Capital Raising Online While Deterring Fraud (Crowd)
On April 5, 2012 President Obama signed the JOBS Act into law. Part of the JOBS Act is the Crowdfunding Act, the full title of which is the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012”. The Crowdfunding Act, creates a new exemption under the newly designated Section 4(6) of the Securities Act of 1933, as amended.
The new crowdfunding exemption allows Issuers to raise up to $1 million in a twelve month period, as long as no individual investment exceeds certain threshold amounts. The threshold amount sold to any single investor, cannot exceed (a) the greater of $2,000 or 5% of the annual income or net worth of such investor, if their annual income or next worth is less and $100,000; and (b) 10% of the annual income or net worth of such investor, not to exceed a maximum $100,000, if their annual income or net worth is more than $100,000. The Crowdfunding Act reads such that this exemption will integrate with (i.e. be added to) securities sold under other exemptions during the 12 month period.
In addition, an Issuer must:
- File with the SEC and provide potential investors and the funding intermediary (whether a Funding Portal or broker dealer) with:
- The name, legal status, physical address, and website address of the Issuer;
- The names of the directors and officers, and each person holding more than 20% 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, including (i) for offerings of $100,000 or less – income tax returns for the most recently completed year and financial statements certified by the principal executive officer as true and correct; (ii) for offerings more than $100,000 but less than $500,000 – financial statement reviewed by an independent public accountant; and (iii) for offerings more than $500,000 – audited financial statements;
(e) A description of the stated purpose and intended use of the proceeds of the offering;
- The target offering amount and a deadline to reach the target and regular updates regarding the progress of meeting the target;
- The price to the public of the securities and the method of determining the price;
- A description of the ownership and capital structure of the Issuer including (i) terms of other securities offered and detailed dilution disclosures; (ii) any anti-dilution rights of principals and their impact to investors; (iii) name and ownership levels of anyone owning 20% or more; (iv) how securities being offered are valued; and (v) risks related to minority ownership and other capital related risks;
- Risk factors of the offering;
- Not advertise the terms of the offering, except for notices which direct investors to the Funding Portal or broker;
- Not compensate, directly or indirectly, any person to promote the offering; and
- File annual reports with the SEC and provide such reports to investors, with results of operations and financial statements.
In addition, the Crowdfunding Act imposes severe liability on Issuers and officers and directors of Issuers for material misstatements and omissions.
Section 302 of the Crowdfunding Act requires that all Crowdfunding offerings be conducted through an intermediary that is a broker dealer or funding portal that is registered with the SEC. Section 304 of the Crowdfunding Act provides that Funding Portals are exempt from the broker dealer registration requirements, as long as they are registered with the SEC as Funding Portals and follow all such registration and ongoing rule and reporting requirements. In accordance with Section 304, Funding Portals must be “subject to the examination, enforcement and other rulemaking authority” of the SEC. In addition, all Funding Portals, and broker dealers, must be a member of an SRO registered with the SEC under Section 15A. Currently FINRA is the only such SRO.
Funding Portal Defined
Subject to additional requirements that the SEC may by rule draft, a funding portal is defined as a crowdfunding intermediary that does not: (i) offer investment advice or recommendations; (ii) solicit purchases, sales, or offers to buy securities offered or displayed on its website or portal; (iii) compensate employees, agents, or other persons for such solicitation or based on the sale of securities it lists; or (iv) hold, manage, possess, or otherwise handle investor funds.
Funding Portal Requirements
The Crowdfunding Act creates a new Section 4A of the Securities Act of 1933, entitled “Requirements with Respect to Certain Small Transactions.” New Section 4A sets forth the requirements for Funding Portals. Each of the requirements is subject to the more detailed rules that will be drafted by the SEC.
In addition to being registered with the SEC and being a member of FINRA, a Funding Portal must:
- Provide disclosures, including disclosures related to risks;
- Ensure that each investor reviews investor education information and positively affirms that they understand that they risk losing their entire investment and can afford such loss;
- Ensure that each investor answers questions demonstrating an understanding of the level of risk generally applicable to investments in startups; emerging businesses, and small issuers;
- Ensure that each investor answers questions demonstrating an understanding of the risk of illiquidity;
- Take measures to reduce the risk of fraud by establishing rules and procedures including obtaining background and securities enforcement history checks on each officer, director and person holding more than 20% of the outstanding equity of an Issuer;
- Not later than 21 days prior to the first day securities are sold, file with the SEC and make available to potential investors all disclosure information required and provided by the Issuer
- Ensure that no offering proceeds are given or available to the Issuer until the target offering amount has been raised and allow investors to cancel their investment during that time;
- Make efforts to ensure that no investor exceeds its allowable investment amount in any 12 month period, including from all Issuers, and all Funding Portals (i.e. $2,000 or 5% of annual net income or net worth if net income or net worth is less than $100,000 or 10% of annual income or net worth up to $100,000 if annual income or net worth is over $100,000)
- Take steps to protect the privacy of information collected from investors;
- Not compensate promoters, finders, or lead generators for providing the broker or Funding Portal with personal indentifying information of any potential investor;
- Prohibit its directors, officers or partners from having any financial interest in any Issuer using its service.
- Not offer investment advice or make recommendations or solicit purchases, sales or offers of securities
- Not compensate employees, agent, or other persons for soliciting purchases, sales or offers of securities; and
- Not hold, manage, possess or otherwise handle investor funds or securities
The above is just a brief summary of the law set forth in the Crowdfunding Act and which will become subject to detailed rules and regulations from the SEC. As the rules and regulations are written and become law, Issuers and Funding Portals will require the advice, counsel and document preparation of an experienced securities law attorney. Moreover, as the new crowdfunding industry develops, the SEC, FINRA and potential other regulators will be amending laws, issuing guidance and adjusting positions. It is vital that both Issuers and Funding Portals engage the services of attorneys that stay abreast of the legal changes and the industry itself. At Legal & Compliance, we are and will continue to do both.