By Jason Bramwell
The US Securities and Exchange Commission (SEC) voted unanimously October 23 to propose rules under the Jumpstart Our Business Startups (JOBS) Act that will enable companies to offer and sell securities through crowdfunding.
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, according to the SEC.
The SEC defines crowdfunding as "an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects ranging from innovative product ideas to artistic endeavors, like movies or music."
Title III of the JOBS Act, which was signed into law by President Obama in April 2012, created an exemption under the securities laws so that this type of funding method could be easily used to offer and sell securities. The JOBS Act also established the foundation for a regulatory structure for this funding method.
The intent of the JOBS Act was to make it easier for start-ups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors, according to SEC Chair Mary Jo White.
"There is a great deal of excitement in the marketplace about the crowdfunding exemption, and I'm pleased that we're in a position to seek public comment on a proposal to permit crowdfunding", she said in a written statement October 23. "We want this market to thrive in a safe manner for investors."
During Wednesday's meeting, SEC Commissioner Kara Stein said the proposal is a particularly challenging one for the SEC.
"We are proposing an entirely new regime for the regulation of some types of securities offerings", she said in a speech during the meeting. "The proposal before us seeks to strike a balance between our statutory duty to create a new regulatory regime for capital formation and our long-standing duty to protect investors. It is clear to me that the proposal before us seeks to make that vision a reality. But, in truth, we won't know if we achieve that reality until the rule is finalized and this new method of securities offering begins."
The SEC is seeking public comment on the proposed rules for a ninety-day period following their publication in the Federal Register.
In a written statement, Howard Landers, director of regulatory affairs for the National Crowdfunding Association (NLCFA) and co-CEO of funding portal developer eBarnRaiser LLC, said the association is pleased the SEC has given the industry a framework on which to build.
"The industry will now study the proposed rules and engage with the regulators to ensure that investment crowdfunding in the United States is efficient, effective, and aids in capital creation while taking investor protection into account", he said. "The NLCFA looks forward to working with all regulatory bodies – the SEC, FINRA [Financial Industry Regulatory Authority], and members of the North American Securities Administrators Association [NASAA] – to help create the investment crowdfunding marketplace and to give the industry participants a voice through the NLCFA."
The NLCFA said it will be reviewing the 585 pages of proposed rules, along with the 295 questions in the release, before issuing a comprehensive response to the SEC.
Overview of Proposed Rules
According to the SEC, the proposed rules would stipulate the following:
- A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a twelve-month period.
- Investors, over the course of a twelve-month period, would be permitted to invest up to: $2,000, or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000; or (2) ten percent 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 twelve-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.
Certain businesses would not be eligible to use the crowdfunding exemption, including:
- Non-US companies.
- Companies that are already 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.
- Companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.
Under Title III of the JOBS Act, 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.
The proposed rules would require companies conducting a crowdfunding offering 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. The information required would include:
- Information about officers and directors as well as owners of 20 percent or more of the company.
- 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.
- A description of the financial condition of the company.
In addition, financial statements of the company that, depending on the amount offered and sold during a twelve-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 material changes and provide updates on the company's progress toward reaching the target offering amount.
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.
The SEC noted that one of the key investor protections Title III of the JOBS Act provides for crowdfunding is the requirement that crowdfunding transactions take place through an SEC-registered intermediary – either a broker-dealer or a funding portal. Under the proposed rules, the offering 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 do the following:
- Provide investors with educational materials.
- Take measures to reduce the risk of fraud.
- Make available information about the issuer and the offering.
- Provide communication channels to permit discussions about offerings on the platform.
- Facilitate the offer and sale of crowdfunded securities.
Funding portals would be prohibited from the following:
- Offering investment advice or making recommendations.
- Soliciting purchases, sales, or offers to buy securities offered or displayed on their website.
- Imposing certain restrictions on compensating people for solicitations.
- Holding, possessing, or handling investor funds or securities.
The proposed rules would also provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.