Category: Securities Laws

Watch Out For Oregon’s Securities Laws

On By crowdfundattnyIn Securities LawsLeave a comment

Oregon is a beautiful state and its people among the friendliest and most caffeinated in the country. But watch out for its securities laws.

A New York law firm found out the hard way in a case called Houston v. Seward Kissel, LLP. The firm prepared offering documents for a company that was later sued by an Oregon investor claiming fraud. The unhappy investor sued the law firm under ORS 59.115(3), which imposes liability on anyone who “participates or materially aids” in the sale of a security. The judge allowed the case to go forward without even requiring the plaintiff to show the law firm knew about the alleged fraud. 

In another case under the same statute, Ainslie v. Spolyar, the court granted summary judgment against a junior associate in a law firm that prepared offering documents, where the issuer allegedly violated the terms of the offering documents.

How dare they sue lawyers!

But lawyers aren’t the only ones potentially on the hook. Other potential targets include finders, agents, funding portals, accountants, financial advisors, employees of the issuer, even banks that extend financing to investors. If you touch the offering, you’re potentially liable. And under the statute, everyone is “jointly and severally” liable, meaning everyone, even the lowly associate in Ainslie v. Spolyar is liable for 100% of the damages.

The only defense is to show that you didn’t know of the facts underlying the claim (e.g., the fraud or violations of Oregon’s securities laws) and couldn’t have known of them “in the exercise of reasonable care.” That’s a very tough burden for two reasons:

  • Suppose the issuer has committed fraud. Proving that you didn’t know about it is one thing. Proving that you couldn’t have discovered it is extremely difficult because there it is, in broad daylight today.
  • Because the burden is on the defendant, these cases will rarely be dismissed on summary judgment. That means you’re in for a long, expensive fight.

The Oregon statute doesn’t matter too much for issuers because issuers are always liable for fraud and other wrongdoing and know all the facts. But for third parties, including websites and funding portals, at least consider excluding Oregon investors from your offerings, if possible.

Questions? Let me know. 

Kim Kardashian Fined For Promoting Crypto Without Disclosure

On By crowdfundattnyIn Cryptocurrencies, Promoting Crypto, Securities LawsLeave a comment

I was disappointed to learn that Kim Kardashian doesn’t read my blog posts, at least not all of them. With her hectic lifestyle she probably misses out on a lot of other fun stuff as well. Had Kim read my blog post on May 2, 2018 she would have known about section 17(b) of the Securities Act of 1933:

It shall be unlawful for any person. . . . to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof [italics added].

Kim was paid $250,000 to promote EMAX tokens to her 330 million Instagram followers. “ARE YOU GUYS INTO CRYPTO????” she wrote, including a link to Ethereum Max’s website. Whoops! By failing to disclose her compensation she violated section 17(b) and will now pay a $1.26 million fine to the SEC.

Sometimes it’s tempting to think of the SEC as all-powerful. In reality the SEC is a tiny agency compared with the size of the markets it regulates. Faced with a chronic shortage of resources, the SEC picks and chooses the cases to enforce, looking for easy cases with maximum visibility. Well, they couldn’t have asked for a better one. As of today another 330 million people know about section 17(b), almost doubling the number who knew from this blog.

Matt Damon, looking for a lawyer?

Questions? Let me know.

set of medical protective face masks

Covid-19 Disclosures In Crowdfunding Offerings

On By crowdfundattnyIn 10b-5, Coronavirus, COVID-19, Crowdfunding, Disclosures, Form 1-U, Form 8-K, Raising Money, Reg CF, Regulation A, Regulation A Plus, Risk Factor, Securities Laws, Selling Securities, Title II, Title II Crowdfunding, Title III, Title III Crowdfunding, Title IV of the JOBS Act, UncategorizedLeave a comment

The COVID-19 pandemic illustrates why we include a list of “risk factors” when we sell securities. Suppose a company issued stock on January 1, 2020 without disclosing that its major supplier was located in Wuhan, China and that Wuhan was experiencing an outbreak of a new virus. Investors who bought the stock likely would be entitled to their money back and have personal claims against the founders, officers, and directors.

If the company issued stock on October 1, 2019, before the pandemic began, its duty to tell investors about the pandemic would depend on which version of Crowdfunding it used:

  • If it used Title II Crowdfunding (Rule 506(c)) the company would have no duty to tell investors about the pandemic.
  • If it used Title III Crowdfunding (Regulation CF) the company would be required to tell investors about the pandemic in its next annual report.
  • If it used Title IV Crowdfunding (Regulation A) the company would be required to tell investors about the pandemic in its next semiannual or annual report, whichever comes first.

