Crowd Funding Regs Hold Some Surprises

Upon review of the SEC’s proposed crowd funding regulations released this week, I found a number if items that could be problematic for companies that thought they would have a relatively easy time raising funds using the new Section 4(a)(6) exemption, including:

• Crowd funding companies can use only one intermediary and cannot conduct concurrent crowd funding offerings.

• Crowd funding deals are “all or none,” modeled after the Kickstarter process, rather than the Indiegogo process that permits the company can keep whatever it has raised by the deadline.

• Investor commitments to purchase the security are not firm until 48 hours before the offering deadline. So, even if the company has met or exceeded the targeted amount well prior to the deadline, it cannot be assured of a successful offering until the time that cancellations are no longer allowed. If the company wants to close the offering early, it must notify the subscribers of the new deadline at least 5 business days prior and give them the ability to cancel their subscriptions up to 48 hours before the new closing date.

• The level of detailed disclosure required by the Form C that must be filed with the SEC prior to making the offering (including financial information or projected financial information); that the Form C must be filed with EDGAR and that certain information must be provided in XML format. While public companies are familiar with this procedure, most small companies (e.g.,  startups) will find a sharp learning curve or need to hire a law firm or financial printer to assist with this.

• That the type of financial information review required to register the offering is based on all prior crowdfunded deals within the past 12 months plus the amount being raised currently. So, if a company raised $100,000 in Month 1 and is back raising $400,000 in Month 5, it will need to provide reviewed financial statements.

• Audited financial statements that contain a “qualified,” adverse, or disclaimer opinion are not considered audited financial statements and cannot be used in a crowd funding offering. This would prevent many capital strapped companies with negative earnings from using this exemption.

• Companies must disclose “disqualifying events” related to certain insiders if those events occurred before the effective date of the final rule (if after that date, the company cannot use the rule at all). Although the funding portals are required to perform background checks, if the disclosure is not made, the offering will fall out of the exemption. The instruction says that the issuer has to exercise reasonable care to disclose this information and that reasonable care requires a “factual inquiry.” So, it appears that the company may also be required to do a background check unless the portal shares its background check results and the check done by the portal is reliable.

• If there is a material change in the offering or the company, it must be noticed on a Form C amendment and investors have 5 business days to affirmatively reconfirm their participation or their subscription is automatically cancelled.

• Companies must be able to prove to their funding portals that they have an established means to keep accurate records of their security holders after the offering. Commissioner Stein, in her comments at the Open SEC Meeting, suggested that a registered transfer agent may be required by the final rule.

• Funding portals must perform sufficient due diligence to determine that the company trying to list with it does not “present the potential for fraud” or otherwise raise concerns regarding investor protection. If the portal cannot assess the risk of fraud by a potential issuer or cannot effectively assess the risk of fraud of the issuer or its potential offering, it must deny the issuer a spot on its website. If this assessment occurs during an offering, the portal must terminate the offering and direct that investor funds be promptly returned.

• Neither the funding portal nor the issuer have to perform any diligence regarding the investor’s investment limitations; self certification by the investor will be sufficient.

• The only entity that can hold investor funds solicited by a funding portal is a bank.

• Funding portal registration with the SEC will take effect at the later of 30 days after filing or the date when the portal is approved for membership by FINRA. So, there may be a wait before a portal can get it business online.

• Funding portals will need to obtain a $100,000 (minimum) fidelity bond.

• Funding portals must comply with the U.S. Treasury’s anti-money laundering regulations.

• Funding portals will be able to “curate” the companies they put on their website using “objective criteria” applied consistently that provides a broad selection of issuers and they may not deny a listing based on the in- advisability of investing in the issuer. The criteria may include geographic location, the business or industry of the issuer, or the type of securities being offered.

• The SEC has created a new family member called the “spousal equivalent” for purposes  of transferability of the purchased securities but not for determining whether a secondary purchaser of a crowd funded security is an “accredited investor.”

• A company will not have its deal lose the exemption if the funding portal violated the rules and the issuer did not know of the violation or if the portal violated the rules for another company’s offering.

More to come as the analysis continues…


About JeffKoeppel

I am a corporate/securities attorney in the Washington, DC area. Prior to joining the firm, I was a Senior Attorney Advisor in the Division of Corporation Finance at the U.S. Securities and Exchange Commission. I am a member of the Bars of the States of Maryland, New York and the District of Columbia. You can also follow this blog on LinkedIn at:
This entry was posted in Banking, Broker dealers, Congress, Crowd Fund Act, Crowd Fund Act of 2012, Crowd Funding At the Margins, Crowd Funding Platforms, Film, FINRA, Funding Portals, Investments, Jobs, Legislative Intent, SEC, Small Business, Venture Capital, Wall Street and tagged , , , , , , , , , , , , , , , , , , , , , , . Bookmark the permalink.

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