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SEC Adopts Regulations Implementing “Regulation Crowdfunding” Under Section 4(a)(6) Of the Securities Act

On October 30, 2015, the Securities and Exchange Commission voted to adopt “Regulation Crowdfunding” (Regulation CF). Regulation CF is the set of rules and forms that will implement securities crowdfunding in the United States. The SEC was required to adopt these rules under the provisions of Title III of the JOBS Act of 2012. The final rules come after the SEC reviewed and considered over 485 comment letters from professional trade associations, investor organizations, law firms, investment companies and investment advisers, broker-dealers, potential funding portals, members of Congress, the SEC’s Investor Advisory Committee, state securities regulators, government agencies, potential issuers, accountants, and other interested parties. The rules will go into effect on May 16, 2016, although entities that wish to act as broker-dealers and “crowdfunding portals” under Regulation CF will be able to start the application process from the end of January. The changes from the SEC’s proposed rules originally published in October 2013 are limited, and almost all those changes fall on the side of reducing burdens on the issuer. Of note is the fact that first-time issuers under the new rules will not be required to have their financial statements audited, and ongoing reports are not required even to be reviewed by an accountant. Additionally, the rules increase the ability of crowdfunding portals to use subjective criteria in deciding which companies’ offerings to host on their sites, and to invest in those offerings. From a technical perspective, the fact that the SEC has made it possible to file documents in PDF form will reduce the logistical burden on issuers. On the negative side, individual investment limits were reduced to be based on the lesser of a person’s income or net worth. Additionally, the exclusion of crowdfunding shareholders from the “shareholder of record” count that triggers full registration with the SEC has become conditional.

Three weeks prior to the SEC adopting its final rules, FINRA, which is the self-regulatory organization for broker-dealers and which will also oversee the new “funding portals,” submitted its final Funding Portal Rules to the SEC for final approval.

Section 4(a)(6) of the Securities Act, the “crowdfunding exemption”

Offers of securities to the public (which includes offers made over the internet) must be registered with the SEC under the Securities Act of 1933, unless an exemption from registration is available. The JOBS Act added a new exemption to the Securities Act, Section 4(a)(6), to permit securities crowdfunding without registration. The exemption is subject to the following statutory conditions: The aggregate amount sold to “all investors,” including any amount sold in reliance on the new exemption, may not exceed $1 million in any 12-month period. The language of the statute (the JOBS Act) suggests that offerings made under other exemptions (Regulation D, for example) might count towards the $1 million limit, but the SEC’s view is that since Congress intended crowdfunding to be an additional source of funds for small companies, the limit applies solely to sales under Section 4(a)(6), and that amounts sold under other exemptions will not affect the limit. As discussed below, the SEC will permit crowdfunding offerings to be made concurrently with other exempt offerings, effectively permitting unlimited sizes of offerings to be made without registration.

An investor is limited in the amount he or she may invest in crowdfunding securities in any 12-month period:

  • If either the annual income or the net worth of the investor is less than $100,000, the investor is limited to the greater of $2,000 or 5% of the lesser of his or her annual income or net worth.
  • If the annual income and net worth of the investor are both greater than $100,000, the investor is limited to 10% of the lesser of his or her annual income or net worth, to a maximum of $100,000.

For calculating an investor’s net worth, Regulation CF uses the same method as used in Regulation D, which excludes the value of the investor’s primary residence. Investors may include their spouse’s income for the purposes of the income test. The “lesser of” standard is a change from the proposed rules, which took a “greater of” approach to calculating the investment limit based on income or net worth. This change will significantly limit the funds available from non-accredited investors. However, the SEC’s rules permit concurrent offerings under Section 4(a)(6) and Rule 506(b) or (c), which may effectively result in accredited investors not being subject to any limit on their investment.

The transaction must be made through a broker, or through a “funding portal” (a new designation under the Securities Exchange Act of 1934) that meets the requirements set out below. The issuer must comply with the disclosure and other requirements set out below. Note that compliance with each of these requirements is a condition to availability of the exemption from registration. If these conditions are not met and the relief for “insignificant deviations” discussed below is not available, then the issuer will have violated the Securities Act by making an unregistered offering of securities to the public.

Requirements for issuers - Incorporation and eligibility

The issuer must be incorporated or organized under the laws of a state or territory of the United States, or the District of Columbia. It may not be an “investment company” as defined under the Investment Company Act of 1940 and cannot be an SEC-reporting company. “Blank check” companies formed for unspecified purposes or to acquire other companies cannot make offerings under Regulation CF. Additionally, the exemption is not available to any issuer that is disqualified by reason of the bad actor disqualification, or if the issuer (or any entities controlled by or under common control with the issuer) has previously offered securities under Regulation CF and failed to file its ongoing reports with the SEC.

Many commentators urged the SEC to allow issuers to be able to issue securities using single purpose funds. This would avoid the “messy cap table” problem identified by some angel and venture capital investors who do not want to have to deal with numerous small investors in a company. However, the SEC declined to create such an exemption, citing Congressional intent and the language of the statute, which specifically excludes investment companies from being able to rely on Section 4(a)(6).

When determining issuer eligibility for funds to be raised and financial statements requirements, the SEC has clarified the language contained in the statutory text of Section 4(a)(6) that the definition of issuer includes all entities controlled by or under common control with the issuer and any predecessors of the issuer. For example, a single real estate developer that is raising funds for multiple issuers is subject to a 12-month cap of $1 million raised under Regulation CF aggregated across all issuing companies. Additionally, if an issuer controlled by that developer had made a previous offering under Regulation CF, then all future offerings in any company controlled by the
developer more than $500,000 would be required to include audited financial statements.

The definition of common control may also have an impact on franchisees. If the franchise agreement controls the issuer and all other franchisees (i.e., has the power to direct or cause the direction of the management and policies of the entity), then all franchisees would be aggregated together when determining amounts offered and sold under Regulation CF and the financial statements to be required.

Disclosure

The SEC requires that issuers provide certain information to investors through the intermediaries’ platforms and to the SEC directly via a filing of Form C on EDGAR, the SEC’s data handling system. Form C will consist of XML-fillable fields in the front portion of the Form and then “Exhibits” which will include the rest of the information required to be filed. Some information is mandatory, but the issuer may include other information in the Form. The mandatory information for each issuer includes:

  • The name, legal status (i.e., form, state, and date of organization), physical address, and website address.
  • The names of the directors and officers (and any persons occupying a similar status or performing a similar function), the positions and offices held by those persons, how long they have served in those positions, and the business experience of those persons over the past three years.
  • The name of each person who is a beneficial owner of 20% or more of the issuer’s outstanding voting equity securities. These are the same shareholders covered by the “Bad Actor” disqualification provisions discussed below.
  • A description of the business of the issuer and anticipated plan of business.
  • The current number of employees of the issuer.
  • A discussion of the material risk factors that make an investment in the issuer speculative or risky.
  • The target offering amount and the deadline to reach the target amount, including a statement that if the sum of the investment commitments does not equal or exceed the target offering amount at the offering deadline, no securities will be sold in the offering, investment commitments will be cancelled and committed funds will be returned.
  • Statement with respect to whether the issuer will accept investment in excess of the target amount and the maximum it will it accept. If the issuer accepts investments above the stated target, it must state the method it will use to allocate oversubscriptions.
  • A description of the purpose and intended use of the offering proceeds. The SEC elaborates that it expects issuers to provide a detailed description of the intended use of proceeds with enough information to allow investors to understand how the offering proceeds will be used. If an issuer is uncertain how the proceeds will be used, it should identify the probable uses and the factors impacting the selection of each use. Similarly, if the issuer accepts proceeds above the target amount, it should indicate the purpose and intended use of those excess funds.
  • A description of the process to complete the transaction or to cancel an investment commitment.
  • The price of the securities or the method for determining the price. If the issuer has not set a price at start of the campaign, it must provide a final price prior to any sale of securities.

A description of the ownership and capital structure of the issuer. This requirement also includes:

  • Disclosure of the terms of the securities being offered as well as each other class of security of the issuer;
  • Any rights held by principal shareholders;
  • Name and ownership level of any 20% beneficial owner;
  • How the securities being offered are valued and how the securities may be valued in the future;
  • Risks to purchasers of the securities relating to minority ownership and the risks associated with corporate actions like the additional issuance of shares, issuer repurchases, and the sale of the issuer or issuer assets to related parties; and
  • Description of the restrictions on the transfer or the securities.
  • The name, SEC file number and Central Registration Depository number of the intermediary conducting the offering.
  • A description of the intermediary’s financial interests in the issuer’s transaction, including the amount of compensation paid to the intermediary for conducting the offering and the amount of any referral or other fees associated with the offering.
  • A description of the material terms of any indebtedness of the issuer. Material terms include the amount, interest rate, maturity date, and any other terms a purchaser would deem material.
  • A description of any exempt offering conducted within the past three years. The description should include the date of the offering, the offering exemption relied upon, the type of securities offered, the amount of securities sold, and the use of proceeds.
  • A description of any completed or proposed transaction involving the issuer or any entity under common control with the issue for value exceeding five percent of the amount raised under Section 4(a)(6) within the past 12 months, including the current offering, when a control person, promoter, or family member had a direct or indirect material interest.
  • A description of the financial condition of the issuer, including discussion of liquidity, capital resources, and historical results of operations covering each period for which financial statements are provided.
  • The tax information and financial statements certified by the principal executive officer, reviewed financial statements, or audited financial statements of the issuer, depending on the level of the raise and raises within the previous 12 months, or whether this is the first offering of the issuer under Regulation CF.
  • A description of any events that would have triggered disqualification under the Bad Actor disqualification had they occurred after the effective date of the final rule.
  • Updates on progress towards meeting the target offering amount.
  • A statement regarding where on the issuer’s website investors will be able to find the issuer’s annual report, and the date by which the annual report will be available.
  • A statement regarding whether the issuer or any of its predecessors failed to comply with the ongoing reporting requirements of Regulation CF.
  • Any other material information necessary to make previous statements not misleading.

Other than the information about the issuer that is required to be entered the XML portion of the Form C (which is covers things like name, address, size of offering, etc.), the SEC does not specify the format or medium in which the mandatory disclosure must be presented, leaving flexibility for crowdfunding issuers to present some information in written offering documents, some in videos, and other information by graphic means.

In response to suggestions made in the comment process, the SEC includes an optional Question and Answer (“Q&A”) format that an issuer can follow to provide the mandatory disclosure not covered by the XML portion of the Form. While this might assist some issuers, who have not sought professional advice to make sure that they do not miss any important items, the Q&A itself is quite technical, and uses securities concepts such as “beneficial owner” and “material terms of outstanding classes of securities” which may be confusing to non-lawyers.

All information about an offering posted on an intermediary’s site must be filed with the SEC via its electronic EDGAR data-handling system. The wording of the SEC’s original proposals suggested that while the mandatory disclosure would have to be filed on Form C, it might be possible to post on the intermediary’s website additional information that did not have to be filed. The SEC has made it clear that this is not the case. Online offerings, currently normally made in reliance on the exemption from registration provided by Regulation D, use a variety of offering materials, including offering memoranda, slide decks, videos and other materials. All these will need to be filed, but the SEC has made that process easier by permitting the filing of data in PDF format (not permitted in other types of SEC filing). Video and audio cannot be filed through EDGAR; a transcript must be filed instead. Not only must all these optional materials be filed, but the issuer (and in some circumstances the intermediary, as discussed in “Liability” below) is liable for any misstatements made in them.

Financial statements

Issuers of securities under Regulation CF are required to provide financial statements prepared in accordance with US Generally Accepted Accounting Practices (U.S. GAAP) covering the two most recently completed fiscal years (or shorter period since inception). The type of review that these financial statements have to undergo depends on the amount sought, the amount of securities that the issuer has already sold in reliance on Regulation CF in the preceding 12 months, and whether the issuer has previously sold securities in an offering under Regulation CF:

  • If current offer plus previous raises amount to $100,000 or less, the financial statements must be certified by the principal executive officer and accompanied by information from the company’s tax returns (but not the tax returns themselves).
  • If current offer plus previous raises amount to $100-500,000, the financial statements will be required to be reviewed by a CPA.
  • If current offer plus previous raises amount to $500,000 or more, the financial statements must be audited by a CPA. However, if the issuer has not previously sold securities under Regulation CF, the financial statements will only be required to be reviewed by a CPA.

The financial statements are not permitted to be more than 18 months old. If more than 120 days has passed since the end of the most recently-ended fiscal year, the issuer will have to produce financial statements for that most recent year, but until that point could use financial statements from the preceding year. No interim financials are required. The review standards to be used by the accountant are the Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. While there has been widespread applause at the more flexible position taken by the SEC in the final rules with respect to audit requirements, issuers should realize that the review process is a substantive one and that if they have been using simple financial statement software like QuickBooks, the reviewing CPA is likely to require them to revise, reformat and expand their financial statements to meet GAAP requirements. One issue that startups with revenue should pay attention to is their revenue recognition policies.

