Audit, Compliance and Risk Blog

The 2012 Jumpstart Our Business Startups (JOBS) Act enacted a number of changes to national securities laws intended to make it easier for small companies to raise capital privately, before having to confront the possibilities of initial public offerings or acquisition. One important piece directed the Securities and Exchange Commission (SEC) to enact rules to allow “crowdfunding” of qualifying small capital issues without requiring registration of the securities or issuer with SEC itself. The JOBS Act directed SEC to issue its rules by January 2013, but SEC only completed the task in November 2015, with rules that will become effective in May 2016. (I blogged about the proposal here) SEC’s new Regulation Crowdfunding (codified as 17 Code of Federal Regulations (CFR) part 227) defines requirements for issuers, and a new category of registered entities called “intermediaries”, who must register with SEC as brokers (using pre-existing rules) or as a new category of party called “funding portals.”

What are the Aggregate Annual Limits On Transactions?

• Sales limit on issuers. The aggregate amount an issuer can sell to all investors under this exemption, including the subject transaction and all others during the 12 months preceding the subject transaction, must be no more than $1 million.

• Purchase limit on buyers. The aggregate amount bought by any one investor from all issuers under this exemption, in the subject transaction and during the 12-months preceding the subject transaction, must not exceed either of the following:

  • The greater of $2,000 or 5 percent of the investor’s annual income or net worth, if either is less than $100,000.

  • 10 percent of the investor’s annual income or net worth, if both are $100,000 or more.

What Compliance Requirements Must Issuers Meet?

Issuers must meet additional requirements to use this exemption. First, the issuer must be organized under, and subject to the laws of a State or territory of the U.S., and must not be any of the following:

• Already required to file reports under 1934 Act Section 13 or 15(d) (e.g., for registered securities).

• An investment company under the Investment Company Act of 1940, or operating under a statutory exclusion from that definition.

• Disqualified under “bad actor” provisions because the issuer or a named participant is subject to specified administrative, civil or criminal sanctions.

• Has already sold securities in reliance on this exemption, but has not provided required annual reports during the preceding two years.

• Is a “blank check company” (has no specific business plan, or its business plan is to engage in a merger or acquisition with an unidentified company or companies).

In addition, issuers must meet extensive compliance requirements established by Regulation Crowdfunding. These include notice and disclosure requirements relating to the offering (akin to that required for a registered offering, but subject to less stringent requirements), including:

• Information about the issuer, the issuer, and the use of funds received.

• Information about the intermediary being used for the offering (see below).

• Target offering amount, with disclosure that the offering may be cancelled if the target is not reached.

• Target offering timing, with disclosure that the offering may close early if the target is reached and/or may remain open seeking even more funding.

• Process for investors to complete the transaction or cancel an investment commitment, including a statement that:

1. Investors may cancel an investment commitment until 48 hours prior to the deadline identified in the issuer’s offering materials;

2. The intermediary will notify investors when the target offering amount is met;

3. If the target offering amount is reached before the deadline identified in the offering materials, the issuer may close the offering early if it provides notice about the new deadline at least five business days before such new offering deadline; and

4. If an investor does not cancel its commitment at least 48 hours before the offering deadline, the funds will be released to the issuer upon closing of the offering and the investor will receive securities.

• Statement that if an investor does not reconfirm his or her investment commitment after notice of a material change to the offering, the investor’s commitment will be cancelled and committed funds will be returned;

The issuer must provide this information to SEC on a new Form C, and the information must also be available through the intermediary’s portal (see below). An updated new Form C must be filed annually, or in response to specified events.

During the offering, the issuer must not advertise (directly or indirectly) the terms of the offering, except through notices that meet the following requirements:

• A statement that the issuer is conducting an exempt crowdfunding offering, the name of the intermediary through which the offering is being conducted, and a link directing potential investors to the intermediary’s platform.

• The terms of the offering.

• The following factual information about the issuer: name; address, phone number and Web site; email address of a representative; and a brief description of the issuer’s business.

What Are Intermediaries and What Requirements Must They Meet?

An exempt crowdfunding offering must be conducted through a single intermediary, which must be:

• Registered with SEC, as either of the following:

  • Broker

  • Funding portal

• A member of a registered national securities association.

• Be financially independent of the issuer except for compensation paid to provide intermediary services.

• Take measures to reduce the risk of fraud by the issuer, including background checks on the issuer and its principal owners and personnel.

• Limit securities purchases through it platform to investors who have an account with the intermediary, have demonstrated eligibility to make the investment, and have received required notices about this investment opportunity, applicable procedures, and risks of investments and the specific crowdfunding underway.

• Provide communication channels for persons – account holders and others – to communicate with one another and with issuer representatives about offerings available on the platform, in compliance with required procedures.

• Provide investors with specified information about each purchase through the platform, and meet requirements for managing funds related to transactions.

• Meet notice and investment management requirements for offerings, including those applicable to completion of offerings, cancellations and reconfirmations.

Self-Assessment Checklist

• Is the organization eligible to use the crowdfunding exemption?

Am I an individual interested in using crowdfunding procedures to invest in companies that are not publicly traded?

Is my organization considering provision of intermediary services for crowdfunding transactions?

• Is the organization a registered broker?
• Is the organization considering registration as a funding portal?

• SEC press release summarizing crowdfunding rules  

• SEC Release adopting Crowdfunding rules and conforming revisions to other rules 

Specialty Technical Publishers (STP) provides a variety of single-law and multi-law services, intended to facilitate clients’ understanding of and compliance with requirements. These include:

• Securities Law: A Guide to the 1933 and 1934 Acts and their Amendments, including Sarbanes-Oxley and Dodd-Frank

• Directors' and Officers' Liability

• Directors' Liability in Canada

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