The SEC recently adopted rules that allow companies to offer and sell securities through crowdfunding.  The Jumpstart Our Business Startups Act (the “JOBS Act”), enacted in 2012, established a regulatory framework for startups and small businesses to raise capital through securities offerings using crowdfunding. The SEC’s rules that implement this framework, referred to as Regulation Crowdfunding, govern the offer and sale of securities under new Section 4(a)(6) of the Securities Act of 1933.  In addition, Regulation Crowdfunding provides rules for the regulation of registered funding portals and broker-dealers that issuers are required to use in the offer and sale of securities in reliance on Section 4(a)(6).

Certain issuers are not eligible to rely on the registration exemptions in Regulation Crowdfunding.  These include non-U.S. companies, Securities Exchange Act of 1934 (“Exchange Act”) reporting companies, certain investment companies, companies subject to disqualification under the crowdfunding rules, companies that have not complied with annual reporting requirements under the crowdfunding rules during the two years immediately preceding the filing of the offering statement, and companies with no specific business plan or companies that have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.

For those companies that are permitted to rely on the registration exemptions in Regulation Crowdfunding, the SEC limits the amount of money an issuer can raise using crowdfunding and imposes disclosure requirements on issuers involved in crowdfunding.

Investment Limits

Under the crowdfunding rules, individuals are allowed to invest in securities-based crowdfunding transactions subject to certain investment limits.  The crowdfunding rules permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.  Individuals are permitted to invest in the aggregate across all crowdfunding offerings, over a 12-month period, up to: (1) if either their annual income or net worth is less than $100,000, than the greater of (a) $2,000 or (b) 5 percent of the lesser of their annual income or net worth; or (2) if both their annual income and net worth are equal to or more than $100,000, 10 percent of the lesser of their annual income or net worth.  In addition, during a 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.

Disclosure Obligations

Issuers relying on Regulation Crowdfunding must file certain information with the SEC, and provide this information to investors and the intermediary that is facilitating the offering.  This information includes, but is not limited to, the price to the public of the securities or the method for determining the price, a discussion of the company’s financial condition, financial statements of the company, a description of the business and the use of proceeds from the offering, information about officers and directors of the company, as well as certain related party transactions.  In addition, issuers are required to amend their offering documents during the offering period to reflect material changes in this information and provide updates on their progress toward reaching the target offering amount.  Issuers are also required to file an annual report with the SEC and provide it to investors.

Crowdfunding Platforms

Regulation Crowdfunding transactions must take place through an SEC-registered intermediary that is either a broker-dealer or a funding portal.  A funding portal is required to register with the SEC on Form Funding Portal, and become a member of FINRA.  In order to facilitate a crowdfunding transaction, the broker-dealer or funding portal must, among other things:

  • provide investors with educational materials that explain the process for investing and the types of securities being offered;
  • provide disclosure to investors about the compensation the intermediary receives;
  • accept an investment commitment from an investor only after that investor has opened an account;
  • have a reasonable basis for believing an investor complies with the investment limitations;
  • provide investors with notices once they have made investment commitments and confirmations at or before the completion of a transaction; and
  • comply with maintenance and transmission of funds requirements.

Regulation Crowdfunding also includes certain rules that are specific to registered funding portals and take into account the more limited activities that they may engage in as compared to a registered broker-dealer.  Specifically, the rules prohibit funding portals from, among other things, offering investment advice or making recommendations; soliciting purchases, sales or offers to buy securities; compensating promoters and other persons for solicitations; and holding investor funds or securities.

These crowdfunding rules will be effective 180 days after they are published in the Federal Register. The forms enabling funding portals to register with the SEC will be effective Jan. 29, 2016.