[Federal Register Volume 80, Number 220 (Monday, November 16, 2015)]
[Rules and Regulations]
[Pages 71388-71615]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-28220]
[[Page 71387]]
Vol. 80
Monday,
No. 220
November 16, 2015
Part III
Book 2 of 2 Books
Pages 71387-71680
Securities and Exchange Commission
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17 CFR Parts 200, 227, 232, et al.
Crowdfunding; Final Rule
Federal Register / Vol. 80 , No. 220 / Monday, November 16, 2015 /
Rules and Regulations
[[Page 71388]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 200, 227, 232, 239, 240, 249, 269, and 274
[Release Nos. 33-9974; 34-76324; File No. S7-09-13]
RIN 3235-AL37
Crowdfunding
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission is adopting new
Regulation Crowdfunding under the Securities Act of 1933 and the
Securities Exchange Act of 1934 to implement the requirements of Title
III of the Jumpstart Our Business Startups Act. Regulation Crowdfunding
prescribes rules governing the offer and sale of securities under new
Section 4(a)(6) of the Securities Act of 1933. Regulation Crowdfunding
also provides a framework for the regulation of registered funding
portals and broker-dealers that issuers are required to use as
intermediaries in the offer and sale of securities in reliance on
Section 4(a)(6). In addition, Regulation Crowdfunding conditionally
exempts securities sold pursuant to Section 4(a)(6) from the
registration requirements of Section 12(g) of the Securities Exchange
Act of 1934.
DATES: The final rules and forms are effective May 16, 2016, except
that instruction 3 adding part 227 and instruction 15 amending Form ID
are effective January 29, 2016.
FOR FURTHER INFORMATION CONTACT: With regard to requirements for
issuers, Eduardo Aleman, Julie Davis, or Amy Reischauer, Division of
Corporation Finance, at (202) 551-3460, and with regard to requirements
for intermediaries, Joseph Furey, Joanne Rutkowski, Timothy White,
Devin Ryan, or Erin Galipeau, Division of Trading and Markets, at (202)
551-5550, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background
B. Title III of the JOBS Act
II. Final Rules Implementing Regulation Crowdfunding
A. Crowdfunding Exemption
1. Limit on Capital Raised
2. Investment Limits
3. Transaction Conducted Through an Intermediary
4. Exclusion of Certain Issuers From Eligibility Under Section
4(a)(6)
B. Issuer Requirements
1. Disclosure Requirements
2. Ongoing Reporting Requirements
3. Form C and Filing Requirements
4. Prohibition on Advertising Terms of the Offering
5. Compensation of Persons Promoting the Offering
6. Other Issuer Requirements
C. Intermediary Requirements
1. Definitions of Funding Portals and Associated Persons
2. General Requirements for Intermediaries
3. Measures To Reduce Risk of Fraud
4. Account Opening
5. Requirements With Respect to Transactions
6. Completion of Offerings, Cancellations and Reconfirmations
7. Payments to Third Parties
D. Additional Funding Portal Requirements
1. Registration Requirement
2. Exemption From Broker-Dealer Registration
3. Safe Harbor for Certain Activities
4. Compliance
5. Records To Be Created and Maintained by Funding Portals
E. Miscellaneous Provisions
1. Insignificant Deviations From Regulation Crowdfunding
2. Restrictions on Resales
3. Information Available to States
4. Exemption From Section 12(g)
5. Scope of Statutory Liability
6. Disqualification Provisions
7. Secondary Market Trading
III. Economic Analysis
A. Baseline
1. Current Methods of Raising Up to $1 Million of Capital
2. Current Sources of Funding for Startups and Small Businesses
That Could Be Substitutes or Complements To Crowdfunding
3. Current Crowdfunding Practices
4. Survival Rates for Startups and Small Businesses
5. Market Participants
B. Analysis of Final Rules
1. Broad Economic Considerations
2. Crowdfunding Exemption
3. Issuer Requirements
4. Intermediary Requirements
5. Additional Funding Portal Requirements
6. Insignificant Deviations
7. Relationship With State Law
8. Exemption From Section 12(g)
9. Disqualification
IV. Paperwork Reduction Act
A. Background
B. Estimate of Issuers and Intermediaries
1. Issuers
2. Intermediaries That Are Registered Brokers
3. Funding Portals
C. Estimate of Burdens
1. Issuers
2. Brokers and Funding Portals
D. Collections of Information Are Mandatory
E. Confidentiality
F. Retention Period of Recordkeeping Requirements
V. Final Regulatory Flexibility Act Analysis
A. Need for the Rule
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Rules
D. Projected Reporting, Recordkeeping and Other Compliance
Requirements
E. Agency Action To Minimize Effect on Small Entities
1. Issuers
2. Intermediaries
VI. Statutory Authority
Exhibit A
I. Introduction
A. Background
Crowdfunding is a relatively new and evolving method of using the
Internet to raise capital to support a wide range of ideas and
ventures. An entity or individual raising funds through crowdfunding
typically seeks small individual contributions from a large number of
people. Individuals interested in the crowdfunding campaign--members of
the ``crowd''--may share information about the project, cause, idea or
business with each other and use the information to decide whether to
fund the campaign based on the collective ``wisdom of the crowd.''
The Jumpstart Our Business Startups Act (the ``JOBS Act''),\1\
enacted on April 5, 2012, establishes a regulatory structure for
startups and small businesses to raise capital through securities
offerings using the Internet through crowdfunding. The crowdfunding
provisions of the JOBS Act were intended to help provide startups and
small businesses with capital by making relatively low dollar offerings
of securities, featuring relatively low dollar investments by the
``crowd,'' less costly.\2\ Congress included a number of provisions
intended to protect investors who engage in these transactions,\3\
including
[[Page 71389]]
investment limits, required disclosures by issuers, and a requirement
to use regulated intermediaries. The provisions also permit Internet-
based platforms to facilitate the offer and sale of securities in
crowdfunding transactions without having to register with the
Commission as brokers.
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\1\ Pub. L. 112-106, 126 Stat. 306 (2012).
\2\ See, e.g., congressional statements regarding crowdfunding
bills that were precursors to the JOBS Act: 157 Cong. Rec. S8458-02
(daily ed. Dec. 8, 2011) (statement of Sen. Jeff Merkley) (``Low-
dollar investments from ordinary Americans may help fill the void,
providing a new avenue of funding to the small businesses that are
the engine of job creation. The CROWDFUND Act would provide startup
companies and other small businesses with a new way to raise capital
from ordinary investors in a more transparent and regulated
marketplace.''); 157 Cong. Rec. H7295-01 (daily ed. Nov. 3, 2011)
(statement of Rep. Patrick McHenry) (``[H]igh net worth individuals
can invest in businesses before the average family can. And that
small business is limited on the amount of equity stakes they can
provide investors and limited in the number of investors they can
get. So, clearly, something has to be done to open these capital
markets to the average investor[.]'').
\3\ See, e.g., congressional statements regarding crowdfunding
bills that were precursors to the JOBS Act: 158 Cong. Rec. S1781
(daily ed. Mar. 19, 2012) (statement of Sen. Carl Levin) (``Our bill
creates new opportunities for crowdfunding but establishes basic
regulatory oversight, liability, and disclosure rules that will give
investors the confidence to participate in this promising emerging
source of money for growing companies.'').
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In the United States, crowdfunding generally has not involved the
offer of a share in any financial returns or profits that the
fundraiser may expect to generate from business activities financed
through crowdfunding. Such a profit or revenue-sharing model--sometimes
referred to as the ``equity model'' of crowdfunding--could trigger the
application of the federal securities laws because it likely would
involve the offer and sale of a security. Under the Securities Act of
1933 (``Securities Act''), the offer and sale of securities is required
to be registered unless an exemption is available. Some observers have
stated that registered offerings are not feasible for raising smaller
amounts of capital, as is done in a typical crowdfunding transaction,
because of the costs of conducting a registered offering and the
resulting ongoing reporting obligations under the Securities Exchange
Act of 1934 (``Exchange Act'') that may arise as a result of the
offering. Limitations under existing regulations, including purchaser
qualification requirements for offering exemptions that permit general
solicitation and general advertising, have made private placement
exemptions generally unavailable for crowdfunding transactions, which
are intended to involve a large number of investors \4\ and not be
limited to investors that meet specific qualifications.\5\
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\4\ In this release, ``investors'' includes investors and
potential investors, as the context requires. See Rule 100(d) of
Regulation Crowdfunding.
\5\ See Eliminating the Prohibition Against General Solicitation
and General Advertising in Rule 506 and Rule 144A Offerings, Release
No. 33-9415 (July 10, 2013) [78 FR 44771 (July 24, 2013)] (adopting
rules to implement Title II of the Jumpstart Our Business Startups
Act) (``Rule 506(c) Adopting Release''). Title II of the JOBS Act
directed the Commission to amend Rule 506 of Regulation D to permit
general solicitation or general advertising in offerings made under
Rule 506, provided that all purchasers of the securities are
accredited investors. Accredited investors include natural persons
who meet certain income or net worth thresholds. Although this rule
facilitates the type of broad solicitation emblematic of
crowdfunding, crowdfunding is premised on permitting sales of
securities to any interested person, not just to investors who meet
specific qualifications, such as accredited investors.
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Moreover, someone who operates a Web site to effect the purchase
and sale of securities for the account of others generally would, under
pre-existing regulations, be required to register with the Commission
as a broker-dealer and comply with the laws and regulations applicable
to broker-dealers.\6\ A person that operates such a Web site only for
the purchase of securities of startups and small businesses, however,
may find it impractical in view of the limited nature of that person's
activities and business to register as a broker-dealer and operate
under the full set of regulatory obligations that apply to broker-
dealers.
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\6\ Exchange Act Section 15(a)(1) generally makes it unlawful
for a broker or dealer to effect any transactions in, or induce the
purchase or sale of, any security unless that broker or dealer is
registered with the Commission pursuant to Exchange Act Section
15(b). 15 U.S.C. 78o(a). See discussion in Section II.D.2. Because
brokers and dealers both register as broker-dealers (i.e., there is
no separate ``broker'' or ``dealer'' registration under Exchange Act
Section 15(b)), we use the term ``broker-dealer'' in this release.
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B. Title III of the JOBS Act
Title III of the JOBS Act (``Title III'') added new Securities Act
Section 4(a)(6),\7\ which provides an exemption from the registration
requirements of Securities Act Section 5 \8\ for certain crowdfunding
transactions. To qualify for the exemption under Section 4(a)(6),
crowdfunding transactions by an issuer (including all entities
controlled by or under common control with the issuer) must meet
specified requirements, including the following:
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\7\ 15 U.S.C. 77d(a)(6).
\8\ 15 U.S.C. 77e.
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The amount raised must not exceed $1 million in a 12-month
period;
individual investments in all crowdfunding issuers in a
12-month period are limited to:
[cir] The greater of $2,000 or 5 percent of annual income or net
worth, if annual income or net worth of the investor is less than
$100,000; and
[cir] 10 percent of annual income or net worth (not to exceed an
amount sold of $100,000), if annual income or net worth of the investor
is $100,000 or more; and
transactions must be conducted through an intermediary
that either is registered as a broker-dealer or is registered as a new
type of entity called a ``funding portal.''
In addition, Title III:
Adds Securities Act Section 4A,\9\ which requires, among
other things, that issuers and intermediaries that facilitate
transactions between issuers and investors in reliance on Section
4(a)(6) provide certain information to investors and potential
investors, take other actions and provide notices and other information
to the Commission;
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\9\ 15 U.S.C. 77a.
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adds Exchange Act Section 3(h),\10\ which requires the
Commission to adopt rules to exempt, either conditionally or
unconditionally, ``funding portals'' from having to register as a
broker-dealer pursuant to Exchange Act Section 15(a)(1); \11\
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\10\ 15 U.S.C. 78c(h).
\11\ 15 U.S.C. 78o(a)(1).
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mandates that the Commission establish disqualification
provisions under which an issuer would not be able to avail itself of
the Section 4(a)(6) exemption if the issuer or an intermediary was
subject to a disqualifying event; and
adds Exchange Act Section 12(g)(6),\12\ which requires the
Commission to adopt rules to exempt from the registration requirements
of Section 12(g),\13\ either conditionally or unconditionally,
securities acquired pursuant to an offering made in reliance on Section
4(a)(6).
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\12\ 15 U.S.C. 78l(g)(6).
\13\ 15 U.S.C. 78l(g).
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On October 23, 2013, we proposed new rules and forms to implement
Title III of the JOBS Act.\14\ We received over 485 comment letters on
the Proposing Release, including from professional and trade
associations, investor organizations, law firms, investment companies
and investment advisers, broker-dealers, potential funding portals,
members of Congress, the Commission's Investor Advisory Committee,\15\
state securities regulators, government agencies, potential issuers,
accountants, individuals and other interested parties. We have reviewed
and considered all of the comments that we received on the Proposing
Release and on Title III of the JOBS Act.\16\ In this
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release, we are adopting new rules and forms to implement Sections
4(a)(6) and 4A and Exchange Act Sections 3(h) and 12(g)(6). The rules
are described in detail below.
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\14\ See Rel. No. 33-9470 (Oct. 23, 2013) [78 FR 66427 (Nov. 5,
2013)] (the ``Proposing Release''), available at: http://www.sec.gov/rules/proposed/2013/33-9470.pdf.
\15\ The SEC Investor Advisory Committee (``Investor Advisory
Committee'') was established in April 2012 pursuant to Section 911
of the Dodd-Frank Wall Street Reform and Consumer Protection Act
[Pub. L. 111-203, sec. 911, 124 Stat. 1376, 1822 (July 21, 2010)]
(the ``Dodd-Frank Act'') to advise the Commission on regulatory
priorities, the regulation of securities products, trading
strategies, fee structures, the effectiveness of disclosure,
initiatives to protect investor interests and to promote investor
confidence and the integrity of the securities marketplace. The
Dodd-Frank Act authorizes the Investor Advisory Committee to submit
findings and recommendations for review and consideration by the
Commission.
\16\ To facilitate public input on JOBS Act rulemaking before
the issuance of rule proposals, the Commission invited members of
the public to make their views known on various JOBS Act initiatives
in advance of any rulemaking by submitting comment letters to the
Commission's Web site at http://www.sec.gov/spotlight/jobsactcomments.shtml. The comment letters relating to Title III of
the JOBS Act submitted in response to this invitation are located at
http://www.sec.gov/comments/jobs-title-ii/jobs-title-iii.shtml.
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II. Final Rules Implementing Regulation Crowdfunding
Regulation Crowdfunding, among other things, permits individuals to
invest in securities-based crowdfunding transactions subject to certain
thresholds, limits the amount of money an issuer can raise under the
crowdfunding exemption, requires issuers to disclose certain
information about their offers, and creates a regulatory framework for
the intermediaries that facilitate the crowdfunding transactions. As an
overview, under the final rules:
An issuer is permitted to raise a maximum aggregate amount
of $1 million through crowdfunding offerings in a 12-month period;
Individual investors, over the course of a 12-month
period, are permitted to invest in the aggregate across all
crowdfunding offerings up to:
[cir] If either their annual income or net worth is less than
$100,000, then the greater of:
[ssquf] $2,000 or
[ssquf] 5 percent of the lesser of their annual income or net
worth.
[cir] If both their annual income and net worth are equal to or
more than $100,000, then 10 percent of the lesser of their annual
income or net worth; and
During the 12-month period, the aggregate amount of
securities sold to an investor through all crowdfunding offerings may
not exceed $100,000.
Certain companies are not eligible to use the Regulation
Crowdfunding exemption. Ineligible companies include non-U.S.
companies, companies that already are Exchange Act reporting companies,
certain investment companies, companies that are disqualified under
Regulation Crowdfunding's disqualification rules, companies that have
failed to comply with the annual reporting requirements under
Regulation Crowdfunding during the two years immediately preceding the
filing of the offering statement, and companies that have no specific
business plan or have indicated their business plan is to engage in a
merger or acquisition with an unidentified company or companies.
Securities purchased in a crowdfunding transaction generally cannot
be resold for a period of one year. Holders of these securities do not
count toward the threshold that requires an issuer to register its
securities with the Commission under Section 12(g) of the Exchange Act
if the issuer is current in its annual reporting obligation, retains
the services of a registered transfer agent and has less than $25
million in assets.
Disclosure by Issuers. The final rules require issuers conducting
an offering pursuant to Regulation Crowdfunding to file certain
information with the Commission and provide this information to
investors and the relevant intermediary facilitating the crowdfunding
offering. Among other things, in its offering documents, the issuer is
required to disclose:
Information about officers and directors as well as owners
of 20 percent or more of the issuer;
A description of the issuer's business and the use of
proceeds from the offering;
The price to the public of the securities or the method
for determining the price, the target offering amount, the deadline to
reach the target offering amount, and whether the issuer will accept
investments in excess of the target offering amount;
Certain related-party transactions;
A discussion of the issuer's financial condition; and
Financial statements of the issuer that are, depending on
the amount offered and sold during a 12-month period, accompanied by
information from the issuer's tax returns, reviewed by an independent
public accountant, or audited by an independent auditor. An issuer
relying on these rules for the first time would be permitted to provide
reviewed rather than audited financial statements, unless financial
statements of the issuer are available that have been audited by an
independent auditor.
Issuers are required to amend the offering document during the
offering period to reflect material changes and provide updates on the
issuer's progress toward reaching the target offering amount.
In addition, issuers relying on the Regulation Crowdfunding
exemption are required to file an annual report with the Commission and
provide it to investors.
Crowdfunding Platforms. One of the key investor protections of
Title III of the JOBS Act is the requirement that Regulation
Crowdfunding transactions take place through an SEC-registered
intermediary, either a broker-dealer or a funding portal. Under
Regulation Crowdfunding, offerings must be conducted exclusively
through a platform operated by a registered broker or a funding portal,
which is a new type of SEC registrant. The rules require these
intermediaries to:
Provide investors with educational materials;
Take measures to reduce the risk of fraud;
Make available information about the issuer and the
offering;
Provide communication channels to permit discussions about
offerings on the platform; and
Facilitate the offer and sale of crowdfunded securities.
The rules prohibit funding portals from:
Offering investment advice or making recommendations;
Soliciting purchases, sales or offers to buy securities
offered or displayed on its platform;
Compensating promoters and others for solicitations or
based on the sale of securities; and
Holding, possessing, or handling investor funds or
securities.
The rules provide a safe harbor under which funding portals can
engage in certain activities consistent with these restrictions.
The staff will undertake to study and submit a report to the
Commission no later than three years following the effective date of
Regulation Crowdfunding on the impact of the regulation on capital
formation and investor protection. The report will include, but not be
limited to, a review of: (1) Issuer and intermediary compliance; (2)
issuer offering limits and investor investment limits; (3) incidence of
fraud, investor losses, and compliance with investor aggregates; (4)
intermediary fee and compensation structures; (5) measures
intermediaries have taken to reduce the risk of fraud, including
reliance on issuer and investor representations; (6) the concept of a
centralized database of investor contributions; (7) intermediary
policies and procedures; (8) intermediary recordkeeping practices; and
(9) secondary market trading practices.
A. Crowdfunding Exemption
Section 4(a)(6) provides an exemption from the registration
requirements of Securities Act Section 5 for certain crowdfunding
transactions. To qualify for this exemption, crowdfunding transactions
by an issuer must meet specified requirements, including limits on the
dollar amount of the securities that may be sold by an issuer and the
dollar amount that may be invested by an individual in a 12-month
period. The crowdfunding transaction also must be conducted through a
registered
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intermediary that complies with specified requirements.\17\ Title III
also provides limitations on who may rely on the exemption and
establishes specific liability provisions for material misstatements or
omissions in connection with Section 4(a)(6) exempt transactions. As
discussed below, the rules we are adopting are designed to aid issuers,
investors and intermediaries in complying with these various
limitations and requirements.
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\17\ See Section II.C for a discussion of the intermediary
requirements. See also Section II.D for a discussion of the
additional funding portal requirements.
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1. Limit on Capital Raised
a. Proposed Rules
The exemption from registration provided by Section 4(a)(6) is
available to a U.S. issuer provided that ``the aggregate amount sold to
all investors by the issuer, including any amount sold in reliance on
the exemption provided under [Section 4(a)(6)] during the 12-month
period preceding the date of such transaction, is not more than
$1,000,000.'' Under Securities Act Section 4A(h), the Commission is
required to adjust the dollar amounts in Section 4(a)(6) ``not less
frequently than once every five years, by notice published in the
Federal Register, to reflect any change in the Consumer Price Index for
All Urban Consumers published by the Bureau of Labor Statistics.''
Consistent with the statute, we proposed in Rule 100(a) of
Regulation Crowdfunding to limit the aggregate amount sold to all
investors by the issuer in reliance on the new exemption to $1 million
during a 12-month period. Capital raised through other exempt
transactions would not be counted in determining the aggregate amount
sold in reliance on Section 4(a)(6).
We also provided guidance clarifying our view that offerings made
in reliance on Section 4(a)(6) will not be integrated \18\ with other
exempt offerings made by the issuer, provided that each offering
complies with the requirements of the applicable exemption that is
being relied upon for the particular offering.
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\18\ The integration doctrine seeks to prevent an issuer from
improperly avoiding registration by artificially dividing a single
offering into multiple offerings such that Securities Act exemptions
would apply to multiple offerings that would not be available for
the combined offering. See, e.g., Final Rule: Nonpublic Offering
Exemption, Release No. 33-4552 (Nov. 6, 1962).
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Under Section 4(a)(6), the amount of securities sold in reliance on
Section 4(a)(6) by entities controlled by or under common control with
the issuer must be aggregated with the amount to be sold by the issuer
in the current offering to determine the aggregate amount sold in
reliance on Section 4(a)(6) during the preceding 12-month period. Under
the proposed rules, for purposes of determining whether an entity is
``controlled by or under common control with'' the issuer, an issuer
would be required to consider whether it has ``control'' based on the
definition in Securities Act Rule 405.\19\ As proposed, the amount of
securities sold in reliance on Section 4(a)(6) also would include
securities sold by any predecessor of the issuer in reliance on Section
4(a)(6) during the preceding 12-month period.
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\19\ See 17 CFR 230.405 (``The term control (including the terms
controlling, controlled by and under common control with) means the
possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of a person, whether
through the ownership of voting securities, by contract, or
otherwise.''). Exchange Act Rule 12b-2 contains the same definition.
See 17 CFR 240.12b-2.
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b. Comments on the Proposed Rules
A few commenters supported a $1 million limit on capital raised by
an issuer in reliance on Section 4(a)(6),\20\ while many other
commenters believed that the proposed $1 million limit was too low and,
in some instances, recommended higher limits.\21\ Several commenters
urged that the $1 million limit be net of fees charged by the
intermediary to host the offering on the intermediary's platform,\22\
while other commenters generally opposed this idea.\23\
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\20\ See, e.g., Leverage PR Letter; StartEngine Letter 1;
StartEngine Letter 2; Wilson Letter.
\21\ See, e.g., Advanced Hydro Letter; Bushroe Letter; Cole D.
Letter; Concerned Capital Letter; Hamman Letter; Harrison Letter;
Hillside Letter; Jazz Letter; Kickstarter Coaching Letter; McCulley
Letter; McGladrey Letter; Meling Letter; Miami Nation Enterprises
Letter; Multistate Tax Service Letter; Peers Letter; Pioneer Realty
Letter; Public Startup Letter 2; Qizilbash Letter; Rosenthal O.
Letter; Sarles Letter; SBM Letter; Taylor R. Letter; Taylor T.
Letter; Wales Capital Letter 1; Wales Capital Letter 3; WealthForge
Letter; Wear Letter; Wilhelm Letter; Winters Letter; Yudek Letter.
\22\ See, e.g., Benjamin Letter; FundHub Letter 1; Hackers/
Founders Letter; Joinvestor Letter; Odhner Letter; Omara Letter;
Public Startup Letter 2; RFPIA Letter; RoC Letter; RocketHub Letter;
Seed&Spark Letter; Thomas Letter 1; Wales Capital Letter 1; Whitaker
Chalk Letter; Wilson Letter.
\23\ See, e.g., Arctic Island Letter 4; ASSOB Letter;
Commonwealth of Massachusetts Letter; MCS Letter; PeoplePowerFund
Letter.
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Commenters were divided on the proposed guidance that other exempt
offerings should not be integrated when determining the amount sold
during the preceding 12-month period for purposes of the $1 million
limit, with some supporting this approach,\24\ and others opposing
it.\25\
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\24\ See, e.g., AngelList Letter; Arctic Island Letter 4;
Campbell R. Letter; CFA Institute Letter; CFIRA Letter 11;
EarlyShares Letter; EMKF Letter; Farnkoff Letter; Feinstein Letter;
Growthfountain Letter; Hackers/Founders Letter; Heritage Letter;
NSBA Letter; Parsont Letter; Perfect Circle Solutions Letter; Public
Startup Letter 2; RoC Letter; RocketHub Letter; Wales Capital Letter
1; Wefunder Letter; Whitaker Chalk Letter; Wilson Letter.
\25\ See, e.g., AFL-CIO Letter (not integrating other exempt
offerings will make crowdfunding available to larger companies and
``crowd out'' smaller companies that lack other options for raising
capital); AFR Letter; Brown J. Letter; Consumer Federation Letter
(not integrating other exempt offerings will allow issuers to evade
regulatory requirements); Fund Democracy Letter (not integrating
other exempt offerings will give issuers an incentive to engage in
advertising in concurrent private offerings to indirectly publicly
advertise their crowdfunding offering); IAC Recommendation; MCS
Letter; NASAA Letter.
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c. Final Rules
We are adopting as proposed rules that limit to $1 million the
aggregate amount that may be sold to all investors by the issuer in a
12-month period in reliance on the new exemption.\26\ We continue to
believe this approach is consistent with the statute and will provide
for a meaningful addition to the existing capital formation options for
smaller companies while maintaining important investor protections.
Moreover, Regulation Crowdfunding is a novel method of raising capital
for smaller companies, and we are concerned about expanding the
offering limit of the exemption beyond the level specified in Section
4(a)(6) at the outset of the adoption of final rules. Some commenters
suggested that the $1 million limit be net of fees charged by the
intermediary to host the offering on the intermediary's platform,\27\
which would be an indirect way of increasing the $1 million limit. We
are concerned that expanding the offering limit in this way would
provide less certainty and could raise interpretive questions, which
would make the exemption more costly for issuers to comply with. If a
funding portal's fees are not known in advance, for example, this may
create uncertainty for issuers about how much capital they would be
able to raise. Therefore, we are adopting as proposed the limit on the
aggregate amount sold.
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\26\ See Rule 100(a)(1) of Regulation Crowdfunding. There is a
technical change to the rule text (``offer and sell securities'' is
changed to ``offer or sell securities'') to clarify that an issuer
does not have to complete a sale in order to rely on the Section
4(a)(6) exemption for an offering.
\27\ See, e.g., Benjamin Letter; FundHub Letter 1; Hackers/
Founders Letter; Joinvestor Letter; Odhner Letter; Omara Letter;
Public Startup Letter 2; RFPIA Letter; RoC Letter; RocketHub Letter;
Seed&Spark Letter; Thomas Letter 1; Wales Capital Letter 1; Whitaker
Chalk Letter; Wilson Letter.
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[[Page 71392]]
Title III provides that the $1 million limit applies to the
``aggregate amount sold to all investors by the issuer, including any
amount sold in reliance on the exemption provided under [Section
4(a)(6)].'' Securities Act Section 4A(g), however, provides that
``[n]othing in the exemption shall be construed as preventing an issuer
from raising capital through means other than [S]ection 4[(a)](6).''
Considered together, these two provisions create statutory ambiguity
because the first provision could be read to provide for the
aggregation of amounts raised in all exempt transactions, even those
that do not involve crowdfunding, while the second provision could be
read to provide that nothing in the Section 4(a)(6) exemption should
limit an issuer's capital raising through other methods. We believe
that the overall intent of providing the exemption under Section
4(a)(6) was to provide an additional mechanism for capital raising for
startup and small businesses and not to affect the amount an issuer
could raise outside of that exemption. Thus, we believe that only the
capital raised in reliance on the exemption provided by Section 4(a)(6)
should be counted toward the limit. Capital raised through other means
should not be counted in determining the aggregate amount sold in
reliance on Section 4(a)(6). The opposite approach--requiring
aggregation of amounts raised in any exempt transaction--would be
inconsistent with the goal of alleviating the funding gap for startups
and small businesses because, by electing crowdfunding, such issuers
would be placing a cap on the amount of capital they could raise. An
issuer that already sold $1 million in reliance on the exemption
provided under Section 4(a)(6), for example, would be prevented from
raising capital through other exempt methods and, conversely, an issuer
that sold $1 million through other exempt methods would be prevented
from raising capital under Section 4(a)(6).
