Jumpstart or False Start? SEC Proposes New Rules to Implement Crowdfunding Provisions of the JOBS Act
On October 23, 2013, the Securities and Exchange Commission (SEC) proposed long-awaited rules to implement the securities crowdfunding provisions of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act). On balance, the proposed crowdfunding rules (the Proposed Rules) reflect a conservative approach by the SEC to securities crowdfunding, which has disappointed many in the startup and small issuer community that had hoped for a more streamlined set of regulations within the broad outlines established by the JOBS Act. This News Alert will highlight various aspects of the Proposed Rules and a number of areas where the SEC is seeking comment from the public. The Proposed Rules are subject to a 90 day comment period ending on February 3, 2014. It is important to note that securities crowdfunding is not permitted until final rules are adopted by the SEC and become effective.
Background. Under the Securities Act of 1933 (the Securities Act), the offering and sale of securities must be registered with the SEC unless a specific exemption applies. Title III of the JOBS Act added Section 4(a)(6) to the Securities Act to establish an exemption from registration for a specific type of offering – crowdfunding – which is a method of raising capital in which a large number of individual investors purchase relatively small amounts of the issuer’s securities. (For purposes of this Alert, we refer to securities sold in reliance on Section 4(a)(6) as “crowdfunding securities”.) Among other things, Section 4(a)(6) sets forth certain statutory requirements for the crowdfunding exemption that (i) limit the amount of crowdfunding securities an issuer can offer and sell in any 12-month period, (ii) limit the amount an investor may invest in crowdfunding securities in any 12-month period, (iii) mandate the method by which crowdfunding securities may be offered and sold (that is, through a single crowdfunding intermediary that is an SEC-registered broker or a new type of SEC-registered entity called a “funding portal”) and (iv) impose certain disclosure and ongoing reporting requirements on crowdfunding issuers. Within these statutory constraints, the Proposed Rules set forth additional provisions to implement the crowdfunding provisions of the JOBS Act.
Issuer Limit. The JOBS Act provides that the aggregate amount an issuer may raise via crowdfunding within a 12-month period is limited to $1 million. Although there is a statutory ambiguity as to whether all exempt securities offerings by an issuer should be counted toward this limit, only securities sold in reliance on Section 4(a)(6) would be aggregated to reach the $1 million limit under the Proposed Rules. Crowdfunding securities sold by an issuer’s predecessor or by any entity controlled by the issuer or under common control with the issuer within the same 12-month period would also be counted against the limit. The SEC has requested public comment on whether fees charged by the intermediary should be netted out of the offering amount when calculating the $1 million limit, whether certain non-crowdfunding offerings by the issuer should be counted against the limit and under what circumstances should a crowdfunding offering be “integrated” for securities law purposes withnon-crowdfunding offerings. Generally, the Proposed Rules contemplate that crowdfunding offerings could be made concurrently with other exempt securities offerings (e.g., Regulation D private placements), so long as each offering separately satisfied its conditions for exemption, but the SEC has specifically requested comment on this approach.
Investor Limit; Resale Restrictions. The JOBS Act imposes an investment limitation on individual investors that caps the amount of crowdfunding securities that can be sold to any single investor within a 12-month period. An investor whose annual income or net worth is less than $100,000 may invest the greater of $2,000 or 5% of the investor’s annual income or net worth. An investor whose annual income or net worth is $100,000 or more may invest up to 10% of the investor’s annual income or net worth, not to exceed $100,000. The Proposed Rules would allow investors that fall within both of the foregoing categories to rely on the higher limit. Calculation of annual net income and net worth would be made in the same manner as for “accredited investor” status under Regulation D (e.g., net worth would exclude the value of a person’s primary residence and annual income and net worth may be calculated jointly with the investor’s spouse). Although the SEC has requested public comment on whether this investment limitation should apply only to certain types of investors, the current Proposed Rules provide that all investors participating in a crowdfunding offering would be subject to the investment limits described above even if they qualified as accredited investors or institutional investors under Regulation D or otherwise. Under the JOBS Act and the Proposed Rules, investors that purchase crowdfunding securities in an offering are not permitted to transfer the securities for a period of one year from the date of purchase except (a) to the issuer, (b) to an accredited investor (as defined in Regulation D under the Securities Act), (c) as part of an offering registered with the SEC, or (d) to a family member or in connection with the death or divorce of the investor.
