new risk factors for crowdfunding and beyond

Trump II: New Risks Factors for Crowdfunding and Beyond

On By crowdfundattnyIn Crowdfunding, Risk Factor, Tariffs, Trump AdministrationLeave a comment
New risk factors for crowdfunding & beyond

Disclosure is at the heart of the U.S. securities laws, and of all the information that can be disclosed, the most important are the risks associated with the investment. That’s why every disclosure document, from the most humble Private Placement Memorandum to the most extensive S-1, includes a list of risk factors.

Some risks are general: the risk that the business might be affected by another pandemic. Some are technical: the risk that our new technology might not work. Some are legal:  the risk that our product infringes on a patent that belongs to someone else.

Whatever their political persuasion, lawyers who draft disclosure documents should now include risks associated with the new Administration. Different businesses will be subject to different risks, but here is a partial list:

  • Risk of Higher Inflation and Interest Rates:  The new Administration has imposed tariffs on Canada, Mexico, and China, and is threatening tariffs on other allies, including the European Union. According to economists, the cost of tariffs will fall on American consumers, raising prices for a large number of goods and thereby fueling inflation. At the same time, the Administration is proposing large tax cuts funded by higher federal budget deficits, which will also contribute to inflation. The Federal Reserve has struggled to bring inflation down to its 2% target, and these policies will likely lead to interest rates h igher than they would have been otherwise.
  • Risk of Labor Shortages:  The new Administration is cracking down on undocumented immigrants, seeking to deport millions by force. Undocumented immigrants make up approximately 40% of the American agricultural labor market, approximately 15% – 25% of the housing labor market, and approximately 20% of the food services labor market, among others. The absence of these workers would cause acute shortages, leading to higher prices and scarcity.
  • Risk of Future Pandemics:  The COVID-19 pandemic in 2020 was devastating for many industries and for the American economy as a whole. The new Administration is populated by “vaccine skeptics,” chief among them Robert F. Kennedy, Jr., who has propagated misinformation not only about COVID vaccines but about vaccines of all kinds, claiming without evidence that childhood vaccines cause autism and opposing vaccines for illnesses ranging from measles to polio. As the Secretary of Health and Human Services, Mr. Kennedy has already taken action against vaccine research, just as the Administration is defunding scientific research generally. These actions increase the risk of another pandemic.
  • Risks to Agricultural Sector:  The American agricultural sector depends heavily on exports, including exports to China. With China now retaliating against the Administration’s tariffs, and the possible loss of almost half its workforce, the agricultural sector could face severe impacts.
  • Risks to Housing Sector:  The American housing industry contributes approximately $1.2 trillion annually, or about 4.5% of America’s gross domestic product. Tariffs imposed on Canadian exports, retaliation by Canada and other countries, increases in interest rates caused by Administration policies, and the possible loss of approximately 20% of its workforce could damage the housing sector severely.
  • Risks Associated with Government Closures:  The new Administration has slashed some government spending, including spending mandated by Congress, in ways that could disrupt the economy or specific industries. For example, in the weeks that followed a fatal midair collision near Reagan National Airport, the Administration announced a reduction in funding for the Federal Aeronautics Administration, which controls flight safety. These cuts could lead to more travel delays and possibly more fatalities, which would have negative effects on the economy.
  • Risk of Government Action Concerning DEI Initiatives:  The new Administration has moved aggressively against initiatives favoring “diversity, equity, and inclusion.” A project that relies on federal funding for any such initiatives will be affected adversely.
  • Risk of Climate Change:  Climate change (aka “global warming”) caused by human activity is already imposing costs and risks for the American economy, including unusual and unpredictable storms, droughts, and other weather-related events. The new Administration has moved aggressively against initiatives to address climate change, like alternative energy, removing mention of “climate change” from government websites, and defunding the National Oceanic and Atmospheric Administration, in favor of carbon-based energy. These actions will increase the rate of global warming and the associated risks.
  • Risks of Legal and Economic Uncertainty:  The new Administration has announced that it will not enforce laws it does not like, such as the Tik-Tok ban, while also putting in the hands of the White House decisions that have historically been made by administrative agencies like the Securities and Exchange Commission. The Administration has also reversed itself on important issues like tariffs, then reversed the reversals. Economic and legal uncertainty can create a climate where businesses are reluctant to invest, increasing the cost of capital and adding to overall economic risks.
  • Risk of Economic Disruption from Tariffs:  Facing a deepening depression, the administration of Herbert Hoover signed into the law the Smoot-Hawley Tariff Act of 1930, which raised tariffs on imported goods. That statute is widely regarded as having worsened, or even caused, the Great Depression by stifling international trade. The steep tariffs imposed by the new Administration could have a similar effect, or even worse.  World economies are far more connected today than they were in 1930. Everything from iPhones to automobiles are made not just in one country but in many. Canada, Mexico, and China have all announced plans to retaliate against the U.S., and a series of tit-for-tat actions could unravel the free trade networks that have been at the foundation of economic growth for 80 years. Any such disruption increases the risk of recession, if not worse.
  • Risks of Recession:    Consumer sentiment has dropped while expectations for future inflation have risen, even before consumers feel the impact of higher prices caused by tariffs. The yield on the 10-year treasury bill has also fallen on fears of recession. Labor shortages, higher prices, disruptions to supply chains, the possible scarcity of goods, and economic uncertainty could combine to create a recession, which would adversely affect most businesses.