In determining the amount that may be sold in reliance on Section
4(a)(6), an issuer should aggregate amounts it sold (including amounts
sold by entities controlled by, or under common control with, the
issuer, as well as any amounts sold by any predecessor of the issuer)
in reliance on Section 4(a)(6) during the 12-month period preceding the
expected date of sale and the amount the issuer intends to raise in
reliance on the exemption. An issuer should not include amounts sold in
other exempt offerings during the preceding 12-month period.
Further, in light of Section 4A(g) and for the reasons discussed
above, we continue to believe that an offering made in reliance on
Section 4(a)(6) should not be integrated with another exempt offering
made by the issuer, provided that each offering complies with the
requirements of the applicable exemption that is being relied upon for
the particular offering. For example, an issuer conducting a concurrent
exempt offering for which general solicitation is not permitted will
need to be satisfied that purchasers in that offering were not
solicited by means of the offering made in reliance on Section
4(a)(6).\28\ As another example, an issuer conducting a concurrent
exempt offering for which general solicitation is permitted, for
example, under Securities Act Rule 506(c), could not include in any
such general solicitation an advertisement of the terms of an offering
made in reliance on Section 4(a)(6), unless that advertisement
otherwise complied with Section 4(a)(6) and the final rules. As such, a
concurrent offering would be bound by the more restrictive solicitation
requirements of Regulation Crowdfunding, unless the issuer can conclude
that the purchasers in the Regulation Crowdfunding offering were not
solicited by means of the offering made in reliance on Rule 506(c).
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\28\ For a concurrent offering under Rule 506(b), an issuer will
have to conclude that purchasers in the Rule 506(b) offering were
not solicited by means of the offering made in reliance on Section
4(a)(6). For example, the issuer may have had a preexisting
substantive relationship with such purchasers. Otherwise, the
solicitation conducted in connection with the crowdfunding offering
may preclude reliance on Rule 506(b). See also Rel. No. 33-8828
(Aug. 3, 2007) [72 FR 45116].
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The amount of securities sold in reliance on Section 4(a)(6) by
entities controlled by or under common control with the issuer must be
aggregated with the amount to be sold by the issuer in the current
offering to determine the aggregate amount sold in reliance on Section
4(a)(6) during the preceding 12-month period. The statute does not
define the term ``controlled by or under common control with'' the
issuer; however, the term ``control'' is defined in Securities Act Rule
405.\29\ Under the final rules, for purposes of determining whether an
entity is ``controlled by or under common control with'' the issuer, an
issuer will be required to consider whether it possesses, directly or
indirectly, the power to direct or cause the direction of the
management and policies of the entity, whether through the ownership of
voting securities, by contract or otherwise, consistent with the
definition of ``control'' in Securities Act Rule 405.\30\
---------------------------------------------------------------------------
\29\ See note 19.
\30\ See Instruction to paragraph (c) of Rule 100 of Regulation
Crowdfunding.
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Under the final rules, the amount of securities sold in reliance on
Section 4(a)(6) also includes securities sold by any predecessor of the
issuer in reliance on Section 4(a)(6) during the preceding 12-month
period.\31\ We believe this approach is necessary to prevent an issuer
from exceeding the $1 million limit by reorganizing into a new entity
that would otherwise not be limited by previous sales made by its
predecessor.
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\31\ See Rule 100(c) of Regulation Crowdfunding (defining
issuer, in certain circumstances, to include all entities controlled
by or under common control with the issuer and any predecessor of
the issuer).
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2. Investment Limits
a. Proposed Rules
Under the exemption from registration set forth in Securities Act
Section 4(a)(6)(B), the aggregate amount of securities sold to any
investor by an issuer, including any amount sold in reliance on the
exemption during the 12-month period preceding the date of such
transaction, cannot exceed: ``(i) the greater of $2,000 or 5 percent of
the annual income or net worth of such investor, as applicable, if
either the annual income or the net worth of the investor is less than
$100,000; and (ii) 10 percent of the annual income or net worth of such
investor, as applicable, not to exceed a maximum aggregate amount sold
of $100,000, if either the annual income or net worth of the investor
is equal to or more than $100,000.''
In the Proposing Release, we noted that this statutory language may
present ambiguity in some cases about which of the two investment
limits governs, because paragraph (i) applies if ``either'' annual
income or net worth is less than $100,000 and paragraph (ii) applies if
``either'' annual income or net worth is equal to or more than
$100,000. Accordingly, in a situation in which annual income is less
than $100,000 and net worth is equal to or more than $100,000 (or vice
versa), the language of the statute may be read to cause both
paragraphs to apply. Paragraph (i) also fixes the maximum annual
investment by an investor at 5 percent of ``the annual income or net
worth of such investor, as applicable'' and paragraph (ii) fixes the
maximum annual investment by an investor at 10 percent of ``the annual
income or net worth of such investor, as applicable,'' but neither
states when that percentage should be applied against the investor's
[[Page 71393]]
annual income and when it should be applied against the investor's net
worth.
Under proposed Rule 100(a) of Regulation Crowdfunding, the
aggregate amount of securities sold to any investor by any issuer in
reliance on Section 4(a)(6) during the 12-month period preceding the
date of such transaction, including the securities sold to such
investor in such transaction, could not exceed the greater of: (i)
$2,000 or 5 percent of the annual income or net worth of the investor,
whichever is greater, if both annual income and net worth are less than
$100,000; or (ii) 10 percent of the annual income or net worth of the
investor, whichever is greater, not to exceed an amount sold of
$100,000, if either annual income or net worth is equal to or more than
$100,000.
We did not propose to alter these investment limits for any
particular type of investor or create a different exemption based on
different investment limits. Under the proposal, the annual income and
net worth of a natural person would be calculated in accordance with
the Commission's rules for the calculation of annual income and net
worth of an accredited investor, and an investor's annual income or net
worth could be calculated jointly with the annual income or net worth
of the investor's spouse. An issuer would be able to rely on the
efforts of an intermediary to determine that the aggregate amount of
securities purchased by an investor will not cause the investor to
exceed the investment limits, provided the issuer does not have
knowledge to the contrary.
b. Comments on the Proposed Rules
Commenters were divided on the proposed investment limits. Many
commenters supported some type of investment limit without necessarily
expressing a specific opinion on the proposed investment limits,\32\
while many others generally opposed any type of investment limit.\33\ A
number of commenters recommended changes to the proposed limits.\34\
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\32\ See, e.g., Accredify Letter; Ahmad Letter; Crowley Letter;
Farnkoff Letter; Merkley Letter; Milken Institute Letter; Patel
Letter; Saunders Letter; StartEngine Letter 1; Wales Capital Letter
1.
\33\ See, e.g., ASSOB Letter; Crowdstockz Letter; Hamman Letter;
Holland Letter; McCulley Letter; Meling Letter; Qizilbash Letter;
Ramsey Letter; SBM Letter; Taylor R Letter.
\34\ See, e.g., Crowdstockz Letter; Gill Letter; Johnston
Letter; Morse Letter; Qizilbash Letter; Vossberg Letter; Winters
Letter.
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While some commenters supported the proposal to apply the higher
investment limit (10 percent, as set forth in Section 4(a)(6)(B)(ii))
if only one of the annual income or net worth of the investor is equal
to or more than $100,000,\35\ some commenters also supported the lower
investment limit ($2,000 or 5 percent, as set forth in Section
4(a)(6)(B)(i)) unless both the annual income and net worth of the
investor are equal to or more than $100,000.\36\
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\35\ See, e.g., ABA Letter; CFA Institute Letter; CFIRA Letter
12; Craw Letter; Finkelstein Letter; RocketHub Letter; Wilson
Letter.
\36\ See, e.g., AFL-CIO Letter; BetterInvesting Letter; Consumer
Federation Letter; Fund Democracy Letter; IAC Recommendation;
Jacobson Letter; NASAA Letter; Schwartz Letter.
---------------------------------------------------------------------------
A number of commenters supported the proposal that within each of
the two levels of investment limits, the limits would be calculated
based on the ``greater of'' an investor's annual income or net
worth,\37\ while a number of other commenters preferred a ``lesser of''
approach.\38\ A few commenters suggested a combination of the
approaches (e.g., if either annual income or net worth is below
$100,000, the lower investment limit level ($2,000 or 5 percent) would
apply, but within that level, the limit would be based on the greater
of annual income or net worth).\39\
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\37\ See, e.g., ABA Letter; Anonymous Letter 6; CFIRA Letter 12;
Craw Letter; EarlyShares Letter; Jacobson Letter; Omara Letter;
RocketHub Letter; Wilson Letter.
\38\ See, e.g., AFR Letter; BetterInvesting Letter; Consumer
Federation Letter; Fund Democracy Letter; Fryer Letter;
Growthfountain Letter; IAC Recommendation (stating that the
``greater of'' approach would be appropriate for accredited
investors); Merkley Letter; NASAA Letter; Schwartz Letter; Zhang
Letter (recommending that net worth not be used to calculate the
investment limit).
\39\ See, e.g., Consumer Federation Letter; Fund Democracy
Letter; Jacobson Letter.
---------------------------------------------------------------------------
Many commenters supported the proposal that an issuer may rely on
the efforts of an intermediary to determine that the aggregate amount
of securities purchased by an investor will not cause the investor to
exceed the investment limits, provided that the issuer does not have
knowledge that the investor had exceeded, or would exceed, the
investment limits as a result of purchasing securities in the issuer's
offering.\40\ A few commenters recommended that an issuer be required
to obtain a written representation from the investor that the investor
has not and will not exceed the limits by purchasing from the
issuer.\41\
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\40\ See, e.g., Arctic Island Letter 4; CFA Institute Letter;
Consumer Federation Letter; CrowdBouncer Letter; EarlyShares Letter;
EMKF Letter; Finkelstein Letter; Fund Democracy Letter; Heritage
Letter; Joinvestor Letter; Public Startup Letter 2; RoC Letter;
RocketHub Letter; Vann Letter; Wefunder Letter; Whitaker Chalk
Letter.
\41\ See, e.g., FundHub Letter 1; Public Startup Letter 2;
RocketHub Letter.
---------------------------------------------------------------------------
Commenters were divided about the joint calculation of annual
income and net worth with the investor's spouse. Several commenters
supported the proposal that an investor's annual income and net worth
be calculated jointly with that of the investor's spouse,\42\ while
other commenters generally opposed that aspect of the proposal.\43\
Several commenters recommended that if an investor's annual income and
net worth are to be calculated jointly, the Commission should establish
higher thresholds or an aggregate investment limit applicable to both
spouses.\44\
---------------------------------------------------------------------------
\42\ See, e.g., Arctic Island Letter 4; Heritage Letter;
Joinvestor Letter; NSBA Letter; Omara Letter; RocketHub Letter;
Wilson Letter.
\43\ See, e.g., Brown J. Letter; Consumer Federation Letter;
Fund Democracy Letter; Jacobson Letter; Projectheureka Letter;
Public Startup Letter 2.
\44\ See, e.g., Brown, J. Letter; Consumer Federation Letter;
Fund Democracy Letter; Jacobson Letter.
---------------------------------------------------------------------------
A number of commenters favored different or no investment limits
for accredited and institutional investors. Many commenters supported
exempting accredited and institutional investors from the investment
limits,\45\ although a number of other commenters opposed such an
exemption.\46\ A few commenters recommended allowing higher investment
limits for accredited and institutional investors.\47\ One commenter
stated that applying the investment limits to accredited and
institutional investors would deter those investors from participating,
but noted that allowing concurrent offerings under Securities Act Rule
506(c) \48\ may mitigate this problem.\49\
---------------------------------------------------------------------------
\45\ See, e.g., ASSOB Letter; Crowdstockz Letter; Crowley
Letter; EMKF Letter; FundHub Letter 1; Gibb Letter; Heritage Letter;
Joinvestor Letter; Public Startup Letter 2; RoC Letter; RocketHub
Letter; Vann Letter; Wales Capital Letter 1; WealthForge Letter;
Wefunder Letter.
\46\ See, e.g., CFA Institute Letter; FundDemocracy Letter;
Hackers/Founders Letter; Jacobson Letter; PeoplePowerFund Letter;
Projectheureka Letter; Whitaker Chalk Letter; Wilson Letter.
\47\ See, e.g., Growthfountain Letter; RFPIA Letter; WealthForge
Letter.
\48\ 17 CFR 230.506.
\49\ See Arctic Island Letter 4.
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c. Final Rules
Consistent with the statute, we are adopting investment limits for
securities-based crowdfunding transactions, but with some modifications
from the proposed rules. We have modified the final rules from the
proposal to clarify that the investment limit reflects the aggregate
amount an investor may invest in all offerings under Section 4(a)(6) in
a 12-month period across all issuers. In addition, as noted above, some
commenters supported a ``greater of'' approach to implementing the two
statutory investment limits, while others supported a ``lesser of''
approach. After
[[Page 71394]]
considering the comments received, we have decided to adopt a ``lesser
of'' approach. Thus, under the final rules, an investor will be limited
to investing: (1) The greater of: $2,000 or 5 percent of the lesser of
the investor's annual income or net worth if either annual income or
net worth is less than $100,000; or (2) 10 percent of the lesser of the
investor's annual income or net worth, not to exceed an amount sold of
$100,000, if both annual income and net worth are $100,000 or more.\50\
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\50\ See paragraph (a)(2) of Rule 100 of Regulation
Crowdfunding.
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Under this approach, an investor with annual income of $50,000 a
year and $105,000 in net worth would be subject to an investment limit
of $2,500, in contrast to the proposed rules in which that same
investor would have been eligible for an investment limit of
$10,500.\51\ We recognize that this change from the proposed rules
could place constraints on capital formation. Nevertheless, we believe
that the investment limits in the final rules appropriately take into
consideration the need to give issuers access to capital while
minimizing an investor's exposure to risk in a crowdfunding
transaction.
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\51\ See Instruction 2 to paragraph (a)(2) of Rule 100 of
Regulation Crowdfunding.
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The chart below illustrates a few examples:
------------------------------------------------------------------------
Investor annual Investor net Investment
income worth Calculation limit \52\
------------------------------------------------------------------------
$30,000............. $105,000 Greater of $2,000 $2,000
or 5% of $30,000
($1,500).
150,000............. 80,000 Greater of $2,000 4,000
or 5% of $80,000
($4,000).
150,000............. 100,000 10% of $100,000 10,000
($10,000).
200,000............. 900,000 10% of $200,000 20,000
($20,000).
1,200,000........... 2,000,000 10% of $1,200,000 100,000
($120,000),
subject to
$100,000 cap.
------------------------------------------------------------------------
A number of commenters expressed concerns about investors
potentially incurring unaffordable losses under the proposed rule,\53\
and we find these comments persuasive given the risks involved. The
startups and small businesses that we expect will rely on the
crowdfunding exemption are likely to experience a higher failure rate
than more seasoned companies.\54\ Applying the lower limit ($2,000 or
5%, rather than 10%) for investors whose annual income or net worth is
below $100,000 and applying that formula to the lesser of annual income
or net worth will potentially limit investment losses in crowdfunding
offerings for investors who may be less able to bear the risk of loss.
We are concerned about the number of households where there is a
sizeable gap between net worth and annual income, and the ability of
these households to withstand the risk of loss. According to Commission
staff analysis of the data in the 2013 Survey of Consumer Finances,
approximately 20% of U.S. households with net worth over $100,000 have
annual income under $50,000.
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\52\ This ``Investment Limit'' column reflects the aggregate
investment limit across all offerings under Section 4(a)(6) within a
12-month period.
\53\ See, e.g., AFL-CIO Letter; BetterInvesting Letter; Consumer
Federation Letter; Fund Democracy Letter; IAC Recommendation;
Jacobson Letter; Merkley Letter; NASAA Letter; Schwartz Letter.
\54\ For a more detailed discussion of survival rates for
startups and small businesses see Section III.A, below.
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Consistent with the proposed rules, the final rules allow an issuer
to rely on efforts that an intermediary is required to undertake in
order to determine that the aggregate amount of securities purchased by
an investor does not cause the investor to exceed the investment
limits, provided that the issuer does not have knowledge that the
investor had exceeded, or would exceed, the investment limits as a
result of purchasing securities in the issuer's offering.\55\
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\55\ See Instruction 3 to paragraph (a)(2) of Rule 100 of
Regulation Crowdfunding.
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We are adopting, as proposed, final rules that allow an investor's
annual income and net worth to be calculated as those values are
calculated for purposes of determining accredited investor status.\56\
Securities Act Rule 501 specifies the manner in which annual income and
net worth are calculated for purposes of determining accredited
investor status.\57\ As in the proposal, the final rules allow spouses
to calculate their net worth or annual income jointly. Although some
commenters opposed permitting net worth or annual income to be
calculated jointly, we believe this approach is appropriate in light of
the stricter investment limits being adopted in the final rules.
Several commenters recommended that, if the final rules permit net
worth and annual income to be calculated jointly, we should establish
an aggregate investment limit applicable to both spouses.\58\
Consistent with this recommendation, the final rules add an instruction
to explain that when such a joint calculation is used, the aggregate
investment of the spouses may not exceed the limit that would apply to
an individual investor at that income and net worth level.\59\ We
believe this approach is necessary to preserve the intended protections
of the investment limits.
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\56\ See Instruction 1 to paragraph (a)(2) of Rule 100 of
Regulation Crowdfunding.
\57\ 17 CFR 230.501. Thus, for example, a natural person's
primary residence shall not be included as an asset in the
calculation of net worth. 17 CFR 230.501(a)(5)(i)(A).
\58\ See Brown J. Letter; Consumer Federation Letter; Fund
Democracy Letter; Jacobs Letter.
\59\ For example, if each spouse's annual income is $30,000, the
spouses jointly may invest up to an aggregate of 5% of their joint
income of $60,000. If one spouse's annual income is $120,000 and the
other's is $30,000, the spouses jointly may invest up to an
aggregate of 10% of their joint income of $150,000, the same
investment limit that would apply for an individual investor with
income of $150,000. See Instruction 2 to paragraph (a)(2) of Rule
100 of Regulation Crowdfunding.
---------------------------------------------------------------------------
While a number of commenters supported the creation of a different
investment limit for accredited or institutional investors, or
exempting them altogether, we are not making such a change. As noted
above, crowdfunding is an innovative approach to raising capital in
which the entity or individual raising capital typically seeks small
individual contributions from a large number of people. As such, we
believe that crowdfunding transactions were intended under Section
4(a)(6) to be available equally to all types of investors.\60\ The
statute provides specific investment limits, and the only reference in
the statute to changing those investment limits is the requirement that
we update the investment limits not less frequently than every five
years based on the Consumer Price Index. Further, issuers can rely on
other exemptions to offer
[[Page 71395]]
and sell securities to accredited investors and institutional
investors. As discussed above, concurrent offerings to these types of
investors are possible if the conditions of each applicable exemption
are met.\61\ Therefore, we are not altering the investment limits for
any particular type of investor or to create a different exemption
based on different investment limits. Thus, as proposed, the investment
limits will apply equally to all investors, including retail,
institutional and accredited investors.
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\60\ See 158 CONG. REC. S1689 (daily ed. Mar. 15, 2012)
(statement of Sen. Mark Warner (``There is now the ability to use
the Internet as a way for small investors to get the same kind of
deals that up to this point only select investors have gotten that
have been customers of some of the best known investment banking
firms, where we can now use the power of the Internet, through a
term called crowdfunding.'').
\61\ For a discussion of integration, see Section II.A.1.c.
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3. Transaction Conducted Through an Intermediary
a. Proposed Rules
Section 4(a)(6)(C) requires that a transaction in reliance on
Section 4(a)(6) be conducted through a broker or funding portal that
complies with the requirements of Securities Act Section 4A(a). To
implement this provision, we proposed in Rule 100(a)(3) of Regulation
Crowdfunding that for any transaction conducted in reliance on Section
4(a)(6), an issuer use only one intermediary (that complies with the
requirements of Section 4A(a) and the related requirements in
Regulation Crowdfunding) and that the transaction be conducted
exclusively on the intermediary's platform. We also proposed to permit
the intermediary to engage in back office \62\ or other administrative
functions other than on the intermediary's platform, and to define
``platform'' as ``an Internet Web site or other similar electronic
medium through which a registered broker or a registered funding portal
acts as an intermediary in a transaction involving the offer or sale of
securities in reliance on Section 4(a)(6).''
---------------------------------------------------------------------------
\62\ Back office personnel typically perform functions such as,
but not limited to, recordkeeping, trade confirmations, internal
accounting, and account maintenance.
---------------------------------------------------------------------------
b. Comments on the Proposed Rules
Commenters were divided about the proposed prohibition on an issuer
using more than one intermediary for any transaction conducted pursuant
to Section 4(a)(6). Supporters of the proposed prohibition expressed
the view that the prohibition would benefit communication between
issuers and investors.\63\ One commenter stated that the prohibition
also would assist in assessing whether investors are within their
investment limits.\64\ Commenters who opposed the proposed prohibition
noted that increasing the number of platforms used per transaction
would both increase the likelihood of investors becoming informed that
a transaction is taking place, as well as elicit information from a
more diverse crowd.\65\
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\63\ See, e.g., CFA Institute Letter; Rockethub Letter.
\64\ See CFA Institute Letter.
\65\ See, e.g., Graves Letter.
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Commenters were generally divided about the proposed requirement
that transactions made in reliance on Section 4(a)(6) be conducted
exclusively through the intermediary's platform. Commenters who
supported \66\ the proposed requirement cited concerns that allowing
the transactions to be effected through means other than the
intermediary's platform could increase the potential for fraudulent
activity \67\ and prevent the leveraging of information sharing and
crowdsourced review that are intended through crowdfunding.\68\
Commenters who opposed \69\ the proposed requirement expressed their
view that permitting other means would allow persons who lack Internet
access to invest through crowdfunding,\70\ and also would foster
different types of in-person communication that are not possible to
achieve online.\71\ One commenter expressed a preference for issuers to
be able to host their own offerings subject to certain conditions.\72\
One commenter also suggested that intermediaries should be able to
engage in certain activities other than on their platforms, such as
physically meeting with representatives of issuers and investors, and
hosting launch parties. \73\
---------------------------------------------------------------------------
\66\ See, e.g., Joinvestor Letter; RoC Letter; RocketHub Letter;
Wilson Letter.
\67\ See, e.g., StartupValley Letter.
\68\ See, e.g., RocketHub Letter.
\69\ See, e.g., Benjamin Letter; Omara Letter; Public Startup
Letter 2.
\70\ See, e.g., Projecteureka Letter.
\71\ See, e.g., Benjamin Letter (``Without doubt, the web
fosters a crowd and a convenient forum to express ideas and learn
about the Issuer. However, small community gatherings provide
similar feedback loops and often times serve the community and some
investors better by fostering nuanced forms of communication that
can never be achieved. Further, some SEC concerns can be assuaged
regarding the loss of creating a `crowd' online because some
investors that may rely on the Web site to educate themselves may
not be inclined to contribute to the `crowd intelligence' online,
yet would be vocal in a community gathering.'').
\72\ See Public Startup Letter 2. We note that Section 4(a)(6)
of the Securities Act requires that, as a condition of the
exemption, the transaction be ``conducted through a broker or
funding portal that complies with the requirements of section
4A(b).'' 15 U.S.C. 77d(a)(6).
\73\ See Wilson Letter.
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A few commenters supported, but suggested technical revisions to,
our proposed definition of ``platform.'' \74\ One commenter suggested
deleting the phrase ``an Internet Web site or other similar electronic
medium'' and replacing the phrase with ``a software program accessible
via TCP/IP enabled applications'' or to more commonly define
``platform'' as ``a software program accessible via the Internet.''
\75\
---------------------------------------------------------------------------
\74\ See, e.g., Arctic Island Letter 1, Arctic Island Letter 3;
Arctic Island Letter 4; and Startup Valley Letter (explaining that
Web sites, application programmable interfaces (APIs) and other
electronic media are generally only the means to access a platform,
which itself is an Internet-accessible software program).
\75\ See Arctic Island Letter 1; Arctic Island Letter 4 (noting
that a ``platform'' is actually a software program that is
accessible via the Internet and that a ``Web site or other
electronic medium'' is merely a way to access the platform, not the
platform itself).
---------------------------------------------------------------------------
c. Final Rules
After considering the comments, we are adopting as proposed Rule
100(a)(3). We also are adopting the definition of ``platform'' with one
clarifying amendment and with a change in location to Rule 300(c).
As stated in the Proposing Release, we believe that requiring an
issuer to use only one intermediary to conduct an offering or
concurrent offerings in reliance on Section 4(a)(6) would help foster
the creation of a ``crowd'' and better accomplish the purpose of the
statute. In order for a crowd to effectively share information, we
believe it would be most beneficial to have one meeting place for the
crowd to obtain and share information, thus avoiding dilution or
dispersement of the ``crowd.'' We also believe that limiting a
crowdfunding transaction to a single intermediary's online platform
helps to minimize the risk that issuers and intermediaries would
circumvent the requirements of Regulation Crowdfunding. For example,
allowing an issuer to conduct an offering using more than one
intermediary would make it more difficult for intermediaries to
determine whether an issuer is exceeding the $1 million aggregate
offering limit.
We continue to believe that crowdfunding transactions made in
reliance on Section 4(a)(6) and activities associated with these
transactions should occur over the Internet or other similar electronic
medium that is accessible to the public. Such an ``online-only''
requirement enables the public to access offering information and share
information publicly in a way that will allow members of the crowd to
share their views on whether to participate in the offering and fund
the business or idea. While we acknowledge, as one commenter observed,
that there are forms of communication that cannot be achieved
[[Page 71396]]
online,\76\ we nevertheless believe that the requirement that the
transaction be conducted exclusively through the intermediary's
platform will help to ensure transparency, provide for ready
availability of information in one place to all investors, and promote
greater uniformity in the distribution of information among investors.
We also do not believe that funding portals should be permitted to
physically meet with investors to solicit investments and offerings on
its platform, or host launch parties, as one commenter recommended,
because these activities likely violate the statutory prohibition on
funding portals soliciting and providing investment advice and
recommendations. However, we continue to believe that intermediaries
should be able to engage in back office and other administrative
functions other than on their platforms.
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\76\ See Benjamin Letter (in-person gatherings may foster more
``nuanced forms of communication'').
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In a change from the proposed rules, and consistent with the
suggestions of commenters, the final rules define ``platform'' as ``a
program or application accessible via the Internet or other similar
electronic communication medium through which a registered broker or a
registered funding portal acts as an intermediary in a transaction
involving the offer or sale of securities in reliance on Section
4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6))'' [emphasis
added].\77\ We believe that this definition is more technically
accurate and also will accommodate innovation in the event of
technological advancements. We are moving the definition of
``platform'' from Rule 100 to Rule 300(c) so that it will be located
alongside the other Regulation Crowdfunding definitions related to
intermediaries. Also, in a change from the proposed rule, we are moving
to the definition of platform an instruction stating that an
intermediary through which a crowdfunding transaction is conducted may
engage in back office or other administrative functions other than on
the intermediary's platform.\78\
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\77\ Rule 300(c) of Regulation Crowdfunding.
\78\ In the final rule, this is an instruction to Rule
300(c)(4). The instruction was proposed under proposed Rule
100(a)(3), but we believe it is more appropriate under the
definition of platform because the instruction explains that back
office activities can happen off the platform.
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4. Exclusion of Certain Issuers From Eligibility Under Section 4(a)(6)
Securities Act Section 4A(f) excludes certain categories of issuers
from eligibility to rely on Section 4(a)(6) to engage in crowdfunding
transactions. These are: (1) Issuers that are not organized under the
laws of a state or territory of the United States or the District of
Columbia; (2) issuers that are subject to Exchange Act reporting
requirements; \79\ (3) investment companies as defined in the
Investment Company Act of 1940 (the ``Investment Company Act'') \80\ or
companies that are excluded from the definition of investment company
under Section 3(b) or 3(c) of the Investment Company Act; \81\ and (4)
any other issuer that the Commission, by rule or regulation, determines
appropriate.
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\79\ These are issuers who are required to file reports with the
Commission pursuant to Exchange Act Sections 13(a) (15 U.S.C.
78m(a)) or 15(d) (15 U.S.C. 78o(d)).
\80\ 15 U.S.C 80a-1 et seq.
\81\ 15 U.S.C. 80a-3(b) or (c).