Offering Via Crowdfunding Intermediary Only. The JOBS Act requires the issuer to offer and sell crowdfunding securities via a single intermediary only (either a broker or “funding portal”), and transactions must occur exclusively through that intermediary’s web-based platform. An issuer would not be permitted to conduct an offering, or concurrent offerings, using more than one intermediary. One of the key aspects of the crowdfunding model of fundraising is that it should provide members of the “crowd” (i.e., the potential investor pool) the opportunity to share information and opinions and evaluate whether to invest on the “collective wisdom” of the crowd. Accordingly, the JOBS Act and the Proposed Rules require an issuer’s crowdfunding offering to occur on a single web-based platform that would facilitate this information sharing as well as limit the possibility of multiple “crowds” discussing the same offering. The SEC has requested public comment on, among other things, whether the Proposed Rules should impose (or permit intermediaries to impose) platform access restrictions, such as invite-only offerings, and whether crowdfunding transactions should be permitted by means other than an intermediary’s electronic platform.
Requirements for Issuers
Eligibility. Under the JOBS Act and the Proposed Rules, four categories of issuers are prohibited from relying on Section 4(a)(6) to engage in securities crowdfunding: (1) issuers that are not incorporated or organized under the laws of a U.S. state or territory; (2) issuers that are subject to the reporting requirements of the Securities Exchange Act of 1934; (3) certain entities that either fall within or are specifically excluded from the definition of “investment company” under the Investment Company Act of 1940 (e.g., mutual funds, hedge funds, private equity funds); and (4) any other issuer the SEC deems appropriate. In addition, the Proposed Rules provide that an issuer may be prohibited from claiming the crowdfunding exemption if it fails to comply with the proposed reporting requirements described below by, for example, failing to provide its annual updating reports.
Disclosures and Reporting. Under the JOBS Act and the Proposed Rules, an issuer is required to make several disclosures to the SEC and to investors and prospective investors through the web-based platform of the issuer’s crowdfunding intermediary. These disclosures include, among other things: (1) the issuer’s contact information and legal status; (2) identification of the issuer’s directors and officers, and persons who hold more than 20% of the issuer’s outstanding voting equity securities; (3) a description of the issuer’s business and anticipated business plan; (4) a discussion of material risk factors relating to the investment; (5) a description of the issuer’s financial condition; (6) tax returns, reviewed financial statements or audited financial statements of the issuer (depending on the size of the current offering and all other crowdfunding offerings within the previous 12 months); (7) the target offering amount, the deadline for reaching the target, and regular updates on the issuer’s progress in reaching the target; (8) a description of the intended use of the offering proceeds; (9) the price of securities offered or a method by which to determine the price; and (10) a description of the issuer’s ownership and capital structure. An issuer would have a continuing obligation to amend its disclosures to reflect any material changes to the disclosure previously provided to investors or to the terms of the offering.
The SEC recognizes that startups will likely be unable to provide highly detailed business plans, therefore the Proposed Rules specify no particular presentation format or content which must be included in a business plan. However, some specificity is required. For example, an issuer would not be permitted to list as a business plan its intent to engage in an acquisition or merger transaction with an unspecified company or companies. The Proposed Rules contemplate that the mandated disclosures would be filed with the SEC via an XML-based form (“Form C”). Variants of Form C would be used for the several different types of disclosure filings required under the Proposed Rules, including the initial filing, amendment filings, required progress updates and required annual amendments. The Proposed Rules provide that Form C would be filed with the SEC via its EDGAR system and provided to the issuer’s intermediary. Issuers may then direct investors and potential investors to the intermediary’s website for the information. The SEC has requested comment on the substance of the mandatory issuer disclosures (including financial reports), as well as whether 20% beneficial owners and/or other persons having power over, or economic exposure to, the issuer’s shares should be identified in the disclosures, among other issues.
