On October 30, 2015, the Securities and Exchange Commission (SEC) voted to adopt final rules implementing Title III of the Jumpstart Our Business Startups Act (JOBS Act), known as “crowdfunding”. The final rules, to be codified as “Regulation Crowdfunding” in furtherance of Section 4(a)(6) of the Securities Act of 1933, are expected to become effective in May 2016. A copy of the final rules can be found here.
Regulation Crowdfunding will allow smaller, non-public U.S. companies to raise up to $1 million in any 12-month period by selling securities over the Internet (including through apps and other technologies) to individual investors who are not required to meet any sophistication or wealth standards, but will be subject to relatively small investment limits.
Notable Changes from the Proposed Rules
The SEC’s vote on the final crowdfunding rules occurred just over two years from the date the SEC issued the proposed crowdfunding rules. Notwithstanding the long delay and almost 500 comment letters, the final rules were largely consistent with the proposed rules. Notable modifications to the proposed rules are set forth below.
- Audited Financial Statements. The final rules include a one-time exception to the requirement that issuers provide audited financial statements for a proposed crowdfunding offering in excess of $500,000. As a result, issuers may provide reviewed financial statements instead of audited financial statements the first time they launch such a crowdfunding offering if audited financial statements are not available. While this accommodation will provide a measure of relief for some first-time issuers, it remains to be seen whether it goes far enough and whether small businesses and startups will be able to bear the expense of obtaining audited financial statements for additional crowdfunding offerings.
- Ongoing Reporting Requirements. The final rules add two circumstances in which an issuer may terminate its obligation to file annual reports otherwise required by Regulation Crowdfunding: (i) the issuer has filed at least one annual report and it has fewer than 300 holders of record; and (ii) the issuer has filed annual reports for at least the three most recent years and it has total assets of $10 million or less. This change will be a source of relief for many issuers in light of the significant costs and burdens ongoing reporting requirements will have on most small businesses and startups.
- Intermediary Compensation. The final rules eliminate the restriction on intermediaries (i.e., the funding portals and broker-dealers who will manage crowdfunding offerings) from receiving stock or other financial interests in issuers as compensation for services provided. This modification will allow issuers to pay intermediaries in stock, which will be important to issuers that do not have sufficient available funds to pay intermediary fees in cash. Issuers may report compensation paid to intermediaries as either a dollar value or percentage of the offering amount and may use a good faith estimate if the parties are unable to identify an exact amount at the time of filing the offering statement on Form C.
- Intermediary Curation. The final rules allow funding portals and broker-dealers to use their discretion in determining whether to let an issuer use their platforms. This change is designed to allow intermediaries to better perform their intended “gate-keeping” function and should allow intermediaries to establish targeted or branded platforms, which should assist investors in selecting suitable intermediaries and issuers.
- Disclosure Obligations. The final rules impose an affirmative requirement on issuers to disclose any material information “necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” This modification will require issuers to disclose all material information not specifically enumerated in the required disclosure items of Regulation Crowdfunding.
- Tax Return Requirement. The final rules eliminate the requirement that issuers provide copies of their federal income tax returns when conducting offerings of $100,000 or less and instead add a less-burdensome requirement to disclose, with the principal executive officer’s certification, the issuer’s amount of total income, taxable income and total tax as set forth in its filed tax returns.
Broad Overview of Crowdfunding Framework
Eligibility : All companies other than the below listed categories of companies will be eligible to use Regulation Crowdfunding.
- non-U.S. companies
- public reporting companies
- blank check companies and special purchase acquisition companies (SPACs)
- certain investment companies
- companies that fall under Regulation Crowdfunding’s disqualifying provisions (e.g., bad actors)
- companies that have failed to file their annual report required by Regulation Crowdfunding for the past two years
Download: SEC Finally Adopts “Regulation Crowdfunding”
*The authors wish to acknowledge the efforts of senior law clerk Naresh Lall, who assisted in the preparation of this Client Alert.