Crowdfunding Intermediaries or Funding portals (the terms are interchangeable) are hurrying up to be ready to implement rules that will be enacted in early 2013 while at the same time, waiting to find out what those rules will be.  On May 7, 2012, the SEC issued limited guidance for crowdfunding intermediaries.  As has been the case since enactment of the JOBS Act, the SEC continues to ask for public comments and input on its regulatory initiative.  The full text of the guidance discussed in this blog is available on the SEC website.

For my information on funding portals and details of the JOBS Act text related to them, please see my blog entitled Jobs Act Intermediaries – hurry up and wait.

Intermediary Use and Registration Requirements

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.  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 are members of a registered self regulatory organization (SRO).  Currently that SRO is Financial Industry Regulatory Authority (FINRA).

• The Crowdfunding Act carves out a new class of “broker dealer” called “Funding Portals” that can act as Crowdfunding intermediaries.  Section 304 of the Crowdfunding Act provides that Funding Portals are exempt from the broker dealer registration requirements, as long as they are registered with the SEC as Funding Portals and follow all such registration and ongoing rule and reporting requirements.  In accordance with Section 304, Funding Portals must be “subject to the examination, enforcement and other rulemaking authority” of the SEC and must be a member of an SRO, such as FINRA.

Funding Portal Defined

Subject to additional requirements that the SEC may by rule draft, a funding portal is defined as a crowdfunding intermediary that does not: (i) offer investment advice or recommendations; (ii) solicit purchases, sales, or offers to buy securities offered or displayed on its website or portal; (iii) compensate employees, agents, or other persons for such solicitation or based on the sale of securities it lists; or (iv) hold, manage, possess, or otherwise handle investor funds.

SEC Guidance

The SEC guidance reminds all potential funding portals that they may not act as such until when and if the SEC has drafted and enacted the Crowdfunding rules and regulations and each funding portal has registered with the SEC.  The SEC reminded broker dealers that they are under the same restriction.  Crowdfunding is not yet legal and the SEC has issued many reminders to people to not jump the gun.

The SEC further stated the obvious, they don’t know yet what the forms or process will be for registration, as the rules have not yet been written, nor the forms drafted.

Although it is unclear if FINRA or a new SRO will ultimately act as the regulatory for funding portals, the SEC reminded us that as of today, FINRA is the only SRO in existence registered with the SEC and accordingly, unless and until a new SRO registers under Section 15A of the Securities Exchange Act, FINRA will be the regulating SRO.

The SEC set forth the general terms of the JOBS Act related to funding portals, including that a Funding Portal must:

1. Provide disclosures, including disclosures related to risks;
2. Ensure that each investor reviews investor education information and positively affirms that they understand that they risk losing their entire investment and can afford such loss;
3. Ensure that each investor answers questions demonstrating an understanding of the level of risk generally applicable to investments in startups; emerging businesses, and small issuers;
4. Ensure that each investor answers questions demonstrating an understanding of the risk of illiquidity;
5. Take measures to reduce the risk of fraud by establishing rules and procedures including obtaining background and securities enforcement history checks on each officer, director and person holding more than 20% of the outstanding equity of an Issuer;
6. Not later than 21 days prior to the first day securities are sold file with the SEC and make available to potential investors all disclosure information required and provided by the Issuer
7. Ensure that no offering proceeds are given or available to the Issuer until the target offering amount has been raised and allow investors to cancel their investment during that time;
8. Make efforts to ensure that no investor exceeds its allowable investment amount in any 12 month period, including from all Issuers, and all Funding Portals (i.e. $2,000 or 5% of annual net income or net worth if net income or net worth is less than $100,000 or 10% of annual income or net worth up to $100,000 if annual income or net worth is over $100,000)
9. Take steps to protect the privacy of information collected from investors;
10. Not compensate promoters, finders, or lead generators for providing the broker or Funding Portal with personal indentifying information of any potential investor; and
11. Prohibit its directors, officers or partners from having any financial interest in any Issuer using its service.
12. Not offer investment advice or make recommendations or solicit purchases, sales or offers of securities
13. Not compensate employees, agent, or other persons for soliciting purchases, sales or offers of securities
14. Not hold, manage, possess or otherwise handle investor funds or securities

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger 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 SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

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Summary of JOBS Act Changes Effecting General Solicitation and Advertising of Private Offerings