Ongoing Disclosures. The Proposed Rules require that issuers conducting crowdfunding offerings must disclose and file offering “progress reports” not later than five business days after reaching 50% and 100% of the targeted offering amount, as well as a final progress report if the issuer accepts proceeds in excess of the targeted amount. Additionally, any issuer that has sold crowdfunding securities is required to make an annual filing and disclosure within 120 days after the end of the issuer’s fiscal year which contains information similar to that required in its initial Form C filing. Notably, in addition to tax returns or financial statements, the Proposed Rules require the issuer to provide a narrative description of its financial condition similar to the “management discussion and analysis” (MD&A) required of issuers of SEC registered offerings. These annual filing requirements would continue until the issuer becomes a reporting company under the Securities Exchange Act of 1934, the issuer or another party purchases or repurchases all of the crowdfunding securities, or the issuer ceases to do business. The SEC has requested public comment on whether the Proposed Rules should specify particular events that would trigger additional reporting requirements, such as filing for bankruptcy, and whether the obligation to provide ongoing reporting should be a condition to claiming exemption under Section 4(a)(6).
Advertising and Publicity. As noted above, one of the key features of a crowdfunding offering is the use of the intermediary’s platform as the exclusive means to share issuer communications about the offering with all investors and to encourage the exchange of opinions and information among investors. Accordingly, the Proposed Rules allow issuers to make only very limited public communications about the offering outside of the intermediary’s platform. Generally, issuers may not advertise the terms of the offering except for notices directing investors to a broker or funding portal. Such notices must include a link to the intermediary’s platform and may include only the issuer’s name and location, the price of the offering, the amount of securities offered, the nature of securities offered, and the date on which the offering period will close. Any public communication regarding the offering that does not meet these requirements is not permitted and may result in a violation of the Securities Act by the issuer. Communications regarding the issuer’s business that do not relate to the terms of the offering are not subject to these limitations. Among other things, the SEC has requested public comment on whether to further expand or restrict the categories of information that an issuer can communicate outside the intermediary’s platform, whether to prohibit the use of certain types of media (e.g., TV, radio or phone calls) to promote crowdfunding offerings, and whether to specify a specific format for issuer offering notices.
Communications by Promoters. Under the JOBS Act and the Proposed Rules, an issuer would be prohibited from directly or indirectly compensating anyone for promoting its offering on an intermediary’s communication channels unless it has taken reasonable steps to ensure that the promoter discloses the receipt of both past and prospective compensation each time the promoter makes a promotional communication. The SEC notes that it is important for investors to know when communications may be motivated by financial self interest or other bias. This prohibition is intended to have broad application and include persons acting on behalf of the issuer regardless of whether they received specific compensation for the promotional activities. For example, a founder that participated in the intermediary’s communication channels would be required to disclose, with each posting, that he or she is acting on behalf of the issuer. The SEC has requested public comment on whether promoters should be required to register as such with the intermediary and disclose their compensation arrangements to the intermediary, and whether requiring the issuer to take “reasonable steps” is the appropriate standard to impose on issuers.
Requirements for Intermediaries
Status; Limitation on Activities; Registration. As noted above, under the JOBS Act, crowdfunding transactions must be conducted through an intermediary that is either a broker or a funding portal as defined in the Securities Exchange Act of 1934 (the Exchange Act). The Exchange Act defines a “broker” as “any person that effects transactions in securities for the account of others”. The Exchange Act, as amended by the JOBS Act, and the Proposed Rules define “funding portal” as any person acting as an intermediary in connection with an offering or sale of crowdfunding securities by others that does not: (i) offer investment advice or recommendations; (ii) solicit purchases, sales or offers to buy the securities offered or displayed on its platform or portal; (iii) compensate employees, agents or other persons for such solicitation or based on the sale of securities displayed or reference on its platform or portal; or (iv) hold, manage or possess or otherwise handle investor funds or securities. The Proposed Rules clarify that any person that falls within the definition of funding portal is also deemed to be a broker under federal securities laws. Provisions of the Proposed Rules also apply in many cases to associated persons of a funding portal, which is defined as any partner, officer, director or manager of a funding portal (or having similar status or function), any person directly or indirectly controlling or controlled by a funding portal and any employee of a funding portal whose functions are not solely ministerial or clerical.