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a. Proposed Rules
Rule 100(b) of Regulation Crowdfunding, as proposed, would exclude
the categories of issuers specifically identified in Section 4A(f). In
addition, the proposed rules would exclude: (1) Issuers that are
disqualified from relying on Section 4(a)(6) pursuant to the
disqualification provision in Rule 503(a) of Regulation Crowdfunding;
(2) issuers that have sold securities in reliance on Section 4(a)(6) if
they have not filed with the Commission and provided to investors, to
the extent required, the ongoing annual reports required by Regulation
Crowdfunding during the two years immediately preceding the filing of
the required new offering statement; and (3) issuers that have no
specific business plan or that have indicated that their business plan
is to engage in a merger or acquisition with an unidentified company or
companies.
b. Comments on the Proposed Rules
Foreign Issuers, Exchange Act Reporting Companies, and Investment
Companies. Several commenters opposed the exclusion of foreign issuers,
Exchange Act reporting companies, and investment companies.\82\ Other
commenters, however, supported the exclusion of investment companies or
companies that are excluded from the definition of investment company
under Section 3(b) or 3(c) of the Investment Company Act.\83\ Some
commenters recommended that, despite the exclusion of investment
companies, the Commission allow a single purpose fund, including LLCs
and LPs, to conduct an offering in reliance on Section 4(a)(6) if such
fund were organized to invest in, or lend money to, a single
company.\84\
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\82\ See, e.g., M.A.V. Letter (opposing the exclusion of public
companies from eligibility to rely on Section 4(a)(6)); Ritter
Letter (asking for clarification regarding companies that are
excluded from the definition of investment company pursuant to 3(b)
of the Investment Company Act); TAN Letter (opposing the exclusion
of foreign issuers over concerns that investors would not have Title
III protections when investing in foreign issuers and that
investors' ability to invest in early opportunities would be
reduced).
\83\ See, e.g., Commonwealth of Massachusetts Letter;
PeoplePowerFund Letter.
\84\ See, e.g., EMKF Letter (stating that having hundreds of
direct shareholders can give startups ``messy cap tables'' that
deter follow-on financing and alternatively recommending the
Commission permit an intermediary, including a funding portal, to
act as a holder of record); Fryer Letter; Growthfountain Letter;
Martin Letter (recommending that crowdfunding be operated through a
trust fund mechanism that would own shares of the entity seeking
capital); Propellr Letter 2; Ritter Letter; Wefunder Letter.
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Delinquent in Ongoing Reporting. A number of commenters supported
the exclusion of issuers that are delinquent in their reporting
obligations,\85\ although others opposed the exclusion of delinquent
issuers.\86\ Some commenters suggested options such as disclosure of
the issuer's reporting delinquency in its offering documents or on its
Web site or a cure provision.\87\
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\85\ See, e.g., ASSOB Letter; Commonwealth of Massachusetts
Letter; Consumer Federation Letter; Fund Democracy Letter; Grassi
Letter; Joinvestor Letter; NASAA Letter; Wefunder Letter.
\86\ See, e.g., ABA Letter; Parsont Letter; Projectheureka
Letter; Public Startup Letter 2; RocketHub Letter.
\87\ See, e.g., ABA Letter (suggesting a reasonable cure period
and limiting the ``look-back'' period to one year); Grassi Letter
(recommending that a delinquent issuer be required to file a form
with the Commission and publish on its Web site and the relevant
intermediary's platform a notice to potential investors that it has
not met its reporting obligations); Parsont Letter (recommending the
Commission treat the ongoing reporting requirements as a condition
to the Section 4(a)(6) exemption and create a notice and cure
provision in the proposed insignificant deviation safe harbor);
RocketHub Letter (suggesting delinquent issuers be required to
disclose their delinquent status in their offering documents); Vann
Letter (recommending a grace period for curing the deficiency).
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We also received comments about whether the exclusion should extend
to issuers that are delinquent in other reporting requirements (e.g.,
updates on the progress of the issuer in meeting the target offering
amount, issuers whose affiliates have failed to comply with the ongoing
reporting requirements, and issuers with an officer, director, or
controlling shareholder who served in a similar capacity with another
issuer that failed to file its ongoing reports). Commenters generally
opposed extending the exclusion beyond issuers delinquent in their
ongoing annual reports during the two years immediately preceding the
filing of the required new offering statement.\88\
[[Page 71397]]
Further, two commenters opposed the idea of excluding an issuer whose
officer, director, or controlling shareholder served in a similar
capacity with another issuer that failed to file its annual
reports.\89\
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\88\ See, e.g., Grassi Letter (stating that further exclusions
would impose a more onerous burden on issuers under Section 4(a)(6)
than that placed on current registrants filing under Exchange Act
Sections 13(a) or 15(d) or emerging growth companies);
Projectheureka Letter.
\89\ See Grassi Letter (stating that these persons may not have
the authority or responsibility to file an annual report); Whitaker
Chalk Letter.
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Business Plans. Commenters were divided on excluding issuers that
have no specific business plan from eligibility to rely on Section
4(a)(6).\90\ Commenters, however, supported the exclusion of issuers
that have business plans to engage in a merger or acquisition with an
unidentified company.\91\
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\90\ For commenters who expressed support, see, e.g., Anonymous
Letter 2; CFA Institute Letter; CFIRA Letter 7; Commonwealth of
Massachusetts Letter; Consumer Federation Letter; Hackers/Founders
Letter; NASAA Letter; ODS Letter; Traklight Letter; Whitaker Chalk
Letter. For commenters who expressed opposition, see, e.g., ABA
Letter (expressing concern that a particular business idea disclosed
by a crowdfunding issuer might be deemed after-the-fact to be too
non-specific to have permitted reliance on Section 4(a)(6), thus
exposing that issuer to a potential Section 5 violation); FundHub
Letter 1; Projectheureka Letter; Public Startup Letter 2; RoC
Letter; RocketHub Letter; SBM Letter; Wilson Letter.
\91\ See, e.g., ABA Letter; CFA Institute Letter; Commonwealth
of Massachusetts Letter; Consumer Federation Letter; Grassi Letter;
ODS Letter; RFPIA Letter.
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c. Final Rules
We are adopting the issuer eligibility requirements as proposed,
with the addition of two clarifications. As noted above, Section 4A(f)
expressly excludes foreign issuers, Exchange Act reporting companies
and companies that are investment companies as defined in the
Investment Company Act or companies that are excluded from the
definition of investment company under Section 3(b) or 3(c) of the
Investment Company Act from the exemption for crowdfunding transactions
provided by Section 4(a)(6). Although some commenters expressed
concerns about these statutory exclusions, including that such
exclusions could limit the investment choices of crowdfunding
investors, we are not creating additional exemptions for these
categories of issuers. In reaching this determination, we have
considered that the primary purpose of Section 4(a)(6), as we
understand it, is to facilitate capital formation by early stage
companies that might not otherwise have access to capital.\92\ As a
general matter, we do not believe that Exchange Act reporting
companies, investment companies and foreign issuers accessing the U.S.
capital markets constitute the types of issuers that Section 4(a)(6)
and Regulation Crowdfunding are intended to benefit. Moreover, we
believe that certain of these issuers, such as foreign issuers or
investment companies, may present unique risks that would make them
unsuitable for the scaled regulatory regime associated with securities-
based crowdfunding transactions. Accordingly, the final rules exclude
these categories of issuers from Regulation Crowdfunding.\93\
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\92\ See, e.g., 158 Cong. Rec. S1765 (daily ed. Mar. 29, 2012)
(statement of Sen. Jack Reed) (``[Crowdfunding] is the place where
we envision the smallest entrepreneurs could obtain much needed seed
capital for their good ideas.''); 158 Cong. Rec. H1581 (daily ed.
Mar. 27, 2012) (statement of Rep. Patrick McHenry (``Crowdfunding is
the best of microfinancing and crowdsourcing. You use a wide network
of individuals and you can raise capital for your new business, your
start-up, or your small business.'').
\93\ See Rule 100(b) of Regulation Crowdfunding.
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We are not creating, as suggested by some commenters,\94\ an
exception to this exclusion for a single purpose fund organized to
invest in, or lend money to, a single company. The statute specifically
excludes investment funds from eligibility to rely on Section 4(a)(6)
and investment fund issuers present considerations different from those
for non-fund issuers.
---------------------------------------------------------------------------
\94\ See, e.g., EMKF Letter; Fryer Letter; Growthfountain
Letter; Martin Letter; Propellr Letter 2; Wefunder Letter.
---------------------------------------------------------------------------
In addition to these statutorily excluded categories of issuers,
the final rules also exclude, as proposed, several additional
categories of issuers. Below we discuss each of these additional
categories:
Disqualification Provisions. As discussed further in Section II.E.6
below, the final rules also exclude issuers that are disqualified from
relying on Section 4(a)(6).\95\
---------------------------------------------------------------------------
\95\ See Rule 100(b)(4) of Regulation Crowdfunding. See also
Rule 503 of Regulation Crowdfunding and Section II.E.6 for a
discussion of the disqualification provisions.
---------------------------------------------------------------------------
Delinquent in Ongoing Reporting. Consistent with the proposed rules
and the views of a number of commenters,\96\ the final rules exclude an
issuer that has sold securities in reliance on Section 4(a)(6) if the
issuer has not filed with the Commission and provided to investors, to
the extent required, the ongoing annual reports required by Regulation
Crowdfunding \97\ during the two years immediately preceding the filing
of the required new offering statement.\98\ As discussed further in
Section II.B.2 below, we believe that the annual ongoing reporting
requirement will benefit investors by enabling them to consider updated
information about the issuer, thereby allowing them to make more
informed investment decisions. If issuers fail to comply with this
requirement, we do not believe that they should have the benefit of
relying on the exemption under Section 4(a)(6) again until they file,
to the extent required, the two most recent annual reports.\99\ In
addition, as discussed further in Section II.B.1 below, in a
modification to the proposed rules, the final rules require an issuer
to disclose in its offering statement and annual report if it, or any
of its predecessors, previously failed to comply with the ongoing
reporting requirements of Regulation Crowdfunding.
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\96\ See, e.g., ASSOB Letter; Commonwealth of Massachusetts
Letter; Consumer Federation Letter; Fund Democracy Letter; Grassi
Letter; Joinvestor Letter; NASAA Letter; Wefunder Letter.
\97\ See Rules 202 and 203(b) of Regulation Crowdfunding and
Section II.B.2 for a discussion of the ongoing reporting
requirements.
\98\ See Rule 100(b)(5) of Regulation Crowdfunding.
\99\ We note that even if an issuer has regained eligibility to
rely on Regulation Crowdfunding, the Commission could still bring an
enforcement action under the federal securities laws based on the
issuer's failure to make the required filings. In addition, as
discussed in Section II.E.4., new Rule 12g-6 provides an exemption
from Section 12(g) conditioned, among other things, on the issuer's
compliance with the annual reporting requirements of Rule 202 of
Regulation Crowdfunding.
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We note that some commenters read the provision requiring issuers
to have filed their two most recent annual reports to mean that the
disqualification would be triggered only after the issuer was
delinquent for two consecutive years or that an issuer would be
disqualified for two years.\100\ Instead, the final rule requires that
any ongoing annual report that was due during the two years immediately
preceding the currently contemplated offering must be filed before an
issuer may rely on the Section 4(a)(6) exemption. For example, if more
than 120 days have passed since the issuer's fiscal year end and the
issuer has not filed the required annual report for that most recently
ended fiscal year, the issuer will not be able to conduct a new
offering of securities in reliance on the Section 4(a)(6) exemption
until the delinquent annual report has been filed. Similarly, if an
issuer did file an annual report for the most recently ended fiscal
year but did not file an annual report for the fiscal year prior to
that, the issuer will not be able to rely on the Section 4(a)(6)
exemption until the missing report has been filed. In both cases, as
soon as the issuer has filed with the Commission and provided to
investors both of the annual reports required during the two years
immediately preceding the filing
[[Page 71398]]
of the required offering statement, the issuer will be able to rely on
the Section 4(a)(6) exemption. The final rule text includes an
instruction to clarify this requirement.\101\
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\100\ See, e.g., Consumer Federation Letter; Fund Democracy
Letter; NASAA Letter.
\101\ See instruction to paragraph (b)(5) of Rule 100 of
Regulation Crowdfunding.
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Consistent with the proposal and the recommendations of
commenters,\102\ we are not extending the exclusion to issuers that are
delinquent in the progress update or termination of reporting
requirements, nor are we excluding issuers whose officer, director, or
controlling shareholder served in a similar capacity with another
issuer that failed to file its annual reports. Extending the exclusion
to those issuers would impose more stringent requirements than those
faced by current reporting companies and issuers under Regulation A.
---------------------------------------------------------------------------
\102\ See, e.g., Grassi Letter; Projectheureka Letter; Whitaker
Chalk Letter.
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Business Plans. The final rules also exclude an issuer that has no
specific business plan or has indicated that its business plan is to
engage in a merger or acquisition with an unidentified company or
companies.\103\ We believe that the exemption under Section 4(a)(6) is
intended to provide an issuer with an early stage project, idea or
business an opportunity to share it publicly with a wider range of
investors. Those investors may then share information with each other
about the opportunity and use that information to decide whether or not
to invest. Thus, we believe that an issuer engaging in crowdfunding
under the exemption should give the public sufficient information about
a particular proposed project or business to allow investors to make an
informed investment decision.\104\
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\103\ See Rule 101(b)(6) of Regulation Crowdfunding.
\104\ See, e.g., Section 4A(b)(1)(C) (requiring a description of
the business of the issuer and the anticipated business plan of the
issuer).
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As discussed in the proposal, we are cognizant of the challenges
noted by some commenters \105\ in distinguishing between early-stage
proposals that have information sufficient to support the crowdfunding
mechanism and those that cannot by their terms do so. After considering
the comments received,\106\ we continue to believe that the rules
should exclude issuers that have no specific business plan or whose
business plan is to engage in a merger or acquisition with an
unidentified company or companies. We understand that issuers engaging
in crowdfunding transactions may have businesses at various stages of
development in differing industries, and therefore, we believe that a
specific ``business plan'' for such issuers could encompass a wide
range of project descriptions, articulated ideas, and business models.
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\105\ See, e.g., ABA Letter; FundHub Letter 1; Projectheureka
Letter; Public Startup Letter 2; RoC Letter; RocketHub Letter; SBM
Letter; Wilson Letter.
\106\ See, e.g., ABA Letter; Anonymous Letter 2; CFA Institute
Letter; CFIRA Letter 7; Commonwealth of Massachusetts Letter;
Consumer Federation Letter; FundHub Letter 1; Grassi Letter;
Hackers/Founders Letter; NASAA Letter; ODS Letter; Projectheureka
Letter; Public Startup Letter 2; RFPIA Letter; RoC Letter; RocketHub
Letter; SBM Letter; Traklight Letter; Whitaker Chalk Letter; Wilson
Letter.
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Overall, we believe that the exclusions in the final rules
appropriately consider the need to limit the potential risks to
investors that could result from extending issuer eligibility to
certain types of entities without unduly limiting the benefits of the
exemption as a tool for capital formation.
B. Issuer Requirements
1. Disclosure Requirements
Securities Act Section 4A(b)(1) sets forth specific disclosures
that an issuer offering or selling securities in reliance on Section
4(a)(6) must ``file with the Commission and provide to investors and
the relevant broker or funding portal, and make available to potential
investors''. These disclosures include:
The name, legal status, physical address and Web site
address of the issuer; \107\
---------------------------------------------------------------------------
\107\ Section 4A(b)(1)(A).
---------------------------------------------------------------------------
the names of the directors and officers (and any persons
occupying a similar status or performing a similar function), and each
person holding more than 20 percent of the shares of the issuer; \108\
---------------------------------------------------------------------------
\108\ Section 4A(b)(1)(B).
---------------------------------------------------------------------------
a description of the business of the issuer and the
anticipated business plan of the issuer; \109\
---------------------------------------------------------------------------
\109\ Section 4A(b)(1)(C).
---------------------------------------------------------------------------
a description of the financial condition of the issuer;
\110\
---------------------------------------------------------------------------
\110\ Section 4A(b)(1)(D).
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a description of the stated purpose and intended use of
the proceeds of the offering sought by the issuer with respect to the
target offering amount; \111\
---------------------------------------------------------------------------
\111\ Section 4A(b)(1)(E).
---------------------------------------------------------------------------
the target offering amount, the deadline to reach the
target offering amount and regular updates about the progress of the
issuer in meeting the target offering amount; \112\
---------------------------------------------------------------------------
\112\ Section 4A(b)(1)(F).
---------------------------------------------------------------------------
the price to the public of the securities or the method
for determining the price; \113\ and
---------------------------------------------------------------------------
\113\ Section 4A(b)(1)(G).
---------------------------------------------------------------------------
a description of the ownership and capital structure of
the issuer.\114\
---------------------------------------------------------------------------
\114\ Section 4A(b)(1)(H). Specifically, Section 4A(b)(1)(H)
requires a description of: ``(i) terms of the securities of the
issuer being offered and each other class of security of the issuer
. . .; (ii) a description of how the exercise of the rights held by
the principal shareholders of the issuer could negatively impact the
purchasers of the securities being offered; (iii) the name and
ownership level of each existing shareholder who owns more than 20
percent of any class of the securities of the issuer; (iv) how the
securities being offered are being valued . . .; and (v) the risks
to purchasers of the securities relating to minority ownership in
the issuer, the risks associated with corporate actions, including
additional issuances of shares, a sale of the issuer or of assets of
the issuer, or transactions with related parties.''
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In addition, Section 4A(b)(1)(I) specifies that the Commission may
require additional disclosures for the protection of investors and in
the public interest.
As discussed further in Section II.B.3 below, we are requiring
issuers to file these disclosures with the Commission on Form C.\115\
Unless otherwise indicated in the form, Form C must be filed in the
standard format of eXtensible Markup Language (XML). The XML-based
fillable portion of Form C will enable issuers to provide information
in a convenient medium without requiring the issuer to purchase or
maintain additional software or technology. This will provide the
Commission and the public with readily available data about offerings
made in reliance on Section 4(a)(6). Other required disclosure that is
not required to be provided in the XML-based text boxes will be filed
as attachments to Form C. We are not mandating a specific presentation
format for the attachments to Form C; however, the final Form C does
include an optional Q&A format that crowdfunding issuers may use to
provide disclosures that are not required to be filed in XML
format.\116\ We believe that this optional format should help reduce
the burden on crowdfunding issuers of preparing disclosures.
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\115\ Issuers will use Form C to provide the required
disclosures about the crowdfunding transaction and the information
required to be filed annually. See Section II.B.3.
\116\ See Item 1 of General Instruction III to Form C of
Regulation Crowdfunding.
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By filing Form C with the Commission and providing it to the
relevant intermediary, issuers will satisfy the requirement of
Securities Act Section 4A(b) that issuers relying on Section 4(a)(6)
must ``file with the Commission and provide to investors and the
relevant broker of funding portal, and make available to potential
investors'' certain information. In a clarifying change from the
proposal, we have moved the definition of ``investor'' from proposed
Rule 300(c)(4) to Rule
[[Page 71399]]
100(d) to clarify that for purposes of all of Regulation Crowdfunding,
``investor'' includes any investor or any potential investor, as the
context requires.\117\ In connection with this clarifying move we have
deleted the phrase ``and make available to potential investors'' each
time it appeared in the proposed Rules 201 and 203 to avoid
redundancy.\118\
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\117\ See Rule 100(d) of Regulation Crowdfunding.
\118\ See Rules 201 and 203(a) of Regulation Crowdfunding.
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Additionally, as we clarify in the final rules, to the extent that
some of the required disclosures overlap, issuers are not required to
duplicate disclosures.
a. Offering Statement Disclosure Requirements
(1) Information About the Issuer and the Offering
(a) General Information About the Issuer, Officers and Directors, and
Certain Shareholders
(i) Proposed Rules
To implement Sections 4A(b)(1)(A) and (B), we proposed in Rule 201
of Regulation Crowdfunding to require an issuer to disclose information
about its legal status, directors, officers and certain shareholders
and how interested parties may contact the issuer. Specifically, we
proposed to require that an issuer disclose:
Its name and legal status, including its form of
organization, jurisdiction in which it is organized and date of
organization;
its physical address and its Web site address; and
the names of the directors and officers, including any
persons occupying a similar status or performing a similar function,
all positions and offices with the issuer held by such persons, the
period of time in which such persons served in the positions or offices
and their business experience during the past three years, including:
[cir] Each person's principal occupation and employment, including
whether any officer is employed by another employer; and
[cir] the name and principal business of any corporation or other
organization in which such occupation and employment took place.
We proposed to define ``officer'' consistent with the definition in
Securities Act Rule 405 and in Exchange Act Rule 3b-2. We further
proposed to require disclosure of the business experience of directors
and officers of the issuer during the past three years.
Section 4A(b)(1)(B) requires disclosure of ``the names of . . .
each person holding more than 20 percent of the shares of the issuer.''
In contrast, Section 4A(b)(1)(H)(iii) requires disclosure of the ``name
and ownership level of each existing shareholder who owns more than 20
percent of any class of the securities of the issuer'' (emphasis
added). We proposed in Rule 201(c) to require disclosure of the names
of persons, as of the most recent practicable date, who are the
beneficial owners of 20 percent or more of the issuer's outstanding
voting equity securities, calculated on the basis of voting power (``20
Percent Beneficial Owners''). Neither Section 4A(b)(1)(B) nor Section
4A(b)(1)(H)(iii) states as of what date the beneficial ownership should
be calculated. We proposed in Rule 201(c) to require issuers to
calculate beneficial ownership as of the most recent practicable date.
(ii) Comments on the Proposed Rules
Of the commenters that addressed the proposed issuer, officer and
director disclosure rules, some generally supported them,\119\ while
others opposed specific disclosure requirements. For example, one
commenter opposed requiring issuers to disclose a Web site
address.\120\ Other commenters opposed requiring issuers to disclose
the business experience of their officers and directors,\121\ while one
commenter suggested narrowing the definition of the term ``officer.''
\122\ Some commenters expressed opposition to any revision to the
proposed rules that would require disclosure of any court orders,
judgments or civil litigation involving any directors and
officers.\123\
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\119\ See, e.g., Angel Letter 1; CCI Letter; Denlinger Letter 1;
Mollick Letter; Wefunder Letter; Wilson Letter.
\120\ See Vann Letter (recommending that the disclosure
requirement be optional or only required for businesses that have a
Web site).
\121\ See, e.g., Public Startup Letter 2; RocketHub Letter;
Schwartz Letter; Zhang Letter.
\122\ See RocketHub Letter (stating that only relevant officers
for most companies using Regulation Crowdfunding would be the
principal executive officer and the principal financial officer,
which may be the same person.)
\123\ See, e.g., FundHub Letter 1; RocketHub Letter; Wefunder
Letter.
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Some commenters supported the proposed three-year time period to be
covered by the officer and director disclosure rules,\124\ while others
recommended that officer and director disclosure cover the previous
five years.\125\ Some commenters recommended we require additional
disclosures about an issuer's officers, directors and persons occupying
a similar status or performing a similar function.\126\
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\124\ See, e.g., Denlinger Letter 1; Joinvestor Letter; Wefunder
Letter.
\125\ See, e.g., Commonwealth of Massachusetts Letter; NASAA
Letter.
\126\ See, e.g., Angel Letter 1 (qualifications of candidates
for the board of directors); Denlinger Letter 1(educational
background of the officers and directors); Mollick Letter (online
identities of the officers and directors); ODS Letter (educational
background of the officers and directors); Wilson Letter (technical
and business skills of the officers and directors); Zeman Letter
(any officer and director positions held by the officers and
directors or their family members, as well as any 10 percent
beneficial holdings they may have with other SEC registrants; and
disputes the officers and directors had with other employers).
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A few commenters commented on the proposed 20 Percent Beneficial
Owner rules. One commenter supported the requirement to disclose the
names of persons who are the 20 Percent Beneficial Owners,\127\ while
one commenter opposed the requirement.\128\ One commenter recommended
that, to provide greater certainty for investors and more guidance for
issuers, the beneficial ownership be calculated as of a specific date,
rather than the most recent practicable date, and that the disclosure
be updated when there are significant changes in beneficial
ownership.\129\ Finally, one commenter recommended that the Commission
keep the requirement as simple as possible.\130\
---------------------------------------------------------------------------
\127\ See RocketHub Letter.
\128\ See Public Startup Letter 2.
\129\ See NASAA Letter.
\130\ See RocketHub Letter.
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(iii) Final Rules
We are adopting the issuer, officer and director, and 20 Percent
Beneficial Owners disclosure requirements largely as proposed.\131\ An
issuer will be required to disclose information about its president,
vice president, secretary, treasurer or principal financial officer,
comptroller or principal accounting officer and any person routinely
performing similar functions. As noted by at least one commenter,\132\
an issuer may not have officers serving in each of these roles.
Accordingly, the final rules require the disclosure only to the extent
an issuer has individuals serving in these capacities or performing
similar functions.\133\ The required information includes all positions
and offices held with the issuer, the period of time in which such
persons served in the position or office and their prior business
experience.\134\ Contrary to the views of some commenters,\135\ we
[[Page 71400]]
believe that additional disclosures about an issuer's officers,
directors and persons occupying a similar status or performing a
similar function would be unduly burdensome and generally not necessary
for investors to be in a position to make an informed investment
decision. Given the diverse nature of the startups and small businesses
that we anticipate will seek to raise capital in reliance on Section
4(a)(6), additional disclosures such as those recommended by some
commenters may not be relevant in all instances.
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\131\ See Rule 201(a)-(c) of Regulation Crowdfunding.
\132\ See RocketHub Letter.
\133\ See Instruction to paragraph (b) of Rule 201 of Regulation
Crowdfunding.
\134\ See Rule 201(b) of Regulation Crowdfunding.
\135\ See, e.g., Denlinger 1 Letter (educational background of
officers); ODS Letter (educational background of officers, directors
and similar persons); Zeman Letter (proposing that officers and
directors of an issuer be required to disclose their (or family
members) officer and director positions with other SEC registrants,
and disclose material holdings of more than 10% with other SEC
registrants).
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The required disclosure about the business experience of the
directors and officers (and any persons occupying a similar status or
performing a similar function) must cover the past three years,\136\
which, as some commenters noted,\137\ is shorter than the five-year
period that applies to issuers conducting registered offerings \138\ or
exempt offerings pursuant to Regulation A.\139\ We believe that
startups and small businesses that may seek to raise capital in
reliance on Section 4(a)(6) generally will be smaller than the issuers
conducting registered offerings or exempt offerings pursuant to
Regulation A, and generally are likely to have a more limited operating
history.\140\ Therefore, in comparison to registered offerings and
Regulation A, we believe the three-year period is more relevant given
the stage of development of these issuers and should help to reduce
compliance costs for issuers conducting offerings pursuant to Section
4(a)(6) while still providing investors with sufficient information
about the business experience of directors and officers of the issuer
to make an informed investment decision.
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\136\ See Rule 201(b) of Regulation Crowdfunding.
\137\ See, e.g., Commonwealth of Massachusetts Letter; NASAA
Letter.
\138\ See Item 401(e) of Regulation S-K [17 CFR 229.401(e)].
\139\ See Item 8(c) of Form 1-A [17 CFR 239.90].
\140\ There is no limit on the amount of proceeds that may be
raised in a registered offering, and Regulation A permits offerings
of up to $50 million of securities annually.
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Notwithstanding the suggestion of one commenter, and consistent
with the statute, the final rules require disclosure of an issuer's Web
site.\141\ Given the Internet-based nature of Crowdfunding, we
anticipate that every issuer will have a Web site or be able to create
one at a minimal cost.
---------------------------------------------------------------------------
\141\ See Rule 201(a) of Regulation Crowdfunding.
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We also are adopting the 20 Percent Beneficial Owner disclosure
requirement as proposed with one modification.\142\ Instead of
requiring issuers to disclose the name of each 20 Percent Beneficial
Owner as of the most recent practicable date, we are requiring such
disclosure as of the most recent practicable date, but no earlier than
120 days prior to the date the offering statement or report is filed.
We believe that this change should address commenter concerns \143\
about the discretion afforded by the proposed ``most recent practicable
date.'' While we are not adding to Rule 201(c) a specific requirement
that the disclosure be updated when there are significant changes in
beneficial ownership, as requested by one commenter,\144\ to the extent
a material change in beneficial ownership takes place during the
offering, an issuer would be required to file an amended offering
statement on Form C/A: Amendment.
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\142\ See Rule 201(c) of Regulation Crowdfunding.
\143\ See NASAA Letter.
\144\ Id.
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As stated in the Proposing Release, we believe that the universe of
20 Percent Beneficial Owners should be the same for the disclosure
requirements and the disqualification provisions \145\ because this
would ease the burden on issuers by requiring them to identify only one
set of persons who would be the subject of these rules. We continue to
believe that assessing beneficial ownership based on total outstanding
voting securities is consistent with Section 4A(b)(1)(B). Section
4A(b)(1)(B) is not limited to voting equity securities, but we believe
the limitation is necessary to clarify how beneficial ownership should
be calculated since issuers could potentially have multiple classes of
securities with different voting powers.
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\145\ See Rule 503 of Regulation Crowdfunding and Section II.E.6
for a discussion of the disqualification provisions.
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(b) Description of the Business
(i) Proposed Rules
Consistent with Section 4A(b)(1)(C), we proposed in Rule 201(d) of
Regulation Crowdfunding to require an issuer to disclose information
about its business and business plan. The proposed rules did not
specify the disclosures that an issuer would need to include in the
description of the business and the business plan.
