ALERT. The SEC s Final Crowdfunding Rules: Still May Not Be a Crowd Pleaser. Author: Issuer and Investor Eligibility.

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1 ALERT Nvember 4, 2015 The SEC s Final Crwdfunding Rules: Still May Nt Be a Crwd Pleaser Authr: Dnna L. Brks (860) dbrks@gdwin.cm On Octber 30, 2015, the Securities and Exchange Cmmissin (the SEC ) released the final rules under the Jumpstart Our Business Startups ( JOBS ) Act t permit cmpanies t ffer and sell securities thrugh crwdfunding. These new rules are designated as Regulatin Crwdfunding. The SEC had prpsed the rules in Octber 2013 with a 90-day cmment perid. That cmment perid turned int ver tw years with clse t 500 cmment letters. Cmpanies have been able t use crwdfunding t raise mney thrugh small cntributins frm a large number f individuals withut issuing securities (but ften by prviding a prduct r a gift) thrugh ppular websites such as Kickstarter and Indiegg. Hwever, because f federal and state securities laws, crwdfunding has nt been available t cmpanies seeking t raise capital thrugh the issuance f securities. Regulatin Crwdfunding will change that and allw such capital raising beginning six mnths after publicatin f the rules in the Federal Register. Under the Securities Act f 1933 (the Securities Act ), an ffer r sale f securities must be registered with the SEC unless an exemptin frm such registratin is available. Title III f the JOBS Act amends the Securities Act t prvide a new exemptin frm the SEC s registratin requirements fr crwdfunding, but it was subject t the SEC adpting final rules. Under the SEC s final rules, which are substantially similar t the prpsed rules, a new registratin exemptin (Sectin 4(a)(6)) wuld be available frm the SEC registratin requirements under certain cnditins described belw. Issuer and Investr Eligibility Fr issuers t be eligible t make a crwdfunding ffering and fr investrs t invest in thse fferings, the fllwing rules apply: An issuer is permitted t raise a maximum aggregate amunt f $1 millin thrugh crwdfunding fferings in a 12-mnth perid (ther nn-crwdfunding fferings made by the issuer are nt integrated - cmbined - with crwdfunding fferings t determine the maximum, but crwdfunding fferings by affiliates f the issuer will be cunted). Individual investrs, ver the curse f a 12-mnth perid, are permitted t invest in the aggregate acrss all crwdfunding fferings (f all issuers) up t: If either their annual incme r net wrth is less than $100,000, then the greater f: > $2,000 r > 5% f the lesser f their annual incme r net wrth.

2 If bth their annual incme and net wrth are equal t r mre than $100,000, then 10% f the lesser f their annual incme r net wrth. During the 12-mnth perid, the aggregate amunt f securities sld t an investr thrugh all crwdfunding fferings may nt exceed $100,000. The issuer must be a dmestic cmpany that is nt subject t the reprting requirements under the Securities Exchange Act f 1934, cannt be a cmpany that is disqualified under Regulatin Crwdfunding s disqualificatin ( bad actr ) rules, cannt be a cmpany that has failed t cmply with the annual reprting requirements under Regulatin Crwdfunding during the tw years immediately preceding the filing f the ffering statement, and may nt be an investment cmpany, a private investment r hedge fund, a shell cmpany r a blank check cmpany. The securities purchased may nt be transferred fr a ne-year perid after the purchase (ther than transfers t the issuer, accredited investrs r family members r transfers effected in cnnectin with a registered ffering r the death r divrce f the investr). The issuer need nt cunt the hlders f crwdfunded securities tward the threshld that requires an issuer t register its securities with the SEC under Sectin 12(g) f the Securities Exchange Act if the issuer is current in its annual reprting bligatin, retains the services f a registered transfer agent and has less than $25 millin in assets. Issuer Disclsure Issuers will need t prvide fairly substantial disclsure abut the business and the ffering and will need t prvide prgress updates and disclsure amendments fr material changes in the ffering r prir disclsure. The disclsure requirements include the fllwing: The issuer will prvide the SEC (thrugh the EDGAR public filing system), investrs and the relevant brker-dealer r funding prtal with certain infrmatin n a new Frm C, including: a descriptin f the material risks f the investment; a descriptin f the business f the issuer and its business plan; a reasnably detailed descriptin f the purpse f the ffering and the use f prceeds frm the ffering; infrmatin abut the directrs and fficers (including names and three-year emplyment histry) and each persn hlding mre than 20 percent f the shares f the issuer; the target ffering amunt, the deadline t reach the target ffering amunt, and whether the issuer will accept investments in excess f the target ffering amunt; 2

