OUT OF THE QUAGMIRE: SEC ADOPTS CROWDFUNDING RULES, AND OTHER DEVELOPMENTS UNDER THE JOBS ACT

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1 OUT OF THE QUAGMIRE: SEC ADOPTS CROWDFUNDING RULES, AND OTHER DEVELOPMENTS UNDER THE JOBS ACT November 2015

2 Prepared By: Thomas More Griffin Denver Edwards B. Seth Bryant The Jumpstart Our Business Startups Act (the JOBS Act ) was signed into law by President Obama on April 5, The JOBS Act has key, substantial provisions that govern exempt and registered offerings, initial public offerings ( IPOs ) and issuer reporting requirements. The main purpose of the legislation is to enhance the capital raising of small and medium sized businesses and thereby to enable and assist startups and venture capital companies in raising funds from stakeholders, which in turn will create and increase jobs. The JOBS Act also assists those companies that traditionally have had difficulty raising money from banks and other traditional financial lenders. The JOBS Act has positively effected capital raising by small and medium sized companies. And after small companies and investors waited over two years for the Securities and Exchange Commission ( SEC or Commission ) to finalize crowdfunding rules, the SEC issued final rules on October 30, These rules will be effective by the end of May 2016, except that certain regulations relating to forming funding portals will be effective January 29, SEC Chair Mary Jo White stated in the crowdfunding adoption release that There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need It should also be noted that on October 30, 2015, the SEC proposed 2

3 amendments to Securities Act Rule 147 and Rule 504 of Regulation D to facilitate intrastate and regional securities offerings. The JOBS Act consists of six principal parts or Titles. This article focuses mainly on developments in the first four Titles. Title I creates a new class of registrants Emerging Growth Companies ( EGCs ) that may file their draft IPO registration statement with the SEC on a confidential basis for staff review. EGCs have reduced disclosure requirements, no restrictions on test-the-market communications with qualified institutional buyers ( QIBs ) and institutional accredited investors ( AIs ) before and after the filing of their IPO registration statement, and relaxed requirements regarding compensation disclosure and analyst research relating to the offering. Title II of the JOBS Act eliminates the prohibition on general solicitation and general advertising in Rule 506(c) private placement offerings (under Regulation D of the Securities Act of 1933, as amended (the 1933 Act or the Securities Act )) when securities sales are only made to AIs and Rule 144A investors. Title III of the JOBS Act is the crowdfunding provision that creates an exemption from the registration requirements of the federal securities laws for small offerings of securities. Crowdfunding is a novel, seed stage capital raising provision at the heart of the JOBS Act, designed to facilitate small securities offerings by small companies whose investors are not likely to be AIs. Title IV creates the Regulation A+ offering exemption for interstate offerings up to $50 million with enhanced disclosure requirements. Regulation A+ offerings may be viewed as quasi public offerings. 3

4 Titles V and VI amended the Securities Exchange Act of 1934, as amended ( Exchange Act ), principally to raise, from 500 to 2,000 beneficial owners, the threshold for the number of beneficial owners of a company s equity securities triggering registration obligations under the Exchange Act. Below is a chart comparing the JOBS Act provisions and regulations relating to Regulation A+, Rule 506(c), and crowdfunding offerings. It should be noted that SEC regulations relating to EGCs, Regulation A+ offerings and Rule 506(c) offerings to AIs and QIBs using general advertising and general solicitation have been adopted. SEC regulations regarding crowdfunding were adopted October 30, Provision Reg A+ Reg D/ Rule 506(c)* Crowdfunding* Maximum Offering Amount Offeree Types Individual Investment Limits on Investors Tier 1 -- $20 million Tier 2 -- $50 million All, including non-accredited investors Per Offering: greater of 10% of income or 10% of net worth Unlimited $1,000,000 Accredited Investors Only None Investor Verification Self-Certification Heightened Accredited Investor Verification; Financial Information Required; No Bad Actors in offering Advertising/General Solicitation Pre-filing/test the waters Testing the waters allowed No filing requirements (yet) with no pre-filing; must file solicitation materials with first offering statement; offering circular must be filed 48 hours prior to first sale All Special rules for Unaccredited Investors All offerings (over 12 mos.): greater of $2,000 or 5% of lesser of annual income or net worth (if either annual income or net worth below $100,000); and 10% of lesser of annual income or net worth, not to exceed maximum sales of $100,000 (if both annual income and net worth is equal to or more than $100,000) Self-certification Unrestricted Unrestricted Limited to notices; all must occur on internet Pre-filing with SEC required before any offer (no testing the waters) Closing Speed Slow SEC Approval Fast No SEC Involvement Medium SEC Pre-Filing 4

