Regulatory Alert November 2013

Transcription

1 THE SEC ISSUES PROPOSED CROWDFUNDING RULES Opening investing to the crowd but with many strings attached On October 23, 2013 the United States Securities and Exchange Commission ( SEC ) released its proposed rules regarding equity-based crowdfunding. These proposed rules were issued almost a year and a half after Congress passed the Jumpstart Our Business Startups (JOBS) Act in April In our April 2012 Client Alert we highlighted certain key takeaways of the CROWDFUND Act (adopted as part of the JOBS Act) and noted that while the crowdfunding exemption represents a substantial revision of the securities laws governing capital raising, companies will still be required to comply with numerous investor-protection requirements. As anticipated, the SEC s proposed rules, if adopted, will contain detailed and strict requirements for issuers, intermediaries and investors to meet when raising funds through the crowdfunding exemption, including, among other things, strict disclosure and reporting requirements. In this Client Alert we highlight some of the key requirements set forth in the proposed rules. Crowdfunding Crowdfunding is a term used to describe an evolving method of raising money through the internet. This funding method has been used to generate financial support for artistic endeavors such as films and music recordings, typically through small individual contributions from a large number of people, in exchange for in kind items such as CDs or theater tickets. Title III of the JOBS Act established the foundation for a regulatory structure that would permit securities-based crowdfunding. Specifically, the CROWDFUND Act creates a new exception to the registration requirement under the Securities Act of 1933, as amended (the Securities Act ) for securities offerings conducted through crowdfunding, subject to limitations on the total amount offered and how much a single investor may invest, as well as certain other restrictions intended to protect investors. In addition, it created a new entity a funding portal to allow Internet-based platforms or intermediaries to facilitate the offer and sale of securities without having to register with the SEC as brokers. Highlights from the Proposed Rules The SEC s proposed rules place detailed and strict requirements on issuers, investors and intermediaries who want to raise capital through crowdfunding. The following are some highlights from the proposed rules 1 : $1 Million Limit: A company may raise investment capital through crowdfunding only if the company raises no more than $1 million in securities through crowdfunding in the trailing 12 month period. Investment Limitation: Investors are limited to how much they can invest in all crowdfunding ventures in a 12-month period as follows: The greater of $2,000 or 5 percent of the annual income or net worth of such investor if both the annual income and the net worth of the investor is less than $100,000; and 1 The proposed rules include many other provisions and conditions not addressed in these highlights, which are not intended to be a complete review of the proposed rules.

2 10 percent of the annual income or annual net worth of such investor, whichever is greater, not to exceed a maximum aggregate amount of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000. Income and net worth are to be calculated in accordance with the rules used by the Commission to calculate the income and net worth of an accredited investor. In that regard, the value of a person s primary residence is excluded in the net worth calculation. In addition, an investor s annual income and net worth may be calculated jointly with the income and net worth of the investor s spouse. Exclusion of Certain Issuers: the proposed rules exclude the following issuers: Issuers that are not organized under the laws of a state or territory of the United States or the District of Columbia; Issuers that are subject to Exchange Act reporting requirements; Certain investment companies (including hedge funds); Companies that fail to comply with the annual reporting requirements in the proposed rules; Companies with no specific business plan or which have indicated a business plan to engage in a merger or acquisition with an unidentified company or companies; Companies that are disqualified under the proposed bad actor disqualification rules; and Any other issuer that the Commission, by rule or regulation, determines appropriate for exclusion. Resale Restrictions: Securities sold in crowdfunding transactions would be subject to resale restrictions for one year, during which time transfers could only be made to family members, accredited investors, or the company, or in registered transactions. Disclosure Requirements: The proposed rules would require that the issuer file certain specified disclosures, including financial disclosures, with the Commission, provide the disclosure to investors and the relevant broker or funding portal, and make the disclosures available to potential investors. The Commission is not proposing to mandate a specific disclosure format, but it is proposing that the disclosures be made on a new filing form known as Form C. The disclosures must then be filed on the SEC s EDGAR electronic filing system and on the intermediary s website. The Commission proposes that the disclosures include, among other things: Description of the ownership and capital structure of the company and information about officers and directors as well as owners of 20 percent or more of the company; The company s anticipated business plan and the purpose and intended use of the proceeds of the offering; Description of the company s financial condition; The target offering amount, the deadline to reach the target offering amount and progress updates about meeting the target offering amount; Price to the public of the securities or the method of determining the price;

