Category: Regulation A

The Crowdfunding Bad Actor Rules Don’t Apply To Investors

On By crowdfundattnyIn 100 Investor Rule, Accredited Investor, Investor, Investor Disclosures, Reg CF, Regulation A, Rule 506, Title III, Title III CrowdfundingLeave a comment

I often see Subscription Agreements asking the investor to promise she’s not a “bad actor.” This is unnecessary. The term “bad actor” comes from three sets of nearly indistinguishable rules:

  • 17 CFR §230.506(d), which applies to Rule 506 offerings;
  • 17 CFR §230.262, which applies to Regulation A offerings; and
  • 17 CFR §227.503, which applies to Reg CF offerings.

In each case, the regulation provides that the issuer can’t use the exemption in question (Rule 506, Regulation A, or Reg CF) if the issuer or certain people affiliated with the issuer have violated certain laws.

Before going further, I note that these aren’t just any laws – they are laws about financial wrongdoing, mostly in the area of securities. Kidnappers are welcome to use Rule 506, for example, while ax murderers may find Regulation A especially useful even while still in prison.

Anyway.

Reg CF’s Rule 503 lists everyone whose bad acts we care about:

  • The issuer;
  • Any predecessor of the issuer;
  • Any affiliated issuer;
  • Any director, officer, general partner or managing member of the issuer;
  • Any beneficial owner of 20 percent or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
  • Any promoter connected with the issuer in any capacity at the time of filing, any offer after filing, or such sale;
  • Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with such sale of securities; and
  • Any general partner, director, officer or managing member of any such solicitor.

Nowhere on that list do you see “investor.” The closest we come is “Any beneficial owner of 20 percent or more of the issuer’s outstanding voting equity securities,” but even there the calculation is based on voting power. In a Crowdfunding offering you wouldn’t give an investor 20% of the voting power, for reasons having nothing to do with the bad actor rules. 

So it just doesn’t matter. This is one more thing we can pull out of Subscription Agreements. 

I know some people will say “But we want to know anyway.” To me this is unconvincing. If you don’t ask about kidnapping you don’t need to ask about securities violations.

Questions? Let me know.

The SEC Can Stop Your Regulation A Offering At Any Time

On By crowdfundattnyIn Featured, Regulation A, Uncategorized5 Comments

The SEC has two powerful tools to stop your Regulation A offering anytime.

Rule 258

Rule 258 allows the SEC to immediately suspend an offering if

  • The exemption under Regulation A is not available; or
  • Any of the terms, conditions, or requirements of Regulation A have not been complied with; or
  • The offering statement, any sales or solicitation of interest material, or any report filed pursuant to Rule 257 contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in light of the circumstances under which they are made, not misleading; or
  • The offering involves fraud or other violations of section 17 of the Securities Act of 1933; or
  • Something happened after filing an offering statement that would have made Regulation A unavailable had it occurred before filing; or
  • Anyone specified in Rule 262(a) (the list of potential bad actors) has been indicted for certain crimes; or
  • Proceedings have begun that could cause someone on that list to be a bad actor; or
  • The issuer has failed to cooperate with an investigation.

If the SEC suspends an offering under Rule 258, the issuer can appeal for a hearing – with the SEC – but the suspension remains in effect. In addition, at any time after the hearing, the SEC can make the suspension permanent.

Rule 258 gives the SEC enormous discretion. For example, the SEC may theoretically terminate a Regulation A offering if the issuer fails to file a single report or files late. And while there’s lots of room for good-faith disagreement as to whether an offering statement or advertisement failed to state a material fact, Rule 258 gives the SEC the power to decide.

Don’t worry, you might think, Rule 260 provides that an “insignificant” deviation will not result in the loss of the Regulation A exemption. Think again: Rule 260(c) states, “This provision provides no relief or protection from a proceeding under Rule 258.”

Rule 262(a)(7)

Rule 262(a)(7) is even more dangerous than Rule 258.

Rule 258 allows the SEC to suspend a Regulation A offering if the SEC concludes that something is wrong. Rule 262(a)(7), on the other hand, allows for suspension if the issuer or any of its principals is “the subject of an investigation or proceeding to determine whether a. . . . suspension order should be issued.”

That’s right: Rule 262(a)(7) allows the SEC to suspend an offering merely by investigating whether the offer should be suspended.

Effect on Regulation D

Suppose the SEC suspends a Regulation A offering under either Rule 258 or Rule 262(a)(7). In that case, the issuer is automatically a “bad actor” under Rule 506(d)(1)(vii), meaning it can’t use Regulation D to raise capital, either.

In some ways, it makes sense that the SEC can suspend a Regulation A offering easily because the SEC’s approval was needed in the first place. But not so with Regulation D, and especially not so with a suspension under Rule 262(a)(7). In that case, the issuer is prevented from using Regulation D – an exemption that does not require SEC approval – simply because the SEC is investigating whether it’s done something wrong. That seems. . . .wrong.

Conclusion

As all six readers of this blog know, I think the SEC has done a spectacular job with Crowdfunding. But what the SEC giveth the SEC can taketh away. I hope the SEC will use discretion exercising its substantial power under Rule 258 and Rule 262(a)(7).

List OF Accredited Investors for PPMs

On By crowdfundattnyIn Investor Disclosures, PPM, Regulation ALeave a comment

Every Private Placement Memorandum includes a list of accredited investors, summarizing 17 CFR §230.501(a). With the new definitions coming into effect on December 8th, I thought it might be useful to post a summary here.

“An ‘accredited investor’ includes:

  • A natural person who has individual net worth, or joint net worth with the person’s spouse or spousal equivalent, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
  • A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse or spousal equivalent exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year;
  • A natural person who holds any of the following licenses from the Financial Industry Regulatory Authority (FINRA):  a General Securities Representative license (Series 7), a Private Securities Offerings Representative license (Series 82), or a Licensed Investment Adviser Representative license (Series 65);
  • A natural person who is a “knowledgeable employee” of the issuer, if the issuer would be an “investment company” within the meaning of the Investment Company Act of 1940 (the “ICA”) but for section 3(c)(1) or section 3(c)(7) of the ICA;
  • An investment adviser registered under the Investment Advisers Act of 1940 (the “Advisers Act”) or the laws of any state;
  • Investment advisers described in section 203(l) (venture capital fund advisers) or section 203(m) (exempt reporting advisers) of the Advisers Act;
  • A trust with assets in excess of $5 million, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person;
  • A business in which all the equity owners are accredited investors;
  • An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • A bank, insurance company, registered investment company, business development company, small business investment company, or rural business development company;
  • A charitable organization, corporation, limited liability company, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets exceeding $5 million;
  • A “family office,” as defined in rule 202(a)(11)(G)-1 under the Advisers Act, if the family office (i) has assets under management in excess of $5,000,000, (ii) was not formed for the specific purpose of acquiring the securities offered, and (iii) is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment;
  • Any “family client,” as defined in rule 202(a)(11)(G)-1 under the Advisers Act, of a family office meeting the requirements above, whose investment in the issuer is directed by such family office;
  • Entities, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that were not formed to invest in the securities offered and own investment assets in excess of $5 million; or
  • A director, executive officer, or general partner of the company selling the securities, or any director, executive officer, or general partner of a general partner of that issuer.”

This list doesn’t try to capture every detail of every definition. For purposes of a disclosure document it’s plenty.

Why Everyone Benefits from the SEC’s New Crowdfunding Rules

On By crowdfundattnyIn Crowdfunding Laws, Regulation ALeave a comment

To the delight of both issuers and investors, the SEC continues to make crowdfunding better as they have announced major changes to their crowdfunding rules. In this podcast, crowdfunding attorney Mark Roderick and Co-Founder of Lex Nova Law goes over what he believes are the most important and impactful changes including raising the limits for Regulation A and Regulation CF deals as well as the ability of “finders” to legally accept commissions for bringing deals to the table. And perhaps most importantly, the changes regarding accredited and non-accredited investors are a complete game changer! In this podcast, you’ll find out why that is.

Listen to “Why Everyone Benefits from the SEC's New Crowdfunding Rules” on Spreaker.

We can’t elect a President, but there’s certainly a preponderance of positive energy being circulated in the crowdfunding industry with respect to these rules revisions from the SEC! By increasing the raise limit of Reg.A and Reg.CF offerings, the entire process has become much more realistic in terms of making everything successful on just about every level and aspect of the industry. Now, accredited investors can have whatever stake of a project they want, and non-accredited investors can participate in ways unimaginable just a short time ago. And what’s an accredited investor? That rule has changed too!

One of the biggest changes the SEC has implemented is the legality of “finders” receiving commissions or payments for brokering deals and introducing investors to issuers, syndicators, developers, etc. Before this change, only broker-dealers were allowed to receive compensation for such deals. With the new changes, these finders can now legally receive these commissions and other transaction-based compensation from issuers. The ability to legally monetize your connections is something many have been waiting for for quite a long time!

