Crowdfunding Update- SEC Adopts New Rules for Investments under Reg A+

Crowdfunding is going to continue to explode in the near future. On March 25, 2015, the SEC adopted new rules to implement the provisions of the JOBS Act and Regulation A surrounding raising capital up to $50 million by smaller companies and, most likely, raise that money online on their websites or through social media. (The rules don’t go into effect until 60 days after they are published in the Federal Register and here is a copy of the rules and the SEC Press Release).  The new changes have been called “Regulation A+” and hailed by many as significant improvements in giving smaller companies more access to capital.

There are requirements for certain disclosures and filings with the SEC as well as registration of the websites with the SEC as funding portals like a securities “broker-dealer.”  There are also tiers for the companies that depend upon factors like the amount of money raised and state what the requirements will be for each tier.  The end result is that you are going to see much more investment opportunities on the internet and social media geared towards everyday consumers without the requirement that they be classified by higher wealth or income as “accredited investors”, so caveat emptor and let the buyer beware!

For those who aren’t sure, what exactly is “Crowdfunding”?  Most of the discussion in this area involves securities laws.  When a company needs to raise money, they may offer an investment in the company by way of stock, LLC units, convertible debt, or other investments.  These are all securities covered by US and State law and regulated primarily by the US Securities and Exchange Commission.  The company does not need to be a publicly traded stock like a Facebook or Microsoft to worry about the SEC and state regulators.  Any company or person offering or selling stock or other “security” can be subject to regulation.  When companies want to raise capital without the expense of registering their stock with the SEC, they rely upon exemptions from registration.  Most of those exemptions limit companies to seeking investors who meet the definition of “accredited investors.”  These are basically people with over a $1 million net worth or whose income is over $200,000.  Smaller investors are often kept out of these investments by rules designed to protect them assuming that they don’t have the financial savvy to protect themselves.  Crowdfunding is an effort to raise money for a company or a cause from a large number of investors each investing a small amount of money.  It was difficult to use crowdfunding to seek investors for a company if you were limited to only finding “accredited investors” and fall under an exemption from registration.  The provisions of the JOBS Act and the rules that the SEC is issuing are meant to expand access to capital for smaller companies.  Part of the provisions of the JOBS Act were to allow and expand the use of crowdfunding.  Instead of a company raising $250,000 by seeking $25,000 each from 10 accredited investors, the company will now try to raise $250 each from 1,000 regular investors.

It is hard to know the future impact of crowdfunding and the JOBS Act’s attempts to increase access to capital due to many possible areas for possible fraud or misleading of investors.  It looks like the SEC is going to keep a close eye on this topic and they are taking years to be sure the rules implementing the JOBS Act from 2012 cover all possible problems.  We will have to wait and see the impact, but it seems like many smaller companies will be able to gain access to previously difficult to obtain capital.

Don’t Go Advertising Your Funding Needs Just Yet

Anyone who has been watching the regulatory environment for securities and fund raising over the last few years or even months is familiar with the changes coming from the JOBS Act.  On July 10, 2013, the SEC announced that they will implement rules following the JOBS Act requirement that the ban on general solicitation and advertising in private placements be lifted in certain circumstances.

Although that sounds like good news, this was what the JOBS Act was intended to do when it was passed and the SEC is just now starting to implement rules based upon existing law.  The process is that the SEC proposes the rules to implement the provisions of the JOBS Act.  There is a public comment period and the rules go into effect 60 days after being published in the Federal Register.   This means the proposed rules are still not yet valid until that time frame has passed.

The new rules require a Form D to be filed with the SEC 15 days prior to any general solicitation and materials about the proposed offering need to be provided to the SEC.

Just like with crowdfunding, don’t listen to the hype and think that because the JOBS Act passed, people can start relying on crowdfunding exemptions.  The SEC has to fully implement the rules and procedures first.

Here is the SEC Fact Sheet on the July 10th, 2013 proposed new rules:

 

July 10, 2013

Background

Current Offering Process

Companies seeking to raise capital through the sale of securities must either register the securities offering with the SEC or rely on an exemption from registration. Most of the exemptions from registration prohibit companies from engaging in general solicitation or general advertising – that is, advertising in newspapers or on the Internet among other things – in connection with securities offerings. Rule 506 of Regulation D is the most widelyused exemption from registration.

