Category Archives: Securities Exchange Commission

NEW DOMAIN EXTENSIONS BECOME AVAILABLE

Crowdfunding Image - XXXL - iStock_000037694192XXXLargeWe started with .COM. Then .NET, .EDU, .INFO, .ORG, and a handful of others. But we’re about to be flooded with new domain extensions, more than a thousand of them.

In the world of finance, we’re going to have .BANK, .BROKER, .CAPITAL, .FUND, .INVESTMENTS, and .FINANCE. In the world of food we’re about to have .FOOD, .EAT, .GROCERY and .KITCHEN. You get the idea.

The flood of new extensions offers opportunity and challenge. Maybe the .FUND extension would work great for your new Crowdfunding portal. On the other hand, maybe you’re already using portal.com and now you have to worry about a competitor using portal.fund (Hint: a different domain extension doesn’t give a competitor the right to violate your trademark).

Some of the new extensions are already available, while the rest are coming soon. For a complete list and to register, go to a registrar website such as www.Godaddy.com.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

CROWDFUNDING TO FOREIGN INVESTORS THROUGH REGULATION S

crowdfunding_investorMost portal operators think sooner or later about raising money from foreign investors. SEC Regulation S offers a convenient mechanism to do just that.

Regulation S allows a U.S. company to sell debt or equity securities to foreign investors under the following conditions:

  • The issuer must reasonably believe that the investors are offshore.
  • The issuer may not engage in any “direct selling efforts” in the U.S.
  • For debt securities, sales to U.S. persons are prohibited for 40 days. For equity securities, the period is increased to one year.
  • Various legends and Bylaw provisions are required to enforce the prohibition on U.S. sales.

(Careful readers will note that none of these requirements is geared toward protecting the foreign investors. Instead, all of the requirements are geared toward ensuring the the securities are sold only to foreigners. As a U.S. regulatory agency, the SEC simply has no jurisdictional mandate to protect foreign investors.)

Three features make Regulation S especially useful for Crowdfunding portals and issuers:

  • A Regulation S offering may be conducted using general solicitation and advertisement, i.e., through Crowdfunding.
  • A Regulation S offering to foreign investors may be conducted concurrently with a Regulation D offering to U.S. investors, even for the same securities.
  • Under Regulation S, the issuer can be indifferent as to whether foreign investors are accredited.

That’s not the end of it, of course. Other countries have their own securities laws and their own SEC’s, and a U.S. issuer must comply with those rules as well.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.

INVESTOR VERIFICATION: QUESTIONS AND ANSWERS FROM THE SEC

The SEC recently issued four questions and answers dealing with investor verification.

Question #1

If a purchaser’s annual income is not reported in U.S. dollars, what exchange rate should an issuer use to determine whether the purchaser’s income meets the income test for qualifying as an accredited investor?

Answer: The issuer may use either the exchange rate that is in effect on the last day of the year for which income is being determined or the average exchange rate for that year.

Question #2

Can assets in an account or property held jointly with another person who is not the purchaser’s spouse be included in determining whether the purchaser satisfies the net worth test in Rule 501(a)(5)?

Answer: Yes, assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the net worth test, but only to the extent of his or her percentage ownership of the account or property. [July 3, 2014]

Question #3

Rule 506(c)(2)(ii)(A) sets forth a non-exclusive method of verifying that a purchaser is an accredited investor by, among other things, reviewing any Internal Revenue Service form that reports the purchaser’s income for the “two most recent years.” If such an Internal Revenue Service form is not yet available for the recently completed year (e.g., 2013), can the issuer still rely on this verification method by reviewing the Internal Revenue Service forms for the two prior years that are available (e.g., 2012 and 2011)?

Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. We believe, however, that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by:

  • Reviewing the Internal Revenue Service forms that report income for the two years preceding the recently completed year; and
  • Obtaining written representations from the purchaser that (i) an Internal Revenue Service form that reports the purchaser’s income for the recently completed year is not available, (ii) specify the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor, and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year.