5 Required Required Offering Documents Strong SEC Approval Required No Specific Requirements Medium SEC Pre-Filing Required Financial Disclosure Audited Financials No Specific Requirements Limited financial disclosure for offerings under $100,000; Reviewed $100,000 - $500,000; Audited above $500,000 Ongoing Disclosure/Filing Annual, Semi-Annual, Current Reports including audited financials None. Companies have to file a Form D with the SEC. Termination of Ongoing Reporting Less than 300 holders of Reg A+ stock N/A Transfer Restrictions None Restricted Securities. 1 Year; none for Rule 144A sales to QIBs Annual Disclosure & Financials Retirement of all Crowdfunded Securities 1 Year or to Issuer or Accredited Investor Shareholder Limit 2,000 persons or 500 2,000 accredited investors Unlimited unaccredited investors Intermediary None Required None Required Funding Portal or Broker-Dealer Required; Internet Portal Required State Preemption Tier 1 comply with state blue sky laws Tier 2 no need to comply with state blue sky laws for sales to qualified purchasers Yes. Exempt as covered security under Section 18 of 1933 Act. Section 18 (c) (2) (A) of the 1933 Act permits states to require notice filings. Yes, but must make filing in home state and any state with greater than 50% of crowdfunders Liability Section 12(a)(2) of 1933 Act and Rule 10b-5 of 1934 Act liability Rule 10b-5 of 1934 Act liability Investor Tests/Requirements None Accredited Investor testing verification requirements higher than prior reasonable belief Portal Liability; Burden of Proof for Diligence Defense is on Issuer. Rule 10b-5 liability for Issuer Test Required * Note that the proposed SEC crowdfunding and Regulation D rules (both of which are discussed herein) have not yet been adopted. The above chart was adapted from the chart set forth in the Crowd Fund Insider article, The Reg A+ Bombshell: $50M Unaccredited Equity Crowdfunding Title IV takes Center Stage, published on March 25, Investment bankers are warming up to the JOBS Act, according to a survey released by BDO USA LLP in July The BDO report highlights that 51% of the 100 bankers surveyed believe that the JOBS Act has had a positive effect for IPOs, up from 14% two years ago. They are viewing the JOBS Act s positive impact on IPOs and private placements, and are taking advantage of the Act to grow these businesses. Recently, at a PLI conference on securities regulation held in New York City at the end of October 2015, members of the SEC commented that: 1 5

6 approximately 1,000 EGC IPO filings have been made to date; regarding Regulation A+ offerings, 34 companies have filed offering statements, 16 of which have made confidential non-public filings; the SEC qualified three offerings; for the year ended December 31, 2014, $1.3 trillion dollars was raised for Rule 506(b) and Rule 506(c) offerings; only a very small percentage of these offerings were Rule 506(c) offerings; and few issuers have taken advantage of Title I s research reports provisions. Title I - Emerging Growth Companies Title I of the JOBS Act is viewed as the IPO on ramp or IPO runway for EGCs. An EGC is an issuer with total annual gross revenues of less than $1 billion dollars during its most recently completed fiscal year. An issuer s EGC status terminates on the earliest of (i) the last day of the first fiscal year during which the issuer had annual gross revenues of $1 billion or more; (ii) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the issuer s IPO; (iii) the date on which the issuer has issued more than $1 billion in convertible debt during the prior three-year period determined on a rolling basis; or (iv) the date on which the issuer is deemed to be a large accelerated filer under the Exchange Act. EGCs have the following advantages: They may submit to the SEC a draft IPO registration for confidential review; filings must be submitted to the SEC no later than 21 days before the EGC conducts its road show; They may submit only two (2) years of audited financial statements instead of three (3) years for most registrants; 6

7 EGCs may test the waters by having oral and/or written communications with QIBs and institutional AIs to determine interest in the offering; Auditor attestation and internal controls compliance requirements are phased in over five (5) years instead of present compliance; EGCs may choose to comply with non-egc accounting standards but may not selectively comply with these standards; EGCs may comply with executive compensation disclosure requirements for smaller reporting companies; and EGCs are exempt from the requirement to hold non-binding advisory stockholder votes on executive compensation ( say on pay ) for one to three (3) years after the issuer is no longer an EGC. Title I has been very successful in promoting the growth of the IPO market and many filers are taking advantage of the confidential filing provision. Recently, The Wall Street Journal reported ( Secret IPO Filings Feed Deal Frenzy, July 28, 2015) that one of the unintended effects of EGCs filing their IPO registration statements confidentially is sparking interest in the filers from prospective acquirers. Under Title I the EGC is able to announce publicly that it has filed its registration statement (the SEC is forbidden from disclosing that a confidential EGC filing has been made). Recent stealth EGC filers, such as Planet Fitness Inc. and Houlihan Lokey Inc., have publicly disclosed the fact that they made confidential SEC filings. Some companies may make an EGC confidential filing to invite bids from prospective acquirers. According to The Wall Street Journal, the SEC received EGC confidential filings from around 850 companies in the past three years through June 30, But according to Dealogic, a prominent research firm, only 479 of those filings lead to a consummated 7

