Category Archives: Investor

IRAs AS CROWDFUNDING INVESTORS

Many Americans, including many accredited investors, self-direct their Individual Retirement Accounts, meaning they choose what to invest in and how much. As such, self-directed IRAs are a great target market for Crowdfunding portals. 

But sometimes even too much of a good thing is too much. If IRAs and certain pension plans take 25% or more of a deal, then the complicated ERISA rules come into play. The assets of the deal itself – whether a real estate project, a tech startup, or otherwise – are deemed to be “plan assets,” with the following undesirable consequences, among others: 

  • The project sponsors will be subject to ERISA’s stringent fiduciary duties 
  • In some situations, the project sponsors must be registered investment advisors 
  • The project is subject to annual reporting, open to the public 

To make sure that doesn’t happen, portals should bake a measuring tool into their technology, flashing red as investments from IRAs and pension plans approach 25%.

Questions? Contact Mark Roderick.

CROWDFUNDING AND THE LIFE SCIENCES: AN EVENING WITH THE EXPERTS

Last night I had the honor of moderating an all-star panel hosted by Pharmaceutical Consulting Consortium International (PCCI) in Philadelphia, focused on Crowdfunding in the life science space.

Our panelists:

  • Don Skerrett, the President of PCCI and a serial entrepreneur, who spoke from the perspective of an early-stage life science CEO
  • Barbara Schilberg, an experienced life science investor, the CEO of BioAdvance, a leading life science fund that has invested in almost 60 companies – leading to $1.7 billion of additional financing – and a senior executive in four active life science businesses
  • Darrick Mix, a shareholder at Duane Morris and an expert in Federal and State securities laws
  • Samuel Wertheimer, the Chief Investment Officer at Poliwogg, a Title II portal devoted to the health care industry and one of the most exciting and innovative portals of any kind in the world

Among the issues discussed:

  • The advantages and disadvantages of Crowdfunding from the perspective of a life science company
  • The nuts-and-bolts mechanics of Crowdfunding
  • The role of portals
  • The due diligence process for life science companies
  • The legal liability of life science companies and portals
  • The effect of Crowdfunding on the life science market specifically and the capital formation industry generally

The panel agreed that while Crowdfunding in the real estate market is very active, with more than 100 real estate portals already in operation, Crowdfunding in the life science market is at a very early stage. How the market will develop, how much capital it will provide to life science companies, how existing capital sources like BioAdvance will coordinate with new capital sources like Poliwogg, whether the life science market will divide into sectors as the real estate market is doing – these questions are all unanswered. But the panel also agreed that Crowdfunding holds great opportunities for the life science sector even if the details have yet to be worked out.

Thanks to those who attended, to PCCI for making the event possible, and especially to our excellent panelists for making the event so informative and worthwhile.

Questions? Contact Mark Roderick.

CROWDFUNDING CHEAT SHEET

Crowdfunding now comes in multiple flavors:

  • Title II Crowdfunding – Rule 506(c)
  • Title III Crowdfunding
  • Title IV Crowdfunding – Regulation A+
  • Existing Regulation A
  • Rule 504 of Regulation

All have one thing in common:  the entrepreneur can use “general solicitation and advertising” to raise money.

But that’s all they have in common. They differ on such critical features as: 

  • Who is allowed to invest
  • How much money can be raised
  • Whether Internet portals can be used
  • How much each investor can investCFCS
  • The degree of SEC oversight
  • Whether foreign companies can participate

I’ve created a chart to keep it all straight – a Crowdfunding Cheat Sheet. The chart won’t
format properly here in the blog, so you’ll need to click here to view it. You might want to print it for future reference.

CLICK HERE TO VIEW THE CROWDFUNDING CHEAT SHEET 

This is my takeaway from the chart:

Of the five flavors of Crowdfunding that will soon be available, only Title II Crowdfunding and Regulation A+ Crowdfunding are likely to play a major role. Title III Crowdfunding – ironically, the only thing the media talked about when the JOBS Act was passed in 2012 – seems doomed to a non-speaking part, at least as long as the $1 million limit remains in place. Those satisfied with raising money from only accredited investors will probably look to the simplicity of Title II while those needing to cast a wider net will likely take the plunge into Regulation A+. As for Rule 504 and the old version of Regulation A – they’re history.

But it’s a brand new world in the capital markets, and impossible to predict.

 Questions? Contact Mark Roderick.

SEC ANSWERS QUESTIONS ON TITLE II CROWDFUNDING

On January 23, 2014, the SEC issued two Securities Act Rules “compliance and disclosure interpretations” regarding Title II Crowdfunding. Both of the new C&DIs provide transition guidance for Rule 506 offerings that started before September 23, 2013, the effective date of the new Rule 506(c) exemption.

Question 260.33: An issuer commenced an offering in reliance on Rule 506 before September 23, 2013, the effective date of the new Rule 506(c) exemption.  The issuer decides, at some point after September 23, 2013, to continue that offering as a Rule 506(c) offering under the transition guidance in Securities Act Release No. 9415 (July 10, 2013).  In such circumstances, is the issuer required to take “reasonable steps to verify” the accredited investor status of investors who purchased securities in the offering before the issuer conducted the offering in reliance on Rule 506(c)?

Answer: No.  For an offering that commenced before September 23, 2013 and that, pursuant to the Commission’s transition guidance, the issuer continues in accordance with Rule 506(c) after that date, the issuer must take reasonable steps to verify the accredited investor status of only investors who purchase securities in the offering after the issuer begins to make offers and sales in reliance on Rule 506(c).  The issuer must amend any previously-filed Form D to indicate its reliance on the Rule 506(c) exemption for its offering.  See Securities Act Rules C&DI 260.05.

Question 260.34: An issuer commenced a Rule 506 offering before September 23, 2013 and made sales either before or after that date in reliance on the exemption that, as a result of Securities Act Release No. 9415 (July 10, 2013), became Rule 506(b).  The issuer now wishes to continue the offering in reliance on Rule 506(c).  Can the issuer rely on the transition guidance in Securities Act Release No. 9415 that permits switching from Rule 506(b) to Rule 506(c) if it already sold securities to non-accredited investors before relying on the Rule 506(c) exemption?

Answer: Yes, as long as all sales of securities in the offering after the issuer begins to offer and sell in reliance on Rule 506(c) are limited to accredited investors and the issuer takes reasonable steps to verify the accredited investor status of those purchasers.

While these C&DIs are important for issuers caught mid-stream when Title II Crowdfunding came into effect, the more general message is that the SEC continues to be quite lenient toward Crowdfunding. On both of these questions the decision could have gone the other way, but the SEC chose to make life easier.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

What IS REGULATION A, AND WHAT’S IT GOT TO DO WITH CROWDFUNDING?

As if companies and investors didn’t have enough letters and numbers to remember, in December the SEC issued proposed new rules under Regulation A. We already have Title II Crowdfunding under the JOBS Act and Title III Crowdfunding under the JOBS Act – these new rules can be thought of as Title IV Crowdfunding under the JOBS Act.

Putting the new rules in context, Regulation A has always allowed companies to use general solicitation to find investors. But the drawbacks of Regulation A were very significant: a company could raise no more than $5 million; issuers were required to file a mini-registration statement with the SEC; and offerings under Regulation A were subject to the labyrinth of state securities laws, i.e., “blue sky” laws in every state where the securities were offered. As a result, Regulation A has been used very rarely.

But Title IV of the JOBS Act directed the SEC to liberalize Regulation A. The rules proposed by the SEC on December 18, 2013 would do just that:

  • They would create a new kind of Regulation A offering – already referred to as Regulation A+.
  • In a Regulation A+ offering, an issuer could raise up to $50 million during any 12 months.
  • The issuer could use general solicitation and advertising to find investors, e.g., the Internet.
  • The issuer could sell to non-accredited investors, subject to a maximum investment of 10% of the investor’s income or net worth in Regulation A+ offerings.
  • Regulation A+ offerings would be exempt from registration or qualification under state blue sky laws.

