After 24 months of comment, review and consideration the Securities and Exchange Commission finally adopted the final rules relating to equity crowdfunding on October 30, 2015, by a 3-1 vote. My hopeful prediction that we were a “solid six months away…from crowdfunding becoming legal” was certainly optimistic. The long anticipated enactment adopts an exemption from securities registration for Internet based securities offerings. This will allow businesses to raise up to $1 million every 12 months in capital from regular ‘ol non-accredited investors … aka the “crowd”. These crowdfunding rules comprise the last major set of rules called for in Congress’ April 5, 2012, legislation. They are the rules for Title III of the JOBS Act.
The rules take effect 180 days after publication in the Federal Register – so we are looking at legal crowdfunding in May 2016.
In my October 23, 2013 post, SEC Proposes Crowdfunding Rules, I highlighted a few points of interest from the behemoth rules proposal totaling 585 pages. The final rules are even more complex in their 686 pages of analysis and rules. So to spare you the agony of a complete recap, I again take a 1,000 foot view instead of an in-depth analysis of the final crowdfunding rules.
- Companies’ ability to advertise crowdfunding offering. An issuer can only advertise by directing potential investors to the funding portal. There is still no open season for social media.
- Cancellation period. Investors may cancel their commitment up to 48 hours prior to the deadline identified in the offering materials.
- Individual investment limitations and net worth calculations. The final rules clarify that the investment limit reflects the aggregate amount an investor may invest in all Regulation Crowdfunding offerings for a 12 month period from any issuer. A “lesser of” approach to determining which category applies to an investor’s maximum contribution based on net worth or annual income is adopted. As an example, an individual with a $50,000 salary and net worth of $105,000 can contribute up to $2,500 in a given 12 month period (or 5% of their annual salary, as it is less than their total net worth), as opposed to under the proposed rules where that investor could have contributed up to $10,500. An individual with an annual income of $150,000 and total net worth of $80,000 can only contribute up to $4,000 under the final rules, as opposed to $15,000 under the proposed rules.
- Implementation of “Funding Portals”. Funding portals are seen as the “gatekeepers” that help to provide investor protection, according to SEC Commissioner Aguilar. FINRA published applicable rules for intermediaries prior to the SEC vote and was only waiting for the Commission to implement the crowdfunding rules. Unlike broker dealers, the funding portals cannot offer investment advice. The final rules generally remain the same as proposed here, except that the definition of “platform” was modified slightly to be more technical. Platform means “a program or application accessible via the Internet or other similar electronic communication medium through which a registered broker or registered funding portal acts as an intermediary in a transaction involving the offer or sale of securities.” The instruction that intermediaries can also engage in back office or other administrative functions was added to the final rules.
- Audits are “out” for the most part. SEC Chair Mary Jo White stated in her opening statement that in considering comment letters, the final rules exempt first time issuers from having an audit requirement when raising money through equity based crowdfunding to reduce overall costs. If you read my 2013 post, you’ll know the proposed requirement that businesses raising in excess of $500,000 must prepare audited financial statements was disappointing. Others echoed this concern. The final rules only require first-time crowdfunding issuers submit reviewed financial statements when raising between $500,000 and $1,000,000. Additionally, Chair White said “issuers conducting smaller offerings would not be required to file tax returns, as proposed, but rather would be required to disclose specific information from the returns, which should address privacy concerns.” So an issuer won’t have to publicly disclose their entire tax return, but will need to disclose certain relevant information.
- On-going audit requirement is also “out”. Most importantly, we were also successful in getting the SEC to avoid imposing an on-going reporting requirement that also required for issuers to undergo an audit in perpetuity. Annual reports simply need to be certified by an officer of the issuer.
- Specific disclosures are mandated. The broad requirement regarding disclosure of any material information necessary to make the statements made was adopted as well as a requirement for disclosure of payments to an intermediary (disclosed as a dollar amount or percentage), location of the issuer’s website that has the issuer’s annual report and date of report availability, whether the issuer or any predecessor has failed to comply with ongoing reporting requirements under the crowdfunding rules. Financial disclosure requirements and contents vary depending on the size of the offering.
- Intermediaries’ are able to hold financial interest. The final rules allow an intermediary to be compensated with a financial interest in issuers that conduct an offering on the intermediary’s funding portal, as long as it is disclosed to investors. The intermediary can only be compensated with the same type of security being offered to crowdfunding investors. This means no preferential treatment for the funding portal!
- Ability to simultaneously conduct multiple offerings. The SEC provided clarification to conducting simultaneous offers pursuant to different exemptions and allows businesses to raise money via crowdfunding without that offering impacting a company’s ability to also pursue other forms of exempt capital raises (as long as it complies with requirements for each applicable exemption). In short, this isn’t an “either/or” proposition. Issuers can crowdfund and also raise money the old fashioned way.
So, the adopted final rules show some victories for us while also keeping certain less practical requirements in place (like the requirement that businesses publish their financial statement on their company website).
All in all, will issuers and investors flock to crowdfunding with all these complex rules? Probably not. But we can be optimistic that a handful of brave issuers will successfully prove that equity crowdfunding is an important part of not only a company capital structure, but also of a successful strategy to connect with the company’s customers.
* A special thanks to Amanda Salvione for her assistance. One person should never have to read 686 pages of anything from the SEC alone.