The purpose of the “Risks of Investing” is to alert prospective investors to risks and thereby reduce the chance of a successful investor lawsuit after the fact. Lawyers will have to decide on a project-by-project basis whether these and other policy-related risks should be disclosed. Few, if any, businesses will go unscathed.

Questions? Let me know.

A Radical Proposal For Liquidity In Crowdfunding Investments

A Radical Proposal For Liquidity In Crowdfunding Investments

On By crowdfundattnyIn Uncategorized7 Comments

Many smart people believe the main impediment to Crowdfunding in general and Reg CF in particular is the lack of liquidity. Who wants to invest without the chance to get out?

I don’t agree. I note that:

  • Plenty of money flows into real estate projects with no guaranty of liquidity.
  • Enormous amounts of money has flowed through Silicon Valley over the last 40 years with no guaranty of liquidity.
  • Even before Crowdfunding and outside Silicon Valley, lots of money flowed into private companies with no guaranty of liquidity.

Nevertheless, I agree the lack of liquidity is important and have a proposal to fix it, for those willing to take some risk.

Too often, in my opinion, proposals to allow liquidity focus on the SEC. For example, smart people propose that the SEC should adopt a rule providing that an online marketplace for Reg CF securities won’t be treated as an “exchange.” 

I don’t agree with that, either. One, the SEC probably doesn’t have that authority. Two, and far more important, it wouldn’t help. As described here and here, the absence of vibrant secondary markets for private securities isn’t because of the law. It’s because private securities are really hard to market and sell. The lack of transparency, the reliance on a tiny management team, the lack of the investor protections built into NASDAQ and other national exchanges, the miniscule market cap and public float – all these things and more make private securities illiquid.

Forget about petitioning the SEC or introducing another “Improvements in Crowdfunding” bill in Congress. Trying to create liquidity by legal fiat is like pushing string.

Funding portals can provide liquidity on their own. A funding portal could simply require every issuer to provide for liquidity in its organizational documents. The organizational documents could provide, for example, that within some period of time, say seven years, the issuer would either (i) buy out investors, or (ii) arrange for an exit, either a cash sale or a merger with a company with publicly traded securities. Only with a majority vote of investors (super majority?) could the deadline be extended.

Even an individual issuer could provide such a guaranty, without a mandate from the funding portal.

Think of the marketing campaigns. “Our company guaranties liquidity!” “Every company on our platform guaranties liquidity!”

For those who think seven years is too long, don’t buy private securities if you might need to sell them sooner. For those who think seven years is too short, write your own blog!

Seriously, the proposal has one big flaw, from the perspective of issuers. I’ve recommended before that Crowdfunding investors shouldn’t have the right to vote. My liquidity proposal, in contrast, gives investors the right to force the sale of the company. That might hamstring the company and, more important, it might inhibit the company’s ability to attract future, large investors.

To address that flaw, should we provide that the right of liquidity goes away if the company raises $X in the future? 

Everything is a tradeoff. If you believe a guaranty of liquidity will open the floodgates of investors, you’ll consider taking the plunge. If you doubt that a guaranty of liquidity will attract investors, on the other hand, then the tradeoff might be too high. But that takes us back to the beginning. If you think liquidity is the key, and you acknowledge that no change in the law will get us there, a proposal like this could be an option worth considering. 

