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by Laura Anthony, Esq.

Proposed Crowdfunding Rules – Part IV

As required by Title III of the JOBS Act, on October 23, 2013, the SEC published proposed crowdfunding rules.  The SEC has dubbed the new rules “Regulation Crowdfunding.” The entire text of the rule release is available on the SEC website.  In a series of blogs, I am summarizing the lengthy rule release.  This Part IV of my series continues a discussion of the in-depth disclosure requirements for Issuers for use in their offering statements.  In particular, Parts II and III addressed the Issuer disclosure requirements, other than financial disclosures.  This Part IV in the series discusses Issuer financial disclosure obligations.

Summary Breakdown of Proposed New Rules – Requirements on Issuers

Disclosure Requirements

Pursuant to the CROWDFUND Act as set forth in the JOBS Act, an Issuer who offers or sells securities in a crowdfunding offering must file with the SEC and provide investors and the funding intermediary (whether a funding portal or broker-dealer) and make available to potential investors:

(a) The name, legal status, physical address, and website address of the Issuer (discussed in Part II of this blog series);

(b)  The names of the directors and officers, and each person holding more than 20% of the shares of the Issuer (discussed in Part II of this blog series);

(c)  A description of the business of the Issuer and the anticipated business plan of the Issuer (discussed in Part III of this blog series);

(d)  a description of the financial condition of the Issuer, including (i) for offerings of $100,000 or less, income tax returns for the most recently completed year and financial statements certified by the principal executive officer as true and correct; (ii) for offerings of more than $100,000 but less than $500,000, financial statements reviewed by an independent public accountant in accordance with SEC standards and rules for such review; and (iii) for offerings more than $500,000, audited financial statements (note that the offering amount is determined by totaling all Section 4(6) offerings within the preceding 12-month period);

(e)  A description of the stated purpose and intended use of the proceeds of the offering (discussed in Part III of this blog series);

(f)  The target offering amount and a deadline to reach the target and regular updates regarding the progress of meeting the target (discussed in Part III of this blog series);

(g)  The price to the public of the securities and the method of determining the price (discussed in Part III of this blog series);

(h)  A description of the ownership and capital structure of the Issuer including (i) terms of other securities offered and all other classes of securities of the Issuer including details on the differences and potential dilution that could result from a different class (for example, if preferred stock was converted); (ii) a description of how the exercise of rights held by principal shareholders could negatively impact the purchasers of the securities being offered; (iii) name and ownership levels of each existing shareholder owning 20% or more; (iv) how securities being offered are valued and examples of how they may be valued in the future; and (v) risks related to minority ownership and other capital-related risk, such as by the issuance of additional shares, sales of assets, or transactions with related parties (discussed in Part III of this blog series).

The proposed rules do not create or mandate a specific disclosure format for information to be provided to investors but rather will leave that to the industry working with intermediaries and counsel.  As for information required to be submitted to the SEC, the proposed rules create a new Form C.  The Form C would be a fillable form that can be submitted to the SEC with the ability to add attachments as needed.

Offering Statement Disclosure Requirements – In-depth discussion

Financial Disclosure

As noted in (d) above, the CROWDFUND Act requires a tiered financial disclosure as follows: “a description of the financial condition of the Issuer, including (i) for offerings of $100,000 or less, income tax returns for the most recently completed year and financial statements certified by the principal executive officer as true and correct; (ii) for offerings of more than $100,000 but less than $500,000, financial statement reviewed by an independent public accountant in accordance with SEC standards and rules for such review; and (iii) for offerings more than $500,000, audited financial statements (note that the offering amount is determined by totaling all Section 4(6) offerings within the preceding 12-month period).”  The SEC received numerous comments on these requirements.

In determining the threshold offering amount for disclosure, the proposed rules require that an Issuer aggregate any amounts offered and sold (rather than all offered amounts, including those not sold) under Regulation Crowdfunding in the preceding 12-month period.  In addition, possible oversubscriptions must be added and included.

The proposed rules require all Issuers to file with the SEC, provide to investors and the intermediary and make available to potential investors a complete set of their financial statements (a balance sheet, income statements, statement of cash flows and states of changes in ownership equity), prepared in accordance with U.S. GAAP covering the shorter of the two most recent fiscal years or the period since inception.

For the first 120 days following the end of a fiscal year, an Issuer can rely on the prior year’s financial statements so long as the Issuer was not otherwise required to provide updated financial statements as a result of ongoing reporting obligations, or if the current year financial statements were, in fact, complete and available.

Regardless of the age of financial statements, an Issuer must include a discussion of any changes in financial condition subsequent to the statements.

As required in the JOBS Act, the proposed rules require an Issuer that is conducting an offering of $100,000 or less to provide its filed income tax returns for the most recently completed fiscal year, if any, and its financial statements certified by its principal executive officer.  The proposed rule will require Issuers to redact personal identifiable information such as social security numbers.  If tax returns are not completed and filed as of the date of the offering, the prior year’s returns can be provided with a discussion of any changes.  The SEC has created a form of certification for executive officers to sign attesting to the truth and accuracy of financial statements.

For offerings of more than $100,000 but less than $500,000, the Issuer must file with the SEC and provide potential investors and intermediaries with financial statement reviewed by an independent public accountant.  To qualify as independent, an accountant will need to comply with the SEC’s existing independence rules as set out in Rule 2-01 of Regulation S-X.  Moreover, the financial statements must be reviewed in accordance with the Statements on Standards for Accounting and Review Services (“SSARS”) issued by the Accounting and Review Services Committee of the American Institute of Certified Public Accountants (“AICPA”).  These are the most widely used review standards, and the SEC did not see any reason to modify them for purposes of Regulation Crowdfunding.  The Issuer will be required to provide the SEC, investors and intermediaries with a copy of the accountant’s review report.

For offerings of more than $500,000, the Issuer must file with the SEC and provide potential investors and intermediaries with audited financial statements together with the audit report.  The auditor must be independent, and the audit must be conducted in accordance with the AICPA or PCAOB standards.  The proposed rule does not require that the auditor be PCAOB registered.  The receipt of a qualified audit opinion would not discount the audited financial statements; however, an adverse opinion or disclaimer of opinion by the auditor would render the audited financial statements unusable for purposes of the rule.

The SEC has requested comments on many aspects of the proposed rules including, but not limited to: whether a different standard than the U.S. GAAP should be acceptable for financial statements; should there be exemptions from financial statement requirements for start-up entities with no operating history; should financial statements for interim periods and quarters be required; when should financial statements go stale; have privacy concerns been adequately addressed and in particular as relates to income tax returns; should the SEC require that financial statements only be prepared by PCAOB auditors; should there be exemptions for financial statements that require unreasonable effort or expense; and should an adverse opinion disqualify the financial statements in total?

Conclusion

This Part IV in the series of blogs discussing the proposed Regulation Crowdfunding concludes the discussion on the disclosure requirements for Issuers in their offering documents.  Part V will discuss the necessity for Issuers to provide progress updates and requirements related to amendments to the disclosure documents.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm 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’s legal team 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. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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