Part of the JOBS Act that just passed Congress is the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012” or the “CROWDFUND Act,” which enables businesses to sell stock online through intermediaries.
Unless an exemption applies, businesses need to file a registration statement with the SEC before they can publicly solicit the sales of stock. The CROWDFUND Act creates a new class of transactions that are exempted from the requirement of filing a registration statement. (Filing a registration statement typically costs millions, takes months to complete, and subjects a company to ongoing reporting requirements.)
The CROWDFUND Act excludes transactions from the registration requirement provided that:
1. Issuers do not raise more than $1,000,000 from the sale of securities during any 12 month period;
2. Issuers do not raise more than the greater of $2,000 or 5% of the annual income or net worth of an investor with an annual income or net worth less than $100,000;
3. Issuers do not raise more than the lesser of $100,000 or 10% of the annual income or net worth of an investor with an annual income or net worth equal to or greater than $100,000;
4. The transaction is conducted through a broker or funding portal that complies with the requirements of 4A(a) (see below); and
5. The issuer complies with the requirements of section 4A(b).
Section 4A(a) Requirements for Intermediaries
A person acting as an intermediary in a transaction under the CROWDFUND Act shall:
1. Register with the SEC as a broker or a funding portal;
2. Register with any applicable self-regulatory organization (as defined in section 3(a)(26) of the ’34 Act);
3. Provide investor education materials, and disclose risks as the SEC shall determine appropriate;
4. Ensure that each investor understands the risk of loss, illiquidity (shares won’t be freely tradeable—there’s a mandatory holding period for unregistered securities), and other matters as the SEC shall determine appropriate;
5. Take measures to reduce the risk of fraud as SEC shall determine appropriate, including background and securities enforcement regulatory history check on each officer, director and person holding more than 20% of the outstanding equity of every issuer whose securities are offered by such person;
6. Make available to the Commission and potential investors 21 days prior to first day securities are sold to any investor any information provided by the issuer pursuant to Section 4A(b);
7. Only distribute proceeds to issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest as the SEC shall determine appropriate;
8. Follow SEC rules to ensure that no investor in a 12 month period has purchased securities offered pursuant to the CROWDFUND exemption that in the aggregate, from all issuers, exceed the investment limits set forth in section 4(6)(b) (that’s paragraphs 2 and 3 of the first section above);
9. Follow SEC rules to protect the privacy of information collected from investors;
10. Not compensate promoters, finders, or lead generators for providing the intermediary with the personal information of any potential investor;
11. Prohibit directors, officers, or partners from having financial interest in an issuer using its services; AND
12. Meet any other requirements that the SEC may supply for the protection of investors and the public interest.
Section 4A(b) Requirements for Issuers
To comply with the CROWDFUND Act exemption, issuers must:
1. Provide to investors and file with the SEC the following information:
1.1. The name, legal status, physical address, and website address of the issuer;
1.2. The names of the directors and officers (and any persons occupying a similar status or performing a similar function);
1.3. A description of the business of the issuer and the anticipated business plan of the issuer;
1.4. A description of the financial condition of the issuer, including:
1.4.1. For offerings of $100,000 or less: (a) income tax returns filed by the issuer in the most recent year (if any); AND (b) financial statements of the issuer, which shall be certified by the principal executive officer of the issuer to be true and complete;
1.4.2. For offerings more than $100,000 and less than $500,000: financial statements reviewed by an independent public account; and
1.4.3. For offerings more than $500,000: audited financial statements.
1.5. A description of the intended use of the proceeds;
1.6. The target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target;
1.7. The price to the public of the securities or the method for determining that price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities;
1.8. A description of the ownership and capital structure of the issuer, including:
1.8.1. Terms of the securities being offered, and the terms of each other class of security, including how such terms may be modified, and a summary of the differences between the securities;
1.8.2. A description of how the rights of the securities being offered may be materially limited, diluted, or qualified by the rights of any other class of security of the issuer;
1.8.3. A description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;
1.8.4. The name and ownership level of each existing shareholder who owns more than 20% of any class of securities being offered by the issuer;
1.8.5. How the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions; and
1.8.6. The risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions such as the issuances of shares a sale of the company or of the assets of the company, and of the risks of transactions with related parties;
1.9. Other information that the SEC may require;
2. Not advertise the terms of the offering, except for notices which direct investors to the funding portal or to the broker;
3. Not compensate or commit to compensate any person to promote its offerings through communications channels provided by a broker or funding portal without taking steps provided by the SEC to ensure that the compensation associated with any promotion is adequately disclosed;
4. Not less than annually, file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer; and
5. Comply with other requirements that the SEC may prescribe for the protection of investors and the public interest.
4A(c) Liability for Material Misstatements and Omissions
Cause of Action Created
A person who purchases a security in a transaction exempted by the provisions of the CROWDFUND Act may bring an action against an issuer in law or equity to recover the consideration paid for such security with interest, less the amount of any income received from the stock if the issuer (or issuer’s agent) made a material misstatement or omission.
4A(e) Restriction on Resales of CROWDFUND Act Securities
1. Securities issued pursuant to a CROWDFUND Act transaction may not be transferred by the purchaser during a one year period beginning on the date of purchase unless the securities are transferred:
1.1. To the issuer of the securities;
1.2. To an accredited investor;
1.3. As part of an offering registered with the SEC (a public offering); and
1.4. To a family member in connection with death or divorce of the purchaser;
2. Other limitations as the SEC shall establish.
Disqualification of Certain Parties
The SEC shall create rules to establish the disqualifications of issuers, brokers, and funding portals. Included in those disqualifications shall be individuals who have been convicted of violating securities laws.
Funding Portal Defined
A funding portal is an intermediary in a transaction involving the offer or sale of securities for the account of others solely pursuant to the CROWDFUND Act, that does not:
1. Offer investment advice or recommendations;
2. Solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;
3. Compensate employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal;
4. Hold, manage, possess, or otherwise handle investor funds or securities; OR
5. Engage in other activities prescribed by the SEC.
Funding Portal Regulations
The SEC shall exempt registered funding portals from the requirement to register as a broker or dealer provided that such funding portal:
1. Remains subject to the examination, enforcement, and rulemaking authority of the SEC;
2. Is a member of a national securities association registered under section 15A; and
3. Is subject to other requirements that the SEC may supply.