CAUTION:  That assumes the Company was finished selling stock on October 1, 2019. If it was continuing to sell stock when it learned of the pandemic, then the Company would be required to tell new investors. And if a Title III offering hadn’t yet closed, all existing investors would have the right to change their minds.

CAUTION:  A company – even a publicly-reporting company – generally is not required to tell investors about COVID-19 if it is not selling securities currently, because pandemics are not on the list of disclosure items found in Form 1-U (for Regulation A issuers) or Form 8-K (for publicly-reporting companies). But be careful. For example, if a Regulation A issuer redeems stock without disclosing the effect of COVID-19, it could be liable under Rule 10b-5 and otherwise.

Assume that we’re required to tell investors about COVID-19 today, whether because we’re selling stock or are filing an annual or semiannual report. What do we say?

If this were January, we might say something simple:  “Wuhan, China is experiencing an outbreak of a highly-contagious virus, which is disrupting economic activity. If this virus should spread to the United States, as epidemiologists predict, it could have an adverse effect on our business.”

But this isn’t January. We have much more information today and are therefore required to say more. Exactly how much information we share is as much an art as a science. Our goal is always to give investors enough information to make an informed decision without making the disclosure so dense as to be useless.

Here are two examples, one for multi-family housing projects and the other for a technology company.

Multi-Family Housing

With unemployment reaching levels not seen since the Great Depression, by some estimates already 20% and rising, we are already experiencing a number of negative effects from the COVID-19 pandemic:

  • We are experiencing a decrease in the number of phone calls and visits from potential new tenants. Year-to-year compared to 2019, we experienced a decrease in traffic of approximately ____% in March and ____% in April.
  • We are experiencing an increase in rent delinquency. Year-to-year compared to 2019, the rate of delinquencies greater than 30 days rose from ____% to ____% during March and ____% to ____% during April.
  • We are spending more time and resources on collections and marketing.

Although we are working from incomplete information, we expect these trends to continue and perhaps accelerate, depending on the trajectory of the virus and the ability to re-open the economy. Among possible outcomes:

  • Occupancy levels might decrease, although they have not decreased yet as compared to the same periods in 2019.
  • We do not intend to raise rents until the pandemic eases. Depending on circumstances we could be forced to decrease rents.
  • We expect some tenants to re-locate for economic reasons, from Class A projects to Class B projects and from Class B projects to Class C projects. In some cases tenants might leave the market altogether, by moving in with relatives, for example. Because we operate primarily Class B properties, we are uncertain whether the net effect for our properties will be positive or negative.
  • Conversely, we expect that economic uncertainty will cause some families to postpone buying a house and rent instead, increasing the pool of potential tenants.
  • The pandemic has caused significant uncertainly in the value of many assets, including real estate. Until the uncertainty is resolved it might be difficult for us to borrow money or raise capital by selling equity.
  • If occupancy rates and rents decrease while delinquencies increase, we could be unable to meet our obligations as they become due. A reduction in cash flows and/or asset values could also cause us to be in default under the loan covenants under our senior debt. Either scenario could lead to foreclosure and the loss of one or more properties.

At least in the short run we expect the pandemic to cause our revenue to decrease, perhaps significantly. As a result, we are taking steps to conserve cash. Among other things we have decided not to make any cash distributions until the economic outlook stabilizes and have reduced our staff. We have also begun to contact lenders to request a deferral of our mortgage loan obligations.

We do not know how long the pandemic will last or how its effects will ripple through the American economy. In a best-case scenario we would experience a short-term drop in cash flow and a dip in asset values as the economy adjusts to a new reality. In a worst-case scenario, where occupancy and rent levels drop significantly over an extended period of time, we would be unable to make mortgage payments and possibly lose assets, risking or even forfeiting investor equity if asset values drop far enough. Based on the information currently available to us we expect an outcome closer to the former scenario than to the latter and are marshalling all our experience and assets toward that end.

Technology

Our software provides a virtual connection between internet-based office telephone systems and cellular phones, allowing incoming calls to the office number to be re-directed to the cellular phone and outgoing calls made from the cellular phone to appear to the recipient as if they were made from the office number. Will tens of millions of people working remotely due the COVID-19 pandemic, the demand for our software has grown substantially. On January 1, 2020 our software had been installed on ________ cellular devices worldwide. On May 1, 2020 it was installed on ________ devices.

