On October 23, 2013, the Securities and Exchange Commission (the “SEC”) proposed Regulation Crowdfunding, setting forth the rules governing the offer and sale of securities through crowdfunded offerings, pursuant to Title III of the Jumpstart Our Business Startups Act (the “JOBS Act”).
Within days, FINRA published its proposed rules for the licensing and regulation of “funding portals.” The recent SEC and FINRA proposals have spurred an interest in crowdfundedsecurities offerings. This blog post discusses the most common questions we receive about crowdfunding.
Q. Which companies will be able to engage in equity crowdfunding?
A. US companies that are not subject to the SEC’s reporting requirements will be eligible to rely on the crowdfunding exemption from registration. Both registered and exempt investment companies will not be eligible. Additionally, companies may be disqualified under Rule 503, which includes, among other things, certain designated “bad actor” disqualifications. Companies that have no specific business plan, or companies whose sole business plan is to engage in a merger or acquisition with another company, cannot use crowdfunding.
Q. How much can an eligible company raise using Crowdfunding?
A. An eligible crowdfunding issuer will be able to to raise up to $1 million in a 12-month period.
Q. Will funds raised in a Regulation D offering be counted towards the $1 million allowed by crowdfunding?
A. No. Funds raised through Regulation D offerings or other securities exemptions, would not be counted in determining the aggregate amount sold in reliance on Section 4(a)(6).
Q. Can my crowdfunding offering be integrated with other securities offerings?
A. No. An offering made in reliance on Section 4(a)(6) will not be integrated with other exempt offerings made by an issuer.
Q. Do crowdfunding investors have to be accredited investors?
A. No. There are no limitations on who may invest in a crowdfunding offering.
Q. How much can I invest in a crowdfunding offering?
A. During the trailing 12 months preceding any crowdfunded transaction, an investor will be allowed to invest no more than: (i) the greater of $2,000 and 5 percent of his annual income or net worth, as applicable, if both the annual income and net worth of the investor is less than $100,000; or (ii) 10 percent of his annual income or net worth, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or the net worth of the investor exceeds $100,000 (Proposed Rule 100(a)(2)).
Q. Are there restrictions on the resale of securities purchased in crowdfunding offerings?
A. Yes. The proposed crowdfunding rules prohibit offers and sales of crowdfund-issued securities during the first year after purchase with certain exceptions including sales and transfers to the issuer, accredited investors and family members or as part of a public offering.
Q. Does Regulation Crowdfunding impose a verification requirement with respect to secondary transactions?
A. No. Regulation Crowdfunding does not impose on intermediaries a verification requirement with respect to secondary transactions
Q. Who may act as a crowdfunding intermediary in an offering?
A. Section 4A permits two types of intermediaries for a crowdfunding offering. These are registered broker-dealers and crowdfunding portals.
Q. Can I use more than one intermediary in my crowdfunding offering?
A. An issuer may use only one intermediary in its crowdfunded offering.
Q. What are the registration requirements for broker-dealers and funding portals?
A. Broker-dealers registered with the SEC and FINRA do not need to register or make filings in order to engage in crowdfunding offerings. Their activities are governed by Regulation Crowdfunding. Funding portals must register with both the SEC and FINRA before engaging in crowdfunding offerings.
Q. What activities are funding portals allowed to engage in during a crowdfunding offering?
A. Based on the proposals, Funding Portals will function only in a limited capacity, and be subject to a reduced version of broker-dealer regulations, including registration with the SEC and FINRA, reporting of disciplinary actions, a “just and equitable principles of trade” standard in their dealings, the establishment and maintenance of a supervisory structure, compliance with anti-money laundering rules and maintenance of a fidelity bond and retention of books and records.
Q. Can a Funding Portal own shares of a company conducting a crowdfunding offering?
A. Regulation Crowdfunding prohibits any direct or indirect ownership of the issuer by the intermediary or any of its officers, directors or partners. This prohibition includes any interest that is economic or financial in nature.
Q. Can a funding portal or broker-dealer be compensated in shares of a Crowdfunding issuer?
A. No, Regulation Crowdfunding prohibits the receipt of such an interest as compensation for intermediating the offering.
Q. Does Regulation Crowdfunding impose specific disclosure obligations on issuers?
A. Yes, an issuer relying upon Section 4(a)(6) and Regulation Crowdfunding must provide specific disclosures to investors and file the disclosures with the SEC.
Q. What disclosures are intermediaries required to provide to investors?
A. The required disclosures include:
♦ the issuer’s name, legal status, physical address and website address;
♦ identity and background information of the issuer’s officers and directors as well as owners of 20 percent or more of the issuer’s securities;
♦ a description of the issuer’s business, planned use of proceeds from the offering and financial condition;
♦ the current number of employees;
♦ material terms of any indebtedness of the issuer and any exempt offerings conducted within the past three years;
♦ the proposed public offering price, target offering amount, deadline to reach the target amount and whether the company will accept investments in excess of the target amount;
♦ a description of related-party transactions;
♦ the issuer’s ownership and capital structure;
♦ financial statements of the company;
♦ information about the intermediary and its compensation;
♦ material risks associated with the investment; and
♦ certain mandatory legends and notices.
