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From Securities Regulation Daily, October 30, 2015

SEC adopts final crowdfunding rules; proposes amendments to rules governing intrastate offerings

By Jacquelyn Lumb

The SEC adopted final rules to regulate offerings of securities through crowdfunding—the last of the major rules mandated by the JOBS Act. The rules set thresholds on the amount a company may raise through crowdfunding in a 12-month period and on the amount individuals may invest, based on their net worth or income. Companies that conduct a crowdfunding offering must provide specific information to the SEC, to investors, and to the intermediaries that are used to facilitate the offering. The rules also address the requirements for funding portals that are used to facilitate the crowdfunding offerings. The rules were adopted in a three-to-one vote with Commissioner Michael Piwowar voting in opposition. The SEC also approved, in a three-to-one vote, a proposal to amend Securities Act Rules 147 and 504 to modernize their approach to smaller companies’ intrastate offerings.

Response to comments. In opening remarks, SEC Chair Mary Jo White noted that the crowdfunding proposal had generated significant interest among potential issuers, investors, and intermediaries. The final rules include a number of changes to the initial proposal in response to comments that were received. For example, White said the staff revisited some of the provisions in the initial proposal to ensure that adequate measures were in place to facilitate capital raising by an issuer population that is expected to be very different from the others the SEC oversees.

Crowdfunding thresholds. The crowdfunding rules will permit a company to raise a maximum aggregate amount of $1 million in a 12-month period. Over that same period, individual investors may invest in the aggregate, across all crowdfunding offerings, up to the greater of $2,000 or 5 percent of their annual income or net worth if either is less than $100,000. If both their annual income and net worth are more than $100,000, individuals may invest up to 10 percent of the lesser amount of their annual income or net worth. The aggregate amount of securities sold to an investor through crowdfunding offerings may not exceed $100,000 during a 12-month period.

Noneligible entities. Non-U.S. companies, Exchange Act reporting companies, certain investment companies, and companies subject to certain disqualifications are not eligible for crowdfunding, nor are companies with no specific business plan or a business plan that anticipates a merger or acquisition with an unidentified company.

Disclosure requirements. Companies that rely on the crowdfunding rules must disclose to the SEC, to investors, and to the intermediary that is facilitating the offering, the price of the securities or the method for determining the price, the target offering amount, the deadline for reaching the target, and whether investments in excess of the target amount will be accepted. They also must disclose a description of the business, the planned use of proceeds, information about the officers, directors and 20 percent shareholders, and certain related-party transactions.

Depending on the amount of securities offered and sold during a 12-month period, the financial statements must include information from the company’s tax returns, must be reviewed by an independent public accountant, or must be audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities, when relying on the crowdfunding rules for the first time, may provide reviewed rather than audited financial statements unless audited financial statements are available.

Funding portals. Securities purchased in a crowdfunding transaction cannot be resold for one year. All of the crowdfunding transactions must take place through an SEC-registered broker-dealer or funding portal. Funding portals will register on a new Form Funding Portal, and must become members of FINRA. Companies may conduct crowdfunding offerings on only one platform at a time.

Intermediaries must explain to investors the process for investing on the platform, the types of securities being offered, and the information that the company must provide. They must have a reasonable basis for believing that a company complies with Regulation Crowdfunding and has established a means of keeping accurate records. The platform also must enable discussions about the offerings.

One change from the initial proposal will permit an intermediary to receive a financial interest in a company as compensation for its services, subject to certain conditions. Portals are prohibited from offering investment advice, making recommendations, soliciting offers or sales, or holding investor funds or securities.

Monitoring activities. A working group has been formed to monitor the crowdfunding market to help the SEC assess how the rules are working, detect any fraud, and make adjustments as necessary. The staff will submit a report to the SEC no later than three years after the effective date of the rules. White said it will be particularly important to see how the crowdfunding rules interact with the other JOBS Act changes, both with respect to issuer behavior and the development of secondary markets. The Office of Compliance Inspections and Examinations will continue to review broker-dealer compliance with the rules for quoting unregistered securities under Rule 15c2-11.

Aguilar’s concerns. Commissioner Luis Aguilar said the combination of JOBS Act rules will result in more companies with more shareholders without the need to register under the federal securities laws. This raises a host of problems, in his view, particularly with respect to the lack of an active secondary market for their securities. He said this increased number of unregistered and unlisted securities calls for new solutions, and he proposed two possibilities. One is the development of venture exchanges, which may include new listing tiers for these securities. The other is to reform Exchange Act Rule 15c2-11, known as the piggyback exception.

At Aguilar’s request, the staff included a discussion about Rule 15c2-11 in the crowdfunding release and will include an evaluation of the rule in light of recent market developments. As part of the staff report on Regulation Crowdfunding, the staff will assess the development of the secondary market and report whether further actions are needed with respect to the rule. Meanwhile, Aguilar urged the staff to intensify its efforts to police compliance with the rule and to include it in future risk-based exams conducted by the Office of Inspections Compliance and Examination.

Piwowar’s dissent to the crowdfunding rules. Piwowar criticized the final crowdfunding rules for their complexity and the burdens they will place on small businesses. He also objected to the rules for failing to trust ordinary Americans to exercise appropriate judgments in investing their resources and said the investment limits could discourage companies from engaging in crowdfunding.

Effective dates. The new rules and forms will be effective 180 days after publication in the Federal Register. The forms for funding portals to register with the SEC will be effective January 29, 2016.

Amendments to Rules 147 and 504. The proposed amendments to Rule 147 would eliminate the restriction on offers, but continue to require that sales be made only to residents of the issuer’s state or territory. It would ease some of the issuer eligibility requirements. The proposed amendments to Rule 504 would increase the amount of securities that may be sold in a 12-month period from $1 million to $5 million. It would include a bad actor disqualification which is substantially the same as that for Rule 506 under Regulation D. The comment period will be open for 60 days.

Piwowar’s dissent to proposed Rule 147 amendments. Piwowar supported the proposed amendments to Rule 504, but strongly disagreed with two of the provisions in the proposed amendments to Rule 147. First, he objected to the use of percentage thresholds for determining the intrastate nature of an issuer. Second, he objected to the provision which holds that if an offering is conducted pursuant to an exemption from state law registration, it must be limited to no more than $5 million in a 12-month period and must impose an investment limitation on investors. The provision suggests that the states are not able to protect their own residents, he said.

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