In an offering that qualifies for the Rule 506 exemption, an issuer may raise an unlimited amount of capital from an unlimited number of “accredited investors” and up to 35 nonaccredited investors. Under SEC rules, accredited investors are individuals who meet certain minimum income or net worth levels, or certain institutions such as trusts, corporations, or charitable organizations that meet certain minimum asset levels.

JOBS Act

In April 2012, Congress passed the Jumpstart Our Business Startups Act (JOBS Act). Section 201(a)(1) of the JOBS Act directs the SEC to remove the prohibition on general solicitation or general advertising for securities offerings relying on Rule 506 provided that sales are limited to accredited investors and an issuer takes reasonable steps to verify that all purchasers of the securities are accredited investors. By requiring the SEC to remove this general solicitation restriction, Congress sought to make it easier for companies to find investors and thereby raise capital.

While issuers will be able to widely solicit and advertise for potential investors, the JOBS Act required the SEC to adopt rules that “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.” In other words, there is no restriction on who an issuer can solicit, but an issuer faces restrictions on who is permitted to purchase its securities.

Comments on the 2012 Proposal

Last August, in order to comply with the Congressional mandate to implement Section 201(a)(1) of the JOBS Act, the Commission proposed a rule that would remove the general solicitation ban in certain Rule 506 offerings in which sales would be limited to accredited investors and issuers would be required to take reasonable steps to verify such accredited status. After doing so, the Commission received comments from a wide range of commenters including issuers, investor organizations, individuals, law firms, state government officials, and professional and trade associations.

Some of these commenters suggested that the SEC consider measures that they believed would provide additional protections for investors in connection with removing the general solicitation ban. Several suggestions related to the notice that is required to be filed by an issuer in connection with a Rule 506 offering. This notice, called Form D, is filed with the SEC and available for review by the public. Other suggestions included changing the definition of accredited investor, imposing requirements governing the content and manner of general solicitations, and requiring issuers to file general solicitation materials with, or submit them to, the SEC.

New Rule Proposal

The Commission approved a proposal intended to enhance the SEC’s ability to assess developments in the private placement market now that the rule to lift the ban on general solicitation has been adopted. In particular, the proposal would improve the SEC’s ability to evaluate the development of market practices in Rule 506 offerings and would address certain concerns raised by investors related to issuers engaging in general solicitation.

The proposal requires issuers to file an advance notice of sale 15 days before and at the conclusion of an offering…

Currently, an issuer – such as a company or a fund – selling securities using Rule 506 is required to file a Form D no later than 15 calendar days after the first sale of securities in an offering. That form is a type of notice that provides information about the issuer and the securities offering. 

Under the proposal, issuers that intend to engage in general solicitation as part of a Rule 506 offering would, in addition to the current requirements, be required to file the Form D at least 15 calendar days before engaging in general solicitation for the offering. Also, within 30 days of completing an offering, issuers would be required to update the information contained in the Form D and indicate that the offering has ended.

The proposal requires issuers to provide additional information about the issuer and the offering…

Currently, Form D requires identifying information about the company or the fund selling the securities, any related persons, the exemption the issuer is relying on to conduct the offering, and certain other factual information about the issuer and the offering. 

Under the proposal, issuers are required to provide additional information to enable the SEC to gather more information on the changes to the Rule 506 market that could occur now that the general solicitation ban has been lifted.

The additional information would include:

  • Identification of the issuer’s website.
  • Expanded information on the issuer.
  • The offered securities.
  • The types of investors in the offering.
  • The use of proceeds from the offering.
  • Information on the types of general solicitation used.
  • The methods used to verify the accredited investor status of investors.

The proposal disqualifies issuers who fail to file Form D…

Under the proposal, an issuer is disqualified from using the Rule 506 exemption in any new offering if the issuer or its affiliates did not comply with the Form D filing requirements in a Rule 506 offering. As proposed, the disqualification would continue for one year beginning after the required Form D filings are made. Issuers would be able to rely on a cure period for a late Form D filing and, in certain circumstances, could request a waiver from the staff.