As a result, we expect both our revenue and our net income for 2020 to increase substantially. However, with many workers now returning to their offices on a full-time or part-time basis it is unclear whether the high demand for our software will continue. Consequently, we are unable to provide a reliable forecast for revenue or net income at this time.

With more than ________ new users, even if temporary, we are accelerating developing of our new consumer-based communications tools. We expected to launch these tools in Q1 2021 but are now aiming for Q3 2020.

Even before the pandemic many of our employees worked remotely at least part of the time. Therefore, our operations have not been affected significantly by the pandemic. Tragically, however, David Newsome, the leader of our marketing team, contracted COVID-19 and died on March 27th in Brooklyn, NY. We have not yet found a replacement for David, who was with the company from its founding in 2013.

We were considering purchasing a commercial building in Palo Alto as the headquarters for our engineering team. Given our successful experience working remotely we have decided to put those plans on hold at least for the time being.

SEC Issues Emergency Rules To Facilitate Title III Crowdfunding During Covid-19 Crisis

On By crowdfundattnyIn COVID-19, Crowdfunding, Crowdfunding Laws, Crowdfunding Portals, Equity Crowdfunding, JOBS Act, Reg CF, Regulation CF, SEC, SEC Proposals, Securities Exchange Commission, Securities Laws, Title III CrowdfundingLeave a comment

With credit markets tightened and 30 million Americans newly out of work, the SEC has adopted temporary rules to make Title III Crowdfunding a little easier from now until August 31, 2020.

The temporary rules are available here. They aim to make Title III a little faster and easier in four ways:

#1 – Launch Offering without Financial Statements

An issuer can launch the offering – go live on a funding portal – before its financial statements are available. (But investment commitments aren’t binding until the financial statements have been provided.)

#2 – Lower Standard for Some Financial Statements

An issuer trying to raise between $107,000 and $250,000 in a 12-month period doesn’t have to produce financial statements reviewed by an independent accountant, only financial statements and certain information from its tax return, both certified by the CEO.

#3 – Quicker Closing

An issuer can close the offering as soon as it has raised the target offering amount, even if the offering hasn’t been live for 21 days, as long as the closing occurs at least 48 hours after the last investment commitment and the funding portal notifies investors of the early closing.

#4 – Limit on Investor Cancellations 

Investors can cancel within 48 hours of making a commitment, but can’t cancel after that unless there’s a material change in the offering.

CAVEAT:  These rules are not available if the issuer:

  • Was organized or operating within six months before launching the offering (e., this is not for brand-new companies); or
  • Previously raised money using Title III Crowdfunding but failed to comply with its obligations.

I’m not sure how much difference these rules will make in practice. But that’s not the main point as far as I’m concerned. The main point is that with about a million other things on its plate, the SEC took the time to think about and draft these rules. The SEC must believe that equity Crowdfunding can play an important role in our capital markets.

On that basis, I predict that the proposals the SEC made on March 4th will be adopted soon after the public comment period expires on June 1st. And after that, who knows.

Questions? Let me know.

Using “Finders” To Sell Securities, Including Tokens

On By crowdfundattnyIn Finders, SEC, Securities Laws, Selling SecuritiesLeave a comment

Selling securities is hard, and it makes perfect sense that an issuer or a portal would hire someone to help. And once you’ve hired someone, it also makes perfect sense business-wise to pay her a percentage of what she raises, aligning her interests with yours.

It’s perfect, but it might be illegal.

The Legal Issue

The Securities Exchange Act of 1934 generally makes it illegal for any “broker” to sell securities unless she’s registered with the SEC. The Exchange Act defines the term “broker” to mean “any person engaged in the business of effecting transactions in securities for the account of others.” That’s not a very helpful definition, but if you earn a commission from selling securities, like the helper above, you might be a broker.

So what? Well, if someone who’s a “broker” sells securities without registering with the SEC, lots of bad things can happen:

  • All the investors in the offering could have a right of to get their money back, and that right could be enforceable against the principals of the issuer.
  • The issuer could lose its exemption, g., its exemption under Regulation D.
  • By violating the securities laws, the issuer and its principals could become “bad actors,” ineligible to sell securities in the future.
  • The issuer could be liable for “aiding and abetting” a violation of the securities laws.
  • The issuer could be liable under state blue sky laws.
  • The person acting as the unregistered broker could also face serious consequences, including sanctions from the SEC and lawsuits from its customers.

What is a Broker?

