Overview

On October 23, 2013, the U.S. Securities and Exchange Commission (SEC) proposed rules under the Jumpstart Our Business Startups (JOBS) Act1 to permit companies to offer and sell securities through "crowdfunding." In a prior memorandum,2 we discussed the key elements of crowdfunding under the JOBS Act. Crowdfunding describes an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a multitude of projects. Title III of the JOBS Act created an exemption under the securities laws to permit this type of funding method to be used to offer and sell securities. The JOBS Act also established the foundation for a regulatory structure for this funding method. The goal of the JOBS Act is to make it easier for startups and small businesses to raise funds from a range of potential investors and provide additional investment opportunities for investors.

The proposed rules would, among other things, permit individuals to invest subject to certain thresholds, limit the amount of money a company can raise, require companies to disclose certain information about their offers, and create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions. The full text of the proposed rules is available at http://www.sec.gov/rules/proposed/2013/33-9470.pdf.

The SEC is seeking public comment on the proposed rules for a 90-day period following their publication in the Federal Register.

Qualifying under the Proposed Rules

The proposed rules impose the following thresholds and limits:

  • A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
  • Investors, over the course of a 12-month period, would be permitted to invest up to:
  • $2,000 or 5% of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
  • 10% of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Not all companies would be eligible to utilize the crowdfunding exemption. Excluded companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies, companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules and companies that have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.

Also, securities purchased in a crowdfunding transaction could not be resold for a period of one year. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Exchange Act.

Disclosure Requirements for the Issuer under the Proposed Rules

The proposed rules would require the issuer to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering and make it available to potential investors.

Among other things, an issuer would be required to disclose the following in an offering document:

  • a description of the company's business and the use of proceeds from the offering;
  • the price to the public of the securities being offered, 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;
  • certain related-party transactions;
  • information about officers and directors, as well as owners of 20% or more of the company;
  • a description of the financial condition of the company; and
  • financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company's tax returns or reviewed or audited by an independent public accountant or auditor.

Companies would be required to amend the offering document to reflect any material changes and provide updates on the company's progress toward reaching the target offering amount.

Also, companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

Crowdfunding Intermediaries

Crowdfunding transactions must take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. The offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.

The proposed rules would require these intermediaries to:

  • make information available about the issuer and the offering;
  • provide investors with educational materials;
  • take measures to reduce the risk of fraud;
  • provide communication channels to permit discussions about offerings on the platform; and
  • facilitate the offer and sale of crowdfunded securities.

The proposed rules would prohibit funding portals from:

  • soliciting purchases, sales or offers to buy securities offered or displayed on its website;
  • offering investment advice or making recommendations;
  • imposing certain restrictions on compensating people for solicitations; and
  • holding, possessing or handling investor funds or securities.

The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

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.