SEC Proposes Regulations Related to Crowdfunding (Part 1)

by Allen Matkins

The Securities and Exchange Commission ("SEC") proposed for comment new regulations on Crowdfunding.

Crowdfunding is the general term used to describe a new way of raising capital using the Internet. A crowdfunding campaign generally has a specified target amount of money to be raised, an identified use of those funds, and is often associated with small investments from a large group of people. Until now, crowdfunding websites did not facilitate the sale of securities.

The Jumpstart Our Business Startups Act ("JOBS Act"), enacted on April 5, 2012, created a regulatory framework which permits, upon the adoption of these rules by the SEC, individuals and companies to sell securities to the public using crowdfunding. (It should be noted that these rules do not apply to "crowdfunding" websites that sell securities but limit the investors to "accredited investors.")

The JOBS Act established a new exemption under the Securities Act of 1933 under Section 4(a)(6). These proposed regulations would provide additional requirements that both issuers and companies that are seeking to engage in the crowdfunding business as an intermediary would need to meet.

Below we summarize and discuss the proposed rules applicable to issuers that, in our view warrant particular attention. Part 2, to be addressed in our next alert, discusses the proposed rules applicable to the crowdfunding intermediaries, as well as the proposed rules relating to the liability scheme.

As a general matter, the SEC has proposed rules that are often difficult and technical in nature. The disclosure obligations include items such as financial statements (which must be audited if the issuer is raising over $500,000, certified by an independent public accountant, if the issuer is raising between $100,000 and $500,000), a written summary of the issuer's financial conditions, such as one would find in a Management Discussion and Analysis section of a prospectus, and a discussion of the material factors that make an investment in the issuer speculative or risky.

In addition, reliance on this exemption obligates the issuer to provide ongoing annual reports to its shareholders, in many cases forever. These annual reports would mirror the offering statement, including the narratives discussed above, and in many cases would require audited financial statements on a yearly basis.

The proposed rules do permit the intermediary to provide advice in complying with the rules (whether this constitutes providing legal advice under state law is another matter). However, the SEC is not proposing a form to assist the issuers, or even providing a general outline of some of the required disclosures. This makes it very difficult for the average company to meets its legal obligations under Section 4(a)(6) and these proposed regulations.

The complexity of these rules all but requires companies to utilize substantial legal assistance in connection with their offerings. This requires these small companies to use their limited resources, not on product development, research or other potentially value creating activities, but on accountants and lawyers. To make matters more difficult, the regulatory liability scheme for crowdfunding offerings can leave directors, officers, and other employees involved in the offering with personal liability despite acting on behalf of the entity.

Despite the supposed good intentions, crowdfunding under Section 4(a)(6), as currently proposed, does not appear ready to help small businesses close the funding gap. In this author's view, the proposed rules should be designed to foster an open and transparent market, with a few limited, but clear rules regarding disclosures. Strong civil and criminal liability, as exists under the current statute, would protect investors from fraudulent activity. The twin stated goals of investor protection and capital formation would be better served by truly relying upon the "wisdom of the crowd" instead of re-creating the obligations under a registration statement, through rules that require 568 pages to propose (that is not a typo).

These rules are proposed, and have not yet been adopted. Until rules have been adopted, the Section 4(a)(6) exemption is not yet available.

If you do not agree with the SEC's proposed rules or have any other thoughts or comments on them, please send them to the SEC. Comments should be received by the SEC on or before February 3, 2014.


The JOBS Act enacted a new exemption for the offer and sale of securities pursuant to Section 4(a)(6) of the Securities Act of 1933 (the "Securities Act"), which provides for an exemption from the registration requirements of the Securities Act of Section 5 for certain transactions.

To qualify for this exemption, transactions by an issuer must meet certain specified requirements, including: 

  • The amount raised in all Section 4(a)(6) offerings must not exceed $1 million in a 12-month period; 
  • Each investor is limited to an agreement amount of investments under Section 4(a)(6) of either; 
  • The greater of $2,000 or 5 percent of annual income or net worth, if annual income or net worth of the investor is less than $100,000; and 
  • 10 percent of annual income or net worth (not to exceed an amount sold of $100,000), if annual income or net worth of the investor is $100,000 or more; and 
  • The transaction must be conducted through an intermediary that is either registered as a broker or is registered as a new type of entity, called a "funding portal;" 
  • The issuer must provide certain information to investors and potential investors, take certain other actions and provide notices and other information to the Commission;

The JOBS Act required the SEC to propose certain rules regarding the implementation of these provisions, as well rules that would implement exemptions from the Securities Exchange Act of 1934 (the "Exchange Act").

