
One of the most important aspects of the new regulation is the essential information, necessary for an informed reflection of investors about the possibility of investing in the offer. To standardize the informational set of offers of investment-based crowdfunding and ensure that the main features of the offer and its risks are properly disclosed, CVM prepared a default list of information that is consolidated in Annex 8 of ICVM 588/2017.
This essential set of data to be inserted in the offer includes information about (i) the small business company; (ii) the business plan; (iii) the characteristics of the offered securities; (iv) the syndicate, if any; (v) the communication of continuous information after the offer; (vi) alerts on risks; (vii) conflicts of interest; (viii) remuneration of the platform; and (ix) other relevant information.
The platform must ensure that the essential minimum information set out in Annex 8 is clear so that the investor can make a conscious decision to invest in the offer.
- Access to Information
The concept of investment-based crowdfunding is centered on the broad dissemination of an idea, project or venture, which is presented by means of an internet portal to a large number of individuals as an investment opportunity. The wide dissemination of information to the general public offer requires the electronic media, and this model has been adopted in ICVM 588/2017. Therefore, the offer registry exemption must be performed exclusively by means of the electronic media.
One of the basic principles of regulation of public offerings of securities is that the access to information of the offer must be equitable and unrestricted to any audience. Platforms must adapt their current mode of operation, where the information about the offers is only accessed by persons previously registered on the portal. For the same reason, the publication and viewing comments in the discussion forum on the offer cannot be subject to access barriers to the general public.
The platforms play a key role in the securities offerings of small business companies. It is up to the platform to bring together issuers and investors and also disclose the information about the offer and the company. Additionally, the platform does business intermediation by digital media, and disseminates the company's data to keep investors informed about the progress of the deal, after the completion of the offer.
They can act punctual and strictly in the distribution of securities in this type of offer, provided that a set of demands is complied with. The role, the performance, the responsibilities, and the duties of the platforms are clearly defined in ICVM 588/2017.
The platform will act as a gatekeeper, assuming a set of responsibilities before the investors and CVM. This function is of great importance, since the offers will be conducted in the automatic registry exemption scheme and, therefore, there will be no prior assessment by the technical areas of CVM.
A set of standards of conduct must be followed by the platforms, including, for example: (a) the restriction of the offers to eligible issuers; (b) the control of the amount contributed by retail investors with respect to the authorized limits; (c) the development and dissemination of educational material; and (d) the signature collection of the investors in the Term of Acknowledgment of Risk (Termo de Ciência de Risco), which can be accomplished through digital means.
Given the fact that CVM does not examine the offer prior to its completion, the platform must notify the investors that the offer and the issuer have been exempted from registration by CVM and that CVM does not guarantee the veracity of the information provided or the adequacy of the offer to the legislation in force and it also does not make any judgment about the quality of the small business company.
In view of the need to fulfill the essential role of gatekeeper, the permission for the performance of the platform in the securities distribution system depends on prior registration with CVM, even when the distribution is punctual and restricted to offers of investment-based crowdfunding. To this end, the platform must prove the suitability of its administrators, the existence of human and technological resources suited to the provision of the service, the supply of a minimum capital stock, and the elaboration of a code of conduct to regulate the activities of its members, administrators, employees and agents.
The platform must have economic and financial capacity compatible with the operations to be performed, and a minimum net worth of R$ 100 thousand.
This minimum net work requirement seeks to ensure that the company that operates the platform has conditions to maintain appropriate systems and it is able to adopt the necessary internal controls to comply with the obligations imposed by ICVM 588/2017. CVM is especially concerned to ensure that platforms have a professional activity and that will not terminate their activities abruptly leaving investors without support.
The provision of information about the offer is an activity of great importance in the grounds of the investment decision. The platform must adopt all the appropriate steps to ensure that the information provided by the small business company is true, consistent, correct and sufficient.
