Articles Posted in Crowdfunding

On October 16, 2018 the Securities and Exchange Commission announced that it is implementing temporary rules for issuers who are making offerings pursuant to Regulation Crowdfunding and Regulation A in order to assist issuers who were directly or indirectly impacted by Hurricane Michael. These temporary rules will postpone the filing deadlines for certain reports and forms which must be filed under Regulation Crowdfunding and Regulation A to a later date, provided that Hurricane Michael affected the issuer filing the reports and forms. The rules are set to be effective through November 23, 2018.

Regulation Crowdfunding and Regulation A allow issuers to offer and sell securities that have not been registered under the Securities Act, provided that the issuers follow specified conditions. One of those conditions is that the issuer in question must comply with continual reporting requirements. According to the SEC, the reporting requirements improve investor protection and reduce the likelihood that there will be information disparities between issuers and investors. Ongoing reporting also requires issuers to update their information, which allows investors to base their investment decisions on the most current information available.

When Hurricane Michael made landfall, numerous businesses in the area, including those of issuers making offerings pursuant to Regulation Crowdfunding or Regulation A, experienced disruptions. The SEC expects that the shortage in communications, electricity, facilities, and professional advisors in areas affected by Hurricane Michael could delay companies’ ability to meet their reporting requirements. However, the SEC also acknowledges that those who invest in securities offered pursuant to Regulation Crowdfunding and Regulation A would like for information about the companies that offer those securities to be readily available. In particular, investors will likely have an interest in knowing of any material adverse effects that Hurricane Michael had on the issuer or its business. The SEC found that the most appropriate solution to this dilemma would be to issue temporary relief pursuant to Section 28 of the Securities Act, which permits the SEC to, by rule or regulation, to make exemptions for any person, security, or transaction, provided that the exemption in question is in the public interest and is in harmony with the protection of investors.

On October 3, 2017, the South Dakota Division of Insurance- Securities Regulation published proposed rules which would establish notice filing requirements for federal regulation crowdfunding and Regulation A, Tier 2 offerings.  According to the Division, these rules are being proposed “so the Division may monitor these types of offerings by receiving information about the issuer and the offering.”

The proposed rules governing notice filings for federal crowdfunding offerings would require an issuer who offers and sells securities pursuant to the federal crowdfunding registration exemption to make a notice filing in South Dakota if the following conditions are met: (1) the issuer’s principal place of business must either be in South Dakota or (2) the issuer must plan to sell 50 percent or more of the total offering to South Dakota residents.  As part of the initial notice filing, the issuer would need to include either a completed Uniform Notice of Federal Crowdfunding Offering form or copies of every document filed with the Securities and Exchange Commission.  If the issuer does not use the Uniform Notice of Federal Crowdfunding Offering Form, it would also need to file a consent to service of process form (“Form U-2”), along with a $250 fee.  The notice filing would be effective for a period of twelve months beginning with the filing date.  To renew the notice filing, the issuer would need to file with the Division a Uniform Notice of Crowdfunding Offering form marked “renewal” together with a cover letter asking for renewal, along with a $250 fee. Continue reading

On October 11, 2017, the Iowa Insurance Division announced that it has adopted amendments to the Iowa Administrative Code, adding notice filing requirements for federal crowdfunding offerings and updates to the notice filing requirements for Regulation A, Tier 2 offerings.  In addition, the amendments adopt two policy statements published by the North American Securities Administrators Association (“NASAA”).  The amendments went into effect on November 15, 2017.