8 IPO. 2 According to this article, confidentiality around IPOs will make it more challenging for the IPO market to recover from its slow start this year. Information is the grease of the capital markets You would think that we would want more transparency, not less. Nonetheless, these companies have taken advantage of the ability to test the waters with AIs and QIBs for the offering and have a behind the scenes dialogue with the SEC. Title II - Rule 506(c) Regulation D Upgrade - General Solicitations and General Advertising Permitted In Certain Private Placement Offerings Section 4(b) of the Securities Act provides that offers and sales of securities exempt under Rule 506 of Regulation D (as revised by Title II of the JOBS Act) shall not be deemed public offerings under the Federal securities laws as a result of general advertising and general solicitation. Rule 506(c) is excluded from Rule 502(c) of Regulation D, which bans general solicitations and general advertising as a general condition to a Regulation D offering. Rule 506(c) exempts from the registration requirements sales of securities to an unlimited number of AIs provided certain requirements are met (discussed below). Also, the removal of the prohibition against general solicitation and advertising applies to funds that rely on Sections 3(c)(1) and 3(c)(7) under the Investment Company Act of 1940 ( Investment Company Act ) for sales to U. S. persons. Also, funds with concurrent U.S. and non-u.s. offerings (under Regulation S) would not be integrated (general advertising and general solicitations are not deemed to be direct selling efforts under Regulation S). The conditions to offerings that are generally advertised and solicited in reliance on Rule 506(c) are: 2 Secret IPO Filings Feed Deal Frenzy, The Wall Street Journal (July 28, 2015), at B4. 8

9 Issuer takes reasonable steps to verify that purchasers are AIs and/or QIBs; All purchasers are AIs/QIBs at the time of the sale of the securities; and Conditions of Rules 501, 502(a), and 502(d) of Regulation D are satisfied. The issuer may satisfy the AI reasonable steps to verification process in several suggested, but not mandatory, ways, including the following: Fact based determination (for example, public company documentation); IRS tax returns; Bank or brokerage statements; and Written confirmation from registered broker-dealer, investment adviser, attorney, or CPA. The SEC has stressed that exclusive reliance on potential investor responses in a fund application or subscription document would not be adequate verification. The issuer must also determine that no bad actors are involved in the private placement s base of covered persons (e.g., issuer, affiliated issuer, officer, director, beneficial owners of 20% or more of issuer s voting equity securities, promoters, etc.). If any of these covered persons is subject to a disqualifying event (e.g., criminal convictions, court injunctions and restraining orders, final orders of state and federal regulators, SEC/FINRA disciplinary orders, etc.), an offering is disqualified from relying on Rule 506(c). Note that if the issuer did not know and, in the exercise of reasonable care, it could not have known that a covered person with a disqualifying event participated in the offering, an issuer may rely on Rule 506(c). 9

10 The Rule 506 amendments also impact broker-dealers, investment advisers, and investment companies and their associated persons. SEC disciplinary orders relating to these entities or persons are disqualifying events under the bad actor rule. In addition, FINRA rules governing Rule 506(c) offering-related communications are complex. FINRA Rule 5123 (FINRA member selling private placement securities to non-members must file private placement documents with FINRA within 15 days of their first sale of securities in Private Placement Filing Systems in FINRA Firm Gateway) and FINRA Rule 2210 (pre-approved, filing, record keeping and communications with customers and advertising) do not synch well with Rule 506(c) offerings deploying general solicitation and general advertising. Broker-dealers participating in private placements under Rule 506(c) must comply with FINRA rules requiring all member communications to be based upon principles of good faith and fair dealing and prohibiting broker-dealers from making false, exaggerated and unwarranted or misleading statements or claims in any communications. In a world where general solicitation rules are relaxed and Internet offerings can be quickly constructed, broker dealers and their counsel will have to be extra vigilant about ensuring adequate disclosure. Commodity Pool Operators ( CPOs ) and Commodity Trading Advisors ( CTAs ) have been reluctant to use Rule 506(c) in connection with private placements/commodities fund offerings. Certain CFTC rules don t gel well with Rule 506(c). CFTC Regulation 4.7 provides that CPOs and CTAs whose participants and advisees are limited to qualified eligible persons ( QEPs ) may claim relief from providing participants with a disclosure document; general solicitation is not permitted. Under CFTC Regulation 4.7, offerings must qualify for registration exemptions pursuant 10

