June 16, 2019

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Regulation Crowdfunding Takes Effect

Summary

On May 16, 2016, the final rules adopted by the Securities and Exchange Commission (SEC) with respect to Title III of the Jumpstart Our Business Startups Act (JOBS Act) took effect (except for certain forms allowing funding portals to register with the SEC, which became effective on January 29, 2016). These rules (known as Regulation Crowdfunding) are designed to allow companies, such as startups and small businesses, to access the capital markets through low-dollar amount online securities offerings directed to the “crowd”. The following is an overview of the rules and requirements under Regulation Crowdfunding.  

In Depth

On May 16, 2016, the final rules adopted by the Securities and Exchange Commission (SEC) with respect to Title III of the Jumpstart Our Business Startups Act (JOBS Act) took effect (except for certain forms allowing funding portals to register with the SEC, which became effective on January 29, 2016). These rules (known as Regulation Crowdfunding) are designed to allow companies, such as startups and small businesses, to access the capital markets through low-dollar amount online securities offerings directed to the “crowd”.

The following is an overview of the rules and requirements under Regulation Crowdfunding. 

Offering Size and Investment Limitations 

The maximum aggregate amount that a company may raise through Regulation Crowdfunding during a 12-month period is $1 million. The maximum aggregate amount that individual investors (whether non-accredited or accredited) may purchase depends on their annual income and net worth. For those with either annual income or net worth below $100,000, the limit is the greater of (a) $2,000 or (b) 5 percent of the lesser of their annual income and net worth. For those with both annual income and net worth over $100,000, the limit is 10 percent of the lesser of their annual income or net worth, up to a maximum of $100,000.

Exclusions from Eligibility

Non-US companies, reporting companies under the Securities Exchange Act of 1934 (the Exchange Act), certain investment companies, companies that are disqualified under Regulation Crowdfunding’s “bad actor” disqualification rules, companies that have failed to comply with annual reporting requirements under Regulation Crowdfunding and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies (e.g., shell companies) are not eligible to use Regulation Crowdfunding.

Intermediaries

Companies relying on Regulation Crowdfunding must conduct their offerings through an SEC-registered intermediary, either a registered broker-dealer or a new type of entity called a “funding portal.”  Companies are required to conduct a crowdfunding offering exclusively through one such intermediary at a time. Among other things, intermediaries must provide investors with certain educational materials, take measures to reduce the risk of fraud, make available information to investors about the company and the offering during the offering period and for a minimum of 21 days before any sale, provide communication channels to permit offering discussions and facilitate the offer and sale of crowdfunding securities. Intermediaries that are funding portals must register with the Financial Industry Regulatory Authority (FINRA) as well as the SEC and are subject to additional restrictions on their activities over those applicable to broker-dealers (for example, funding portals may not provide investment advice or recommendations, solicit investors, compensate employees or other persons for soliciting sales, or manage or handle investor funds or securities).

Disclosure Requirements

A company conducting an offering under Regulation Crowdfunding is required to comply with certain disclosure requirements by filing an offering statement on new Form C with the SEC through its online “EDGAR” filing system in addition to providing investors and the relevant intermediary with the offering statement.  In its offering statement, the company must disclose a substantial amount of information with respect to, among other things, its capital structure, management, business operations, and financial condition in addition to information about the offering.  The offering statement must also include US generally accepted accounting principles (GAAP) financial statements, and in some cases tax returns, with the level of financial statement disclosure (i.e., whether such financial statements are audited, reviewed or simply certified by the company’s principal executive officer) depending generally on the size of the offering. 

If an offering has not yet been completed or terminated, the company must amend its disclosures if there is any material change to the offering terms or to any other disclosure previously provided to investors and provide regular updates on the company’s progress in reaching its target offering amount. In addition, during the course of an offering, the company must provide to investors and the relevant intermediary certain progress updates including its progress in meeting the target offering amount when the company reaches 50 percent and 100 percent of the target offering amount.

Advertising

To advertise the terms of an offering under Regulation Crowdfunding, a company or any person acting on its behalf may only provide a notice that includes limited “tombstone ad” type information about the company and the terms of the offering and directs investors to the platform of the intermediary. All other forms of advertising by the company are prohibited.

Restrictions on Resale

An investor that purchases securities issued in reliance on Regulation Crowdfunding may not resell or otherwise transfer such securities for one year after the date of purchase, except to the company it purchased securities from, to an accredited investor, as part of a registered offering, to a family member or the equivalent, or in connection with certain events, such as the investor’s death or divorce.

