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Brian Korn - Equity Crowdfunding Legal Aspect
1. Equity Crowdfunding Legal Landscape:
What’s Allowed and What’s Not
Midwest Crowdfunding
Chicago, Illinois
Brian Korn
November 15, 2013
2. Agenda
• Equity Crowdfunding –
What is it? How does it
compare to other
crowdfunding?
• Legal status of equity
crowdfunding
• SEC Proposed Rules
• New Private Placement
Rules
• Bad Actor
Disqualification
4. JOBS Act Overview
“To increase American job creation and economic growth by improving access to
the public capital markets for emerging growth companies.”
• Crowdfunding – online fundraising…but there’s a catch
• Regulation A+ - from $5mm to $50 mm
• Private Placement Reforms
− General Solicitation relaxed – effective Sept. 23
− Enhanced verification of Accredited Investors if Soliciting
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“Go Public” Shareholder Thresholds Increased
IPO On-Ramp and Emerging Growth Companies
Relaxation on Research Restrictions
Decimalization – move to $.09 tick increments?
Prospective Issuer Outreach
Signed into law April 5, 2012
5. Crowdfunding background
• Comprises Title III of the JOBS Act
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Capital
Raising
Online
While
Deterring
Fraud and
Unethical
NonDisclosure
• Originated from two perceived
needs:
− that smaller retail investors did not
have access to early stage investment
opportunities
− that start-up companies did not have
adequate access to available capital,
particularly online capital raising
• Adds exemption from SEC
registration for crowdfunding
transactions in the form of new
Section 4(6) of the Securities Act
6. Backdrop: Current Crowdfunding
Landscape – Five* Varieties
Type
Equity to
Accredited
Investors
Equity to the
Public
Peer-to-Peer
Lending
*Advertised Private
Placements/Title II
Examples
Kickstarter,
Indiegogo,
Rockethub,
Youcaring
FundersClub,
AngelList, Ourcrowd
???
Lending Club,
Prosper, Zopa (UK)
Private Placements
using advertising and
general solicitation
Securities Reg
Status
Not sales of
“securities”
Sales of securities
to accredited
investors
Sales of
securities to the
general public
Registered
borrower-payment
dependent notes
Exempt private
placements under Rule
506(c)
Regulation
State-level
antifraud only;
not SECregulated
SEC-regulated, noaction letters protect
website solicitations
from being public
offerings
Extensive SEC
regulation;
currently illegal
until SEC rules
are finalized
SEC-registered
securities, not really
crowdfunding;
banking regulations,
not legal in several
states
Extensive SEC
regulation and
proposed regulation;
enhanced investor
verification
Bad Actor
Disqualification
6
Rewards/
DonationBased
Not applicable
Applies for all
issuers and for the
crowdfunding sites
themselves
Not applicable
under JOBS Act,
but SEC has said
it will apply
Not applicable
Yes
7. Public Equity Crowdfunding
Information Regarding the Use of the Crowdfunding Exemption in the JOBS Act
On April 5, 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law. The Act
requires the Commission to adopt rules to implement a new exemption that will allow
crowdfunding. Until then, we are reminding issuers that any offers or sales of securities
purporting to rely on the crowdfunding exemption would be unlawful under the federal securities
laws.
