Last week, the U.S. Securities and Exchange Commission (SEC) adopted the final rule permitting crowdfunding, permitting investors to purchase securities over the Internet using a crowdfunding exchange, on October 30, 2015. The SEC also proposed amendments to existing Securities Act Rule 147 and Rule 504 of Regulation D to facilitate small business capital-raising.
The SEC first proposed the crowdfunding rule in 2013 under the congressional mandate contained in Title III of the Jumpstart Our Business Startups Act of 2012 (JOBS Act). The JOBS Act established the foundation for start-ups and small businesses to raise capital through Internet-based crowdfunding intermediated by a registered broker-dealer or funding portal. The SEC received more than 480 comment letters which raised concerns over investor protection and the workability of the rule for issuers.
The final crowdfunding rule permits issuers to raise up to $1 million in a 12-month period through online portals run by broker-dealers or funding portals registered with the SEC. Issuers are required to file financial statements and certain information about their business and the securities offering with the SEC on the new Form C. Issuers must provide such information to investors, potential investors, and the crowdfunding intermediary for the offering. The rule also creates a regulatory framework for the broker-dealers and funding portals that will facilitate crowdfunding offerings.
The investor protection provisions in the final crowdfunding rule limit the amount individual investors may invest in all crowdfunding offerings over a 12-month period based on annual income and net worth. Investors with either annual income or net worth of less than $100,000 can invest up to 5 percent of the lesser of their annual income or net worth, or $2,000, whichever is greater, every 12 months. An investor with annual income or net worth greater than $100,000 can invest up to 10 percent of the lesser of their annual income or net worth every 12 months. The aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000 in a 12-month period.
The new crowdfunding rule and related Form C will be effective 180 days after they are published in the Federal Register. Forms enabling funding portals to be registered with the SEC will be effective January 29, 2016.
Principal Changes in the Final Rule
The principal changes to the crowdfunding rule appear designed to make the rule more workable for start-ups and small businesses and to provide additional investor protections. These changes include:
Exemption to Audit Requirement–While the final rule retains the requirement that issuers with offerings in excess of $500,000 provide audited financial statements, an exemption has been added for first-time crowdfunding issuers, who can provide reviewed financial statements.
Disclosure Requirements–Issuers conducting smaller offerings are not required to file tax returns, as proposed, but can instead disclose specific information from the returns. In addition, the final rule contains an optional Q&A format that issuers can use to provide the required disclosure under new Form C.
Investment Limitations–The final rule contains stricter investment limitations. The total amount of securities sold to any single investor by the issuer during a 12-month period is now based on the lesser of the issuer’s annual income or net worth, as detailed above.
Intermediary Financial Interest–The final rule permits intermediaries to receive a financial interest in the issuer as compensation for its services, so long as the interest received is on the same terms as the offered securities and it is disclosed on the portal.
Proposed Amendments to Rule 147
The proposed amendments to Rule 147 seek to modernize the rule to permit companies to conduct intrastate offerings using the Internet and other technologies without having to concurrently register at the federal level. As proposed, amended Rule 147 would:
Permit general solicitation and general advertising
Require that all sales be made only to residents of the state where the issuer’s principal place of business is located
Impose thresholds for eligibility relating to an issuer’s presence within the state of offering, and
Limit the exemption to offerings that are registered under state law or conducted under an exemption from state law registration that limits the total offering amount to $5 million in a 12-month period and imposes certain investment limitations on investors.
Proposed Amendments to Rule 504
The proposed amendments to Rule 504 of Regulation D would increase the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million and disqualify certain bad actors from participating in such offerings.