Questions? Let me know.

Non-Competes Are Back

On By crowdfundattnyIn Non-Compete Agreements1 Comment

On April 23, 2024, the Federal Trade Commission issued a final rule that would prohibit restrictive covenants (non-compete agreements) for most employees, effective on September 4, 2024.

Last Monday, I was about to write a blog post predicting that FTC’s rule couldn’t survive. A Supreme Court that struck down major environmental rules, eliminated the 40-year-old Chevron doctrine, and created from scratch a shocking new doctrine of presidential immunity that has Washington, Jefferson, Hamilton, et al rolling in their graves, all in one week, was not going to tolerate a national rule opposed by most businesses.

Two days later, on July 3rd, in Ryan v. FTC, a federal District Court judge in Texas saved the Supreme Court the trouble, issuing an injunction against the FTC’s rule. For the time being the injunction applies only to the plaintiff in the case. However, there is a very high probability that the injunction will become national when the District Court issues its final opinion at the end of August. With several other cases pending and the position of the Supreme Court so clear, it’s also possible that another court will issue a national injunction first.

For practical purposes, it is reasonable to assume that the FTC’s rule will never come into effect.

Questions? Let me know.

Crowdfunding Legal Links

Supreme Court Curbs SEC Enforcement Actions, And That’s Not All

On By crowdfundattnyIn Reg CF, SEC1 Comment

Last week, in a 6-3 opinion, the U.S. Supreme Court held that the SEC must use the regular federal court system, not its internal administrative proceedings, in an antifraud suit against an investment adviser seeking civil damages. The Court ruled that litigating the case through the SEC’s internal proceedings violated the defendants right to a jury trial under the Seventh Amendment of the U.S. Constitution.

The case throws into question all pending SEC administrative proceedings. Like most Supreme Court decisions, the opinion in SEC v. Jarkesy leaves important questions open. What about proceedings that do not involve fraud? What about proceedings where the SEC is not seeking civil penalties? 

SEC v. Jarkesy must be read in conjunction with two other Supreme Court decisions issued last week, Ohio v. EPA and Loper Bright Enterprises v. Raimondo. In the former, the Court held that the EPA had overstepped its bounds in interpreting the Clean Air Act. In the later, the Court overturned a 40-year precedent, the “Chevron Doctrine.” This doctrine, established by the Supreme Court in Chevron U.S.A. v. Natural Resources Defense Council in 1977, held that except in unusual cases, courts should defer to the judgment of administrative agencies in interpreting the laws with the jurisdiction of the agencies.

Many have welcomed the trio of decisions, believing they will free individuals and businesses from the biases of the “administrative state.” I am more skeptical.

Take an example close to my heart. As enacted by Congress, the exemption under section 4(a)(6) of the Securities Act of 1933, aka Reg CF, imposed a limit of $1,000,000, which proved completely inadequate. A couple years ago the SEC increased the limit to $5,000,000. Under Loper Bright Enterprises v. Raimondo, I’m not sure the SEC had the power to increase the limit. If someone challenges the limit, he or she might win.

You show me a regulation you don’t like, I’ll show you others you do like. You show me a decision by an SEC administrative law judge you don’t like, I’ll show you a decision by a federal judge, or by the Supreme Court itself, that you hate. Mr. Jarkesy, the investment adviser accused of fraud, might be happy that the administrative proceedings against him are stopped. Will he be better off in federal court?

As I see it, these cases are about a transfer of power away from the Executive branch to the Supreme Court. Chief Justice John Roberts said as much: “Chevron’s presumption is misguided because agencies have no special competence in resolving statutory ambiguities. Courts do.” 

The Chevron Doctrine was born when the Supreme Court realized in 1977 that courts were not equipped to handle the complexities of modern life and would therefore defer to experts. Since then, modern life has become far more complex. All the same decisions will have to be made. Personally, I see no reason to think the Supreme Court will reach better decisions for the environment or for Reg CF than bureaucrats with subject matter expertise will reach. With bureaucrats we hold an election every four years. With the federal court system, never.

One thing I know for sure, the changes will be great for lawyers. Lawyers benefit from change, and in legal terms the changes the Supreme Court made last week are monumental. The federal courts are about to be flooded with claims from every point on the ideological spectrum. There aren’t nearly enough federal judges to handle all the claims the Supreme Court has just invited, but there are plenty of lawyers!

