Yesterday, the SEC proposed long awaited rules on crowdfunding. As we reported to you on September 23, 2013, the SEC ended the ban on advertising to “accredited investors” in Rule 506(c) offerings. The new SEC proposed rules are for public solicitation to the general public.

Crowdfunding is generally a method to raise funds through the Internet. Title III of the JOBS Act created an exemption from registration under federal securities laws for crowdfunding in the investment context.

The SEC is seeking public comment on the proposed rules for a 90-day period following their publication in the Federal Register.

Title III of the JOBS Act establishes the foundation for a regulatory structure that permits entities to use crowdfunding. The JOBS Act provides for funding portals to allow Internet-based platforms or intermediaries to facilitate the offer and sale of securities without having to register with the SEC as brokers. As mandated by the JOBS Act, the proposed rules would:

• Allow individuals to invest subject to certain limited amounts;
• Limit the amount of money an issuer can raise;
• Require issuers to provide extensive information; and
• Create a regulatory framework for intermediaries to facilitate the crowdfunding transactions.

• $1 million maximum amount may be raised by an issuer during any 12-month period.
• Maximum amount per investor of:

  • $2,000 or 5% of annual income or net worth, whichever is greater, if both annual income and net worth are less than $100,000; or
  • 10% of annual income or net worth, whichever is greater, if either annual income or net worth is equal to or more than $100,000.

 • During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

The following will not be able to use crowdfunding:
• Non-U.S. companies;
• Companies that already are SEC reporting companies;
• Certain investment companies;
• Companies that are disqualified under the proposed disqualification rules;
• Companies that have failed to comply with the annual reporting requirements in the proposed rules; and
• “Blind Pools.”

There will be a resale restriction of one year for crowdfunding securities.

Disclosure requirements are fairly extensive.

Required disclosures:

• Information on officers, directors and 20% or more owners;
• Business description and use of proceeds;
• The price to the public of the securities, the target offering amount, the deadline to reach the target offering amount, and whether the issuer will accept investments in excess of the target offering amount;
• Related-party transactions;
• Financial condition description; and
• Financial statements of the issuer 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 by an independent public accountant or auditor.

Other requirements:

• Must amend offering document to reflect material changes and provide updates on progress toward reaching the target offering amount;
• Offering documents would be filed with the SEC and the relevant intermediary; and
• Issuers relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

Crowdfunding Platforms.

Crowdfunding transactions must take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, crowdfunding offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal (a new type of SEC registrant).

Under the proposed rules, the intermediaries must:
• Provide investors with certain educational materials;
• Take certain measures to reduce fraud risk;
• Make available information about the issuer and the offering; and
• Provide communication channels to permit discussions about crowdfunding offerings on the platform.

The proposed rules would prohibit funding portals from:
• Offering investment advice;
• Soliciting purchases, sales or offers to buy securities offered or displayed on its website; and
• Holding, possessing, or handling investor funds or securities.

These proposals are sure to raise questions regarding portal duties and liabilities, because it is an unchartered business model. The SEC release on the proposals is 585 pages and we have not had the time to review it in depth. We expect that a more detailed memorandum on the crowdfunding proposal will be forthcoming soon. However, the crowdfunding issuers will not be vetted by any investment banking firms, and it may result in unreasoned, unworthy issuers seeking financing, and $1 million will not be enough to fund most businesses. The incentive to misstate material facts or omit material facts may be significant. Potential purchasers should proceed with extreme caution.

If you have any questions concerning the above, feel free to contact the following members of our securities practice group:

Reid A. Godbolt 303-573-6767
Samuel E. Wing 303-785-1648
Robert H. Davenport 303-573-1600
Brad H. Hamilton 303-573-1600
David A. Thayer 303-785-1623
Cyrus Rajabi 303-785-1625
Adam J. Fogoros 303-785-1618
Glen A. Payne 303-573-1600

This information is not intended as legal advice. Readers should seek specific legal advice before acting with regard to the subjects mentioned herein.