Since President Obama signed the JOBS Act into law on April 5, 2012, we have been waiting for the SEC to finalize the rules on Crowdfunding, which has the potential to change investing as we know it.
The SEC finally acted, at least on one of the two components of Crowdfunding. Sometime in mid-September, companies will be allowed to use “general solicitation” in certain “Rule 506 offerings.” This means that companies raising money will be allowed to advertise (e.g., in newspapers or on Facebook), something that has never been allowed before. The rules governing the other component of Crowdfunding, where small issuers will be allowed to raise money through Internet portals from small, unsophisticated investors, will have to wait for later in the year.
Even so, these new regulations mark the largest change to the securities laws in almost 80 years. Companies will now be allowed to raise money from accredited investors (in the case of individuals, those with over $1 million of net worth or incomes over $200,000 per year) through social media, print materials, email, and other means. Not only will companies have greater access to the capital they need, but the new rules are likely to significantly disrupt the money-raising industry, displacing brokers, lawyers, and other middlemen just as the Internet has displaced so many middlemen before them.
Now the technical rules.
The rules allow general solicitation and general advertising where:
- All purchasers are accredited investors; and
- The company takes reasonable steps to verify that the purchasers are accredited investors; and
- All of the requirements in Rule 501 and Rule 502(a) and (d) are satisfied.
Whether the company has taken “reasonable steps” will be determined on a case-by-case basis. Among the relevant factors:
- The type of accredited investor that the purchaser claims to be (e.g., the CEO of a Fortune 100 company or a store clerk).
- The amount and type of information that the issuer has about the purchaser.
- The nature of the offering, including the manner of the solicitation.
When the regulations were proposed last August, many people complained about the absence of hard-and-fast rules and the resulting ambiguity. The final rules take a large step in the direction of certainty by providing that a company will be considered to have taken reasonable steps to verify that a natural person is an accredited investor if it does any of the following:
- If basing the decision on the purchaser’s net income:
- Reviews W-2s, 1099s, or other IRS documents that report the person’s income for the past two years; and
- Obtains a written representation that the person reasonably expects to reach the income level required to qualify as an accredited investor in the current year.
- If basing the decision on the purchaser’s net worth:
- Reviews one or more of certain types of documents dated within the past three months, including bank statements, brokerage statements, tax assessments, and a report from one of the national consumer reporting agencies concerning liabilities; and obtains a written representation that the person has disclosed all liabilities necessary to make a net worth determination; or
- Obtains a written representation from certain third parties, including registered broker-dealers or investment advisors, that they have taken reasonable steps to verify the person's accredited investor status within the past three months and have determined that the person is an accredited investor; or
- Permits existing security-holders who had acquired issuer securities in a previous Rule 506 offering and had qualified as accredited investors at that time to certify his or her accredited investor status at the time of the sale.
These steps are neither exclusive nor mandatory. The final rules also discuss other factors and procedures.
In addition to taking reasonable steps to verify that purchasers are accredited, the company must also have a reasonable belief that they are accredited. This has always been part of Rule 506 and was not changed by the JOBS Act.
NOTE: These new rules offer enormous opportunities for entrepreneurs seeking to raise money for their existing businesses or start new businesses. Please contact Mark Roderick or Bill Skinner if you would like to discuss your idea.
Stay up-to-date on news and links to important information pertaining to the JOBS Act and Crowdfunding by reading Mark Roderick's Crowdfunding blog. This legal alert, "SEC Finalizes 'General Solicitation' Regulations: Full Steam Ahead," along with updates, also can be found on his blog.