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The SEC’s New Crowdfunding Rules Under the JOBS Act to Become Effective May 2016

January 29, 2016

 

Regulation Crowdfunding, a set of new rules that enables private companies to raise up to $1 million in a 12-month period without registration under the Securities Act of 1933, as amended (“Securities Act”), will become effective May 16, 2016. 

Regulation Crowdfunding:

  • provides a new means for businesses, especially start-up companies, to raise money that may supplement friends and family, angel networks, venture capital financing, and debt financing;
  • dramatically increases the number of people who are eligible to participate in private financings from the small percentage of Americans who qualify as “accredited investors” to virtually the entire U.S. population;
  • imposes substantive requirements on businesses and crowdfunding intermediaries seeking to employ new business models to take advantage of the new flexibility; and
  • imposes liabilities for fraud and creates incentives for crowdfunding intermediaries to carefully structure their business processes to avoid liability.

Regulation Crowdfunding seeks to balance flexibility for issuers with respect to financial statement and other disclosures against investor protections through the investment limitations and the role of intermediaries. The new capital raising alternative may appeal to smaller private companies in need of additional financing alternatives as well as larger private companies who may view it as a means to seek greater engagement from customers or other stakeholders. Although Regulation Crowdfunding will simplify and may facilitate capital raising by smaller issuers, issuers will need to weigh the cost of financial statement and other disclosure issues and the impact of required participation by market intermediaries against the potential benefits from access to investors who are currently excluded from participation in unregistered securities offerings. 

Regulation Crowdfunding—Overview

All offers or sales of securities in the U.S. must either be registered under the Securities Act or be exempt from registration.  Section 4(a)(6) of the Securities Act was added by the Jumpstart Our Business Startups (“JOBS”) Act of 2012 to provide an exemption from registration for certain crowdfunding transactions in which an issuer publicly sells securities to a person who is neither an accredited investor nor a sophisticated investor.  Transactions conducted in compliance with Section 4(a)(6) are also exempt from state registration.  In addition, issuers do not need to count the holders of those securities for purposes of determining registration thresholds under the Securities Exchange Act of 1934, as amended (“Exchange Act”) so long as the issuer has less than $25 million in assets, it is current in its Regulation Crowdfunding annual reporting obligations and retains a registered transfer agent for shareholder recordkeeping.  If properly structured, Section 4(a)(6) crowdfunded transactions may also be conducted in tandem with more traditional Regulation D private placement or venture financings.

 

Total Offering Amount Limitation

$1 million in any 12-month period.

Permitted Investors

Everyone (not limited to accredited investors).

Total Investment Amount Limitation

Investors are limited to investing (in all Regulation Crowdfunding offerings by any issuer during any 12-month period):

  • the greater of $2,000 or 5 percent of the lesser of the investor’s annual income or net worth (to be calculated in accordance with Regulation D), if the annual income or net worth of the investor is less than $100,000; or

  • 10 percent of the lesser of the investor’s annual income or net worth (not to exceed an amount sold of $100,000), if both of the investor’s annual income and net worth are $100,000 or more.

During any 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000

Required Use of Intermediary (discussed in detail in our funding portal release)

Must be conducted exclusively through an intermediary that is registered as either a broker-dealer or as a funding portal.

May only use a single intermediary’s online platform during any particular crowdfunding transaction.


Restrictions on Communications

May not advertise the terms of the offering outside of the broker or funding portal facilitating the offering.

May publish notices of the offering, in newspapers or on social media sites or the issuer’s website, that include:

  • a statement that the issuer is conducting an offering;

  • the name of the intermediary;

  • a link to the intermediary’s online platform;

  • certain limited terms of the offering, including (i) the amount of securities offered; (ii) the nature of the securities; (iii) the price of the securities; and (iv) the closing date of the offering period; and

  • factual information about the legal identity and business location of the issuer.

Resale Restrictions

Securities issued in a crowdfunding transaction may not be resold by any purchaser of such securities for a period of one year unless such securities are sold or transferred:

  • to the issuer of the securities;

  • to an accredited investor;

  • as part of a registered offering; or

  • to a family member in connection with the death or divorce of the purchaser.

Disqualified Persons

(i) A non-U.S. company; (ii) a reporting company under the Exchange Act; (iii) an investment company, or a company excluded from the Investment Company Act pursuant to Section 3(b) or 3(c) thereunder; (iv) a company that is subject to disqualification under Regulation Crowdfunding; (v) a company that has failed to comply with the annual reporting requirements of Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement; and (vi) a blank check company.

