State Crowdfunding Using Intrastate Offerings and Rule 147
The SEC has yet to publish proposed rules under Title III of the JOBS Act – the Crowdfunding Act. The Crowdfunding Act amends Section 4 by of the Securities Act of 1933 (the Securities Act) to create a new exemption to the registration requirements of Section 5 of the Securities Act. The new exemption allows Issuers to solicit “crowds” to sell up to $1 million in securities as long as no individual investment exceeds certain threshold amounts.
The threshold amount sold to any single investor cannot exceed (a) the greater of $2,000 or 5% of the annual income or net worth of such investor, if their annual income or net worth is less than $100,000; and (b) 10% of the annual income or net worth of such investor, not to exceed a maximum $100,000, if their annual income or net worth is more than $100,000. In addition, Section 302 of the Crowdfunding Act requires that all Crowdfunding offerings be conducted through an intermediary that is a broker-dealer or funding portal that is registered with the SEC and be a member of the Financial Industry Regulatory Authority (FINRA).
The actual implementation and rule making associated with the Crowdfunding Act is in the hands of the SEC. Moreover, many proponents are concerned that the federal Crowdfunding Act as promulgated by the SEC will be cumbersome for small businesses, and the states are cognizant of this concern and the immediate need for a method for small businesses to raise funds using social media and other general solicitation and advertising without accredited investor restrictions. Accordingly, many states have recently either enacted or introduced state-specific crowdfunding legislation. Georgia, Kansas and Idaho have already enacted legislation. California has granted at least one permit to allow for a crowdfunded offering. Washington and North Carolina have pending crowdfunding bills, and Nebraska and Maine are drafting bills.
Federal Authority for State Crowdfunding Legislation
Both the federal government and individual states regulate securities, with the federal provisions often preempting state law. When federal provisions do not preempt state law, both federal and state law must be complied with. On the federal level, every issuance of a security must either be registered under Section 5 of the Securities Act, or exempt from registration. Section 3(a)(11) of the Securities Act of 1933, as amended (Securities Act) provides an exemption from the registration requirements of Section 5 for “[A]ny security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.” Section 3(a)(11) is often referred to as the Intrastate Exemption. Rule 147 promulgated under Section 3(a)(11) provides for further details on the application of the Intrastate Exemption.
On the federal level, Issuers relying on state crowdfunding statutes rely upon the Intrastate Exemption together with Rule 147 promulgated thereunder. The Intrastate Exemption is only available for bona fide local offerings. That is, the Issuer must be a resident of and doing business within the state in which all offers and sales are made, and no part of the offering may be offered or sold to nonresidents. Because of the strict rules against any sales or offers to nonresidents, Issuers conducting concurrent or consecutive offerings need to be extra careful to avoid the integration of any non-intrastate transactions with the Intrastate Exemption.
Avoiding Integration While Using the Intrastate Exemption
The determination of whether two or more offerings could be integrated is a question of fact depending on the particular circumstances at hand. Rule 502(a) and SEC Release 33-4434 set forth the factors to be considered in determining whether two or more offerings may be integrated. In particular, the following factors need to be considered in determining whether multiple offerings are integrated: (i) are the offerings part of a single plan of financing; (ii) do the offerings involve issuance of the same class of securities; (iii) are the offerings made at or about the same time; (iv) is the same type of consideration to be received; and (v) are the offerings made for the same general purpose.
In addition, Rule 147(b)(2) provides an integration safe harbor. That is, offerings made under Section 3 or Section 4(2) of the Securities Act or pursuant to a registration statement will not be integrated with an Intrastate Exemption offering if such offerings take place six month prior to the beginning or six month following the end of the Intrastate Exemption offering. To rely on this safe harbor, during the six-month periods, an Issuer may not make any offers or sales of securities of the same class as those offering in the Intrastate offering. Rule 147(b)(2) is merely a safe harbor. Issuers and practitioners may still conduct their own analysis in accordance with the five-factor test enumerated above.
Determining Whether an Issuer is a “Resident” of and Doing Business in a Particular State
For purposes of the Intrastate Exemption, an Issuer shall be deemed to be a resident of the state in which: (i) it is incorporation or organized if it is an entity requiring incorporation or organization; (ii) its principal office is located if it is an entity not requiring incorporation or organization; or (iii) his or her principal residence is located, if an individual.
For purposes of the Intrastate Exemption, an Issuer shall be deemed to be doing business within a state if: (i) the Issuer, together with is subsidiaries, derived at least 80% of its gross revenues in the most recent fiscal year or most recent six-month period from that state, whichever is closer in time to the offering; (ii) the Issuer had 80% of its assets located in that state in the most recent semiannual fiscal year; (iii) the Issuer intends to use and uses at least 80% of the net proceeds from the Intrastate offering in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services in that state; and (iv) the principal office of the Issuer is located within that state.
Determining Whether the Investors and Potential Investors are Residents of a Particular State
All offers, offers to sell, offers for sale and sales of securities in an Intrastate exempted offering must be made to residents of the state in which the offering is conducted. For the purpose of determining the residence of an offeree or Purchaser: (i) a corporation, partnership, trust or other form of business organization shall be deemed to be a resident of a state if, at the time of the offer and sale, it has its principal office within such state; (ii) an individual shall be deemed to be a resident of a state if, at the time of the offer and sale, his or her principal residence is within that state; and (iii) a corporation partnership, trust or other form of business organization formed specifically to take part in an Intrastate offering will not be resident of the state unless all of its beneficial owners are resident of that state.
Even though securities issued relying on the Intrastate Exemption are not restricted securities for purposes of Rule 144, Rule 147(e) prohibits the resale of any such securities for a period of nine months except for resales made in the same state as the Intrastate Offering. Moreover, market makers or dealers desiring to quote such securities after the nine-month period must comply with all of the requirements of Rule 15c2-11 regarding current public information. Moreover, Rule 147 specifically requires the placing of a legend on any securities issued in an Intrastate offering setting forth the resale restrictions. In the case of an allowable in-state resale, the purchaser must provide written representations supporting their state of residence.
Advertising and Solicitation
There is no prohibition in Section 3(a)(11) or Rule 147 regarding general advertising or general solicitation as long as such general advertising or solicitation complies with applicable state law and does not result in an offer or sale to nonresidents of such state.
State Crowdfunding Statutes
As state crowdfunding statutes rely on Section 3(a)(11) and Rule 147, each state statute contains provisions that mirror and effectuate the local requirements of the federal statue and rule. In addition, each state statute to date contains provisions similar to Title III of the JOBS Act. For example, the pending Washington bill allows companies to sell up to $1,000,000 in securities in a 12-month period through crowdfunding. Investors may purchase the greater of $2,000 in securities or 5% of their annual income or net worth if it’s less than $100,000 or 10% of their annual income or net worth if same is more than $100,000. Crowdfunding portals are required to register with the state, and such portals are limited to operations within the state of Washington.
The North Carolina statute limits a raise to $1,000,000 in a 12-month period unless audits for the prior year are provided, in which case the raise is limited to $2,000,000. Unaccredited investors could buy up to $2,000 in stock, with higher limits for accredited investors. Portals are required to register with the state.
Attorney Laura Anthony
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Merger and Corporate Attorneys
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms.
Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.
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