The U.S. Securities and Exchange Commission (SEC) voted 3 to 1 today (Oct. 30) to approve rules governing the sale of securities through online equity crowdfunding. The approval cleared the last major hurdle in the long-awaited provision of the Jumpstart Our Businesses and Startups Act (JOBS Act), commonly known as Title III equity crowdfunding.
"The gist is, entrepreneurs will be able to raise money in the U.S. from anybody — rich or poor, accredited or unaccredited," Doug Ellenoff, a corporate and securities attorney working with the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) on the Title III rules, told Business News Daily. "It's a real revolutionary change in securities law."
Under the new rules, small businesses and startups would be able to solicit up to $1 million annually in crowdfunded securities investments, according to a copy of the federal legislation. In a bid to deter investment fraud, Congress placed restrictions on the amount that individuals would be able to invest in this way. Further, those investments would be required to go through intermediaries known as "funding portals," which would be subject to certain restrictions, and would be required to both register with the SEC and be a member of FINRA. With the adoption of the final rules, funding portals can register with the SEC as of Jan. 29, 2016.
The new Title III rules depart from the SEC's October 2013 proposal, which stalled due in part to public concerns over the costs of audits to small businesses and startups seeking to raise capital through crowdfunding. The rules also establish per-investor contribution limits, details about disclosure requirements for issuers, and the role and responsibilities of funding portals, which will host the offerings.
The new rules open up an online avenue for nonaccredited investors – those who have a net worth of less than $1 million and made less than $200,000 in each of the past two years – to invest in small businesses and startups alongside more financially sophisticated investors. Under the SEC's rules, investors with a net worth or annual income below $100,000 would be restricted to investing either five percent of their annual income or net worth – whichever is less – or $2,000 if the five percent is below that amount. Investors with a net worth or annual income greater than $100,000 would be able to invest 10 percent of whichever is lesser. Through a 12-month period, investors may not purchase more than $100,000 in securities through all crowdfunded offerings.
In addition, the rules relax a previously proposed audit requirement for issuers, instead only requiring an audit for offerings amounting to $500,000 or more. First-time Title III issuers would simply be required to provide reviewed financials even for offerings worth more than $500,000, rather than the more stringent audits, unless audited financials were already available before the filing.
"In comments on the proposed rule in 2014, I urged the SEC to ‘avoid costly, paternalistic requirements on crowdfunding that have the effect of keeping the status quo and locking ordinary investors out of startup capital," John Berlau, senior fellow at the Competitive Enterprise Institute, told Business News Daily. "It looks like the SEC has taken this advice from me and others and will eliminate burdensome requirements such as audited financials for small crowdfunding firms."
The rules also include measures requiring intermediary funding portals to protect investors by providing educational materials about the offerings, taking steps to reduce fraud, and making company disclosures public at least 21 days before the sale of securities. Intermediaries are also prohibited from offering investment advice, maintaining a financial interest in a company with an offering on their platform, and compensating individuals for providing identifying information on potential investors.
The rules provide small business owners an entirely new way to generate capital from nonaccredited investors, which were previously limited to direct public offerings. Ellenoff offered some advice to small business owners looking to capitalize on the rule change.
"Raising money online remains a securities transaction, and you need to be responsible in how you sell your securities to investors," he said. "And they need to make sure they work with qualified professionals to do it in an informed way that won't harm investors."
The SEC's rules will go into effect in 180 days following their publication in the Federal Register, with the exception of registration forms for the online intermediaries, which will be available Jan. 29, 2016.