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SEC Proposes
Crowdfunding Rules
By Mark Litwak
The
Securities and Exchange Commission (“SEC”) has finally proposed, for comment,
new Regulations for Crowdfunding to implement the requirements of the Jumpstart
Our Business Startups Act (“JOBS Act”), enacted on April 5, 2012. More than one
year overdue, the SEC has released a 585-page comprehensive report with its
proposed rules and underlying rationale.
The public has 90 days to offer comments on the rules. Therefore, it is likely that
entrepreneurs seeking to raise capital will have to wait at least another six
months or so before the agency finalizes its rules. The proposed regulations
prescribe a rigorous registration process for portals, handled by both the SEC
and the Financial Industry Regulatory Authority (“FINRA”), Wall Street’s self-policing body. The rules also
establish record-keeping and anti-money laundering procedures.
Under
existing regulations, it is difficult and expensive for a company to legally
raise small amounts from ordinary investors. Crowdfunding
will allow investors with an annual net income or net worth of less than
$100,000 to invest up to five percent of that amount, or $2,000, whichever is
more, every 12 months. Investors with an annual income or net worth exceeding
$100,000 can invest up to ten percent of their annual income or net worth every
12 months. On the other hand, promoters are limited to raising $1 million during
a 12-month period.
Until
now, crowdfunding has been generally limited to donations. Websites such as Kickstarter
have been very successful in raising funds for various artistic endeavors, like
films. However, these sites do not offer equity or profit sharing in the
business. Typically, donors receive T-shirts, an invite to the wrap party or
festival premiere, a screen credit, or some other nominal benefit; however,
they do not share in any revenue derived from the movie.
Under
the recommended rules, transactions must be conducted through an intermediary
that is registered as a broker or is registered as a new type of entity called
a “funding portal.” The rules would require these intermediaries to deliver
educational materials that explain how the offering process works and the risks
associated with investing in crowdfunding. The materials could be in any
electronic format, including videos. Investors will be required to represent
that they have reviewed the materials and understand the risks they are taking.
The portals would also be required to obtain a fidelity bond and maintain
coverage for the duration of its registration.
The
proposed rules will restrict advertising by directing investors to the portals,
which will contain more specific information and various disclosures. They will
also restrict intermediaries from promoting an offering unless they clearly
disclose any past or future compensation every time that there is a
communication. Likewise, the portals must disclose to potential investors how
they are compensated.
The
suggested rules would promote online social media by requiring intermediaries to
provide the means, for investors who have opened accounts, to post comments
about the offering on the portal, which would be available for both investors
and the public to see.
Portals
would be required to notify investors that they have 48 hours to cancel their
commitment to invest. Moreover, funds would be directed to banks where they
would be held until the offering was completed or cancelled. If a target amount
is not raised, the funds would be returned to the investor.
Surprisingly,
the SEC intends to allow funding portals to be based outside the United States.
The
recommended rules would require a non-resident funding portal to appoint an
agent for service of process in the United States, and to certify and provide
opinion of counsel that the funding portal can provide the SEC with prompt
access to its books and records and can submit to onsite inspection and
examination.
There
are a growing group of companies that have already indicated they intend to
become funding portals. According to FINRA, approximately 36 companies have
already submitted the voluntary Interim Form for Funding Portals indicating
their intention to act as funding portals under the JOBS Act.
Overall, the SEC has struck a sensible balance between
protecting investors and assisting startups in seeking a cost effective way to
raise funds through crowdfunding.
The
proposed rules can be reviewed at:
