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Proposed Crowdfunding Rules – Part III

As required by Title III of the JOBS Act, on October 23, 2013, the SEC has 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 III in my series continues a discussion of the in-depth disclosure requirements for Issuers for use in their offering statements.  Part IV will discuss 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;

(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;

(f)  The target offering amount and a deadline to reach the target and regular updates regarding the progress of meeting the target;

(g)  The price to the public of the securities and the method of determining the price;

(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.

Many commenters expressed concern that these requirements would be burdensome to Issuers.

The SEC’s proposed rules on each of the disclosure requirements are discussed below.  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

                Description of the Business

The proposed rules require Issuers to disclose information about their business and business plan; however, the proposed rule specifically declines to set out the parameters of such disclosure.

The SEC has sought comment as to whether the rules should require specific disclosures about an Issuer’s business and business plan.

   Use of Proceeds

As required by the JOBS Act, the proposed rules require a description of the use of the proceeds from the offering.  In its commentary, the SEC notes that it expects the disclosure to “provide a sufficiently detailed description of the intended use of proceeds to permit potential investors to evaluate the investment.”  Examples of possible specific line items include specific acquisitions, repayment of affiliated or non-affiliated debt, intermediary compensation and commissions, employee compensation, repurchase of outstanding securities and general working capital. Moreover, it is suggested that the working capital line item disclose the amount of time such working capital is expected to last.  If an Issuer indicates that it will allow an oversubscription of the target offering amount, it will be required to provide a separate use of proceeds for the excess proceeds.

The SEC has requested comment as to whether it should require specific line-item disclosures or include a non-exclusive list of possible line items in the final rule.

    Target Offering Amount and Deadline

As required by the JOBS Act, the proposed rules require Issuers to disclose the target offering amount and a deadline to reach the target and regular updates regarding the progress of meeting the target.  In addition, the rules require disclosure as to whether the Issuer will allow an oversubscription from the target amount and an absolute maximum amount it will accept:  “For example, if the issuer sets a target amount of $200,000 but is willing to accept up to $750,000, the issuer would be required to disclose both the $200,000 target offering amount and the $750,000 maximum offering amount that it will accept.”  Disclosure as to how oversubscribed shares will be allocated will be required.

The proposed rules require Issuers to describe the process to cancel a subscription or investment commitment or to complete and close the investment once the target amount has been achieved, including the following statement:

  • Investors may cancel an investment commitment until 48 hours prior to the deadline identified in the Issuer’s offering materials;
  • The intermediary will notify investors when the target offering amount has been met;
  • If an Issuer reaches the target offering amount prior to the deadline identified in its offering materials, it may close the offering early if it provides notice about the new offering deadline at least five business days prior to that new deadline (absent another material change that would require an extension of the offering and reconfirmation of the investment commitment); and
  • If an investor does not cancel an investment commitment before the 48-hour period prior to the offering deadline, the funds will be released to the Issuer upon closing of the offering and the investor will receive securities in exchange for his or her investment.

The proposed rules also require Issuers to disclose that if an investor does not reconfirm their investment decision following a material change, the investment will be canceled and the committed funds will be returned.  A reconfirmation cannot be had through negative response.  Finally, if the target amount is not achieved by the offering deadline, the offering will be canceled and all funds will be returned.

The SEC has sought comment generally on the proposed disclosure and specifically on the rules related to accepting oversubscriptions.

Offering Price

As required by the JOBS Act, the proposed rules require an Issuer to disclose the offering price or the formula for determining the offering price, provided that if only a formula is disclosed, prior to the sale, each investor must be provided in writing with a final price.

Ownership and Capital Structure

As required by the JOBS Act, the proposed rules require an Issuer to disclose its ownership and capital structure.  Such disclosure includes:

  • The terms of the securities being offered and each other’s class of security of the Issuer, including the number of securities being offered and/or outstanding ones, whether or not such securities have voting rights, any limitations on voting rights, how the terms of the securities can be modified and a summary of the differences between the different classes of securities of the Issuer, and how the rights of the securities can be limited, diluted, or qualified.
  • A description of how the exercise of the rights held by the principal shareholders of the Issuer could affect the investor’s securities;
  • The name and ownership level of persons who are 20% or more beneficial owners;
  • How the securities being offered are valued and examples of methods that the Issuer may use to value securities in the future;
  • The risks to the purchasers of the securities related to minority ownership in the Issuer and the risks associated with corporate actions including additional issuances, Issuer repurchases, a sale of the Issuer or of assets or transactions with related parties; and
  • A description of the restrictions on the transfer of the securities.

Additional Disclosure Requirements

In addition to the disclosures mandated by the JOBS Act, the SEC’s proposed rules also require:

  • Disclosure of the name, commission file number and CRD number of the intermediary conducting the offering;
  • Disclosure of the amount of compensation paid to the intermediary, including the amount of any referral or other fees associated with the offering;
  • Disclosure of certain legends to be included in the offering statement, including regarding ongoing reporting requirements of the Issuer;
  • Disclosure of the current number of employees of the Issuer;
  • A discussion of the material risk factors;
  • A description of the material terms of any indebtedness of the Issuer, including the amount, interest rate and maturity date;
  • Disclosure of certain related party transactions including by and between the Issuer and any officer, director, promoter, or 20% or more beneficial owner or immediate family members of the foregoing.

Part IV in this blog series will pick up with a discussion of financial disclosure obligations of the Issuer.

The Author

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

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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