•
Deadline for SEC rulemaking was due December 31, 2012
8. Issuers Not Eligible to Crowdfund
• Non-US companies
• Public reporting companies (only required filers are
excluded, not “voluntary filers”)
• Investment companies, including companies excluded
from the definition of Investment Company by 3(b) or
3(c) of the Investment Company Act of 1940, including:
− Mutual Funds
− Private Equity Funds
− Asset Management Vehicles
− Business Development Companies
9. Crowdfunding vs. Other Exemptions
Feature
Public Crowdfunding
Regulation A+
Regulation D Rule 506 (4(a)(2))
Maximum Total Raised
$1 million per 12 month period
$50 million per 12 month
period
Unlimited
Number of Investors
Investor Disclosure
Required, must be filed with
SEC
Unlimited accredited investors; up to 35
non-accredited investors unless
soliciting
Unrestricted
Unrestricted
Restricted by income/net worth
Unrestricted
Investment Per Investor
Unlimited but subject to
maximum total raised
Required, must be filed
with SEC
Not required if all accredited investors;
Form D filing proposed
Intermediary Required
Yes – broker/dealer or funding
portal
Yes, at least annually, possibly
more frequently
No
Subject to ongoing SEC
reporting following raise
No
Yes; at least audited
financials filed annually
No
10. Crowdfunding vs. Other Exemptions
Feature
Crowdfunding
Regulation A+
Regulation D Rule 506 (4(a)(2))
Disclosure Liability
Yes, full disclosure liability with
a knowledge exception
Yes, full disclosure liability
with a knowledge
exception
Only anti-fraud liability
No
Yes, for public companies most can sell
under Rule 144 after six months
Shares restricted
Yes, for one year
State Filing
Advertising and general
solicitation
Possibly, depends on future
rules by state
Not allowed
No, if securities sold are
listed on a national
securities exchange or if
sold only to “qualified
investors”
Usually no if only offering to accredited
investors
Allowed
Allowed if sales are made only to
accredited investors and issuer takes
reasonable steps to verify accredited
status
Can public cos., foreign
issuers, investment companies
and exempt inv. companies
issue
No
Yes
Yes
11. Crowdfunding Requirements
• Investment limitations (per trailing 12 month period)
− Company: Can receive up to $1 million
− Investor:
• Less than $100K: greater of $2,000 or 5% of annual income
or net worth
• $100K or more: 10% of annual income or net worth
• Must be conducted through broker or “funding portal”
• Must file with the SEC and provide to broker/funding
portal and investors extensive disclosure, including tax
returns ($100K or less), reviewed financial statements
($100K-$500K) or audited financial statement
(>$500K)
12. Crowdfunding Requirements
• Must not advertise except to direct investors to
broker/portal
• Must not pay promoters except as SEC allows
• Must file annual or more frequent reports with the SEC
• Prospectus liability for disclosures with knowledge out
• 1 year holding period on shares sold except to issuer,
accredited investor, family member or through
registered offering
• Crowdfunded shares do not count towards the 2,000
shareholder rule to force a company public, but see
above re SEC reporting
13. Funding Portals
• Created by Crowdfunding rules
• Must be used as “publicity intermediary” in all
crowdfunding transactions
• Exempt from broker-dealer regulation, but must
register with FINRA; FINRA can only enforce and
examine rules specifically written for funding portals
• Prohibited from:
− Offering investment advice or recommendations
− Soliciting purchases, sales or offers to buy the securities
− Compensating employees based on sales
− Holding, managing or possessing investor funds or
securities
14. More Funding Portal Requirements
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Register with the SEC and any applicable SRO
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Provide disclosures related to risks and other investor education materials as the SEC shall
require
− Must ensure that each investor reviews investor education materials
− Obtain investor representation that he or she understands:
• that entire investment is at risk
• that investing in start-ups and emerging companies is risky
• that crowdfunding investments are illiquid
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Must obtain background check on officers, directors and 20% or greater shareholders
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File with SEC and distribute disclosure materials at lest 21 days prior to first sale date
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Ensure offering proceeds are only provided to issuer when raise has met target; allow investors
to cancel orders
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Make efforts to ensure no investor exceeds individual crowdfunding cap across all transactions
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Protect investor privacy
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Not compensate promoters, finders or lead generators who direct investors to the portal
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Not work with issuers where a portal officer, director or partner has a financial interest
16. New Structure of Rule 506
• Rule 506 now has two alternatives: (b) and (c)
− 506(b) is the traditional rule
• no general solicitation or advertising permitted
• offers and sales must be to either accredited or financially
sophisticated investors
• up to 35 non-accredited investors permitted
• information requirements for non-accredited investors
• unlimited accredited investors permitted
• unlimited dollar amount of offering
− 506(c) is the new rule
• general solicitation or advertising is permitted
• sales must be to accredited investors only
• unlimited accredited investors permitted
• unlimited dollar amount of offering
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17. Can Advertising Be Private?
• Historically, Regulation D’s prohibition against general
advertising/solicitation generally restricted funds and issuers
from utilizing any kind of article, advertisement, seminar,
meeting or notice to promote their Rule 506 offering
• Under the JOBS Act amendments, private fund advisers may
now publicly advertise their funds, discuss funds in interviews
and informal investor settings, conduct capital raising
meetings, etc.
− No limitation to “friends and family”; no more pre-existing
arrangements required
− The risk of “foot faults” (where too much information about a
private fund is unintentionally disclosed) should largely be
eliminated
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18. Advertising (cont.)
