CROWDFUNDING RULES NOW IN THE HANDS OF THE SEC, IT HAS 270 DAYS TO MEET THE DEADLINE MANDATED BY CONGRESS

The future of crowdfunding is now in the hands of the Securities and Exchange Commission. When Congress passed the law making it legal to sell small stakes in private companies to the general public online, lawmakers left it up to regulators to determine the mechanics of how such transactions will actually work.

In the crowdfunding portion of the Jumpstart Our Business Startups Act, there are 22 places for the SEC to make rules, Karen Kerrigan, president of the Small Business and Entrepreneurship Council, said Thursday at the first Crowdfunding Conference in New York. That’s just one section of the law. The agency, which raised concerns about aspects of the statute as it was debated, has 270 days from its April 5 enactment to make rules. That means they should be in place by Jan. 1, 2013. The SEC started taking public comments last week.

The commission will have to make rules for crowdfunding websites—”intermediaries” in the law’s jargon—including, for example, what disclosures they must make to investors, how they’ll make sure people don’t invest more of their money than the law allows, and how they’ll vet the people behind the companies selling shares.

For Kerrigan, who was among the law’s most vocal backers, it means the SEC might tie up the industry in red tape.   She told the conference.

“There is a lot of opportunity for the SEC to do more regulatory damage, if you will, to this space.” 

The law puts a lot of new work on the table for securities regulators who are already behind on implementing the Dodd-Frank reforms, says Joan MacLeod Heminway, a law professor at the University of Tennessee who spoke on a panel with Kerrigan. It’s not clear if the agency has the resources to police a new class of unregistered securities and the websites that will connect issuers and investors. Says Heminway:

“I think the SEC’s got a big problem on its hands.”

COMMENTARY:    The Crowdfund Intermediary Regulatory Association will commit to providing investor protection and market integrity through effective and efficient regulation of those within the crowdfunding industry. CFIRA will create rules, oversight and a united voice for the CrowdFund Investing platform companies as the industry is formed. CFIRA announced today that the founding partners will be:

• Startup Exemption, The CrowdFund Investing authors that wrote the framework for the Crowdfund legislation passed by Congress.
• The SoHo Loft Capital Creation (TSLCC) Events, the definitive event platform for the private markets aimed at facilitating capital formation and job creation.
• Gate Technologies & GATE Impact, a platform and electronic marketplace and that provides regulatory compliant private market transactions.

CFIRA is a membership organization that includes members of the CrowdFund Investing and donation-based crowdfunding community as well as representatives of related industries including angel and venture capital firms.

CFIRA will provide intermediaries with regulation, reporting, and compliance oversight and will provide investors with educational tools to help make more informed decisions about the opportunities and risks of CrowdFund Investing. CFIRA is committed to working with the SEC to create reasonable and appropriate regulations and oversight to reduce fraud and protect investors.

The JOBS Act now allow entrepreneurs to directly solicit investors, something that Regulation D of the SEC forbid, provided that investors are fully-accredited.  It does exempt startups from filing financial disclosures the SEC once they reach 500 individual investors.  The limit has now been raised to 2,000 individual investors, but 1,500 of those investors must be fully-accredited investors as defined by the SEC.  Employees issued stock under employee benefit plan securities (stock options) are excluded from the 2,000 investor limit.

Overview of Crowdfunding Exemption Component of JOBS Act

In a blog post dated April 6, 2012, I described in  great detail the major compoents of the JOBS Act as it relates to the new crowdfunding exemption.  

The JOBS Act establishes the new crowdfunding exemption, which is designated as Section 4(6) of the Securities Act, with the following parameters:

• The aggregate proceeds from all investments in the issuer, including amounts sold under the crowdfunding exemption during the preceding 12 months, must be less than $1,000,000.
• The aggregate amount invested by any investor in all issuers pursuant to the crowdfunding exemption must not exceed a limit determined on a sliding scale based on net worth or annual income. The limit is 5% of net worth or annual income that is less than $100,000 (or $2,000, if greater than the 5% calculation), and 10% of net worth or annual income that is $100,000 or more. No investor may invest more than $100,000 in an issuer pursuant to the crowdfunding exemption. Income and net worth are to be calculated in the same fashion as the tests for accredited investors. Accordingly, equity in a principal residence is excluded from net worth.
• The transaction must be conducted through an intermediary that is either a registered broker-dealer or “funding portal.”
• Funding portals are not required to register as broker-dealers, but are subject to SEC registration and must be members of a national securities association, such as FINRA.
• The intermediary must provide disclosures, including disclosures related to risks and other investor education materials (as determined by SEC rules).
• The intermediary must ensure that investors review investor-education information (as determined by SEC rules).
• The intermediary must ensure that investors answer questions demonstrating that they understand the risks of investing in startups, including the risk of loss of the entire investment, and that each investor can afford such loss.
• The intermediary must provide the disclosures to the SEC and to investors at least 21 days prior to accepting any investments.
• The intermediary must take fraud-prevention measures to be determined by SEC rules, including background checks of officers, directors and 20% holders.
• The intermediary must ensure that proceeds are not released to issuers until a set target amount is reached and must allow investors to withdraw their commitment in accordance with SEC rules.
• The intermediary must take steps to be determined by SEC rules to ensure that each investor has not exceeded its crowdfunding limit in a 12-month period, which as noted above applies to all investments in all issuers under the crowdfunding exemption.
• The intermediary must take steps to ensure the privacy of information collected from investors in accordance with SEC rules.
• Intermediaries cannot pay finders fees.
• Directors, officers and partners of the intermediary may not have a financial interest in the issuer.
• The issuer must make the following mandatory disclosures to the SEC, the intermediary and investors:
  • identifying information about the issuer, including its website
  • the names of officers, directors and 20% shareholders
  • a description of the business and the anticipated business plan
  • a description of the financial condition of the issuer, with scaled requirements depending on the target amount of the offering.
    • For offerings of $100,000 or less, the income tax return for the last completed year and financial statements certified by the principal executive officer to be true and correct
    • For offerings of $100,000 to $499,999, financial statements reviewed by an independent public accountant
    • For offerings over $500,000, financial statements audited by an independent public accountant
  • the intended use of proceeds
  • the target offering amount, the deadline to meet the target offering amount, and regular updates regarding the progress of the issuer toward the target
  • the price or the method of determining the price, and if the price is not fixed, a reasonable opportunity for the investor to rescind its commitment once the price is determined
  • detailed information about the capital structure of the issuer, the securities being offered and the risks associated with those securities
  • how the securities being offered are being valued, and how they might be valued in the future in connection with a corporate transaction
• The issuer may not advertise the terms of the offering except for notices which direct investors to the intermediary.
• The issuer may not compensate finders except in accordance with SEC rules that will ensure the recipient clearly discloses such compensation.
• The issuer must file annual reports of results of operations and financial statements with the SEC and provide to investors, in accordance with SEC rules.
• No resales are permitted for one year except to the issuer, an accredited investor, a member of the investor’s family or pursuant to a registered offering.
• The exemption is available only for U.S. issuers that are not investment companies and are not subject to periodic reporting under the Exchange Act.
• The issuer and its directors, partners, principal executive officer, principal financial officers and controller/principal accounting officer will be liable to investors for any material omissions or misstatements unless they can sustain the burden of proof that they did not know, and in the exercise of reasonable care, could not have known, of such untruth or omission.

CFIRA Update

On Monday, April 23, 2012, there will be a live chat  at 9 am PST / 12pm EST / 5pm BST with CFIRA leadership group, the group organizing to develop a self-regulatory framework for the crowdfunding industry.  The chat will provide updates from a recent leadership group meeting held in NY on Wednesday, April 18 and meetings with FINRA and the SEC on Friday, April 20. You can submit your questions for this panel of experts right now in the comments at the end of this post, or to eric.mack@crowdsourcing.org.

It's was a busy and fruitful week with well attended meetings held in NY on Wednesday, April 18. The group agreed on two important mandates.

• Firstly, the efforts to work with the SEC to guide the development of a framework for the regulation of the US crowdfunding industry. 
• Secondly, the need to work to coalesce the industry in order to form a united group that could represent the needs of the industry, beyond the development of a workable regulatory framework.

In this weeks Live Chat Crowdfunding.org will be providing updates on the progress that has been made including details of meetings held with FINRA and the SEC.

Crowdfunding.org invites you to join members of CFIRA's leadership group and its securities attorney's for this week's live chat in order to learn of the progress that has been made and to invite you to continue to ask questions and provide input.

Please post any questions you have for this next Live Chat as comments to this post or to eric.mack@crowdsourcing.org. We will field the questions.

As I indicated in my blog post dated April 6, 2012, the crowdfunding exemption is going to require that the SEC establish regulations that insure investor disclosures, qualifications and protection.  

Courtesy of an article dated April 19, 2012 appearing in Bloomberg Businessweek