Ongoing Reporting Requirements

Once the company has sold securities under Regulation Crowdfunding, the company will be required to file regular annual reports with the SEC containing similar information to the offering statement (with applicable updates), including financial statements, no later than 120 days after the end of each fiscal year and post copies of the annual reports on its website.  Regardless of the size of the offering, the company’s financial statements included with the annual reports need only be certified by its principal executive officer (unless reviewed or audited financial statements are available). A company will continue to be subject to ongoing reporting requirements until it becomes a reporting company under the Exchange Act, it or another party purchases or repurchases all of the securities issued pursuant to Regulation Crowdfunding or it liquidates or dissolves. Further, if a company has filed at least one annual report and has less than 300 stockholders of record or has filed at least three annual reports and has total assets that do not exceed $10 million, it will no longer be subject to ongoing reporting requirements.

Statutory Liability

Under Section 4A(c) of the Securities Act of 1933, an “issuer” that conducts an offering made in reliance on Regulation Crowdfunding will be liable to investors for material misstatements or omissions in its offering documents and other communications, unless the issuer did not know, and in the exercise of reasonable could not have known, of such misstatements or omissions.  The term “issuer” is defined broadly to include not only the company selling the securities but also directors and certain principal officers of the company among others. The SEC specifically declined to exempt intermediaries from such liability or interpret Section 4A(c) as categorically excluding intermediaries as “issuers” for purposes of such liability.

State Securities Law Preemption

Offerings under Regulation Crowdfunding are not subject to state securities law, or “blue sky,” registration and qualification requirements. Despite the preemption of state securities law, the antifraud provisions of state securities law will continue to apply where applicable.

Looking Ahead

Regulation Crowdfunding seeks to balance the competing interests of creating a mechanism that allows low-cost, low-dollar amount online securities offerings while at the same time providing protection to investors who have greater exposure to unscrupulous and fraudulent activity. Companies considering whether to conduct an offering under Regulation Crowdfunding should assess whether they will have the resources to comply with the burdensome disclosure and other requirements under Regulation Crowdfunding, as well as weigh the benefits and risks of raising money from the “crowd” compared to the alternatives such as raising money under Regulation D or Regulation A+. Crowdfunding intermediaries should consider whether it is possible to develop a viable business model that accounts for the burdens of acting as stewards of equity crowdfunding in a marketplace of low-dollar amount securities offerings.

Only time will tell whether Regulation Crowdfunding achieves its goal of helping jumpstart access to capital for startups and small businesses.

© 2019 McDermott Will & Emery

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David A. Cifrino, McDermott Will Emery Law Firm, Corporate Attorney
Partner

David Cifrino is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Boston office.  He is co-head of its Public Companies group.  David represents financial services, industrial, high technology, consumer products and other companies, public and private (from start-ups to Fortune 50), in securities, merger, acquisition, disposition, commercial, strategic, governance and executive compensation matters.  He represents clients in both public and privately placed equity and debt financings under the Securities Act of 1933 and...

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Robert H. Cohen, Corporate Attorney with McDermott Will law firm
Partner

Robert H. Cohen is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s New York office.  He focuses his practice on transactional and securities work for a broad range of clients, including initial and follow-on public offerings, registered direct and PIPE financings, private placements, bridge financings, equity line and reverse mergers.

Bob has extensive experience in the areas of mergers and acquisitions, joint ventures, 1933 & 1944 Act representation and licensing and distribution arrangements.

From his years of experience, Bob has developed industry-specific knowledge across numerous markets, particularly in the life sciences industry having represented the financing and mergers & acquisitions activity for  pharmaceutical and medical device companies.

He is admitted to practice in New York and before the U.S. District Court for the Eastern District of New York and U.S. District Court for the Southern District of New York.

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Thomas P. Conaghan, Mcdermott Will Emery law Firm,  (M&A), joint ventures, strategic investments, spin-offs,
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Thomas P. Conaghan is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s Washington, D.C., office.  Tom represents both publicly held and closely held businesses, underwriters and other sources of capital, corporate boards and board committees and corporate executives.  He advises both U.S. and foreign-based public companies on issues relating to public and private offerings of securities, disclosure, periodic reporting, corporate governance, executive compensation, the rules of the New York Stock Exchange and the Nasdaq Stock Market and compliance with the...

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Gary Emmanuel is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s New York office. He focuses his practice on corporate securities matters.

With over 15 years of experience, Gary represents both domestic and foreign companies that are navigating the process of capital raising including initial public offerings, registered direct offerings, follow-on offerings, private placements, PIPEs and bridge financings. Gary has worked extensively with biotechnology and other life science companies, both as company counsel...

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Mark J. Mihanovic, McDermott Will Emery, Corporate Finance Attorney, Mergers Acquisitions Lawyer,
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Mark J. Mihanovic is a partner in the law firm of McDermott Will & Emery LLP.  Mark heads our Firm’s California corporate practice and serves as corporate liaison partner in the Firm’s strategic alliance with MWE China Law Offices based in Shanghai.  His practice is primarily focused in the areas of corporate finance and mergers and acquisitions involving companies in a broad range of industries, with a particular emphasis on technology, life science and health care companies.  Mark has served as lead counsel on behalf of issuers and underwriters in numerous public...

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