(ii) Comments on the Proposed Rules
While several commenters expressed concerns about requiring an
issuer to disclose a description of its business and business
plan,\146\ most commenters supported this proposed requirement.\147\
Some commenters recommended that the disclosure include specific items,
such as disclosure of any material contracts of the issuer, any
material litigation or any outstanding court order or judgment
affecting the issuer or its property; \148\ the issuer's business value
proposition, revenue model, team, regulatory issues and executive
compensation; \149\ how the issuer will build value for the
shareholders; \150\ and plans for implementation, concrete next steps,
outside recommendations about the validity of the business, backgrounds
of the individuals involved and prototypes or concept drawings.\151\
One commenter recommended that the disclosure requirement be scaled to
match the size of the offering.\152\
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\146\ See, e.g., ABA Letter; ASSOB Letter; Public Startup Letter
2; Traklight Letter.
\147\ See, e.g., Anonymous Letter 2; Arctic Island Letter 5;
Benjamin Letter; CFIRA Letter 7; Consumer Federation Letter; EMKF
Letter; Hackers/Founders Letter; Mollick Letter; NFIB Letter;
RocketHub Letter; Saunders Letter; Wefunder Letter.
\148\ See, e.g., Arctic Island Letter 4 (referencing only
pending litigation); Arctic Island Letter 5 (referencing only
threatened or pending litigation); FundHub Letter 1; Wilson Letter.
\149\ See, e.g., Arctic Island Letter 5.
\150\ See, e.g., Hackers/Founders Letter.
\151\ See, e.g., Mollick Letter.
\152\ See Consumer Federation Letter.
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Some commenters recommended that the Commission provide a non-
exclusive list of the types of information an issuer should consider
disclosing, templates, examples or other guidance to assist the issuer
in complying with this disclosure requirement.\153\ One commenter
recommended that the Commission not specify the information to be
included in the description of the business or the business plan.\154\
Commenters also opposed revising the proposed business description
requirement to require the description to include the information
requirements of Items 101(a)(2) and 101(h) \155\ of Regulation S-
K.\156\
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\153\ See, e.g., ABA Letter; Benjamin Letter; CFIRA Letter 7;
Commonwealth of Massachusetts Letter; FundHub Letter 1 (recommending
a safe harbor list of requirements); Traklight Letter; Wilson Letter
(recommending a checklist or prescribed list of questions).
\154\ See RocketHub Letter.
\155\ 17 CFR 229.101.
\156\ See, e.g., Hamilton Letter; Public Startup Letter 2;
RocketHub Letter.
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(iii) Final Rules
Consistent with the proposal, Rule 201(d) requires an issuer to
disclose information about its business and business plan. We are not
modifying the proposed rule, as some commenters
[[Page 71401]]
recommended,\157\ to specify the disclosures that an issuer must
include in the description of the business and the business plan or to
provide a non-exclusive list of the types of information an issuer
should consider disclosing. We anticipate that issuers engaging in
crowdfunding transactions may have businesses at various stages of
development in different industries, and therefore, we believe that the
rules should provide flexibility for these issuers regarding what
information they disclose about their businesses. This flexible
approach is consistent with the suggestion of one commenter that the
business plan requirements be scaled to match the size of the
offering.\158\ We also are concerned that a non-exclusive list of the
types of information an issuer should consider providing would be
viewed as a de facto disclosure requirement that all issuers would feel
compelled to meet and would, therefore, undermine the intended
flexibility of the final rules.
---------------------------------------------------------------------------
\157\ See, e.g., ABA Letter; Arctic Island Letter 4; Arctic
Island Letter 5; Benjamin Letter; CFIRA Letter 7; Commonwealth of
Massachusetts Letter; FundHub Letter 1; Hackers/Founders Letter;
Mollick Letter; Traklight Letter; Wilson Letter.
\158\ See Consumer Federation Letter.
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(c) Use of Proceeds
(i) Proposed Rules
Consistent with Section 4A(b)(1)(E), we proposed in Rule 201(i) of
Regulation Crowdfunding to require an issuer to provide a description
of the purpose of the offering and intended use of the offering
proceeds. We expected that such disclosure would provide a sufficiently
detailed description of the intended use of proceeds to permit
investors to evaluate the investment. Under the proposed rules, if an
issuer did not have definitive plans for the proceeds, but instead had
identified a range of possible uses, then the issuer would be required
to identify and describe each probable use and factors affecting the
selection of each particular use. In addition, if an issuer indicated
that it would accept proceeds in excess of the target offering
amount,\159\ the issuer would be required to provide a separate,
reasonably detailed description of the purpose and intended use of any
excess proceeds with similar specificity.
---------------------------------------------------------------------------
\159\ See Section II.B(1)(d) below for a description of the
final rule's disclosure requirements with respect to target amounts.
---------------------------------------------------------------------------
(ii) Comments on the Proposed Rules
Most commenters supported the requirement that issuers disclose the
intended use of the offering proceeds.\160\ One commenter recommended
that we prescribe the use of proceeds disclosure or provide a list of
examples that issuers should consider when providing such
disclosures.\161\ Others recommended a variety of circumstances under
which an issuer should be required to update the use of proceeds
disclosure.\162\
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\160\ See, e.g., ABA Letter; ASSOB Letter; Consumer Federation
Letter; Joinvestor Letter; Saunders Letter; Traklight Letter;
Whitaker Chalk Letter; Wilson Letter. But see, Public Startup Letter
2.
\161\ See Commonwealth of Massachusetts Letter.
\162\ See, e.g., ASSOB Letter (five percent change); CFIRA
Letter 7 (material deviations in the offering statement and any
deviations in the annual report); Commonwealth of Massachusetts
Letter (material change); Joinvestor Letter (substantial change);
RocketHub Letter (significant change); Traklight Letter (material
deviations); Whitaker Chalk Letter (material change); Wilson Letter
(any deviation). See also Section II.B.3 for discussion of when an
amendment to the offering statement may be required.
---------------------------------------------------------------------------
(iii) Final Rules
We are adopting the use of proceeds disclosure requirement
substantially as proposed in Rule 201(i). An issuer will be required to
provide a reasonably detailed description of the purpose of the
offering, such that investors are provided with enough information to
understand how the offering proceeds will be used.\163\ While one
commenter \164\ recommended that we prescribe this disclosure or
provide a list of examples, we believe a more prescriptive rule would
not best accommodate a diverse range of issuers. Instead, below we
provide several examples of the disclosures issuers should consider
making with respect to various uses of proceeds.
---------------------------------------------------------------------------
\163\ See Instruction to paragraph (i) of Rule 201 of Regulation
Crowdfunding.
\164\ See Commonwealth of Massachusetts Letter.
---------------------------------------------------------------------------
The disclosure requirement is designed to provide investors with
sufficient information to evaluate the investment. For example, an
issuer may intend to use the proceeds of an offering to acquire assets
or businesses, compensate the intermediary or its own employees or
repurchase outstanding securities of the issuer. In providing its
description, an issuer would need to consider the appropriate level of
detail to provide investors about the assets or businesses that the
issuer anticipates acquiring, based on its particular facts and
circumstances, so that the investors could make informed decisions. If
the proceeds will be used to compensate existing employees or to hire
new employees, the issuer should consider disclosing whether the
proceeds will be used for salaries or bonuses and how many employees it
plans to hire, as applicable. If the issuer will repurchase outstanding
issuer securities, it should consider disclosing its plans, terms and
purpose for repurchasing the securities. An issuer also should consider
disclosing how long the proceeds will satisfy the operational needs of
the business. If an issuer does not have definitive plans for the
proceeds, but instead has identified a range of possible uses, then the
issuer should identify and describe each probable use and the factors
the issuer may consider in allocating proceeds among the potential
uses.\165\ If an issuer indicates that it will accept proceeds in
excess of the target offering amount, the issuer must provide a
reasonably detailed description of the purpose, method for allocating
oversubscriptions, and intended use of any excess proceeds with similar
specificity.\166\
---------------------------------------------------------------------------
\165\ See Instruction to paragraph (i) of Rule 201 of Regulation
Crowdfunding.
\166\ See Instruction to paragraph (i) of Rule 201 of Regulation
Crowdfunding.
---------------------------------------------------------------------------
(d) Target Offering Amount and Deadline
(i) Proposed Rules
Consistent with Section 4A(b)(1)(F), we proposed in Rule 201(g) of
Regulation Crowdfunding to require issuers to disclose the target
offering amount and the deadline to reach the target offering amount.
In addition, we proposed in Rule 201(h) to require an issuer to
disclose whether it would accept investments in excess of the target
offering amount, and, if it would, we proposed to require the issuer to
disclose, at the commencement of the offering, the maximum amount it
would accept. The issuer also, under proposed Rule 201(h), would be
required to disclose, at the commencement of the offering, how shares
in oversubscribed offerings would be allocated. We further proposed in
Rule 201(j) to require issuers to describe the process to cancel an
investment commitment or to complete the transaction once the target
amount is met, including a statement that:
Investors may cancel an investment commitment until 48
hours prior to the deadline identified in the issuer's offering
materials; \167\
---------------------------------------------------------------------------
\167\ Section II.C.6 further discusses the cancellation
provisions.
---------------------------------------------------------------------------
the intermediary will notify investors when the target
offering amount has been met;
if an issuer reaches the target offering amount prior to
the deadline identified in its offering materials, it may close the
offering early if it provides at least five business days'
[[Page 71402]]
notice prior to that new deadline (absent a material change that would
require an extension of the offering and reconfirmation of the
investment commitment); \168\ and
---------------------------------------------------------------------------
\168\ Id.
---------------------------------------------------------------------------
if an investor does not cancel an investment commitment
before the 48-hour period prior to the offering deadline, the funds
will be released to the issuer upon closing of the offering and the
investor will receive securities in exchange for his or her investment.
In addition, proposed Rule 201(k) would require issuers to disclose
that if an investor does not reconfirm his or her investment commitment
after a material change is made to the offering, the investor's
investment commitment will be cancelled and committed funds will be
returned. Proposed Rule 201(g) also would require issuers to disclose
that if the sum of the investment commitments does not equal or exceed
the target offering amount at the time of the offering deadline, no
securities will be sold in the offering, investment commitments will be
cancelled and committed funds will be returned.\169\
---------------------------------------------------------------------------
\169\ See Section 4A(a)(7) (requiring intermediaries to ``ensure
that all offering proceeds are only provided to the issuer when the
aggregate capital raised from all investors is equal to or greater
than a target offering amount. . . .'') and discussion in Section
II.C.6.
---------------------------------------------------------------------------
(ii) Final Rules
Commenters were supportive of the proposed rules, and we are
adopting the target offering amount and deadline disclosure rules as
proposed.\170\ As an example of how the final rules will apply, if an
issuer sets a target offering amount of $80,000 but is willing to
accept up to $650,000, the issuer will be required to disclose both the
$80,000 target offering amount and the $650,000 maximum offering amount
that it will accept.\171\ In an instance where an issuer reaches the
target offering amount prior to the deadline identified in its offering
materials, it may close the offering early if it provides at least five
business days' notice about the new offering deadline as set forth in
Rules 201(j) and 302(d) of Regulation Crowdfunding. Accelerating the
deadline would not require an extension of the offering and
reconfirmation of the investment commitment; however, issuers would
need to consider whether any material change occurred that would
require an extension and reconfirmation from investors.\172\
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\170\ See Rules 201(g), 201(h), 201(j) and 201(k) of Regulation
Crowdfunding.
\171\ The issuer in this case also will need to disclose the
intended use of the additional proceeds. See Instruction to
paragraph (i) of Rule 201 of Regulation Crowdfunding. See also
Section II.B.1.a.i(c) above. In addition, the issuer in this case
will be required to provide financial statements reviewed by an
independent public accountant (rather than certain tax return
information for the most recently completed fiscal year and
financial statements certified by the principal executive officer).
See Section II.B.1.a.ii for a discussion of the financial statement
requirements.
\172\ Section II.B.1.c discusses the amendment and
reconfirmation requirements.
---------------------------------------------------------------------------
We do not believe it is necessary for us to prescribe how
oversubscribed offerings must be allocated if the issuer is required to
disclose, at the commencement of the offering, how shares in
oversubscribed offerings will be allocated. Commenters were supportive
of this approach,\173\ and we believe this disclosure should provide
investors with important information while maintaining flexibility for
issuers to structure the offering as they believe appropriate.
---------------------------------------------------------------------------
\173\ See, e.g., CFA Institute Letter; RoC Letter; RocketHub
Letter; Wilson Letter.
---------------------------------------------------------------------------
We believe that investors in a crowdfunding transaction will
benefit from clear disclosure about their right to cancel, the
circumstances under which an issuer may close an offering early and the
need to reconfirm the investment commitment under certain
circumstances, as they will be more aware of their rights to rescind an
investment commitment. Therefore, we are adopting disclosure
requirements covering these points, as proposed.
(e) Offering Price
Consistent with Section 4A(b)(1)(G), we proposed in Rule 201(l) of
Regulation Crowdfunding to require an issuer to disclose the offering
price of the securities or, in the alternative, the method for
determining the price, so long as before the sale each investor is
provided in writing the final price and all required disclosures.
Commenters were supportive of the proposed disclosure \174\ and we
are adopting the offering price disclosure rules as proposed.\175\ We
believe that disclosure of the price or the methods used for
determining the price, coupled with investors' rights to cancel their
investment upon determination of the final price, provide sufficient
opportunity for investors to evaluate the price.
---------------------------------------------------------------------------
\174\ See, e.g., CFA Institute Letter; Wilson Letter. As
discussed below, however, a few commenters recommended that the
Commission require a fixed price at the commencement of an offering.
See, e.g., Joinvestor Letter; RocketHub Letter. We address those
comments in Section II.B.6.
\175\ See Rule 201(l) of Regulation Crowdfunding.
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(f) Ownership and Capital Structure
(i) Proposed Rules
Consistent with Section 4A(b)(1)(H), we proposed in Rule 201(m) of
Regulation Crowdfunding to require an issuer to provide a description
of its ownership and capital structure. This disclosure would include:
The terms of the securities being offered and each other
class of security of the issuer, including the number of securities
being offered and those outstanding, whether or not such securities
have voting rights, any limitations on such voting rights, how the
terms of the securities being offered may be modified and a summary of
the differences between such securities and each other class of
security of the issuer, and how the rights of the securities being
offered may be materially limited, diluted or qualified by the rights
of any other class of security of the issuer;
a description of how the exercise of the rights held by
the principal shareholders of the issuer could affect the purchasers of
the securities;
the name and ownership level of persons who are 20 Percent
Beneficial Owners;
how the securities being offered are being valued, and
examples of methods for how such securities may be valued by the issuer
in the future, including during subsequent corporate actions;
the risks to purchasers of the securities relating to
minority ownership in the issuer and the risks associated with
corporate actions including additional issuances of securities, issuer
repurchases of securities, a sale of the issuer or of assets of the
issuer or transactions with related parties; and
a description of the restrictions on the transfer of the
securities.
As proposed, the rules would require disclosure of the number of
securities being offered and those outstanding, whether or not such
securities have voting rights, any limitations on such voting rights
and a description of the restrictions on the transfer of the
securities.
(ii) Comments on the Proposed Rules
A number of commenters supported the proposed ownership and capital
structure disclosure rules,\176\ while two commenters opposed them as
burdensome.\177\ One of these
[[Page 71403]]
commenters suggested that issuers should only be required to disclose
the price of a share and the percentage ownership represented by a
share, and noted that the principals of an issuer conducting a
crowdfunding offering may not consider the issuer's capital structure
or whether its shareholders will have voting rights.\178\
---------------------------------------------------------------------------
\176\ See, e.g., CFA Institute Letter; Commonwealth of
Massachusetts Letter; Hackers/Founders Letter; Joinvestor Letter;
NASAA Letter; RocketHub (supporting only to the extent that such
disclosures do not require additional form submission or accountant
or legal work); Saunders Letter; Wilson Letter.
\177\ See Campbell R. Letter; Schatz Letter.
\178\ Schatz Letter.
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(iii) Final Rules
We are adopting the ownership and capital structure disclosure
rules as proposed, with the addition of language specifying that
beneficial ownership must be calculated no earlier than 120 days prior
to the date of the filing of the offering statement or report,\179\
consistent with the treatment of beneficial ownership elsewhere in the
rule.\180\ Investors in crowdfunding transactions will benefit from
clear disclosure about the terms of the securities being offered and
each other class of security of the issuer. The final rules require
disclosure of the number of securities being offered and those
outstanding, whether or not such securities have voting rights, any
limitations on such voting rights \181\ and a description of the
restrictions on the transfer of securities.\182\ Although Section
4A(b)(1)(H) does not specifically call for all aspects of this
disclosure, we believe that such disclosure is necessary to provide
investors with a more complete picture of the issuer's capital
structure than would be obtained solely pursuant to the statutory
requirements. This should help investors better evaluate the terms of
the offer before making an investment decision.
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\179\ See Rule 201(m) of Regulation Crowdfunding.
\180\ See Rule 201(c) of Regulation Crowdfunding.
\181\ Id.
\182\ See Rule 501 of Regulation Crowdfunding and Section II.E.2
for a discussion of restrictions on resales.
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(g) Additional Disclosure Requirements
(i) Proposed Rules
We also proposed to require the following additional disclosures:
\183\
---------------------------------------------------------------------------
\183\ Section 4A(b)(1)(I) provides us with discretion to require
crowdfunding issuers to provide additional information for the
protection of investors and in the public interest.
---------------------------------------------------------------------------
Disclosure of the name, SEC file number and Central
Registration Depository number (``CRD number'') (as applicable) \184\
of the intermediary through which the offering is being conducted;
---------------------------------------------------------------------------
\184\ The Financial Industry Regulatory Authority, Inc.
(``FINRA'') issues CRD numbers to registered broker-dealers.
---------------------------------------------------------------------------
disclosure of the amount of compensation paid to the
intermediary for conducting the offering, including the amount of any
referral or other fees associated with the offering;
certain legends in the offering statement;
disclosure of the current number of employees of the
issuer;
a discussion of the material factors that make an
investment in the issuer speculative or risky;
a description of the material terms of any indebtedness of
the issuer, including the amount, interest rate, maturity date and any
other material terms;
disclosure of any exempt offerings conducted within the
past three years; and
disclosure of related-party transactions since the
beginning of the issuer's last fiscal year in excess of five percent of
the aggregate amount of capital raised by the issuer in reliance on
Section 4(a)(6) during the preceding 12-month period, inclusive of the
amount the issuer seeks to raise in the current offering.
(ii) Comments on the Proposed Rules
Identity of the Intermediary. Several commenters supported the
proposed requirement that issuers identify the intermediary through
which the offering is being conducted.\185\ Two commenters opposed such
a requirement as unnecessary.\186\
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\185\ See, e.g., Commonwealth of Massachusetts Letter;
Joinvestor Letter; Schwartz Letter; Wilson Letter (recommending that
issuers also disclose whether the intermediary specializes in
offerings based on criteria such as industry size or type).
\186\ See Public Startup Letter 2; RocketHub.
---------------------------------------------------------------------------
Compensation Paid to the Intermediary. Some commenters supported
the proposed requirement that issuers disclose the amount of
compensation paid to the intermediary for conducting the offering,
including the amount of any referral or other fees associated with the
offering.\187\ One commenter noted that to the extent components of the
intermediary's fee are percentage based, the exact amount of the
compensation may not be calculable at the onset of an offering.\188\ A
few commenters recommended that issuers also should disclose all
payments and fees, if any, they make to the intermediary.\189\
---------------------------------------------------------------------------
\187\ See, e.g., ASSOB Letter; Commonwealth of Massachusetts
Letter; RocketHub Letter; Startup Valley Letter; Wilson Letter. But
see, e.g., Grassi Letter (opposing the requirement unless offering
proceeds will be used to compensate the intermediary); Public
Startup Letter 2; Schwartz Letter.
\188\ See RocketHub Letter.
\189\ See, e.g., ASSOB Letter (recommending disclosure of all
payments); RocketHub Letter (recommending disclosure of fees paid
for compliance and overhead to enhance transparency for investors).
---------------------------------------------------------------------------
Legends. Comments were mixed as to the proposed requirement that
issuers include specified legends in the offering statement about the
risks of investing in a crowdfunding transaction and the required
ongoing reports. Some commenters supported such a requirement,\190\
while others opposed the requirement.\191\
---------------------------------------------------------------------------
\190\ See, e.g., ABA Letter; CFA Institute Letter; Commonwealth
of Massachusetts Letter; Jacobson Letter; Schwartz Letter; Wilson
Letter.
\191\ See, e.g., Grassi Letter (recommending that general risks
be disclosed on the intermediaries' platforms rather than in each
issuer's offering statement); Hackers/Founders Letter (noting that
crowdfunding issuers will tend to be smaller and lack the resources
of large companies, and intermediaries should be required to provide
examples of risks associated with crowdfunding offerings); Public
Startup Letter 2; Startup Valley Letter (stating that a legend by
the issuer about the risks of investing in a crowdfunding
transaction is not needed because it is the responsibility of the
intermediary to educate the public about this information).
---------------------------------------------------------------------------
Current Number of Employees. While several commenters supported the
proposed requirement that issuers disclose their current number of
employees,\192\ two commenters opposed such a requirement.\193\ One
commenter opposed this requirement, noting that the number of employees
is not useful for investors in evaluating early-stage startups, and is
likely to increase during the course of a crowdfunding offering
conducted concurrently with an offering pursuant to Rule 506(c).\194\
This commenter also noted that many early-stage startups spend the
majority of their initial funds on consultants.\195\ Another commenter
noted that it may be unreasonably costly, relative to the benefit
gained, to accurately count the number of employees in instances where
businesses engage many contract workers, or have workers on
arrangements such as ``flex-time'' or ``half-time.'' \196\
---------------------------------------------------------------------------
\192\ See, e.g., NASAA Letter; Wilson Letter; Zhang Letter.
\193\ See Schwartz Letter; Wefunder Letter.
\194\ See Wefunder Letter.
\195\ Id.
\196\ See Schwartz Letter.
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Risk Factors. Commenters were divided as to the proposed
requirement that issuers discuss the material factors that make an
investment in the issuer speculative or risky. A number of commenters
supported this proposed requirement,\197\ while a number of others
opposed it.\198\ Some commenters
[[Page 71404]]
recommended that we provide examples of, or develop standard
disclosures for, issuer risk factor discussions.\199\
---------------------------------------------------------------------------
\197\ See, e.g., ASSOB Letter; CFA Institute Letter;
Commonwealth of Massachusetts Letter; Consumer Federation Letter;
EMKF Letter; Jacobson Letter; McGladrey Letter; STA Letter;
StartupValley Letter; Wilson Letter.
\198\ See, e.g., ABA Letter; Campbell R. Letter; Cole A. Letter;
Grassi Letter; Hackers/Founders Letter; RocketHub Letter
(recommending that a generic 500-word statement suffice); Schwartz
Letter; Scruggs Letter.
\199\ See, e.g., Commonwealth of Massachusetts Letter; EMKF
Letter; Heritage Letter (recommending also that the Commission
define ``material''); Jacobson Letter; SBA Office of Advocacy
Letter. But see, StartupValley Letter (opposing such a
recommendation).
---------------------------------------------------------------------------
Indebtedness. Commenters supported the proposed requirement that
issuers describe the material terms of any indebtedness of the
issuer.\200\ Two commenters recommended that we clarify that this
disclosure requirement could be satisfied if the issuer includes such
disclosure in its financial statements.\201\ Another recommended that
we require issuers to disclose the identities of their creditors.\202\
---------------------------------------------------------------------------
\200\ See, e.g., Consumer Federation Letter; ODS Letter;
Schwartz Letter; Wilson Letter.
\201\ See Grassi Letter; EY Letter.
\202\ See ODS Letter.
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Prior Exempt Offerings. Commenters supported the proposed
requirement that issuers disclose their prior exempt offerings.\203\
One commenter recommended that we require additional disclosure to help
non-accredited investors understand how well aligned their interests
are with earlier accredited investors,\204\ while other commenters
suggested scaling back this disclosure in order to contain costs.\205\
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\203\ See, e.g., CFA Institute Letter (recommending a brief
statement about prior capital raising transactions); Commonwealth of
Massachusetts Letter; Grassi Letter; Joinvestor Letter; ODS Letter;
Parsont Letter; RoC Letter (supporting the disclosure covering the
past three years); RocketHub Letter (recommending disclosure of
successful prior offerings only); Whitaker Chalk Letter
(recommending that the disclosure exclude the target amount of any
offerings made in reliance on Section 4(a)(6) and whether such
target was reached); Wilson Letter. But see, e.g., Heritage Letter;
Public Startup Letter 2; Schwartz Letter; Wefunder Letter.
\204\ See Parsont Letter.
\205\ See, e.g., Grassi Letter (recommending disclosure of only
the date, amount raised, type of securities sold and a link to a Web
site where more information on such prior offerings can be found);
Wefunder Letter (recommending disclosure of only the aggregate
capital raised in all prior exempt transactions, as well as the
date, terms, valuation of and types of securities issued in the most
recent exempt offering).
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Related-Party Transactions. Commenters generally supported our
proposal to require disclosure of certain related-party transactions
between the issuer and any director or officer of the issuer, any
person who is a 20 Percent Beneficial Owner, any promoter of the issuer
(if the issuer was incorporated or organized within the past three
years) or immediate family members of the foregoing persons.\206\
Rather than using the definition of ``immediate family member''
contained in Item 404 of Regulation S-K,\207\ one commenter recommended
that we use a common definition for ``immediate family member'' in the
related-party transactions context and ``member of the family of the
purchaser or the equivalent'' in the resale restrictions context.\208\
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\206\ See, e.g., AICPA Letter (recommending disclosure of
transactions between the issuer and 10 percent beneficial owners);
Commonwealth of Massachusetts Letter; Grassi Letter (also
recommending disclosure of transactions between the issuer and
employees or affiliated entities with common ownership or control);
NASAA Letter; RocketHub Letter; Wilson Letter. But see, Public
Startup Letter 2; Schwartz Letter.
\207\ 17 CFR 229.404.
\208\ See Brown J. Letter. See also, Section II.E.2 for a
discussion of the restrictions on resales.
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One commenter supported the proposal to limit the disclosure of
related-party transactions to transactions since the beginning of the
issuer's last fiscal year.\209\ Other commenters recommended that the
related-party transaction disclosure cover the period for which
financial statements are required.\210\ In addition, one commenter
supported the proposal to limit disclosure of related-party
transactions based on the size of the offering,\211\ while a few
commenters suggested alternatives to such proposal.\212\
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\209\ See RocketHub Letter.
\210\ See AICPA Letter; Grassi Letter.
\211\ See AICPA Letter.
\212\ See, e.g., Grassi Letter (recommending disclosure of all
related-party transactions not deemed de minimis); NASAA Letter
(recommending a lower percentage threshold); RocketHub Letter
(recommending a fixed threshold).
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Other Disclosures. Several commenters specifically recommended that
we not require any additional disclosures.\213\ One commenter pointed
out that there was no ``catch-all'' clause requiring any other material
information not specifically enumerated in Rule 201 of Regulation
Crowdfunding.\214\
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\213\ See, e.g., ABA Letter; Public Startup Letter 2; RocketHub
Letter; Schwartz Letter.
\214\ See CrowdCheck Letter 1.
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Other commenters recommended that we require issuers to disclose
general information; \215\ executive compensation; \216\ zoning issues
and issues with the Environmental Protection Agency or Food and Drug
Administration; \217\ a copy of their articles of incorporation; \218\
the extent to which they are affected by market risk, material
contracts, business backlogs and the names of, and number of shares
being sold by, existing shareholders; \219\ and the credit history of
the business and the business owners.\220\
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\215\ See, e.g., ODS Letter; STA Letter; Tiny Cat Letter. Such
general information may include the issuer's contact information;
agent for service; information about the manner in which ownership
interests will be evidenced; who will be providing record keeping
services; where records of ownership will be maintained; and/or
statements that the issuer may not provide account statements and
that investors will have the responsibility of monitoring their
investments, communicating with the record keeper and updating their
information with the record keeper.
\216\ See, e.g., Arctic Island Letter 4; Denlinger Letter 1
(recommending disclosure of deferred compensation, stock options or
warrants, contingent payments for services, shareholder and other
related-party loans and contingent liabilities); Grassi Letter
(recommending separate amounts for base salary, bonus and an
``other'' category for the three highest paid individuals and the
number and type of equity instruments granted); NASAA Letter; RFPIA
Letter (recommending inclusion of owners' compensation).
\217\ See, e.g., Arctic Island Letter 4.
\218\ See, e.g., Hackers/Founders Letter.
\219\ See, e.g., CFA Institute Letter.
\220\ See, e.g., SBM Letter.
