SEC Adopts Regulation Crowdfunding
The Securities and Exchange Commission (SEC) has adopted Regulation Crowdfunding to implement the crowdfunding exemption from registration authorized by the Jumpstart Our Business Startups (JOBS) Act. The new rules will permit a private company to sell securities without registration under the Securities Act of 1933 (Securities Act) in small amounts to a large number of investors who are not accredited investors. The new rules will go into effect 180 days after they are published in the Federal Register.
Regulation Crowdfunding permits individuals to invest in securities-based crowdfunding transactions up to certain amounts, limits the amounts an issuer can raise under the exemption, requires issuers to disclose certain information and creates a regulatory framework for the intermediaries that issuers are required to use in crowdfunding transactions. Regulation Crowdfunding also conditionally exempts the securities sold in an exempt crowdfunding transaction from the registration requirements of Section 12(g) of the Securities Exchange Act of 1934 (Exchange Act).
Regulation Crowdfunding is complex and will involve substantial cost and effort for the issuers who want to use the registration exemption. Much of the complexity and cost is a result of the investor protection requirements that were included in the JOBS Act.
The following is a summary of the key provisions of Regulation Crowdfunding that apply to issuers.
Limitation on the Amount an Issuer Can Raise
The amount an issuer can raise under Regulation Crowdfunding is limited to an aggregate amount of $1 million in any 12-month period, including amounts sold by entities controlled by, or under common control with, the issuer and any amounts sold by a predecessor of the issuer. Capital raised by an issuer using other registration exemptions will not be included in this $1 million limit. An offering made in reliance on the crowdfunding exemption will not be integrated with other exempt offerings made by the issuer as long as each offering complies with the requirements of the applicable exemption.
Limitation on Amount Persons May Invest
An investor is limited in the aggregate dollar amount that can be invested in all exempt crowdfunding transactions of all issuers during a 12-month period. The limit is based upon the income and net worth of the investor. If an investor’s net worth or annual income is less than $100,000, the limit is the greater of $2,000 or five percent of the lesser of the investor’s annual income or net worth. If an investor’s annual income and net worth are both $100,000 or more, the limit is 10 percent of the lesser of the investor’s annual income or net worth, subject to a maximum amount of $100,000 that may be invested. Annual income and net worth of an individual are calculated the same way they are to determine an individual’s accredited investor status under Securities Act Rule 501. In addition, spouses can calculate their net worth or annual income jointly. If this joint calculation is used, the aggregate amount the spouses may invest cannot exceed the amount that a single person can invest based on that net income and net-worth level.
Required Use of Intermediary Platform
An offering made in reliance on the crowdfunding exemption must be made through the platform of a registered broker or of a registered funding portal. A platform is an Internet website or other similar electronic medium accessible to the public used by the intermediary for the offering. Only one intermediary may be used for a crowdfunding transaction, and the offer must be made exclusively through the intermediary’s Internet website or other similar electronic medium.
Offering Disclosure Requirements
An issuer relying on the crowdfunding exemption must file a new Form C: Offering Statement with the SEC prior to the commencement of the offering and must provide certain prescribed information to investors and to the intermediary used in the offering. The required information covers the following areas:
- name, legal status, address and website of the issuer;
- specified information about the directors and officers of the issuer;
- names of the beneficial owners of 20 percent or more of the issuer’s voting equity securities;
- a description of the issuer’s business and its anticipated business plan;
- number of employees;
- risk factors;
- the target offering amount and deadline;
- maximum amount of offering and how oversubscriptions will be allocated;
- use of proceeds;
- process to complete the transaction or cancel an investment commitment;
- a statement that if a material change is made to the offering, an investor’s investment commitment will be cancelled and the committed funds will be returned if the investor does not reconfirm his or her investment commitment;
- the price or method for determining the price of the securities being offered;
- ownership and capital structure;
- the intermediary being used and its interest in the issuer and the transaction;
- the material terms of any indebtedness of the issuer;
- exempt offerings by the issuer in the last three years;
- related party transactions;
- a narrative discussion of the issuer’s financial condition;
- financial statements;
- matters that would have resulted in the issuer being disqualified from using the Section 4(a)(6) exemption but occurred before the effective date of Regulation Crowdfunding (see "Disqualification" below);
- updates regarding the progress of the issuer in meeting the target offering amount;
- where on the issuer’s website investors will be able to find the issuer’s annual report required by Regulation Crowdfunding, and the date by which such report will be available on the issuer’s website;
- whether the issuer or any of its predecessors previously failed to comply with the ongoing reporting requirements of Regulation Crowdfunding; and
- any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
Significantly, the disclosures required about the offering process specify certain procedural requirements that must be used in the offering. If the investment commitments received by an issuer in the offering do not equal or exceed the target offering amount at the offering deadline, no securities can be sold in the offering, investment commitments must be cancelled and committed funds must be returned. Investors may cancel an investment commitment at any time until 48 hours before the deadline specified in the offering statement. If an issuer reaches the target offering amount prior to the specified deadline, it may close the offering early, but only if it provides five business days’ advance notice of the accelerated deadline.
An issuer must amend its offering statement for any material change in the offer terms or disclosure previously provided to investors. The amended disclosure must be filed with the SEC on Form C-A: Amendment and provided to investors and the intermediary. In addition, material changes would require reconfirmation by investors of their investment commitments within five business days.