The SEC does not exempt very early-stage companies from these requirements. The SEC reiterated its position in the Proposing Release that “financial statements prepared in accordance with U.S. GAAP are generally self-scaling to the size and complexity of the issuer, which reduces the burden of preparing financial statements for many early stage issuers.” Thus, even companies at the business plan stage seeking $500,000 would have to produce financial statements reviewed by a CPA.

Issuer Filing Requirements and Form C

The Form C must be filed and made public prior to the start of the offering. This means that no “exclusive first look,” either by the issuer or any intermediary, will be permitted. All potential investors must have access to the offering at the same time. Regulation CF creates a new XML-based fillable form, Form C, for use in allowing issuers to provide required information. There are several variants of Form C:

  • Form C: used for the original offering statement to provide the required disclosures.
  • Form C/A: used for amendments to a previously filed Form C.
  • Form C-U: used by issuers at the end of the offering to disclose the total amount of securities sold.
  • Form C-AR: used by issuers to provide the required annual reports.
  • Form C-AR/A: used for amendments to a previously filed Form C-AR.
  • Form C-TR: used by issuers who are terminating their reporting.

Form C will be used for the provision of some of the mandatory information in XML format, with other required disclosures being submitted as an attachment to Form C. Those attachments can be in PDF form, which is a new and very welcome development for the EDGAR filing process. (The attachments can also be in “EDGAR HTML” or ASCII.) As discussed above, so long as all the mandatory information is filed and presented to investors, the media used to present that disclosure are not specified by the SEC.

When information is presented in the form of video, the text of the video script must be filed; the EDGAR system does not handle video files.

Regulation CF requires issuers to file Form C with the SEC via EDGAR, as well as providing the Form C to the intermediary, investors, and potential investors; however, it allows issuers to satisfy this latter requirement by providing the intermediary with a copy of the disclosures provided to the SEC and directing investors to the intermediary via email or the issuer’s website. To file a Form C the issuer must have EDGAR filing codes and a Central Index Key (CIK) code. If an issuer does not already have these codes it can obtain them from the SEC. The issuer may also work with an intermediary to prepare the disclosures and have the intermediary submit the Form C.

The SEC does not review, comment on or in any way approve the disclosure. It would be foolish, however, to assume that the SEC will not read information that is on EDGAR. An investor protection agency cannot be expected to look the other way if it sees information that it finds troubling, and issuers should operate on the assumption that the SEC staff and the state regulatory authorities will be scouring the Forms C that are filed for potentially misleading statements.

Ongoing disclosure requirements

Issuers that have sold securities in reliance on Section 4(a)(6) must file information with the SEC and post it on their websites on an annual basis. The annual filing must be made within 120 days of the issuer’s fiscal year-end. The information included in the annual report is like that required in the initial filing, except that, in response to numerous objections to the burden of ongoing reporting as originally proposed, no accountants’ audit or review of the financial statements will be necessary.

Regulation CF provides for five ways in which a company can cease filing ongoing reports with the SEC. Annual filing requirements continue until:

  • The issuer becomes a fully-reporting registrant with the SEC;
  • The issuer has filed at least one annual report, but has no more than 300 shareholders of record;
  • The issuer has filed at least three annual reports, and has no more than $10 million in assets;
  • The issuer or another party purchase or repurchases all the securities sold in reliance on Section 4(a)(6); or
  • The issuer ceases to do business.

The ability for an issuer to cease filing if it has 300 or fewer holders of record, or assets not exceeding $10 million, is a modification from the proposed rule. These changes mitigate some of the compliance cost for small companies that have issued securities under Regulation CF, as does the elimination of the requirements for CPA review or audit.

Advertising and publicity

Pursuant to Section 4A(b)(2) of the Securities Act, an issuer may “not advertise the terms of the of the offering, except for notices which direct investors to the funding portal or broker.” Under the new rules, an issuer and any person acting on behalf of the issuer may publish a limited notice (sometimes called a “tombstone”) that advertises the terms of an offering so long as the notice includes the address of the intermediary’s platform on which information about the issuer and offering may be found. While acknowledging that the statute restricts the ability of potential issuers to advertise, the SEC has explained that restrictions on advertising the terms of the offering are meant to direct the investors to the intermediary’s platform. Once at the intermediary platform, the investors will have access to the information that will allow them to make an informed decision about the offering. Under the rules, a notice advertising the terms of an offering may contain no more than the following (it can contain less):

  • A statement that the issuer is conducting an offering, the name of the intermediary conducting the offering and a link to the intermediary’s platform;
  • The terms of the offering (the amount of the securities being offered, the nature of the securities, the price of the securities, and the closing date of the offering period); and
  • Information about the legal identity and the business location of the issuer. This information is limited to the name of the issuer of the security, the address, phone number and the website of the issuer, an email address for a representative of the issuer, and a brief description of the issuer’s business.

The rules do not place restrictions on how the issuer distributes these notices, the format of the notice, or its medium. Issuers can use social media, audio, video or street theater, so long as only the permitted content is included. An issuer could place these notices on various social media sites to attract potential investors and the notice would direct them to the intermediary page where they could access the information necessary to make an informed investment decision.

No other public communications about the offering are permitted. Posts on Facebook, tweets on Twitter, LinkedIn updates and the like that do not follow these limitations would all likely result in the issuer’s violation of Section 5 of the Securities Act.

Under the rules, an issuer can communicate with investors and potential investors about the terms of the offering through communication channels provided by the intermediary through its platform, so long as the issuer identifies itself as the issuer in all communications. Anyone acting on behalf of the issuer must identify their affiliation with the issuer on all communications on the intermediary’s platform. The SEC has clarified that the restrictions apply only to persons acting on behalf of the issuer. If a person whose only connection to the issuer was that she loved the company’s product were to tweet that she intended to invest because the company was sure to succeed, this would be unlikely to be a problem for the issuer.

Issuers may engage third-parties to promote the offering in two contexts – through the communication channels provided by the intermediary, and through tombstone notices.
Intermediaries are required to create communication channels on their platforms to facilitate discussion between prospective investors and the issuer (see below). Regulation CF anticipates instances where the issuer will have paid a promoter to respond to investors through those communication channels. In that situation, such compensation must be disclosed by the promoter with any communication on the platform. The second context involves payments to third-parties for publishing tombstone notices that direct to the intermediary’s offering page.

Regulation CF states that an issuer may not pay a third party to do what it cannot do itself. Paid promoters should consider whether the disclosure requirements of Section 17(b) of the Securities Act apply to them. An issuer would not be prohibited from disseminating other information about the company in the normal course of its business that does not relate to the terms of the offering, such as general business advertising.

Requirements for intermediaries

The following requirements apply to both broker-dealers and funding platforms; funding platforms will be subject to some limitations on their activities discussed in “Special limitations on funding portals” below.

Registration

A person acting as an intermediary in a transaction involving the sales of securities for someone else pursuant to Section 4(a)(6) must:

  • Register with the SEC as a broker or as a funding portal. Regulation CF creates a streamlined registration process for funding portals. Non-U.S. funding portals are only being allowed to register with the SEC if the funding portal is based in a jurisdiction that has an information sharing agreement with the SEC, and the funding portal is registered in that jurisdiction.
  • Register with a self-regulatory organization, or SRO (the only eligible SRO at present being FINRA).

Obligations with respect to fraud prevention and compliance

The statute requires intermediaries to take risks to reduce the risk of fraud, and Regulation CF requires intermediaries to take positive action in several areas: Intermediaries must have a “reasonable basis for believing” that the issuer has met the disclosure and process requirements described below. An intermediary may rely on issuer representations to form that reasonable basis for belief. However, the SEC emphasized that an intermediary has a responsibility to assess whether reliance on representations is reasonable, given its course of interactions with potential issuers. This means that the representation must be detailed enough to evidence a reasonable awareness by the issuer of its obligations and its ability to comply with those obligations. As a result, this requirement cannot be met with a simple representation (“checking the box”) that the issuer has complied with Regulation CF, but requires an inquiry into the issuer and the steps it has taken to comply with Regulation CF.

Intermediaries must have a “reasonable basis for belief” that the issuer has established a way to keep accurate records of the holders of securities. Similarly, with the reasonable basis for belief as to issuer compliance, the SEC provides that an intermediary may accept representations from an issuer that it has established a means to keep track of securityholders. However, any such representation from the issuer must detail record keeping functions such as:

  • Monitoring the issuance of securities through the intermediary’s platform;
  • Maintaining a master security holder list;
  • Maintaining a transfer journal or other such log;
  • Effecting the exchange or conversion of any securities;
  • Maintaining a control book demonstrating historical registration of those securities; and
  • Countersigning and legending physical certificates.
  • If the issuer has engaged a registered transfer agent, the intermediary will be deemed to have met the requirement of establishing a reasonable basis for belief.