The deposits made by the investors that intend to invest in the investment-based crowdfunding project must be carried out in a blocked current account at a financial institution and segregated from the accounts of the small business company and of the platform. The platform cannot receive deposits of the amounts provided by the investors at a current account nor perform any private activity of financial institution. This restriction is also applicable to the controlling partners, administrators and employees of the platform. The same restriction applies to the leading investor and its partners, administrators, related persons and controlled companies.
In order that the investment-based crowdfunding play an effective role in reducing the financing bottlenecks of early-stage companies, it is necessary that some features are observed in this type of offer. For example, the small business company should not be overwhelmed with regulatory requirements, the costs should be as low as possible and the offer should be speed. Thus, it is clear to CVM that the automatic registry exemption scheme is best suited for this activity, in view of the low values involved.
However, considering that the offers will reach a large number of retail investors, and it is very likely that many of these investors will be people with little prior exposure to the securities market, plus the fact that many of the issuers still do not have a known history of operations and revenues, CVM decided to prohibit the use of any advertising material with this type of offer.
The use of advertising materials would require the prior review and approval by CVM. So, in addition to introducing costs and significantly reduce the speed of the whole process of the offer, such use would eventually eliminate the simplicity of investment-based crowdfunding. Therefore, CVM considered that the use of propaganda is incompatible with the objectives of the regulation.
Another desirable feature of investment-based crowdfunding is that the investment opportunities should be available to any investor, through the process in which many invest small amounts, after an open information exchange among people interested in a digital forum operated by the platform. This feature depends on the virtual electronic media. The search for potential investors outside of the virtual environment of the platform or by campaigns that include telephone contact is not admitted, and business cannot occur in shops or other establishments.
Therefore, the platform and its controlling partners, administrators, employees and agents cannot under any circumstances practice any of the following acts: (i) to demand, out of the electronic environment of the platform or through telephone contact, the offered securities with registry exemption, in whole or in part, of indeterminate subscribers or purchasers; (ii) to trade the offered securities with registry exemption in store, office or establishment open to the public, in whole or in part, with indeterminate subscribers or purchasers; (iii) to use advertising material to publicize the offer by any means, including the electronic environment of the platform; (iv) to promise predetermined income to the investors; (v) to make discretionary management of the investors' resources; (vi) to make personalized recommendations to the investors on public offerings conducted with registry exemption; (vii) to receive deposits of amounts provided by the investors at current accounts or perform any private activity of financial institutions; (viii) to perform private activities of manager entities of the organized securities markets; (ix) to perform secondary intermediation of securities' activities; (x) to perform the custody of securities purchased by the investors; (xi) to grant credit to investors or the small business company; (xii) to provide mechanisms that allow investors to realize automatic investments in more than one offer; (xiii) to restrict the participation in the offer to people who have already purchased products or services of the issuer; (xiv) to request transfer of resources from investors before the start of the public offering; (xv) to distribute, outside the electronic platform environment, securities of small business company object of public offering in progress; and (xvi) prior to the offer, either through direct participation or convertible securities, to have a participation of more than 20% of the share capital of the small business company object of public offering, except in the event of subsequent offer or offer the platform itself as a small business company.
- Participatory Investment Syndicates
ICVM 588/2017 allows the platforms to admit in their electronic environment a group of investors supporters of a leading investor ("supporting investors") in a participatory investment syndicate ("syndicate") for the purpose of participating in public offerings distribution of securities of small business companies held with CVM registry exemption.
The regulation allows the incorporation of an investment vehicle ("vehicle") for the syndicate to participate in public offerings distribution of securities carried out with exemption from registration, provided that: (i) each vehicle is restricted to participate in one single public offering of securities, and the purchase of securities issued by more than on small business company is prohibited; (ii) the vehicle does not expose the supporting investors to additional risks than those that they would incur when investing individually on the same offer; (iii) the vehicle not subject the supporting investors to credit risk other than that of the small business company issuer of publicly offered securities; (iv) fair treatment is guaranteed to all supporting investors that join the vehicle; (v) the vehicle has adequate governance rules that allow the participation of supporting investors in the event of need for deliberations concerning the invested small business company or securities issued by such company; (vi) in the event of conversion or transfer of investment made by the vehicle it must be guaranteed to each of the supporting investors the individual right to choose to receive the securities or the funds received by the vehicle, except for the portion corresponding to the performance fee payable to the leading investor and the platform, if applicable; and (vii) in relation to item (vi), it is stipulated a period not exceeding 30 days for the transfer of the securities or of the funds received by the vehicle to the supporting investors.