Limitation on Capital Raised under Section 4(a)(6)

As discussed above, Section 4(a)(6) provides that "the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under [Section 4(a)(6)] during a 12-month period preceding the date of such transaction is not more than $1,000,000. 

  • The proposed rules clarify that only capital raised under Section 4(a)(6) is counted toward the limitation. Capital raised through other means would not be counted in determining the aggregate amount sold in reliance on Section 4(a)(6) 
  • The proposed rules also permit an issuer to complete an crowdfunding transaction under Section 4(a)(6), simultaneously with, proceeded by, or following, another exempt offering. The proposed rules add some limitations, particularly in the case of an exempt offering for which general solicitations is permitted. 
  • In determining the 1,000,000 aggregate amount limitation, an issuer is required to aggregate its sales with all sales under Section 4(a)(6) made by all entities that are controlled by or under common control with the issuer, as well as any predecessors of the issuer. 
  • The SEC is proposing to use the same definition of "control" that is set forth in Rule 405, which is "the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities by contract, or otherwise." Generally the SEC views officers, directors, and certain large shareholders as generally having control. The use of this definition may cause problems for issuers, particularly in the technology space with certain angel investors, and directors, having roles at multiple companies. If enacted as proposed, companies will need to be extremely careful of the calculation of this limitation.

Investment Limitations

As indicated above, Section 4(a)(6) limits the amount of securities that any individual can purchase annually. The limits are based upon the income or assets of the purchaser.

The proposed rules: 

  • Clarify that there is an overall investment limit of $100,000 per year. 
  • Clarify that annual income and net worth may be calculated jointly with the annual income and net worth of the investor's spouse. 
  • Permit the issuer to rely upon the efforts that intermediary take in order to determine that the aggregate amount of securities purchased by an investor will not cause the investor to exceed the investor limits, provided that the issuer does not have knowledge that the investors had exceeded, or would exceed, the investor limits as a result of purchasing in the offering.

Use of Crowdfunding Intermediary

Under Section 4(a)(6), a transaction made in reliance on the exemption, "must be conducted through a broker or funding portal that complies with the requirements of Section 4A(a)."

The proposed rules: 

  • Require an issuer to use only one intermediary, rather than allowing the issuer to use multiple intermediary, to conduct an offering or concurrent offerings in reliance on Section 4(a)(6). 
  • Require that the offering be effected exclusively through the intermediary's internet website or other similar electronic medium. A intermediary may, however, perform certain back office and other administrative functions offline. 
  • Require that the intermediary, in its standard account opening materials, obtain from the investors consent for electronic delivery of all documents and other information in connection with the offering.

Exclusion of Certain Issuers from Eligibility under Section 4(a)(6)

Section 4A(f) of the Securities Act excludes certain categories of issuers from eligibility to rely upon Section 4(a)(6) to engage in exempt crowdfunding exemptions. These are (1) foreign issuers (2) issuers that are subject to Exchange Act reporting requirements (generally public companies); (3) investment companies, or companies that are excluded from the definition of investment company under Section 3(b) or 3(c) of the Investment Company Act.

The proposed rules also exclude the following: 

  • Issuers that are subject to the "bad-boy" disqualifications provisions under Section 302(d) of the JOBS Act; 
  • Issuers that had previously sold securities in reliance on Section 4(a)(6) and that have not filed with the SEC and provided to investors, to the extent required, the ongoing annual reports proposed to be required under these regulations (the annual reporting requirement is discussed below); and 
  • Issuers that have no specific business plan, or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies.

Disclosure Requirements for Issuers

Section 4A(b)(1) provides that an issuer offering or selling securities in reliance on Section 4(a)(6) must file certain specified disclosures, including financial disclosures, with the SEC, provide these disclosures to investors and the relevant broker or funding portal and make these disclosures available to potential investors.