In addition to disclosures required during the offering, issuers of successful crowdfunding offerings will be required to provide investors with an annual report and file the report with the SEC.
Regulation Crowdfunding requires that issuers submit a newly-created Form C through the SEC’s EDGAR system. The Form C template has not yet been made available.
Q. Will audited financial statements be required?
A. Issuers wishing to raise less than $100,000 may compile their own statement. Issuers wishing to raise between $100,000 and $500,000 must have their statements reviewed by an independent accountant. Issuers wishing to raise between $500,000 and $1 million must provide audited financial statements.
When must the disclosures be available to investors?
A. The disclosures must be available for at least 21 days prior to the first sale of securities, but the intermediary may accept indications of interest during this period. The issuer must timely amend its offering document to reflect material changes and provide updates on its progress toward reaching the target minimum offering amount. A notice to investors disclosing the total amount of securities sold must occur no later than five days after the closing of the offering.
Q. How are the disclosures provided to investors?
A. The disclosures must be provided on the broker-dealer’s or funding portal’s platform which is likely a website.
Q. What are the intermediary’s duties?
Intermediaries duties include:
♦ Provide an internet platform to facilitate the offering that includes the required disclosures, and a communication channel that allows potential investors and others to discuss the offering;
♦ Take steps to reduce the risk of fraud, including conducting due diligence of the issuer and its offering;
♦ Deny access to issuers that are disqualified or present the potential for fraud;
♦ Open an account for each investor, and provide each investor with required educational materials, confirmations of investment commitments and purchases, and notifications of various events such as cancellation of the offering; and
♦ Arrange for the transmission of funds and securities in connection with the closing of the offering.
Can I advertise my crowdfunded offering?
A. Generally, an issuer cannot advertise a crowdfunded offering, except through its intermediary’s platform. Issuers can disseminate a notice with the offering terms, basic factual information about the issuer and the intermediary’s platform and which contains a statement explaining how an investor can obtain additional information and/or invest. If the intermediary is a funding portal, the funding portal may not advertise the offering, but can advertise its services as an intermediary in crowdfunding transactions and identify one or more issuers or offerings available on its crowdfunding platform.
Q. Are issuers required to have a communications mechanism for investors to interact?
A. Intermediaries are required to have a communications mechanism on their platforms so that investors may interact, and it must be available in all crowdfunded offerings.
Q. Can an issuer participate in discussions on the platform?
A. An issuer may participate in any discussions on the forum but must identify itself as the issuer. Issuers can compensate promoters for participating through the communications channel, so long as the promoter identifies itself as such and discloses that it has or will be compensated for its efforts.
Q. Who can pay and receive compensation in connection with crowdfunded offerings?
A. Issuers may compensate the intermediary for its participation in the offering, so long as that compensation does not include a financial interest in the issuer. The intermediary must disclose to all investors who open accounts with it the manner in which it will be compensated in connection with an offering.
Broker-dealer intermediaries may pay transaction-based compensation to appropriately registered persons (but not funding portals) for the referral of issuers and/or investors.
Funding portals may compensate others for the referral (but not solicitation) of issuers and investors so long as the compensation is not transaction-based, unless the person it will pay is a registered broker-dealer.
Funding portals may not compensate anyone for soliciting investors or prospects and may not pay transaction-based compensation in connection with a crowdfunded offering.
Misinformation About Crowdfunding
While websites like Kickstarter, Earlyshares, Crowdfunder, and Microventures offer crowdfunding opportunities, they do not offer or sell securities to the general public. Until the JOBS Act, crowdfunding could not be used to offer or sell securities to the general public. The SEC and FINRA proposals remain pending and until they become final crowdfunding is not available to issuers. Both the SEC and FINRA have sought comment on their proposed rules. The comment period will end in early February 2014.
For further information about this crowdfunding blog post, please visit www.jobsact101.com or contact Brenda Hamilton,Securities Attorney at (561) 416-8956 or firstname.lastname@example.org. This memorandum is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. For more information concerning the rules and regulations affecting the use of Rule 144, Form 8K, FINRA Rule 6490, Rule 506 private placement offerings, Regulation A, Rule 504 offerings, Rule 144, SEC reporting requirements, SEC registration on Form S-1 and Form 10, Pink Sheet listing, OTCBB and OTCMarkets disclosure requirements, DTC Chills, Global Locks, reverse mergers, public shells, go public direct transactions and direct public offerings or please contact Hamilton and Associates at 101 Plaza Real South, Suite 202 N, Boca Raton, Florida, or visit www.jobsact101.com. Please note that the prior results discussed herein do not guarantee similar outcomes.
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Brenda Hamilton, Securities Attorney
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