Tag: SEC

SEC Relaxes Accredited Investor Verification Rule For Wealthy People

SEC Relaxes Accredited Investor Verification Rule For Wealthy People

On By crowdfundattnyIn Investor, Investor Verification, Rule 506(c), SEC2 Comments

An issuer raising capital using Rule 506(c) must take “reasonable steps” to verify that all the investors are accredited. Until now, that has normally meant using a third party like VerifyInvestor, which in turn gets a letter from the investor’s accountant. Now it’s going to be a little easier, at least for investors writing big checks.

In a private no-action letter, the SEC allowed the issuer to verify investors without looking at the investor’s tax returns, seeing a letter from the investor’s accountant, or using any of the other methods described in the regulations under Rule 506(c) if:

  • The investor is writing a big enough check — $200,000 for an individual and $1 million for an entity; and
  • The investor promises that he, she, or it is accredited and has not financed the investment through a third party; and
  • The issuer does not have actual knowledge of any facts indicating that the investor is not accredited or has financed the investment.

Technically, the no-action letter doesn’t have the same force as a statute or a regulation. It does, however, reflect the view of the staff of the SEC. Issuers and their lawyers generally can rely on no-action letters, with the understanding that the staff could decide to withdraw or modify its position at any time.

Verifying that an investor is accredited was already so easy, the question is why anyone bothered to ask for this no-action letter. I’m afraid the answer is that growing income and wealth disparities in this country. In some socio-economic circles and for some funds, everyone writes big checks, just as everyone is a “qualified purchaser” for purposes of section 3(c)(7) of the Investment Company Act. The result of the no-action letter is that for that segment of American society, the verification rules no longer exist. 

Two sets of rules, one for the wealthy, another for everyone else. I certainly understand the logic of the no-action letter, but I’m not sure it’s healthy in a macro sense. 

Questions? Let me know.

title III crowdfunding outline for portals and issuers

The Crowdfunding Bad Actors Rule: Applying For A Waiver

On By crowdfundattnyIn Applying For A Waiver, Bad Actors Rule, Reg CF, Regulation A, Regulation CFLeave a comment

Reg CF, Rule 506(c), and Regulation A all include what have come to be known as “bad actor” rules, codified in 17 CFR §227.503, 17 CFR §230.506(d), and 17 CFR §230.262. In each case, the rule provides that the company can’t use the exemption in question to raise capital if the company itself or certain people affiliated with the company (directors, officers, etc.) have violated certain securities-related laws.

(The bad actor rules don’t apply to investors!)

In each case, the rule allows a company to apply for a waiver. The waiver provisions are codified in 17 CFR §227.503(b)(2), 17 CFR §230.506(d)(2)(ii), and 17 CFR §230.262(b)(2). Each provides for waiver “Upon a showing of good cause and without prejudice to any other action by the Commission, if the Commission determines that it is not necessary under the circumstances that an exemption be denied.”

The SEC Has Complete Discretion

The SEC has identified some factors it will consider but, in truth, whether it is “necessary under the circumstances that an exemption be denied” is highly ambiguous and therefore highly subjective. As a result, the SEC has enormous discretion whether to grant waivers. Faced with two waiver requests with similar facts, the SEC might reach different conclusions. 

What Factors Matter

With that said, the SEC has identified the following factors, for now:

  • Did the Violation Involve the Sale of Securities?  An individual can become a bad actor without violating securities laws – for example, if a state regulator prohibits her from being associated with savings and loan associations. The SEC might be more inclined to give her a waiver, as compared to a person found guilty of having violated federal securities laws.
  • Did the Violation Involve Bad Intent?  Some violations involve bad intent (in legalese, “scienter”), like the intentional failure to disclose important information to investors. The SEC is less likely to grant waivers in those cases than where the violation was technical and unintentional, like the inadvertent failure to file a report.
  • Who Was Responsible for the Misconduct?  Suppose that while Mr. X was its Managing Partner, Company Y engaged in conduct causing it to become a bad actor, and that Mr. X was responsible. Two years later, Mr. X is no longer with Company Y. The SEC is more likely grant Company Y a waiver than if Mr. X were still at the helm. 
  • Is the Culture of the Company Good or Bad?  Underlining that waiver requests are highly subjective, the SEC believes that, where the bad actor is an entity rather than individual, it should take into account the culture, or “tone at the top,” of the entity. If the C-suite executives are trying to comply, the SEC would be more likely to grant a waiver than if they have obstructed the SEC’s investigations.
  • How Long did the Misconduct Last?  If the misconduct was brief, even an isolated event, the SEC would be more inclined to rule favorably than if it occurred over an extended period.
  • What Remedial Steps Have Been Taken?  The SEC will consider “what remedial measures the party seeking the waiver has taken to address the misconduct, when those remedial measures began, and whether those measures are likely to prevent a recurrence of the misconduct and mitigate the possibility of future violations.” Remedial steps could include (i) improving internal training, (ii) adopting or revising policies and procedures, (iii) improving internal controls, (iv) terminating employees responsible for the misconduct, and (v) completing educational courses. I believe the most effective remedial action, from the SEC’s perspective, would be to hire an outside compliance consultant, take her recommendations seriously, and implement as many as possible. 
  • Will Bad Things Happen if the Waiver is Denied?  The SEC will consider who will be hurt if the waiver is denied, and how badly. For example, suppose Company XYZ has already raised $50 million from 2,700 investors for a real estate development, using Regulation A. It needs to raise $5 million more using Rule 506(b) but has been designated a bad actor. If it is unable to raise the additional capital all the existing investors will lose their money. The SEC would take the potential harm to existing investors into account, along with other factors.

