Cutting Edge Capital Applauds Today’s SEC Release
Regarding Title III JOBS Act Crowdfunding …Direct Public Offerings!
The Securities and Exchange Commission’s announcement today was monumental – but not for the reasons most people had been anticipating.
While the final rules are now out for Title III of the JOBS Act regarding crowdfunding, Cutting Edge Capital was most excited to see that the Commission has also proposed new amendments for Intrastate and Regional Securities offerings!
The proposal is to increase the aggregate amount of money that may be offered and sold for Direct Public Offerings using the federal exemption from $1 million to $5 million and apply bad actor disqualifications to this Rule 504 offerings to provide additional investor protection.
Highlights of the Proposed Amendments to Rule 147
The SEC has proposed modernizing Rule 147 to permit companies to raise money from investors within their state without concurrently registering the offers and sales at the federal level. The proposed amendments to Rule 147 would:
- Eliminate the restriction on offers, while continuing to require that sales be made only to residents of the issuer’s state or territory.
- Refine what it means to be an intrastate offering and ease some of the issuer eligibility requirements in the current rule.
- Limit the availability of the exemption to offerings that are registered in-state or conducted under an exemption from state law registration that limits the amount of securities an issuer may sell to no more than $5 million in a 12-month period and imposes an investment limitation on investors.
Highlights of the Proposed Amendments to Rule 504
The proposed amendments to Rule 504 of Regulation D would increase the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million and disqualify certain bad actors from participation in Rule 504 offerings.
The Commission will seek public comment on the proposed rules for 60 days. The Commission will then review the comments and determine whether to adopt the proposed rules.
Needless to say, Cutting Edge Capital will be supporting the Commission’s efforts to “assist smaller companies with capital formation consistent with its investor protection mission.”
JOBS Act – Crowdfunding
The SEC also finally adopted all of the major final rules via Title III of the JOBS Act.
These new rules create a federal exemption under the securities laws so that 6 months from now, companies can offer and sell securities on approved crowdfunding platforms to raise a maximum aggregate amount of $1 million in a 12-month period. A company must conduct its offering exclusively through one intermediary platform at a time.
Cutting Edge Capital’s DPO Lab will be offered to companies that need state-of-the art tools to best prepare for creating their own offerings.
Also, the SEC will now permit individuals to invest in securities-based crowdfunding transactions on a federal level via approved platforms or through registered broker dealers, but subject to certain investment limits.
For example, individuals who have annual income or a net worth of less than $100,000 will be limited to an investment of $2,000 or 5% of the lesser of their annual income or net worth. If an individual investor’s annual income and net worth are equal to or more than $100,000, the limit will be 10% of the lesser of their annual income or net worth. However, during a 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
Note – How these limitations will be enforced, and who will be obligated to ensure these individuals do not exceed their limits will be left for the soon-to-be published rules, and FINRA to determine.
Disclosure by Companies
The new JOBS Act rules impose specific disclosure requirements on issuers for certain information about their business and the securities offering. Companies will be required to file certain information with the Commission and provide this information to investors and the intermediary facilitating the offering.
These disclosures are fairly typical of what any securities offering should have, including:
- A description of the business and the use of proceeds from the offering;
- Information about officers and directors as well as owners of 20 percent or more of the company;
- The price, the method for determining the price, 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 discussion of the company’s financial condition;
- Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor.
- A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements, unless financial statements of the company are available that have been audited by an independent auditor;
In addition, companies relying on the crowdfunding exemption would be required to file an annual report with the Commission and provide it to investors.
Note – The SEC has set a “reviewed” audited financial statement requirement here for first time filers. While this is not as onerous or expensive as having to file audited financials at first, it is certainly not the same as having to file “compiled” financials. There will still be significant costs to have reviewed financials created. Also, the cost of preparing for and filing annual reports with the SEC is still unknown at this point.
A funding portal (i.e. “intermediary”) will need to be registered with the Commission, and become a member FINRA.
The SEC rules require intermediaries to:
- Provide investors with educational materials that explain, among other things, the process for investing on the platform, the types of securities being offered and information a company must provide to investors, resale restrictions, and investment limits;
- Take “certain measures” to reduce the risk of fraud, including having a reasonable basis for believing that a company complies with Regulation Crowdfunding and that the company has established means to keep accurate records of securities holders;
- Make information that a company is required to disclose available to the public on its platform throughout the offering period and for a minimum of 21 days before any security may be sold in the offering;
- Provide communication channels to permit discussions about offerings on the platform;
- Provide disclosure to investors about the compensation the intermediary receives;
- Accept an investment commitment from an investor only after that investor has opened an account;
- Have a “reasonable basis” for believing an investor complies with the investment limitations;
- Provide investors notices once they have made investment commitments and confirmations at or before completion of a transaction;
- Comply with maintenance and transmission of funds requirements; and
- Comply with completion, cancellation and reconfirmation of offerings requirements.
The rules also prohibit intermediaries from engaging in certain activities, such as:
- Providing access to their platforms to companies that they have a reasonable basis for believing have the potential for fraud or other investor protection concerns;
- Having a financial interest in a company that is offering or selling securities on its platform unless the intermediary receives the financial interest as compensation for the services, subject to certain conditions;
- Compensating any person for providing the intermediary with personally identifiable information of any investor or potential investor;
- Offering investment advice or making recommendations;
- Soliciting purchases, sales or offers to buy securities;
- Compensating promoters and other persons for solicitations or based on the sale of securities; and
- Holding, possessing, or handling investor funds or securities.
