In April 2012, Congress passed the JOBS Act, which included Title III that created a new securities offering exemption under Section 4(a)(6) that sets the framework for equity crowdfunding.

On October 23, 2013, the Securities and Exchange Commission issued 595 pages of proposed rules that will eventually govern the regulation of equity “crowdfunding” for public comment. “Crowdfunding” is a method of raising investment capital by selling securities on the Internet.

To qualify for this exemption, crowdfunding transactions must meet these broad requirements, which include the following:

• The amount raised must not exceed $1 million in a 12-month period (adjusted for inflation at least every five years);
• Individual investments in a 12-month period are limited to:
  a. the greater of $2,000 or 5 percent of annual income or net worth, if the investor’s annual income or net worth is less than $100,000; and
  b. 10 percent of annual income or net worth (not to exceed an amount sold of $100,000), if annual income or net worth is $100,000 or more;
• Transactions are conducted through an intermediary that is either registered as a broker or is registered as a new type of entity called a “funding portal.”

Crowdfunding is often confused with “crowd-sourcing,” which is a non-equity based model of sourcing crowd funds for a wide array of activities and campaigns ranging from artistic endeavors to local community projects where contributors either receive nothing for their donations or other token items. The companies that host the Internet venues for these types of crowd-sourcing are numerous and, in some cases, like Kickstarter, well known. Crowd-sourcing does not, and more importantly, cannot involve the offer and sale of securities because the offer and sale of securities triggers regulation federally by the SEC, by all 50 states’ securities’ regulators, and the self-regulatory organization, FINRA. a.the greater of $2,000 or 5 percent of annual income or net worth, if the investor’s annual income or net worth is less than $100,000; and b.10 percent of annual income or net worth (not to exceed an amount sold of $100,000), if annual income or net worth is $100,000 or more;

Unlike the current federal private placement exemptions of Regulation D, which were created using the SEC’s rulemaking authority in 1982, the Crowdfunding exemption was created by Congress, which tasked the SEC to adopt implementing rules for its use by December 31, 2012. As the proposed Crowdfunding rules are nearly a year over-due, those in the entrepreneurial community are anxious to learn how this exemption will work and take advantage of this new source of capital access for emerging businesses.

While this brief article cannot provide a comprehensive review of all the Crowdfunding proposed rules, Golan & Christie wants to take this opportunity to highlight key elements of the Section 4(a)(6) exemption as addressed in the proposed rules:

Intermediaries – It appears all Crowdfunding securities offerings will be conducted elec-tronically by registered intermediaries hosting Web-based platforms that foster communication channels, information sharing, and qualification of potential investors.

Integration – Generally, to comply with existing private placement exemptions issuing companies must take care to avoid the “integration” of one exempt offering with another exempt offering that could void its ability to claim either or both exemptions. The proposed SEC Crowdfunding rules address the concept of “integration” but also recognized that the $1 million limit may be too low and identified that Section 4(a)(6) does not explicitly prevent an issuer from raising capital through means other than this exemption and, therefore, “capital raised through other means should not be counted in determining the aggregate amount sold in reliance on Section 4(a)(6)” thus, allowing for the possibility of an issuer conducting concurrent offerings raising in excess of $1 million.

Investment Amount Limits – The JOBS Act sets a floor of $2,000 and a ceiling of $100,000 investment limits in Crowdfunded offerings depending on the investor’s annual income or net worth (to be determined consistently with Regulation D’s definition of an “accredited investor”), but does address when or how these tests are to be applied. The SEC proposes to interpret this part of the legislation using a “greater of” test so that the applicable percentage (5% or 10%) is to be applied to the greater of the investor’s annual income or net worth.

Investor Characteristics – The proposed Crowd-funding rules discuss the possibility of creating different investor criteria depending on whether the investor is an individual or an institution and on whether the investor is a U.S. citizen or domiciled company. The proposals indicate that the SEC does not favor a tiered regulatory structure for this element, nor will non-US based investors be prohibited from participating in Crowdfunded offerings.

Nature of and Requirements for Issuers – Indications are that only US domiciled issuers will be permitted to use Section 4(a)(6) and that the issuers must provide prospective investors with written disclosure documents prior to accepting equity subscriptions.

Issuer Disclosure Requirements – SEC proposes to use a base Form C to streamline issuers’ filings to meet their disclosure obligations, including Form C (Offering Statement); Form C-A (Amendments); Form C-U (Progress Updates); Form C-AR (Annual Report); and Form C-TR (Termination).

Advertising and Notice Requirements – Issuers may not “advertise” or “generally solicit” for their offerings, but the SEC believes a “central tenant of the concept of Crowdfunding is that members of the crowd decide whether or not to fund an idea or business after sharing information with each other.” Therefore, issuers will be required to give investors and potential investors “notices” of a variety aspects of the offerings, including the identity of the intermediary, the terms of the offering, the legal identity and other basic facts about the issuers and its capital structure.

To discuss whether your business should explore Crowdfunding, please contact Rita W. Garry at (312) 696-1366 or rwgarry@golanchristie.com and keep an eye out for details about how to register for the complimentary Golan & Christie breakfast seminar in April.