On May 14, 2012, the SEC staff met with representative of the National Crowdfunding Association to discuss issues regarding the implementation of Title III of the JOBS Act, i.e. the Crowdfunding Act. The SEC posted a memo on the meeting, which is available for review on the SEC website. This blog summarizes the memo, which memo was prepared by the National Crowdfunding Association prior to the meeting as an agenda and discussion memo and was subsequently posted on the SEC website, by the SEC.
National Crowdfunding Association Compiles List of Issues and Comments
The National Crowdfunding Association set forth a list of issues and comments on the pending Crowdfunding Act SEC rules and regulations. Unless otherwise stated, I agree with and support all of the comments and issues discussed by the National Crowdfunding Association.
The issues and comments are summarized as follow:
1. Investment Limitations. The crowdfunding exemption allows Issuers to raise up to $1 million in a twelve month period, 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 next worth is less and $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. Funding intermediaries are required to make efforts to ensure that no investors exceed these threshold amounts.
The National Crowdfunding Association points out the need for a clear definition of the term “investor.” The National Crowdfunding Association notes that SEC rules and regulations generally differentiate between non-accredited, institutional and accredited investors. Generally, accredited and institutional investors are sophisticated and able to fend for themselves. Like many other exemptions from registration it is argued and requested that accredited and institutional investors be excluded from the definition of an “investor” and that no limits on the amount or number of offerings be imposed on such investors.
2. Rights of Rescission. The Crowdfunding Act grants investors the right of rescission until the target offering amount is reached. The National Crowdfunding Association points out that it is unclear when an investor’s commitment becomes binding. The National Crowdfunding Association suggests that the SEC rules limit the right to rescind to 48 hours from the time of the initial commitment, a change of investment terms, or a materially adverse disclosure. They point out that the current rule would promote unfair practices such as seeding a deal by having investors commit that later intend to rescind once enough attention is brought to a project. I completely agree with the rational and suggested limitation.
3. Compensation. The Act requires that a funding portal “Prohibit its directors, officers or partners from having any financial interest in any Issuer using its service.” It is unclear whether equity is considered a financial interest and accordingly whether services can be paid for with equity. The National Crowdfunding Association suggests that the limitation be limited to the time of the offering. I do not necessarily agree. I think intermediaries should be allowed a financial interest so long as such interest is disclosed and other safeguards are put in place such as against promotion of a deal they have an interest in vs. one they do not, are put in place. In addition, the interest could be capped to a non-affiliated level (under 10%).
4. Fees. The fee structure to which an intermediary may request and be paid is completely unclear. The Act really provides little if any guidance on what fee structure would be acceptable and what services can properly be charged for. The National Crowdfunding Association asks for clarification.
5. Liability. The Act provides for a private cause of action by investors against Issuer’s for material misstatements and omissions. The National Crowdfunding Association requests clarification as to whether an intermediary will be required to confirm information and what, if any, liability the intermediary will have for misstatement and omissions by an Issuer.
6. Personal Liability of Directors and Officers. The National Crowdfunding Association asks for clarification as to the extent that directors and officers of crowdfunding issuers could face personal or derivative liability and in particular in connection with shareholder actions.
7. Securities. The Act permits the sale of equity, debt, and debt convertible into equity. The Act does not distinguish classes of securities. The National Crowdfunding Association requests that it be clearly set out that Issuers can also offer classes of each type of securities, such as preferred stock.
8. Integration. It is unclear what other exempt offerings will integrate with a crowdfunding offering which is limited to $1 million in any 12 month period. The National Crowdfunding Association believes that the Act only integrates offerings made under the crowdfunding exemption (Section 4(6)), however, clarification is needed and requested.
I note that in different sections of the JOBS Act, the wording is “all other offerings” and in other sections the wording is limited to Section 4(6) offerings. The SEC will need to be very clear as to the integration standards among both Section 4 and Section 3 offerings.
9. Held of Record. The Act requires a one year holding period by investors, with certain exceptions. The National Crowdfunding Association reads the Act such that original crowdfunding investors are not included in the count of shareholders of record but rather only transferees of such securities are counted. Clarification is needed. Issuers should that have over 2,000 shareholders from a crowdfunding offering should not see necessary registration looming within a year of the offering.