Where the issuer has reason to question the purchaser’s claim to be an accredited investor after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor. For example, if, based on this review, the purchaser’s income for the most recently completed year barely exceeded the threshold required, the foregoing procedures might not constitute sufficient verification and more diligence might be necessary.

Question #4

A purchaser is not a U.S. taxpayer and therefore cannot provide an Internal Revenue Service form that reports income. Can an issuer review comparable tax forms from a foreign jurisdiction in order to rely on the verification method provided in Rule 506(c)(2)(ii)(A)?

Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. In adopting this safe harbor, the Commission noted that there are “numerous penalties for falsely reporting information” in Internal Revenue Service forms. See Securities Act Release No. 33-9415 (July 10, 2013). Although the safe harbor is not available for tax forms from foreign jurisdictions, we believe that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by reviewing filed tax forms that report income where the foreign jurisdiction imposes comparable penalties for falsely reported information.

Where the issuer has reason to question the reliability of the information about the purchaser’s income after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor.

The Takeaway

The lesson is that issuers and portals should not try to verify investors on their own. Leave that to a third party service like Crowdentials or VerifyInvestor – they keep track of these rules so you won’t have to.

Questions? Contact Mark Roderick

SEC RULES 506(B) AND 506(C): CLEARING UP THE CONFUSION

Some Crowdfunding portals offer Rules 506(b) transactions in addition to, and sometimes even in lieu crowd funding word cloudof, Rule 506(c) transactions. Let’s clear up the confusion.

In the beginning. . . .

Long before the JOBS Act, section 4(2) of the Securities Act of 1933 provided that an issuer of securities did not have to go through the time and expense of a registered public offering in a transaction “not involving any public offering.” Recognizing the putting-the-rabbit-in-the-hat nature of that language and wishing to provide more clarity to the public, the SEC issued Regulation D in 1982, which provides a series of Rules guiding issuers through the shoals of private – as opposed to public – offerings.

One of the Rules in Regulation D, Rule 506(b), describes a kind of private offering that has been the favorite of issuers and their lawyers for many years:

  • An unlimited amount of money raised
  • An unlimited number of accredited investors plus 35 non-accredited investors
  • Exemption from state Blue Sky registration

Rule 506(b) provides great flexibility to issuers. However, consistent with the distinction inherent in Regulation D between private and public offerings, Rule 506(b) prohibited the use of “general solicitation and advertising” to find investors. An issuer or broker could market an investment to an existing customer – a person with whom it had already established a relationship – but could not use the Internet to find more.

2013 No-Action Letters

In the beginning of 2013, the SEC issued no-action letters to FundersClub and AngelList under Rule 506(b). These no-action letter provided that if an online portal merely “registered” a user with a name and email address, the portal could immediately show investments to the user. To many familiar with the history of Rule 506(b) that sounded a lot like general solicitation and advertising, but the SEC concluded that it was not.

With the two no-action letters, the SEC effectively launched the Crowdfunding industry even before the JOBS Act officially came into effect.

The JOBS Act

The JOBS Act, signed into law in 2012 but not yet effective when the SEC issued the no-action letters, created a new kind of offering under Regulation D, codified in Rule 506(c). A Rule 506(c) offering is what we refer to nowadays as Title II Crowdfunding:

  • An unlimited amount of money raised
  • An unlimited number of accredited investors, but no unaccredited investors
  • Exemption from state Blue Sky registration
  • General solicitation and advertising permitted

If Rule 506(c) sounds a lot like Rule 506(b), that’s because it is. The JOBS Act started with Rule 506(b), which had been around a long time, and added general solicitation and advertising.

Why Both?

Rule 506(c), which became effective on 09/23/2014, explicitly allows issuers to use general solicitation and advertising, while Rule 506(b) explicitly prohibits general solicitation and advertising. Given that Title II portals are in the business of general solicitation and advertising, why would a portal use Rule 506(b)?

There are a few reasons.

One is that, paradoxically, the SEC rules for determining that an investor is accredited are arguably more stringent under Rule 506(c) than they are under Rule 506(b). Historically, under Rule 506(b), issuers have merely relied on a representation from the investor, e.g., “I promise I am accredited.” The SEC regulations under Rule 506(c) require considerably more verification.