3 Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company s tax returns or reviewed or audited by an independent public accountant or auditor; and Related-party transactions. Companies would also be required to file an annual report providing certain updated financial and business disclosure with the SEC and provide it to investors through the issuer s website. Intermediaries: Under the proposed rules, crowdfunding transactions would be conducted exclusively online through a platform operated by a registered broker or a funding portal. The proposed rules would define funding portal as any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to the crowdfunding exemption. The proposed rules apply to funding portals, as well as their associated persons in many instances. Funding portals would not be permitted to: Offer investment advice or recommendations; Solicit purchases, sales or offers to buy the securities offered or displayed on its platform or portal; Compensate employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced in the platform or portal; Hold, manage, possess or otherwise handle investor funds or securities; or Engage in such other activities as the Commission, by rule, determines appropriate. Although a funding portal may not compensate employees, agents or other persons... based on the sale of securities displayed on the platform, the New York Times reported that David Bass, Chief Counsel of the SEC s Division of Trading and Marketing, has clarified that funding portals themselves may charge commissions on the sale of the issuer s securities. The proposed rules would bar an intermediary and its directors, officers or partners (or any person occupying a similar status or performing a similar function) from having any financial interest in any class of the issuer s securities. This proposed rule is intended to protect investors from the conflicts of interest that may arise when the persons facilitating a crowdfunding transaction have a financial stake in the outcome. The proposed rules would also have an intermediary act as a gatekeeper against fraud. For instance, the proposed rules would require that an intermediary have a reasonable basis for believing that the issuer is in compliance with relevant regulations and has established means to keep accurate records of holders of the securities it offers, and by requiring that the intermediary deny access if it believes the issuer or its offering would present a potential for fraud. Discussion in the proposed rules suggests that intermediaries could be held liable for misrepresentations made in crowdfunding offerings. State Law Preemption: The new crowdfunding rules would preempt state blue sky laws by making the securities offered covered securities under Section 18(b)(4) of the Securities Act. Certain notice filing requirements and state enforcement powers would remain.

4 Exchange Act Exemption: Holders of securities sold in a crowdfunding offering would not count towards the requirement that a company register as a reporting company once it had more than $10 million in assets and at least 2000 record holders, or 500 holders who were not accredited investors. Conclusion The proposed rules regulating crowdfunding are much more restrictive than the SEC s recent revisions to Rule 506 permitting public advertising (see our August 2013 Client Alert) this reflects the fact that the new Rule 506 rules permit sales only to accredited investors, while the crowdfunding rules are not so limited, the extensive requirements for a crowdfunding offering raise significant cost-benefit questions for issuers. One of the other challenges, which will require careful planning, is managing the governance of an issuer with so many shareholders once the issuer reaches the stage when it wants to attract larger investment.

5 Since 1919, Moses & Singer has provided legal services to diverse businesses and to prominent individuals and their families. Among the firm s broad array of U.S. and international clients are leaders in banking and finance, entertainment, media, real estate, healthcare, advertising, and the hotel and hospitality industries. We provide cost-effective and result-focused legal services in the following areas: Accounting Law Practice Advertising Asset Protection Banking and Finance Business Reorganization, Bankruptcy and Creditors Rights Corporate/M&A Corporate Trust Global Outsourcing and Procurement Healthcare Hospitality Income Tax Intellectual Property Internet/Technology Labor, Employment & Employee Benefits Legal Ethics & Law Firm Practice Litigation Matrimonial and Family Law Privacy and Cybersecurity Private Funds Promotions Real Estate Securities and Capital Markets Securities Litigation Sports & Entertainment Trusts and Estates White Collar Criminal Defense and Government Investigations Moses & Singer LLP is the New York City law firm member of the MSI Global Alliance (MSI). MSI is one of the world's leading international alliances of independent legal and accounting firms, with over 250 member firms in 100 countries - Moses & Singer LLP The Chrysler Building 405 Lexington Avenue New York, NY Tel: , Fax: Fletcher Avenue Fort Lee, NJ Tel: , Fax: Abraham Y. Skoff, Esq. Managing Attorney for New Jersey 10 Cuttermill Road Suite 201 Great Neck, NY Tel: , Fax: James Alterbaum, Esq. Managing Attorney for Long Island

6 Disclaimer Viewing this or contacting Moses & Singer LLP does not create an attorney-client relationship. This does not contain a complete legal analysis or constitute an opinion of Moses & Singer LLP or any member of the firm on the legal issues herein described. This contains information that may be modified or rendered incorrect by future legislative or judicial developments. It is recommended that readers not rely on this in structuring or analyzing individual transactions or matters but that professional advice be sought in connection with any such transaction or matter. Attorney Advertising It is possible that under the laws, rules or regulations of certain jurisdictions, this may be construed as an advertisement or solicitation. Copyright 2013 Moses & Singer LLP, All Rights Reserved