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From Securities Regulation Daily, October 23, 2013

SEC proposes regulatory framework for crowdfunding offerings

By Jacquelyn Lumb

The SEC commissioners this morning unanimously approved a proposed regulatory framework for offerings conducted under the crowdfunding provisions of the JOBS Act. The JOBS Act created an exemption to permit securities-based crowdfunding without registering the offerings with the SEC. The proposal is intended to facilitate capital raising by small businesses while at the same time providing investor protection measures. The comment period will be open for 90 days.

Offering and investing limits. The proposal will permit companies to raise up to $1 million through crowdfunding offers during any 12-month period. Investors would be permitted to invest during any 12-month period up to $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000. Investors may invest up to 10 percent of their annual income or net worth, whichever is greater, if either is equal to or more than $100,000. Investors would not be permitted to purchase more than $100,000 of securities during any 12-month period through crowdfunding.

Securities that are purchased in a crowdfunding transaction may not be resold for a year under the proposal. The holders of the securities would not count toward the threshold that requires a company to register with the SEC under Exchange Act Section 12(g).

Disclosure requirements. Companies that conduct crowdfunding offerings must file certain information with the SEC and make it available to investors and to the intermediary that is used to facilitate the offering. The offering documents must include information about officers, directors, and holders of more than 20 percent of the issuer’s securities. The disclosure would include a business description, a description of the use of the proceeds from the offering, and the price of the securities being offered.

The proposed disclosure also would include certain related-party transactions, a description of the financial condition of the company, and its financial statements. Companies would be required to update the offering document to include material changes and to provide updates about the progress in reaching the targeted offering amount. Crowdfunding issuers also must file annual reports with the SEC and provide the annual reports to investors.

Intermediaries. The new framework requires that crowdfunding transactions take place through an SEC-registered intermediary, which will be either a broker-dealer or a funding portal. The intermediaries will conduct the offerings through online platforms. Intermediaries will be required to provide investors with educational materials that outline the risks of investing. They also must take measures to reduce the risk of fraud.

Funding portals may not offer investment advice or make recommendations. They may not solicit purchases, sales, or offers to buy securities offered or displayed on their websites. The proposed rules impose restrictions on compensating people for solicitations and prohibit the funding portals from holding, possessing, or handling investor funds or securities. The proposal includes a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

Chair and commissioners’ remarks. SEC Chair Mary Jo White said that because of the impact the crowdfunding rules may have on the market, the staff has been directed to develop a work plan to review and monitor the use of the crowdfunding exemption. If the rules are adopted, the staff will proceed with the work plan, under which it will evaluate the types of issuers that use the crowdfunding exemption, compliance with the rule, and whether the exemption is promoting capital formation and effectively protecting investors.

White acknowledged that there is a great deal of excitement about the crowdfunding exemption. She said the SEC wants this market to thrive in a manner that is safe for investors.

Commissioner Luis Aguilar said he hopes the relatively high risk of fraud in this market will be minimized by the disclosure rules and the gatekeeping role of the intermediaries. He is concerned that crowdfunding may reach particularly vulnerable parts of the investing community and that it may be used to perpetrate affinity fraud.

Commissioner Daniel Gallagher noted that the crowdfunding provision of the JOBS Act received overwhelming support by Congress and was praised by President Obama as a potential game-changer for small businesses.

Commissioner Kara Stein highlighted three areas in which comments will be particularly helpful, including how much any single investor should be permitted to invest, whether funding portals that are not located in the U.S. should be able to conduct crowdfunding transactions in the U.S., and the proposed recordkeeping provisions. If the SEC does not get it right, she said the promise of crowdfunding will be lost.

Commissioner Michael Piwowar believes the SEC is up to the challenge of creating a crowdfunding framework consistent with its core mission. The concept of the “wisdom of the crowd” will be unleashed to allocate capital to more productive uses, he said.

MainStory: TopStory JOBSAct SecuritiesOfferings SECNewsSpeeches

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