Under the Proposed Rules, a crowdfunding intermediary is required to be registered with the SEC as either a broker or a funding portal, in addition to being a member of the appropriate self-regulatory organization (i.e., FINRA). The Proposed Rules contemplate a streamlined SEC registration process for funding portals modeled on the existing broker-dealer registration process. Registration would be effective on the later of (i) 30 days after the SEC receives the funding portal’s registration materials or (ii) the date the funding portal is accepted for membership by FINRA (or another SRO). Registration materials filed by funding portals would be made available to the public. A foreign intermediary may also register with the SEC and FINRA as a funding portal, but would be subject to certain additional conditions and regulatory oversight.
The SEC has requested public comment on a number of issues related to the above provisions of the Proposed Rules, including how to ensure there are no regulatory imbalances that would favor brokers over funding portals, and whether there should be particular licensing requirements for intermediaries and the associated persons beyond those imposed by an SRO.
Limitation on Financial Interests in Issuer. Under the JOBS Act, crowdfunding intermediaries are required to prohibit their directors, officers or partners (or person with similar status or function) from having any financial interest in any issuer utilizing the intermediary’s services. The Proposed Rules additionally prohibit the intermediary itself from having such an interest in any issuer utilizing its services, and from receiving a financial interest in an issuer as compensation for services provided. The SEC’s view is that this prohibition is necessary to avoid conflicts of interest that might arise if persons facilitating the offering (i.e., the intermediary and its related persons) had an economic stake in the success of the issuer’s offering, which could be exacerbated if the intermediary’s investment were on terms different from those offered to other investors, for example. However, the SEC has requested public comment on whether there are certain circumstances under which an intermediary should be allowed to have a financial interest – for example, so long as it is on the same terms as other investors and is disclosed, or if it does not exceed as certain de minimis amount.
Diligence Requirements. To reduce the risk of fraud, the JOBS Act requires an intermediary to obtain background information, including a securities enforcement history, on all issuers who conduct crowdfunding transactions through the intermediary’s platform. This information must also be obtained for all directors and officers of the issuer, and for all persons who hold more than 20% of the issuer’s shares. The intermediary is required to deny an issuer access to its platform if it has a reasonable basis to believe that the issuer or any of its officers or directors (or persons of similar status or function) or 20% shareholders is subject to disqualification, or if it believes that the issuer or the offering presents the potential for fraud or serious investor protection concerns. The SEC’s view is that such steps should result in investors being more willing to invest in crowdfunding offerings, to the extent this diligence lessens the likelihood of “inappropriate or nefarious activity” while obviating the need for investors to do their own costly background inquiries of issuers and/or associated persons. Additionally, the Proposed Rules would require intermediaries to have a reasonable basis for believing each issuer is in compliance with the Securities Act and the final SEC crowdfunding rules, as well as for believing that the issuer has established an accurate means of record keeping to track the ownership of crowdfunding securities, which the SEC views as “critical for maintaining the integrity” of the crowdfunding process in connection with the initial offering as well as subsequent sales. However, the Proposed Rules indicate an issuer can reasonably rely on representations of the issuer in this regard, absent knowledge or circumstances indicating the representations may not be true.
The SEC has requested comment on a number of facets of the Proposed Rules described above, including whether the “reasonable basis” standards applicable to intermediaries are appropriate as a general matter, whether an issuer should be required to appoint a transfer agent to keep ownership records of the securities, whether intermediaries should be required to make the results of background checks publicly available, and whether intermediaries should be required to report to the SEC (or other agency) if they have denied access to an issuer.