Because the Exchange Act does not define what it means to be “engaged in the business of effecting transactions in securities,” the SEC and the courts have typically relied on a variety of factors, including whether the person:

  • Is employed by the issuer
  • Receives a commission rather than a salary
  • Sells securities for others
  • Participates in negotiations between the issuer and an investor, g., helps with sales presentations
  • Provides advice on the merits of the investment
  • Actively (rather than passively) finds investors

More recently, in court cases and in responses to requests for no-action letters, the SEC seems to be moving toward a more aggressive position:  that if a person receives a commission she’s a broker and must be registered as such, end of story.

So far, courts are rejecting the SEC’s hard-line approach. In a 2011 case called SEC v. Kramer, the court stated:

[T]he Commission’s proposed single-factor “transaction-based compensation” test for broker activity (i.e., a person ‘engaged in the business of effecting transactions in securities for the accounts of others’) is an inaccurate statement of the law. . . . . an array of factors determine the presence of broker activity. In the absence of a statutory definition enunciating otherwise, the test for broker activity must remain cogent, multi-faceted, and controlled by the Exchange Act.

As reassuring as that statement sounds, it was made by a District Court, not a Court of Appeals and certainly not the Supreme Court. A District Court in a different part of the country might take the SEC’s side instead.

But I Know Someone Who. . . .

Yes, I know. There are lots of people out there selling securities, including tokens that are securities, and receiving commissions, and nothing bad happens to them.

There are so many of these people we have a name for them:  Finders. The securities industry, at least at the level of private placements, is permeated by Finders. I had a conversation with a guy who offered to raise money for my issuer client in exchange for a commission, and when I mentioned the Exchange Act he said “What are you talking about? I’ve been doing this for 25 years!”

I’m sure he has. The SEC would never say so publicly, but the reality is that where broker-dealer laws are concerned there are two worlds:  one, the world of large or public deals, where the SEC demands strict compliance; and the world of small, private deals, where the SEC looks the other way.

In my opinion, Crowdfunding offerings and ICOs fall in the “large or public deals” category, even though it’s hard to tell a Crowdfunding client they can’t do something the guy down the street is doing.

So What Can I Do?

If you’re selling securities in a Crowdfunding offering or an ICO, don’t hire that person who promises to go out and find investors in exchange for a commission, unless she’s a registered broker.

On the other hand, in an isolated case, if you know someone with five wealthy friends, who promises to introduce you to those friends, without participating in any sales presentations, you might be willing to offer a commission, relying on current law, as long as (1) you understand that a court might hold against you, adopting the SEC’s hard-line approach; and (2) you hire a securities lawyer to draft the contract.

The Future

Several years ago the SEC created an exemption for Finders in the mergers & acquisitions area. I am far from alone in suggesting that we need a similar exemption for Finders in non-public offerings. The current situation, where a substantial part of the securities industry operates in a legal Twilight Zone, is not tenable as online capital raising becomes the norm rather than the exception.

Questions? Let me know.

Can A Crowdfunding Issuer Sell Its Own Securities?

On By crowdfundattnyIn Crowdfunding Laws, Securities LawsLeave a comment

Securities Cash Register

Some states, including Texas, require all securities to be sold through licensed brokers. Do these state laws mean that Crowdfunding issuers can’t sell their own securities? Do they have to use a “clearing broker” instead?

For Title III the answer is easy. Securities under Title III may be offered and sold only through a licensed broker or a licensed funding portal. If you’re selling through a licensed broker then you’re complying with the state law, and section 15(i)(2)(A) of the Securities and Exchange Act of 1934 prohibits states from regulating funding portals in their businesses as such.

For Title II (Rule 506(c)) and Title IV (Regulation A), the answer is less clear. The issue is especially acute under Title IV, just because of the number of investors.

Section 18(a)(1) of Securities Act

Added to the law in 1996, section 18(a)(1) of the Securities Act of 1933 provides that:

Except as otherwise provided in this section, no law, rule, regulation, or order, or other administrative action of any State or any political subdivision thereof requiring, or with respect to, registration or qualification of securities, or registration or qualification of securities transactions, shall directly or indirectly apply to a security that is a covered security.

Because the term “covered security” includes securities offered under Rule 506(c) and Regulation A (also Title III, for that matter), the law clearly prohibits states from requiring the registration of a Crowdfunding offering. But does it also prohibit states from regulating who sells the securities?

Here’s the statute again, with extra words removed:

No law requiring registration or qualification of securities transactions shall apply to a covered security.

A sale of a security is definitely a “securities transaction.” So here’s the question:  does a state law that requires the sale to be effected through a licensed broker amount to requiring “registration or qualification” of the sale? Many smart people conclude that it does, making any such law unenforceable. That’s why you can go online today and find issuers offering securities directly to investors, despite state laws saying otherwise.