Title II of the JOBS Act provides that, within 90 days of the passage of the JOBS Act (i.e. July 5, 2012), the SEC will amend Section 4(2) of the Securities Act of 1933 and Regulation D promulgated there under, to eliminate the prohibition on general solicitation and general advertising in a Rule 506 offering, so long as all purchasers in such offering are accredited investors.  The JOBS Act directs the SEC to make the same amendment to Rule 144A so long as all purchasers in the Rule 144A offering are qualified institutional buyers.  Neither a Rule 506 offering nor a Rule 144A offering will be considered a public offering (i.e. will lose its exemption) by virtue of a general solicitation or general advertising so long as the issuer has taken reasonable steps to verify that purchasers are either accredited investors or qualified institutional buyers, respectively.  Since it would be impossible to ensure that only accredited investors, or qualified institutional buyers, receive, review or become aware of general solicitations and advertisements, the rule focuses on ensuring that the purchasers qualify.

The SEC will need to formulate rules to determine what “reasonable steps” will be required from issuers to verify a purchaser’s status as either an accredited investor or a qualified institutional buyer.

JOBS Act Changes Number of Shareholders Requiring Registration

The JOBS Act amends Section 12(g) and Section 15(d) of the Exchange Act as to threshold shareholder requirements and registration and deregistration requirements such that the shareholder threshold before requiring registration and subsequent reporting with the SEC has been increased from 500 to either (a) 2,000 or more, or (b) 500 or more unaccredited shareholders;

Impact on Hedge Funds

The impact on hedge funds is obvious – they can now advertise for both accredited and qualified institutional investors.  Moreover, with the increased number of shareholders allowed before registration, a fund qualified for an exemption under Section 3(c)(7) of the Investment Company Act of 1940, can now advertise, and have 1999 accredited shareholders before they would have to register with the SEC and become reporting.

The lift on advertising goes beyond your basic ability to promote on the internet.  It is a lift on the ban for general solicitation, advertising and marketing in general.  For instance, for the first time, hedgefunds will be able to sponsor sporting events and sporting teams.

One caveat of the new rules is that advertising is only allowed where ALL investors are accredited or qualified institutions.  Accordingly, a fund with 35 unaccredited investors, would not be able to advertise, while those unaccredited investors remain in the fund.

Right now, many hedgefunds do not provide any details at all about their investment strategies, historical performance or forecasts of future performance for fear that such open information could be viewed as a solicitation and therefore a violation of the rules.  Upon enactment of the new rules (around mid July) that will all change.

Hedge Funds May Discuss Strategies and Performance

Now, not only will hedge funds be able to discuss their strategies, deal and performance in depth on their website, but on a broader scale, amongst each other.  Broker dealers will be able to pitch investors with glossy brochures.  Open invitation seminars, together with all the trimmings will make a comeback.

Of course the SEC and state anti-fraud rules stay in place (and I expect will be beefed up) as do FDA standard truth in advertising rules.

It is widely agreed that these changes will have a dramatic impact on smaller hedgefunds.  Now the big boys turn away investors; the smaller ones now have a way to find them.  Established hedgefunds think the idea of advertising is not only ludicrous, but somehow below them – a sign of weakness.   Although in the short term, they will not feel the impact, I would bet that in two years’ time, the entire hedge fund landscape will have evolved.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger 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 SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

I have been blogging extensively on the JOBS Act and Crowdfunding Act.  My last blog addressed Herculean effort the SEC must undertake to write the laws and rules which will bring the Crowdfunding Act to fruition by early 2013.  In addition to fashioning the exemption that will allow companies to raise funds using the Crowdfunding Act, the SEC must also fashion rules to govern the funding portals that companies will be required to use in the process.

Funding Portals are popping up everywhere, at least in name and concept.  All of these portals are busy putting together systems internally, but all of those systems are subject to the SEC rules that have yet to be drafted.  Funding portals are hurrying up to be ready to implement rules that will be enacted in early 2013 while at the same time, waiting to find out what those rules will be.

Intermediary Use and Registration Requirements

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.  As of today, all entities that effect small transactions in securities between an investor and Issuer company (Issuer) must be licensed broker dealers, registered with the SEC and members of a self regulatory organization (SRO) that is a national securities association.  Currently that SRO is Financial Industry Regulatory Authority (FINRA).

The Crowdfunding Act carves out a new class of “broker dealer” called “Funding Portals” that can act as Crowdfunding intermediaries.  Section 304 of the Crowdfunding Act provides that Funding Portals are exempt from the broker dealer registration requirements, as long as they are registered with the SEC as Funding Portals and follow all such registration and ongoing rule and reporting requirements.  As with other aspects of the new law, these rules and ongoing reporting requirements have yet to be drafted.   In accordance with Section 304, Funding Portals must be “subject to the examination, enforcement and other rulemaking authority” of the SEC and must be a member of an SRO, such as FINRA.