Account Opening, Educational Materials and Electronic Delivery. Before participating in a crowdfunding transaction, an investor is required to open an account with the intermediary and to consent to the electronic delivery of all relevant materials, documents and disclosures (including notices, confirmations, risk disclosures and educational materials) through the platform. Under the Proposed Rules, the intermediary is required to provide investors with a range of educational materials addressing various topics, including the process of investing in securities through the intermediary, the limitations on resale of crowdfunding securities, the risks associated with an investment in crowdfunding securities, the types of information and reports an issuer is required to provide in connection with a crowdfunding offering, the limitations on how much an investor may invest in crowdfunding offerings, and the circumstances under which an issuer may cancel an offering or the investor may cancel his or her investment commitment. Additionally, the intermediary is required to disclose to investors how it will be compensated in connection with the offering and sale of securities on its platform. Depending on the type of material to be delivered, and the intended audience (e.g., investors only or the public at large), the Proposed Rules contemplate that electronic delivery of materials could occur by, among other things, email of the content itself or a link to the information on the intermediary’s platform or the issuer’s website, as applicable. The SEC has requested public comment on, among other things, the scope of the educational materials that an intermediary is required to provide, the various types of electronic delivery that are permitted and whether other non-electronic methods of delivery are appropriate for certain materials.
Compliance with Investment Limit. Under the Proposed Rules, an intermediary would be required to have a reasonable basis for believing an investor was in compliance with the 12-month limitation on the aggregate amount of crowdfunding securities that an investor is allowed to purchase. In recognition of the difficulty that an intermediary would face in monitoring or independently verifying an investor’s history of purchasing crowdfunding securities, the SEC proposes that an intermediary may rely on the investor’s self-certification of compliance with the investment limits unless it has reason to question the reliability of the investor’s certifications. The SEC has requested public comment on whether an intermediary should be required to utilize “readily available information” regarding investor limits and envisions that a centralized database might be developed in the future that would be helpful in this regard, although none presently exists.
Acknowledgement of Risk. The Proposed Rules require an intermediary to take steps to ensure that, each time an investor makes an investment commitment, the investor has reviewed the information supplied by the intermediary in the account opening process and provides an affirmative “acknowledgement of risk” via a questionnaire demonstrating that the investor understands the level of risk involved in investing in startups, emerging issuers and small issuers, the risk of illiquidity, and the limitations on the investor’s ability to cancel its investment commitment, among other things. The SEC has requested public comment on whether other topics should be covered in the risk acknowledgment and whether the SEC should provide recommended forms of questionnaires and/or investor representations.
Communication Channels. Under the Proposed Rules, an intermediary’s platform must provide channels through which investors and issuers can communicate about particular offerings. Communications on these channels must be made available for public viewing but comment posting privileges would be limited only to persons who have opened an account with the intermediary. Investors can communicate about the offering both on and off the channels; however, all communications between the issuer or its representatives and the investors would be required to occur on these channels. The intermediary itself would be prohibited from participating on these channels other than to establish the communication guidelines and remove potentially abusive or fraudulent statements or information. The SEC has requested public comment on whether there should be additional or different restrictions on the communication channels, whether postings by unregistered or anonymous posters should be permitted, and how long the communication channels should be maintained – during the post offering period, for example, so that investors could continue their dialogue with the issuer after the offering has been completed.
Issuer Information. An intermediary is required to make the basic issuer disclosures required under the Proposed Rules (as described above), and any additional information provided by the issuer, available to the public and the SEC on the intermediary’s platform for at least 21 days before any securities are sold in the offering. Anyone accessing the information on the intermediary’s platform must be able to save, downloaded and/or store the posted information, and the information must remain publicly available until the offer and sale of securities is completed or the offering is otherwise cancelled. An intermediary cannot require a person to open an account with the intermediary in order to access the information. The SEC has requested public comment on whether an intermediary should be required to keep the information publicly available for a period of time after the closing of an offering, whether an intermediary should be required to ascertain if investors have actually accessed the available information on the issuer, and whether intermediaries should be required to deliver the information instead of simply making it available.
