Limitations on the Crowdfunding Legislation

Now that the Jumpstart Our Business Startups — “JOBS” — Act has passed, many people are jumping to get into the crowdfunding game. There are masses of start-ups and operating companies that are seeking to use crowdfunding as a way to access cash for their new ventures or to expand existing business operations. There are also many scrambling to become an “intermediary” between those who want the money and those who are willing to fund a project. The excitement is overwhelming, but we must understand that the Act put into place limitations and obligations for intermediaries and companies — i.e. issuers — to follow. These limitations and obligations, while intended to protect the small investor, may drive up the cost of trying to access this capital.

Requirements of Intermediaries

The U.S. Securities and Exchange Commission has warned that the Act requires intermediaries to follow specific obligations and rules that the SEC has been given the power to determine. The SEC has stated on its website that intermediaries are required to do the following.

  • Adequate disclosures. Must provide disclosures as the SEC may determine are appropriate by issuing rules. These disclosures will include providing disclosure information to the potential investors.
  • Inform investors. Must ensure that each investor: (a) reviews investor education materials; (b) positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and (c) answer questions that demonstrate that the investor understands the level of risk generally applicable to investments in startups, emerging businesses, and small issuers and the risk of illiquidity.
  • Protect privacy. Must take steps to protect the privacy of information collected from investors.
  • Minimize risk of fraud. Take such measures to reduce the risk of fraud with respect to such transactions as established by the SEC rules, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person.
  • Pass along issuer information. Make available to investors and the SEC, at least 21 days before any sale, any disclosures provided by the issuer — i.e. the company receiving the money.
  • Track the money. Ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest;
  • Enforce maximum limits. Make efforts to ensure that no investor in a 12-month period has purchased crowdfunded securities that, in the aggregate, from all issuers, exceed the investment limits set forth in section Title III of the JOBS Act; and
  • Other rules. Any other requirements that the SEC determines are appropriate.

Although the obligations and limitations described above are directed at the intermediary, those trying to raise money will need to supply the information and disclosure documents for the intermediary to comply with the SEC rules. The more detailed the disclosure documents need to be, the more costly they will be to generate.

Rules To Be Determined

The exemption for crowdfunding will not be available until 2013. As you can see, many of the rules above are described generally and have not yet been determined. The SEC continues to issue answers to questions and it is aware that many websites are trying to jump into the crowdfunding arena early. It has started to give public warnings about the availability of crowdfunding and the requirements involved in these transactions to notify the public to be wary of any website that purports to be an intermediary dealing in securities. Once the exemption is available, it will be a good alternative for raising money. However, intermediaries and companies should be aware that there will still be many documents and disclosures required before they can access the crowd.

Jeff Jacobson, Jd, Llm
Jeff Jacobson, Jd, Llm
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