Questions? Let me know.

Four Becomes Three: Regulation A Offerings Are Easier Now

On By crowdfundattnyIn Regulation A, SECLeave a comment

In this blog post from long ago, I wondered whether a company raising money through Regulation A could legally sell directly to investors. On one hand, the law in a handful of states require all sales to be through broker-dealers. On the other hand, those state laws might be invalid under section 18(b) of the Securities Act of 1933.

It looks as if common sense and the market are answering the question without litigation.

Late last year, Florida changed its laws to allow direct sales. Florida is a big state with lots of investors, so that’s a big deal. What we once referred to as four “problems states” has become three:  Texas, New Jersey, and Washington.

In my humble opinion, the state laws don’t make sense. A Regulation A offering is reviewed by the Securities and Exchange Commission through a process much like a public offering. Under federal law, the SEC review is enough to allow sales to both accredited and non-accredited investors. I cannot see a justification for a state to require more protection in the form of a broker-dealer review; in fact, this reasoning makes me think that section 18(b) should override the state laws.  

The state laws also add a very significant cost to a Regulation A offering. I’m not aware of any broker-dealer willing to sell Regulation A securities only to residents of three states. Instead, broker-dealers charge more than 2% of the whole raise. Broker-dealers need to charge these fees to cover their own costs and risks, obviously. By driving up the costs of the offering, however, the state laws undermine a primary goal of Crowdfunding, i.e., to make great investments available to ordinary Americans.

Off the soapbox now.

Of the three remaining problem states, New Jersey is the easiest. You file a form to register as a “dealer” and you’re done.

Washington is hard. Washington also allows registration as a dealer, but in my experience the designated dealer must be an individual who is also a general partner/manager of the issuer. For liability reasons, that might not be acceptable. If in doubt, don’t sell securities in Washington.

Texas also allows registration as a dealer. While Texas generally requires that the individual registering have FINRA licenses, that requirement can be waived. The process can take a couple months.

My recommendation:  register in New Jersey; register in Texas and ask for a waiver (start that process early); and don’t sell in Washington.

If anyone has more current advice or information I’d love to hear it.

Questions? Let me know.

new risk factors for crowdfunding and beyond

More Noise About Accredited Investors In Crowdfunding

On By crowdfundattnyIn Accredited Investor, Exchange Act, Investment Company Act, Regulation A, SEC1 Comment

The House of Representatives just passed not one, not two, but three different bills that would expand the definition of “accredited investor.” Does this mean the definition will change? No.

The three proposed changes are:

  • Include in the definition of accredited investor anyone who says he or she understands the risks, using a form of not more than two pages issued by the SEC. This would effectively eliminate the concept of accredited investor.
  • Include in the definition of accredited investor anyone who has received personalized advice from a person who has himself or herself become an accredited investor under 17 CFR §230.501(A)(10), by passing an exam approved by the SEC. The mystery here is why the proposed bill wouldn’t include anyone who has received personalized advice for a registered investment adviser.
  • Allow anyone, including non-accredited investors, to invest in the aggregate up to 10% of their income or net worth in private securities. No time period is provided.

The proposed changes to the definition of accredited investor are part of a larger package of legislation that would ease more than a dozen rules in the federal securities laws, including:

  • Expand the definition of “emerging growth companies.”
  • Create a safe harbor for brokers and finders in private placements.
  • Ease the “independence” rule for auditors.
  • Ease the registration requirements under section 12(g) of the Exchange Act.
  • Expand the definition of venture capital fund for purposes of section 3(c)(1) of the Investment Company Act.
  • Add a new exemption under the Securities Act of 1933 for issuers raising less than $250,000.
  • Double the Regulation A offering limit from $75,000,000 to $150,000,000.

And so on.

This legislation can best be understood by reference to the man who introduced it, Representative McHenry of North Carolina. Representative McHenry was the principal sponsor of the JOBS Act, which created Crowdfunding. Before and since, he has been an advocate for improving access to capital for entrepreneurs and giving ordinary Americans access to opportunities now reserved for the very wealthy.

But Representative McHenry is leaving Congress. He was a close friend of Kevin McCarthy and briefly assumed leadership of the House when McCarthy was deposed. That episode seems to have drained his enthusiasm; he announced his plan to retire shortly afterward.

