SEC Issues Proposed Equity Crowdfunding Rules

At an open meeting on October 23, 2013, SEC Chair Mary Jo White announced that the SEC has issued a proposed rule on crowdfunding. The rule would exempt qualifying crowdfunding transactions from registration and prospectus delivery requirements.

By way of background, crowdfunding is a method of raising capital through small investment amounts from a large number of investors, such as over the Internet or through social media. Companies and individuals are already using crowdfudning to raise money for products, projects or nonprofit ventures on platforms such as Kickstarter or Indiegogo. Today, backers typically get a thank you, free product or other gift for their support.

Some companies are also already using crowdfunding platforms to sell unregistered stock to accredited investors, but they cannot sell stock to unaccredited investors until the Jobs Act provision takes effect. With the issuance of the proposed rule, it is anticipated that startup companies will be able to start selling unregistered securities to unaccredited investors (i.e. “mom and pop”) by the middle of next year.

The proposed rule (link) includes a number of parameters aimed at facilitating capital formation while protecting investors, including:

  • Crowdfunding transactions must be  done through broker/dealers registered with the SEC or a new intermediary  called a funding portal that has to be registered by the SEC;
  • The maximum raised or invested through crowdfunding is $1 million in any 12-month period;
  • Issuers must file financial  statements with the SEC and provide them to investors and intermediaries.  The financial statements must cover the shorter of the: (1) issuer’s two  most recent fiscal years or (2) length of time the issuer has been in  existence; and
  • The proposal includes certain “bad actor” restrictions to bar certain issuers from taking advantage of the  crowdfunding exemption.

It should be noted that specified disclosures must be provided to investors and potential investors, including information on the business, owners, use of proceeds raised, and certain related party information. For example, entrepreneurs seeking funding through equity crowdfunding also must disclose how they would use the money they raise, a description of the financial health of the company and depending on how much equity is sold in a 12-month period, a copy of the company’s tax returns.

The amount individuals could invest would be capped depending on their net worth. In any 12-month period, an individual could invest $2,000 or 5 percent of his or her annual income or net worth, whichever is greater, if both annual income and net worth are less than $100,000. Meanwhile, for those investors whose annual income or net worth are more than $100,000, an individual could opt to invest as much as 10 percent of their annual income or net worth, whichever is greater. Investors could buy no more than $100,000 worth of securities in companies through crowdfunding in any 12-month period. If an investor purchases securities in a company via crowdfunding, he or she would not be permitted to sell that equity for one year.

And, it appears that under the proposed rules, investors who come in through crowdfunding platforms will not count toward the 2,000-investor limit private companies can have before they must register with the SEC.

The SEC will accept public comments on the proposed rules for 90 days. After that, SEC staff will digest the comments before submitting a final rule to the SEC’s commissioners for a vote. The final rule would take effect 60 days after publication in the federal register.

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