11 to Section 4(a)(2) of the Securities Act. Rule 506(c) is not an exemption pursuant to Section 4(a)(2) of the Securities Act. The CFTC addressed in its words this discrepancy between marketing restrictions in current Commission regulations and Regulation D and Rule 144A, as amended pursuant to the JOBS Act by granting exemptive relief. This relief was granted by the CFTC s Division of Swap Dealers and Intermediary Oversight. For Rule 506(c) offerings in which the CPO needs reporting relief from Regulation 4.7, relief was granted from the provision that the offering must be exempt pursuant to Section 4(a)(2) of the Securities Act and that interests be granted solely to QEPs. For Rule 506(c) offerings in which the offering entity seeks to claim the de minimus registration exemption of Regulation 4.13(a)(3), relief was granted from the requirement that offers and sales be conducted without marketing to the public. Note that this area is very complex and requires close scrutiny of the conditions for exemptive relief. Since the SEC issued its final rule eliminating the ban against general solicitation and general advertising in private placements to AIs and QIBs in July 2013, the marketplace reaction for deploying this private offering feature has been mixed. Many private equity, hedge, venture capital and other investment funds cherish their confidentiality and have not deployed general solicitation and general advertising strategies. Most of the Regulation D offerings are done pursuant to Rule 506(b). On the other hand, relatively new matchmaking websites such as Circle Up and Go Fund Me, which link AIs with private placement issuers, have increased and flourished under Rule 506(c). As a result of the relaxation of the general advertising and solicitation prohibition in Rule 506(c) private placements, these sites are able to introduce 11

12 prospective AIs to companies seeking private placement investors/capital. Such sites must limit their activities in order that they are not broker-dealers requiring registration. Also, these sites will presumably set up portals for crowdfunding offerings to non-ais. Under the JOBS Act, a matchmaking site is exempt from registering as a brokerdealer in Rule 506 offerings if it does not receive compensation such as a brokerage commissions for the purchase or sale of private placement securities; it does not handle customer funds or securities; and it is not a bad actor. Some matchmaking sites have affiliated broker-dealers that receive a commission upon the sale of private placement securities to AIs pursuant to the matchmaking site. According to SEC no action letters and FAQs (Frequently Asked Questions), a matchmaking site may have a platform permitting the offer, sale, purchase or negotiation of securities, or permit general solicitation and advertising by issuers of securities, whether online, in person, or through any other means. A matchmaking site may also provide ancillary services, such as due diligence services and provision of standardized documents to issuers and investors. These provisions apply only to the activities of matchmaking sites in Rule 506(c) private placement offerings to AIs. Title II - Regulation D Amendments On September 27, 2013, the SEC proposed, and subsequently re-opened, a comment period for discussion of the proposed rules and amendments relating to Regulation D and Rule 156. These proposed rules would: Require a Form D filing before the issuer engages in general solicitation and to amend its Form D regarding inclusion of additional information in a Form D regarding the offering; 12

13 Require a Form D closing amendment to be filed with the SEC after the termination of any Rule 506 offering; Require written general solicitation materials in Rule 506(c) offerings to have legends and other disclosures; Extend Rule 156 s anti-fraud provisions to sales literature of private funds; Require filing with the SEC of written general solicitation materials in Rule 506(c) offerings; and Disqualify issuers for one year for future offerings if the issuer did not comply within the last five years with Form D requirements. These regulations have not been enacted and it is possible that some might be adopted and others will not. Title III - Crowdfunding Crowdfunding is one of the most misunderstood aspects of the JOBS Act largely because a significant number of people are unaware that crowdfunding includes equity and debt offerings in addition to donor and reward-based crowdfunding. This is due to the fact that the SEC s crowdfunding rules took over two years to finalize and the success during that time of non-equity crowdfunding as a means to raise money for artistic projects, a charity or other causes capturing the interest or sympathy of the multitude of crowd funders. In these instances, the crowd has no expectation of receiving anything of value for the investment. However, crowdfunding, as used in Title III the JOBS Act, concerns securities funding for commercial ventures through small investors. 13