Escrow of Offering Proceeds. Under the JOBS Act and the Proposed Rules, the proceeds of a crowdfunding offering are required to be escrowed until the aggregate amount raised equals or exceeds the target offering amount. Brokers would be required to comply with established requirements for the maintenance and transfer of investor funds as provided in the Exchange Act rules. Because the JOBS Act specifically prohibits funding portals from receiving investor funds, investors would have to send funds directly to the applicable escrow bank. The Proposed Rules would allow a minimum-maximum offering, with the minimum raise serving as the target offering amount for the release of funds to the issuer. Funds would be returned to the investor if the offering were cancelled or the investor timely cancelled his or her investment commitment as provided below. Among other things, the SEC has requested public comment on the escrow mechanics for investor funds, the timing for deliveries out of escrow, the criteria for escrow agents, whether funding portals should be subject to certain net capital requirements and whether investors should be prohibited from using certain payment methods (e.g., credit cards) to purchase crowdfunding securities.
Cancellation of Commitments. If an investor makes an investment commitment, the intermediary is required to promptly send the investor an electronic notice disclosing certain basic information, including the name of the issuer, the dollar amount of the commitment, the price of the securities, if known, and the date and time by which the investor may cancel his or her commitment. Under the Proposed Rules, brokers and funding portals must allow an investor to withdraw his or her commitment up to 48 hours prior to the deadline for closing of the offering, as identified in the offering materials. Commitments made in the final 48 hours would not be cancelable except in the case of a material change to the offering. If the issuer reaches its target offering amount prior to the specified deadline, the issuer may set a new deadline and close the offering early so long as it meets certain conditions, including providing investors with at least five business days prior notice of the new deadline and giving them the opportunity to cancel their commitment until 48 hours prior to the new deadline. Material changes to the offering, or to the information provided by the issuer in connection with the offering, would require the issuer to notify all investors of the change, stating that their commitments will be cancelled unless they reconfirm their commitment to the issuer within five business days of receipt of that notice. The SEC has requested public comment on, among other things, the timing and mechanics of cancelling investor commitments and offerings, the mechanism for making material modifications to disclosure materials and obtaining an investor’s confirmation of his or her commitment following a modification, and the timing for notifying investors if an offering has been cancelled.
Compensation; Payments to Third Parties. As proposed, the rules require an intermediary to disclose whether it receives compensation from an issuer, the amount of such compensation, and the manner in which it is compensated. Subject to certain conditions, an intermediary may compensate a person for directing investors to the intermediary’s platform although it may not compensate a person for providing personal information about an investor or potential investors. Additionally, the compensation paid by the intermediary for the referral cannot be based, directly or indirectly, on the purchase or sale of a crowdfunding security unless the recipient is a registered broker or dealer. The SEC has requested public comment on whether additional limitations should be placed on such referral compensation, including whether to require investor disclosures in this context.
Funding portals are subject to various additional statutory requirements and limitations under the Proposed Rules. In addition to SEC registration and FINRA membership, funding portals would be required to obtain a $100,000 fidelity bond covering the funding portal and its associated persons. So long as the funding portal remained subject to the authority of the SEC and FINRA, it would not be required to register as a broker-dealer. A funding portal would be required to establish and enforce written compliance policies and procedures and adhere to certain record retention requirements, including with respect to its communication channels. Among other things, the SEC has requested public comment on the registration process for funding portals, the fidelity bond requirement (including its amount and coverage), whether restrictions or prohibitions should be imposed on funding portals’ affiliations with other entities (e.g., affiliation with a broker-dealer or registered transfer agent), and whether a funding portal should be permitted to operate multiple intermediary websites under a single registration.
FINRA has also proposed rules and related forms to implement the provisions of the JOBS Act for funding portals. These proposed rules, which address the membership application process for funding portals, standards of conduct, compliance requirements and various procedural matters, are open for public comment until February 3, 2014.
