SEC Proposes Crowdfunding Rules

Investment Management Update

Date: October 29, 2013

The Jumpstart Our Business Startups Act (JOBS Act), enacted in April 2012, added new Section 4(a)(6) (Exemption) under the Securities Act of 1933, as amended (Act), to exempt issuers in crowdfunding transactions from the Act’s registration requirements provided they satisfy certain requirements as further discussed below. In SEC Releases No. 33-9470 and 34-70741 (Crowdfunding), the U.S. Securities and Exchange Commission (SEC) on October 23, 2013 issued proposed rules designed to help issuers and investors determine the applicable limitations on capital raised and individual investments in reliance on the Exemption (Proposed Rules). The Proposed Rules also would provide a framework for regulating registered funding portals and brokers that issuers are required to use as intermediaries to offer and sell securities in reliance on the Exemption. In addition, the Proposed Rules would exempt securities sold pursuant to Section 4(a)(6) from the registration requirements of Section 12(g) of the Securities Exchange Act of 1934, as amended.

Fundraising Limitation

The Exemption permits issuers to raise $1 million per year from non-accredited investors in any 12-month period without registering.1 The Proposed Rules require that any capital raised in reliance on the Exemption be counted toward the limitation; however, amounts raised through other means would not count toward the limitation. The Proposed Rules also establish a limit on the aggregate amount of securities sold to any investor by an issuer, including any amount sold in reliance on the Exemption during the 12-month period preceding the date of such transaction. The aggregate amount of securities cannot exceed:

  • $2,000 or 5 percent of the greater of the investor’s annual income or net worth, if both are less than $100,000; or
  • If either the investor’s annual income or net worth equals or exceeds $100,000, then the aggregate amount shall not exceed 10 percent of the annual income or net worth, whichever is greater, but not to exceed $100,000.

An investor’s annual net income or net worth may be calculated jointly with the income and/or net worth of the investor’s spouse. However, unlike the newly implemented rules regarding general solicitation under Rule 506, the Proposed Rules do not require issuers to verify the income levels and net worth of investors in crowdfunding. Issuers may instead rely on a determination made by an intermediary on whether an investor’s purchase of securities will cause the investor to exceed the limits. However, if relying on an intermediary’s determination, an issuer must not have knowledge that an investor exceeded, or would exceed, the investor limits by purchasing securities in the issuer’s offering. Securities purchased through a crowdfunding exchange will be restricted and subject to the 12-month holding period under Rule 144.

Crowdfunding Exchanges

The Exemption provides that any sale of securities in reliance on Section 4(a)(6) must be “conducted through a broker or funding portal.” The Proposed Rules require that an issuer use only one intermediary to conduct an offering or concurrent offerings in reliance on Section 4(a)(6). The SEC has stated that a single exchange intermediary would help foster the creation of a crowd and better accomplish the purpose of the JOBS Act. Furthermore, allowing an issuer to conduct an offering of securities through multiple intermediaries would create a situation in which information is channeled through numerous sources, creating an inefficient distribution of information amongst the same “crowd.” The Proposed Rules also require that the crowdfunding exchange use an “online-only” platform, allowing the public to access offering information and share information publicly in a way that will allow crowd members to decide whether or not to participate in the offering and fund the business and/or idea.

Disclosure Requirements

The Proposed Rules require an issuer to make certain disclosures regarding its legal status, directors, officers and certain shareholders, and how investors may contact the issuer. Under the Proposed Rules, an issuer would be required to disclose information such as:

  • Its name and legal status, including its form of organization, jurisdiction in which it is organized and date of organization
  • Its physical address and website address
  • The names of the directors and officers (including any persons occupying a similar status or performing a similar function), all positions and offices they hold with the issuer, the period of time for which each has served in the position or office, and his or her business experience during the past three years
  • The names of persons, as of the most recent practicable date, who are beneficial owners of 20 percent or more of the issuer’s outstanding voting equity securities

An issuer is also required to disclose, among other things, information about its business and business plan, the use of proceeds, and the target offering amount and deadline to reach it. The Proposed Rules make clear that the disclosures do not impose specific requirements regarding the issuer’s business, but rather the Exemption provides flexibility, understanding that issuers may be in various stages of development. The Proposed Rules also provide general guidelines regarding disclosures on use of proceeds and the target offering amount and deadline to reach it.

Advertising Prohibition

The Proposed Rules would permit an issuer to publish a notice advertising the terms of the offering so long as the notice includes no more than the following:

  • A statement that the issuer is conducting an offering, the name of the intermediary through which the offering is being conducted and a link directing potential investors to the intermediary’s platform
  • The terms of the offering2
  • Factual information about the legal identity and business location of the issuer
Preventing Fraud

An intermediary is required to take measures to reduce the risk of fraud when conducting an offering of securities in reliance on the Exemption. The Proposed Rules require an intermediary to have a reasonable basis for believing that the issuer seeking to rely on the Exemption is in compliance with relevant regulations and has established means to keep accurate records of holders of the securities it offers. The intermediary is also required to deny access if it believes the issuer or its offering would present a potential for fraud. While the Proposed Rules do not enumerate a list of particular actions that would satisfy an intermediary’s obligations, they permit the intermediary to rely on the issuer’s representations regarding its compliance, absent any actual knowledge to the contrary.3 The Proposed Rules require an intermediary to deny access to its platform if it has a reasonable basis for believing an issuer is subject to a disqualification from the offering in reliance on the Exemption or if it believes the issuer or the offering presents the potential for fraud or otherwise raises concerns regarding investor protection.4 The Proposed Rules also require that an intermediary deny access to an issuer if it believes it cannot adequately or effectively assess the risk of fraud posed by the issuer or its potential offering in reliance on the Exemption.

The SEC is soliciting comments on the Proposed Rules, which must be received on or before the 90th day following publication in the Federal Register.


For more information, please contact:

Richard S. Heller

Shashi N. Khiani


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1Amounts sold by entities controlled by, or under common control with, the issuer, as well as any amounts sold by any predecessor of the issuer, would count toward the limitation.

2Under the Proposed Rules, “terms of the offering” would include the amount of securities offered, the nature of the securities, the price of the securities and the closing date of the offering period.

3An issuer could demonstrate or represent that it has established the necessary recordkeeping by indicating it has capabilities to maintain accurate records of its securities. The intermediary also may be able to establish a reasonable belief, for example, if the issuer has engaged a broker, transfer agent or other third party that can provide the requisite recordkeeping services.

4Intermediaries would be required to conduct a background check on each issuer whose securities are to be offered by the intermediary, as well as on each of its officers, directors and certain shareholders.