The disclosures set forth in Section 4A include items such as 

  • the names of the directors and officers of the issuer, and each person holding more than 20 percent of the shares of the issuer; 
  • a description of the business of the issuer and the anticipated business plan of the issuer; 
  • a description of the financial condition of the issuer (which requires that issuer's offering more than $500,000 file with the Commission, provide to investors and the intermediary, and make available to potential investors audited financial statements). 
  • a description of the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount; 
  • the target offering amount; 
  • the deadline to reach the target offering amount and regular updates regarding the progress of the issuer in meeting the target offering amount; 
  • the price to the public of the severities or the method for determining the price; and 
  • a description of the ownership and capital structure of the issuer.

In addition to these statutory requirements, the proposed rules: 

  • require the issuer to provide a discussion of the material factors that make an investment in the issuer speculative or risky; 
  • require a narrative discussion of the issuer's financial condition. This discussion will need to address, to the extent material, the issuer's historical results of operations in addition to its liquidly and capital resources. If an issuer does not have a prior operating history, the discussion should focus on financial milestones and operational, liquidity and other challenges. If an issuer has a prior operating history, the discussion should focus on whether historical earnings and cash flows are representative of what investors should expect in the future; 
  • mandate specific disclosures related to ownership and capital structure, such as a detailed explanation of the terms of the securities being offered and each other class of security of the issuer, a description of how the exercise of the rights held by the principal shareholders of the issuers could affect the purchasers, and how the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future; 
  • require the issuer to identify whether the issuer will accept investments in excess of the target offering amount; 
  • do not specify which disclosures are required in the description of the business and the business plan; 
  • require the disclosure of the amount of compensation paid to the intermediary for conducting the offering; 
  • require a discussion of the material factors that make an investment in the issuer speculative or risky; 
  • require disclosure of the material terms of any indebtedness of the issuer, 
  • disclosure related to exempt offerings conducted within the last three years; 
  • disclosure of certain related party transactions; and 
  • require that these disclosures be filed with the SEC on EDGAR in the XML format using a XML fillable form.

Progress Updates and Amendments

The proposed rules would require an issuer to prepare regular updates on its progress in meeting the target offering amount – currently at one-half and one hundred percent of the target offering amount. These updates would also need to be filed with the SEC on EDGAR.

The proposed rules also require a filing of a final progress update, no later than five business days after the offering deadline, disclosing the total mount of securities sold in the offering.

The proposed rules also require that any material changes in the offer terms or other disclosures must be filed with the SEC via EDGAR.

Ongoing Reporting Requirements

Section 4A requires that an issuer that has raised capital using the Section 4(a)(6) exemption must file with the SEC and provide to investors reports of the results of operations and financial statements of the Issuer not less than annually.

The proposed rules: 

  • require that the issuer post the annual report on their website. 
  • require that these reports disclose information similar to the information required in the offering, including disclosure about its financial condition that meets the financial statement requirements applicable in the offering state. In many cases, this will require that the financial statements be audited. 
  • The rules would require the issuer to continue filing these reports until (1) the issuer becomes a report company required to file reports under the Exchange Act Sections 13(a) or 15(d) (2) the issuer or another party purchases or repurchases all of the securities issued pursuant to Section 4(a)(6), including any payment in full of debt securities or any complete redemption of redeemable securities or (3) the issuer liquidates or dissolves its business in accordance with state law.

Prohibition on Advertising Terms of the Offering

Section 4A(b)(2) provides that an issuer shall "not advertise the terms of the offering, except for notices which direct investors to the funding portal or broker."

The proposed rules: 

  • Provide that an issuer can publish a notice advertising the terms of the offering in reliance on Section 4(a)(6), provided that the notice includes the address of the intermediary's platform on which additional information about the issuer and the offering may be found; 
  • State that the notice advertising may include no more than the following: 
  • a statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted, and a link directing the potential investor to the intermediary's platform, 
  • the terms of the offering ("terms of the offering" would include (1) the amount of securities offered, (2) the nature of the securities offered, (3) the price of the securities, and (4) the closing date of the offering period.); and 
  • factual information about the legal identity and business location of the issuer, limited to the name of the issuer of the security, the address, phone number and website of the issuer, the e-mail address of a representative of the issuer and a brief description of the business of the issuer.  
  • There are no limitations in the proposed rules on how these advertisements may be distributed; 
  • Issuers may only communicate with investors and potential investors about the terms of the offering through specified "communication channels" hosted on the intermediaries website.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Allen Matkins | Attorney Advertising

Written by:

Allen Matkins

Allen Matkins on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.