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SEC Proposes Crowdfunding Rules
By Mark Litwak
The Securities and Exchange Commission (“SEC”) has finally proposed, for comment, new Regulations for Crowdfunding to implement the requirements of the Jumpstart Our Business Startups Act (“JOBS Act”), enacted on April 5, 2012. More than one year overdue, the SEC has released a 585-page comprehensive report with its proposed rules and underlying rationale.
The public has 90 days to offer comments on the rules. Therefore, it is likely that entrepreneurs seeking to raise capital will have to wait at least another six months or so before the agency finalizes its rules. The proposed regulations prescribe a rigorous registration process for portals, handled by both the SEC and the Financial Industry Regulatory Authority (“FINRA”), Wall Street’s self-policing body. The rules also establish record-keeping and anti-money laundering procedures.
Under existing regulations, it is difficult and expensive for a company to legally raise small amounts from ordinary investors. Crowdfunding will allow investors with an annual net income or net worth of less than $100,000 to invest up to five percent of that amount, or $2,000, whichever is more, every 12 months. Investors with an annual income or net worth exceeding $100,000 can invest up to ten percent of their annual income or net worth every 12 months. On the other hand, promoters are limited to raising $1 million during a 12-month period.
Until now, crowdfunding has been generally limited to donations. Websites such as Kickstarter have been very successful in raising funds for various artistic endeavors, like films. However, these sites do not offer equity or profit sharing in the business. Typically, donors receive T-shirts, an invite to the wrap party or festival premiere, a screen credit, or some other nominal benefit; however, they do not share in any revenue derived from the movie.
Under the recommended rules, transactions must be conducted through an intermediary that is registered as a broker or is registered as a new type of entity called a “funding portal.” The rules would require these intermediaries to deliver educational materials that explain how the offering process works and the risks associated with investing in crowdfunding. The materials could be in any electronic format, including videos. Investors will be required to represent that they have reviewed the materials and understand the risks they are taking. The portals would also be required to obtain a fidelity bond and maintain coverage for the duration of its registration.
The proposed rules will restrict advertising by directing investors to the portals, which will contain more specific information and various disclosures. They will also restrict intermediaries from promoting an offering unless they clearly disclose any past or future compensation every time that there is a communication. Likewise, the portals must disclose to potential investors how they are compensated.
The suggested rules would promote online social media by requiring intermediaries to provide the means, for investors who have opened accounts, to post comments about the offering on the portal, which would be available for both investors and the public to see.
Portals would be required to notify investors that they have 48 hours to cancel their commitment to invest. Moreover, funds would be directed to banks where they would be held until the offering was completed or cancelled. If a target amount is not raised, the funds would be returned to the investor.
Surprisingly, the SEC intends to allow funding portals to be based outside the United States. The recommended rules would require a non-resident funding portal to appoint an agent for service of process in the United States, and to certify and provide opinion of counsel that the funding portal can provide the SEC with prompt access to its books and records and can submit to onsite inspection and examination.
There are a growing group of companies that have already indicated they intend to become funding portals. According to FINRA, approximately 36 companies have already submitted the voluntary Interim Form for Funding Portals indicating their intention to act as funding portals under the JOBS Act.
Overall, the SEC has struck a sensible balance between protecting investors and assisting startups in seeking a cost effective way to raise funds through crowdfunding.
The proposed rules can be reviewed at: