The SEC substantially adopts prior proposed rules.
On October 30, pursuant to Title III of the Jumpstart Our Business Startups Act, which was passed in 2012, the US Securities and Exchange Commission (SEC) finally adopted rules (referred to as Regulation Crowdfunding) that permit companies to offer and sell securities through crowdfunding (essentially, through the Internet). According to the SEC, the new rules are designed to assist smaller companies with raising capital while providing investors with additional protections. These new rules and forms are expected to take effect during the second quarter of 2016 (six months after publication in the Federal Register).
Here are some quick facts about the new rules.
Companies will be allowed to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
Companies must disclose the following:
Will a company need an audit? |
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If a company offers less than $500,000 of securities |
No, the company is permitted to provide reviewed rather than audited financial statements.*
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If a company offers more than $500,000 but not more than $1 million of securities and relies on these rules for the first time
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No, the company is permitted to provide reviewed rather than audited financial statements.*
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If a company offers more than $500,000 but not more than $1 million of securities and is not relying on these rules for the first time.
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Yes, audited statements are required.
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*Unless independently audited financial statements are available. |
Companies’ Annual Reports
Effect on Exchange Act Section 12(g)
Holders of these securities would not count toward the threshold that requires a company to register its securities under section 12(g) of the Securities Exchange Act of 1934 (Exchange Act), as amended, if the company is current in its annual reporting obligations, retains the services of a registered transfer agent, and has less than $25 million in total assets as of the end of its most recently completed fiscal year.
Ineligibility
Companies not eligible to use the crowdfunding exemption include the following:
No Effect on Rule 506(c)
The new crowdfunding regulation does not affect the ability to conduct general solicitation to only accredited investors pursuant to SEC Rule 506(c).
How much can an individual invest throughout 12 months?* |
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Annual income or net worth is less than $100,000
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Greater of $2,000 or 5% of the lesser of the individual’s annual income or net worth |
Annual income and net worth are equal to or greater than $100,000
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10% of the lesser of the individual’s annual income or net worth** |
*Aggregate limitations are across all crowdfunding offerings. Aggregate amount sold through all crowdfunding offerings may not exceed $100,000 during a 12-month period. **The value of an individual’s primary residence is not included in his or her net worth calculation. |
Example Calculations of Maximum Investment (Taken from the SEC’s Adopting Release): |
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Investor Annual Income |
Investor Net Worth |
Calculation |
Investment Limit |
$30,000 |
$105,000 |
Greater of $2,000 or 5% of $30,000 ($1,500) |
$2,000 |
$150,000 |
$80,000 |
Greater of $2,000 or 5% of $80,000 ($4,000) |
$4,000 |
$150,000 |
$100,000 |
10% of $100,000 ($10,000)
|
$10,000 |
$200,000 |
$900,000 |
10% of $200,000 ($20,000)
|
$20,000 |
$1,200,000 |
$2,000,000 |
10% of $1,200,000 ($120,000), subject to $100,000 cap |
$100,000 |
All transactions that rely on the new rules would be required to take place through an SEC-registered intermediary—either a broker-dealer or a funding portal.
A funding portal would be required to register with the SEC on the new Form Funding Portal and become a member of a national securities association (currently, the Financial Industry Regulatory Authority). A company that relies on the rules would be required to conduct its offering exclusively through one intermediary platform at a time.
The rules would require intermediaries to, among other things,
The rules also would prohibit intermediaries from engaging in certain activities, such as
Regulation Crowdfunding would contain certain rules specific to registered funding portals consistent with their more limited activities than that of a registered broker-dealer. The rules would prohibit funding portals from offering investment advice or making recommendations; soliciting purchases, sales, or offers to buy securities; compensating promoters and other persons for solicitations or based on the sale of securities; and holding, possessing, or handling investor funds or securities.
The rules would provide a safe harbor under which funding portals could engage in certain activities consistent with these restrictions and require funding portals to maintain certain books and records related to their transactions and business.
The forms that enable funding portals to register with the SEC will take effect January 29, 2016.
The foregoing summary was adapted from the SEC Fact Sheet on Regulation Crowdfunding published on October 30, 2015.
The long-awaited adoption of these new rules is a momentous occasion, because they have the potential to greatly facilitate raising capital through general solicitation, including through the Internet and social media platforms. However, some of the restrictions put in place to protect nonaccredited investors, such as having reviewed or audited financial statements and requiring an intermediary that will charge a fee, will make it more costly than traditional methods of raising capital from accredited investors in a private placement.
Further, companies that use the exemption must be willing to post their financial information on their websites in an annual report for the world (including competitors) to view. Last, the individual investor limitations will necessitate many more investors to have a meaningful capital raise. For example, if a company is trying to raise $1 million at $2,000 per investor, that will result in 500 new stockholders. It will be costly and/or time consuming to manage all of these new stockholders, and a variety of nonsecurities law considerations will also need to be considered in that context (such as state corporate law statutes, fiduciary duties, and flow of information to stockholders).
Alternative security provisions, such as nonvoting common stock or a voting proxy, or even new types of specialized crowdfunding securities may emerge as a way to navigate scenarios where companies have a high number of investors. That said, we stand ready to help companies, investors, and intermediaries navigate this process to facilitate a successful fundraising.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers in our Securities Group or Emerging Business and Technology Practice Group:
Boston
Michael K. Barron
Michael A. Conza
London
Timothy J. Corbett
Moscow/London
Carter Brod
New York
Thomas P. Giblin, Jr.
Howard A. Kenny
Kimberly M. Reisler
Eric Tajcher
Philadelphia
Jeffrey P. Bodle
Justin W. Chairman
Andrew Hamilton
James W. McKenzie, Jr.
Joanne R. Soslow
Pittsburgh
Marlee S. Myers
Kimberly A. Taylor
Princeton
Steven M. Cohen
Silicon Valley
Scott D. Karchmer
Thomas W. Kellerman
Albert Lung
E. John Park
Singapore
Bernard Lui
Joo Khin Ng
Washington, DC
Andrew M. Ray
David A. Sirignano
George G. Yearsich
Special thanks to our associates Bryan Keighery, Lisa Perri, and Danielle Henderson for helping prepare this LawFlash.