Under the amendments, an issuer who plans to make a crowdfunding offering under the federal Securities Act must file notice in Iowa if the issuer has its principal place of business in Iowa or plans to sell 50 percent or more of the total offering to residents of Iowa.  The issuer’s notice filing must include either a completed Uniform Notice of Federal Crowdfunding Offering form (“Form U-CF”) or a Uniform Consent to Service of Process form (“Form U2”).  The issuer must also pay a filing fee of $100.  If the issuer’s principal place of business is in Iowa, the notice filing must be completed as soon as the issuer files its initial Form C filing with the Securities and Exchange Commission.  If the issuer’s principal place of business is not in Iowa but Iowa residents have bought 50 percent or more of the offering’s total amount, the notice filing should be completed “when the issuer becomes aware that such purchases have met this threshold and in no event later than 30 days from the date of completion of the offering.” Continue reading

If you build it, will they come? In the movie Field of Dreams, Kevin Costner’s character Ray Kinsella was promised by a mysterious Voice that if he built a baseball field in the middle of an Iowa cornfield, “they”- ghost baseball players which ultimately included his deceased father – would come. As the formerly cynical, suspicious sportswriter Terrance Mann (James Earl Jones) promised would happen, Ray’s faith in the Voice was rewarded. [1]

The same question might be asked about Crowdfunding Portals, although with decidedly less fantasy and romanticism and no sign of James Earl Jones: If you build it, will they come?

So far, 36 portals have registered with FINRA under Regulation CF, which went effective on May 16, 2016. Two registrations have already been withdrawn, leaving 34 portals in various stages of activity and levels of success.

Approximately 35 states have created exemptions in their securities acts or rules in order to allow businesses seeking relatively small amounts of capital to raise funds locally without undergoing an expensive and complicated registration process. Offerings under these exemptions – typically called intrastate “crowdfunding” exemptions – have usually required compliance with the federal intrastate offering exemption under either Section 3(a)(11) of the 1933 Securities Act, or SEC Rule 147, which allows issuers to avoid the burdens of federal registration as well.

A key element of most of these newly-adopted state provisions has been to allow issuers to use general solicitation to seek investors. However, the federal exemption, together with restrictive historical SEC staff guidance, effectively operated to prohibit internet advertising, and restrict other types of solicitation. The federal intrastate exemption prohibited out-of-state offers of securities, even when those offers were deemed such solely because of their being visible to non-home state residents on the internet. The federal rules also prohibited an issuer formed in another state from availing itself of the intrastate exemption in its “home” state for all other purposes. Other constraints dealing with the issuer’s business activity (such as determining the percentage of its revenue derived from the home state) sometimes complicated the determination about whether an issuer would qualify for the federal, and therefore the state, exemption.

These restrictions, which had not been significantly changed in many years, led to widespread criticism that changing business and legal practices, not to mention the rise of the internet as a marketing tool, had made the intrastate exemption largely obsolete.

The JOBS Act requires the SEC to make inflation adjustments to certain JOBS Act rules every five years. Recent SEC action marks the first of these adjustments, effective on the fifth anniversary of the JOBS Act’s April 5, 2012 adoption. The following adjustments have been announced for Title III Regulation Crowdfunding or “Regulation CF”:

1. The maximum aggregate amount an issuer can sell under Regulation CF in a 12 month period has been increased from $1,000,000 to $1,070,000;

2. The threshold for assessing an investor’s annual income or net worth to determine investment limits is increased from $100,000 to $107,000;

As Regulation Crowdfunding or “Reg CF,” the SEC’s extensive rules implementing the federal/interstate crowdfunding provisions (Title III) of the JOBS Act, recently marked its one-year anniversary, the congressional author of Title III, Congressman Patrick McHenry (R-NC), is now urging the SEC to essentially rewrite Reg CF.

McHenry, a leading crowdfunding industry proponent, outlines his proposal in a seven page May 15th letter to newly sworn-in SEC Chairman Jay Clayton. In his letter to Clayton, McHenry calls for a “comprehensive reform” of Reg CF, outlining in great detail 13 specific revisions to Reg CF that he believes necessary for start-ups and small businesses to fully take advantage of the opportunities that crowdfunding offers. McHenry is hardly alone in his criticism of Reg CF, as the crowdfunding community has roundly panned Reg CF as excessively regulatory in nature and far too costly for start-ups to comply with. While it is unclear if or when the SEC will respond to McHenry’s letter, the proposal should be considered as the opening salvo in what will likely be a full court press by the crowdfunding community to have the rules implementing interstate crowdfunding rewritten in a way much more favorable to the start-up and growth company sectors. Indeed, Clayton’s multi-decade background as an M&A lawyer suggests that the SEC may at least adopt a heightened focus on capital formation issues.