This legislation should probably be viewed as Representative McHenry’s swan song, his wish list, even his legacy. Unfortunately, and as I’m sure he recognizes, it’s likely that none of it will find its way into law.

Questions? Let me know.

Self-hosted Reg CF offerings legal analysis SEC crowdfunding rules

How To Draft A Form C For Regulation Crowdfunding

On By crowdfundattnyIn Crowdfunding Vehicles, Form C, Reg CF, SPVLeave a comment

Form C is the disclosure document used in Reg CF. Because I see so many Form Cs that aren’t done properly, I thought it would be worthwhile to explain how a Form C should be drafted and why too many lawyers go astray.

Rule 201 (17 CFR §227.201) tells us exactly what should be disclosed in a Form C:

  • Rule 201(a) calls for the name, legal status, physical address, and website of the issuer.
  • Rule 201(b) calls for the names and business experience of officers and directors. 
  • Rule 201(c) calls for the name of each person owning 20% or more of the voting stock.
  • All the way through Rule 201(z), which calls for copies of testing the waters materials.

Rule 201 is exhaustive, i.e., there is no disclosure requirement in Reg CF outside Rule 201, other than a short financial summary. 

If you had never prepared a disclosure document, how would you provide the disclosures required by Rule 201? Chances are, you would simply go down the list, from Rule 201(a) to Rule 201(z), and provide answers to all the questions. And that is exactly the right way to do it.

Look at this Form C, for a company called ScienceCast, Inc. Look at the Table of Contents, how it just goes through Rule 201, item-by-item. Look at the body, where each item is labeled with the corresponding rule. Look how the Form C describes the role of the crowdfunding vehicle, or SPV. If you had never prepared a disclosure document and were trying to do things right, I bet this is how you would do it.

Yet look at most of the Form Cs that are filed with the SEC. They don’t follow this format at all or follow it only loosely. In the worst case, of which there are many examples, you can’t even tell it’s a Form C. It looks like a typical Private Placement Memorandum you would see in a Regulation D offering.

And that explains why too many lawyers go off track. A lawyer who has prepared hundreds of Private Placement Memoranda thinks “A Form C is just another type of disclosure document. I’ll start with the form I’m already familiar with rather than create something new from scratch.”

Legal forms can be very useful, but they can also become like an old ship encrusted with barnacles. Over time, lawyers tend to add things to form documents as new cases are decided or new concepts come to mind, but rarely is any of the old stuff scraped away, much less the whole document re-thought.

Using the fresh-out-of-the-box Form C rather than the encrusted Private Placement Memorandum has many benefits:

  • It’s far easier to make sure all the disclosures are there.
  • It’s far easier to check for accuracy.
  • It’s far easier to create an easy-to-understand template.
  • It’s far more efficient, cutting costs.
  • It’s far easier for a lawyer to prepare or review, cutting costs.
  • It’s far easier for the funding portal to explain to the issuer.
  • It avoids all the duplication you see in a typical PPM.
  • It avoids all the state notices and other unnecessary legal boilerplate you see in a typical PPM.
  • It’s far easier for an investor to compare one offering to another.
  • It’s far easier for an investor to read and understand.
  • It uses less energy, reducing the impact of Reg CF on the fragile coral reefs surrounding Australia.

For Reg CF to grow, the industry must standardize. I hope it can at least standardize around a Form C.

Questions? Let me know.

Artificial Intelligence

Anthropic: SPVs And The Investment Company Act

On By crowdfundattnyIn Investment Company Act, SPV10 Comments

I spend lots of time talking about special purpose vehicles (SPVs) and the Investment Company Act of 1940. Now we have a real-world example.

Anthropic was founded by Dario Amodei, who wrote the basic artificial intelligence model for OpenAI before leaving to start his own company. Once ChatGPT launched Anthropic has had no trouble raising money. They’ve raised $7.5 billion and counting in the last year.

In my humble opinion, the amount of money being thrown at Anthropic is insane. Most obviously, it demonstrates the psychological power of The Fear of Missing Out. More subtly, it represents the brokenness of venture capital culture. VCs have backed themselves into a position where they can no longer invest in businesses that are merely profitable. They need huge wins, grand slams. They bet a chunk of the farm on crypto/blockchain and lost. Now they need even bigger wins, or at least the promise of bigger wins, to keep their LPs writing checks.