The intermediary must deny access to its platform if it has a reasonable basis to believe that any specified person is subject to a “Bad Actor” disqualification. This requirement is tied to the statutory mandate under Section 4A(a)(5) of the Securities Act that an intermediary conduct a background and securities enforcement regulatory history check on the issuer and its covered persons. To meet this requirement, the intermediary must conduct these checks on the issuer, predecessors of the issuer, officers and directors (or any person occupying a similar status or performing a similar function), and any 20 percent beneficial owner of the issuer.

The intermediary must deny access to its platform if it has a reasonable basis to believe that the issuer or the offering presents the potential for fraud or otherwise raises concerns about investor protection. Here, the intermediary must be able to adequately and effectively assess the risk of fraud from the issuer or its offering and may not ignore facts about the issuer that indicate fraud or investor protection concerns. If it cannot adequately assess the issuer or resolve concerns, the intermediary must deny access to its platform. This may occur, for example, where an issuer’s directors are foreign nationals whose country of origin does not allow for third parties to review criminal or regulatory enforcement background information. If it becomes aware of the potential for fraud after granting access to its platform, it must cancel the offering. The SEC does not further define what constitutes “concerns about investor protection,” and creates some ambiguity as to what is required of intermediaries.

Opening of investor accounts

An intermediary may not accept any investment commitment from investors in a transaction under Regulation CF, until that investor has opened an account with the intermediary and consented to electronic delivery of materials. The SEC does not specify the exact information that the intermediary must obtain from an investor and leaves it to intermediaries to determine what they will require for business purposes and compliance purposes. The requirements that investors consent to electronic delivery of information is important for the functioning of securities crowdfunding. As almost all activity related to the offering and ongoing reporting will be delivered electronically via email, by being directed to a URL, and through the intermediary’s portal, investors are required to consent to such delivery of information in lieu of paper mailings.

Notices regarding promoters of the issuer

At the time that an investor opens an account with an intermediary, the intermediary must inform the investor that anyone who promotes an offering in exchange for compensation, or who is a founder or an employee of an issuer promoting the issuer through the communication channels on the platform must disclose the fact that he or she is engaging in promotional activities on behalf of the issuer. The SEC believes this requirement will assist investors by alerting them at the outset about the promotional activities of issuers or representatives of issuers.

Compensation disclosure

An additional notice requirement for intermediaries when establishing an account for an investor includes disclosure of the way they will be compensated in connection with offerings and sales made in reliance on Section 4(a)(6). For a platform that will accept a range of compensation types from issuers (e.g., flat fee, commission, equity interest, etc.), each type of compensation that it will accept must be disclosed. The SEC determined that this requirement is better suited to the time of an investor’s account opening rather than prior to the point when an investor makes an investment commitment because it will help investors make better-informed decisions when reviewing offerings on the platform.

Provision of educational materials

As part of the statutory requirements for offerings under Section 4(a)(6), intermediaries are required to provide disclosures and investor educational materials. Regulation CF requires these educational materials to be provided to investors at the time they open accounts with intermediaries. Regulation CF further requires that the materials be written in plain language and otherwise designed to communicate effectively specified information. These materials are required to cover:

  • The process for investing on the intermediary’s platform.
  • The risks associated with crowdfunding securities.
  • The types of securities that may be offered on the intermediary’s platform and the risks associated with each, including dilution (note that the intermediary may be deemed not to have met this criterion if an issuer sells a securities product not previously explained in its education materials).
  • Restrictions on resale.
  • The type of information that an issuer is required to deliver annually, and that such information may cease to be provided in the future.
  • Investor limit amounts.
  • The limitations on an investor’s right to cancel an investment commitment and circumstances in which an issuer may cancel and investment commitment.
  • The need for an investor to consider whether crowdfunding securities are appropriate for him or her.
  • That at the end of the offering, there might not be any ongoing relationship between the issuer and the intermediary.

The circumstances under which an issuer may cease to publish annual reports and the corresponding absence of current financial information about the issuer.
The SEC declined to develop its own investor educational materials for the purpose of this requirement, instead leaving it to each platform to determine the best means to educate their investors. These educational materials must be made continuously available. Should the intermediary make material revisions to its educational materials, it must provide the updated materials to all investors prior to accepting any additional investment commitments or effecting any further transactions.