14 The SEC issued final crowdfunding regulations on October 30, They are effective at the end of May The market exhaled for a brief moment replaced by wonder as to whether equity and debt raises by crowdfunding will be successful after this capital raising starts in June By way of background, Title III of the JOBS Act was designed to exempt crowdfunding securities offerings from registration under the Securities Act. The JOBS Act added Section 4(a)(6) to the Securities Act, which section provides an exemption from the registration requirement in Section 5 of the Securities Act for certain crowdfunding transactions. In order to qualify for the exemption under Section 4(a)(6), an issuer and investors in a crowdfunding transaction must meet specified requirements, including the following: The amount raised must not exceed $1 million in a 12-month period (amount to be adjusted every five years); this amount is the gross, not net, amount that may be raised; Individual investments in a 12-month period are limited to: o The greater of $2,000 or 5 percent of the lesser of annual income or net worth, if either the annual income or net worth of the investor is less than $100,000; o 10 percent of the lesser of annual income or net worth (not to exceed $100,000 in all crowdfunding transactions in a 12-month period), if both annual income and net worth of the investor are $100,000 or more; and o Issuers must conduct transactions through an intermediary that is either a registered broker/dealer or a funding portal. Issuers cannot use multiple intermediaries for an offering or concurrent offerings in reliance on the exemption. The Commission is of the view that policing compliance of 14

15 the offering would be more effective if one intermediary oversees the offering. Issuers and funding portals, intermediaries that facilitate transactions between issuers and investors in reliance on Section 4(a)(6), must provide certain information to investors and potential investors, take certain other actions and provide notices and other information to the SEC. The issuer must not have a disqualifying event pursuant to the bad actor provisions of the Jobs Act. Requirements as to Issuers Below are detailed requirements to utilize the Section 4(a)(6) exemption: A. Statutory Disclosures. Issuers must file certain statutory disclosures with the Commission, provide these disclosures to investors and the relevant broker or funding portal, and make these disclosures available to potential investors. The disclosures include: (1) the name, legal status, physical address and website of the issuer; (2) names of the directors and officers (and any person occupying similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer; (3) a description of the business of the issuer and the anticipated business plan of the issuer; (4) a description of the financial condition of the issuer; (5) a description of the stated purpose and intended use of proceeds of the offering sought by the issuer with respect to the target offering amount; (6) the target offering amount and regular updates regarding the progress of the issuer in meeting the target offering amount; (7) the price of the securities or the method to determine the price; and (8) a description of the ownership and capital structure of the issuer. The crowdfunding rules establish a framework of tiered financial disclosure based on the aggregate target offering amounts of the offering and all other offerings made in reliance on 15

16 Section 4(a)(6) within the preceding 12-months. Issuers must file with the Commission, provide to investors and the relevant intermediary, and make available to potential investors, the following materials: For issuers offering $100,000 or less, total income, taxable income and total tax as reflected in the issuer s federal income tax returns certified by its principal executive officer (no requirement that issuer provide copies of entire tax return); or if issuer has financial statements reviewed or audited by an independent public accountant, these financial statements should be provided to investors; For issuers offering more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant independent of the issuer; if audited financial statements are available, issuer must provide these to investors; For issuers offering more than $500,000 but not more than $1,000,000 for the first time, financial statements reviewed by an independent accountant; if audited financial statements are available, issuer must provide these to investors; Issuers that have previously sold securities under the crowdfunding rules must provide audited financial statements; and Financial statements must be prepared in accordance with U.S. GAAP. These requirements could be burdensome, but the Commission takes the position that the rule pertains to the type of information that an issuer would be generally required to disclose, and to alleviate some of the burden, the issuer and the intermediary have discretion to determine the format that best conveys the required information and any other information the issuer determines is material to investors. 16

17 B. Additional Disclosures Proposed by the SEC. In addition to the statutory disclosures, the proposed rules require disclosure of (1) the name, Commission file number and Central Registration Depository number ( CRD Number ) of the funding portal or intermediary through which the offering is being conducted; (2) the amount of compensation paid to the intermediary for conducting the offering, including the amount of any referral or other fees associated with the offering; (3) certain legends to be included in the offering statement; (4) the number of current employees of the issuer; (5) the material factors that make an investment in the issuer speculative or risky; (6) the material indebtedness of the issuer, including the amount, interest rate, maturity date, and any other material terms; (7) exempt offerings conducted within the past three years; and (8) related party transactions. While seemingly burdensome for a small offering, these detailed disclosures are intended to enable investors to make an informed investment decision and help regulators to monitor compliance with the exemption. Crowdfunding takes a very different approach for offerings of less than $1,000,000 as compared to Rule 504 of Regulation D (which covers offerings up to $1,000,000 in a twelve month period in which issuers may generally not use general advertising and solicitation), and is limited to private placement offerings. Crowdfunding hopefully will create the infrastructure and data for an Internet enabled micro-market for the securities of early stage companies. C. Method for Disclosures. The crowdfunding rules set forth a disclosure regime as follows: (1) issuers must use Form C for the initial required disclosures known as the offering statement; (2) amendments to Form C must be filed on Form C-A to report material changes; (3) progress reports/updates must be made on Form C-U; (4) annual reports must be done on Form C-AR; and (5) termination of reporting obligations must be made on Form C-TR. Form C-AR must be filed within 120 days of the end of the issuer s fiscal year. The annual report should 17