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As discussed in Section II.B.2 below in connection with ongoing
annual reports, a number of commenters recommended ways to make it
easier for investors to locate an issuer's annual reports.\221\
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\221\ See, e.g., Arctic Island Letter 5; CFA Institute Letter
(recommending advance notice as to when and where annual reports
will be available); RocketHub Letter.
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(iii) Final Rules
We are adopting the additional disclosure requirements as proposed
in Rule 201 with several modifications. As discussed below, we have
added a requirement to disclose any material information necessary in
order to make the statements made, in light of the circumstances under
which they were made, not misleading.\222\ We also have modified the
rule to require disclosure of the compensation to be paid to the
intermediary so that it could be disclosed either as a dollar amount or
percentage of the offering amount or as a good faith estimate if the
exact amount is not available at the time of the filing.\223\ We also
have added a requirement to disclose the location on the issuer's Web
site where investors will be able to find the issuer's annual report
and the date by which such report will be available on the issuer's Web
site.\224\ In addition, we have added a requirement to disclose whether
the issuer or any of its predecessors previously has failed to comply
with the ongoing reporting requirements of Regulation
Crowdfunding.\225\
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\222\ See Rule 201(y) of Regulation Crowdfunding.
\223\ See Rule 201(o) of Regulation Crowdfunding.
\224\ See Rule 201(w) of Regulation Crowdfunding.
\225\ See Rule 201(x) of Regulation Crowdfunding.
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We agree with the suggestion by some commenters that issuers should
not be required to disclose in multiple places the information required
to be provided
[[Page 71405]]
to investors.\226\ As a result, to avoid duplicative disclosure, an
issuer will not be required to repeat what is already provided
elsewhere in the issuer's disclosure, including the financial
statements.\227\ Issuers may cross-reference within the offering
statement or report, including to the location of the information in
the financial statements.\228\
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\226\ See, e.g., EY Letter (noting that certain required
disclosure would be included in an issuer's financial statements);
Grassi Letter (same).
\227\ See Instruction to Item 201 of Regulation Crowdfunding.
\228\ Id.
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Identity of the Intermediary. Despite the suggestion of one
commenter that this disclosure is unnecessary,\229\ we believe
requiring an issuer to identify the name, SEC file number and CRD
number (as applicable) of the intermediary through which the offering
is being conducted should assist investors and regulators in obtaining
information about the offering and use of the exemption.\230\ It also
could help investors obtain background information on the intermediary,
for instance, through filings made by the intermediary with the
Commission, as well as through the Financial Industry Regulatory
Authority's (``FINRA'') BrokerCheck system for broker-dealers \231\ or
a similar system, if created, for funding portals.
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\229\ See RocketHub Letter.
\230\ See Rule 201(n) of Regulation Crowdfunding.
\231\ See FINRA, FINRA BrokerCheck, available at http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/P015175.
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Compensation Paid to the Intermediary. Requiring an issuer to
disclose the amount of compensation paid to the intermediary for
conducting the offering, including the amount of any referral or other
fees associated with the offering, will permit investors and regulators
to determine how much of the proceeds of the offering is used to
compensate the intermediary. Based on a comment received,\232\ we
understand that in some instances the exact amount of compensation and
fees to be paid to the intermediary will not be known at the time the
Form C is filed, and we have modified the rule from the proposal to
address this issue. Consistent with this understanding, and to avoid
suggesting that only amounts certain and paid to date must be
disclosed, the final rules require disclosure of all compensation paid
or to be paid to the intermediary for conducting the offering, which
may be disclosed as a dollar amount or as a percentage of the offering
amount. If the exact amount of the compensation paid or to be paid is
not available at the time of the filing, issuers are permitted to
provide a good faith estimate.\233\
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\232\ See RocketHub Letter.
\233\ See Rule 201(o)(1) of Regulation Crowdfunding.
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In addition, we are modifying the rule text from the proposal to
require issuers to disclose any other direct or indirect interest in
the issuer held by the intermediary, or any arrangement for the
intermediary to acquire such an interest.\234\ The proposed rules would
have prohibited an intermediary from holding any financial interest in
the issuers conducting offerings on its platforms. However, as
discussed in Section II.C.2.b below, the final rules permit
intermediaries to hold such interests. We believe that, similar to the
amount of compensation paid to the intermediary, an intermediary's
interests in an issuer and the issuer's transaction could be material
to an investment decision in the issuer. Therefore, we believe that
issuers should disclose such interests to investors.
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\234\ See Rule 201(o)(2) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Legends. We are adopting this requirement as proposed.\235\ The
requirement for an issuer to include in the offering statement
specified legends about the risks of investing in a crowdfunding
transaction is intended to help investors understand the general risks
of investing in a crowdfunding transaction. We continue to believe,
despite the suggestions of some commenters,\236\ that requiring legends
in each issuer's offering statement, regardless of any general warnings
available on an intermediary's platform, will provide additional
investor protection with minimal costs. For example, the requirement
that an issuer include in the offering statement certain legends about
the required ongoing reports, including how those reports will be made
available to investors and how an issuer may terminate its ongoing
reporting obligations, will help investors understand an issuer's
ongoing reporting obligations and how they will be able to access those
reports.
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\235\ See Item 2 of General Instruction III to Form C.
\236\ See, e.g., Grassi Letter; Hackers/Founders Letter; Public
Startup Letter 2; Startup Valley Letter.
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Current Number of Employees. Consistent with the proposal and the
recommendation of several commenters,\237\ the final rules require
disclosure of the current number of employees.\238\ We believe this
disclosure is important to investors in evaluating a crowdfunding
transaction because it will give investors a sense of the size of the
issuers using the exemption. We expect that the early-stage issuers who
are likely to use securities-based crowdfunding will not have many
employees, so we do not believe this requirement will be unreasonably
burdensome.
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\237\ See, e.g., NASAA Letter; Wilson Letter; Zhang Letter.
\238\ See Rule 201(e) of Regulation Crowdfunding.
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Risk Factors. We are adopting this disclosure requirement as
proposed.\239\ While some commenters expressed concerns about potential
expenses or confusion associated with risk disclosure,\240\ we agree
with those commenters who indicated that disclosure of the material
factors that make an investment in the issuer speculative or risky is
important to help investors understand the risks of investing in a
specific issuer's offering.\241\ To help investors to better understand
these risks, we believe that risk factor disclosure should be tailored
to the issuer's business and the offering and should not repeat the
factors addressed in the required legends.\242\ For similar reasons, we
are not providing examples of, or developing standard disclosure for,
issuer risk factor discussions, as we believe issuers will be in the
best positions to articulate the risks associated with their business
and offerings in light of their particular facts and circumstances.
---------------------------------------------------------------------------
\239\ See Rule 201(f) of Regulation Crowdfunding.
\240\ See, e.g., Campbell R. Letter; Cole A. Letter; Grassi
Letter; Hackers/Founders Letter; RocketHub Letter; Schwartz Letter;
Scruggs Letter.
\241\ See, e.g., ASSOB Letter; CFA Institute Letter;
Commonwealth of Massachusetts Letter; Consumer Federation Letter;
EMKF Letter; Jacobson Letter; McGladrey Letter; STA Letter;
StartupValley Letter; Wilson Letter.
\242\ See Item 2 of General Instruction III to Form C.
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Indebtedness. Consistent with the proposal, we are adopting the
requirement to provide a description of the material terms of any
indebtedness of the issuer.\243\ We believe disclosure of the material
terms of any indebtedness of the issuer, including, among other items,
the amount, interest rate and maturity date of the indebtedness, is
important to investors because servicing debt could place additional
pressures on an issuer in the early stages of development. We expect
that for many issuers this information will be included in the
financial statements, which will satisfy this reporting
requirement.\244\
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\243\ See Rule 201(p) of Regulation Crowdfunding.
\244\ See Instruction to Rule 201 of Regulation Crowdfunding;
Items 1 and 3 of General Instruction III to Form C.
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While one commenter recommended that we require issuers to disclose
the
[[Page 71406]]
identities of their creditors,\245\ we do not believe, as a general
matter, that such disclosure would provide meaningful information to
investors. Accordingly, under the final rules, such disclosure is
required only to the extent the creditor's identity is a material
aspect of the indebtedness.\246\
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\245\ See ODS Letter.
\246\ See Rule 201(y) of Regulation Crowdfunding.
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Prior Exempt Offerings. Consistent with the proposal and with
commenters' recommendations, we are requiring issuers to provide
disclosure about the exempt offerings that they conducted within the
past three years.\247\ For each exempt offering within the past three
years, issuers must describe the date of the offering, the offering
exemption relied upon, the type of securities offered and the amount of
securities sold and the use of proceeds.\248\ We believe that
information about prior offerings will better inform investors about
the capital structure of the issuer and will provide information about
how prior offerings were valued.
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\247\ See Rule 201(q) of Regulation Crowdfunding.
\248\ See Instruction to paragraph (q) of Rule 201 of Regulation
Crowdfunding.
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Related-Party Transactions. We are adopting this disclosure
requirement substantially as proposed.\249\ Related-party transactions
create potential conflicts of interest that may result in actions that
benefit the related parties at the expense of the issuer or the
investors. After considering the comments received, we continue to
believe the related-party transactions disclosure will assist investors
in obtaining a more complete picture of the financial relationships
between certain related parties and the issuer and provide additional
insight as to potential uses of the issuer's resources, including the
proceeds of the offering. The final rule differs from the proposal in
that an issuer is required to disclose transactions with any person who
is, as of the most recent practicable date but no earlier than 120 days
prior to the date the offering statement or report is filed, the
beneficial owner of 20 percent or more of the issuer's outstanding
voting equity securities. Limiting the relevant period to 120 days
prior to the date of the offering statement or report is consistent
with the treatment of beneficial ownership elsewhere in Regulation
Crowdfunding.\250\ We also believe this limitation and the consistency
it provides will help limit compliance costs for issuers.
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\249\ See Rule 201(r) of Regulation Crowdfunding.
\250\ See, e.g., Rules 201(c) and 201(m) of Regulation
Crowdfunding.
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The final rule also includes an instruction to clarify that, for
purposes of Rule 201(r), a transaction includes, but is not limited to,
any financial transaction, arrangement or relationship (including any
indebtedness or guarantee of indebtedness) or any series of similar
transactions, arrangements or relationships.\251\ This instruction is
consistent with Item 404 of Regulation S-K.\252\
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\251\ See Instruction 2 to Rule 201(r) of Regulation
Crowdfunding.
\252\ See Instruction 2 to Item 404(a) of Regulation S-K [17 CFR
229.404(a)].
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Given the early stage of development of the small businesses and
startups that we expect will seek to raise capital pursuant to Section
4(a)(6), as well as the investment limits prescribed by the rules, we
believe that limiting the disclosure of related-party transactions to
transactions occurring since the beginning of the issuer's last fiscal
year, as proposed, will help to limit compliance costs for issuers
while still providing investors with sufficient information to evaluate
the relationship between related parties and the issuer.\253\ In
addition, we are requiring issuers to disclose only related-party
transactions that, in the aggregate, are in excess of five percent of
the aggregate amount of capital raised by the issuer in reliance on
Section 4(a)(6) during the preceding 12-month period, inclusive of the
amount the issuer seeks to raise in the current offering under Section
4(a)(6). We also have added an instruction to clarify that any series
of similar transactions, arrangements or relationships should be
aggregated for purposes of determining whether related-party
transactions should be disclosed.\254\ For example, an issuer seeking
to raise $1 million will be required to disclose related-party
transactions that, in the aggregate, are in excess of $50,000, which is
the same dollar threshold required in Form 1-A \255\ for offerings of
any size made pursuant to Tier 1 of Regulation A,\256\ and an issuer
that raises $250,000 will be required to disclose such transactions in
excess of $12,500. We believe that, in light of the sizes and varieties
of issuers that may make offerings in reliance on Section 4(a)(6), this
approach could mitigate the potential for the requirement to be
disproportionate to the size of certain offerings and issuers. While
one commenter suggested we use a percentage threshold less than five
percent, we believe this threshold appropriately takes into
consideration the need to provide investors with relevant information
about the issuer's activities involving related parties during this
crucial early stage of development.
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\253\ We note, however, that financial statements covering the
two most recently completed fiscal years will include disclosure of
related-party transactions, as required by U.S. GAAP, for each of
the years presented.
\254\ See Instruction 1 to Rule 201(r) of Regulation
Crowdfunding.
\255\ 17 CFR 239.900
\256\ 17 CFR 230.251 through 230.263
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As suggested by one commenter,\257\ in a change from the proposal,
we are adopting a definition for ``member of the family'' in the
related-party transactions context that is consistent with the
definition of ``member of the family of the purchaser or the
equivalent'' in the resale restrictions context.\258\ The final rule
defines ``member of the family'' as a ``child, stepchild, grandchild,
parent, stepparent, grandparent, spouse or spousal equivalent, sibling,
mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-
law, or sister-in-law, [including] adoptive relationships'' of any of
the persons identified in Rules 201(r)(1), (r)(2) or (r)(3).\259\ This
definition tracks the definition of ``immediate family'' in Exchange
Act Rule 16a-1(e),\260\ but with the addition of ``spousal
equivalent,'' which the final rule defines to mean ``a cohabitant
occupying a relationship generally equivalent to that of a spouse.''
\261\ We believe a common definition of ``member of the family'' that
is consistent with our disclosure rules in other contexts \262\ will
provide certainty for issuers in identifying the persons covered by the
rule.
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\257\ See Brown J. Letter.
\258\ See Rule 501(a) of Regulation Crowdfunding;
\259\ See Rule 201(r)(4) of Regulation Crowdfunding.
\260\ 17 CFR 240.16a-1(e).
\261\ See Rule 201(r)(4) of Regulation Crowdfunding.
\262\ See, e.g., Exchange Act Rule 16a-1(e).
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Other Disclosures. We are adopting this provision as proposed but
with the addition of three issuer disclosure requirements in response
to comments received.
The first is a requirement that an issuer disclose the location on
its Web site where investors will be able to find the issuer's annual
report and the date by which such report will be available on its Web
site.\263\ We believe this requirement addresses the concern expressed
by commenters that investors may not know where to find an issuer's
annual report. We do not believe physical delivery of the annual report
is necessary due to the electronic nature of the crowdfunding
marketplace, nor do we believe that email delivery of the annual report
is practical because the
[[Page 71407]]
issuer may not have access to email addresses of its investors.
Instead, we are requiring issuers to disclose this information in the
offering statement, which will assist investors in locating the
information while limiting the compliance costs for issuers.
---------------------------------------------------------------------------
\263\ See Rule 201(w) of Regulation Crowdfunding. See also,
Section II.B.2 for a discussion of the requirement on issuers to
post their annual reports on their Web sites.
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The second additional disclosure requirement, as suggested by a
commenter,\264\ is a requirement that the disclosure include any
material information necessary in order to make the statements made, in
light of the circumstances under which they were made, not
misleading.\265\ This provision should help ensure that investors have
all of the material information they need on which to base their
investment decisions.
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\264\ See CrowdCheck Letter 1.
\265\ See Rule 201(y) of Regulation Crowdfunding.
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The third additional requirement, similar to suggestions from some
commenters,\266\ requires the issuer to disclose whether it or any of
its predecessors previously failed to comply with the ongoing reporting
requirements of Regulation Crowdfunding.\267\ While we continue to
believe, and the final rules provide, that only those issuers that have
failed to file their two most recent annual reports should be
prohibited from relying on the exemption available under Section 4A(6),
we also believe that any history of non-compliance with ongoing
reporting obligations would provide important information to investors
about the issuer.
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\266\ See Grassi Letter; RocketHub Letter.
\267\ See Rule 201(x) of Regulation Crowdfunding.
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Although we appreciate that commenters made various suggestions for
additional issuer disclosure requirements, such as those relating to
executive compensation, market risk and material contracts, we are not
mandating further disclosures. In adopting issuer requirements for
Regulation Crowdfunding, we have been mindful of the limited resources
and start-up operations of issuers likely to use security-based
crowdfunding and have sought to consider the need to provide investors
with relevant information to make an informed investment decision while
limiting the compliance costs for issuers. We believe the issuer
disclosure requirements we are adopting along with other protections,
such as investment limits, achieve this goal.
(2) Financial Disclosure
Section 4A(b)(1)(D) requires ``a description of the financial
condition of the issuer.'' It also establishes a framework of tiered
financial disclosure requirements based on aggregate target offering
amounts of the offering and all other offerings made in reliance on
Section 4(a)(6) within the preceding 12-month period.
(a) Financial Condition Discussion
(i) Proposed Rules
Consistent with Section 4A(b)(1)(D), we proposed in Rule 201(s) of
Regulation Crowdfunding to require an issuer to provide a narrative
discussion of its financial condition.
(ii) Comments on the Proposed Rules
Commenters generally supported the proposed requirement that
issuers provide a narrative discussion of their financial
condition.\268\ One commenter expressed concern that the requirement
could be challenging for issuers at an early stage of development and
result in duplicative disclosure.\269\ The same commenter suggested
that issuers be encouraged, rather than mandated, to discuss material
historical operating results.\270\
---------------------------------------------------------------------------
\268\ See, e.g., ABA Letter; CFA Institute Letter; CFIRA Letter
5; Commonwealth of Massachusetts Letter; Grassi Letter; Jacobson
Letter; Joinvestor Letter; Saunders Letter. But see, e.g., EY
Letter; Public Startup Letter 2; RocketHub Letter.
\269\ See EY Letter.
\270\ Id.
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(iii) Final Rules
We are adopting this requirement as proposed, with a few technical
modifications.\271\ Rule 201(s) clarifies that the description must
include, to the extent material, a discussion of liquidity, capital
resources and historical results of operations. Rule 201(s) also
includes an instruction noting that issuers will be required to include
a discussion of each period for which financial statements are provided
and a discussion of any material changes or trends known to management
in the financial condition and results of operations of the issuer
subsequent to the period for which financial statements are
provided.\272\ In connection with this instruction, an issuer will need
to consider whether more recent financial information is necessary to
make the disclosure in the offering document not misleading. The
instruction in final Rule 201(s) was included in proposed Rule 201(t)
as an instruction to the financial statement requirements, but we have
moved this instruction to Rule 201(s) because it elicits narrative
disclosure that we believe is more appropriately presented as part of
the discussion of the issuer's financial condition. In addition,
another instruction clarifies that references to the issuer in Rule
201(s) refer to the issuer and its predecessors, if any.\273\
---------------------------------------------------------------------------
\271\ See Rule 201(s) of Regulation Crowdfunding.
\272\ See Instruction 1 to Rule 201(s) of Regulation
Crowdfunding.
\273\ See Instruction 4 to Rule 201(s) of Regulation
Crowdfunding.
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We expect that the discussion required by the final rule and
instructions will inform investors about the financial condition and
results of operations of the issuer by providing management's
perspective on the issuer's operations and financial results, including
information about the issuer's liquidity and capital resources and any
known trends or uncertainties that could materially affect the
company's results. Because issuers seeking to engage in crowdfunding
transactions will likely be smaller, less complex and at an earlier
stage of development than issuers conducting registered offerings or
Exchange Act reporting companies, we expect that the discussion
generally will not, contrary to the concern of at least one
commenter,\274\ need to be as lengthy or detailed as the management's
discussion and analysis of financial condition and results of
operations of those issuers. Accordingly, we are not prescribing a
specific content or format for this information, but instead set forth
general principles for making this disclosure.\275\ The discussion
should address, to the extent material, the issuer's historical results
of operations in addition to its liquidity and capital resources. If an
issuer does not have a prior operating history, the discussion should
focus on financial milestones and operational, liquidity and other
challenges. If an issuer has a prior operating history, the discussion
should focus on whether historical earnings and cash flows are
representative of what investors should expect in the future. An
issuer's discussion of its financial condition should take into account
the proceeds of the offering and any other known or pending sources of
capital. Issuers also should discuss how the proceeds from the offering
will affect their liquidity, whether these funds and any other
additional funds are necessary to the viability of the business and how
quickly the issuer anticipates using its available cash. In addition,
issuers should describe the other available sources of capital to the
business, such as lines of credit or required contributions by
principal shareholders. To the extent these items of disclosure overlap
with the issuer's discussion of its business or business plan, issuers
are not required to make
[[Page 71408]]
duplicate disclosures.\276\ While we are not mandating a specific
presentation, we expect issuers to present the required disclosures,
including any other information that is material to an investor, in a
clear and understandable manner.
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\274\ See EY Letter.
\275\ See Instructions 1 and 2 to Rule 201(s) of Regulation
Crowdfunding.
\276\ See Instruction to Rule 201 of Regulation Crowdfunding.
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(b) Financial Disclosures
(i) Proposed Rules
Proposed Rule 201(t) of Regulation Crowdfunding would have
established financial statement disclosure requirements that are based
on aggregate target offering amounts within the preceding 12-month
period:
Issuers offering $100,000 or less would be required to
file with the Commission and provide to investors and the relevant
intermediary income tax returns filed by the issuer for the most
recently completed year (if any) and financial statements that are
certified by the principal executive officer to be true and complete in
all material respects;
issuers offering more than $100,000, but not more than
$500,000, would be required to file with the Commission and provide to
investors and the relevant intermediary financial statements reviewed
by a public accountant that is independent of the issuer; and
issuers offering more than $500,000 would be required to
file with the Commission and provide to investors and the relevant
intermediary financial statements audited by a public accountant that
is independent of the issuer.
Under proposed Rule 201(t), issuers would be permitted to
voluntarily provide financial statements that meet the requirements for
a higher aggregate target offering amount.
The proposed rules also would have set forth the following
requirements for the financial statements:
Basis of Accounting. All issuers would be required to file
with the Commission and provide to investors and the relevant
intermediary a complete set of their financial statements (balance
sheets, income statements, statements of cash flows and statements of
changes in owners' equity), prepared in accordance with U.S. generally
accepted accounting principles (``U.S. GAAP'').
Public Accountant Requirements. To qualify as independent
of the issuer, a public accountant would be required to comply with the
Commission's independence rules, which are set forth in Rule 2-01 of
Regulation S-X.\277\
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\277\ 17 CFR 210.2-01.
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Periods Covered in the Financial Statements. The financial
statements would be required to cover the shorter of the two most
recently completed fiscal years or the period since inception of the
business.
Age of Financial Statements. During the first 120 days of
the issuer's fiscal year, an issuer would be able to conduct an
offering in reliance on Section 4(a)(6) and the related rules using
financial statements for the fiscal year prior to the most recently
completed fiscal year if the financial statements for the most recently
completed fiscal year are not otherwise available or required to be
filed.
Review and Audit Standards. Reviewed financial statements
would be required to be reviewed in accordance with the Statements on
Standards for Accounting and Review Services (``SSARS'') issued by the
American Institute of Certified Public Accountants (``AICPA''). Audited
financial statements would be required to be audited in accordance with
the auditing standards issued by either the AICPA or the Public Company
Accounting Oversight Board (``PCAOB'').
Review and Audit Reports. Issuers would be required to
file with the Commission and provide to investors and the relevant
intermediary a copy of the public accountant's review or audit report.
An issuer that received an adverse opinion or disclaimer of opinion in
its audit report would not be in compliance with the audited financial
statement requirements.
Exemptions from the Financial Statement Requirements. The
proposed rules would not exempt any issuers from the financial
statement requirements.
(ii) Comments on the Proposed Rules
Commenters were divided on the proposed financial statement
requirements,\278\ although commenters generally supported allowing
issuers to voluntarily provide financial statements that meet the
requirements for a higher aggregate target offering amount.\279\
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\278\ For an example of those who generally supported the
proposed financial disclosure requirements, see, e.g., ABA Letter
(recommending some modifications); CFA Institute Letter;
Commonwealth of Massachusetts Letter; Consumer Federation Letter
(the financial information is critical to an informed evaluation of
the investment opportunity); Denlinger Letter 1; Funderbuddies
Letter; NASAA Letter.
For an example of those who generally opposed, see, e.g., AEO
Letter; Joinvestor Letter (recommending that only issuer-generated
documents produced in good faith be required); Marsala Letter;
RocketHub (stating that ``requirements are excessive in cost and
misguided in intent''); Traklight Letter (recommending that instead
of pre-raise and ongoing financial statement reviews or audits,
issuers only be required to have a limited review engagement on the
use of proceeds after the raise); Zhang Letter.
\279\ See, e.g., AICPA Letter; Denlinger Letter 1; Grassi
Letter; Heritage Letter; RocketHub Letter; Wilson Letter. But see
Public Startup Letter 2.
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Offerings of $100,000 or less. In general, commenters supported
requiring issuers to provide financial statements certified by the
principal executive officer to be true and complete in all material
respects.\280\ Further, several recommended that all issuers relying on
the Section 4(a)(6) exemption be required to provide such
certification.\281\
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\280\ See, e.g., AICPA Letter; Zeman Letter.
\281\ See, e.g., AICPA Letter; Denlinger Letter 1; Grassi
Letter; Jacobson Letter. But see Public Startup Letter 2.
---------------------------------------------------------------------------
Commenters were divided on the requirement that issuers offering
$100,000 or less file and provide to investors their federal income tax
returns. Supporters of the tax return requirement noted that income tax
returns would be a source of credible information for investors that
should be readily available without requiring issuers to bear
significant additional preparation expenses.\282\ On the other hand,
opponents of the tax return requirement raised concerns about
privacy,\283\ identity theft and tax fraud.\284\ One commenter
expressed concern that small issuers may not be adequately prepared to
consider the patchwork of state and federal privacy laws that might
apply to the disclosure of tax returns.\285\
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\282\ See, e.g., Angel Letter 1 (``tax returns are even more
credible than audited financial statements, as companies are highly
unlikely to exaggerate profitability to the IRS.''); Fund Democracy
Letter; NPCM Letter; Zeman Letter (``the small risk for these
investors does not meet the consideration of audited financial
statements.'').
\283\ See, e.g., AICPA Letter (disclosing an issuer's tax return
``. . . has the potential to cause serious problems. Tax returns are
intended to be confidential and should remain so.''); Public Startup
Letter 2; RocketHub Letter; SBM Letter; Wilson Letter (personal
income tax information should be on a voluntary basis only); Zhang
Letter.
\284\ See AICPA Letter.
\285\ See AICPA Letter.
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Several commenters suggested approaches to allow access by
investors to the information available from a tax return,\286\
including permitting issuers to digitally submit the data from their
[[Page 71409]]
tax return in a standardized format.\287\ Supporters of digital
submission suggested that approach would provide a standardized format
and protect issuers from accidental disclosure of confidential
information. Commenters generally supported the proposal to require
issuers to redact personally identifiable information from their tax
returns,\288\ although some requested clarifications.\289\
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\286\ See, e.g., Arctic Island Letter 5 (recommending that only
the two primary pages and not the schedules be made public);
CrowdBouncer Letter (recommending the Commission allow issuers to
disclose electronic transcripts of filed tax returns to investors
through the intermediary platforms); NPCM (expressing concern that
unless tax returns are filed as a PDF stamped by the IRS, there is
no way to know if the posted document is a true reflection of the
tax return); RocketHub Letter.
\287\ See, e.g., RocketHub Letter (suggesting digital submission
``will protect the issuers from accidental disclosure of
confidential information, and will allow investors to view the
information in a structured and consistent manner. For example, if
each issuer were to upload their version of a financial statement,
the responsibility of learning to understand each format would fall
to the investor. Standardized formats for financial projections,
financial statements, and business plans will allow investors to
quickly compare issuances and more readily evaluate investment
opportunities.''); Zhang Letter.
\288\ See, e.g., ABA Letter; AICPA Letter; Fund Democracy
Letter; Whitaker Chalk Letter.
\289\ See, e.g., ABA Letter (recommending the Commission provide
a non-exhaustive list of the specific types of information that may
be redacted); AICPA Letter (recommending that if the tax return
requirement is adopted, the Commission define ``personally
identifiable information'' and clarify that the redaction includes
third-party information).
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Two commenters recommended that the timing of financial statement
disclosures correspond to any extended tax filing deadlines,\290\ while
two other commenters opposed such application.\291\ Further, a few
commenters supported the proposal to permit an issuer that has not yet
filed its tax return for the most recently completed fiscal year to use
the tax return filed for the prior year and update the information
after filing the tax return for the most recently completed fiscal
year.\292\ One commenter recommended that at least one tax return be
available,\293\ and another recommended that the Commission provide
guidance for issuers who have not filed a U.S. tax return.\294\ One
commenter supported requiring issuers to describe any material changes
that are expected in the tax returns for the most recently completed
fiscal year,\295\ while another recommended that such disclosure be
permitted, but not required.\296\
---------------------------------------------------------------------------
\290\ See EY Letter; Grassi Letter.
\291\ See, e.g., ASSOB Letter (recommending that issuers should
provide their tax accounts within three months of the end of the
reporting period); Fund Democracy Letter.
\292\ See, e.g., Grassi Letter; RocketHub Letter.