The platform that enables a syndicate constituted in the form of a vehicle to participate in public offerings in its electronic environment must check whether there is contractual forecast consistent with the need for resources for funding the activities related to the functioning of the syndicate. The platform must inform the portion of the raised amount expressed in Brazilian currency and fixed value, to be paid at the closing of the offering, intended exclusively for payment of expenses until the closure of the activities of the syndicate.
The syndicate may have a leading investor in order to reduce the informational asymmetry between the issuer and the investors. A leading investor must submit his/her/it personal investment thesis exposing the justifications for the choice of the small business company, in order to assist the investors in their decision-making process. He/she/it must disclose his/her/its previous experience in leading investment rounds or with personal investments in small business company, including any equity percentage and the results received.
The leading investor can still act: (i) next to the small business company, applying his/her/it knowledge, experience and networking in order to increase the chances of success of the company, and (ii) as an interlocutor between the small business company and the syndicate, always in a manner aligned with the interest of the investors of the syndicate.
The supporting investors can pay a performance fee to the leading investor and the platform, including by means of the delivery of securities issued by the small business company.
The lead investor must meet the following requirements: (i) do not hold, before the offer, either through direct participation or convertible securities, an equity of more than 20% of the share capital of the small business company object of the public offering; (ii) carry out investment using own resources in the small business company of at least 5% of the minimum target value raised in a public offering and on the same terms from other supporting investors of the syndicate; (iii) not be disabled or suspended for office with financial institutions and other entities authorized to operate by CVM, the Central Bank of Brazil (Banco Central do Brasil – Bacen), the Private Insurance Superintendence (Superintendência de Seguros Privados - SUSEP) or by the Brazilian Superintendence of Supplementary Pension (Superintendência Nacional de Previdência Complementar – PREVIC); (iv) not to have been convicted of any crime of bankruptcy, prevarication, bribery, graft, embezzlement, money-laundering or concealment of property, rights and values, against the economy, the economic order, consumer relations, public faith or public property, the Brazilian financial system or any criminal penalty which is a final decision and prevents him/her, even if temporarily, to hold a public office, except if rehabilitation is feasible; and (v) have not suffered in the last five years punishment as a result of any activity subject to the control and supervision of CVM, Bacen, SUSEP or PREVIC.
If the leading investor is a legal entity, then the above-mentioned requirements would apply to its partners and administrators.
The platform shall enter into a contract with the leading investor establishing the following negative covenants during the exercise of its activities: (i) not to receive any kind of remuneration, except for the variable performance rate in relation to the return of the securities purchased by the leading investors of the syndicate; (ii) not to perform any activities prohibited to platforms, partners, managers and employees; and (iii) not to increase the performance arising out of the essential information of the offer after the closing of the transaction.
- Final Considerations
The platform must maintain, for a period of at least five years from the date of closure of the offer, or for a higher period as determined by CVM, all documents and information required by ICVM 588/2017. These documents and information can be stored in physical or electronic means. The original documents may be replaced by their scanned images.
The administrators of the platform, within their competence, have a duty to ensure compliance with the obligations imposed on the platform. Likewise, the administrators of the small business company that issue the securities (issuer) have also the same duty regarding compliance with the obligations of the issuer.
 This activity attracts the jurisdiction of CVM, pursuant to article 2, item IX, of Law No. 6,385, of December 7, 1976, which reads as follows:
"Article 2. The following securities shall be subject to the provisions of this law:
IX – when publicly offered, any other collective investment instrument or agreement that creates the right of participation on profits or remuneration, including as a result of the rendering of services, and whose profits derive from the efforts of the entrepreneur or from the efforts of third parties."