18 update information on Form C. An issuer also must update its information by reporting amendments and progress updates to the offering statement on Form C. These reporting obligations continue until the issuer becomes a reporting company, all securities are sold in crowdfunded offerings are redeemed or repurchased by a third party, or the issuer liquidates or dissolves. D. Ineligible Issuers. The JOBS Act excludes certain issuers from participating in crowdfunding, including the following: (1) foreign issuers; (2) issuers that are reporting companies under the Exchange Act; (3) investment companies as defined under the Investment Company Act or companies excluded from the definition of investment companies under Section 3(b) or 3(c) of that Act; (4) issuers that have taken advantage of Section 4(a)(6), but have failed to file with the Commission or provide to investors on-going annual reports to the Commission during the two years preceding a current offering; (5) issuers subject to disqualification under crowdfunding disqualification rules; (6) issuers, typically known as blank check issuers, that are early stage development stage companies without a business plan or corporate purpose, or development companies that have indicated that they intend to merge or acquire an unaffiliated company or companies; and (7) companies that have not complied with the crowdfunding rules during the two years preceding the filing of an offering statement. E. Integration with Other Exempt Offerings. Offerings made pursuant to the Section 4(a)(6) exemption will not be integrated with another exempt offering that precedes the crowdfunding offering, or that takes place concurrently or subsequently with such offering. The issuer must ensure that it has satisfied all of the conditions for the exemption that it is claiming for each such offering. If the issuer is conducting a Rule 506(c) offering (using general 18

19 solicitation), it must ensure that the crowdfunded offering it is making or made complied with all crowdfunding rules (such as the restrictions on advertising). F. Advertising and Promotion. Because crowdfunding occurs online, there is a sense that the offerings are broadly advertised. However, the proposed rules would only allow limited advertising consisting of specific notices advertising the terms of the offering to include only the following: (1) a statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted, and a link directing the potential investor to the intermediary s platform; (2) the terms of the offering; and (3) factual information about the legal identity and business location of the issuer that is limited to the name of the issuer of the security, the address, phone number and website of the issuer, the address of a representative of the issuer and a brief description of the business of the issuer. G. Restrictions on Resale. Securities purchased in a crowdfunded transaction cannot be resold for a period of one year after the date of purchase, except when transferred (1) to the issuer of the securities; (2) to an accredited investor in compliance with the federal securities laws; (3) as part of a registered offering; or (4) to a family member of the purchaser or the equivalent, or in connection with certain events, including death or divorce of the purchaser, or other similar circumstances, subject to the discretion of the Commission. The one year restriction applies to any purchaser, not just the initial purchaser. A person reselling securities to an AI must have a reasonable belief that the prospective purchaser is an AI. H. Exemption from Rule 12(g). The proposed rules exempt from the registration requirements of Section 12(g) of the Exchange Act, either conditionally or unconditionally, securities acquired pursuant to an offering made in reliance on Section 4(a)(6). In other words, Section 4(a)(6) securities would be exempt from and not count toward the holder of record 19

20 count for purposes of determining if registration of a class of equity securities is required under Section 12(g). Logistically, securities may be difficult to track by a new issuer and retaining a transfer agent may be necessary. Requirements on Funding Portals as Intermediaries The crowdfunding rules impose significant gate keeping responsibilities on brokers and/or funding portals. These responsibilities appear onerous and raise questions around how crowdfunding intermediaries would be incentivized to serve in such capacity. Below is a brief and summary discussion of the requirements. A. Broker and Funding Portals. Section 4(a)(6) requires a crowdfunding offering to be conducted through a broker or a funding portal that complies with the requirements of Section 4A(a) of the Securities Act. A funding portal, as defined by Section 304 of the JOBS Act, is any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to Section 4(a)(6). Funding portals will not be subject to broker-dealer registration under Exchange Act Section 15(a)(1), but would be subject to an alternative regulatory scheme largely managed by FINRA with oversight by the Commission. But unlike matchmaking sites in Rule 506(c) offerings, funding portals may receive compensation. B. Impermissible Actions. Funding portals cannot: (1) offer investment advice or recommendations; (2) solicit purchases, sales or offers to buy the securities offered or displayed on its platform or portal; (3) compensate employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced on its platform or portal; (4) hold, manage, possess or otherwise handle investor funds or securities; or (5) engage in such other prohibited activities that the Commission may determine by rulemaking. 20