An issuer seeking to engage in a crowdfunding transaction under Regulation Crowdfunding must file new Form C with the SEC, including certain financial information (discussed further below) as well as the following information in XML format:

 

  • its officers, directors, and greater than 20% shareholders

  • website (and the location and date of availability of its annual report on its website)

  • business and business plan

  • use of proceeds

  • ownership and capital structure

  • offering price of the securities (or the method of determining the price)

  • target offering amount, maximum offering amount, treatment of oversubscriptions, jurisdictions where offering made, and offering deadline

  • the identity of and compensation paid or to be paid to the crowdfunding intermediary and any other direct or indirect interest in the issuer held by the intermediary (or any arrangement for the intermediary to acquire such an interest)

  • certain legends

  • current number of employees

  • material risk factors that make investments in the issuer speculative or risky

  • the material terms of any indebtedness

  • any other exempt offerings during the past three years

  • related party transactions

  • any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading

  • whether the issuer or any of its predecessors previously failed to comply with the ongoing reporting requirements of Regulation Crowdfunding

Form C includes an optional Q&A format, which issuers may elect to use to provide the disclosures that are not required to be filed in XML format. Issuers opting to use this format would prepare their disclosures by answering the questions provided and filing that disclosure as an exhibit to Form C.

Sliding Scale of Financial Disclosure Requirements

Issuers are required to file with the SEC and provide to intermediaries and prospective investors a sliding scale of financial information based on the aggregate target offering amount under the crowdfunding exemption within the preceding 12-month period:

 

Offering Size

Financial Disclosure Requirements

$100,000 or Less

The amount of total income, taxable income and total tax as reflected in the issuer’s federal income tax returns certified by the principal executive officer (in lieu of filing a copy of the underlying tax return), and financial statements certified by the principal executive officer, unless financial statements of the issuer that have been reviewed or audited by an independent public accountant are available.

$100,000 to $500,000

Financial statements reviewed by an independent public accountant, unless financial statements of the issuer that have been audited by an independent public accountant are available.

Over $500,000 to

$1 million

For a first-time offering: financial statements reviewed by an independent public accountant, unless financial statements of the issuer that have been audited by an independent auditor are available.

For a non-first-time offering: audited financial statements prepared by an independent public accountant.

Issuers are required to disclose information about the issuer’s progress toward the target offering amount. If the intermediary does not make such information publicly available on the intermediary’s platform, the issuer is required to file the interim progress updates with the SEC. In addition, all issuers must report to the SEC the total amount of securities sold in an offering at the end of the offering on new Form C-U.

Annual Reporting Requirement

An issuer, who has conducted an offering pursuant to Regulation Crowdfunding, will be required to file annual reports with the SEC on new Form C-AR, and to post such reports on its website. The disclosure contained on new Form C-AR will closely mirror the disclosure provided to investors during the crowdfunding offering, and will be due within 120 days after the end of the issuer’s fiscal year. Unlike the offering disclosures on new Form C, however, the annual reports do not require audited or reviewed financial statements unless such financial statements have been prepared for other purposes. Instead, the annual reports of an issuer only need to include financial statements of the issuer certified by its principal executive officer.

Termination of Annual Reporting Requirement

Issuers will be required to continue filing annual reports on Form C-AR until the earliest of one of the following:

  • the issuer becomes an Exchange Act reporting company;
  • the issuer has filed one annual report and has fewer than 300 holders of record;
  • the issuer has filed at least three annual reports and has total assets that do not exceed $10 million;
  • the issuer repurchases all of the securities issued pursuant to the crowdfunding exemption; or
  • the issuer liquidates or dissolves in accordance with state law.

Issuers are required to file new Form C-AR to disclose that their reporting obligations have been terminated.

Insignificant Deviations

Regulation Crowdfunding provides a safe harbor for insignificant deviations from a term, condition, or requirement of the crowdfunding rules. To qualify for the safe harbor, an issuer must demonstrate that:

  • the issuer’s failure to comply was insignificant with respect to the offering as a whole;
  • the issuer made a good-faith and reasonable attempt to comply with the requirements of the crowdfunding rules; and
  • the issuer did not know of the failure to comply, where the failure to comply with a term, condition or requirement was the result of the failure of the intermediary, or such failure by the intermediary occurred solely in offerings other than the issuer’s offering.

Statutory Liability

Section 4A(c) provides that an issuer, who conducts a crowdfunding offering, will be liable to a purchaser of its securities if, in the offer or sale of the securities, such issuer (i) makes an untrue statement of a material fact, or (ii) omits to state a material fact required to be stated or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading; provided, however, that the purchaser does not know of the untruth or omission, and the issuer is unable to prove that it did not know, and in the exercise of reasonable care could not have known, of the untruth or omission.

The full text of the adopting release is available here, Title III and other provisions of the JOBS Act are explained more fully in our JOBS Act client alert, available here, and the provisions governing crowdfunding intermediaries are addressed in more detail in our client alert available here.

Please contact the attorneys listed below or your contacts with O’Melveny if you have any questions regarding this release.


This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Robert Plesnarski, an O'Melveny partner licensed to practice in the District of Columbia and Pennsylvania, Eric Sibbitt, an O'Melveny partner licensed to practice law in California and New York, James Harrigan, an O'Melveny associate licensed to practice law in the District of Columbia and Maryland, and Zhao Liu, an O'Melveny associate licensed to practice law in the District of Columbia and California, contributed to the content of this alert. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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