\293\ See Fund Democracy Letter.
\294\ See AICPA Letter.
\295\ See Grassi Letter.
\296\ See RocketHub Letter (also recommending that the
Commission define what qualifies as a material change).
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A number of commenters recommended raising the maximum offering
amount for issuers that provide this level of financial
information.\297\
---------------------------------------------------------------------------
\297\ See, e.g., Hackers/Founders Letter ($500,000); Kickstarter
Coaching Letter ($250,000); RocketHub Letter ($500,000); Zeman
Letter (recommending that offerings under $500,000 require two years
of tax returns and unaudited balance sheets).
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Offerings of more than $100,000 but not more than $500,000. Some
commenters supported the requirement in the proposed rules that
offerings of more than $100,000 but not more than $500,000 include
financial statements reviewed by an independent public accountant,\298\
while other commenters opposed such requirement.\299\ A number of
commenters recommended a different range of offering amounts or methods
for determining when an issuer is required to file and provide reviewed
financial statements.\300\
---------------------------------------------------------------------------
\298\ See, e.g., Denlinger Letter 1; Leverage PR Letter (stating
that the industry will evolve to provide lower cost reviews);
StartEngine Letter 1 (stating that the industry will evolve to
provide lower cost reviews, such as in the $1,500-$10,000 range for
smaller, newer companies).
\299\ See, e.g., Angel Letter 1 (recommending requiring audited
financial statements if they are available and tax returns if they
are not); Arctic Island Letter 5 (recommending only for issuers that
have greater than $15 million in annual revenue); Johnston Letter;
McGladrey Letter (recommending only after the issuer meets certain
revenue and operational thresholds); NACVA Letter; Public Startup
Letter 2; Zeman Letter.
\300\ See, e.g., ABA Letter; CIFRA Letter 5 (noting the
financial disclosure standards of the SBA's Section 8(a) program
require reviewed financial statements for companies with gross
annual receipts for $2 million to $10 million); Grassi Letter
($300,000 to $700,000); Kickstarter Coaching Letter ($250,000 to $1
million).
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Offerings of more than $500,000. We received extensive comments on
our proposal that issuers offering more than $500,000 be required to
file with the Commission and provide to investors and the relevant
intermediary financial statements audited by an independent public
accountant. A significant number of those commenters opposed the
proposed requirement,\301\ although some commenters expressed
support.\302\ Some commenters recommended the elimination of the audit
requirement,\303\ and others recommended that we consider additional
criteria for determining when an issuer would be required to provide
audited financial statements.\304\ A number of commenters opposed the
proposed $500,000 threshold as being too low,\305\ and a number
recommended alternative thresholds.\306\ A number of commenters stated
that funding the upfront cost of an audit would be particularly
difficult for issuers raising capital for the first time.\307\
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\301\ See, e.g., AEO Letter; Angel Letter 1; AWBC Letter; CFIRA
Letter 5; CfPA Letter; CrowdFundConnect Letter; EarlyShares Letter;
EMKF Letter; EY Letter; Finkelstein Letter; FundHub Letter 1;
Generation Enterprise Letter; Fryer Letter; Grassi Letter; Graves
Letter; Guzik Letter 1; Hakanson Letter; Holland Letter; Johnston
Letter; Kickstarter Coaching Letter; McGladrey Letter; Milken
Institute Letter; NACVA Letter; NFIB Letter; NPCM Letter; NSBA
Letter; PBA Letter; Reed Letter; RocketHub Letter; Saunders Letter;
SBA Office of Advocacy Letter; SBEC Letter; SBM Letter; Seyfarth
Letter; WealthForge Letter; Wefunder Letter; Woods Letter; Zeman
Letter.
\302\ See, e.g., AICPA Letter; Consumer Federation Letter; CSTTC
Letter; Denlinger Letter 2; FundDemocracy Letter; Leverage PR; NASAA
Letter; StartEngine Letter 1.
\303\ See, e.g., CrowdFundConnect Letter; FundHub Letter 1;
Johnston Letter; SBEC Letter; StartupValley Letter (for issuers less
than two years old); Woods Letter.
\304\ See, e.g., Angel Letter 1 (only if such financial
statements are available); Arctic Island Letter 5 (only apply to
issuers that have greater than $15 million in revenue); EY Letter
(only if issuer has raised $5 million in equity securities in
crowdfunding transactions unless audited financial statements are
otherwise available); McGladrey Letter (eliminate the audit
requirements until the issuer meets certain revenue and operational
thresholds); Reed Letter (if an audit is required, the requirement
only apply to issuers that reach a certain size in investment or
investors); RocketHub Letter ($5 million offering amount and the
issuer has been in operation for more than two years). But see AICPA
Letter (additional criteria would add complexity without any
additional benefit).
\305\ See, e.g., ABA Letter; CCA Letter; CFIRA Letter 5; CfPA
Letter; CrowdFundConnect Letter; EarlyShares Letter; EMKF Letter; EY
Letter; FundHub Letter 1; Generation Enterprise Letter; Grassi
Letter; Graves Letter; Guzik Letter 1; Kickstarter Coaching Letter;
Milken Institute Letter; NFIB Letter; PBA Letter; RocketHub Letter;
SBA Office of Advocacy Letter; SBM Letter; Seyfarth Letter;
WealthForge Letter; Wefunder Letter; Woods Letter. But see AICPA
Letter; Denlinger Letter 1; Fund Democracy Letter; Zeman Letter.
\306\ See, e.g., ABA Letter ($750,000); EarlyShares Letter ($1
million); EMKF Letter ($800,000); EY Letter ($5 million, unless
audited financial statements are otherwise available); Grassi Letter
($700,000); Graves Letter ($900,000); Guzik Letter 1 ($700,000);
Kickstarter Coaching Letter ($1 million); PBA Letter ($1 million);
RocketHub Letter ($5 million and the issuer has been in operation
for more than two years); Seyfarth Letter ($1 million); WealthForge
Letter ($1 million).
\307\ See, e.g., AEO Letter (expressing concern that start-up
businesses with no revenue to date, and raising capital for the
first time, would find it difficult or impossible to fund the cost
of an audit); AWBC Letter; CFIRA Letter 5 (stating that the proposed
level of financial disclosure for capital raises over $500,000 would
be an impediment for small business when many will have limited
financial resources to absorb the expense prior to raising capital
using crowdfunding); CfPA Letter (suggesting the Commission
determine an alternate audit threshold because ``the costs of an
audit must necessarily be incurred prior to an offering, and in the
numerous expected cases of unsuccessful offerings, would lead to
substantial net losses to the businesses that Crowdfunding is
supposed to help''); EMKF Letter (stating that many of the issuers
looking to raise capital through crowdfunding will be startups with
little or no revenue to afford audited financial statements);
Generation Enterprise Letter; Grassi Letter; Graves Letter; Holland
Letter; McGladrey Letter; NSBA Letter; Reed Letter (noting that few
start-ups could afford auditing fees); RocketHub Letter (stating
that the filing and audit requirements establish an upfront cost
that is too high for small businesses to accept); SBM Letter (noting
that many startups do not have the resources to obtain audited
financials); Seyfarth Letter (stating that the audit requirement
will deny access to issuers who do not have the necessary upfront
capital); WealthForge Letter; Wefunder Letter.
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[[Page 71410]]
We received a number of comments expressing concern about the
anticipated costs associated with audited financial statements.\308\
Other commenters noted that costs would be lower than those estimated
in the Proposing Release or in other comment letters.\309\
---------------------------------------------------------------------------
\308\ See, e.g., AEO Letter; CfPA Letter; CFIRA Letter 5;
CrowdCheck Letter 4; ErrandRunner Letter; Finkelstein Letter;
FundHub Letter 1 (stating that the difference in cost for reviewed
versus audited financial statements could easily run into tens of
thousands of dollars); Graves Letter (stating that a partner from a
leading accounting firm predicted the cost to small businesses of
providing audited financial statements could be upwards of $18,000
to $25,000); Grassi Letter (stating that audits take more time than
companies seeking capital may have); NFIB Letter; RocketHub Letter;
SBA Office of Advocacy Letter; SBEC Letter; SBM Letter; Seyfarth
Letter; StartupValley Letter (stating that audits for small startups
with no financials can cost $10,000 and that GAAP audits typically
cost 25-50% more than other comprehensive basis of accounting
audits); Stephenson Letter; Traklight Letter (stating that audit
costs have been cited as low as $5,000 and as high as $20,000 for a
startup; also stating that review costs are estimated at about 60%
of the cost of an audit); WealthForge Letter.
\309\ See, e.g., CCA Letter (analyzing regulatory costs borne by
Title II issuers); CrowdFranchise Letter 1; CrowdFunding Network
(stating that projected costs are already decreasing through market
forces); D'Amore Letter; ddbmckennon Letter (noting that the
majority of issuers will be newly formed with limited historical
operations and that an audit for such companies may range from
$4,000-$9,000 in year one); Denlinger Letter 1 (citing a study that
found that about half of the cost of an audit is made up for in
interest rate savings on bank loans); Denlinger Letter 2 (the market
will evolve for small issuers such that audit costs may be in the
range of $2,000-$4,000); FundHub Letter 2 (noting the emergence of
CPA firms willing to do a complete audit for a startup business for
$2,500 or less); Holm Letter (stating that new providers are
offering compliance services at much lower costs than anticipated);
JumperCard Letter; Kemp Letter; Leverage PR Letter; Sfinarolakis
Letter; StartEngine Letter 1 (noting that reviews and audits will be
in the range of $1,500-$10,000 for smaller, newer companies);
StartEngine Letter 2 (noting the emergence of third-party service
providers); tempCFO Letter; Upchurch Letter (stating that the market
will adjust for costs).
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Basis of Accounting. Commenters generally were divided on whether
issuers relying on Section 4(a)(6) should be required to prepare
financial statements in accordance with U.S. GAAP.\310\ Commenters in
support of requiring U.S. GAAP noted the benefit to investors of having
a single standard to facilitate comparison of different issuers,\311\
and also that U.S. GAAP would be more likely to provide investors with
a fair representation of an issuer's financial position and results of
operations than financial statements using a comprehensive basis of
accounting other than U.S. GAAP.\312\
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\310\ For supporters, see, e.g., AICPA Letter (for offerings
over $100,000); CFA Institute Letter; EY Letter (for offerings over
$100,000 for only the most recent year); Hackers/Founders Letter;
Heritage Letter (recommending for issuers with assets over $100,000,
that if financial statements are not prepared in accordance with
U.S. GAAP, the issuer be required to note any variance from U.S.
GAAP and state the reason for such variance); NASAA Letter;
RocketHub Letter; Whitaker Chalk Letter (for offerings over $500,000
until such time as the Commission accepts IFRS for U.S. domestic
issuers).
For opponents, see, e.g., ABA Letter (noting that the benefits
associated with GAAP-compliant financial statements do not outweigh
the burdens that mandatory application of GAAP would impose);
CrowdCheck Letter 4; EarlyShares Letter; Graves Letter (recommending
that U.S. GAAP only be required for issuers with $5 million in
revenue); Milken Institute Letter (recommending that U.S. GAAP only
be required for issuers with $5 million in revenue, the threshold at
which the IRS requires a switch to accrual accounting); Public
Startup Letter 2; SBEC Letter (noting the AICPA's release of new
guidelines in June 2013 for small and mid-size businesses); Tiny Cat
Letter; U.S. Chamber of Commerce Letter; Wilson Letter (recommending
that the Commission consider the stage of the business in
determining whether to require compliance with U.S. GAAP); Zhang
Letter.
\311\ See, e.g., NASAA Letter.
\312\ See, e.g., EY Letter.
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A number of commenters recommended that, as a less expensive
alternative to requiring U.S. GAAP, the Commission allow financial
statements prepared in accordance with a comprehensive basis of
accounting other than U.S. GAAP.\313\ Other commenters recommended that
if financial statements prepared in accordance with U.S. GAAP are
required, they only be required in certain circumstances.\314\
---------------------------------------------------------------------------
\313\ See, e.g., ABA Letter (for offerings of $100,000 or less,
but stating that the Commission could require providing U.S. GAAP
financial statements if available); AICPA Letter; CFIRA Letter 5;
CFIRA Letter 7; CrowdCheck Letter 4; EarlyShares Letter; EY Letter
(for offerings of $100,000 or less, unless U.S. GAAP financial
statements are available); Grassi Letter; Graves Letter (for issuers
with less than $5 million in revenue); Mahurin Letter (stating that
simple Excel spreadsheets accompanied by bank records should meet
the financial statement requirements); Milken Institute Letter (for
early-stage issuers); NFIB Letter; SBEC Letter; StartupValley
Letter; Tiny Cat Letter (for offerings of less than $500,000);
Whitaker Chalk Letter (for offerings of less than $500,000 if the
issuer has an asset or income level below a certain level).
\314\ See, e.g., ABA Letter (suggesting that: (i) In offerings
of $100,000 or less, the certifying principal executive officer
could be required to represent that the issuer is unable to prepare
financial statements in accordance with U.S. GAAP without
unreasonable effort or expense; (ii) in offerings of more than
$100,000, but not more than $500,000, the exception could also
require the principal executive officer representation and be
limited to issuers that have not prepared U.S. GAAP-compliant
financial statements for any other purpose and who have no operating
history, no revenues and/or a minimal amount of assets (e.g.,
$500,000); and (iii) in offerings of more than $500,000, the
exception could require the principal executive officer
representation, including a representation that the other
comprehensive basis of accounting methodology selected is acceptable
under AICPA standards, and be limited to issuers with no operating
history or revenue and minimal assets).
---------------------------------------------------------------------------
A few commenters recommended that issuers relying on Section
4(a)(6) be permitted to take advantage of the extended transition
period applicable to private companies for complying with new or
revised accounting standards.\315\ A few commenters expressed concern
that Section 4(a)(6) issuers may be viewed as ``public business
entities'' by FASB.\316\ One commenter recommended that the Commission
provide an exemption from this definition for such issuers.\317\
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\315\ See, e.g., EY Letter; U.S. Chamber of Commerce Letter.
\316\ See, e.g., ABA Letter; EY Letter (noting also the
definition of ``public entity'' under the Accounting Standards
Codification).
\317\ See EY Letter.
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Periods Covered in the Financial Statements. While two commenters
generally supported requiring two years of financial statements,\318\ a
number of commenters generally opposed the proposal, recommending one
year of financial statements instead.\319\ Many commenters opposed
requiring interim financial statements,\320\ while several supported
such a requirement.\321\ Several commenters recommended that if interim
financial statements are required, they not be subject to audit or
review,\322\ while another commenter recommended that they not be filed
with the Commission, but only be provided to investors.\323\
---------------------------------------------------------------------------
\318\ See ASSOB Letter; Zeman Letter.
\319\ See, e.g., Denlinger Letter 1; EY Letter; Grassi Letter;
Joinvestor Letter; Public Startup Letter 2; RFPIA Letter (as it
relates to audited financial statements); RocketHub Letter; Verrill
Dana Letter.
\320\ See, e.g., CFIRA Letter 7; EMKF Letter; EY Letter; FundHub
Letter 1; Grassi Letter; Public Startup Letter 2; RocketHub Letter;
Traklight Letter; Wefunder Letter; Whitaker Chalk Letter.
\321\ See, e.g., AICPA Letter; Consumer Federation Letter
(recommending supplementing the proposed financial statement
requirements with unaudited CEO-certified financial statements
through the end of the month ending no more than two months before
the offering begins); Denlinger Letter 1 (recommending quarterly
basic financial reporting, including a balance sheet, income
statement and statement of cash flows); Fund Democracy Letter.
\322\ See, e.g., CFIRA Letter 7; Consumer Federation Letter;
Denlinger Letter 1; Fund Democracy Letter; Traklight Letter.
\323\ See, RocketHub Letter.
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Age of Financial Statements. Several commenters opposed our
proposal that financial statements be dated within 120 days of the
start of the offering,\324\ while one commenter supported it.\325\ Some
commenters opposed our proposal to permit an issuer, during the first
120 days of the issuer's fiscal year, to conduct an offering in
reliance on Section 4(a)(6) using financial statements for the fiscal
year prior to the
[[Page 71411]]
most recently completed fiscal year,\326\ while two others supported
such accommodation.\327\ One commenter recommended that, to provide
``truly current financials'' for large offerings, the Commission could
require unaudited financial statements through the end of the month
that ends no more than two months before the month in which the
offering begins (e.g., an offering any day in March would require
financials up to January 31); for smaller offerings, the commenter
indicated a modified standard for providing current information might
be appropriate.\328\
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\324\ See, e.g., Grassi Letter; Public Startup Letter 2;
RocketHub Letter.
\325\ See Denlinger Letter 1.
\326\ See, e.g., Consumer Federation Letter (stating that the
proposal allows for the provision of stale and limited financial
information because it ``would allow issuers to submit financial
statements that are more than a year out of date and that cover only
a very limited portion of the issuer's existence.''); EY Letter
(recommending this time period be extended to 180 days if an issuer
presents interim financial statements certified by the principal
executive officer that cover the first six months of the issuer's
most recently completed fiscal year); Fund Democracy Letter (noting
that financial statements could be 16-months stale); Merkley Letter
(recommending that the Commission not permit financial statements
``to be so thoroughly out of date''); Public Startup Letter 2.
\327\ See, e.g., Grassi Letter (noting that the material change
disclosure requirements should be sufficient to keep investors
updated); RocketHub Letter.
\328\ See Fund Democracy Letter.
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Public Accountant Requirements. We received several comments on
standards for audit firms.\329\ Commenters supported not requiring
audits to be conducted by a PCAOB-registered firm.\330\ Some commenters
supported our proposal to require the public accountant reviewing or
auditing an issuer's financial statements to comply with the
independence requirements set forth in Rule 2-01 of Regulation S-
X,\331\ while other commenters recommended allowing the public
accountant to comply by meeting the independence requirements of the
AICPA.\332\ Some commenters noted that many startups and early-stage
small businesses require assistance in the preparation of financial
statements, and that complying with the independence standards of
Regulation S-X would require such issuers to engage two external
accountants--one to assist in preparing the financial statements and
another to audit or review them.\333\ One commenter asked the
Commission not to create new independence standards.\334\
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\329\ See, e.g., Grassi Letter (recommending no audit be
accepted that has been performed by a firm that is not subject to,
or that has received a fail report under, the AICPA peer review
standards); ASSOB Letter (recommending the rules not place
restrictions on the type of accountant an issuer is required to use
to review or audit its financial statements); Multistate Tax Letter
(an issuer should not be required to obtain accounting services).
\330\ See, e.g., AICPA Letter; ASSOB Letter (recommending the
rules not place restrictions on the type of accountant an issuer is
required to use to review or audit its financial statements);
Denlinger Letter 1; Funderbuddies Letter; EY Letter; Grassi Letter;
Heritage Letter; Multistate Tax Letter (an issuer should not be
required to obtain accounting services); Public Startup Letter 2;
RocketHub Letter; Traklight Letter. See also RFPIA Letter
(recommending the public accountants conducting an audit be required
to be members of the AICPA or the PCAOB for one year.).
\331\ See, e.g., ABA Letter; Commonwealth of Massachusetts
Letter; RocketHub Letter.
\332\ See, e.g., AICPA Letter; Denlinger Letter 1; EY Letter;
Grassi Letter; McGladrey Letter.
\333\ See, e.g., AICPA Letter; EY Letter; Grassi Letter.
\334\ See AICPA Letter (recommending that the Commission not
create new independence, review, or auditing standards or that the
definition of ``a complete set of financial statements'' be
different than under U.S. GAAP because doing so would result in
confusion, further complexity and increased costs).
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Review and Audit Standards. With respect to review standards,
commenters supported requiring reviewed financial statements to be
reviewed in accordance with the SSARS issued by the AICPA.\335\
Commenters also opposed creating a new set of review standards.\336\
---------------------------------------------------------------------------
\335\ See, e.g., ABA Letter; AICPA Letter; Denlinger Letter 1;
EY Letter; Fund Democracy Letter; Grassi Letter. But see Public
Startup Letter 2.
\336\ See, e.g., AICPA Letter; Denlinger Letter 1; Grassi
Letter; Traklight Letter.
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With respect to audit standards, several commenters supported our
proposal to require that financial statements be audited in accordance
with the auditing standards issued by either the AICPA or the
PCAOB,\337\ while several others opposed it.\338\ Two commenters
recommended that audits be required to be conducted in accordance with
the auditing standards issued by the PCAOB.\339\ Commenters generally
opposed creating a new set of audit standards,\340\ although one
commenter recommended that if the Commission were to create a new set
of audit standards, it ``should be designed as an ultra-low-cost
procedure.'' \341\
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\337\ See, e.g. AICPA Letter; Denlinger Letter 1; EY Letter;
Grassi Letter.
\338\ See, e.g., Consumer Federation Letter; Fund Democracy
Letter; Public Startup Letter 2; RocketHub Letter; Rucker Letter
(stating that GAAS fit poorly with the kinds of businesses Title III
is intended to accommodate).
\339\ See Consumer Federation Letter; Fund Democracy Letter.
\340\ See, e.g., AICPA Letter; Grassi Letter (recommending that
the Commission require issuers to use the same standards used in the
offering or higher standards, with the PCAOB standards deemed to be
the higher standard, when complying with the ongoing reporting
requirements); Heritage Letter; Traklight Letter.
\341\ RocketHub Letter.
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Review and Audit Reports. With respect to review reports, two
commenters supported our proposal that a review report that includes
modifications would satisfy the reviewed financial statement
requirement,\342\ while one commenter opposed it.\343\ With respect to
audit reports, commenters supported our proposal that a qualified audit
opinion would satisfy the audited financial statement
requirements,\344\ although one commenter opposed it.\345\ One
commenter requested clarification as to the requirements that may be
applicable to the issuer and the public accountant when an issuer
intends to include a previously issued audit or review report in an
offering statement.\346\
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\342\ See AICPA Letter; Heritage Letter (for going concern
opinions).
\343\ See Grassi Letter.
\344\ See, e.g., AICPA Letter; Arctic Island Letter 5 (noting
that most small business audit opinions are likely to include a
going concern clause); Denlinger Letter 1 (noting, however, that a
going concern opinion is not a qualified opinion); EY Letter;
Heritage Letter (noting that a majority of crowdfunding issuers
should receive going concern opinions but should not be
disqualified); RocketHub Letter; Traklight Letter (recommending that
going concern opinions and noncompliance with U.S. GAAP should be
allowed); Whitaker Chalk Letter.
\345\ See Grassi Letter.
\346\ See EY Letter.
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Exemptions from Financial Statement Requirements. While the
proposed rules did not exempt any issuers from the financial statement
requirements, a number of commenters recommended exempting issuers with
no operating history or issuers that have been in existence for fewer
than 12 months from the requirement to provide financial
statements,\347\ although a few commenters opposed such a concept.\348\
A number of commenters recommended that if an exemption for such
issuers is allowed, the exempted issuers should provide certain basic
disclosures,\349\ and two commenters specifically recommended that if
an exemption for such issuers is allowed, the exempted issuers should
still provide a balance sheet.\350\
---------------------------------------------------------------------------
\347\ See, e.g., Arctic Island Letter 5 (supporting only an
exemption from the audit requirement); CFIRA Letter 5; CFIRA Letter
7; CrowdFundConnect Letter; Crowdpassage Letter 2; EY Letter; Grassi
Letter; Hackers/Founders Letter; Joinvestor Letter; McGladrey
Letter; PBA Letter; PeoplePowerFund Letter; RocketHub Letter
(recommending that the audit requirements should only apply to
issuers that have been in operation for more than two years and are
raising more than $5 million); StartupValley Letter (supporting an
exemption from the audit requirements); Wefunder Letter; Whitaker
Chalk Letter.
\348\ See, e.g., AICPA Letter; Denlinger Letter 1; Wilson
Letter.
\349\ See, e.g., ASSOB Letter; CFIRA Letter 5; Denlinger Letter
1; Grassi Letter; McGladrey Letter; PBA Letter; PeoplePowerFund
Letter; RocketHub Letter; Wefunder Letter; Whitaker Chalk Letter;
Zhang Letter.
\350\ See EY Letter; PBA Letter.
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(iii) Final Rules
We are adopting financial disclosure requirements for Title III
issuers in Rule
[[Page 71412]]
201(t) with a number of changes from the proposal. As described in more
detail below, the final requirements are based on the amount offered
and sold in reliance on Section 4(a)(6) within the preceding 12-month
period, as follows:
For issuers offering $100,000 or less: Disclosure of the
amount of total income, taxable income and total tax as reflected in
the issuer's federal income tax returns certified by the principal
executive officer to reflect accurately the information in the issuer's
federal income tax returns (in lieu of filing a copy of the tax
returns), and financial statements certified by the principal executive
officer to be true and complete in all material respects.\351\ If,
however, financial statements of the issuer are available that have
either been reviewed or audited by a public accountant that is
independent of the issuer, the issuer must provide those financial
statements instead and need not include the information reported on the
federal income tax returns or the certification of the principal
executive officer.
---------------------------------------------------------------------------
\351\ See Rule 201(t)(1) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Issuers offering more than $100,000 but not more than
$500,000: Financial statements reviewed by a public accountant that is
independent of the issuer.\352\ If, however, financial statements of
the issuer are available that have been audited by a public accountant
that is independent of the issuer, the issuer must provide those
financial statements instead and need not include the reviewed
financial statements.
---------------------------------------------------------------------------
\352\ See Rule 201(t)(2) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Issuers offering more than $500,000:
[cir] For issuers offering more than $500,000 but not more than $1
million of securities in reliance on Regulation Crowdfunding for the
first time: Financial statements reviewed by a public accountant that
is independent of the issuer. If, however, financial statements of the
issuer are available that have been audited by a public accountant that
is independent of the issuer, the issuer must provide those financial
statements instead and need not include the reviewed financial
statements.
[cir] For issuers that have previously sold securities in reliance
on Regulation Crowdfunding: Financial statements audited by a public
accountant that is independent of the issuer.\353\
---------------------------------------------------------------------------
\353\ See Rule 201(t)(3) of Regulation Crowdfunding. See also
discussion below under ``Offerings of more than $500,000.''
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Content of Financial Statements. We are adopting substantially as
proposed the requirement that all issuers file with the Commission and
provide to investors and the relevant intermediary a complete set of
their financial statements, which includes balance sheets, statements
of comprehensive income, statements of cash flows, statements of
changes in stockholders' equity and notes to the financial
statements.\354\ In order to avoid potential confusion as to the
presentation of financial statements, and consistent with Tier 1
offerings under Regulation A,\355\ the final rule adds an instruction
that financial statements that are not audited must be labeled as
unaudited.\356\ Consistent with the proposal, the final rules do not
exempt any issuers from the financial statement requirements. Although
some commenters expressed concerns about the costs of the financial
statement requirements for issuers with no operating history or issuers
that have been in existence for fewer than 12 months,\357\ we believe
that financial statements are important information for investors and
that the changes from the proposed rules described below will help
reduce the costs associated with preparing financial statements for
many of those issuers.
---------------------------------------------------------------------------
\354\ See Instruction 3 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\355\ See Paragraph (b) of Part F/S of Form 1-A.
\356\ See Instruction 3 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\357\ See, e.g., Arctic Island Letter 5; CFIRA Letter 5; CFIRA
Letter 7; CrowdFundConnect Letter; Crowdpassage Letter 2; EY Letter;
Grassi Letter; Hackers/Founders Letter; Joinvestor Letter; McGladrey
Letter; PBA Letter; PeoplePowerFund Letter; RocketHub Letter;
StartupValley Letter; Wefunder Letter; Whitaker Chalk Letter. But
see AICPA Letter; Denlinger Letter 1; Wilson Letter.
---------------------------------------------------------------------------
The final rule also includes an instruction to clarify that
references to the issuer in Rule 201(t) refer to the issuer and its
predecessors, if any.
Offerings of $100,000 or less. Consistent with Securities Act
Section 4A(b)(1)(D)(i), we are adopting as proposed the requirement in
Rule 201(t)(1) that an issuer offering $100,000 or less provide
financial statements of the issuer that are certified by the principal
executive officer of the issuer to be true and complete in all material
respects.\358\ While we believe it will be beneficial for investors to
have an independent accountant review financial statements in offerings
over $100,000, we believe that for offerings of $100,000 or less this
certification is sufficient and will contribute to the integrity of the
issuer's financial reporting process. It will affirm for investors
that, although the financial statements have not been reviewed or
audited by an independent public accountant, there has been senior
executive attention paid to the financial statements. We are not
requiring this certification for reviewed or audited financial
statements, as some commenters suggested, because we believe the
certification is intended as an added measure of assurance that is not
needed in offerings of this size when an independent accountant reviews
or audits the financial statements. We also are adopting the form of
the certification that must be provided by the issuer's principal
executive officer as proposed with one change relating to the
information from the issuer's tax return.\359\
---------------------------------------------------------------------------
\358\ See Rule 201(t)(1) of Regulation Crowdfunding.
