October 24, 2013

SEC & FINRA Propose Crowdfunding Rules: 585 Pages Worth! (Kill Me Now)

As I blogged a few days ago, the SEC calendared an open Commission meeting on short notice to propose “Regulation Crowdfunding” – the overdue crowdfunding rules under Title III the JOBS Act, which was proposed yesterday by a unanimous vote. There is a 90-day comment period.

The 585-page proposing release was posted shortly after the meeting. Here’s the press release – and here are remarks from the open meeting from SEC Chair White and Commissioners Piwowar, Aguilar, Stein and Gallagher. We’ll be posting the inevitable slew of memos in our “Crowdfunding” Practice Area.

Best reaction I received yesterday from a member: “585 pages on crowdfunding? Kill me now.”

In addition, FINRA proposed rules yesterday regarding crowdfunding funding portals, with a comment period that expires on February 3rd. The text of FINRA’s rule is 50 pages in itself (and here’s the proposed forms). Here is FINRA’s proposing release.

Analysis: SEC’s Crowdfunding Proposal

Here’s some initial analysis of the SEC’s proposal from Hunton & Williams Scott Kimpel:

Crowdfunding is a subset of the crowdsourcing movement. At a typical crowdsourcing website, the party seeking financing typically posts a project proposal online and states a funding goal. Potential contributors then visit the website and donate funds to support the project. Sometimes, but not always, the patrons get free samples of the entrepreneurs’ products in exchange for their donations. Proposals have included everything from funding books to movies to mechanical inventions to software apps to charities.

If and when projects meet their funding goals, the websites takes a small percentage of the funds generated and transfer the balance to the projects’ creators. Some popular crowdsourcing websites include Kickstarter, IndieGoGo, GoFundMe and SoMoLend. At this time, these sites generally prohibit the offer or sale of securities, and they thus do not run afoul of the securities laws.

Some features of the SEC’s proposal, which tracks Title III of the JOBS Act, include the following:

– The total amount sold by the issuer to all investors, including amounts sold in reliance on this crowdfunding exemption, during the preceding 12 months may not exceed $1 million. There is no limit on the number of unaccredited investors that may participate.

– The total amount sold to any single investor by the issuer, including amounts sold in reliance on this crowdfunding exemption, during the preceding 12 months may not exceed:
o If either the annual income or net worth of the investor is below $100,000, the greater of $2,000 or 5% of the annual income or net worth of that investor.
o If either the annual income or net worth of the investor is $100,000 or more, 10% of the annual income or net worth of the investor (up to a maximum aggregate amount sold of $100,000).

– The transaction must be conducted through a broker or a new kind of intermediary known as a “funding portal”. The SEC and Finra will be proposing rules that govern these new funding portals.

– Depending on the size of the offering, issuers must provide financial disclosures to potential purchasers. For offerings that, together with all other crowdfunding offerings by the issuer in the past 12 months, have, in the aggregate, target offering amounts of:
o $100,000 or less: the issuer must provide income tax returns for its most recently completed year and financial statements certified by the principal executive officer;
o More than $100,000 but less than $500,000: the issuer must provide financial statements reviewed by a public accountant that is independent of the issuer; and
o More than $500,000 (or such other amount as the SEC establishes by rule): the issuer must provide audited financial statements.

– Issuers must also provide investors a host of other mandatory disclosures, including information about its capital structure and the intended use of proceeds.

– Issuers will have an ongoing requirement to provide a kind of annual report to the SEC (including financial statements) until the issuer becomes subject to a reporting obligation under the Exchange Act.

Given these onerous requirements, I and many observers have real doubts as to how vibrant a market will develop in the SEC crowdfunding space. An issuer seeking to raise funds by means of a general solicitation has a much simpler path under the new Rule 506(c) offering mechanism, so long as the universe of actual purchasers is limited to accredited investors. Nevertheless, quite a few businesses have sprung up in anticipation of the crowdfunding rules’ adoption and hope to capitalize on this new fundraising technique by offering their services to issuers and investors.

Because there has been some confusion in the marketplace, it is worth a reminder that an issuer may not conduct a crowdfunded securities offering to the masses until such time as the SEC adopts final rules. Simply put, a typical crowdfunding offering would include both a general solicitation and the participation of unaccredited investors, and there is likely to be no Section 5 or blue sky exemption for such an offering. (The SEC staff has given no action relief to certain crowdfunding portals that only target accredited investors, and these cites may currently operate because unaccredited investors are barred from investing.) in 2011, the SEC shut down “” because in effect it was conducting an unregistered crowdfunded offering to the public.

I ran a trio of blogs last month that noted potential problems with crowdfunding, including the expenses involved…

Poll: How Long Will It Take to Read a 585-Page Release?

Here’s a poll about how you intend to read the SEC’s 585-page crowdfunding proposing release:

surveys & polls

– Broc Romanek