Without substantial revisions, the Proposed Rules are likely to frustrate startups and small issuers seeking to raise capital via securities crowdfunding. For all but the most sophisticated issuers, navigating the complicated and time-consuming documentation and record-keeping requirements of the Proposed Rules, including the significant ongoing requirements after offerings are completed, will be a formidable challenge and, in many cases, require substantial involvement by attorneys and accountants. Compliance costs, funding portal fees, and related expenses could make crowdfunding offerings cost prohibitive unless portals and other service providers are able to streamline and automate much of the process.
For example, the SEC’s cost-benefit analysis of the Proposed Rules assumes that an issuer conducting a crowdfunding offering would need to pay its intermediary (funding portal or broker) between 5% and 15% of the offering amount, costs of $6,000 for filing an initial Form C for each offering and $400 for each required Form C update; annual costs of $4,000 for each Form C annual report; and annual costs of $14,350 to $28,700 for the accountant’s review or audit of financial statements for offerings of $100,000 or more. Even if intermediary fees are actually at the low end of the SEC’s estimate, the costs of a $200,000 crowdfunding offering would be more than $35,000 and the costs of a $1 million offering would be almost $90,000. At the high end of the SEC’s estimate of intermediary fees, the costs of a $200,000 offering would be more than $55,000 and the costs of a $1 million offering would be almost $190,000, without taking into account the ongoing annual requirements beyond the first year.
In light of this, issuers seeking to raise a limited amount of capital from the general public by means of a public offering may find less costly alternatives to crowdfunding. For example, under Regulation A, which is available to non-reporting (i.e., private) companies, an issuer could raise up to $5 million by public offering, subject to compliance with any applicable state “blue sky” laws. While state blue sky compliance costs have deterred widespread use of Regulation A to date, issuers could find it more appealing than crowdfunding if they are able to target offerings to residents of a single state or a limited number of states in order to limit those costs.
In 2012, the startup and small issuer community, as well as Congress, expressed hope that the crowdfunding provisions of the JOBS Act would usher in a new era of capital raising in a much less costly and free flowing environment by “democratizing” the securities offering process. However, the recently released Proposed Rules have dampened much of that optimism. The SEC’s perception that securities crowdfunding would be especially susceptible to fraud has led it to create a regulatory framework that in many ways mimics the registered offering process – almost a “registration lite” regime, but within the context of an electronic communications platform. If the Proposed Rules emerge from the public comment period without significant modifications, securities crowdfunding may remain more of a theoretical than practical option for most.
For more information regarding this News Alert, please contact Lori Smith (212.714.3075; firstname.lastname@example.org) in our New York office.
 The SEC’s proposed rules and release can be found at http://www.sec.gov/rules/proposed/2013/33-9470.pdf.
 Under the JOBS Act, crowdfunding issuers are required to make available to potential investors and file with the SEC, the following items, depending on the amount of crowdfunding securities offered during the preceding 12-month period: (i) income tax returns filed by the issuer for the most recently completed fiscal year (if any) and financial statements certified by the issuer’s principal executive officer, if the issuer offers $100,000 or less of crowdfunding securities during such period; (ii) financial statements of the issuer reviewed by an accountant that is independent of the issuer, if the issuer offers more than $100,000 but not more than $500,000 of crowdfunding securities during such period; and (iii) audited financial statements of the issuer, if the issuer offers more than $500,000 of crowdfunding securities during such period.
 FINRA’s proposed funding portal rules and regulatory notice can be found at http://www.finra.org/sites/default/files/NoticeDocument/p370743.pdf
 Under Regulation A, the issuer must file an offering statement with the SEC for review (but its financial statements generally do not need to be audited), there are no periodic reporting requirements after the offering, and the issuer may “test the waters” to determine whether there is adequate interest in its securities before filing with the SEC. As with registered offerings, securities issued under Regulation A are not restricted securities and are freely tradable in the secondary market, unlike crowdfunding securities, which only become freely tradable after one year.