In accordance with Section 302(e) of the Crowdfunding Act, the securities issued in a crowdfunding offering are restricted securities. The Crowdfunding Act states that the securities purchased in a crowdfunding offering may not be resold during a one year holding period, beginning on the date of purchase, unless such securities are transferred (A) to the issuer of the securities; (B) to an accredited investor; (C) as part of an offering registered with the SEC; or (D) to a member of the family of the purchaser or the equivalent, or in connection with the death or divorce of the purchaser or other similar circumstance, in the discretion of the SEC. To a layman this provision may seem straight forward and innocuous enough, it’s not!
SEC Will Need To Draft New Rules
The SEC will need to draft new rules to cover these re-sale restrictions as they do not fit within the parameters of the current rule regarding the resale of restricted securities – i.e. Rule 144. Current Rule 144 provides for either a six month or one year holding period dependent on whether the issuing Company is subject to the reporting requirements of the Securities Exchange Act of 1934, or not and on whether the seller is an affiliate or not an affiliate. Moreover, in addition to a holding period, Rule 144 requirements related to current information being available, manner of sale requirements (through a broker dealer); filing requirements (Form 144) and a multitude of provisions dealing with the tacking of a holding period and calculation of when such holding period may begin under different fact scenarios. Moreover, the Issuers of securities being sold in reliance on Rule 144 are public companies, not private. Crowdfunding entities may be and remain private and the time of a proposed resale.
Is There a New Crowdfunding Resale Rule In The Works?
Although the SEC may try to amend Rule 144 to cover crowdfunding offerings and the resale of the securities issued in these offerings, I suspect that a new crowdfunding resale rule is in the works.
The easy provisions are Items (C) and (D). In (C), the company includes the securities in a registration statement filed with the SEC. Generally this would be part of a going public transaction and would result in the Company’s securities trading on either an exchange or the over the counter market.
Item (A) raises a ton of questions. Today, I am just laying out my initial thoughts. In the future I will discuss potential and suggested answers to all these questions. In particular, can the Company engage in a limited or arbitrary buy-back of its securities? Does it have to offer to buy back all the crowdfunding investors at the same time? Are there specific procedures that the Company must go through, or disclosures it must make in connection with the repurchase of its securities? For example, if the Company is engaging in substantive discussions with an investment banking firm, VC or angel investor, does it need to disclose this fact to the investor prior to the buy back? If an investor approaches the Company for a buyback, it may be a simpler transaction, but what are the procedures when it is the other way around. Can a buy-back occur privately between the Company and the Investor or must it be funneled through a portal or intermediary. If the Company is offering to buy back all crowdfunding investors, say as a precondition to a larger transaction, are cramdown and dissenter rights deferred to state law, or will the federal provisions cover all or part of it (as will be discussed in a later blog, federal law, will for the most part, pre-empt state law for crowdfunding offerings).
Procedures Can Be Problematic
Although the technicalities and procedure behind (A) are problematic, the real meat is in (B). The first question raised is whether the transferee is subject to the same resale restrictions as the transferor. So if a crowdfunding investor immediately resells his or her securities to an accredited investor, is that accredited investor bound by the same resale restrictions? Does the one year holding period tack?
Even if the accredited investor is subject to the same re-sale restrictions, they can re-sell to another accredited investor. As I have blogged about in the past in the past few years, there has been an increase in private company market places – PCMP’s. A PCMP is a trading platform that provides a market place for private shareholders to buy and sell shares of private companies from other private shareholders. In fact, Title II of the JOBS Act specifically provides an exemption to the broker dealer registration requirements for websites and entities that act as PCMP’s for the sales of securities to accredited investors under Rule 506 of Regulation D.
The Crowdfunding Aftermarket
I can foresee an immediate trading aftermarket for crowdfunding securities, among accredited investors, through PCMP’s. American business is about to embark on yet another chapter of capitalization through innovation.
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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