But there’s plenty of room for doubt. When a state says that all securities must be sold through licensed brokers, maybe it’s not requiring “registration or qualification” of the transaction; maybe it’s not regulating the sale at all. Maybe, instead, the state is regulating the person making the sale. Because section 18(a)(1) of the Securities Act doesn’t prohibit states from regulating brokers, the way section 15(i)(2)(A) of the Exchange Act prohibits them from regulating funding portals, maybe these laws aren’t affected.

For good measure, I’ve read academic articles arguing that the 1996 law amending section 18(a)(1), and stripping states of their historic regulatory authority over most securities offerings, was an unconstitutional extension of the Commerce Clause of the U.S. Constitution.

What’s At Stake

If an issuer violates a state law by selling securities directly to investors, the issuer could be subject to state enforcement action, i.e., fines and penalties.

The greater risk, in my opinion, is the risk of claims from investors. If a widow in Texas loses money she might not accept her loss graciously. She (or her heirs, or the trustee in her Chapter 7 bankruptcy case) might look for a way to recoup her loss. And if she can show that the issuer violated Texas law, the court may find a right of rescission, i.e., the right to get her money back. The court might even extend that right against the principals of the issuer personally, especially if they were engaged in selling activities.

I imagine the widow on the stand, asking for recourse against the New York based issuer, backed by an amicus curiae brief filed by the Texas Board of Securities and the National Association of State Securities Administrators. Given the room for ambiguity in the statute, I’m not thrilled with my odds.

And even if you win, there’s the time and cost of defending yourself, and the sleeping-well-at-night factor, also.

What To Do

The simplest solution is to sell through a clearing broker licensed in every state.

Another solution is to sell through a clearing broker only in states that require it (I don’t have a list, but maybe a reader does and can share it).

If an issuer doesn’t want to spend the money on a clearing broker, it might decide not to sell securities in any state that requires use of a broker, although that includes some big states.

Or an issuer, guided by counsel, might reasonably decide to live with the uncertainty in the law and sell securities anyway. Just make sure your insurance would cover the widow’s claims.

__________________________________________________________________________________________

My thanks to Jillian Sidoti, Esq. and Anthony Zeoli, Esq., who provided valuable insight.

Questions? Let me know.

SEC Rules 506(B) And 506(C): Clearing Up The Confusion

On By crowdfundattnyIn Crowdfunding, Crowdfunding Portals, Rule 506, Rule 506(b), Rule 506(c), SEC, Securities Exchange Commission, Securities LawsLeave a comment

Some Crowdfunding portals offer Rules 506(b) transactions in addition to, and sometimes even in lieu crowd funding word cloudof, Rule 506(c) transactions. Let’s clear up the confusion.

In the beginning. . . .

Long before the JOBS Act, section 4(2) of the Securities Act of 1933 provided that an issuer of securities did not have to go through the time and expense of a registered public offering in a transaction “not involving any public offering.” Recognizing the putting-the-rabbit-in-the-hat nature of that language and wishing to provide more clarity to the public, the SEC issued Regulation D in 1982, which provides a series of Rules guiding issuers through the shoals of private – as opposed to public – offerings.

One of the Rules in Regulation D, Rule 506(b), describes a kind of private offering that has been the favorite of issuers and their lawyers for many years:

  • An unlimited amount of money raised
  • An unlimited number of accredited investors plus 35 non-accredited investors
  • Exemption from state Blue Sky registration

Rule 506(b) provides great flexibility to issuers. However, consistent with the distinction inherent in Regulation D between private and public offerings, Rule 506(b) prohibited the use of “general solicitation and advertising” to find investors. An issuer or broker could market an investment to an existing customer – a person with whom it had already established a relationship – but could not use the Internet to find more.

2013 No-Action Letters

In the beginning of 2013, the SEC issued no-action letters to FundersClub and AngelList under Rule 506(b). These no-action letter provided that if an online portal merely “registered” a user with a name and email address, the portal could immediately show investments to the user. To many familiar with the history of Rule 506(b) that sounded a lot like general solicitation and advertising, but the SEC concluded that it was not.

With the two no-action letters, the SEC effectively launched the Crowdfunding industry even before the JOBS Act officially came into effect.