There’s no question that crowdfunding still has its growing pains. However, one thing’s for sure: finders, investors, and issuers alike should all be jumping for joy after listening to the information Mr. Roderick goes over in this podcast. Broker-dealers, maybe not… But regardless, it’s a new world for crowdfunding and doors continue to open. The industry is definitely heading in the right direction.

Beneficiary Designations by Crowdfunding Issuers and Portals

On By crowdfundattnyIn Crowdfunding Portals, Regulation ALeave a comment

Some Crowdfunding portals and issuers allow investors to designate a beneficiary, i.e., a person who will take ownership of the security (the LLC interest, debt instrument, whatever) should the investor die. Just be careful.

Most states (not Texas) allow the owners of securities, including privately-held securities, to designate a beneficiary outside the owner’s will, under a version of the Uniform TOD (Transfer on Death) Security Registration Act (the Delaware version is 12 DE Code §801 et seq). For the investor, the advantage of designating a beneficiary is that the security doesn’t go through the probate process but instead passes directly to the designated beneficiary.

For the Crowdfunding issuer or portal, there is a benefit to making life easier for investors. And it’s pretty straightforward to create a beneficiary designation form on your website.

Nevertheless, adding convenience for investors carries some risks. For example:

  • Suppose an investor wants to designate her cousin Jacob as the beneficiary of her LLC interest. She uses Jacob’s name on the beneficiary designation form but mistakenly uses her husband’s social security number, out of habit. What happens?
  • The investor correctly designates Jacob on the form but later changes her mind and designates her husband as the beneficiary of the LLC interest in her will. Unfortunately for her husband, the beneficiary designation made using your form cannot be undone by the will. Your form didn’t make that clear.
  • The investor properly designates Jacob as the beneficiary of her LLC interest and doesn’t change her mind, but she lives in a community property state and your form didn’t tell her she needed her husband’s consent.
  • The investor properly designates Jacob as the beneficiary of her LLC interest but he dies before she does, and she hasn’t designated a successor beneficiary.
  • Your site crashes and the investor’s beneficiary designation is lost.

What’s your budget for legal fees this year?

Designating a beneficiary on your site isn’t the investor’s only option. She can sign a simple will or codicil (if she already has a will) designating a beneficiary for her LLC interest and any other securities or other property, which probably makes more sense than designating beneficiaries security-by-security. And if her cousin and husband end up arguing over the codicil, you’re not involved.

If you’d like a sample of a Beneficiary Designation Form let me know.

Bumblebee and flowers

SEC Proposes Limited Exemptions For “Finders”

On By crowdfundattnyIn Crowdfunding Portals, Exchange Act, Finders, Regulation A, SEC, SEC Proposals, Tier I Finders, Tier II FindersLeave a comment

In theory, only broker-dealers registered under section 15 of the Exchange Act are allowed to receive compensation for connecting issuers with investors. In practice, the world of private securities includes lots of folks we refer to as “finders.” Like bumblebees, these folks should be unable to fly according to the laws of physics but many plants couldn’t survive without them.

Because of the disconnect between theory and reality, industry participants have been urging the SEC for years to develop exemptions for finders.

The SEC just proposed exemptions that would allow some finders to operate legally, i.e., to receive commissions and other transaction-based compensation from issuers.

The SEC proposes two tiers of Finders 

  • Tier 1 Finders would be limited to providing the contact information of potential investors to an issuer in one offering per 12 months. A Tier I Finder couldn’t even speak with potential investors about the issuer or the offering.
  • Tier II Finders could participate in an unlimited number of offerings and solicit investors on behalf of an issuer, but only to the extent of:
    • Identifying, screening, and contacting potential investors;
    • Distributing offering materials;
    • Discussing the information in the offering materials, as long as the Funder doesn’t provide investment advice or advice about the value of the investment; and
    • Arranging or participating in meetings with the issuer and investor.

A Tier II Finder would be required to disclose her compensation to prospective investors up front – before the solicitation – and obtain the investor’s written consent.

The Limits to the Proposed Finders

  • The Finder must be an individual, not an entity.
  • The Finder must have a written agreement with the issuer.
  • The proposed exemptions apply only to offerings by the issuer, not secondary sales.
  • Public companies (companies required to file reports under section 13 or section 15(d) of the Exchange Act) may not use Finders.
  • The offering must be exempt from registration.
  • The Finder may not engage in general solicitation.
  • All investors must be accredited.
  • The Finder may not be an “associated person” of a broker-dealer.
  • The Find may not be subject to statutory disqualification.