Note – How an intermediary platform will meet the FINRA standards for all of these requirements will be interesting. For example, how an intermediary will “take measures to reduce the risk of fraud,” provide communication channels, disclosures, meeting the “reasonable basis” regarding the investor limits, and even maintaining certain books and records related to their transactions and business, all will make for an interesting new FINRA regulatory role.
FINRA is currently the regulator for most all exchanges and broker dealers in the U.S. and anyone familiar with FINRA knows that regulation can be a significant issue in terms of compliance, policies, procedures, communications channel oversight, and staffing. And following FINRA audits and reviews, fines will likely become a significant issue should a platform be found to not be in compliance. An intermediary will need to ensure that they are receiving enough compensation from every transaction to afford to be regulated by FINRA, and this will make for interesting financial dynamics.
 Those final rules and forms will become effective 180 days after they are soon to be published in the Federal Register.
 The forms enabling funding portals to register with the Commission will be effective Jan. 29, 2016.
YES! illustration by Jennifer Luxton.
Two recent publications show the significant disparity in how people are thinking about fixes to the capital system. Each has great merit, but the differences in scope and focus say a lot about how much attention and funds go toward the uber-financialized economy (the one where all the very big pools of newly printed dollars continues to flow), and why more attention needs to be drawn toward the other economy – the one that the rest of us live and play in.
I had been anxiously awaiting the recently released UNEP Inquiry’s global report, “The Financial System We Need: Aligning the Financial System with Sustainable Development” that was launched 8th October in Lima on the occasion of the IMF/World Bank Annual meetings. The thesis of this report is that the “heartland” of the global economy (i.e. the financial system) can evolve to serve its “core purpose of growing and sustaining the real economy.”
The release of this 112 page report summarizes its 3 key findings:
– A ‘quiet revolution’ is underway as financial policymakers and regulators take steps to integrate sustainable development considerations into financial systems to make them fit for the 21st century.
– Momentum is building and is largely driven by developing and emerging nations including Bangladesh, Brazil, China, Kenya, and Peru, with developed country champions including France and the UK.
– Amplifying these experiences through national and international action could channel private capital to finance the transition to an inclusive, green economy and support the realization of the Sustainable Development Goals.
This Report does a credible job of focusing on the very important goals needed in the attempt to harness or govern the uber-financialized system toward a more sustainable path, toward less destruction of the planet, less devastation of our natural resources, and outlining an attempt to reign in the faster growing wealth and income disparities that continue to produce more poverty, ill health and societal ills. However, I was also disappointed that the scope of this Report paid little or no attention to the re-establishment of a capital market structure for the vast majority of companies, and for almost all individuals that could participate in helping to fund those companies.
Earlier this year I had been contacted by Mr. Simon Zadek, one of the three individuals primarily involved in this report, and we discussed its framework and whether there was anything I could contribute. Having come from the world of regulating several U.S. stock exchanges, and teaching a course on capital markets at one of the sustainable MBA graduate schools for many years, Mr. Zadek was hopeful that I might have a particular view that could be helpful to this report.
What we both discovered during out conversations, however, was that the focus on this upcoming report had little to do with what we at Cutting Edge Capital are doing – i.e. working to build healthy resilient capital markets for everyone to participate in; capital markets that can help smaller companies raise funds from all types of investors who currently see few to no options to fund companies that they feel connected to either by geography, community, or some other meaningful affiliation.
And then there is this new article by Keith Harrington, “Patient Finance: Why Slower Money Is the Key to a Real Economic Recovery.” One sentence (among many) in this article stands out to me. Mr. Harrington first shows a keen grasp of the capital markets that attract the vast majority of attention (and large funding dollars to study), and explains well why we continue to be bested by this system that is built for speed and crashes, and then states, “[b]ut one thing is for certain: If we don’t find a way to shift our increasingly financialized economy to stable ground, the next big crash is inevitable.”
He refers here to the very same lack of attention that I encountered with those writing the UNEP Report. Much is made of how we might begin to bring additional measures and actions to bear to make more transparent how the one capital market might make itself more “sustainable,” whatever you take that to mean. But why not also provide a well-funded report on how a new economy, or as Mr. Harrington states, a “new financial landscape” is beginning to take hold.
As one of the proud members of Mr. Harrington’s “checkerboard revolutionaries,” I continue to be amazed at this discrepancy of attention, but we revolutionaries will not be dissuaded by this lack of notice. It is understandable that so much time, focus and funds are spent on a massive economic system fueled by funds that flow as if created almost magically out of thin air. But those funds do very little to touch us in our communities and in our relationships with each other. That one massive capital market system seems almost mythical in its proportions and in the equally massive wealth it creates for just a few. For the rest of us, however, it would seem that we are left to our own devices for building this new economy. And build we will, because the one we are creating is the Community Capital Market that truly impacts us. It is the one we can participate in and know we can make a difference by supporting each other and the communities we identify with.
Viva la Community Capital Revolution!