FINRA or CFIRA?

Shortly after the signing of the JOBS Act, The Crowdfunding Intermediary Regulatory Association (CFIRA) was created to act as an SRO for Funding Portals.  However, the SEC has yet to decide if CFIRA will be the sole Funding Portal SRO body or whether it will be FINRA.  Moreover, FINRA, who opposed the JOBS Act and Crowdfunding Act, has yet to decide if it is willing to take on the role and responsibility of the Funding Portals new master and chief.

Funding Portal Requirements

Whether ultimately a Funding Portal becomes a member of FINRA or the CFIRA, they will have to follow rules and regulation, meet reporting requirements, and impose requirements on Issuers seeking to use their intermediary services. The Crowdfunding Act creates a new Section 4A of the Securities Act of 1933, entitled “Requirements with Respect to Certain Small Transactions.”  New Section 4A(a) sets forth the requirements for Funding Portals.  Each of the requirements is subject to the more detailed rules that will be drafted by the SEC and for which we are all waiting.

In addition to being registered with the SEC and the applicable SRO, and a Funding

Portal must:

1)    Provide disclosures, including disclosures related to risks;

2)    Ensure that each investor reviews investor education information and positively affirms that they understand that they risk losing their entire investment and can afford such loss;

3)    Ensure that each investor answers questions demonstrating an understanding of the level of risk generally applicable to investments in startups; emerging businesses, and small issuers;

4)    Ensure that each investor answers questions demonstrating an understanding of the risk of illiquidity;

5)    Take measures to reduce the risk of fraud by establishing rules and procedures including obtaining background and securities enforcement history checks on each officer, director and person holding more than 20% of the outstanding equity of an Issuer;

6)    Not later than 21 days prior to the first day securities are sold file with the SEC and make available to potential investors all disclosure information required and provided by the Issuer

7)    Ensure that no offering proceeds are given or available to the Issuer until the target offering amount has been raised and allow investors to cancel their investment during that time;

8)    Make efforts to ensure that no investor exceeds its allowable investment amount in any 12 month period, including from all Issuers, and all Funding Portals (i.e. $2,000 or 5% of annual net income or net worth if net income or net worth is less than $100,000 or 10% of annual income or net worth up to $100,000 if annual income or net worth is over $100,000)

9)    Take steps to protect the privacy of information collected from investors;

10) Not compensate promoters, finders, or lead generators for providing the broker or Funding Portal with personal indentifying information of any potential investor; and

11) Prohibit its directors, officers or partners from having any financial interest in any Issuer using its service.

Funding Portal Fees

It is undisputed that a Funding Portal will be able to charge a fee to an Issuer for using its service.  However, how that fee will be determined and how much that fee can be is currently unknown.  Only licensed registered broker dealers can charge a commission for raising money.  Moreover, Section 304 of the Crowdfunding Act defines a Funding Portal as “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to Section 4(6) of the Securities Act of 1933” (i..e the new Crowdfunding section).

Moreover, Section 304 continues, specifically excluding from the definition of a Funding Portal any entity that (i) offers investment advice or recommendations; (ii) solicits purchases, sales, or offers to buy the securities offered or displayed on its website or portal; (iii) compensates employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; or (iv) holds, manages, possesses, or otherwise handles investor funds or securities.

Clearly only licensed registered broker dealers will be able to offer the foregoing services and charge fees for same.  Moreover, I note that a Funding Portal has to ensure that Issuers do not receive money until a target offering is made, but at the same time can’t hold the investors money during that time.   It seems the SEC will have to require the use of a broker dealer or clearing firm by Funding Portals to address this quandary.

In addition to all of the above, each of the rules and requirements set forth in the Crowdfunding Act contains language to the extent that the SEC shall determine, by rule, other rules and practices that are appropriate.  No one outside the SEC (and perhaps inside) knows what these are yet.

Conclusion

Funding Portals will have to meet a plethora of requirements, including registration with the SEC and at least one SRO.  They will have to have websites that operate proficiently and meet all these requirements.  However, other than broad strokes, they don’t know what these rules and requirements will be.  They must hurry up, and wait….