21 C. Required Disclosures by Intermediaries. Funding portals must provide specified disclosures to investors and take the following steps: Not later than 21 days prior to the first day on which securities are sold, make available to the Commission and potential investors the information the issuer is required to provide to investors; Provide investor education materials and ensure that each investor reviews such information and affirms his/her understanding of the risks associated with the investment; Take measures to reduce the risk of fraud, including background checks on issuers officers, directors and holders of 20 percent of their outstanding equity; Only provide offering proceeds to the issuer when the aggregate capital raised from all investors equals or exceeds the target offering amount, and allowing for cancellation of the commitments to purchase in the offering; Make efforts to ensure that no investor in a 12-month period exceeds the limit allowed to be invested in all issuers that have conducted exempt crowdfunding offerings; Take steps to protect privacy of information; Not compensate promoters, finders, or lead generators for providing personal identifying information of personal investors; Prohibit insiders from having any financial interest in an issuer using that intermediary s services; and Meet any other requirements that the SEC may prescribe. 21

22 D. FINRA Rules. On October 22, 2015, FINRA submitted to the SEC its proposed rules regarding funding portals for crowdfunded securities offerings. FINRA s approach is to treat funding portals as a separate category of FINRA member distinct from brokerdealers. FINRA eliminated the fidelity bond requirement and anti-money laundering ( AML ) rule. In brief, FINRA proposed rules include: Rule 100. Funding portals and their associated person would be subject to FINRA s bylaws. Rule 110. The Rule outlines the membership application process and establishes five standards for membership: (1) compliance with FINRA s and the Commission s rules and regulations; (2) binding contractual arrangements sufficient to initiate operations; (3) strong supervisory systems; (4) evidence of direct and indirect funding sources (it is not clear if FINRA would place specific financial requirements on the portal); and (5) record keeping systems. Rule 200. Portal must observe high standards of commercial honor and just and equitable principles of trade. Rule 200 also implicates the Commission s anti-fraud provisions related to effecting transactions in, or inducing the purchase of sale of, any security by means of, or by aiding or abetting, any manipulative or fraudulent device. Rule 300. Portals must establish written policies and procedures and supervisory systems designed to achieve compliance with all applicable rules and report misconduct to FINRA as appropriate. 22

23 Rule 800. Provide information to FINRA regarding the outcome of investigation and sanctions related to the funding portal and associated persons. Rule 900. This rule establishes a code of procedure for funding portals. Rule This rule contains arbitration and mediation procedures for disputes. Liability Scheme Under the proposed crowdfunding rules, like other aspects of the JOBS Act, traditional liability theories remain applicable, including that issuers, including their directors and officers, are liable to purchasers of securities for untrue or materially misleading statements in offering documents. Because an issuer is a person that offers or sells securities in crowdfunding offerings, the SEC stated that it appears likely that the intermediaries would be considered issuers for purposes of [the] liability provisions. 3 With respect to funding portals, intermediaries must use reasonable care in reviewing offering documents, including establishing a reasonable policy to avoid misstatements and untruths. Personal liability could attach to directors, officers and employees of funding portals for such actions as fraud. Assessing the crowdfunding rules and Title III of the Jobs Act, one thing that sets the crowdfunding rules apart is the ability of small companies to create a community of small investors and to give them marketplaces where they can support start-ups. The goals are novel in that the SEC is attempting to facilitate investments in opportunities that have long been viewed as the most speculative and difficult. Given the SEC s overall mandate to protect investors, getting crowdfunding right requires balancing complex and sometimes contradictory 3 SEC Release No (October 23, 2013), at

24 objectives, including balancing the small size of the investment versus the significant administrative framework to facilitate such investments. Title IV - Regulation A+ Offerings On March 25, 2015, the SEC adopted rules known as Regulation A+ that would increase a smaller company s ability to raise capital. The new rules revise Regulation A of the Securities Act. Regulation A is an exemption from the full registration requirements of the Securities Act. The old Regulation A permitted registered public offerings of up to $5 million of securities in any twelve month period, including no more than $1.5 million in sales by security holders. Under Regulation A+ rules companies meeting certain size requirements may offer and sell up to $50 million of securities in a twelve month period, subject to disclosure and reporting requirements. The rules provide for two tiers of securities offerings: (a) Tier 1 for offerings of up to $20 million in a twelve month period, in which selling security holders that are affiliates of the issuer cannot sell more than $6 million of securities, and (b) Tier 2 for offerings of up to $50 million in a twelve month period, in which selling security holders that are affiliates of the issuer cannot sell more than $15 million of securities. Tier 1 offerings are subject to federal and state registration and qualification requirements; issuers may use the coordinated review program developed by the North American Securities Administrators Association ( NASAA ). The rules pre-empt state securities law registration and qualification for securities offered or sold to qualified purchasers in Tier 2 offerings. The rules also limit sales by all security holders to no more than 30% of the issuer s initial Regulation A+ offering and subsequent Regulation A+ offerings for the twelve months after the initial offering. 24