\359\ See Instruction 7 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
Instead of mandating that issuers offering $100,000 or less provide
copies of their federal income tax returns as proposed, the final rules
require an issuer to disclose the amount of total income, taxable
income and total tax, or the equivalent line items from the applicable
form, exactly as reflected in its filed federal income tax returns, and
to have the principal executive officer certify that those amounts
reflect accurately the information in the issuer's federal income tax
returns.\360\ As noted by commenters,\361\ requiring that issuers
provide tax returns may present a significant risk of disclosure of
private information. While the proposed rule would require personally
identifiable information to be redacted, we are persuaded by commenters
that such a requirement might not provide an adequate safeguard against
inadvertent disclosure of this type of information in some instances.
The consequences for an issuer and an intermediary of such disclosure,
including the potential violation of applicable privacy laws, could be
severe. Specifying the information from the tax return that is required
without requiring submission of the tax return itself will provide
standardized disclosure for investors and help protect against the
accidental disclosure of personally identifiable or confidential
information. Requiring that these amounts be certified by the principal
executive officer will provide investors additional assurance of the
accuracy of those amounts in lieu of providing the underlying tax
returns.\362\ At the same
[[Page 71413]]
time, because the principal executive officer will be certifying only
that the amounts are as reported on the applicable income tax return,
we do not expect this requirement to impose any significant new burdens
on principal executive officers, who will already be certifying as to
the truth and completeness of the financial statements themselves. We
believe the alternative approach we are adopting provides a similar
benefit to investors as the proposal while addressing the privacy
concerns raised by commenters.
---------------------------------------------------------------------------
\360\ See Rule 201(t)(1) of Regulation Crowdfunding.
\361\ See, e.g., AICPA Letter; Public Startup Letter 2;
RocketHub Letter; SBM Letter; Wilson Letter; Zhang Letter.
\362\ We note that any intentional misstatements or omissions of
facts may constitute federal criminal violations by the certifying
principal executive officer. See 18 U.S.C. 1001.
---------------------------------------------------------------------------
As we stated in the Proposing Release, it remains unclear to us to
what extent all of the information presented in a tax return would be
useful for an investor evaluating whether to purchase securities from
the issuer. We believe, however, that certain information such as total
income, taxable income and total tax could be informative and would
likely be available to the issuer in tax documentation. The final
rules, therefore, provide that an issuer must disclose its total
income, taxable income and total tax, or the equivalent line items from
its federal income tax documentation and have the principal executive
officer certify that those amounts reflect accurately the information
in the issuer's federal income tax returns.\363\
---------------------------------------------------------------------------
\363\ See Rule 201(t)(1) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Under the final rules, an issuer that offers securities in reliance
on Section 4(a)(6) before filing its tax return for the most recently
completed fiscal year will be allowed to use information from the tax
return filed for the prior year. An issuer that uses information from
the prior year's tax return will be required to provide tax return
information for the most recently completed fiscal year when filed with
the U.S. Internal Revenue Service (if the tax return is filed during
the offering period). An issuer that has requested an extension from
the U.S. Internal Revenue Service would not be required to provide the
information until the date when the return is filed, which is
consistent with the concept of not requiring tax information until that
information has been filed with the U.S. Internal Revenue Service. If
an issuer has not yet filed a tax return and is not required to file a
tax return before the end of the offering period, then the tax return
information does not need to be provided.\364\
---------------------------------------------------------------------------
\364\ See Instruction 6 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
We are adding to Rule 201(t)(1) a requirement that if financial
statements of the issuer are available that have either been reviewed
or audited by a public accountant that is independent of the issuer,
the issuer must provide those financial statements instead, and need
not include the information reported on the federal income tax returns
or the certification of the principal executive officer.\365\ This
approach was suggested by two commenters,\366\ and we believe it will
benefit investors by providing access to audited or reviewed financial
statements that were already prepared for other purposes. Unlike audit
reports in a registered offering,\367\ we are not requiring that review
or audit reports be accompanied by a formal consent or acknowledgment
letter. Rather, the final rules clarify that review and audit reports
must be signed and that the issuers must notify the public accountants
of their intended use in an offering in reliance on Section
4(a)(6).\368\
---------------------------------------------------------------------------
\365\ See Rule 201(t)(1) of Regulation Crowdfunding.
\366\ See Angel Letter 1; EY letter.
\367\ See Securities Act Rule 436; Item 601 of Regulation S-K.
\368\ See Instructions 8 and 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
Offerings of more than $100,000 but not more than $500,000.
Consistent with Section 4A(b)(1)(D)(iii) and the proposed rules,
issuers must file and provide reviewed financial statements when
offering more than $100,000 but not more than $500,000.\369\ Similar to
the addition to Rule 201(t)(1) discussed above, we have added to Rule
201(t)(2) a requirement that if financial statements of the issuer are
available that have been audited by a public accountant that is
independent of the issuer, the issuer must provide those financial
statements instead.\370\ The approach of providing audited financial
statements that are otherwise available is consistent with what the
Commission adopted for issuers undertaking Tier 1 offerings under
Regulation A.\371\ We believe the benefits to investors of having
access to these audited financial statements justify any additional
burden imposed on issuers to provide these statements, which were
already prepared for other purposes.
---------------------------------------------------------------------------
\369\ See Rule 201(t)(2) of Regulation Crowdfunding.
\370\ Id.
\371\ See Paragraph (b) of Part F/S of Form 1-A. While
Regulation Crowdfunding incorporates a number of requirements that
are consistent with Regulation A, it is important to note that
Regulation Crowdfunding and Regulation A are different exemptions
with distinct requirements. For example, unlike offerings under
Regulation Crowdfunding, Tier 1 offerings under Regulation A are
subject to state registration requirements and are required to be
``qualified'' by Commission staff.
---------------------------------------------------------------------------
Offerings of more than $500,000. As proposed, Rule 201(t)(3)
provides that issuers offering more than $500,000 are required to
provide audited financial statements. In a change from the proposal,
the final rule includes an accommodation for issuers offering more than
$500,000 but not more than $1 million that have not previously sold
securities in reliance on Section 4(a)(6).\372\ Under Rule 201(t)(3),
those first-time issuers are permitted to provide reviewed rather than
audited financial statements, unless audited financial statements are
otherwise available.
---------------------------------------------------------------------------
\372\ For purposes of determining whether an issuer has
previously sold securities in reliance on Section 4(a)(6),
``issuer'' includes all entities controlled by or under common
control with the issuer and any predecessors of the issuer. See Rule
100(c) of Regulation Crowdfunding.
---------------------------------------------------------------------------
We are adding this accommodation for first-time issuers in response
to commenters' concerns about the expense of obtaining audited
financial statements. While some commenters expressed support for the
proposed audit requirement,\373\ many others noted that the proposed
audit requirement would be too costly and burdensome for issuers in
comparison to the size of the offering proceeds.\374\ A number of
commenters expressed particular concern that issuers would need to
incur the expense of an audit before having proceeds or even an
assurance of proceeds from the offering.\375\ After considering the
comments, we are persuaded that for issuers undertaking a first-time
crowdfunding offering of more than $500,000 but not more than $1
million, the benefits of requiring audited financial statements are not
likely to justify the costs. Accordingly, consistent with applicable
standards,\376\ for these first-time issuers, we are adopting instead a
requirement that those selling securities in reliance on Section
4(a)(6) in these circumstances
[[Page 71414]]
provide reviewed financial statements. Commenters stated that reviewed
financial statements would cost less than audited financial
statements,\377\ and one commenter noted that the cost of an accounting
review is approximately 60% of the cost of an audit.\378\
---------------------------------------------------------------------------
\373\ See, e.g., AICPA Letter; Consumer Federation Letter; CSTTC
Letter; Denlinger Letter 2; FundDemocracy Letter; Leverage PR; NASAA
Letter; StartEngine Letter 1.
\374\ See, e.g., AEO Letter; Angel Letter 1; AWBC Letter; CFIRA
Letter 5; CfPA Letter; CrowdFundConnect Letter; EarlyShares Letter;
EMKF Letter; EY Letter; Finkelstein Letter; FundHub Letter 1;
Generation Enterprise Letter; Grassi Letter; Graves Letter; Guzik
Letter 1; Hakanson Letter; Holland Letter; Johnston Letter;
Kickstarter Coaching Letter; McGladrey Letter; Milken Institute
Letter; NACVA Letter; NFIB Letter; NPCM Letter; NSBA Letter; PBA
Letter; Reed Letter; RocketHub Letter; Saunders Letter; SBA Office
of Advocacy Letter; SBEC Letter; SBM Letter; Seyfarth Letter;
Verrill Dana Letter; WealthForge Letter; Wefunder Letter; Woods
Letter; Zeman Letter.
\375\ See, e.g., AEO Letter; AWBC Letter; CFIRA Letter 5; CfPA
Letter; EMKF Letter; Generation Enterprise Letter; Grassi Letter;
Graves Letter; Holland Letter; McGladrey Letter; NSBA Letter; Reed
Letter; RocketHub Letter; SBM Letter; Seyfarth Letter; WealthForge
Letter; Wefunder Letter.
\376\ See Securities Act Section 28 [15 U.S.C. 77z-3].
\377\ See, e.g., Crowdcheck Letter 4; CfPA Letter (noting that
many offerings made in reliance on Rule 506 that involve companies
further along in their business development include reviewed but not
audited financial statements); Graves Letter (discussing the
``thorough'' nature of a CPA review and the cost differential
between reviewed and audited financial statements); NFIB Letter;
Traklight Letter.
\378\ See Traklight Letter.
---------------------------------------------------------------------------
Basis of Accounting. We are adopting as proposed the requirement
that all issuers provide financial statements prepared in accordance
with U.S. GAAP.\379\ As discussed in the Proposing Release, financial
statements prepared in accordance with U.S. GAAP are generally self-
scaling to the size and complexity of the issuer, which we believe can
reduce the costs of preparing financial statements for many early stage
issuers. We would not expect that the required financial statements
would be long or complicated for issuers that are recently formed and
have limited operating histories. Although we acknowledge, as some
commenters observed, that other bases of accounting may be less
expensive than U.S. GAAP, we believe the benefit of a single standard
that will facilitate comparison among issuers relying on Section
4(a)(6) justifies any incremental expenses associated with U.S. GAAP.
In addition, we are concerned that it may be difficult for investors to
determine whether the issuer complied with another comprehensive basis
of accounting. For these reasons, we continue to believe that financial
statements prepared in accordance with U.S. GAAP will be the most
useful for investors in securities-based crowdfunding transactions,
particularly when presented along with the required description of the
issuer's financial condition.\380\
---------------------------------------------------------------------------
\379\ See Instruction 3 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\380\ See Rule 201(s) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Additionally, as suggested by one commenter,\381\ in order to be
consistent with the treatment of emerging growth companies \382\ and
offerings relying on Regulation A,\383\ Rule 201(t) permits issuers,
where applicable, to delay the implementation of new accounting
standards to the extent such standards provide for delayed
implementation by non-public business entities.\384\ In this regard, if
the issuer chooses to take advantage of this extended transition
period, the issuer:
---------------------------------------------------------------------------
\381\ See EY Letter.
\382\ See Securities Act of 1933 Section 7(a)(2)(B) [15 U.S.C.
77g(a)(2)(B)].
\383\ See paragraph (a)(3) of Part F/S of Form 1-A.
\384\ See Instruction 5 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
Must disclose such choice at the time the issuer files the
offering statement; and
May not take advantage of the extended transition period
for some standards and not others, but must apply the same choice to
all standards.
However, consistent with the treatment of emerging growth companies
and offerings relying on Regulation A,\385\ issuers electing not to use
this accommodation must forgo this accommodation for all financial
accounting standards and may not elect to rely on this accommodation in
any future filings.\386\
---------------------------------------------------------------------------
\385\ See paragraph (a)(3) of Part F/S of Form 1-A. See also
JOBS Act, Section 107(b)(1) and (3).
\386\ See Instruction 5 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
On December 23, 2013, after we proposed rules for Regulation
Crowdfunding, the Financial Accounting Standards Board (FASB) and
Private Company Council (PCC) issued a guide for evaluating financial
accounting and reporting for non-public business entities.\387\ The PCC
was created in 2012 by the FASB and the Financial Accounting Foundation
to improve the standard-setting process, and provide for accounting and
reporting alternatives, for non-public business entities under U.S.
GAAP.\388\ As the standards for non-public business entities are new,
there are currently very few distinctions between U.S. GAAP for public
and non-public business entities. Over time, however, more distinctions
between non-public business entity and public company accounting
standards could develop.
---------------------------------------------------------------------------
\387\ The Private Company Decision-Making Framework: A Guide for
Evaluating Financial Accounting and Reporting for Private Companies
(the ``PCC Guide''), available at: http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176163703583.
\388\ For a brief history behind the creation of the PCC, see:
http://www.fasb.org/cs/ContentServer?c=Page&pagename=FASB%2FPage%2FSectionPage&cid=1351027243391.
---------------------------------------------------------------------------
Issuers that offer securities pursuant to Regulation Crowdfunding
will be considered ``public business entities'' as defined by the FASB
\389\ and, therefore, ineligible to rely on any alternative accounting
or reporting standards for non-public business entities.\390\ Even
though issuers of securities in a Regulation Crowdfunding offering fit
within the definition of ``public business entity,'' the Commission
retains the authority to determine whether or not such issuers would be
permitted to rely on the developing non-public business entity
standards.\391\ Commenters generally expressed concern about the costs
associated with requiring issuers relying on Section 4(a)(6) to follow
public company U.S. GAAP accounting standards.\392\
---------------------------------------------------------------------------
\389\ Criterion (a) of FASB's Accounting Standards Update 2013-
12, Definition of a Public Business Entity, states that an entity
that ``is required by the U.S. Securities and Exchange Commission
(SEC) to file or furnish financial statements, or does file or
furnish financial statements (including voluntary filers), with the
SEC (including other entities whose financial statements or
financial information are required to be or are included in a
filing)'' is a Public Business Entity.
\390\ See numbered paragraph 12 of the PCC Guide, p. 3.
\391\ Id.
\392\ See, e.g., ABA Letter; CFIRA Letter 5; Grassi; EY Letter;
U.S. Chamber of Commerce Letter.
---------------------------------------------------------------------------
The final rules do not allow Regulation Crowdfunding issuers to use
the alternatives available to non-public business entities under U.S.
GAAP in the preparation of their financial statements. One of the
significant factors considered by the FASB in developing its definition
of ``public business entity'' was the number of primary users of the
financial statements and their access to management.\393\ As the FASB
noted, ``users of private company financial statements have continuous
access to management and the ability to obtain financial information
throughout the year.'' \394\ As the number of investors increases and
their ability individually to influence management decreases, it is
important that all investors receive or have timely access to
comprehensive financial information. As a result, although commenters
generally expressed concern about the costs associated with requiring
issuers relying on Section 4(a)(6) to follow public company U.S. GAAP
accounting standards,\395\ because crowdfunding investors will likely
not have the access to management that the FASB envisions, the
Commission believes that investor protection will be enhanced by
requiring Regulation Crowdfunding issuers to provide financial
statements prepared in the same manner as other entities meeting the
FASB's definition of ``public business entity.''
---------------------------------------------------------------------------
\393\ See PCC Guide, p. 6.
\394\ Id.
\395\ See, e.g., ABA Letter; CFIRA Letter 5; Grassi; EY Letter;
U.S. Chamber of Commerce Letter.
---------------------------------------------------------------------------
Periods Covered in the Financial Statements. We are adopting
substantially as proposed the requirement that financial statements
cover the shorter of the two most recently completed fiscal years or
the
[[Page 71415]]
period since the issuer's inception.\396\ While a number of commenters
recommended only one year of financial statements,\397\ we believe that
requiring a second year will provide investors with a basis for
comparison against the most recently completed period, without
substantially increasing the costs for the issuer.
---------------------------------------------------------------------------
\396\ See Instruction 3 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\397\ See, e.g., Denlinger Letter 1; EY Letter; Fryer Letter;
Grassi Letter; Joinvestor Letter; Public Startup Letter 2; RFPIA
Letter; RocketHub Letter. But see, e.g., ASSOB Letter; Zeman Letter.
---------------------------------------------------------------------------
In addition, consistent with the proposal and with the views of
many commenters,\398\ the final rules do not require interim financial
statements. While we recognize the needs of investors for current
financial information, we are also cognizant of the anticipated costs
of obtaining interim financial statements. We believe that the required
discussion of any material changes or trends known to management in the
financial condition and results of operations of the issuer since the
period for which financial statements are provided will help provide
investors with the necessary information.\399\
---------------------------------------------------------------------------
\398\ See, e.g., CFIRA Letter 7; EMKF Letter; EY Letter; FundHub
Letter 1; Grassi Letter; Public Startup Letter 2; RocketHub Letter;
Traklight Letter; Wefunder Letter; Whitaker Chalk Letter.
\399\ See Instruction 1 to paragraph (s) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
Age of Financial Statements. We are adopting substantially as
proposed rules providing that during the first 120 days of the issuer's
fiscal year, an issuer may conduct an offering in reliance on Section
4(a)(6) using financial statements for the fiscal year prior to the
most recently completed fiscal year if the financial statements for the
most recently completed fiscal year are not otherwise available.\400\
For example, if an issuer that has a calendar fiscal year end conducts
an offering in April 2016, it would be permitted to include financial
statements for the fiscal year ended December 31, 2014 if the financial
statements for the fiscal year ended December 31, 2015 are not yet
available. Once more than 120 days have passed since the end of the
issuer's most recently completed fiscal year, the issuer would be
required to include financial statements for its most recently
completed fiscal year.\401\ Regardless of the age of the financial
statements, an issuer would be required to include in the narrative
discussion of its financial condition a discussion of any material
changes or trends known to management in the financial condition and
results of operations of the issuer during any time period subsequent
to the period for which financial statements are provided to inform
investors of more recent developments.\402\
---------------------------------------------------------------------------
\400\ See Instruction 4 to paragraph (t) of Rule 201 of
Regulation Crowdfunding. The final rule incorporates instructions
consistent with other SEC rules explaining that if the 120th day
falls on a Saturday, Sunday, or holiday, the next business day shall
be considered the 120th day.
\401\ Id.
\402\ See Rule 201(s) of Regulation Crowdfunding and Instruction
1 to paragraph (s) of Rule 201.
---------------------------------------------------------------------------
While some commenters expressed concern that this accommodation
would not provide investors with sufficiently current financial
information,\403\ we believe that this risk will be mitigated by the
requirement that the issuer include a narrative discussion of any
material changes or trends known to management in the financial
condition and results of operations during any time period subsequent
to the period for which financial statements are provided.\404\
Further, we believe this accommodation is needed because otherwise
issuers would not be able to conduct offerings for a period of time
between the end of their fiscal year and the date when the financial
statements for that period are available.
---------------------------------------------------------------------------
\403\ See, e.g., Consumer Federation Letter; Fund Democracy
Letter; Merkley Letter.
\404\ See Rule 201(s) of Regulation Crowdfunding and instruction
1 to paragraph(s) of Rule 201.
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We are not adopting the alternative proposed by one commenter to
require unaudited financial statements through the end of the month
that ends no more than two months before the month in which the
offering began.\405\ Such a requirement would require an issuer to
prepare a set of financial statements at a time when it would not
otherwise be doing so and would be a more onerous requirement than
applies to registered or Regulation A offerings.\406\
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\405\ See Fund Democracy Letter.
\406\ See Rule 3-12(a) of Regulation S-X [17 CFR 210.3-12(a)]
(requires that the latest balance sheet be as of a date no more than
134 days for non-accelerated filers (or 129 days for accelerated and
large accelerated filers) before the effective date of a
registration statement (or date a proxy statement is mailed));
Paragraph (b) of Part F/S of Form 1-A (Tier 1 and Tier 2 issuers are
required to include financial statements in Form 1-A that are dated
not more than nine months before the date of non-public submission,
filing, or qualification, with the most recent annual or interim
balance sheet not older than nine months).
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Public Accountant Requirements. In a change from proposed Rule
201(t), in response to commenters' suggestions, the final rules provide
that to qualify as independent of the issuer, a public accountant would
be required to either: (1) Comply with the Commission's independence
rules, which are set forth in Rule 2-01 of Regulation S-X,\407\ or (2)
comply with the independence standards of the AICPA.\408\ Allowing the
AICPA independence standards as an alternative to the Commission's
independence standards is consistent with the recommendations of a
number of commenters \409\ and the treatment of Tier 1 issuers under
Regulation A.\410\ We believe that providing issuers with this
flexibility is appropriate in light of the potential costs to issuers
that would otherwise be required to engage an accountant who was
independent under Rule 2-01 of Regulation S-X.
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\407\ 17 CFR 210.2-01.
\408\ See Instruction 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\409\ See, e.g., AICPA Letter; Denlinger Letter 1; EY Letter;
Grassi Letter; McGladrey Letter.
\410\ See Paragraph (b)(2) of Part F/S of Form 1-A. See also,
supra, note 371.
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Consistent with the recommendation of one commenter,\411\ in
addition to meeting the independence standards of Rule 2-01 of
Regulation S-X or the AICPA, we are requiring that a public accountant
that audits or reviews the financial statements provided by an issuer
must meet the standards for public accountants of Rule 2-01(a) of
Regulation S-X. The Commission will not recognize as a public
accountant any person who: (1) Is not duly registered and in good
standing as a certified public accountant under the laws of the place
of his residence or principal office; or (2) is not in good standing
and entitled to practice as a public accountant under the laws of the
place of his residence or principal office.\412\ We believe these
standards will promote the use of qualified accountants that are in
compliance with the requirements for their profession for the review or
audit of the financial statements with respect to all offerings,
including offerings in reliance on Section 4(a)(6).
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\411\ See AICPA Letter.
\412\ See 17 CFR 210.2-01(a).
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Consistent with the proposal and recommendations in response to our
request for comments, we are not requiring audits to be conducted by a
PCAOB-registered firm. We believe the final rules will result in a
greater number of public accountants being eligible to audit the
issuers' financial statements, which may reduce issuers' costs.
Review and Audit Standards. In line with the general support
received from commenters,\413\ we are adopting as proposed the
requirement that reviewed financial statements be reviewed in
accordance with the SSARS issued by
[[Page 71416]]
the AICPA.\414\ We also are adopting as proposed the requirement that
audited financial statements, to the extent they are otherwise
available, be audited in accordance with either the auditing standards
of the AICPA (referred to as U.S. Generally Accepted Auditing Standards
or GAAS) or the standards of the PCAOB.\415\ We expect that this
provision will provide issuers with more flexibility to file audited
financial statements that may have been prepared for other purposes.
---------------------------------------------------------------------------
\413\ See, e.g., ABA Letter; AICPA Letter; Denlinger Letter 1;
EY Letter; Fund Democracy Letter; Grassi Letter.
\414\ See Instruction 8 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\415\ See Instruction 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
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We believe that audits conducted in accordance with U.S. GAAS will
provide sufficient protection for investors in these offerings,
especially in light of the requirement that auditors must be
independent under Rule 2-01 of Regulation S-X or AICPA independence
standards. Moreover, we believe that the flexibility adopted in the
final rules is appropriately tailored for the different types of
issuers that are likely to conduct offerings under Regulation
Crowdfunding.
Because issuers under Regulation Crowdfunding are not ``issuers''
as defined by Section 2(a)(7) of the Sarbanes-Oxley Act of 2002 nor
broker-dealers registered with the Commission under Section 15(b) of
the Securities Exchange Act of 1934, AICPA rules would require the
audit to be compliant with U.S. GAAS even if the auditor has conducted
the audit in accordance with PCAOB standards. Staff of the Commission
consulted with the AICPA on this issue and has been advised that an
audit performed by its members of an issuer conducting an offering
under Regulation Crowdfunding would be required to comply with U.S.
GAAS in accordance with the AICPA's Code of Professional Conduct.\416\
As a result, an auditor for such an issuer who is conducting its audit
in accordance with PCAOB standards also will be required to comply with
U.S. GAAS, and the auditor will be required to comply with the
reporting requirements of both the AICPA standards and the PCAOB
standards. Commission staff also consulted with the AICPA on whether an
auditor can currently comply with both sets of standards when issuing
its auditor's report. In August 2015, the Auditing Standards Board of
the AICPA proposed an amendment \417\ to its auditing standards for
situations when the auditor plans to refer to the standards of the
PCAOB in addition to U.S. GAAS in the auditor's report. To comply with
the reporting requirements of both sets of standards in those
situations, the proposed amendment would require the auditor to use the
report layout and wording specified by the auditing standards of the
PCAOB, amended to indicate that the audit was also conducted in
accordance with U.S. GAAS.
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\416\ The AICPA Code of Professional Conduct is available at:
http://pub.aicpa.org/codeofconduct/ethicsresources/et-cod.pdf.
\417\ Proposed Statement on Auditing Standards, Amendment to
Statement on Auditing Standards No. 122, Statement on Auditing
Standards: Clarification and Recodification, section 700, Forming an
Opinion and Reporting on Financial Statements. The proposed
amendment would be effective for audits of financial statements for
periods ending on or after December 15, 2015.
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Review and Audit Reports. We are adopting, with changes from the
proposal, the requirement that issuers file with the Commission and
provide to investors and the relevant intermediary a signed review or
audit report on the issuer's financial statements by an independent
public accountant.\418\ The issuer must notify the public accountant of
the issuer's intended use of the report in the offering.\419\
---------------------------------------------------------------------------
\418\ See Instructions 8 and 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\419\ Id.
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We are adopting as proposed the provision that an audit report that
includes an adverse opinion or disclaimer of opinion will not be in
compliance with the audited financial statement requirements.\420\ In a
change from the proposal, as suggested by one commenter,\421\ the final
rules do not permit a qualified audit report.\422\ As noted above,
under the final rules an issuer is not required to provide audited
financial statements for first-time crowdfunding offerings of more than
$500,000 but not more than $1 million unless otherwise available. We
believe that this change reduces the cost and burden for issuers
generally of providing audited financial statements, and that an
accommodation to permit qualified audit reports is not necessary.
---------------------------------------------------------------------------
\420\ See Instruction 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\421\ See Grassi Letter.
\422\ See Instruction 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding. Accordingly, a qualified audit opinion
would not be considered an audit opinion that is ``available'' for
purposes of Rule 201(t) and 202(a).
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The final rules also provide that a review report that includes
modifications will not satisfy the requirement for reviewed financial
statements.\423\ Although two commenters expressed that a review report
with modifications should be sufficient to satisfy the reviewed
financial statement requirement,\424\ one commenter opposed permitting
modifications to review reports, noting that it considers certain
departures from U.S. GAAP to be ``unacceptable'' and that it would not
be feasible to develop a model of all allowable and disallowable
modifications.\425\ After considering the comments, we are persuaded
that permitting modifications could result in financial statements that
depart materially from U.S. GAAP, and, therefore, are not permitting
modifications to review reports under the final rules. In response to
concerns expressed by some commenters, however, we note that a review
report or audit opinion that includes explanatory language pertaining
to the entity's ability to continue as a going concern is not, under
current auditing standards, a modified report or a qualified
opinion.\426\
---------------------------------------------------------------------------
\423\ See Instruction 8 to paragraph (t) of Rule 201 of
Regulation Crowdfunding. Accordingly, a modified review report would
not be considered an audit opinion that is ``available'' for
purposes of Rule 201(t) and 202(a).
\424\ See AICPA Letter; Heritage Letter.
\425\ See Grassi Letter.
\426\ See, e.g., Public Company Accounting Oversight Board AU
sec. 508, Reports on Audited Financial Statements.
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Exemptions from Financial Statement Requirements. Consistent with
the proposal, the final rules do not exempt any issuers from the
financial statement requirements. While we appreciate the concerns
identified by commenters about the costs of the financial statement
requirements for issuers with no operating history or issuers that have
been in existence for fewer than 12 months,\427\ we believe that
financial statements are important information for all issuers and that
other changes from the proposed rules such as raising the threshold at
which audited financial statements are required will help reduce those
costs.
---------------------------------------------------------------------------
\427\ See, e.g., Arctic Island Letter 5; CFIRA Letter 5; CFIRA
Letter 7; CrowdFundConnect Letter; Crowdpassage Letter 2; EY Letter;
Grassi Letter; Hackers/Founders Letter; Joinvestor Letter; McGladrey
Letter; PBA Letter; PeoplePowerFund Letter; RocketHub Letter;
StartupValley Letter; Wefunder Letter; Whitaker Chalk Letter.