The JOBS Act

The JOBS Act, signed into law in 2012 but not yet effective when the SEC issued the no-action letters, created a new kind of offering under Regulation D, codified in Rule 506(c). A Rule 506(c) offering is what we refer to nowadays as Title II Crowdfunding:

  • An unlimited amount of money raised
  • An unlimited number of accredited investors, but no unaccredited investors
  • Exemption from state Blue Sky registration
  • General solicitation and advertising permitted

If Rule 506(c) sounds a lot like Rule 506(b), that’s because it is. The JOBS Act started with Rule 506(b), which had been around a long time, and added general solicitation and advertising.

Why Both?

Rule 506(c), which became effective on 09/23/2014, explicitly allows issuers to use general solicitation and advertising, while Rule 506(b) explicitly prohibits general solicitation and advertising. Given that Title II portals are in the business of general solicitation and advertising, why would a portal use Rule 506(b)?

There are a few reasons.

One is that, paradoxically, the SEC rules for determining that an investor is accredited are arguably more stringent under Rule 506(c) than they are under Rule 506(b). Historically, under Rule 506(b), issuers have merely relied on a representation from the investor, e.g., “I promise I am accredited.” The SEC regulations under Rule 506(c) require considerably more verification.

Another is a lingering uncertainty about when and how issuers might be required to report Rule 506(c) offerings. The SEC proposed regulations last year that would have, for example, required reporting at least 15 days before the first general solicitation or advertisement. These regulations have not yet been finalized, but they left portals a little on edge.

More broadly, with the two no-action letters in hand, portals may feel they have a clear road map to legal Rule 506(b) offerings, while they remain hesitant about Rule 506(c) pending more advice from the SEC. My own view is that portals are probably more comfortable with the no-action letters than they should be, but that is a story for another day.

The Future

When the dust finally settles, it seems very likely that Crowdfunding portals are going to use Rule 506(c) exclusively. Until then we will have a mix and maybe just a little confusion.

Questions? Let me know.

Legal Focus On Crowdfunding

On By crowdfundattnyIn Crowdfunding, Crowdfunding Articles, Crowdfunding Portals, JOBS Act, SEC, Securities Exchange Commission, Securities Laws, Title II Crowdfunding, Title III Crowdfunding, Title IV of the JOBS ActLeave a comment

Lawyer Monthly magazine has been following Crowdfunding developments, along with the
business community and media. The attached interview highlights a couple of hot button points, including the benefits and common legal implications of Crowdfunding. Click here to read more.

legal focus on crowdfunding

Questions? Let me know.

It’s Easy To Be A Title III Crowdfunding Portal!

On By crowdfundattnyIn Crowdfunding, FINRA, Investing, Investor, SEC, Securities Laws, Title III CrowdfundingLeave a comment

All you have to do is:

  • Register with the Securities and Exchange Commission by filing a Form Funding Portal and posting a bond of at least $100,000.
  • Notify the SEC within 30 days if any of the information on Form Funding Portal changes.
  • Join FINRA and comply with all its rules and regulations.
  • Implement written policies and procedures “reasonably designed to achieve compliance with the federal securities laws.”
  • Comply with the requirements of 31 CFR Chapter X relating to money laundering.
  • Comply with the requirements of 17 CFR 248 relating to privacy.
  • Permit inspection by all your records and facilities by the SEC.
  • For each issuer (company trying to raise money) listed on your platform, have a reasonable basis for believing the issuer (1) complies with all applicable requirements, and (2)  has established a way to keep accurate records of investors.
  • Deny access to any issuer if:
    • You believe the issuer is a “bad actor.” To enforce this requirement you must (at a minimum) conduct a background and securities enforcement check on each issuer and on each officer, director, and beneficial owner of at least 20% of the issuer.
    • You believe the issuer or the offering presents the potential for fraud “or otherwise raises concerns regarding investor protection.” How would you know? If you are unable to “effectively assess the risk of fraud,” you have to deny access.
  • Provide educational materials to potential investors that explain in plain language “and are otherwise designed to communicate effectively and accurately”:
    • The mechanism for purchasing stock of the issuer;
    • The risks of purchasing stock;
    • The types of securities offered on your platform and the risks of each type;
    • The restrictions on resale imposed by law or contract;
    • The kinds of information the issuer is required to provide;
    • The per-investor limitations on investment;
    • The investor’s right to cancel the investment, and the limitations on those rights;
    • The need for the investor to think about whether the investment is appropriate; and
    • That following the investor’s purchase of stock, there might be no further relationship between the investor and your portal.
  • Keep all those educational materials current on your website and, where appropriate, make any revisions available to investors before accepting investments.
  • Tell investors about the requirements applicable to promoters.
  • Disclose to investors how you are being compensated.
  • Make available to investors and the SEC – in
    downloadable form – all the information the issuer itself is required to make available, including:

    • The name, address, and website of the issuer;
    • The names of the directors and officers, their positions with the issuer, and their overall business experience over the last three years;
    • Each person’s principal occupation and employment, and the name and principal business of any other entity where the occupation and employment took place;
    • The name of each person who owns at least 20% of the issuer;
    • A description of the issuer’s business and business plan;
    • The number of the issuer’s employees;
    • A discussion of factors that make the investment risky;
    • The target offering amount, and a statement that if the target is not reached, all the money will be returned;
    • Whether the issuer will accept money in excess of the target, and how;
    • The purpose and intended uses of the offering proceeds;
    • A description of the process to complete a purchase and sale of stock, including statements that:
      • An investor may cancel his investment up to 48 hours before the deadline;
      • The portal (you) will notify investors when the target amount is reached;
      • The issuer may close the offering before the deadline if the target amount is reached; and
      • If the investor does not cancel his investment and the target is reached, the offering will close
    • That a material change is made after an investor commits, his or her money will be returned unless he or she affirmatively re-commits;
    • The price of the stock;
    • A description of the capital structure of the issuer, including:
      • A summary of all securities, including associated voting rights;
      • A statement how the exercise of rights held by the principal stockholders of the issuer could affect investors;
      • The name and “ownership level” of each person who owns 20% or more of the issuer;
      • How the stock purchased by the investor was valued, and might be valued in the future;
      • The risks associated with minority ownership and the issuance of additional securities in the future; and
      • A description of all restrictions on transfer;
    • The name of the portal (you);
    • The amount of your compensation;
    • A description of all indebtedness of the issuer;
    • A description of all non-public offerings of securities within the last three years, including:
      • The date of the offering;
      • The offering exemption;
      • The types of securities offered; and
      • The amount of money raised and how it was used;
    • A description of any transaction since the beginning of the issuer’s last full fiscal year, involving at least 5% of the amount to be raised in the Title III offering, in which any of the following had an interest:
      • A director or officer of the issuer;
      • A person who owned 20% or more of the issuer;
      • A promoter of the issuer; or
      • A family member of any of the foregoing;
    • A description of the issuer’s financial condition;
    • Financial statements (the kind of statement is based on how much money the issuer is raising);
    • Any matters that would have resulted in disqualification under the “bad actor” rules had they occurred after Title III became effective.
  • Make all of that information available to investors and the SEC on a Form C (newly created) at least 21 days before any securities are sold, update the progress of the offering, and keep all of the information available until the offering is completed or canceled.
  • Before accepting money from an investor:
    • Have a reasonable basis for believing the investor satisfies the applicable investment limitations (you can generally rely on the investor’s representations); and
    • Obtain from the investor:
      • A representation that the investor has reviewed the education materials and can bear the entire loss of his or her investment; and
      • A questionnaire demonstrating the investor’s understanding that:
        • There are restrictions on his or her ability to cancel the investment;
        • It may be difficult to re-sell the stock; and
        • Investing is risky – in fact, the investor should be able to afford the loss of his or her entire investment.
  • Establish communications channels (message boards?) that allow investors to communicate with one another and with representatives of the issuers about offerings on your platform, provided that:
      • You can’t participate in these communications;
      • You have to provide unlimited public access to the communications, but can allow comments only from those registered with your platform; and
      • You require anyone posting comments to disclose whether he or she is affiliated with the issuer;
  • Upon receiving a commitment from an investor, you must give him or her notification of:
    • The dollar amount of the commitment;
    • The price of the security;
    • The identify of the issuer; and
    • The deadline for canceling the commitment;
  • Establish a relationship with a bank as an escrow agent under a written escrow agreement and direct that:
    • Funds from investors be transferred to the issuer if the target amount has been reached, the cancellation period has expired, and at least 21 days have elapsed since the issuer’s information was first made available on your platform; and
    • Return the funds to the investor if the investor cancels or the offering terminates.
  • On or before the closing of the offering, give notice to all investors, providing:
    • The date of the closing;
    • The type of security purchased by the investor;
    • The identity, price, and number of securities purchased by the investor;
    • The total amount of securities sold by the issuer and the price(s) at which they were sold;
    • If the security is a debt security, the interest rate, the maturity date, and the yield to maturity;
    • If the security is callable, the first date it can be called; and
    • The amount and source of your remuneration.
    • If the issuer decides to close the transaction earlier than the deadline established initially, give notice to all investors, providing:
      • The date of the new deadline;
      • The right for investors to cancel up to 48 hours before the new deadline; and
      • Whether the issuer will continue to accept commitments during the 48 hour period before the new deadline.
  • If there is a material change to the terms of the offering or the information about the issuer, notify investors that all commitments will be canceled unless investors re-confirm their commitments.
  • If any investor fails to re-confirm within five business days, notify the investor and direct the return of his or her money.
  • If an offering is canceled, notify all investors, direct the return of their money, and ensure that no further commitments are made for the offering.
  • Maintain the following records for five years:
    • Records relating to each investor who purchased securities or tried to;
    • Records relating to each issuer that offered securities or tried to;
    • Records of all communications on your platform;
    • Records relating to anyone who uses your platform to promote securities or communicate with investors;
    • Records that document your compliance with the SEC’s rules and regulations;
    • All your notices to issuers and investors, including your Terms of Use;
    • All your contracts;
    • Daily, monthly, and quarterly summaries of transactions, including:
      • Transactions that have successfully closed; and
      • Transaction volume, expressed in:
        • Number of transactions;
        • Number of securities sold in transactions;
        • Total amounts raised by each issuer; and
        • Total amounts raised by all issuers; and
    • A log reflecting the progress of each issuer.
    • Maintain and preserve all your organizational documents.