Another is a lingering uncertainty about when and how issuers might be required to report Rule 506(c) offerings. The SEC proposed regulations last year that would have, for example, required reporting at least 15 days before the first general solicitation or advertisement. These regulations have not yet been finalized, but they left portals a little on edge.

More broadly, with the two no-action letters in hand, portals may feel they have a clear road map to legal Rule 506(b) offerings, while they remain hesitant about Rule 506(c) pending more advice from the SEC. My own view is that portals are probably more comfortable with the no-action letters than they should be, but that is a story for another day.

The Future

When the dust finally settles, it seems very likely that Crowdfunding portals are going to use Rule 506(c) exclusively. Until then we will have a mix and maybe just a little confusion.

Questions? Contact Mark Roderick.

 

 

 

 

A DOWNPOUR OF #CROWDFUNDREALESTATE ADVICE AND IDEAS

Thank you to the panelists and audience members who braved a biblical downpour to attend the SOLD OUT Harvard Business School Club Innovations in Real Estate: Crowdfund Investing program last night at the UJA Federation of NY Conference Center. Former New York Governor David Paterson kicked off the evening with his typical wit and insight before our panel of Crowdfunding industry experts shared their experiences and knowledge with an extremely engaged and thoughtful audience.

Our panelists:

  • Jason Fritton of Patch of Land and William Skelley of iFunding, two of the earliest Crowdfunding innovators and most successful Title II portals
  • Elvin Ames of Golden Eye Investments and Erin Wicomb of Mavrix Group, two experienced and successful real estate developers who have recently turned to Crowdfunding to raise capital
  • Scott Lichtman, a real estate investor who has himself invested in Crowdfunded deals and did a super job putting the conference together

Thus, all sides the Crowdfunding triangle were represented: portals, developers, and investors. And Jason, William, Elvin, Erin, and Scott – not to mention Governor Paterson – acquitted themselves with flying colors, demonstrated why they have been so successful generally and specifically why they have been leaders in Crowdfunding.

Some of the issues discussed:

  • The build-out of the Title II portal market, and how it is likely to segment into verticals
  • How portals successfully distinguish themselves
  • What investors look for in a portal and a project sponsor
  • The legal basis for Crowdfunding, and its significance in the marketplace
  • Why Crowdfunding is attractive to developers
  • How portals can participate in community development and “do well by doing good”
  • How portals market and price their services
  • How developers distinguish their projects
  • What due diligence means in a Crowdfunded environment

Judging by the number and quality of questions from the audience following the presentation, there are likely a few dozen more Crowdfunding entrepreneurs this morning than there were yesterday. Including one statistician, who asked about the standard deviation of Crowdfunding investments.

Thanks again to everyone. I hope to stay in touch with all of you. Email me at mark.roderick@flastergreenberg.com, subscribe to my Crowdfunding blog at www.crowdfundattny.com, or follow me on Twitter at @CrowdfundAttny.

LEGAL FOCUS ON CROWDFUNDING

Lawyer Monthly magazine has been following Crowdfunding developments, along with the
business community and media. The attached interview highlights a couple of hot button points, including the benefits and common legal implications of Crowdfunding. Click here to read more.

legal focus on crowdfunding

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.

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.

JOBS Act Crowdfunding – The Latest News & Information

I have been asked by the Pennsylvania Bar Institute (PBI) to lead a Crowdfunding breakout session at their annual Business Lawyers’ Institute in Philadelphia on November 13th.

I will discuss the latest news and information on JOBS Act Crowdfunding, including: Proposed Title III Crowdfunding Rroegulations; Rule 506 of Regulation D issued by the Securities & Exchange Commission (SEC); new requirements for establishing that investors are accredited; SEC regulations; mechanics of a Crowdfunded offering; proposed changes to Form D; and the exclusion of “bad actors.”

For additional information on this event, or to register, click here.

I hope to see you there! If you have any questions, please feel free to contact me directly.

MARK RODERICK

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