The SEC issued an excellent graphic summarizing the proposed exemptions

Because they are entities, the typical Crowdfunding portal can’t qualify as a Finder under the SEC’s proposals. And because the proposals don’t allow general solicitation, a Finder who is an individual can’t create a website posting individual deals.

But the no-action letters to Funders Club and AngelList that kick-started the Crowdfunding industry (no pun intended) will invite many Tier 2 Finders to take their businesses online. Under the proposals and the no-action letters, it seems that a Tier 2 Finder could legally create a website offering access to terrific-but-unnamed offerings, but give investors access to the offerings only after registering and going through a satisfactory KYC process per the CitizenVC no-action letter.

A Step Forward for Crowdfunding

Many finders and issuers will jump for joy at the new proposals, while others will be disappointed that the SEC drew the line at accredited investors. In a Regulation A offering or a Rule 506(b) offering open to non-accredited investors, the law requires very substantial disclosure, especially in Regulation A. The SEC must believe that non-accredited investors are especially vulnerable to the selling pressure that might be applied by a finder.

Nevertheless, like the SEC’s proposals to expand the definition of accredited investor, the proposals about finders are a step forward.

CAUTION:  As of today these proposals are just proposals, not the law.

Questions? Let me know.

Two Reasons Why Every Title II Portal Should Add A Title III Portal

On By crowdfundattnyIn Crowdfunding, Portals, Regulation A, Title II, Title II Portal, Title III, Title III CrowdfundingLeave a comment

If you operate a Title II Crowdfunding platform, whether Rule 506(c) or Rule 506(b), you should add the functionality for Title III. Two reasons:

  • It will be good for you, i.e., you will make more money.
  • It will be good for our country.

Adding Title III Will Be Good for You

Any day now the SEC will announce a bunch of changes to the Title III rules, including these: 

  • Sponsors will be able to raise $5M rather than $1.07M.
  • There will be no limit on the amount an accredited investor can invest.
  • The limits for non-accredited investors will be raised.

Most of the deals on your site are less than $5M. Even though the $5M limit under Title III is per-sponsor rather than per-deal, this means that if your Title III portal were up and running today you could expand your potential audience from about 10 million households to about 120 million households.

There are four benefits to making deals available to non-accredited investors.

The first, immediate benefit is that non-accredited investors do have money. By adding non-accredited investors you make it easier to fill deals.

The second, immediate benefit is that adding non-accredited investors allows you to market to affinity groups. If you’re selling a mixed-use project in Washington, D.C. you can market to the neighbors. If you’re selling a company developing a therapy for cystic fibrosis you can market to everyone whose family has been affected.

The third, immediate benefit is you can start taking commissions. If you’re like most Title II portals you spend time and effort to make sure you’re not a broker-dealer. If you were a Title III portal those issues would disappear.

The fourth benefit is not immediate but is much more important than the first three, in my opinion. It’s about building a brand and a funnel of investors.

If you operate a portal you are selling a product, no different than shoes or automobiles. Just as Mercedes offers the A-Class sedan to bring less-affluent customers into the showroom and the Mercedes family, adding Title III can vastly increase your audience and revenue as some non-accredited investors become accredited and the SEC further relaxes the rules for non-accredited investors.

Alternatively, they could start shopping in somebody else’s Title III showroom.

Adding Title III Will Be Good for the Country

Our country is suffering in many ways. Yes, we’re suffering politically, but in some ways the political suffering is just one manifestation of our deep and deepening income and wealth inequalities. You can find a hundred charts showing the same thing:  the very wealthy are becoming wealthier while everyone else, especially the lower 50%, becomes poorer and more desperate.

When I was a teenager I delivered newspapers in Arlington, Virginia. In my suburban territory I delivered papers to accredited investors, whose houses were a little bigger and drove Cadillacs and Town Cars, and to non-accredited investors, whose houses were a little smaller and drove Chevies and Toyotas. One of my customers was George Shulz, the Secretary of the Treasury, who came to the door in his bathrobe and tipped well.

Tax policies, trade policies, all the instrumentalities of government have been focused over the last 40 years to serve the interests of the well-off. Part of it was cynical politics, part too much faith (which I shared) in the power of markets to lift all boats. Most of the boats in our country remain moored at low tide. Steve Mnuchin and his wife wouldn’t dream of living in that neighborhood today while 98% of Americans couldn’t afford to.

Call me an idealist, but I believe Crowdfunding can at least claw back some of the inequality. The deals on your Title II portal should be available to ordinary Americans. They should participate in those returns. They should regain faith that the capitalist system can work for them. We should all hope that the phrase “institutional quality,” when applied to investments, will lose its meaning.