But you must not:

  • Have any financial interest in any of your listed companies.
  • Receive any financial interest as compensation for your services.
  • Offer investment advice or recommendations.
  • Deny access to an issuer based on your assessment of the issuer’s prospects.
  • Solicit purchases, sales or offers to buy the securities offered on your platform.
  • Compensate employees or others for such solicitation.
  • Hold or manage investor funds.
  • Pay anyone for providing personally identifiable information of investors.
  • Pay anyone except registered brokers or dealers for directing issuers or investors to your platform on a commission basis.

That’s all you have to do!

Questions? Let me know.

Proposed Title III Crowdfunding Regulations: Better Late than Never

On By crowdfundattnyIn Crowdfunding, Crowdfunding Portals, Entrepreneurs, Investing, Investor, JOBS Act, Securities Exchange Commission, Securities Laws, Title III CrowdfundingLeave a comment

On October 23, 2013 the SEC proposed regulations to implement Title III Crowdfunding.

There are two extremely important things about the proposed regulations:

  • That they were issued. After a 90 day public comment period, it seems likely that Title III Crowdfunding will finally come into effect in the first quarter of 2014.
  • That they run to almost 600 pages. Given the complexity, there is some question whether, in the end, a company trying to raise money will find Title III Crowdfunding worthwhile.

Recall that the JOBS Act provides for two kinds of Crowdfunding:

  • Title II Crowdfunding allows companies to raise an unlimited amount of money from an unlimited number of accredited investors using general soliciting and advertising. That kind of Crowdfunding came into effect on September 23, 2013 and is now in full swing.
  • Title III Crowdfunding is a different animal. It allows companies to:
    • Raise up to $1 million per year;
    • On an SEC-registered internet portal;
    • From a unlimited number of investors who do not have to be accredited;
    • But with strict limits on the amount each investor can invest.

For a detailed outline of the Title III statute itself, click here.

Despite their length, the proposed regulations do not add much to the statute. There are just a few points worth noting for a company looking to raise money:

  • The company can use only one portal at a time.
  • The company must file information via EDGAR, the SEC’s electronic database.
  • The $1 million-per-year limit applies only to money raised in Title III offerings. Thus, a company could raise $3 million in a traditional private placement (or a Title II offering) while still raising $1 million in a Title III offering.
  • Investors can change their minds up to 48 hours before the investment deadline, in all circumstances, and must also be given the right to terminate in the event of a material change in the investment opportunity.
  • The company must disclose not only its own prior offerings, but the prior offerings in which its directors and other principals were involved.
  • The SEC has created a new Form C to report Title III offerings.
  • The company may advertise, but only to direct potential investors to the portal’s website. The company may not use general solicitation and advertising, as it can in a Title II offering.
  • “Bad actors” are excluded from Title III Crowdfunding, as they are from Title II Crowdfunding.

The proposed regulations are even more important for portals, or would-be portals. The portal is designated as the virtual policeman for ensuring compliance with the law. For example, the proposed regulations provide that the portal must have a reasonable basis for believing that company is complying with the law, and must deny access to the issuer under certain circumstances. In effect, the portal is required to act as an arm of the SEC itself.

Just as a company trying to raise money might decide that Title III is too onerous, an entrepreneur thinking about forming a Title III portal might decide that the fruit are a little too high and a little too green.

Questions? Let me know.