On October 23, 2013, the SEC released a set of proposed rules under the JOBS Act (the “Act”), which would permit emerging growth companies (EGC’s) to offer and sell securities through crowdfunding platforms. In their current form, the proposed rules closely resemble the original parameters outlined in Section III of the Act, the section from which the crowdfunding provision was born. The rules will be available for public comment throughout the next ninety days, after which time the SEC will review the comments and determine whether to adopt the proposed rules. The SEC release, proposed rules and comment submission page can be found here.
A Brief Overview of the Proposed Rules:
The proposed rules focus on the duties and restrictions of the three parties involved in the equity crowdfunding process: 1) investors, 2) EGC’s and 3) crowdfunding platforms.
Previously, private placement investing was a space predominantly reserved for “accredited investors,” those investors that met certain financial requirements, determined by salary and net worth, deemed to have the financial security to sustain the loss of their investment. However, Title III of the JOBS Act does not contain such accredited investor eligibility criteria, allowing the general public increased access to private equity investing regardless of income or net worth.
In order to preserve a level of investor protection, the proposed rules include a limit on how much an investor can invest in one year via crowdfunding platforms. Therefore, over the course of a 12-month period, such an investor would be permitted to invest up to either:
- $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both the investor’s annual income and net worth are less than $100,000, or
- 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. However, during the 12-month period, such investors would not be able to purchase more than $100,000 of securities through crowdfunding.
An EGC is a company that has under $1 billon of total gross revenue during the last fiscal year. Under the proposed rules, an EGC would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period. Aside from the monetary cap, EGC’s will also be responsible for filing with the SEC, as well as making available to investors, potential investors and any relevant intermediaries facilitating the crowdfunding offering, the following information:
- Information about officers and directors as well as owners of 20 percent or more of the company,
- A description of the company’s business and the use of proceeds from the offering,
- The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount,
- Certain related-party transactions, and
- A description of the financial condition of the company.
Financial statements of the company, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns reviewed or audited by an independent public accountant.
Furthermore, EGC’s would be required to amend its offering documents to reflect material changes throughout the offering period, as well as to file an annual report with the SEC and provide the same to its investors.
As the SEC release emphasizes, one of the key investor protections outlined in Title III of the Act is the requirement that crowdfunding transactions take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.
The proposed rules require these intermediaries to:
- Provide investors with educational materials,
- Take measures to reduce the risk of fraud,
- Make available information about the issuer and the offering,
- Provide communication channels to permit discussions about offerings on the platform, and
- Facilitate the offer and sale of crowdfunded securities.
The proposed rules prohibit funding portals from:
- Offering investment advice or making recommendations,
- Soliciting purchases, sales or offers to buy securities offered or displayed on its website,
- Imposing certain restrictions on compensating people for solicitations, and
- Holding, possessing, or handling investor funds or securities.
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