Crowdfunding isn’t the whole solution, but it’s part of the solution. And you can make it happen.

Questions? Let me know.

PODCAST: Is the SEC Democratizing Investment?

On By crowdfundattnyIn Podcasts, Regulation A, UncategorizedLeave a comment

Democratizing investment. A huge step forward.

My guest today is Mark Roderick, founder of Lex Nova Law and one of the top online crowdfunding experts in the country. Mark and I discuss the very exciting changes proposed by the Securities and Exchange Commission to regulation crowdfunding, or Reg CF, the securities regulation that is really the first step taken by the S.E.C. towards democratizing investment. The additional changes proposed will give this regulation real legs.

Impact Real Estate Investing Podcast

Insights and Inspirations

  • Mark believes the latest round of changes to the crowdfunding rules will bring some fundamental changes to the industry including higher quality deals.
  • As the deals get better, so will the industry grow, and more investors join in.
  • He expects to see changes in the physical landscape in just 5 years as these rules begin to have a far-reaching effect.
WRITE YOUR REGULATION A OFFERING CIRCULAR WITH ADVERTISING IN MIND

Write Your Regulation A Offering Circular With Advertising In Mind

On By crowdfundattnyIn Advertising, Regulation A, Regulation A Offering CircularLeave a comment

Too many issuers think of the Regulation A Offering Circular as just a dry legal document between the SEC and the lawyers. It should be more than that.

As I’ve said once or twice before, Crowdfunding is a marketing business. Creating a great company with a great product isn’t enough. “Build it and they will come” worked for Kevin Costner but it doesn’t work for most companies trying to raise capital.

Here are some examples of things you’d like to say to attract investors:

  • We have a terrific track record in this industry going back 15 years.
  • Our performance during the last five years has doubled industry averages.
  • Our Founder has had successful exits from her last three companies.
  • Experts forecast that our market will triple over the next seven years.

Those can be very powerful messages for prospective investors. But here’s the thing:  you’re not allowed to say them in your Facebook ads unless you’ve already said them in your Offering Circular.

You spend all the time and money to have your Regulation A offering qualified by the SEC, only to learn that you’re not allowed to say what you’d like to say to attract investors. 

Write your Offering Circular with advertising in mind. Make your lawyer speak with your marketing team and vice versa, even though they speak different languages. Create your marketing materials — your website, your Facebook ads, your email campaigns — in conjunction with your Offering Circular, so all the pieces are working together rather than pulling in opposite directions.

Questions? Let me know.

RULE 10b-5: THE HIDDEN DISCLOSURE REQUIREMENT IN REGULATION A

Rule 10b-5: The Hidden Disclosure Requirement In Regulation A

On By crowdfundattnyIn 10b-5, Regulation A, Regulation A Offering CircularLeave a comment

Preparing a Regulation A Offering Circular is as much an art as a science.

An issuer offering securities using Regulation A can choose from several disclosure formats, including Form 1-A, Form S-1, or Form S-11. Each of these SEC forms includes a list of information that must be disclosed. For example, Form 1-A lists 17 items, ranging from the cover page to the Exhibits, each with sub-categories and special rules. Transparency and disclosure have been the touchstones of U.S. securities laws since the 1930s, and each form includes hundreds of pieces of information that must be disclosed to prospective investors. 

But even an issuer that made a list of all those items and completed the form meticulously wouldn’t be finished, because 17 CFR §240.10b-5 effectively imposes a catch-all requirement for disclosure.

Rule 10b-5(b) provides:

“It shall be unlawful for any person, directly or indirectly. . . .[t]o make any untrue statement of a material fact or to omit to state a  material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”

The first part of that statement is easy:  you’re not allowed to make untrue statements of material facts, i.e., to lie.

It’s the second part that requires some thought. A couple simple examples:

  • You’re raising money for a grocery delivery business and there’s a guy on your board named Jeffrey Bezos. You’d better tell investors he’s not that Jeffrey Bezos.
  • Your Offering Circular describes the patent with which you expect to revolutionize the world of online payments. You’d better mention the letter you received alleging that your patent is invalid.

In practice, Rule 10b-5(b) means that no matter how many times you compare the SEC form (Form 1-A, Form S-1, Form S-11) to your Offering Circular, checking off all the boxes, if investors lose money a plaintiff’s lawyer can snoop around, with the benefit of hindsight, looking for something else that should have been disclosed. 

That’s why preparing a Regulation A Offering Circular is as much an art as a science.

Questions? Let me know.