New Securities and Exchange Commission (SEC) Rules Open Up Crowdfunding Opportunities Amongst Accredited Investors
Generally speaking, companies seeking to raise capital through the sale of securities must either register the securities offering with the SEC or rely on an exemption from registration. Rule 506 of Regulation D is the most commonly used exemption; it permits the sale of an unlimited dollar amount of securities to an unlimited number of “accredited investors” and up to 35 non-accredited investors without federal Securities Act registration, provided the requirements of the rule are satisfied.
In April 2012, Congress passed the Jumpstart Our Business Startups Act (the “JOBS Act”). At the time, most commentators believed that the JOBS Act would create tremendous new opportunities for emerging growth businesses.
On July 10, 2013, the SEC adopted final rules implementing part of the JOBS Act and relaxing some of the restrictions on offering securities under Rule 506 of Regulation D. These new rules lift the 80-year ban on general solicitation and advertising ofprivate offerings of securities under Rule 506 of Regulation D. However, the ban is only lifted on Rule 506 offerings if: (1) sales of the securities are limited to accredited investors; and (2) an issuer takes reasonable steps to verify that all purchasers of the securities are accredited investors.
The SEC’s new final rules lifting the ban on solicitation will become effective or or about September 8, 2013 (approximately 60 days after July 10, 2013). These rules present an exciting and valuable new opportunity for entrepreneurs and growing businesses to connect with investors and engage crowdfunding communities in ways never before seen. Previously, businesses were limited to advertising or promoting their need for funding and capital only within their personal, known networks. With the ban lifted, companies may advertise, market, and publicly disclose the fact that they are raising capital, thereby reaching a much larger pool of potential investors.
Further, the SEC’s new final rules provide a non-exclusive list of methods that issuers of securities may use to verify the accredited investor status of individual investors. The methods described in the final rule include:
Income. The issuers may review copies of any IRS forms that report the income of the purchaser for the two most recent years and obtain a written representation that the purchaser likely will continue to earn the same income level in the current year;
Net Worth. The issuers may review investor documentation, dated within the prior three months, showing assets (e.g., bank statements, brokerage statements, tax assessments, and appraisal reports) and liabilities (e.g., a credit report), and obtain a written representation from the prospective purchaser that all liabilities necessary to make the net worth determination have been disclosed;
Written Confirmation. The issuers may obtain a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or CPA that such person or entity has taken reasonable steps to verify that the purchaser is accredited; and
Prior Purchasers. A person who invested in a Rule 506(b) offering as an accredited investor prior to the effective date of the new rules may invest in an offering conducted by the same issuer under the new rules by providing a certification that he or she qualifies as an accredited investor.
The SEC rules also provide that an issuer may use a principles-based facts and circumstances method of verification, taking into account the nature of the prospective purchaser and type of accredited investor the prospective purchaser claims to be, the amount and type of information that the issuer has about the prospective purchaser, and the nature of the offering (such as the manner in which the purchaser was solicited to participate in the offering, the terms of the offering, and the minimum investment amount).
The new rules do not provide a similar, non-exclusive list for verifying the accredited investor status of entities.
These new SEC rules do not yet allow non-accredited investors to invest in these crowdfunding opportunities, introduced under Title III of the JOBS Act. SEC officials are expected to deliberate for several more months before lifting the accredited investor requirement, but there is no specific timetable. SEC officials are believed to be concerned that naïve investors (i.e., non-accredited ones) might invest and lose their retirement savings or more in ill-advised crowdfunding opportunities. Lifting the ban on general solicitation was step one in implementing the JOBS Act. Removing the requirement of accredited investors only will be step two.