cyber-codeOn May 3, 2016, the Securities and Exchange Commission (SEC) approved rule amendments to implement changes liberalizing certain rules related to registration thresholds, termination of registration, and suspension of periodic reporting obligations under Section 12(g) and Section 15(d) of the Securities Exchange Act of 1934 (Exchange Act), as mandated by the Jumpstart Our Business Startup Act (JOBS Act) and the Fixing America’s Surface Transportation Act (FAST Act). The following highlights the three major revisions implemented by the amendments. Continue Reading SEC Adopts Rule Amendments Related to Reporting Thresholds

Overview.  Last week, the Securities and Exchange Commission (SEC) adopted new rules permitting “crowdfunding,” a method for growing businesses to raise capital over the Internet by soliciting small investments from a large number of individuals.  The new rules are the final significant rulemaking procedure required by the Jumpstart of Business Startups (JOBS) Act of 2012 and aim to increase access to capital for new companies nationwide.

For Companies Seeking to Raise Capital.  The crowdfunding rules permit issuers to raise up to $1 million in a 12-month period through a funding portal registered with the SEC or through specific online broker-dealer platforms.  Only one offering through one intermediary platform is allowed at any time, and advertisements of the offering outside of the platform are limited to information similar to traditional “tombstone” ads.  To protect investors from the inherent risks associated with crowdfunding offerings, the SEC requires each issuer to provide certain detailed information on a new Form C, including among other things: a detailed description of the business; the target offering amount; the price of the securities offered; the company’s financial statements (subject to scaled requirements based on the targeted offering size); the intended use of the proceeds; all related-party transactions; and the identities of all significant stakeholders, as well as updates when certain milestones are reached in the offering on a prescribed Form C-U.  Issuers will also be required to file annual reports with the SEC on a new Form C-AR and provide the same to investors.

Certain companies are not be eligible to be issuers, such as non-U.S. companies, Exchange Act reporting companies, certain investment companies, companies subject to prior disqualification, and companies with no business plan other than to execute a merger or acquisition.

For Individuals Seeking to Invest.  Under the new rules, the SEC established limits on the amounts that an individual can invest in crowdfunding offerings, based on the individual’s income level.  Investors with an annual income or net worth greater than $100,000 may invest up to ten percent of their income or net worth every 12 months (in total, across all crowdfunding platforms).  For investors with an annual income or net worth below $100,000, the aggregate investment limit is equal to the greater of (i) $2,000 or (2) five percent of their net worth.  Regardless of income level, the amount of securities sold to an investor may not exceed $100,000 in a 12-month period.

For Crowdfunding Platforms.  Each crowdfunding intermediary is required to register with the SEC and become a member of FINRA.  To reduce the risk of fraud, the new rules establish additional operating and process requirements for intermediaries, such as: providing investors with educational materials (on both the issuer and the investment process); reviewing and timely disseminating all issuer disclosures; providing clear channels for prescribed communications; and reasonably policing monetary exchanges.  The rules also prohibit certain intermediary activities, including: offering investment advice; having a financial interest in an issuer (unless received as compensation for its intermediary service, subject to restrictions); compensating promoters; and providing platform access to fraudulent companies.

What’s Next?  The new crowdfunding rules and forms will be effective 180 days after they are published in the Federal Register.  The forms enabling intermediaries to register with the SEC will be effective on January 29, 2016.

In 2010, the Dodd-Frank Act mandated the SEC to adopt rules that would prohibit the use of the Rule 506 exemption for any securities offering in which certain felons and other bad actors are involved, substantially similar to the bad actor disqualification provisions of Regulation A. On July 10, the SEC unanimously adopted final rules similar to those originally proposed in May 2011, with minor modifications to the persons covered and the specific actions covered. Under the final rules, issuers cannot rely on Rule 506 if the issuer or any other person covered by the rule has had a “disqualifying event.”

The final rule, which goes into effect September 23, provides an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.  Disqualification applies only for disqualifying events that occur after the effective date of the rule, and matters that existed before the effective date of the rule and would otherwise be disqualifying are subject to mandatory disclosure to investors.

Click here to read more about the “Bad Actor” Rule, including the definition of “covered person” and “disqualifying event.”

On July 10, 2013, during a contentious open meeting, the SEC adopted rules to permit the use of general solicitation and general advertising in Rule 506 and Rule 144A offerings. The amendment was adopted by a 4-1 vote over strong criticism from Commissioner Luis Aguilar, who believes the rule should only be adopted concurrently with investor-protection safeguards. He admonished the SEC for waiting until now to propose the safeguards instead of including them with the August 2012 proposal to permit general solicitation.

The SEC amended Rules 506 and 144A of the Securities Act of 1933 to allow issuers to solicit investors and to advertise in Rule 506 offerings, provided that the issuer takes reasonable steps to verify that purchasers are accredited investors or that Rule 144A resales of securities are limited to qualified institutional buyers.

Issuers must make an objective determination whether it has taken reasonable steps to verify that purchasers are accredited investors, based on the facts and circumstances of each purchaser and each transaction, and the adopting release provides a nonexclusive, non-mandatory list of methods that issuers may use to verify the accredited investor status of individuals. These three possible methods are:

  • Reviewing copies of any IRS form that reports the purchaser’s income along with a written representation that the purchaser will likely continue to earn the reported amount.
  • Reviewing bank statements, brokerage statements, CDs, tax assessments, appraisal reports and consumer reports with respect to net worth.
  • Receiving a written confirmation from a registered broker-dealer, registered investment advisor, licensed attorney or CPA that such party has taken reasonable steps to verify a purchaser’s accredited investor status.

Finally, the SEC amended Form D to require the issuer to indicate that it intends to use general solicitation or general advertising pursuant to the new Rule 506(c).

The new rules create opportunities for issuers – including private equity and hedge funds – to advertise offerings by issuing press releases or reaching out to various networks to identify accredited investors interested in an offering. Smaller companies and entrepreneurs who have not been able to build relationships with angel investors and venture capital firms will also benefit from the lifting of the general solicitation ban.

The changes go into effect on September 23, 2013.

So, we have to ask – Will investors be willing to provide the information needed to verify their accredited investor status? Will a new industry of verifiers develop? Will advertising increase the number and dollar amount of private placements?

Read more about the SEC’s recently adopted and proposed rules here.