In a rare showing of election year bipartisanship, President Obama recently signed into law the Jumpstart Our Business Startups Act (the JOBS Act). The JOBS Act, which originated in the House and passed by an overwhelming 390-23 vote, also passed the Senate by a 73-26 vote with only one amendment–the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (the CROWDFUND Act)–which strengthened investor protections for crowdfunding offerings and was swiftly adopted by the House. The final JOBS Act makes significant changes to several existing securities laws and regulations, and has been alternatively portrayed as a bill that will create jobs and help small businesses, or as a giveaway to Wall Street and an unjustifiable stripping away of investor protections that have been in place since the Great Depression. Regardless of one’s view about the merits of the legislation, one component of the JOBS Act—legislation permitting crowdfunding—is particularly noteworthy for its innovative approach in bringing securities laws and regulations into the internet age. Now that the JOBS Act has passed, entrepreneurs, business owners, investors, and their financial and legal advisers, will need to determine whether and how to utilize crowdfunding to add value to their organization.
For those unfamiliar with the term, crowdfunding refers to the process of raising capital by soliciting small amounts of money from a large pool of investors, generally over the internet. Crowdfunding has been increasingly utilized over the last several years, mainly by artists looking to fund small independent projects. Musicians, writers, directors and other artists looking to fund creative projects have used their own websites and popular websites such as IndieGoGo and Kickstarter to solicit small donations from hundreds or thousands of interested financial contributors. However, these artists, and others looking to raise money for their ventures online by soliciting contributions on these websites and via Facebook and Twitter, have been forced to rely solely on donations and have not been allowed to offer an equity stake or a return on capital in their venture because of existing securities laws.
Before the JOBS Act, entrepreneurs looking to raise capital by offering equity in their venture without running afoul of federal or state securities laws typically relied on Rule 506 of Regulation D under Section 4(2) of the Securities Act of 1933 (the Securities Act). However, crowdfunding offerings are unable to utilize Rule 506 for two key reasons. First, securities offered in reliance upon Rule 506 must not be offered by means of general solicitation or general advertising (although a provision in the JOBS Act requires the SEC to remove this restriction for all Rule 506 offerings made only to accredited investors). Crowdfunding clearly violates this restriction because it involves offering securities to thousands of unrelated investors over the internet. Second, securities under Rule 506 may be sold solely to so-called ‘‘accredited investors’’ and up to 35 non-accredited investors. Accredited investors are investors who are generally either (1) entities with $5 million or more in net assets, or (2) individuals with a net worth of at least $1 million or an annual net income of at least $200,000 (or $300,000 jointly with their spouse).
New Crowdfunding Legislation
The JOBS Act, as amended by the CROWDFUND Act, will create a new exemption under Section 4(6) of the Securities Act that exempts crowdfunding investing offerings from the registration requirements of Section 5 of the Securities Act, as long as such offerings are conducted through a registered broker or an intermediary website and both the issuer and the intermediary comply with certain rules and regulations designed to protect investors against fraud. Issuers would be able to use crowdfunding offerings to sell as much as $1 million worth of securities in any 12-month period. in reliance upon the new exemption. The maximum amount of securities that may be sold to any one crowdfunding investor must not exceed: (1) the greater of $2,000 or 5 percent of the annual income or net worth of the investor, as applicable, if the investor’s annual income or net worth is less than $100,000, or (2) 10 percent of the investor’s annual income or net worth, up to an aggregate investment amount of $100,000, if the investor’s annual income or net worth, as applicable, is greater than $100,000. In addition, all crowdfunding investors would be excluded in determining whether the issuer as a class of equity securities held of record by either 2,000 or more persons or 500 or more non-accredited investors and therefore must register the securities under Section 12(g) of the Securities Exchange Act of 1934 (the Exchange Act).
Securities issued in a crowdfunding offering are subject to certain transfer restrictions. Specifically, such securities may not be transferred by the purchaser of such securities within one year after the date of purchase, unless such securities are transferred: (a) back to the issuer; (b) to an accredited investor; (c) as part of a registered offering; or (d) to a family member or equivalent affiliated person or in connection with the death or divorce of the purchaser.
Interaction With State Law.
Crowdfunding securities will be exempt from registration, documentation and offering requirements under state blue sky laws as federally covered securities under Section 18(b)(4) of the Securities Act. However, the JOBS Act allows state authorities to take enforcement action for fraud, deceit, or unlawful conduct by a broker, dealer, funding portal or issuer in connection with a crowdfunding offering under Section 4(6). The SEC is also required to make all disclosure materials made by issuers in connection with any crowdfunding offering available to the securities commission (or other relevant agency) of each state. States may also require notice filings for crowdfunding offerings to investors in the state (similar to the Form D notice filing requirements under Regulation D), but states may not charge a filing fee for this notice except for the state of the principal place of business of the issuer or the state of residence of purchasers of 50 percent or greater of the aggregate amount of the issue.
Funding portals are likewise exempt under Section 15(i) of the Exchange Act from any law, rule, regulation or administrative action under state law (except for the laws of the state in which the principal place of business of a registered funding portal is located, as long as any such law, rule, regulation, or administrative action is not in addition to or different from the requirements for registered funding portals established by the SEC).
States may also investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by a broker, dealer, or funding portal in connection with securities or securities transactions. ...
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