Acknowledgement of risk

Prior to accepting any investor commitments for any particular offering, Regulation CF requires that intermediaries receive a representation from the investor that the investor has reviewed the educational materials and understands that the entire amount of the investment is at risk and may be lost. Additionally, intermediaries must require investors to complete a questionnaire that demonstrates the investor’s understanding that:

  • There are restrictions on the investor’s ability to cancel an investment commitment and obtain a return of the commitment.
  • It may be difficult to resell securities acquired in an offering of securities under Section 4(a)(6).

Investing in securities sold under Section 4(a)(6) involves risk and that the investor should not invest any funds unless the investor is able to bear the entire loss of the investment. The SEC declined to develop such a questionnaire and instead left it to the discretion of intermediaries. The SEC stated that this flexibility will allow intermediaries to tailor questionnaires to the business and likely investor base of the intermediary. Intermediaries may require additional information in these questionnaires, such as information concerning the investor’s level of investment experience, where the investor acquired any information about the offering, and the percentage of the investors liquid net worth represented by the proposed investment.

Whatever format the process may take, the intermediary will be required to receive the representation and questionnaire responses from the investor each time an investor makes an investment commitment even if the investor has previously made investments through the intermediary. Requirements for intermediaries with respect to transactions The SEC sets out the methods by which an intermediary must comply with the statutory requirements for managing offerings taking place under Section 4(a)(6) in in Rules 303 and 304. Intermediary must make issuer information available During the course of an offering, the intermediary must make the issuer’s required disclosure information publicly available on the intermediary’s website. This information must be available for at least 21 days prior to any sale of securities and displayed in a manner that allows for any visitor, including regulators, to access, download, and save. This rule poses compliance challenges for intermediaries. First, it is unclear how an issuer’s amendment to its disclosure information impacts the 21-day availability requirements prior to sale. Second, it is possible an intermediary will be liable for allowing sales to occur if the issuer has not supplied the complete set of information it is required to disclose. As such intermediaries must ensure that issuer’s disclosures are complete. The intermediary is not required to ascertain whether investors have reviewed the disclosure material.

Investor qualifications

Intermediaries are responsible for ensuring an investor stays within the annual investment limit. To comply with this requirement, intermediaries must have a reasonable basis for believing that the investor satisfies his or her annual investment limit. An intermediary may rely on investor representations concerning the investor’s annual income, net worth, and the amount of the investor’s other investments made under Section 4(a)(6). Additionally, for each transaction, intermediaries are required to obtain a representation from an investor that the investor has reviewed the educational materials and require the investor to complete a questionnaire covering the restrictions on the ability of the investor to cancel the investment commitment, the limitations on resale of securities, and the riskiness of transactions under Section 4(a)(6).

Communication channels for issuers and investors

Regulation CF is designed on the premise that crowdfunding requires the crowd to be able to communicate with each other and with the issuer to evaluate the investment opportunity. As such, the final rules require that the intermediary establish communication channels on the intermediary’s platform to provide a centralized and transparent means for members of public to asset the investment offering. Specifically, the intermediary must:

  • Permit public access to view the discussions made in the communication channels;
  • Restrict posting of comments to those persons who have opened an account with the intermediary on its platform;
  • Require that any person posting a comment in the communication channels clearly and prominently disclose with each posting whether he or she is a founder or an employee of an issuer engaging in promotional activities on behalf of the issuer, or is otherwise compensated, whether in the past or prospectively, to promote the issuer’s offering; and

If a funding portal, not participate in the communications other than to establish guidelines for communications and remove abusive or potentially fraudulent communication. The SEC leaves open to intermediaries whether to allow their registered users to post under their real names or under aliases. Either choice will affect the quality of communications presented. For example, real names might limit participation, but aliases could encourage inaccurate or abusive posts. Other considerations for intermediaries when establishing communication channels include objective enforcement of communications. For instance, promotion of a positive comment or removal of a negative comment that is not abusive may be considered the provision of investment advice.

Providing notices to prospective purchasers

Upon receipt of an investment commitment, the intermediary must provide the investor with a notification disclosing:

  • The dollar amount of the investment commitment;
  • The price of the securities, if known;
  • The name of the issuer; and
  • The date and time by which the investor may cancel the investment.

 

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