Importantly, McHenry’s recommendations, in his opinion, are all fully within the SEC’s rulemaking ambit, and do not require any legislative action by Congress. Specifically, the main thrusts of McHenry’s proposal are as follows:

Last October, the Securities and Exchange Commission adopted amended rules in several areas designed to facilitate capital formation by small businesses, in large part by coordinating federal requirements with requirements of state “crowdfunding” statutes and rules adopted by approximately 35 states since 2011.

Specifically, the SEC amended Rule 504 of Regulation D to raise the offering limit from $1,000,000 to $5,000,000, and created new Rule 147A, broadening the parameters under which intrastate offerings under existing Rule 147 could be conducted. Rule 147A, among other things, allows unlimited solicitation of offerings, including on the Internet, loosens requirements for issuers to qualify as “doing business in” a state, and allows corporate entities formed out-of-state to conduct intrastate offerings in the state where they primarily do business. Also, the previous requirement that intrastate offerings could only be offered to residents of a single state has been eliminated; the single-state restriction now considers only actual sales.

The effective date for the Rule 504 changes was January 20. However, the effective date of the new Rule 147A does not occur until April 20. Most states’ small business crowdfunding exemptions, whether adopted by statute or by rule, are conditioned upon compliance with Section 3(a)(11) of the 1933 Act or Rule 147. In order for issuers in those states to be able to fully utilize the new Rule 147A, those states will have to amend their exemptions to remove that condition.

On October 26, 2016, the SEC adopted final rules in a year-long administrative rulemaking proceeding seeking to modernize the decades-old federal securities registration exemptions applicable to intrastate (i.e., within the borders of one state) offerings and certain small ($1-5 million) offerings.  The SEC’s adopting order in this proceeding both amends the current intrastate offering “safe harbor” found at Rule 147 under the Securities Act of 1933 (“1933 Act”) and creates a new free-standing intrastate exemption designated Rule 147A.  The newly-released order also impacts small exempt offerings by increasing the offering limit for capital raises conducted pursuant to Rule 504 under Reg D of the 1933 Act to $5 million from $1 million.  Finally, the order repeals the sparsely-utilized Reg D Rule 505.

The primary impetus for this rulemaking and its oft-stated goal of “modernizing” the SEC’s regulatory regime regarding intrastate offerings clearly has been the spread of intrastate crowdfunding exemptions recently adopted pursuant to state “blue sky” securities laws.  Notably, 42 states have currently enacted, or are in some stage of enacting, an intrastate crowdfunding exemption—the vast majority of these relying upon 1933 Act section 3(a)(11) (the statutory provision for which Rule 147 acts as a safe harbor).  Intrastate crowdfunding, however, despite its quick proliferation over the last four years, has not been immune to controversy.  Perhaps the biggest issue has been how to properly fit 21st century securities offerings based on internet communications and marketing/sales platforms onto a securities exemption crafted in 1933.

Section 3(a)(11) provides an exemption from federal registration for “[a]ny security which is part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within, or, if a corporation, incorporated by and doing business within, such State or Territory.”  Accordingly, it has been the SEC’s contention that any kind of general advertising or solicitation must be conducted in a manner consistent with the requirement that offers made in reliance on Section 3(a)(11) and Rule 147 be made only to persons resident within the state or territory of which the issuer is a resident.  In a published 2014 pronouncement, the SEC has stated that while use of the internet would not be incompatible with a claim of exemption under Rule 147, crowdfunding portals would need to implement adequate measures so that offers of securities are made only to persons resident in the relevant state or territory.