The U.S. Securities and Exchange Commission has been widely criticized for dragging its feet in issuing implementing regulations for equity crowdfunding, which was enabled when the Jobs Act was signed into law in April 2012. Finally the agency recently issued some new rulings that will hopefully lead to actual implementation of equity crowdfunding in 2014.
In September, new rules went into effect allowing general solicitation and advertising in order to sell securities in a private placement under Section 506 of the Securities Act of 1933. Companies wishing to sell securities are now able to publicize that fact. Unfortunately, this does little to further true crowdfunding because only “accredited investors” (those with a net worth of at least one million dollars excluding a home, or a $200,000 annual income) can participate. The issuer must take “reasonable steps” to verify that all purchasers are accredited investors.
Accredited investors have always had access to equity investing opportunities. As for full access to crowdfunding investment opportunities by the average person that was envisioned when the Jobs Act was passed, the SEC issued the first set of draft rules — here’s a PDF of the proposal — in October. Following are the proposed regulations.
Regulations for Companies that Want to Raise Equity via Crowdfunding
For companies seeking to raise funds via equity crowdfunding the rules state the following.
- $1 million maximum. A company can raise a maximum aggregate amount of $1 million through crowdfunding offerings in any 12-month period.
- Use established portals. All transactions must be completed using a registered crowdfunding portal or broker-dealer. Companies cannot set up their own website for the offering or use a website that is not registered with the SEC. (Kickstarter, which facilitates crowdfunding on a reward basis, has stated it will not enter the equity arena. Indiegogo has not stated its intention about registering for equity crowdfunding.)
- Less than $100,000. The financial statements of companies raising less than $100,000 need not be reviewed or audited by a certified public accountant.
- $100,000 to $500,000. Those looking to raise between $100,000 and $500,000 are required to have their financial statements reviewed by a CPA.
- More than $500,000. Companies raising more than $500,000 are required to have their financial statements formally audited by a CPA.
Companies raising money via crowdfunding are required by law to disclose the following information.
- Names of officers, directors and large shareholders (those holding more than 20 percent of the ownership).
- Contact information for the company and officers and directors so that people can find and verify its existence.
- A detailed business plan and an explanation of how the funds raised would be used.
- A description of the financial condition of the company including tax returns and financial statements.
- 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.
Companies using crowdfunding to offer and sell securities would be required to file an annual report with the SEC and provide it to investors as well.
Regulations for Investors
Over a 12-month period investors would be permitted to invest as follows.
- $2,000 or five percent of their annual income or net worth, whichever is greater if both their annual income and net worth are less than $100,000.
- Ten percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is at least $100,000.
- $100,000 maximum. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.
- No immediate resale. Securities purchased in a crowdfunding transaction cannot be resold for a period of one year.
Regulations for Intermediaries
Intermediaries must do the following.
- Register with the SEC and the Financial Industry Regulatory Authority (FINRA) as either a portal or a broker-dealer. The funding portal is a new SEC registration category.
- Ensure that investors complete investor education requirements established by the SEC and understand the risks of investing in crowdfunded securities.
- Protect the privacy of investors.
- Take steps to avoid fraud.
- Guarantee that investors do not violate their individual investment limits. This is a particularly difficult requirement of the law to enforce and the SEC may not impose it.
- Not pay finders or affiliates for bringing in investors.
- Prohibit their own directors and officers from investing in companies issuing securities on their platforms.
Intermediaries cannot offer investment advice or make recommendations about funding individual crowdfunding efforts, nor can they solicit purchases of securities offered on their websites. Intermediaries are also prohibited from handling investor funds.
A comment period on the proposed regulations runs to the end of January 2014 and changes to these regulations may occur. Then equity crowdfunding may finally become a reality in spring 2014.
Companies wishing to pursue crowdfunding should consider that if they want to raise less than $100,000, crowdfunding might not be the best choice because the fees and commissions would comprise a high percentage of funds raised and compliance would consume a good deal of time and money.