The Securities and Exchange Commission recently voted unanimously to propose rules that, for the first time, would allow investors to buy stock in companies over the Internet using a crowdfunding exchange. The proposed rules would exempt crowdfunding capital raises from the registration requirements of the Securities Act of 1933, as amended. The rules will revolutionize the way companies raise money by allowing them to bypass the traditional costs of going public or raising capital.

The SEC is required to adopt these rules under the Jumpstart Our Business Startups Act of 2012 (JOBS Act), which established the foundation for start-ups and small businesses to raise capital through crowdfunding, an evolving means of raising capital using the Internet.

The proposed rules are extensive and cover areas such as:

• Limitations on, and method of calculating, the amount of funds an issuer can raise in crowdfunding transactions
• Limitations on the amount an individual investor may invest in such offerings based on their income and assets:
  • Investors with an annual net income or net worth of less than $100,000 can invest up to 5 percent of that amount, or $2,000, whichever is more, every 12 months.
  • Investors with an annual income or net worth exceeding $100,000 can invest up to 10 percent of that every 12 months.
• Disclosure obligations of the company raising funds, which would require the company to prepare an offering statement that must be filed with the SEC, provided to its intermediary, and made available to investors that, among other things, discloses:
  • Information about officers, directors, and 20 percent owners
  • A description of the company’s business and business plans, number of employees, and the use of proceeds from the offering
  • Information about the risks of the offering
  • The price to the public of the securities being offered, how the valuation of the securities was determined, the target offering amount, the deadline to reach the target amount, and whether the company will accept capital in excess of the target amount
  • Information about related-party transactions
  • Information about the financial condition of the company
  • Financial statements that, depending on the target amount offered in crowdfunding transactions during the trailing 12-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
• The duty to update the offering statement for material events over the course of the offering before completion, and to provide investors with the option to back out of their investment as a result
• Prohibitions on advertising crowdfunding offerings, other than very limited notices and communications through the intermediaries described below
• The requirement that crowdfunding transactions must take place exclusively online through platforms operated by an SEC-registered intermediary, either a broker-dealer or a new type of SEC registrant called a “funding portal,” which is required to:
  • Have a reasonable basis for believing that the crowdfunding company is complying with applicable rules
  • Ensure that the company’s disclosure is made publicly available for 21 days before securities are sold
  • Provide investors with educational materials
  • Take measures to reduce the risk of fraud and deny access to any company if it believes the company or the offering presents the potential for fraud or otherwise raises concerns regarding investor protection
  • Make available information about the company and the offering
  • Provide communication channels to permit discussions about offerings on the platform
  • Avoid offering investment advice or making recommendations

The SEC strives in its proposal to strike a balance between maintaining flexibility and cost savings for companies raising capital with the need to protect individual investors. Interestingly, the SEC recognizes that the proposed rules “could significantly affect the viability of crowdfunding as a capital-raising method for startups and small businesses.”

The proposed rules are subject to a 90-day comment period. Echoing its prior guidance, the SEC reminds issuers that, until final rules become effective, issuers and intermediaries may not rely on the crowdfunding exemption created by the JOBS Act.