The proposal requires issuers to include legends and disclosures in written general solicitation materials…

Under the proposal, issuers are required to include certain legends or cautionary statements in any written general solicitation materials used in a Rule 506 offering. 

The legends would be intended to inform potential investors that the offering is limited to accredited investors and that certain potential risks may be associated with such offerings.

In addition, if the issuer is a private fund (a type of pooled investment vehicle) and includes information about past performance in its written general solicitation materials, it would be required to provide additional information in the materials to highlight the limitations on the usefulness of this type of information. The issuer also would need to highlight the difficulty of comparing this information with past performance information of other funds.

The proposal also requests public comment on whether other manner and content restrictions should apply to written general solicitation materials used by private funds.

The proposal requires issuers to submit written general solicitation materials to the SEC…

Under the proposal, issuers are required to submit written general solicitation materials to the Commission through an intake page on the SEC website. Materials submitted in this manner would not be available to the general public. As proposed, this requirement would be temporary, expiring after two years.

The proposal extends guidance about misleading statements to private funds…

Currently, an SEC rule provides guidance on when information in sales literature by an investment company registered with the SEC could be fraudulent or misleading for purposes of the federal securities laws. 

Under the proposal, this guidance – contained in Rule 156 under the Securities Act – would be extended to the sales literature of private funds. It would apply to all private funds whether or not they are engaged in general solicitation activities. In the proposing release, the SEC would express its view that private funds should now begin considering the principles underlying Rule 156.

What’s Next

The proposal is now subject to a 60-day public comment period.

SEC & CFTC Adopt Rules For Definitions of Terms in Derivatives Transactions under Dodd-Frank

On April18, 2012, the SEC, jointly with the Commodities Futures Trading Commission (CFTC), implemented part of the Dodd-Frank Act by adding definitions for use in interpreting what are swaps-related transactions.

The new Rule 3a71-1 under the Securities Exchange Act defines the term “security-based swap dealer” consistent with the criteria set forth in the Dodd-Frank Act as someone who:

  • Holds themselves out as a dealer in security-based swaps.
  • Makes a market in security-based swaps.
  • Regularly enters into security-based swaps with counterparties as an ordinary course of business for their own account.
  • Engages in activity causing them to be commonly known in the trade as a dealer or market maker in security-based swaps.

There is an exception for those who are only involved in a de minimis quantity of these transactions to not be held to this rule.  The rule will go into effect 60 days after the rule is published in the Federal Register.

You can read the entire release and rule through the SEC’s website at:
 http://www.sec.gov/news/press/2012/2012-67.htm

What Do the JOBS Act, Reg D Change, and Crowdfunding Bills Actually Say? Which bill is right? Read H.R. 3606

I have noticed quite a bit of confusion in blogs when discussing crowdfunding, the JOBS Act, and other recent legislation regarding small business, startups, and emerging growth companies.  Even respected news organizations don’t get the specifics exactly right about what this legislation actually says, so I thought I would set the record straight.

President Obama is set to sign H.R. 3606 this week.  The best way to know exactly what this bill says is to read it, despite the somewhat dense language and references to other parts of U.S. law. Here is a link to the actual PDF format of H.R. 3606This is an easier to read version I put together on my site with hyperlinks to each section.  For an overview and summary of this bill and its history you can read here.  These are links directly to the information provided by Congress.  Some of the confusion has been that the legislative process involves a very confusing system where bills are introduced, amended, and sometimes added to existing bills.  That was the case with the JOBS Act and the crowdfunding provisions.  H.R. 2930 was the original crowdfunding bill that passed the U.S. House and went to the Senate, but did not actually pass the Senate.  After adding and deleting portions from various amended versions similar to H.R. 2930, the crowdfunding and other provisions were all put into one bill called H.R. 3606.  This passed the Senate and then went back to the U.S. House after amendments to be passed.  It has passed and was forwarded to the President for signature on March 27, 2012.  He is expected to sign it this week.