That will be music to the ears of many issuers: finding investors through the Internet free of state regulation, selling to non-accredited investors, raising up to $50 million rather than the paltry $1 million allowed in Title III Crowdfunding.

The main drawbacks under the proposed rules:

  • Regulation A+ offerings require a mini-registration statement filed with the SEC before any sales are made, including audited financial statements.
  • Regulation A+ offerings require significant ongoing reporting to the SEC.

Neither Title II Crowdfunding nor Title III Crowdfunding requires a registration statement, mini or otherwise, and Title II Crowdfunding in particular is free of most reporting requirements.

Nevertheless, the benefits of Regulation A+ – the $50 million limit and the ability to sell to non-accredited investors – will make it attractive for many issuers, certainly an option to be considered.

The proposed rules are subject to a 60 day comment period.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

SEC TAKES DIFFERENT APPROACHES ON TITLE II AND TITLE III

If you didn’t know better, you might think the Title II Crowdfunding regulations and the Title III Crowdfunding regulations were written by two different agencies.

On one hand, the Title II regulations take a decidedly hands-off approach to the Crowdfunding marketplace. For example:

  • Title II Portals are required only to take “reasonable steps” to ensure that investors are accredited.
  • Issuers are not required to provide any particular information to prospective investors, not even any particular financial information.
  • Title II Portals are not obligated to register with the SEC.

Recall that in the first version of the Title II regulations, the SEC didn’t even include safe harbors for determining whether an investor is accredited. The safe harbors were added only after a public uproar demanding more rules from the SEC (and thus, from the government).

Even after the addition of the safe harbors, there are many, many questions that the Title II regulations don’t even address. Operating in laissez-faire mode, the SEC has left the answers to the marketplace and to the courts.

On the other hand, the Title III regulations – all 585 pages of them, including the preambles – impose stringent and detailed requirements on issuers and portals alike. For example:

  • Title III portals are required to register with the SEC.
  • Title III portals are required to perform detailed background checks on every issuer and its directors, officers, and significant shareholders.
  • Title III portals must deny access to any issuer if the portal believes the issuer “presents the potential for fraud or otherwise raises concerns regarding investor protection,” or if the portal is unable to adequately or effectively assess the risk.
  • Title III issuers are required to provide reams of information to the investing public, including:
  • The business and employment history of all its directors and officers for the previous three years.
  • The reasons why the investment is risky.
  • How the securities were valued.
  • The names of everyone who owns more than 20% of the stock.
  • An explanation how investors could be affected by the exercise of rights by the principals.
  • An explanation of the capital structure.
  • How the money from investors will be used.
    • Detailed information must be provided not only up front, but on an annual basis.
    • After subscribing, Title III investors are given the right to change their minds up to 48 hours before closing.

The Title III regulations, in fact, create a regulatory scheme that has far more in common with the rules that apply to publicly-traded companies than with the laissez-faire approach of the Title II regulations. The main question about the Title III regulations is whether they are so burdensome that they will snuff out Title III Crowdfunding before it begins.

Did different government agencies create the Title II and Title III regulations? Obviously not. The chasm between Title II and Title III can be explained by one fact:  Title II investors are all accredited (for individuals, income of at least $200,000 or net worth of at least $1 million) while Title III investors can be anyone. The assumption behind the regulations is that wealthier people can take care of themselves while those of modest means need the paternalistic protection of the government.

It’s a theme that has run through U.S. securities laws for a long, long time. We’ll see how well it works for Crowdfunding.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

IT’S EASY TO BE A TITLE III CROWDFUNDING PORTAL!