• The lifting of the solicitation restrictions can be of special
benefit to emerging or growing funds that lack name
recognition
• Solicitations, advertisements and similar communications will
remain subject to the anti-fraud provisions of the Advisers Act,
which include prohibitions against the use of testimonials,
past specific recommendations, and restrictions on the
presentation of performance data
• Web sites no longer need to be “password protected,” but
they still must be truthful and not misleading
•
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19. Advertising (cont.)
• One practical advantage of the lifting of the solicitation
restrictions is the ability to get a group of investors in a room
and just talk to them about a fund offering
• Another practical advantage is the ability to cross-market with
fund managers in unrelated sectors or strategies to gain
exposure to new sources of investors
• The ability to speak freely about fund offerings in informal
settings may be the most significant near-term advantage of
new Rule 506(c)
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20. Investments Still Effectively Limited to
Accredited Investors
•
•
New Rule 506(c) requires that the issuer take “reasonable steps” to
verify that the investor fits within an accredited investor category
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The SEC suggested several “non-exclusive and non-mandatory”
methods by which an issuer may meet the requirement to “take
reasonable steps” to verify that a purchaser is accredited – unless
the issuer has actual knowledge that the investor is not an
accredited investor
•
Funds are still limited to 100 investors in 3(c)(1) funds
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Funds with performance fees or allocations must still only sell to
persons meeting the “qualified client” requirements
•
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The fund or issuer must be satisfied that purchasers (regardless of
to whom a private fund is advertised) are at least accredited
investors
Funds relying on Section 3(c)(7) must still only be sold to qualified
purchasers
21. Verification of Accredited Status
• The proposed new rules require the issuer to take
“reasonable steps to verify” that the purchasers of the
securities are accredited investors, considering the following
factors:
− nature of purchaser / category of accredited investor
− amount and type of information issuer has concerning the
purchaser
− nature of offering
• manner in which purchaser was solicited
• term of the offering
• minimum investment amount, if any
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22. Accredited Investors: Natural Persons
• Natural persons meeting (or reasonably believed to meet)
the following requirements are “accredited investors”:
− Net Worth Test: individual net worth, or joint net worth with
spouse, exceeds $1 million, excluding net equity in primary
residence
− Income Test: individual income in excess of $200,000 in each of
the two most recent years, or joint income with spouse in excess of
$300,000 in each of those years, with a reasonable expectation of
reaching the same income level in the current year
− Insider Status: Director, executive officer or general partner of the
issuer, or director, executive officer or general partner of a general
partner of the issuer
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23. Verification Methods
• Publicly available information in governmental filings, such
as:
− registration of the investor with the SEC as a broker-dealer,
investment company or business development company
− public company proxy statement listing the investor as an executive
officer or director, along with compensation information
− Form 990 tax return for a 501(c)(3) organization investor verifying
at least $5 million in total assets
• Reasonable documentation
− verification of an investor’s status as an accredited investor by a
third party, such as a broker-dealer, attorney or accountant
− copy of investor’s individual tax returns, Forms W-2, Forms 1099, or
pay stubs demonstrating satisfaction of “income test”
− specific publicly available information about the average
compensation earned at the investor’s workplace by persons at the
level of the investor’s seniority
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24. Verification Methods (Cont’d)
• How the investor was solicited
− Open web site solicitation, accompanied by a mere “check-thebox” affirmation of accredited status, is insufficient
− Database of pre-screened accredited investors created and
maintained by a reasonably reliable third party, such as a
registered broker-dealer, is sufficient
• Terms of the offering
− High minimum investment (i.e. $1 million for an individual), not
financed by the issuer or a third party, can provide reasonable
evidence of accredited status
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25. Possible Consequences of
Self-Verification
• If you choose to gather tax return information or forms, you
now must have a way to safeguard the most confidential of
information; it also makes you a potential third-party record
keeper
• This is very different from subscription information, which is
self-provided
• Some funds and issuers may turn to third-party verification
services
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28. History of Bad Actor Disqualification
• Mandated by Section 926 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010
− Requires the SEC to adopt rules that disqualify securities offerings
involving certain “felons and other bad actors” from reliance on
Rule 506 of Regulation D
− Rules must be substantially similar to Securities Act Rule 262,
which contains disqualifications for Regulation A offerings (up to
$5 million; soon-to-be up to $50 million under Section 401 of
JOBS Act)
• SEC proposed rules on May 25, 2011; approved on July 10,
2013; effective on September 23, 2013
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29. New Rule 506(d) of Securities Act
•
To whom does disqualification apply?
