A Primer on Regulation Crowdfunding – Implementation of Title III of the JOBS Act

Title III of the Jumpstart Our Business Startups Act (the “JOBS Act”), enacted April 5, 2012, established a regulatory structure for startups and small businesses to raise capital through securities offerings using the Internet through crowdfunding. The crowdfunding provisions of the JOBS Act were intended to help provide startups and small businesses with capital by making relatively low dollar offerings of securities, featuring relatively low dollar investments by the “crowd,” less costly. Congress charged the Securities and Exchange Commission (the “SEC”) with promulgating enabling regulations to effectuate crowdfunding which it did effective as of May 16, 2016 with its adoption of Code of Federal Regulations [citation] (“Regulation Crowdfunding”). Title III of the JOBS Act included a number of provisions intended to protect investors who engage in these transactions, including investment limits, required disclosures by issuers and rules governing the offer and sale of securities under a new Section 4(a)(6) of the Securities Act of 1933 (the “Securities Act”).

Regulation Crowdfunding also provides a framework for the regulation of registered funding portals and broker-dealers that issuers are required to use as intermediaries in the offer and sale of securities in reliance on new Section 4(a)(6). Additionally, Regulation Crowdfunding conditionally exempts securities sold pursuant to Section 4(a)(6) from the registration requirements of Section 12(g) of the Securities Exchange Act of 1934, which also has undergone modification in connection with the JOBS Act to facilitate the broad precept of capital formation facilitation espoused by the JOBS Act.

Typically, a mode of offering of securities as contemplated under Title III would trigger the application of the federal securities laws insofar as it involves the offer and sale of a security which under Section 5 of the Securities Act requires the security to be registered unless an exemption from registration is available. Securities offerings and sales exempt from registration under Section 5 have classically occurred under notions of limited offering levels under Section 3 of the Securities Act, or in transaction not involving any public offering under Section (4)(2) of the Securities Act, and in all such cases, typically under the safe harbors provided under Regulation D of the SEC, Rules 504, 505 and 506.

Limitations under existing law, including Section 5 of the Securities Act and SEC regulations issued in connection with that law, including purchaser qualification requirements for offering exemptions (e.g. “accredited investors” (e.g. individuals having a prescribed threshold of income or assets) that permit general solicitation and general advertising, have made private placement exemptions generally unavailable for crowdfunding transactions, which are intended to be broadcast, or “offered”, to a large potential investor audience, and not be limited to investors that meet the prescribed qualifications. Title III and Regulation Crowdfunding are intended to transcend classic prohibitions on the general solicitation for the sale of securities so long as conducted in accordance with the Regulation’s mandate, summarized as follows:

  • An issuer is permitted to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period;
  • Individual investors, over the course of a 12-month period, are permitted to invest in the aggregate across all crowdfunding offerings up to:
    • If either their annual income or net worth is less than $100,000, then the greater of:
      • $2,000 or
      • 5 percent of the lesser of their annual income or net worth.
    • If both their annual income and net worth are equal to or more than $100,000, then 10 percent of the lesser of their annual income or net worth; and
  • During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
  • Securities purchased in a crowdfunding transaction generally cannot be resold for a period of one year. Issuers conducting an offering pursuant to Regulation Crowdfunding are required to file certain information with the SEC and provide this information to investors and the relevant intermediary, a “crowdfunding portal”, facilitating the crowdfunding offering. Among other things, in its offering documents, the issuer is required to disclose:
  • Information about officers and directors as well as owners of 20 percent or more of the issuer;
  • A description of the issuer’s business and the use of proceeds from the offering;
  • The price to the public of the securities or the method for determining the price, 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;
  • Certain related-party transactions;
  • A discussion of the issuer’s financial condition; and
  • Financial statements of the issuer that are, depending on the amount offered and sold during a 12-month period, accompanied by information from the issuer’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. An issuer relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements, unless financial statements of the issuer are available that have been audited by an independent auditor.Title III provides as one of the integral components of investor protection that Regulation Crowdfunding transactions take place through an SEC- registered intermediary, either a broker-dealer or a funding portal. Under Regulation Crowdfunding, offerings must be conducted exclusively through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant. The rules require these intermediaries to:
  • Issuers are required to amend the offering document during the offering period to reflect material changes and provide updates on the issuer’s progress toward reaching the target offering amount. Additionally, issuers conducting crowdfunding transactions are required to file an annual report with the SEC and provide it to investors.
  • Provide investors with educational materials;
  • Take measures to reduce the risk of fraud;
  • Make available information about the issuer and the offering;
  • Provide communication channels to permit discussions about offerings on the platform; and
  • Facilitate the offer and sale of crowdfunded securities.
  • The rules prohibit funding portals from:
  • Offering investment advice or making recommendations;
  • Soliciting purchases, sales or offers to buy securities offered or displayed on its platform;
  • Compensating promoters and others for solicitations or based on the sale of securities; and
  • Holding, possessing, or handling investor funds or securities.
  • The rules provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.
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