Anyway, the flood of money created a problem for Anthropic that will sound familiar to many founders. The company was looking for billions, but many investors were able to invest “only” $30 – $50 million. The company didn’t want all those investors on its cap table.

So the company took the logical step:  it put the “small” investors in a separate company, an SPV, and admitted only the SPV to its cap table as a single investor.

Because its business is limited to holding securities in Anthropic, the SPV is an “investment company” under section 3(a) of the Investment Company Act. Yet it has not registered as an investment company. How does that work?

The answer is that it qualifies for the exemption under section 3(c)(1) of the Investment Company Act, section 3(c)(7) of the Investment Company Act, or both.

The exemption under section 3(c)(1) is available if the SPV has no more than 100 owners. That’s possible. If each owner invests $40 million you would raise $4 billion.

(NOTE:  the exemption under section 3(c)(1) allows 250 owners if the SPV follows a “venture capital strategy,” but this SPV was formed to invest in only one company, Anthropic.)

The exemption under section 3(c)(7) is available if each owner is a “qualified purchaser.” That term includes individuals with at least $5 million of investable assets, entities where all the individual owners have at least $5 million of investable assets, as well as other entities. I suspect the SPV qualifies under this exemption as well.

Thus, the SPV is an investment company under section 3(a), but is not required to register as such.

Finally, note that the discussion about the Investment Company Act doesn’t depend on how Anthropic raised money. It probably raised the money using Rule 506(b), taking the position that because everyone in that world knows everyone else, it had a “pre-existing relationship” with all its investors. But it could also have used Rule 506(c), assuming every investor is accredited. The point is that how you raise money and whether you need or qualify for an exemption under the Investment Company Act are unrelated.

I personally was not invited to invest in Anthropic. Imagine!

Questions? Let me know.

blind pool offerings in crowdfunding

Does Reg CF Allow Blind Pool Offerings?

On By crowdfundattnyIn Reg CF, Regulation CF4 Comments

It’s a trick question.

It’s a trick question because the term “blind pool offering” doesn’t appear in Reg CF. If you try to figure out whether Reg CF allows “blind pool offerings” you’ll drive yourself crazy and/or reach the wrong answer. 

To illustrate the point, suppose NewCo was formed to buy Class B multi-family projects in the southeastern United States but has not yet identified any such properties. If you focus on the term “blind pool offering” you might decide that NewCo can’t use Reg CF. But if you read Reg CF instead, you’ll reach the opposite – and correct – conclusion. 

To see whether NewCo is eligible for Reg CF, we look at the eligibility rules in 17 CFR §227.100(b). NewCo is a Delaware entity, so we’re good under section 100(b)(1). NewCo isn’t subject to the reporting requirements of the Exchange Act, so we’re good under section 100(b)(2). And we keep going through the list until we get to section 100(b)(6), which provides that Reg CF may not be used if the issuer:

Has no specific business plan or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies.

Does that describe NewCo? Well, no. NewCo does have a specific business plan and it’s not about merging with anyone. 

Thus, having gone through the whole list of section 100(b), we conclude that NewCo is eligible to use Reg CF, 100%.

I’ll add two epilogues.

First, Regulation A uses exactly the same language as Reg CF, in 17 CFR §230.251(b)(3). And even a cursory review of the Regulation A offerings reviewed and qualified by the SEC reveals many, many companies like NewCo.

Second, Industry Guide 5, issued by the SEC to provide disclosure guidelines for real estate offerings, specifically contemplates issuers like NewCo. Item 20D provides for certain disclosures in offerings where “a material portion of the maximum net proceeds (allowing for reasonable reserves) is not committed (i.e., subject to a binding purchase agreement) to specific properties. . . .” 

During my first year of law school in 1838, a partnership tax guru named Bill McKee insisted that we read the statute first. It has turned out to be excellent advice.

Questions? Let me know.

FinCEN

The Corporate Transparency Act

On By crowdfundattnyIn Corporate Transparency ActLeave a comment

Beginning on January 1, 2024, new and existing companies, with some exceptions, must disclose their owners to the US Department of the Treasury Financial Crimes Enforcement Network (“FinCEN”). This is big news in the legal world, not just for Crowdfunding but for everyone.