25 Both offering Tiers are subject to company eligibility, disclosure and other matters, and allow issuers to submit their draft offering statements for non-public (confidential) review by the SEC staff before filing (similar to rules applicable to EGCs selling their securities in an initial public offering or IPO), permit the use of solicitation materials after the issuer files the offering statement, and require the electronic filing of offering materials. Also, issuers in both Tiers may test the waters of the offering with all investors. In such cases, solicitation materials must be filed with the SEC. Tier 2 offerings also include the following requirements: (a) providing audited financial statements to investors; (b) requiring issuers to file annual, semi-annual and current event reports; and (c) restricting the amount of securities non-accredited investors may purchase to not more than 10% of the greater of the investor s net worth or annual income. Regulation A+ is limited to companies organized in and with their principal place of business in the United States or Canada. Also, Regulation A+ cannot be used by: (a) SEC reporting companies and certain investment companies; (b) companies with no specific business plan or companies that will engage in a mergers and acquisition transaction with an unidentified entity; (c) companies offering asset-backed securities or oil, gas or other mineral rights; (d) companies which have been subject to an SEC order under Section 12(j) of the Exchange Act, (e) companies which have not filed required reports with the SEC for two years; and (f) companies disqualified by the SEC s bad actor rules. If the issuer in a Tier 2 offering meets the following requirements, it will be exempt from the mandatory registration requirements of Section 12(g) of the Exchange Act: (a) the issuer uses a transfer agent registered with the SEC; (b) the issuer is subject to Tier 2 reporting; (c) the issuer 25

26 is current in its annual and semi-annual reporting at fiscal year end; and (d) the issuer has a public float of less than $75 million at the end of its most recent semi-annual period, or in the absence of such float, had annual revenues of less than $50 million as of its last fiscal year. If the company exceeds the dollar amount and Section 12(g) registration thresholds, it would have a two year period before it would have to register its securities. It should be noted that in May 2015 Massachusetts and Montana sued the SEC alleging that Regulation A+ improperly preempted state regulation of Tier 2 offerings, and that the SEC s authority to preempt state securities laws under the JOBS Act is limited to securities offered and sold to qualified purchasers. The dispute stems in part over how the SEC defines qualified purchaser. NASAA and certain present and former members of Congress filed briefs in support of the States. Titles V and VI. Exchange Act Registration Thresholds Titles V and VI of the JOBS Act amended Section 12(g) of the Exchange Act. Section 12(g) as amended requires registration of a class of equity securities if, at the end of its fiscal year, a company has at least $10 million in assets and a class of equity securities held of record by either 2,000 persons, or 500 persons who are not AIs. Banks and bank holding companies do not have to register unless they have, at the end of the fiscal year, at least $10 million in assets and a class of equity securities held of record by 2,000 persons. A non-bank company may deregister its securities if it has 300 holders of record or less. Banks and bank holding companies may deregister if they have 1,200 or fewer holders of record. Exchange Act Section 12(g)(5) was amended to provide that held of record does not include securities held by 26

27 persons who received the securities pursuant to an employee compensation plan in transactions exempted under Section 5 of the Securities Act. Closing Commentary In the three plus years since it became law, the JOBS Act has in fact jump started capital raising in meaningful ways. It has offered a real alternative to traditional registration and private placements for small businesses, including EGCs, which seek to raise funds from investors whether through the IPO on-ramp provisions of Title I, the limited public offerings of Regulation D through Rule 506(c) of Title II, crowdfunding under Title III, and the Regulation A+ provisions of Title IV. Although the success of equity and debt crowdfunding is too early to call, hopefully this will significantly help small companies raise capital. This article has been prepared by Bryant Rabbino LLP as an informational guide for clients and friends.. The information contained in this article should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact one of the attorneys below. The invitation to contact is not a solicitation for legal work under the laws of any jurisdiction in which Bryant Rabbino attorneys are not authorized to practice. Copyright Bryant Rabbino LLP. All Rights Reserved. B. Seth Bryant Denver Edwards Thomas More Griffin , x , x , x136 seth@bryantrabbino.com denveredwards@bryantrabbino.com tgriffin@bryantrabbino.com 27