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“Emerging Growth Companies”- JOBS Act May Provide Eased Regulations

With H.R. 3606, or most commonly referred to as the “JOBS” Act (Bill SummaryBill Text PDF), likely to be signed into law this week by President Obama, there are some new changes that may be of help to startup and small companies.  In addition to the so-called crowdfunding exemption from securities registration which allows pooling of small amounts from investors to fund a company, the JOBS Act puts in place regulations that carve out a category called “emerging growth companies” which have an intermediate level of reporting obligations with the SEC.  It is between the level of disclosures required for a fully reporting large company and a private, non-reporting company.  This could be a very good help for these small to middle market companies to ease the burden of time and expense in being a fully reporting company.

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To Stagger or Not to Stagger Your Board of Directors, That is the Question

One question faced by companies from startup through Fortune 500 status is whether they should stagger or classify their board of directors.  Staggering or classifying occurs when the corporation sets up voting for election of only a minority of members of the board every year, so it often takes several years to replace an entire board.  This is viewed as a good takeover defense and also argued to be good for the corporation because frequent changes of directors can result in corporate policy and corporate governance changing more often or more dramatically. Those against it feel that it doesn’t give shareholders the ability to make major changes when problems arise with the current board’s decisions and it entrenches existing corporate policy and management to not as easily allow for necessary change.  Although some would downplay trying to make this about shareholder rights versus management or existing structure, that is a major factor of the argument.

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Crowdfunding Passed Senate but Reduced By Bill Amendment

H.R. 2930, one part of the multi-bill JOBS Act being pushed through Congress, was to allow more eased securities regulation of so-called crowdfunding.  Some have argued that sites like Kickstarter or others could change their business model (currently only accepts gifts or donations, called pledges, to raise money) to help companies raise money for companies in exchange for stock in that company.  Currently, that model would be prohibited under securities laws as general advertising and public sales of stock are not allowed, especially through an intermediary, with certain exceptions like using a registered broker-dealer or registering the stock with the SEC.

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Insider Trading Crackdown on Congress- STOCK Act | H.R. 1148 S.1871

The Stop Trading on Congressional Knowledge Act (STOCK) has now passed both the U.S. House and Senate and should be signed into law by the president very soon. (Actual Text | Bill Summary & Status) H.R. 1148 or Senate Version S.1871 is the bill that seeks to impose heavier restrictions on insider trading that is done by or is connected to members of congress, federal employees, or employees of congress. Insider trading is covered by the Securities Act of 1934 and other related federal legislation and rules by the SEC and CFTC. It occurs when someone uses inside information as a basis to trade in stocks, commodities, or other types of securities. Inside information is defined as material non-public information. An example would be someone who works for a public company, gains information about something about to happen with that company that has not been disclosed to the public (e.g. significantly increased profits, new products about to be launched, etc.), and trades based upon that information.

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Kickstarter and other crowdfunding platforms to grow in the very near future

Kickstarter is one of the main examples of a crowdfunding type of company.  It solicits money to help fund new projects or companies.  So is this general advertising, solicitation, and funding by a non-broker/dealer or intermediary that is not allowed by law? Yes and no.

Although their terms of use and other information on their website do not specifically state this, they are essentially relying upon the fact that the money used is in the form of a gift (or pledge as they call it) to the company.  The person pledging the money does not get an ownership interest or much else in exchange for their contribution.  Usually a company obtains funding by selling stock or getting a loan and enters into a sale of stock or sale of a promissory note.  These are securities and are subject to federal and state law regarding their offering, purchase, and sale.  Generally, a company cannot use general advertising or solicitation of the investment if they want to use the exemptions from registration available by law.  Two examples: First, Facebook files for an IPO and the world knows they are selling stock.  They have filed a registration statement, or S-1, with the SEC and this complies with laws to allow them to be able to publicly announce the sale.  Second, Most startup or small companies do not have the resources or want to try to go through the process of filing with the SEC.  They rely upon exemptions from registration to sell stock.  The law puts certain requirements that need to be met to be able to use those exemptions, one of which is that they can’t go out and issue a press release or put on their website that they are trying to raise $1 million by the sale of their stock.

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