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger 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 SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

A Whole New Exemption

Over the years I have consistently received calls from potential clients that wish to use the exemptions provided for in Regulation D to raise money for small or start up ventures.  Many of these individuals believe, mistakenly, that Regulation D provides them with a method to raise money.  It does not.  Regulation D only lays out rules to follow to utilize an exemption from the registration requirements in the Securities Act of 1933.  These rules include such items as limitations on the dollar amount raised; who you can raise money from, how you can raise money, prohibitions on advertising and solicitation, disclosure documents required, etc…  All of these rules are necessary and serve a function, but the rules do not provide any insight on how to actually go about raising the money.  For the first time in history, or at least my history, the government may fashion a system that not only sets out an exemption from registration, but provides the “how to raise the money” aspect as well.

Ok, so the JOBS Act doesn’t result in “pick your check up here” but it will allow entrepreneurs, innovators, job creators, and the world of small business to access capital markets in a way never before possible.  The crowdfunding bill provides for SEC regulations that will allow companies to utilize the internet to raise funds from a large number of smaller investors.  The bill removes SEC regulations prohibiting advertising and solicitation for private placements.

In short, companies will be able to raise small amounts of money either directly off their own website or using intermediaries set up for the purpose.  The exemption will likely be codified as a new and separate exemption under Regulation D and will include an overhaul of the current general provisions of Regulation D found in Rules 501-503.  The exemption will be limited to $1 million in any twelve (12) month period.

Crowdfunding Exemption

The exemption is really designed for start-ups and smaller companies that need seed capital.  Since the amount raised is per twelve months, companies need to plan accordingly.  Moreover, since a Company could end up with a couple hundred shareholders to raise $1mill, they will likely need a transfer agent to maintain shareholder records.   At a couple hundred shareholders per round of financing, this is not a route that a company will want to tap more than once or twice.  If a Company will need $30 mil in the next 2-4 years, crowdfunding is not viable, but if they need $2 mil in the same time frame, it is a workable option.

Attorneys for crowdfunding clients should make sure that the insiders maintain shareholder voting control under their state of incorporation to avoid problems getting shareholder approval for future financings or going public transactions.  Attorneys should carefully discuss future plans with their clients.  It is uncertain how venture capital firms, investment bankers and wall street in general will respond to companies that start off with a large shareholder base.  There will definitely be a learning curve, so companies that foresee the need to go the traditional IPO or wall street route within a few years should be cautious.  That doesn’t mean that they shouldn’t partake in the crowdfunding though.  I firmly believe that the markets will quickly adjust and find ways to move these companies up the food chain, where the product, revenues and interest exist.

Other than this brief statement, I will not devote time in this blog to the naysayers because I see too much positive potential and too much of a serious need for this bill to dilute with the negative.   The naysayers are concerned that the changes open the door to additional fraud and scams in the investment world.  There has always been and will likely always be financial crimes committed by the unscrupulous, and opportunistic fraudsters will always find a way to commit their crimes using our capital markets.   Part of progress is dealing with that reality, not ceasing progression.

I’ll discuss more on that in the next blog.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (”Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (”Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

Traditional PIPE Transactions

In particular, a traditional PIPE is generally a set number of securities at a set price (which may be a discount to market at the time of close) and is conditioned only upon the effectiveness of a re-sale registration statement. A traditional PIPE where the price is a discount to market would differentiate from a non-traditional death spiral in that there would only be one closing in the traditional PIPE and there would be multiple closings with continued downward pressure on the stock price and a continued dilutive effect with a non-traditional death spiral. The transaction documents associated with a traditional PIPE are generally very straight forward and do not contain ongoing negative covenants relating to information rights, future financing or corporate governance.

The terms of a non-traditional PIPE can vary widely but the basic requirements that the investment decision be completed in a private transaction prior to the filing of a registration statement and that the investor bear the risk of an investment are consistent.

Re-Sale Registration Statements

The SEC allows the filing of a re-sale registration statement for a PIPE if 1) the initial sale or placement of securities is conducted in a manner consistent with a private placement (no general solicitation or advertising and offerings made to accredited investors) and 2) the investors enter into definitive commitments which are only subject to the satisfaction of closing conditions outside the control of the investor, such as the effectiveness of a re-sale registration statement (that is, investor has made the investment decision and assumed the risk prior to the filing of the registration statement).

Section 9 of the Securities and Exchange Act of 1934, as amended, prevent the Investor from entering into hedging transactions (short sales and the like) from the time of entering into the PIPE transaction agreement through the effectiveness of the registration statement. In addition, Investors must be aware of insider trading rules (Section 10 of the Exchange Act and rules promulgated thereunder), throughout the period of the PIPE transaction. Moreover, the SEC has taken the position that an Investor that engages in short-selling prior to the final closing of PIPE and effectiveness of a registration statement, is engaging the unregistered sale of securities in violation of Section 5 of the Securities Act of 1933, as amended.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!