The SEC has also stated that it might develop a longer and more objective list in the future, based on its experience with actual waiver requests.

Waivers Are Not Black and White

The SEC can say No. It can also say Yes, but with conditions. For example, it might require additional disclosure. It might require additional notices to investors. It might limit the scope or term of the offering(s) for which a waiver is requested. In one instance, the SEC granted the waiver provided that (i) the applicant would retain an independent consultant and submit a written report, (ii) the applicant would implement all the consultant’s recommendations or obtain the SEC’s consent to alternatives, and (iii) the initial waiver would last for only 30 months, with the opportunity to request an extension.

You Might Not Need a Waiver

The bad actor rules apply to offerings under Rule 506, Regulation A, and Reg CF (they also apply to offerings under Rule 505, but that’s not Crowdfunding). Rule 506, Regulation A, and Reg CF are exemptions to the general rule, set forth in section 5 of the Securities Act of 1933, that every time you raise money from investors you have to conduct a full-blown IPO. 

But they are not the only exemptions. Section 4(a)(2) of the Securities Act still provides an exemption for “transactions by an issuer not involving any public offering.” In the early days of our securities laws, the ambiguity of the italicized language led to an enormous amount of litigation, which in turn led the SEC to create some of the exemptions, or “safe harbors,” used regularly today.

But the language is still there and, despite the ambiguity, there is no doubt that exempt offerings can be conducted without relying on Rule 506, Regulation A, or Reg CF. Consider Company XYZ above, which needs $5 million to complete its real estate development. If Company XYZ knows (has an existing relationship with) five wealthy investors each willing to write a $1 million check, it can forego the waiver request.

How to Apply 

Written requests for waivers should explain in detail (i) how the person came to be treated as a bad actor, (ii) her background in the securities industry and otherwise, and (iii) the nature of the offering(s) for which the waiver is sought. Is it a single real estate syndication under Rule 506? A large fund raising capital using Regulation A? A private equity fund raising capital from only qualified purchasers, i.e., people with more than $5 million of investable assets?

Most importantly, the request should explain why disqualification is not necessary. A request that amounts to “He’s a really great person and promises to do better this time” will be denied. A request should correlate with the factors identified by the SEC and identify any other objective factors showing that what happened in the past has little or no bearing on the new offerings. 

Waiver requests should be sent to:

Sebastian Gomez Abero, Chief
Office of Small Business Policy
Division of Corporation Finance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-3628

Confidentiality

Requests for waivers become public documents, just like requests for no-action letters. If you want parts of your waiver request to be treated as confidential, you can ask for confidential treatment separately. Be prepared for the SEC to say No, whereupon you will decide whether to withdraw the request.

Questions? Let me know.

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.

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.

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. 

Why I’m Grateful This Thanksgiving

On By crowdfundattnyIn Uncategorized2 Comments
William Bradford leader of the pilgrims

My 10th-great grandfather was William Bradford, the leader of the Pilgrims. I’m grateful that he and his band of religious refugees made the trip and were saved from starvation by the native population.

I’m grateful for the wisdom of the American people and the resilience of their institutions.

I’m thankful for a culture that rewards risk-taking and innovation and that is slowly, haltingly, inexorably freeing itself of the prejudices of our collective past.

I’m grateful for American entrepreneurs who endlessly question the present and invent the future.

I’m grateful I declined an invitation to sit on OpenAI’s Board.