All you have to do is:

  • Register with the Securities and Exchange Commission by filing a Form Funding Portal and posting a bond of at least $100,000.
  • Notify the SEC within 30 days if any of the information on Form Funding Portal changes.
  • Join FINRA and comply with all its rules and regulations.
  • Implement written policies and procedures “reasonably designed to achieve compliance with the federal securities laws.”
  • Comply with the requirements of 31 CFR Chapter X relating to money laundering.
  • Comply with the requirements of 17 CFR 248 relating to privacy.
  • Permit inspection by all your records and facilities by the SEC.
  • For each issuer (company trying to raise money) listed on your platform, have a reasonable basis for believing the issuer (1) complies with all applicable requirements, and (2)  has established a way to keep accurate records of investors.
  • Deny access to any issuer if:
    • You believe the issuer is a “bad actor.” To enforce this requirement you must (at a minimum) conduct a background and securities enforcement check on each issuer and on each officer, director, and beneficial owner of at least 20% of the issuer.
    • You believe the issuer or the offering presents the potential for fraud “or otherwise raises concerns regarding investor protection.” How would you know? If you are unable to “effectively assess the risk of fraud,” you have to deny access.
  • Provide educational materials to potential investors that explain in plain language “and are otherwise designed to communicate effectively and accurately”:
    • The mechanism for purchasing stock of the issuer;
    • The risks of purchasing stock;
    • The types of securities offered on your platform and the risks of each type;
    • The restrictions on resale imposed by law or contract;
    • The kinds of information the issuer is required to provide;
    • The per-investor limitations on investment;
    • The investor’s right to cancel the investment, and the limitations on those rights;
    • The need for the investor to think about whether the investment is appropriate; and
    • That following the investor’s purchase of stock, there might be no further relationship between the investor and your portal.
  • Keep all those educational materials current on your website and, where appropriate, make any revisions available to investors before accepting investments.
  • Tell investors about the requirements applicable to promoters.
  • Disclose to investors how you are being compensated.
  • Make available to investors and the SEC – in
    downloadable form – all the information the issuer itself is required to make available, including:

    • The name, address, and website of the issuer;
    • The names of the directors and officers, their positions with the issuer, and their overall business experience over the last three years;
    • Each person’s principal occupation and employment, and the name and principal business of any other entity where the occupation and employment took place;
    • The name of each person who owns at least 20% of the issuer;
    • A description of the issuer’s business and business plan;
    • The number of the issuer’s employees;
    • A discussion of factors that make the investment risky;
    • The target offering amount, and a statement that if the target is not reached, all the money will be returned;
    • Whether the issuer will accept money in excess of the target, and how;
    • The purpose and intended uses of the offering proceeds;
    • A description of the process to complete a purchase and sale of stock, including statements that:
      • An investor may cancel his investment up to 48 hours before the deadline;
      • The portal (you) will notify investors when the target amount is reached;
      • The issuer may close the offering before the deadline if the target amount is reached; and
      • If the investor does not cancel his investment and the target is reached, the offering will close
    • That a material change is made after an investor commits, his or her money will be returned unless he or she affirmatively re-commits;
    • The price of the stock;
    • A description of the capital structure of the issuer, including:
      • A summary of all securities, including associated voting rights;
      • A statement how the exercise of rights held by the principal stockholders of the issuer could affect investors;
      • The name and “ownership level” of each person who owns 20% or more of the issuer;
      • How the stock purchased by the investor was valued, and might be valued in the future;
      • The risks associated with minority ownership and the issuance of additional securities in the future; and
      • A description of all restrictions on transfer;
    • The name of the portal (you);
    • The amount of your compensation;
    • A description of all indebtedness of the issuer;
    • A description of all non-public offerings of securities within the last three years, including:
      • The date of the offering;
      • The offering exemption;
      • The types of securities offered; and
      • The amount of money raised and how it was used;
    • A description of any transaction since the beginning of the issuer’s last full fiscal year, involving at least 5% of the amount to be raised in the Title III offering, in which any of the following had an interest:
      • A director or officer of the issuer;
      • A person who owned 20% or more of the issuer;
      • A promoter of the issuer; or
      • A family member of any of the foregoing;
    • A description of the issuer’s financial condition;
    • Financial statements (the kind of statement is based on how much money the issuer is raising);
    • Any matters that would have resulted in disqualification under the “bad actor” rules had they occurred after Title III became effective.
  • Make all of that information available to investors and the SEC on a Form C (newly created) at least 21 days before any securities are sold, update the progress of the offering, and keep all of the information available until the offering is completed or canceled.
  • Before accepting money from an investor:
    • Have a reasonable basis for believing the investor satisfies the applicable investment limitations (you can generally rely on the investor’s representations); and
    • Obtain from the investor:
      • A representation that the investor has reviewed the education materials and can bear the entire loss of his or her investment; and
      • A questionnaire demonstrating the investor’s understanding that:
        • There are restrictions on his or her ability to cancel the investment;
        • It may be difficult to re-sell the stock; and
        • Investing is risky – in fact, the investor should be able to afford the loss of his or her entire investment.
  • Establish communications channels (message boards?) that allow investors to communicate with one another and with representatives of the issuers about offerings on your platform, provided that:
      • You can’t participate in these communications;
      • You have to provide unlimited public access to the communications, but can allow comments only from those registered with your platform; and
      • You require anyone posting comments to disclose whether he or she is affiliated with the issuer;
  • Upon receiving a commitment from an investor, you must give him or her notification of:
    • The dollar amount of the commitment;
    • The price of the security;
    • The identify of the issuer; and
    • The deadline for canceling the commitment;
  • Establish a relationship with a bank as an escrow agent under a written escrow agreement and direct that:
    • Funds from investors be transferred to the issuer if the target amount has been reached, the cancellation period has expired, and at least 21 days have elapsed since the issuer’s information was first made available on your platform; and
    • Return the funds to the investor if the investor cancels or the offering terminates.
  • On or before the closing of the offering, give notice to all investors, providing:
    • The date of the closing;
    • The type of security purchased by the investor;
    • The identity, price, and number of securities purchased by the investor;
    • The total amount of securities sold by the issuer and the price(s) at which they were sold;
    • If the security is a debt security, the interest rate, the maturity date, and the yield to maturity;
    • If the security is callable, the first date it can be called; and
    • The amount and source of your remuneration.
    • If the issuer decides to close the transaction earlier than the deadline established initially, give notice to all investors, providing:
      • The date of the new deadline;
      • The right for investors to cancel up to 48 hours before the new deadline; and
      • Whether the issuer will continue to accept commitments during the 48 hour period before the new deadline.
  • If there is a material change to the terms of the offering or the information about the issuer, notify investors that all commitments will be canceled unless investors re-confirm their commitments.
  • If any investor fails to re-confirm within five business days, notify the investor and direct the return of his or her money.
  • If an offering is canceled, notify all investors, direct the return of their money, and ensure that no further commitments are made for the offering.
  • Maintain the following records for five years:
    • Records relating to each investor who purchased securities or tried to;
    • Records relating to each issuer that offered securities or tried to;
    • Records of all communications on your platform;
    • Records relating to anyone who uses your platform to promote securities or communicate with investors;
    • Records that document your compliance with the SEC’s rules and regulations;
    • All your notices to issuers and investors, including your Terms of Use;
    • All your contracts;
    • Daily, monthly, and quarterly summaries of transactions, including:
      • Transactions that have successfully closed; and
      • Transaction volume, expressed in:
        • Number of transactions;
        • Number of securities sold in transactions;
        • Total amounts raised by each issuer; and
        • Total amounts raised by all issuers; and
    • A log reflecting the progress of each issuer.
    • Maintain and preserve all your organizational documents.

But you must not:

  • Have any financial interest in any of your listed companies.
  • Receive any financial interest as compensation for your services.
  • Offer investment advice or recommendations.
  • Deny access to an issuer based on your assessment of the issuer’s prospects.
  • Solicit purchases, sales or offers to buy the securities offered on your platform.
  • Compensate employees or others for such solicitation.
  • Hold or manage investor funds.
  • Pay anyone for providing personally identifiable information of investors.
  • Pay anyone except registered brokers or dealers for directing issuers or investors to your platform on a commission basis.

That’s all you have to do!

