This week, the Securities and Exchange Commission released new proposed rules that would permit but regulate the offer and sale of securities through crowdfunding. Sounds pretty awesome, except maybe for the “regulate” part.
Crowdfunding, for those of you whose artsy friends have not already solicited Kickstarter donations from you, is an internet-based fundraising method. It typically involves musicians, filmmakers, artists, or designers gathering small financial contributions from a large number of individuals. In exchange for a pledge to the project or startup, backers usually receive some token of appreciation related to the project they are funding — a CD, tickets to live recording session of an orchestral arrangement of music from the Pokemon video game franchise, a signed copy of a book, well wishes from a psychic goat, etc. Websites such as Kickstarter and Indiegogo serve as exchanges where interested investors link up with aspiring artists, entrepreneurs, and inventors.
Currently, crowdfunded projects are not selling ownership rights in the projects to their financial contributors. Those who pledge money for you to open your dreamed-of cheese bar are not buying stock in your cheese bar. Offering contributors a share of future financial returns, after all, usually triggers the application of federal securities regulations. However, thanks to these new rules proposed by the SEC, pushed forward by 2012’s Jumpstart Our Business Startups (JOBS) Act, this may now change. Subject, of course, to some oversight by the Feds. Let’s take a look at the rules and see if they are likely to Kickstart, er, jumpstart our nation’s business startups….
Under the new rules proposed to regulate equity crowdfunding:
● A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
● Investors, over the course of a 12-month period, would be permitted to invest up to:
○ $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
○ 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.
In its offering documents, among the things the company would be required to disclose:
● Information about officers and directors as well as owners of 20 percent or more of the company.
● A description of the company’s business and the use of proceeds from the offering.
● The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
● A description of the financial condition of the company.
● Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.
The FEC also would require companies relying on the crowdfunding exemption to offer and sell securities to file an annual report with the Commission and provide it to investors.
Title III of the JOBS Act requires that crowdfunding transactions occur through an SEC-registered intermediary, either a broker-dealer or a “funding portal.” Under the SEC’s proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal. Funding portals are, essentially, entities like Kickstarter. According to the SEC, the proposed rules would require these intermediaries to:
● Provide investors with educational materials.
● Take measures to reduce the risk of fraud.
● Make available information about the issuer and the offering.
● Provide communication channels to permit discussions about offerings on the platform.
● Facilitate the offer and sale of crowdfunded securities.
The proposed rules would prohibit funding portals from:
● Offering investment advice or making recommendations.
● Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
● Imposing certain restrictions on compensating people for solicitations.
● Holding, possessing, or handling investor funds or securities.
The SEC allows a 90-day public comment period before reviewing the comments and finally approving the proposed rules. So, call up your favorite commissioner and let her know what you think.
Certainly, the aim is to help startups and small businesses raise low-dollar-value capital more easily, without the facing the current regulations on venture capital investments. This is a good thing.
What’s wrong with this proposed system, though, is not hard to see. It still creates a complex, costly regulatory framework, the kind that the federal government excels at promoting. Complying with this new framework is likely to be intimidating and cost-prohibitive for exactly the sort of small businesses and entrepreneurs conventional crowdfunding often attracts. So, while the SEC’s proposed rules may boost the efforts of some small business owners, it is not likely to change the fundraising strategy of most.
I don’t know Braxton Burks or Eric Buchholz, the dudes behind the above-mentioned Pokemon Reorchestrated project, but I’m not sure if those guys have a clean set of financials and a fresh KPMG audit on hand. If not, they may have to stick to the old-fashioned way of raising contributions. Which in the case of crowdfunding, ironically, is not so old-fashioned.
Tamara Tabo is a summa cum laude graduate of the Thurgood Marshall School of Law at Texas Southern University, where she served as Editor-in-Chief of the school’s law review. After graduation, she clerked on the U.S. Court of Appeals for the Fifth Circuit. She will be working at the Center for Legal Pedagogy at Texas Southern University during the 2013-2014 academic year. She looks forward to a career of teaching and writing about, but never practicing, law. You can reach her at firstname.lastname@example.org