SEC PROPOSES MAJOR UPGRADES TO CROWDFUNDING RULES

The SEC just proposed major changes to every kind of online offering:  Rule 504, Rule 506(b), Rule 506(c), Regulation A, and Regulation CF.

The proposals and the reasoning behind them take up 351 pages. An SEC summary is here, while the full text is here. The proposals are likely to become effective in more or less their existing form after a 60-day comment period.

I’ll touch on only a few highlights:

  • No Limits in Title III for Accredited Investors:  In what I believe is the most significant change, there will no longer be any limits on how much an accredited investor can invest in a Regulation CF offering. This change eliminates the need for side-by-side offerings and allows the funding portal to earn commissions on the accredited investor piece. The proposals also change the investment limits for non-accredited investor from a “lesser of net worth or income” standard to a “greater of net worth or income” standard, but that’s much less significant, in my opinion.
  • Title III Limit Raised to $5M:  Today the limit is $1.07M per year; it will soon be $5M per year, opening the door to larger small companies.

NOTE:  Those two changes, taken together, mean that funding portals can make more money. The impact on the Crowdfunding industry could be profound, leading to greater compliance, sounder business practices, and fewer gimmicks (e.g., $10,000 minimums).

  • No Verification for Subsequent Rule 506(c) Offerings:  In what could have been a very important change but apparently isn’t, if an issuer has verified that Investor Smith is accredited in a Rule 506(c) offering and conducts a second (and third, and so on) Rule 506(c) offering, the issuer does not have to re-verify that Investor Smith is accredited, as long as Investor Smith self-certifies. But apparently the proposal applies only to the same issuer, not to an affiliate of the issuer. Thus, if Investor Smith invested in real estate offering #1, she must still be verified for real estate offering #2, even if the two offerings are by the same sponsor.
  • Regulation A Limit Raised to $75M:  Today the limit is $50M per year; it will soon be $75M per year. The effect of this change will be to make Regulation A more useful for smaller large companies.
  • Allow Testing the Waters for Regulation CF:  Today, a company thinking about Title III can’t advertise the offering until it’s live on a funding portal. Under the new rules, the company will be able to “test the waters” like a Regulation A issuer.

NOTE:  Taken as a whole, the proposals narrow the gap between Rule 506(c) and Title III. Look for (i) Title III funding portals to broaden their marketing efforts to include issuers who were otherwise considering only Rule 506(c), and (ii) websites that were previously focused only on Rule 506(c) to consider becoming funding portals, allowing them to legally receive commissions on transactions up to $5M.

  • Allow SPVs for Regulation CF:  Today, you can’t form a special-purpose-vehicle to invest using Title III. Under the SEC proposals, you can.

NOTE:  Oddly, this means you can use SPVs in a Title III offering, but not in a Title II offering (Rule 506(c)) or Title IV offering (Regulation A) where there are more than 100 investors.

  • Financial Information in Rule 506(b):  The proposal relaxes the information that must be provided to non-accredited investors in a Rule 506(b) offering. Thus, if the offering is for no more than $20M one set of information will be required, while if it is for more than $20 another (more extensive) set of information will be required.
  • No More SAFEs in Regulation CF:  Nope.

NOTE:  The rules says the securities must be “. . . . equity securities, debt securities, or securities convertible or exchangeable to equity interests. . . .” A perceptive readers asks “What about revenue-sharing notes?” Right now I don’t know, but I’m sure this will be asked and addressed during the comment period.

  • Demo Days:  Provided they are conducted by certain groups and in certain ways, so-called “demo days” would not be considered “general solicitation.”
  • Integration Rules:  Securities lawyers worry whether two offerings will be “integrated” and treated as one, thereby spoiling both. The SEC’s proposals relax those rules.

These proposals are great for the Crowdfunding industry and for American capitalism. They’re not about Wall Street. They’re about small companies and ordinary American investors, where jobs and ideas come from.

No, the proposals don’t fix every problem. Compliance for Title III issuers is still way too hard, for example. But the SEC deserves (another) round of applause.

Please reach out if you’d like to discuss.

Will The SEC’s 15 Day Notification Rule End Angel Fairs?

No, it won’t.

On July 10, 2013 the SEC proposed rules that would, among other things, require a company to notify the SEC at least 15 days before using any “general solicitation” to raise money under the newly-adopted Rule 506(c) of Regulation D, also known as Title II Crowdfunding.

This proposal triggered more anxiety in the investment community than any other. Angel groups in particular were concerned about the possible effect on “angel fairs” and similar networking events, where companies look for investors and publicity by making presentations and handing out literature. If these activities constituted general solicitation, so the thinking went, and a company had not notified the SEC at least 15 days in advance, the company would be violating the law with potentially serious consequences.

Should companies stop presenting at angel fairs? Should attendance at angel fairs be limited? Would the SEC rule bring a wrenching halt to the way startups have raised money for 30 years?

There are two reasons why the concerns in the investment community are probably overblown.

First, “general solicitation” is not a new concept. Regulation D has always prohibited general solicitation. Rule 506 of Regulation D is itself a regulatory implementation of section 4(a)(2) of the Securities Act of 1933, which provides simply that the registration requirements do not apply to “transactions by an issuer not involving any public offering.” It has always been the position of the SEC, reflected in Rule 502(c), that using general solicitation to attract investors crossed the indistinct line from “private offering” to “public offering.”

Thus, every angel fair that has ever been held for the last several decades has been subject to the SEC prohibition on general solicitation. Yet given all that time and all those opportunities, the SEC has never taken the position that what happens at angel fairs constitutes prohibited general solicitation.

Having stood aside and permitted angel fairs for three decades, it seems unlikely that the SEC would take the opposite position today, after Congress announces its support for Crowdfunding by enacting the JOBS Act!

So far, it is safe to say that the SEC has taken the opposite approach, i.e., by making Crowdfunding easier, not more difficult. Consider, for example, the two no-action letters issued by the SEC on March 26, 2013 to FundersClub and AngelList. It seems very possible, even likely, that these letters would not have been issued before enactment of the JOBS Act. The SEC seems to have taken the wishes of Congress to heart and there is no reason to believe it intended to do otherwise with the 15 day proposal.

The other reason the concerns are overblown is that the rule in question is not yet in effect. The public comment period ended on September 23, 2013 and the SEC is considering the many comments made by the investment community. The chances are very high that when the SEC issues the final rule, these comments will be taken into account.

Maybe I’ll be proven wrong. Maybe the SEC will suddenly reverse course after 30 years and issue final rules that blow angel fairs out of the water, throw up unnecessary impediments to Crowdfunding despite the JOBS Act, and make everyone angry. Don’t bet on it.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.