Nearly four years in the making, the Securities and Exchange Commission on Friday approved Regulation Crowdfunding, making good on a JOBS Act mandate to permit startups and small businesses to raise capital by offering and selling securities through crowdfunding. The vote marks the last significant rulemakings obligation the Commission had under the legislation.
The SEC also advanced separate, but related, proposals that, if approved by a later vote, would amend Securities Act Rule 147 for intrastate offerings and Rule 504 of Regulation D to further facilitate the ability of smaller companies to raise more capital under a set of important state and federal investor protections. Chairman Mary Jo White and commissioners Kara Stein and Louis Aguilar voted in favor of the new rule and proposed amendments; Commissioner Michael Piwowar opposed the full slate.
Crowdfunding, although common on websites like Kickstarter, has not involved the offer of a share in any financial returns or profits from business activities. Doing so currently triggers the application of the full suite of federal securities laws, both for the issuers making the offerings and the brokers who intermediate them. The final rule approved by the Commission would allow securities-based crowdfunding offerings to take place “within a regulatory framework established by statute and tailored to the dynamics of this internet-based method of raising capital,” White said.
The approved framework establishes guidelines for investors and rules for issuers that want to raise up to $1 million a year through crowdfunding and not have to register those publicly offered securities. Whereas private companies are limited to seeking out accredited investors (with a net worth of $1 million or an individual annual income of more than $200,000), crowdfunded ones could reach out to the unaccredited. They would not need to register those securities offerings with the SEC, but will need to meet a variety of requirements. All offerings must be facilitated through an intermediary, defined as either a registered broker-dealer or an online, registered funding portal. Among the requirements for funding portals are providing investors with educational materials about the risks of their investment, and compliance with anti-money laundering controls and privacy requirements. They must also register with the SEC and Financial Industry Regulatory Authority, which has already submitted its plan for Commission approval.
Issuers must provide detailed information on the nature of their business and operations; terms of the offering; and use of proceeds. The securities sold in a crowdfunded offering will be transfer-restricted for one year.
“The final rules also appear to provide some relief with respect to the financial statement requirement, which had been a concern raised by commenters,” says Anna Pinedo, a partner at law firm Morrison & Foerster.
The final rule requires financial statements prepared in accordance with U.S. GAAP for the issuer’s two most recently completed fiscal years (if they have been in business for that long), she explains. Those financial statement requirements are phased depending on the amount being raised. If the issuer proposes to offer $100,000 or less, then the financial statements must be reviewed and certified by the issuer’s chief financial officer. If the issuer is raising more than $100,000 and less than $500,000, the financial statements must be reviewed by an independent accountant. For amounts in excess of $500,000, financial statements must be audited. There will be an accommodation for first-time issuers allowing financial statements to be reviewed rather than audited.
The new rules and the forms will become effective 180 days following Federal Register publication. SEC registration forms for funding portals will be available and effective on Jan. 29.
The Commission also approved a recommendation from the Division of Corporation Finance to propose amendments to Securities Act Rule 147 and Rule 504 of Regulation D. The proposals would modernize Rule 147 by establishing a new exemption to facilitate capital formation through intrastate offerings. The proposal continues to permit companies to raise money from investors within their state without concurrently registering the offers and sales at the federal level. It would eliminate the existing intrastate restriction on offers, but continue to require that sales be made only to residents of the state or territory of the issuer’s principal place of business.
The proposed amendment to Rule 504 of Regulation D would increase the aggregate amount of securities that may be offered and sold in any 12-month period from $1 million to $5 million, while disqualifying “bad actors” from participation in such offerings.