I’m grateful – I’m not joking – to the SEC for providing oversight for the most complex, dynamic, trusted capital markets in the world.

I’m grateful that FINRA. . . .

I’m grateful to my colleagues at Lex Nova Law for helping to build a flexible, modern law firm.

I’m grateful to live in a diverse, changing, sometimes-chaotic country where it often seems we disagree about everything (we don’t). Like others, I worry that so many Americans have chosen alternative realities and conspiracy theories, but I have faith that these afflictions, like others in our history, will prove temporary.

I’m grateful that even while the voices of hate are the loudest, those who yearn for peace – the majority – refuse to be drowned out.

I’m grateful that people can change their minds.

I’m grateful to participate in the fundamental rethinking of capitalism called Crowdfunding, making capital available where it has never been available before and making great investment opportunities available to more and more Americans.

I’m grateful to everyone in the Crowdfunding ecosystem, especially to Doug Ellenoff and others who worked to make the JOBS Act a reality.

I’m grateful for my clients, a diverse, energetic, endlessly-creative group of entrepreneurs who are making America better and in the process making my life infinitely more rewarding.

While complaining that my health insurance premiums went up again, I’m grateful they have not dropped to zero.

Thanks for reading everyone! I hope you enjoy your Thanksgiving as much as I intend to enjoy mine. As always, contact me if you have any questions.

MARK

Securities Exchange Commission

SEC Adopts Final Rules For Private Advisers And Stresses Fiduciary Obligations

On By crowdfundattnyIn Private Fund Advisors, SECLeave a comment

Last year the SEC proposed new rules for private fund advisers. After public comment the SEC just adopted final rules.

Some of the new rules apply only to investment advisers required to be registered with the SEC. Others apply to all investment advisers, including so-called “private fund advisers.” I’m going to focus on the latter set of rules.

NOTE:  The new rules apply more broadly than you might think:

EXAMPLE:  Nikki Chilandra forms an LLC of which she is the sole manager, raises money from her private network of investors (no more than 100), and uses the money to buy a limited partnership interest in one real estate deal. The LLC is a private fund, and Nikki is likely a private fund adviser subject to the new rules.

Here’s a chart comparing the proposed rules with the final rules:

TopicProposed RuleFinal Rule
Charging for Services Not PerformedAn adviser can’t charge for services not provided. For example, if an asset is sold, the adviser can’t charge for the advisory fees that would have been due over the next two years.The final rules do not include this explicit provision. But that’s only because, according to the SEC, advisers are already prohibited from charging for services not performed because of their fiduciary obligations.
Charging for Compliance CostsAn adviser can’t charge the fund for expenses incurred in a regulatory examination of the adviser.The adviser may charge for these expenses with majority consent, unless the investigation results in sanctions under the Investment Advisers Act.
Reducing Clawback for TaxesAn advisor can’t reduce her clawback by the amount of any taxes.The adviser may reduce her clawback for taxes if she notifies investors within 45 days after the end of the quarter in which the clawback occurs.
Limiting Adviser LiabilityAn adviser can’t limit her liability for a breach of fiduciary duty, willful misfeasance, bad faith, recklessness, or even negligence.The final rules do not include this explicit provision. But the SEC explains that, in its view, the provision isn’t needed in light of the fiduciary and anti-fraud obligations already imposed on advisers under the Investment Advisers Act which, according to the SEC, may not be waived by contract (e.g., in an LLC Agreement).
Allocation of Fees Among FundsAn adviser can’t allocate fees among funds on a non-pro rata basis.The adviser may allocate fees on a different basis if (i) the allocation is fair and equitable under the circumstances and (ii) before charging or allocating the fees, the adviser notifies investors, explaining why it is fair and equitable.
Borrowing from FundAn adviser can’t borrow money from the fund.The adviser may borrow money with majority consent.
Preferential Treatment for Redemptions and InformationAn adviser can’t give preferential rights to redemption or preferential information rights to some investors if it would have a material negative effect on other investors.Both are allowed if the same rights are given to all investors (which makes the treatment non-preferential).
Preferential Economic TreatmentAn adviser can’t give other preferential economic rights to some investors without full disclosure to all investors.Preferential treatment is allowed with full disclosure (i) before an investor invests, (ii) when the fundraising period has ended, and (iii) annually.

In my opinion, the most important feature of the new rules isn’t the new rules themselves but the SEC’s statements concerning the fiduciary obligations of investment advisers. The SEC believes that all investment advisers have a duty of care and a duty of loyalty that cannot be waived by contract and can be liable for their negligence, no matter what the contract says.

Questions? Let me know.