THE CROWDFUND ACT OF 2012 (TITLE III OF THE JOBS ACT): SUMMARY OF LAW AND MAJOR ISSUES RAISED IN PRE-COMMENTS TO THE SEC New crwdfunding exemptin 4(6) The Act adds a new exemptin frm registratin under the Securities Act f 1933, Sectin 4(6). The new exemptin is subject t the fllwing cnditins: The aggregate amunt sld t all investrs, including any amunt sld in reliance n the new exemptin, may nt exceed $1 millin in any 12-mnth perid. The language f the statute suggests that fferings made under ther exemptins (Regulatin D, fr example) might cunt twards the $1 millin limit, but discussins with Cmmissin Staff suggest that the best view is currently that the limit applies slely t a crwdfunding rund (pssibly nly t retail investrs), and that amunts sld under ther exemptins (r pssibly t accredited investrs under the 4(6) exemptin) will nt affect the limit. Open issues: clarificatin as t (a) investrs t which $1 millin limit applies; (b) clarificatin with respect t integratin. An investr is limited in the amunt he r she may invest in crwdfunding securities in any 12- mnth perid: If either the annual incme r the net wrth f the investr is less than $100,000, the investr is limited t the greater f $2,000 r 5% f his r her annual incme r net wrth. Issues: what if split between incme and net wrth? If the annual incme r net wrth f the investr is $100,000 r mre, the investr is limited t 10% f his r her annual incme r net wrth, t a maximum f $100,000. Issues: investr limit appears t be with respect t investment in a single issuer and with respect t all crwdfunding securities purchased; statute cntains incnsistencies. The transactin must be made thrugh a brker, r thrugh a funding prtal (a new designatin under the Securities Exchange Act f 1934) which meets the requirements set ut belw. Issues: des this frce all lcal crwdfunding pprtunities that wuld therwise be cmmunity-based t take place nline? The issuer must cmply with the disclsure and ther requirements set ut belw. Requirements fr intermediaries A persn acting as an intermediary in a transactin invlving the sales f securities fr smene else pursuant t sectin 4(6) must: 1
Register with the Cmmissin as a brker r as a funding prtal. Register with a self-regulatry rganizatin r SRO (the nly eligible SRO at present being FINRA). Issues: timing f FINRA rules and requirements. FINRA is used t dealing with large investments and entities that handle ther peple s mney. Prvide Cmmissin-mandated disclsures (including disclsures relating t risk) and investr educatin material. Ensure that investrs review the educatin material, affirm that the investr understands the risk f lss, and answer questins demnstrating an understanding f the risks invlved in investing in small businesses and the risks f illiquidity and ther matters t be determined by the Cmmissin. Issues: hw will investr educatin be mnitred? Can this be dne n an industry-wide as ppsed t prtal-specific basis? Take measures t reduce the risk f fraud as mandated by the Cmmissin, including btaining a backgrund and securities enfrcement regulatry histry check n fficers, directrs and 20% equity hlders f the issuer. Issues: (a) the statute des nt prvide hw the results f such checks are t be used r disclsed; (b) nature f such checks is unclear. Make the required issuer infrmatin (discussed belw) available t investrs and the Cmmissin at least 21 days befre any sales take place. Ensure that the issuer gets the ffering prceeds nly when it has reached the target ffering amunt, and let investrs cancel their cmmitment t purchase securities in accrdance with rules t be set by the Cmmissin. Make such effrts as the Cmmissin may determine t ensure that investrs d nt exceed the limits n investment set ut abve. Issues: hw will this be mnitred, and hw crdinated n an industry-wide basis? Prtect the privacy f infrmatin cllected frm investrs. Funding prtals are exempt frm having t register with the Cmmissin as brkers, but the Cmmissin will be adpting rules establishing cnditins fr that exemptin. Funding prtals may nt: Pay fr finding ptential investrs. Issues: exact prhibitin needs clarificatin. Give investment advice r recmmendatins. (They may srt r curate issuers, and may ffer their services nly t certain types f issuers, but any selectivity with respect t issuers may be prblematic.) Open issues: prtals will need t be able t weed ut bviusly fraudulent r 2
prblematic issuers. They will want t be able t select issuers n the basis f their perceived quality r likely success. Slicit ffers r sales t buy the securities ffered n its prtal. Issue: this brad prhibitin will require significant clarificatin, especially since the psting f a crwdfunding ffering is in itself the slicitatin f an ffer. Cmpensate anyne fr such slicitatin r based n the sale f securities n its prtal. Hld r manage funds. Issues: prtals wuld nt be able t hld securities either, r act as nminees in the way sme cmmenters have requested, unless registered as Stck Transfer Agents. Permit their fficers, directrs r partners frm having a financial interest in an issuer using their services. Issue: des this prhibit prtals frm making investments t shw skin in the game? Undertake ther activities t