The following summary was prepared by Chimuanya Osuoha. If you’re a client of our firm you’ve probably dealt with Chimuanya and know her to be an extremely capable young lawyer.

The Corporate Transparency Act 

General Rule

Beginning January 1, 2024, all entities that are either formed or registered to do business in the United States by filing documents with a secretary of state or a similar office under the law of a State or Indian Tribe (a “Reporting Company”) are subject to the Corporate Transparency Act (the “CTA”). Reporting Companies will be required to file a report with FinCEN including information about its “Beneficial Owners” and “Company Applicants.”

Any changes to the information, including ownership, must be reported within 30 days.

NOTE:  For the time being, the information provided to FinCEN will not be public. I say “For the time being” for two reasons. One, once the information exists there will probably be pressure to make it public. Two, some states are already headed in that direction. For example, the New York legislature has passed something call the New York LLC Transparency Act, requiring public disclosure of the owners of limited liability companies.

Exceptions

Twenty-three kinds of entities are exempt from the CTA. They include (i) “large operating companies,” defined as a company with more than 20 full-time employees, that has filed income tax returns demonstrating more than $5,000,000 in gross receipts or sales and has an operating presence at a physical office within the United States; (ii) companies required to report under section 12 of the Exchange Act; (iii) investment advisers; (iv) public accounting firms registered under Sarbanes-Oxley;  and (v) tax-exempt entities,.

Click here for a list of the 23 exemptions.

Beneficial Owners

A Beneficial Owner is any individual who, directly or indirectly, (i) exercises substantial control over the entity (e.g., LLC Manager, Corporate Officer, etc.) or (ii) owns or controls twenty-five (25%) percent or more of the ownership interests in a Reporting Company. 

An individual exercises substantial control over a Reporting Company if he or she (i) is a senior officer; (ii) has authority to appoint or remove certain officers or a majority of directors of the Reporting Company; (iii) is an important decision-maker; or (iv) has any other form of substantial control over the Reporting Company. That’s very broad!

If the shares or interest of a Reporting Company are held by a trust, the Beneficial Owner of the Reporting Company could be (i) the Grantor or Settlor of the trust who has a right to revoke the trust or withdraw assets, (ii) the Trustee or person holding authority to dispose of trust assets, or (iii) a sole beneficiary who is the recipient of income and principal, or a beneficiary who has the right to demand distribution or withdraw substantially all assets from the trust. 

The definition of Beneficial Owners includes exceptions for minor children,  non-senior employees, and an individual whose only interest in a corporation, LLC, or other similar entity is through a right of inheritance. 

Company Applicant

A Company Applicant is an individual who directly files or is primarily responsible for the filing of the document that creates or registers the company. Each Reporting Company is required to report at least one Company Applicant, and at most two.

Example:  Individual A is creating a new company. Individual A prepares the necessary documents to create the company and files them with the relevant office, either in person or using a self-service online portal. No one else is involved in preparing, directing, or making the filing. Individual A is the Company Applicant and should be included in the report.

Example: Individual A is creating a company. Individual A prepares the necessary documents to create the company and directs individual B to file the documents with the relevant office. Individual B then directly files the documents that create the company. Individual A and B are Company Applicant and both should be included in the report.

The requirement to name Company Applicants applies only to Reporting Companies formed or registered on or after January 1, 2024. 

Information Required 

The Reporting Company must provide the following information about itself:

  1. Legal name, trade name and d/b/a;
  2. Address of principal place of business;
  3. The State, Tribal or foreign jurisdiction of formation or registration of the Reporting Company; and
  4. IRS Tax ID Number

The Reporting Company must provide the following information for each Beneficial Owner and each Company Applicant:

  1. Full Legal Name;
  2. Date of Birth;
  3. Current residential or business street address; and
  4. A Unique identifying number from an acceptable identification document (passport, driver’s license, etc.), or a FinCEN Identifier.

Deadline for Filing

Reporting Companies created or registered to do business on or after January 1, 2024, must file a report with FinCEN within 30 days after receiving notice of the company’s creation or registration. Reporting Companies formed or registered before January 1, 2024, have until January 1, 2025.

******

For more information, please contact Chimuanya A. Osuoha, Esq. at cosuoha@lexnovalaw.com or call 856-382-8452. We look forward to being of service.