− Issuers, underwriters, placement agents and any other “compensated
solicitor”
− …and their directors, officers and significant shareholders, members or
beneficial owners of voting securities (20 percent of voting power)
− For pooled investment funds, the funds’ investment managers and their
principals and officers
• Includes GPs and managing members of funds, and their GPs and MM, and principals and
officers participating in the private placement
•
All officers?
− No, just executive officers and officers working on the transaction
− Point of contention for investment banks in the proposal
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Timing of disqualifying acts?
− Only events after enactment
− But, disclosure is required
•
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SEC confirms crowdfunding and Reg A+ will have their own bad
actor disqualifications
30. What are the Disqualifying Events?
Bad Act
Look-Back Period
Criminal convictions in connection with the sale of
securities or making false statements to the SEC
Issuers – 5 years
All others (including issuer executive officers and
directors) – 10 years
Court orders, judgments or decrees in connection
with the purchase or sale of securities or in
connection with the business of an underwriter,
broker, dealer, municipal securities dealer,
investment advisor
5 years
Final orders of certain regulators, including state
Longer of duration of final order or 10 years from
securities commissions, state banking authorities, final order based on violation of fraudulent,
state insurance commissions, federal banking
manipulative or deceptive conduct, if applicable
agencies or the National Credit Union Association,
which bar the person from:
association with an entity regulated by such
commission
engaging in the business of securities,
insurance or banking, or
engaging in saving association or credit union
activities
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31. Disqualifying Events (cont.)
Bad Act
CFTC orders (bar or final orders) relating to
violations of any law or regulation that prohibits
fraudulent, manipulative or deceptive conduct
Look-Back Period
Longer of duration of final order or 10 years from
final order
SEC disciplinary orders under Sections 15(b) or
Duration of order
15B(c) of the Securities Exchange Act of 1934, as
amended (the Securities Exchange Act), or 201(e)
or (f) of the Investment Advisers Act of 1940, as
amended, that:
suspends or revokes such person’s
registration as a broker, dealer, municipal
securities dealer or investment adviser
limits such person’s activities function or
operations, or
bars person from association with any entity
or from participating in an offering of penny
stock
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32. Disqualifying Events (cont.)
Bad Act
Look-Back Period
SEC orders prohibiting future violations of any
scienter-based anti-fraud provision, including
Sections 5 and 17(a) of the Securities Act, and
Sections 10(b) of the Securities Exchange Act
Suspension or expulsion from membership in or
bar from association with a member of a national
securities exchange or registered national
securities association (currently FINRA is the only
registered national securities association)
Duration of suspension or expulsion
Regulation A bad-actor stop-orders
5 years
U.S. Postal Service false representation orders
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5 years from date of order
Longer of 5 years or duration of order
35. Brian Korn
•
•
Hands-on transaction execution and market expertise across
product categories, including equity capital markets, debt capital
markets, leveraged finance and private equity
•
Former in-house counsel at Barclays and Citigroup investment
banks
•
Specialist in IPOs, the JOBS Act and SEC compliance, as well as
early-stage fundraising, high yield debt and swaps/derivatives
•
Media Appearances: Fox Business Television, Bloomberg, NPR,
CCTV America
•
212.808.2754
kornb@pepperlaw.com
Corporate and Securities practice group, based in New York
Published or Quoted: Forbes, CNBC, MSNBC, New York Law
Journal, Law360, Philadelphia Inquirer, Pittsburgh Post-Gazette,
The Financier, Review of Securities & Commodities Regulation
•
Seasoned 16 year securities expert and frequent speaker: PLI,
NYC Bar faculty member; Speaker at national securities and
crowdfunding conferences
•
J.D. Northwestern University School of Law
− Northwestern Journal of International Law & Business
•
B.A. with Honors and Distinction, University of California, Berkeley
36. For more information, visit
www.pepperlaw.com.
Brian Korn, Esq.
(212) 808-2754
kornb@pepperlaw.com
Pepper Hamilton LLP
The New York Times Building
620 Eighth Avenue
New York, New York 10018