be specified by the Cmmissin. The Cmmissin will specify by rule the circumstances that will disqualify a brker r prtal frm ffering securities under Sectin 4(6). Requirements fr issuers The issuer must be incrprated r rganized under the laws f a US state. It may nt be an investment cmpany under the Investment Cmpany Act f 1940, and cannt be an SEC-reprting cmpany. Issuers f crwdfunded securities must: Prvide (the statute says file but as discussed belw, liability fllws private as ppsed t public standards) the Cmmissin and investrs and the intermediary with the fllwing infrmatin: Name, legal status, web address and physical address. Names f fficers, directrs and 20% sharehlders. Descriptin f business and anticipated business plan. Descriptin f financial cnditin AND: If raising $100,000 r less, tax returns and financial statements certified by principal executive fficer. If raising $100-500,000, reviewed financial statements. If raising $500,000 r mre, audited financial statements. Issues: SEC Staff has indicated that audit will nt be at PCAOB level, but it will still be expensive. If issuer des tw $400,000 raises, audited r nt? Descriptin f intended use f prceeds f ffering. Target ffering amunt, deadline t reach that amunt, and regular updates regarding prgress tward target. 3
Price f securities r methd t determine that price (with the ability fr investr t rescind cmmitment t purchase after the price has been determined). Descriptin f wnership and capital structure f the issuer, including: Terms f securities ffered and each ther class f securities f the issuer (and the differences between them), including hw thse terms might be limited, diluted r qualified by the rights f ther classes f security. A descriptin f hw exercise f rights f cntrlling sharehlders culd affect the rights f crwdfunding sharehlders. Identificatin f hldings f 20% security hlders. Hw securities ffered are valued and hw they may be valued in the future, including during crprate actins. Risks f minrity wnership, risks assciated with future crprate actins, including additinal issuances f shares, sale f issuer s assets and related party transactins. Issues: these are sphisticated cncepts and issuers may require assistance in drafting apprpriate disclsure. Other infrmatin prescribed by the Cmmissin. Nt advertise the terms f the ffering, except fr ntices which direct investrs t the brker r funding prtal. Issues: the Cmmissin may give sme guidance as t the nature f these ntices. Guidance as t hw scial media may be used will be very imprtant, and the circumstances under which scial media cmmunicatins might be attributed t the issuer will require clarificatin. Nt cmpensate anyne fr prmting its fferings withut disclsing that cmpensatin. Issues: wuld this cver, fr example, paid advertising by the prtal? File annual reprts f results f peratins and financial statements in accrdance with Cmmissin rules. Cmply with ther Cmmissin investr prtectin requirements. The Cmmissin will specify by rule the circumstances that will disqualify an issuer frm ffering securities under Sectin 4(6). Liability Issuer (and cntrl persns including directrs and principal fficers) have 12(a)(2)-type liability. If the issuer makes an untrue statement f a material fact r mits t state a material fact necessary t make its statements, in light f the circumstances in which they were made, nt misleading, and cannt sustain the burden f prf that it did nt knw, and in the exercise f reasnable care, culd nt have knwn, f such untruth r missin, it must reimburse the purchase price f securities plus interest. Issues: n substantial cmpliance prvisin. Inadvertent vilatins are likely. 4
State law The Cmmissin will make the issuer infrmatin available t state regulatry authrities. The states are pre-empted frm requiring registratin f Sectin 4(6) fferings, but there is n restrictin f their ability t take enfrcement actin with respect t fraud r deceit by issuers, brkers r funding prtals. States may impse fees if they are the principal place f business f the issuer r if mre than half the purchasers f a crwdfunding ffering are in that state. A funding prtal s hme state may regulate the prtal, but cannt impse rules that are different r additinal t what is required under the Act. Resale restrictins Securities sld under Sectin 4(6) can nly be resld: Back t the issuer. T an accredited investr. In a registered ffering f securities (such as an IPO). T a family member r n death r divrce. The Cmmissin may adpt ther restrictins and will likely clarify that these are restricted securities under the definitin f Rule 144(a). Issues: sme cmmenters have requested the ability t create liquidity platfrms fr crwdfunded securities, which will nt be pssible unless such platfrms are registered as stck exchanges r alternative trading systems. Crwdfunding securities and registratin under the Exchange Act Securities acquired in a Sectin 4(6) ffering are nt included in cunting the number f sharehlders that triggers the need t register a class f securities under the Exchange Act. Issues: presumably nce sld t an accredited investr, the shares wuld then cunt twards the registratin trigger? CrwdCheck, Inc. June 22, 2012 5