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

BEWARE OF FRAUD IN THE CROWDFUNDING MARKET

John Mattera offered a great deal to his investors. Through special-purpose investment vehicles, investors could buy shares in well-known companies like Facebook and Groupon, which were then privately-owned. When the companies went public, investors would reap millions.

Mattera raised more than $13 million from more than 140 investors, some of whom invested their life savings.

The only problem was that Mattera didn’t use the money to buy shares in Facebook or Groupon. Instead, he used the money for the normal trappings of ill-gotten wealth, including a waterfront home in Fort Lauderdale, two Rolls-Royces, and a Lamborghini, according to the government.

Mattera was caught and sentenced to 11 years in prison. But his investors aren’t getting their money back.

Bernie Madoff, John Mattera. . . .there is no shortage of people trying to steal your money through investment scams. Why are thieves attracted to the securities industry? As “Slick Willie” Sutton said when asked why he robbed banks, “Because that’s where the money is.”

It doesn’t matter if you’re smart, sophisticated, and have seen it all. Mattera’s investors thought they had seen it all, too.

Be careful out there.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

Proposed Title III Crowdfunding Regulations: Better Late than Never

On October 23, 2013 the SEC proposed regulations to implement Title III Crowdfunding.

There are two extremely important things about the proposed regulations:

  • That they were issued. After a 90 day public comment period, it seems likely that Title III Crowdfunding will finally come into effect in the first quarter of 2014.
  • That they run to almost 600 pages. Given the complexity, there is some question whether, in the end, a company trying to raise money will find Title III Crowdfunding worthwhile.

Recall that the JOBS Act provides for two kinds of Crowdfunding:

  • Title II Crowdfunding allows companies to raise an unlimited amount of money from an unlimited number of accredited investors using general soliciting and advertising. That kind of Crowdfunding came into effect on September 23, 2013 and is now in full swing.
  • Title III Crowdfunding is a different animal. It allows companies to:
    • Raise up to $1 million per year;
    • On an SEC-registered internet portal;
    • From a unlimited number of investors who do not have to be accredited;
    • But with strict limits on the amount each investor can invest.

For a detailed outline of the Title III statute itself, click here.

Despite their length, the proposed regulations do not add much to the statute. There are just a few points worth noting for a company looking to raise money:

  • The company can use only one portal at a time.
  • The company must file information via EDGAR, the SEC’s electronic database.
  • The $1 million-per-year limit applies only to money raised in Title III offerings. Thus, a company could raise $3 million in a traditional private placement (or a Title II offering) while still raising $1 million in a Title III offering.
  • Investors can change their minds up to 48 hours before the investment deadline, in all circumstances, and must also be given the right to terminate in the event of a material change in the investment opportunity.
  • The company must disclose not only its own prior offerings, but the prior offerings in which its directors and other principals were involved.
  • The SEC has created a new Form C to report Title III offerings.
  • The company may advertise, but only to direct potential investors to the portal’s website. The company may not use general solicitation and advertising, as it can in a Title II offering.
  • “Bad actors” are excluded from Title III Crowdfunding, as they are from Title II Crowdfunding.

The proposed regulations are even more important for portals, or would-be portals. The portal is designated as the virtual policeman for ensuring compliance with the law. For example, the proposed regulations provide that the portal must have a reasonable basis for believing that company is complying with the law, and must deny access to the issuer under certain circumstances. In effect, the portal is required to act as an arm of the SEC itself.

Just as a company trying to raise money might decide that Title III is too onerous, an entrepreneur thinking about forming a Title III portal might decide that the fruit are a little too high and a little too green.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

SEC PROPOSES RULES FOR TITLE III CROWDFUNDING

Today, at long last, the SEC issued proposed regulations implementing Title III Crowdfunding, which will allow companies to raise up to $1 million per year in small increments from non-accredited investors.

With commentary, the proposed regulations run to almost 600 pages. We’ll be posting a summary soon.

Title II Crowdfunding has been live since September 23, 2013. The era of Crowdfunding is now.

Stay tuned for more updates…

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

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