10. Advertisements. The crowdfunding exemption requires that Issuers “not advertise the terms of the offering, except for notices which direct investors to the funding portal or broker.” The National Crowdfunding Association advocates that the rules allow the placement of a notice on the Issuer’s website including the basic terms of the offering. Moreover, they also advocate such notice be allowed in mailings to customers or mailing list subscribers. Moreover, it is unclear whether the SEC rules will permit notices to state the offering period, that investors may contact the issuers management to discuss the offering or if it may include names of accredited investors participating in the offering.
I also suggest reading my previous blog summarizing a letter from the CFIRA to the SEC addressing the topic of advertising and general solicitation. The CFIRA had great suggestions regarding the use of social media.
11. Issuer Solicitation. The Act does not prohibit the compensation to portal employees or agents to solicit Issuers (as opposed to investors).The National Crowdfunding Association advocates allowing such compensation. Clarification is indeed needed.
12. Intermediary Services. The Act requires that intermediaries not hold, manage, possess or otherwise handle investor funds or securities. The National Crowdfunding Association advocates that intermediaries be allowed to act as transfer agents for issuers during the one year holding period following an offering.
13. Investment Advice. The Act prohibits intermediaries from offering investment advice or recommendations. However, the Act does not define either investment advice or recommendations. The National Crowdfunding Association requests clarification as to whether any of the following would constitute investment advice or recommendations: (i) removing an offering after a period of time for lack of sufficient investor commitments; (ii) preventing an Issuer from offering its securities on the intermediary’s website due to a failure to provide sufficient due diligence; (iii) assuming an intermediary allows interactive comments and questions from investors or potential investors on their website, monitoring and removing fraudulent or inappropriate comments; (iv) the positioning of the Issuers documents or offering within the website; (v) providing market and news updated; or (vi) declining to post an offering for not fitting into certain parameters or characteristics.
14. Disclosures. The Act requires that the intermediary provide certain disclosure and educational materials to investors. Clarification is needed as to the form and substance of this information.
I note that clarification needs to be made as to whether these disclosures and educational materials can be deemed investment advice.
15. Investor Education Information. The Act requires that the intermediary provide certain educational materials to investors and confirm that the investors understand the risks of the offering. Clarification is needed as to the form and substance of these materials and the method of obtaining affirmation of the understanding of the risks.
16. Background Checks. The Act requires intermediaries to 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. It is unclear whether the intermediary must simply inform the crowd of their findings and let them determine the value or weight of such findings or whether the intermediary will be required to pass judgment on such findings and take actions, such as denying the Issuer use of their portal.
17. Annual Financial Disclosure. The Act requires Issuers to file annual reports with the SEC and provide such reports to investors, with results of operations and financial statements. The form and substance of this report needs to be clarified as does what constitutes delivery to investors.
18. Audit Requirements. The Act requires that issuers of offerings more than $500,000 provide audited financial statement. The audit standards need to be clarified. Must an Issuer follow GAAP and be prepared by PCAOB qualified auditors? The National Crowdfunding Association suggests that crowdfunding issuers only be required to use accounting standards board (ASB) qualified auditors and not PCAOB.
19. Record Keeping. The Act requires issuers to provide risk disclosure and “ensure their understanding.” The National Crowdfunding Association suggests the use of an online questionnaire.
20. Record Keeping of Aggregate Investments. The Act requires that intermediaries 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. The SEC must provide detailed guidance on how an intermediary can achieve such requirement.
21. Registration. 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 National Crowdfunding Association requests guidance on this registration process as quickly as possible. If the rules come into play without sufficient time for non broker dealers to register with the SEC, broker dealers will be given an unfair advantage.
22. Registration of Service Providers. The registration requirements are unclear as to the extent an intermediary uses a third party service provider for certain services and pays fees to such service provider. It is unclear whether such third party also needs to be registered, and whether and to what extent their services need to be disclosed.
23. Self-Regulatory Organization. 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). Clarification as to the SRO is needed.
24. Funding Portal. The Act defines a funding portal in accordance with Section 3(a)(80) of the Securities Exchange Act of 1934 with the caveat that such funding portal 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. Such definition is in connection with what it does and not the form it takes. The National Crowdfunding Association believes a registered funding portal should be able to own and operate several portal websites.
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.
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