An issuer must also file with the SEC Form C-U: Progress Update and provide investors and the relevant intermediary with a disclosure of its progress in meeting the target offering amount no later than five business days after each of the dates when the issuer reaches 50 percent and 100 percent of the target offering amount. If the issuer will accept proceeds in excess of the target offering amount, the issuer also would be required to file with the SEC and provide investors and the intermediary a final progress update no later than five business days after the offering deadline, disclosing the total amount of securities sold in the offering.
Ongoing Issuer Disclosure Obligations
An issuer that has sold securities using the crowdfunding exemption must file an annual report with the SEC on Form C-AR: Annual Report and post the annual report on its website. The annual report has the same information requirements as the offering statement, except for the offering-specific information. In addition, issuers that do not otherwise have available reviewed or audited financial statements need only provide financial statements certified by the issuer’s principal executive officer.
This ongoing reporting obligation will continue unless and until any of the following occur:
- if the issuer has filed at least one annual report and has fewer than 300 holders of record;
- if the issuer has filed at least three annual reports and has total assets that do not exceed $10 million;
- the issuer becomes an Exchange Act reporting company;
- the issuer or another party purchases or repurchases all of the securities issued pursuant to the crowdfunding exemption; or
- the issuer liquidates or dissolves in accordance with state law.
Prohibition on Advertising
Section 4A of the Securities Act, added by Title III of the JOBS Act, prohibits an issuer from advertising the terms of a crowdfunding offering, except for notices which direct investors to the funding portal or broker. Regulation Crowdfunding permits an issuer to publish a limited notice advertising the terms of an offering using the crowdfunding exemption so long as the notice includes the address of the intermediary’s platform on which additional information about the issuer and the offering may be found. The information which may be included is limited to: (1) a statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted and a link directing the investor to the intermediary’s platform; (2) the terms of the offering; and (3) factual information about the legal identity and business location of the issuer, limited to the name of the issuer of the security, the address, phone number and website of the issuer, the e-mail address of a representative of the issuer and a brief description of the business of the issuer.
Compensation of Persons Promoting the Offering
An issuer, or any person acting on behalf of the issuer, is prohibited from compensating, or committing to compensate, any person to promote the issuer’s offering through communication channels provided by the intermediary, unless the issuer, or person acting on behalf of the issuer, takes reasonable steps to ensure that the person clearly discloses past and prospective compensation each time the person makes a promotional communication. This disclosure is required of all persons engaged in promotional activities, including the issuer’s employees, regardless of whether compensation is provided specifically for promotional activities. In addition, an issuer cannot compensate, or commit to compensate, any person to promote its offerings outside of the communication channels provided by the intermediary, unless the promotion is limited a notice that complies with restrictions discussed above in "Prohibition on Advertising" above.
Certain Issuers are Ineligible
The following issuers are ineligible to use the crowdfunding exemption:
- foreign issuers;
- Exchange Act reporting companies;
- investment companies;
- companies that are excluded from the definition of "investment company" under Section 3(b) or 3(c) of the Investment Company Act;
- an issuer who is disqualified for the reasons referred to in "Disqualification" below;
- an issuer who has sold securities in an exempt crowdfunding transaction but has not filed with the SEC and provided to investors, to the extent required, the required ongoing annual report (see "Ongoing Issuer Disclosure Obligations" above) during the prior two years; and
- an issuer that has no specific business plan or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies.
The crowdfunding exemption will not be available if the issuer is a "bad actor" or if certain other "bad actors" are associated with the issuer or the offering. The persons covered and the bad acts are substantially similar to those for the disqualification for the use or Rule 506 of Regulation D. An issuer will not lose the ability to use the crowdfunding exemption if it did not know, and in the exercise of reasonable care could not have known, of the disqualification.
Insignificant Failure to Comply With Requirements
Regulation Crowdfunding provides a safe harbor for an issuer for the failure to comply with a term, condition, or requirement of Regulation Crowdfunding in connection with an offering if the failure is insignificant to the offering as a whole. To qualify for this safe harbor, the issuer must have made a good faith effort to comply with Regulation Crowdfunding. In addition, in the case of a failure to comply by the intermediary in the offering, the issuer must not have known of the failure, or the failure must have occurred in the offerings of other issuers.
Securities issued in reliance on the crowdfunding exemption may not be transferred by any purchaser of those securities during the one-year period beginning when the securities were issued, except for transfers to:
- the issuer;
- an accredited investor;
- as part of an offering registered with the SEC; and
- to a family member, to a trust controlled by the purchaser, to a trust for the benefit of a family member or in connection with death or divorce or similar circumstance.
Exchange Act Registration
Securities issued using the crowdfunding exemption will not be counted in calculating the number of record holders to determine whether an issuer is required to register under the Section 12(g) of the Exchange Act if certain conditions are satisfied. The issuer must be current in the ongoing annual reports required by Regulation Crowdfunding and must have a registered transfer agent. This exclusion will no longer apply once the issuer has total assets of $25 million or more as of the end of any fiscal year.
Interaction with Blue Sky Laws
Under Section 18(b)(4) of the Securities Act, added by Section 305 of the JOBS Act, securities issued under the crowdfunding exemption do not have to be registered or qualified under state blue sky laws.