3 the price t the public f the securities r the methd fr determining the price prvided that, prir t the actual sale, the issuer must disclse the final price in writing t the investrs, and the issuer must prvide the investrs with a reasnable pprtunity t rescind the cmmitment t purchase the securities; a descriptin f the wnership and capital structure f the issuer, including (1) the terms f the securities being ffered and each ther class f securities f the issuer, including hw such terms may be mdified, and a summary f the differences between such securities, including hw the rights f the securities being ffered may be materially limited, diluted, r qualified by the rights f any ther class f securities f the issuer; (2) a descriptin f hw the exercise f the rights held by the principal sharehlders f the issuer culd negatively impact the purchasers f the securities being ffered; (3) the name and wnership level f each existing sharehlder wh wns mre than 20 percent f any class f the securities f the issuer; (4) hw the securities being ffered are being valued, and examples f methds fr hw such securities may be valued by the issuer in the future, including during subsequent crprate actins; and (5) the risks t purchasers f the securities relating t minrity wnership in the issuer, and the risks assciated with crprate actins, including additinal issuances f shares, a sale f the issuer r f assets f the issuer, r transactins with related parties; whether the issuer r any f its predecessrs previusly has failed t cmply with the nging reprting requirements f Regulatin Crwdfunding; and a descriptin f related party transactins. Issuers will als be required t prvide a descriptin f the financial cnditin f the issuer, which must include, t the extent material, a discussin f liquidity, capital resurces and histrical results f peratins. In additin t this narrative disclsure, issuers will have t prvide financial statements prepared in accrdance with U.S. generally accepted accunting principles (GAAP) fr the shrter f the tw mst recently cmpleted fiscal years r the perid since the issuer s inceptin in accrdance with the fllwing: Fr issuers ffering $100,000 r less: disclsure f the amunt f ttal incme, taxable incme and ttal tax as reflected in the issuer s federal incme tax returns certified by the principal executive fficer t reflect accurately the infrmatin in the issuer s federal incme tax returns (in lieu f filing a cpy f the tax returns), and financial statements certified by the principal executive fficer t be true and cmplete in all material respects. If, hwever, financial statements f the issuer are available that have either been reviewed r audited by a public accuntant that is independent f the issuer, the issuer must prvide thse financial statements instead and need nt include the infrmatin reprted n the federal incme tax returns r the certificatin f the principal executive fficer. Fr issuers ffering mre than $100,000 but nt mre than $500,000: financial statements reviewed by a public accuntant that is independent f the issuer. If, hwever, financial statements f the issuer are available that have been audited by 3

4 a public accuntant that is independent f the issuer, the issuer must prvide thse financial statements instead and need nt include the reviewed financial statements. Fr issuers ffering mre than $500,000: > Fr issuers ffering mre than $500,000 but nt mre than $1 millin f securities in reliance n Regulatin Crwdfunding fr the first time: financial statements reviewed by a public accuntant that is independent f the issuer. If, hwever, financial statements f the issuer are available that have been audited by a public accuntant that is independent f the issuer, the issuer must prvide thse financial statements instead and need nt include the reviewed financial statements. > Fr issuers that have previusly sld securities in reliance n Regulatin Crwdfunding: financial statements audited by a public accuntant that is independent f the issuer. The issuer cannt advertise the terms f the ffering but may issue ntices f the terms f the ffering, including (1) the amunt f securities ffered; (2) the nature f the securities; (3) the price f the securities; and (4) the clsing date f the ffering perid, and such ntices must direct investrs t the funding prtal r brker-dealer. The issuer must clearly disclse all cmpensatin paid directly r indirectly t all persns that have prmted the ffering thrugh the channels f the brkerdealer r funding prtal. The issuer must file an annual reprt f the results f its peratins and financial statements with the SEC after the ffering and prvide that t investrs. The annual reprt will cntain basically the same type f infrmatin required in the riginal disclsure dcuments. Hwever, the required financial statements need nly be certified by the principal executive fficer f the issuer t be true and cmplete in all material respects. Hwever, issuers that have available financial statements that have been reviewed r audited by an independent certified public accuntant because they prepare them fr ther purpses must prvide them and will nt be required t have the principal executive fficer certificatin. Crwdfunding Platfrms Under Regulatin Crwdfunding, each ffering must be cnducted exclusively thrugh ne platfrm perated by a registered brker r a funding prtal, which is a new type f SEC registrant. The rules require these intermediaries t: prvide investrs with educatinal materials; take measures t reduce the risk f fraud; 4

5 make available infrmatin abut the issuer and the ffering; prvide cmmunicatin channels t permit discussins abut fferings n the platfrm; and facilitate the ffer and sale f crwdfunded securities. The rules prhibit funding prtals frm: ffering investment advice r making recmmendatins; sliciting purchases, sales r ffers t buy securities ffered r displayed n its platfrm; cmpensating prmters and thers fr slicitatins r based n the sale f securities; and hlding, pssessing, r handling investr funds r securities. The rules prvide a safe harbr under which funding prtals can engage in certain activities cnsistent with these restrictins. One Cnstitutin Plaza Hartfrd, CT Atlantic Street Stamfrd, CT Church Street - Suite 1207 New Haven, CT Greenwich Avenue Greenwich, CT K St., NW - Suite 600 Washingtn, DC While the funding prtals wuld nt be required t be registered as brker-dealers as such, they wuld be required t register with the SEC using a mdified Frm BD (called a Frm Funding Prtal) and wuld be required t becme a member f a registered natinal securities assciatin (the Financial Industry Regulatry Authrity (FINRA) is currently the nly such assciatin). Cnclusin While the SEC s final rules, which liberalized sme f the prpsed rules, are intended t make it easier fr start-up cmpanies t raise capital, the financial and cmpliance burdens impsed n crwdfunding fferings may make it impractical and prhibitively expensive fr start-up cmpanies t benefit frm them. In additin t the csts that start-up cmpanies will incur t prepare disclsure materials, engage and cmpensate a brker-dealer r funding prtal and prepare financial statements, these cmpanies will be required t regularly file financial and infrmatinal reprts that will be available t the general public (including cmpetitrs, custmers and strategic partners) t review. A cmpany will need t weigh the benefits f raising a limited amunt f capital thrugh crwdfunding against the financial and cmpliance bligatins assciated with Regulatin Crwdfunding, especially if the cmpany is therwise able t raise capital frm accredited investrs under Regulatin D, which nw permits general slicitatin and general advertising. Questins? Fr mre infrmatin, please cntact Dnna Brks at r dbrks@gdwin.cm. This cmmunicatin is being circulated t Shipman & Gdwin LLP clients and friends and des nt cnstitute an attrney client relatinship. The cntents are intended fr infrmatinal purpses nly and are nt intended and shuld nt be cnstrued as legal advice. This may be deemed advertising under certain state laws Shipman & Gdwin LLP. 5