 For the purpose of calculating the limits laid out in ICVM 588/2017, in case of extinction of the company that has held offerings exempt from registration, and the exploitation of its activity is carried on by any remaining partner, under the same or another corporate name, or under an individual firm of limited liability (empresa individual de responsabilidade limitada – EIRL), the successor shall be deemed to be the same small business company.
 It is necessary to have an interval of 120 days between the two offers.
 Pursuant to CVM Instruction No. 554 of December 17, 2014 (CVM Instr. 554/2014), the following entities are considered professional investors: (i) financial institutions and other institutions authorized to operate by the Central Bank of Brazil (Banco Central do Brasil - Bacen); (ii) insurance companies and capitalization societies; (iii) private welfare opened or closed capital organizations; (iv) individuals or legal entities that hold financial investments in an amount superior to R$ 10 million and that additionally attest in writing their qualified investor condition according to an own term, set forth in Annex 9-A to CVM Instruction No. 539, of November 13, 2013 (CVM Instr. 539/2013); (v) investment funds; (vi) investment clubs, provided they have the portfolio managed by a securities´ portfolio administrator authorized by CVM; (vii) autonomous investment agents and securities´ portfolio administrators, analysts and consultants authorized by CVM in relation to their own monies; and (viii) non-resident investors. And the following entities are considered qualified investors: (i) professional investors; (ii) individuals or legal entities that hold financial investments in an amount superior to R$ 1 million and that additionally attest in writing their qualified investor condition according to an own term, set forth in Annex 9-B to CVM Instr. 539/2013; (iii) individuals that have been approved in examinations of technical qualification or who have certifications approved by CVM as requirements for the registration of autonomous investment agents and securities´ portfolio managers, analysts and consultants, in relation to their own monies; and (iv) investment clubs, provided they have their portfolio managed by one or more unit holders, that must be qualified investors. Own social security regimes instated by the Union, the States, the Federal District or the Municipalities may also be deemed professional or qualified investors, provided they are recognized as such as per the specific regulation issued by the Ministry of Social Security.
 Partial distribution is permitted, with the establishment of minimum and maximum target values. The minimum target value must be equal to or greater than 2/3 of the maximum target value.
 CVM has been following closely the performance of regulators in other jurisdictions in relation to progress in the implementation of rules on the investment-based crowdfunding. The Financial Conduct Authority (FCA) of the United Kingdom published in February 2015 a yearly review of the regulatory regime introduced in March 2014. One of the deviations of conduct cited by FCA was the removal of negative comments about offers, which led one regulator to take action against this type of editing, since relevant risks might be unnoticed by the public. CVM decided to include a provision in ICVM 588/2017 preventing the platforms to eliminate critical or negative comments about the offer in these discussion forums (article 29 of ICVM 588/2017).
 The requirements set out in ICVM 588/2017 are also found in the legislation of Australia, Canada, the European Union, France, Italy, Germany, Portugal, Spain, United Kingdom and the United States.
 This requirement is central to the role of gatekeeper, as well as the other requirements laid down in article 19 of ICVM 588/2017.
 The platform is not a financial institution. Consequently, the resources of the investors cannot use the accounts of the platform and/or of the small business company and CVM requires the use of a segregated and blocked account at a financial institution for this purpose. This prohibition is set out in paragraph 1 of article 5 and item VIII of article 28 of ICVM 588/2017.
 Pursuant to paragraph 2 of article 10 of ICVM 588/2017, the small business company, the leading investor, the platform, and their partners, managers and employees are allowed to divulge and promote the offer through contacts, meetings and events, in person or through the internet, provided the following requirements are duly observed: (i) the information provided is consistent with the existing offer information in the electronic environment of the platform; (ii) there is no distribution of documents than those already included in the offering materials; (iii) all communications are recorded and verifiable and under the supervision by the CVM; and (iv) there is no confirmation of local investment or in the electronic environment different from the platform.
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.