BizTech Law Blog

Crowdfunding Flies Through Congress

It caught most observers by surprise, but the Jobs Act, which includes a Title authorizing crowdfunding, passed the U.S. Senate on March 22.  The bill replaced the House's provisions relating to crowdfunding with the Senate's more restrictive version.  The House passed the Senate's version of the Jobs Act on March 27 and President Obama signed it on April 5.

This may not be the end of the story.  Key members of the House of Representatives have expressed their opinion that the Senate's changes to the crowdfunding provisions of the Jobs Act are ill-conceived and burdensome.  These Representatives have stated their intent to mount an effort to change the Senate's crowdfunding provisions after the Jobs Act becomes law.  They did not want to hold up the Jobs Act based solely on their objections to the crowdfunding piece, since the Jobs Act covers many other important topics.

We agree with these Representatives that the crowdfunding provisions of the Jobs Act may not prove to be helpful to capital formation, particularly because of the restrictions placed on intermediaries.  It is possible that potential intermediaries will not be willing to enter the market.  However, there is much left to be determined as many of the details will be determined by the SEC, which is supposed to promulgate rules within 270 days after the Jobs Act is signed by the President.  As a practical matter, the SEC may or may not be able to meet this deadline.

There is considerable detail in the Jobs Act relating to crowdfunding.  At a very high level, the following applies in order to avoid registration of the securities that are being sold to investors using the Internet or similar mass solicitation:

• Transactions must be conducted through an intermediary that:
  • Is registered with the SEC
  • Is registered with any applicable self regulatory organization (such as FINRA)
  • Provides the disclosures required by SEC regulations
  • Ensures that investors review SEC required investor-education information
  • Obtains information and affirmations from investors to assure that investors understand the risks of investment
  • Performs background checks on officers, directors and major investors of the company selling securities
  • Makes information about the company available to the SEC and potential investors at least 21 days before the first sale of securities
  • Establishes minimum investment amounts that must be achieved before any investment can be accepted
  • Follows steps to be determined by the SEC to make sure that investors' investments in all companies through a crowdfunding vehicle do not exceed the maximum that an individual investor is allowed to invest in one company (see below)
  • Follows privacy protection rules to be established by the SEC
  • Does not pay compensation for personal identifying information of any potential investor
  • Does not have a financial interest in the company that is selling securities through the intermediary
• During a rolling 12-month period, the aggregate amount of securities sold to an individual investor may not exceed:
  • The greater of $2,000 or 5% of annual income or net worth, if either the annual income or net worth of the investor is less than $100,000.
  • 10% of annual income or net worth, not to exceed $100,000 if either the annual income or net worth of the investor is equal to or more than $100,000.

[There appears to be an inconsistency in the Act for investors who have annual income on one side of the line and net worth on the other.]

• Resale of the securities purchased through the crowdfunding exemption is prohibited for a one-year period, with limited exceptions.
• The Company selling the securities:
  • Must not sell more than $1 million of securities using the crowdfunding exemption during a rolling 12-month period
  • Must provide information satisfying specific disclosure requirements to the SEC, the intermediary and investors.  The type of financial disclosure required is a function of the size of the offering amounts.
  • May advertise the terms of the offering only through the intermediary
  • Must provide annual reports to the SEC and investors
• State registration requirements are pre-empted, but liability for fraud at both the federal and state level remains.
• "Bad boy" provisions will prevent some companies whose principals have prior enforcement histories from using the crowdfunding exemption.

Please contact me if you have questions regarding crowdfunding.

Categories: Crowdfunding, Venture Capital/Funding