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b. Progress Updates
(1) Proposed Rules
Consistent with Securities Act Section 4A(b)(1)(F), proposed Rule
201(v) and Rule 203(a)(3) of Regulation Crowdfunding would require an
issuer to file with the Commission and provide investors and the
relevant intermediary regular updates on the issuer's progress in
meeting the target offering amount no later than five business days
after each of the dates that the issuer reaches particular intervals--
i.e., 50 percent and 100 percent--of the target offering
[[Page 71417]]
amount. If the issuer will accept proceeds in excess of the target
offering amount, the issuer also would be required to file with the
Commission and provide investors and the relevant intermediary a final
progress update, no later than five business days after the offering
deadline, disclosing the total amount of securities sold in the
offering. If, however, multiple progress updates are triggered within
the same five business-day period (e.g., the issuer reaches 50 percent
of the target offering amount on November 5, 100 percent of the target
offering amount on November 7, and the maximum amount of proceeds it
will accept in excess of the target offering amount on November 9), the
issuer could consolidate such progress updates into one Form C-U, so
long as the Form C-U discloses the most recent threshold that was met
and the Form C-U is filed with the Commission and provided to investors
and the relevant intermediary by the day on which the first progress
update would be due. The proposed rules also would require the
intermediary to make these updates available to investors through the
intermediary's platform.
(2) Comments on the Proposed Rules
Commenters were generally opposed to the progress update
requirements, noting that progress updates filed with the Commission
would be duplicative of what is available from the intermediary's Web
site and generate unnecessary costs.\428\ Based on that same rationale,
a number of commenters supported the concept of exempting issuers from
the requirement to file progress updates with the Commission so long as
the intermediary publicly displays the progress of the issuer in
meeting the target offering amount.\429\
---------------------------------------------------------------------------
\428\ See, e.g., ASSOB Letter; EarlyShares Letter; Public
Startup Letter 2; RFPIA Letter; RocketHub Letter. But see CFIRA
Letter 7.
\429\ See, e.g., Arctic Island Letter 5 (stating that
intermediaries can display both text (e.g. ``$125,000 of $500,000
raised thus far'') and graphics (e.g. a status bar graph) of the
offering progress); ASSOB Letter; PeoplePowerFund Letter; RFPIA
Letter; RocketHub Letter (noting that portals already list progress
for perks-based crowdfunding); Wefunder Letter. But see CFIRA Letter
7 (stating that the issuer should file progress updates with the
Commission on a regular basis to allow for consistency across all
issuers and intermediaries.).
---------------------------------------------------------------------------
(3) Final Rules
The final rules maintain the proposed progress update requirements,
with a significant modification. Based on concerns expressed by
commenters, the final rules permit issuers to satisfy the progress
update requirement by relying on the relevant intermediary to make
publicly available on the intermediary's platform frequent updates
about the issuer's progress toward meeting the target offering
amount.\430\ However, if the intermediary does not provide such an
update, the issuer would be required to file the interim progress
updates. In addition, as described in more detail below, an issuer
relying on the intermediary's reports of progress must still file a
Form C-U at the end of the offering to disclose the total amount of
securities sold in the offering.\431\
---------------------------------------------------------------------------
\430\ See Rules 201(v) and 203(a)(3) of Regulation Crowdfunding.
\431\ See Rule 203(a)(3)(iii) of Regulation Crowdfunding.
---------------------------------------------------------------------------
As stated in the proposal, we continue to believe that the
information available in progress updates will be important to
investors by allowing them to gauge whether interest in the offer has
increased gradually or whether it was concentrated at the beginning or
at the end of the offering period. We believe that these same benefits
can be achieved through information available on the intermediary's
platform about the progress toward the target offering amount. Whether
an issuer provides the required progress update report or relies on the
intermediary's reporting, we believe investors will benefit by being
able to stay informed during the offering of an issuer's progress.
Under the final rules, all issuers must file a Form C-U to report
the total amount of securities sold in the offering. For issuers that
are offering only up to a certain target offering amount, this
requirement will be triggered five business days from the date they
reach the target offering amount.\432\ For issuers accepting proceeds
in excess of the target offering amount, this requirement will be
triggered five days after the offering deadline.\433\ We believe that
requiring a report of the total amount of securities sold in the
offering is necessary to inform investors about the ultimate size of
the offering, especially in cases where an issuer may have sold more
than the target offering amount. Further, this requirement will result
in a central repository of this information at the Commission--
information that otherwise might no longer be available on the
intermediary's platform after the offering terminated. Finally, we note
that requiring a final report will make data available to the
Commission and the general public that could be used to evaluate the
effects of the Section 4(a)(6) exemption on capital formation.
---------------------------------------------------------------------------
\432\ See Rule 203(a)(3)(i) of Regulation Crowdfunding.
\433\ See Rule 203(a)(3)(ii) of Regulation Crowdfunding.
---------------------------------------------------------------------------
c. Amendments to the Offering Statement
(1) Proposed Rules
Proposed Rule 203(a)(2) of Regulation Crowdfunding would require
that an issuer amend its disclosure for any material change in the
offer terms or disclosure previously provided to investors. The amended
disclosure would be filed with the Commission on Form C-A: Amendment
and provided to investors and the relevant intermediary. Material
changes would require reconfirmation by investors of their investment
commitments within five business days. In addition, an issuer would be
permitted, but not required, to file amendments for changes that are
not material.
(2) Comments Received on Proposed Rules
Commenters were mixed on the proposed rules relating to amendments
to the offering statement, with those opposed citing the burden on
issuers.\434\ Some commenters recommended that the Commission specify a
filing deadline for amendments reflecting a material change,\435\ and
some recommended we require that investors be notified of the
amendment.\436\ Two commenters supported our view that the
establishment of the final price should be considered a material change
that would always require an amendment to Form C,\437\ while one
commenter opposed such an approach.\438\ One commenter recommended that
the Commission define ``material change'' in this context.\439\
---------------------------------------------------------------------------
\434\ For commenters generally in support, see, e.g., CFA
Institute Letter; CrowdCheck Letter 1 (recommending that only a
final amendment prior to the offering deadline be required, provided
there is a five day reconfirmation period between filing and the
sale of securities); EMKF Letter; Wefunder Letter.
For commenters generally opposed, see, e.g., ASSOB Letter
(suggesting a supplement could suffice in certain instances); Public
Startup Letter 2; RocketHub Letter (suggesting that not all
amendments be filed with the Commission so long as the information
was made available through the intermediary).
\435\ See, e.g., Commonwealth of Massachusetts Letter; Grassi
Letter; Hackers/Founders Letter; RocketHub Letter.
\436\ See, e.g., Arctic Island Letter 5; CFA Institute Letter;
Grassi Letter; Joinvestor Letter; RoC Letter; RocketHub Letter. But
see Public Startup Letter 2.
\437\ See Grassi Letter (recommending that reconfirmation not be
required if the initial price is established in the offering
documents and does not vary more than within a reasonable range
established in such documents); Joinvestor Letter.
\438\ See Public Startup Letter 2.
\439\ See ODS Letter.
---------------------------------------------------------------------------
(3) Final Rules
We are adopting requirements for the amendment to the offering
statement as
[[Page 71418]]
proposed. The final rules require that an issuer amend its disclosure
for any material change in the offer terms or disclosure previously
provided to investors.\440\ While we recognize commenters' concerns
about the costs that requiring one or more additional filings may
impose on issuers, we note that an amendment will be required only in
instances in which there was a material change. In such circumstances,
we believe the additional efforts required of an issuer to file an
amendment will be justified in order to provide investors with the
information they need to make an informed investment decision.
---------------------------------------------------------------------------
\440\ See Rule 203(a)(2) of Regulation Crowdfunding. See also
Section II.C.6 for discussion of the requirement that investors
reconfirm their investment commitments following a material change.
---------------------------------------------------------------------------
The amended disclosure must be filed with the Commission on Form C
and provided to investors and the relevant intermediary. Under the
final rules, the issuer is required to check the box for ``Form C/A:
Amendment'' on the cover of the Form C and explain, in summary manner,
the nature of the changes, additions or updates in the space
provided.\441\
---------------------------------------------------------------------------
\441\ See Form C.
---------------------------------------------------------------------------
With respect to what constitutes a ``material change,'' as we
stated in the Proposing Release, information is material if there is a
substantial likelihood that a reasonable investor would consider it
important in deciding whether or not to purchase the securities.\442\
For example, we believe that a material change in the financial
condition or the intended use of proceeds requires an amendment to an
issuer's disclosure. Also, in those instances in which an issuer has
previously disclosed only the method for determining the price, and not
the final price, of the securities offered, we believe that
determination of the final price is a material change to the terms of
the offer and must be disclosed. These are not, however, the only
possible material changes that require amended disclosure. We are not
providing additional guidance on what constitutes a ``material
change,'' as requested by one commenter,\443\ because, consistent with
our historical approach to materiality determinations, we believe that
an issuer should determine whether changes in the offer terms or
disclosure are material based on the facts and circumstances.
---------------------------------------------------------------------------
\442\ See Basic Inc. v. Levinson, 485 U.S. 224 (1988) (quoting
TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976)).
\443\ See ODS Letter.
---------------------------------------------------------------------------
In addition, as discussed further in Section II.C.6 below, if any
change, addition or update constitutes a material change to information
previously disclosed, the issuer must check the box on the cover of
Form C indicating that investors must reconfirm their investment
commitments.
A number of commenters recommended that we specify a filing
deadline for amendments reflecting a material change,\444\ and that we
require investors be notified in some manner of the amendment.\445\ We
are not, however, amending the requirement as suggested by those
commenters. We appreciate the need for investors to know this
information in a timely fashion, but we believe that with the
requirement that investors reconfirm their commitments, it will be in
an issuer's interest to file an amendment as soon as practicable and to
notify investors so that it will be in a position to close the
offering. Therefore, we do not believe further procedural requirements
are necessary.
---------------------------------------------------------------------------
\444\ See, e.g., Commonwealth of Massachusetts Letter; Grassi
Letter; Hackers/Founders Letter; RocketHub Letter.
\445\ See, e.g., Arctic Island Letter 5; CFA Institute Letter;
Grassi Letter; Joinvestor Letter; RoC Letter; RocketHub Letter. But
see Public Startup Letter 2.
---------------------------------------------------------------------------
Issuers will be permitted, but not required, to amend the Form C to
provide information with respect to other changes that are made to the
information presented on the intermediary's platform and provided to
investors.\446\ If an issuer amends the Form C to provide such
information, it is not required to check the box indicating that
investors must reconfirm their investment commitments.
---------------------------------------------------------------------------
\446\ See Instruction to paragraph (a)(2) of Rule 203 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
2. Ongoing Reporting Requirements
a. Proposed Rules
Securities Act Section 4A(b)(4) requires, ``not less than annually,
[the issuer to] file with the Commission and provide to investors
reports of the results of operations and financial statements of the
issuer, as the Commission shall, by rule, determine appropriate,
subject to such exceptions and termination dates as the Commission may
establish, by rule.''
To implement the ongoing reporting requirement in Section 4A(b)(4),
we proposed in Rules 202 and 203 of Regulation Crowdfunding to require
an issuer that sold securities in reliance on Section 4(a)(6) to file a
report annually, no later than 120 days after the end of the most
recently completed fiscal year covered by the report. To implement the
requirement that issuers provide the report to investors, we proposed
in Rule 202(a) to require issuers to post the annual report on their
Web sites. Under proposed Rule 202(a), the issuer would be required to
disclose information similar to that required in the offering
statement, including disclosure about its financial condition that
meets the highest financial statement requirements that were applicable
to its offering statement.
We also proposed in Rule 202(b) to require issuers to file the
annual report until one of the following events occurs: (1) The issuer
becomes a reporting company required to file reports under Exchange Act
Sections 13(a) or 15(d); (2) the issuer or another party purchases or
repurchases all of the securities issued pursuant to Section 4(a)(6),
including any payment in full of debt securities or any complete
redemption of redeemable securities; or (3) the issuer liquidates or
dissolves in accordance with state law.
b. Comments on the Proposed Rules
Commenters expressed a range of views on the proposed ongoing
reporting requirements.\447\
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\447\ For commenters generally supporting the proposed ongoing
reporting requirements, see, e.g., CfPA Letter; Commonwealth of
Massachusetts Letter; Grassi Letter; Jacobson Letter; Leverage PR
Letter; StartEngine Letter 1.
For commenters generally opposing the proposed ongoing reporting
requirements, see, e.g., ABA Letter; Campbell R. Letter; EMKF
Letter; Guzik Letter 1; NFIB Letter; Public Startup Letter 2;
RocketHub Letter; SeedInvest Letter 1; Stephenson, et al. Letter.;
Traklight Letter; WealthForge Letter; Winters Letter.
---------------------------------------------------------------------------
Frequency. With respect to frequency, a number of commenters
supported the proposed requirement of annual reporting,\448\ while a
few recommended quarterly reporting.\449\ Some commenters supported
requiring issuers to file reports to disclose the occurrence of
material events on an ongoing basis,\450\ and several recommended that
the Commission provide a list of events that would trigger such
disclosure.\451\
[[Page 71419]]
Two other commenters opposed such a requirement.\452\
---------------------------------------------------------------------------
\448\ See, e.g., AICPA Letter; CFIRA Letter 7; EY Letter; Grassi
Letter; RoC Letter; RocketHub Letter; Traklight Letter.
\449\ See, e.g., ASSOB Letter; CCI Letter; Denlinger Letter 1
(recommending quarterly reporting to provide investors and the
secondary market timely information).
\450\ See, e.g., ABA Letter (recommending amending Form C-AR
within 15 calendar days of the material event); Angel Letter 1
(recommending prompt disclosure through postings on the issuer's Web
site or social media); Denlinger Letter 1; EY Letter (recommending
disclosure within 30 days of the end of the month in which the
material event occurred, with such disclosure scaled for different
tiers of issuers); Hackers/Founders Letter (recommending quarterly
updates); RocketHub Letter (recommending quarterly updates).
\451\ See, e.g., Denlinger Letter 1; EY Letter; Grassi Letter;
RocketHub Letter.
\452\ See Heritage Letter; Public Startup Letter 2.
---------------------------------------------------------------------------
Provision of Reports. Generally, commenters supported requiring
issuers to post the annual report on their Web sites,\453\ although
some commenters favored a more limited distribution.\454\ Similarly, a
number of commenters supported requiring issuers to file the annual
report on EDGAR,\455\ while two commenters opposed such
requirement.\456\ In addition, most commenters opposed requiring
physical delivery of the report directly to investors,\457\ although
some commenters supported requiring direct delivery in some form\458\
or directly notifying investors of the availability of the annual
report.\459\
---------------------------------------------------------------------------
\453\ See, e.g., ABA Letter; Angel Letter 1; CFA Institute
Letter; Commonwealth of Massachusetts Letter; Grassi Letter;
Jacobson Letter; Joinvestor Letter; RFPIA Letter; Traklight Letter.
\454\ See, e.g., Crowdpassage Letter 3 (opposing the public
availability of ongoing financial statements and recommending they
be distributed through a password protected Web site accessible to
investors); Frutkin Letter (recommending the annual report be
provided to investors via email, on a password-protected Web site
accessible to investors or by mailing the report first-class to
investors); Public Startup Letter 2.
\455\ See, e.g., Commonwealth of Massachusetts Letter; Frutkin
Letter; Grassi Letter; RocketHub Letter; Traklight Letter.
\456\ See Crowdpassage Letter 3 (opposing public availability of
ongoing financial statements); Public Startup Letter 2.
\457\ See, e.g., CFIRA Letter 7; CFIRA Letter 8; CfPA Letter;
Crowdpassage Letter 3; Grassi Letter; Jacobson Letter; Public
Startup Letter 2; Traklight Letter.
\458\ See, e.g., Arctic Island Letter 5; CCI Letter; RocketHub
Letter.
\459\ See, e.g., Arctic Island Letter 5; CFA Institute Letter
(recommending advance notice as to when and where annual reports
will be available); RocketHub Letter.
---------------------------------------------------------------------------
Financial Statements. Commenters expressed differing views about
the proposed ongoing financial statements requirements, particularly
the level of public accountant involvement required. While a few
supported requiring certain issuers to provide audited or reviewed
financial statements on an ongoing basis,\460\ a substantial number
opposed an ongoing audit or review requirement.\461\ Further, a number
of commenters recommended that if ongoing financial statements are to
be required for some issuers, the level of review be based on a higher
offering amount threshold than the threshold used to determine the
level of involvement of the accountant in the offering.\462\
---------------------------------------------------------------------------
\460\ See, e.g., ABA Letter; Denlinger Letter 1; Grassi Letter.
\461\ See, e.g., AEO Letter; Arctic Island Letter 5; AWBC
Letter; CrowdCheck Letter 4; EarlyShares Letter; EMKF Letter;
Frutkin Letter; Graves Letter; Guzik Letter 1; iCrowd Letter;
McGladrey Letter; Milken Institute Letter; NFIB Letter; PBA Letter;
Peers Letter; RocketHub Letter; SeedInvest Letter 1; Seyfarth
Letter; StartupValley Letter; Stephenson, et al. Letter; Traklight
Letter; WealthForge Letter.
\462\ See, e.g., Arctic Island Letter 5; CrowdCheck Letter 4;
EarlyShares Letter; EY Letter; Grassi Letter; Graves Letter; iCrowd
Letter; Milken Institute Letter; PBA Letter; Seyfarth Letter;
Traklight Letter.
---------------------------------------------------------------------------
Other Content. A number of commenters recommended that the ongoing
annual reports require a more limited set of disclosure than the
information required in the offering statement.\463\
---------------------------------------------------------------------------
\463\ See, e.g., EarlyShares Letter; EMKF Letter; McGladrey
Letter; Milken Institute Letter; PBA Letter; RocketHub Letter.
---------------------------------------------------------------------------
Exceptions/Termination of Ongoing Reporting Requirement. A number
of commenters recommended that there be exceptions to the ongoing
reporting requirements for certain issuers,\464\ expressing concern
that the ongoing reporting obligations were too costly and could
potentially extend indefinitely.\465\ Others were opposed to such
exceptions.\466\
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\464\ See, e.g., Heritage Letter (issuers raising $100,000 or
less); RocketHub Letter (issuers raising $250,000 or less, although
recommending that intermediaries be permitted to require ongoing
reports on their platform even if exempted by the Commission);
SeedInvest Letter 1 (recommending excepting issuers from ongoing
reporting when: (1) Raising less than $350,000; (2) securities are
structured such that there can be no investment decisions; (3) an
institutional investor, venture capitalist, or angel investor is
leading the deal for investors; or (4) all investors have
contractually waived the right to receive ongoing reports with
informed consent); SeedInvest Letter 4. See also form letters
designated as Type A (supporting SeedInvest Letter 1).
\465\ See SeedInvest Letter 1 (noting that the ongoing reporting
obligations were an ``obstacle to making crowdfunding a viable
option for startups and small businesses'' as the cost structure
would be ``out of proportion with the amounts proposed to be
raised.'')
\466\ See, e.g., Commonwealth of Massachusetts Letter; Denlinger
Letter 1; Grassi Letter; Public Startup Letter 2.
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We also received a range of comments about when the ongoing
reporting requirements should terminate, with two supporting requiring
issuers to file an annual report until one of the enumerated events
occurs,\467\ and others suggesting alternatives to such
requirement.\468\
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\467\ See, e.g., Grassi Letter; Whitaker Chalk Letter.
\468\ See, e.g., ABA Letter; EY Letter (recommending the ongoing
reporting obligations terminate after a certain amount of time if
the issuer has 300 or fewer security holders); Grassi Letter; PBA
Letter (recommending the reporting obligations terminate after three
consecutive annual reports or after an issuer repurchases two-thirds
of the outstanding securities issued in reliance on Section 4(a)(6),
so long as the issuer made a bona fide offer to repurchase all of
such securities); Public Startup Letter 2; RocketHub Letter
(recommending the reporting obligations terminate after three annual
reports).
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Some commenters recommended that the ongoing reporting requirements
be a condition to the Section 4(a)(6) exemption \469\ while several
others generally opposed such concept.\470\
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\469\ See, e.g., Parsont Letter (with a notice and cure
provision); RocketHub Letter (recommending the ongoing reporting
requirements be a condition for a minimum of three years).
\470\ See, e.g., Public Startup Letter 2; Wefunder Letter;
Whitaker Chalk Letter (recommending that (i) a condition, if any,
apply only to the first annual report; (ii) that the failure to file
the annual report restrict an issuer's ability to raise capital in
the future; or (iii) issuers, certain officers, directors and
shareholders have the option to escrow their shares for up to 24
months, with certain penalties for failure to file the annual
report).
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c. Final Rules
After considering the comments received, we are adopting the
ongoing reporting requirements generally as proposed, with a
substantial modification to the level of public accountant involvement
required and another modification to provide for termination of the
ongoing reporting obligation in two additional circumstances.
Frequency. The final rules require an issuer that sold securities
in reliance on Section 4(a)(6) to file an annual report with the
Commission, no later than 120 days after the end of the fiscal year
covered by the report.\471\ We believe that this ongoing reporting
requirement should benefit investors by enabling them to consider
updated information about the issuer, thereby allowing them to make
more informed investment decisions.
---------------------------------------------------------------------------
\471\ See Rule 202(a) of Regulation Crowdfunding.
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We recognize the view of some commenters \472\ that there may be
major events that occur between annual reports about which investors
would want to be updated, and we note that some commenters also
recommended quarterly reporting.\473\ However, we agree with those
commenters \474\ who said an annual requirement is sufficient. We
believe a more frequent filing requirement would require an allocation
of resources to the reporting function of Regulation Crowdfunding
issuers that we do not believe is justified in light of the smaller
amounts that will be raised pursuant to the exemption. We note that
under Tier 1 of Regulation A, issuers can raise significantly more
money--up to $20 million--without any ongoing reporting requirement
other than to file a Form 1-Z exit report upon completion or
termination of the offering. While not required, nothing in the rules
prevents an issuer from updating investors when
[[Page 71420]]
major events occur. Nor do our rules prevent intermediaries from
requiring more frequent reporting. However, we do not believe that it
is necessary in the final rules to require reporting on a more frequent
basis than the annual ongoing reporting directly contemplated by the
statute.
---------------------------------------------------------------------------
\472\ See, e.g., ABA Letter; Angel Letter 1; Denlinger Letter 1;
EY Letter; Grassi Letter; Hackers/Founders Letter; RocketHub Letter.
\473\ See, e.g., ASSOB Letter; CCI Letter; Denlinger Letter 1.
\474\ See, e.g., AICPA Letter; CFIRA Letter 7; EY Letter; Grassi
Letter; RoC Letter; RocketHub Letter; Traklight Letter.
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Provision of Reports. We also are adopting as proposed the
requirement that an issuer post the annual report on its Web site.\475\
Consistent with the proposal, the final rules do not require delivery
of a physical copy of the annual report. As discussed in the Proposing
Release and as supported by a number of commenters, we believe that
investors in this type of Internet-based offering will be familiar with
obtaining information on the Internet and that providing information in
this manner will be cost efficient. While some commenters \476\
suggested that limiting distribution of the annual report to investors
through use of a password-protected Web site would help protect an
issuer's commercially-sensitive information, we believe such a
requirement would add complexity for issuers and investors without
providing significant protection of commercially-sensitive information
since the reports could still be accessed by the public on EDGAR.
---------------------------------------------------------------------------
\475\ See Rule 202(a) of Regulation Crowdfunding.
\476\ See, e.g., Crowdpassage Letter 3; Frutkin Letter.
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Consistent with the proposal, the final rule does not require an
issuer to provide direct notification via email or otherwise of the
posting of the report, as was suggested by some commenters.\477\ As
discussed above in Section II.B.1.a.(i)(g), however, we are revising
the final rules to require an issuer to disclose in the offering
statement where on the issuer's Web site investors will be able to find
the issuer's annual report and the date by which the annual report will
be available on the issuer's Web site.\478\ We believe these changes
will help investors to locate the annual report. As discussed in the
Proposing Release, we believe that many issuers may not have email
addresses for investors, especially after the shares issued pursuant to
Section 4(a)(6) are traded by the original purchasers. Nonetheless, to
the extent email addresses for investors are available, an issuer could
refer investors to the posted report via email.
---------------------------------------------------------------------------
\477\ See, e.g., Arctic Island Letter 5 (intermediary should
notify); Frutkin Letter; RocketHub Letter.
\478\ See Rule 201(w) of Regulation Crowdfunding.
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Financial Statements. After considering the comments, we are
persuaded by the commenters that opposed requiring that an audit or
review of the financial statements be included in the annual
report.\479\ Therefore, instead of requiring financial statements in
the annual report that meet the highest standard previously provided,
the final rules require financial statements of the issuer certified by
the principal executive officer of the issuer to be true and complete
in all material respects.\480\ However, issuers that have available
financial statements that have been reviewed or audited by an
independent certified public accountant because they prepare them for
other purposes must provide them and will not be required to have the
principal executive officer certification.\481\
---------------------------------------------------------------------------
\479\ See, e.g., AEO Letter; Arctic Island Letter 5; AWBC
Letter; CrowdCheck Letter 4 (``ongoing audit requirement will create
an unpredictable on-going burden''); EarlyShares Letter; EMKF Letter
(``audited financial statements, particularly for ongoing reporting
requirements, are so cost-prohibitive for startups that they make
absolutely no sense as an appropriate use of funds.''); Frutkin
Letter; Graves Letter; Guzik Letter 1; iCrowd Letter; McGladrey
Letter; Milken Institute Letter; NFIB Letter; PBA Letter; Peers
Letter; RocketHub Letter; SeedInvest Letter 1; Seyfarth Letter;
StartupValley Letter; Stephenson, et al. Letter; Traklight Letter;
WealthForge Letter.
\480\ See Rule 202(a) of Regulation Crowdfunding.
\481\ Id.
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Many commenters expressed concerns with the costs associated with
preparing reviewed and audited financial statements on an ongoing
basis. Commenters also noted the absence of comparable ongoing
reporting requirements under Tier 1 of Regulation A and other offering
exemptions.\482\ While we recognize that Regulation Crowdfunding is
different in many respects from Regulation A, we believe that
crowdfunding issuers should not have more onerous ongoing reporting
compliance costs than issuers that use another public offering
exemption that permits higher maximum offering amounts. The changes to
the ongoing reporting requirements in the rules we are adopting today
will alleviate some of the costs on crowdfunding issuers. At the same
time, we also believe, consistent with the views of at least one
commenter,\483\ that investors still will be provided with sufficient
ongoing financial information about the issuer under the final rules.
---------------------------------------------------------------------------
\482\ See, e.g., CrowdCheck Letter 4; EMKF Letter; EY Letter.
\483\ See CrowdCheck Letter 4 (``While the on-going audit
requirement is designed to provide investors and potential secondary
purchasers of the company's securities with updated information
about the company, it is unnecessary given the other, less
burdensome, on-going disclosure requirements contained in the
statute and proposed regulation.'').
---------------------------------------------------------------------------
Other Content. With the exception of the financial statement
requirement described above, the final rule adopts as proposed the
requirement that the annual report include the information required in
the offering statement. Although an issuer will not be required to
provide the offering-specific information that it filed at the time of
the offering (because the issuer will not be offering or selling
securities),\484\ it will be required to disclose information about the
company and its financial condition, as required in connection with the
offer and sale of the securities.\485\ While we appreciate the
recommendations of commenters for a more limited set of disclosure in
the annual report, we believe that the disclosure costs of ongoing
reporting for issuers will be less than in the initial offering
statement, because they will be able to use the offering materials as a
basis to prepare the annual reports. We believe investors will benefit
from the availability of annual updates to the information they
received when making the decision to invest in the issuer's securities,
since these updates will allow them to be informed about issuer
developments as they decide whether to continue to hold or sell, or how
to vote, the securities. Under the statute and the final rules, the
securities will be freely tradable after one year. Therefore, this
information also will benefit potential future holders of the issuer's
securities and help them to make more informed investment decisions.
---------------------------------------------------------------------------
\484\ See Rule 202(a) of Regulation Crowdfunding. An issuer will
not be required to provide information about: (1) The stated purpose
and intended use of the proceeds of the offering; (2) the target
offering amount and the deadline to reach the target offering
amount; (3) whether the issuer will accept investments in excess of
the target offering amount; (4) whether, in the event that the offer
is oversubscribed, shares will be allocated on a pro-rata basis,
first come-first served basis, or other basis; (5) the process to
complete the transaction or cancel an investment commitment once the
target amount is met; (6) the price to the public of the securities
being offered; (7) the terms of the securities being offered; (8)
the name, SEC file number and CRD number (as applicable) of the
intermediary through which the offering is being conducted; and (9)
the amount of compensation paid to the intermediary.
\485\ See Rule 202(a) of Regulation Crowdfunding. Issuers will
be required to provide disclosure about its directors and officers,
business, current number of employees, financial condition
(including financial statements), capital structure, significant
factors that make an investment in the issuer speculative or risky,
material indebtedness and certain related-party transactions.
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Exceptions/Termination of Ongoing Reporting Requirement. After
considering the comments, we are providing for termination of the
ongoing reporting obligation in the three
[[Page 71421]]
circumstances that we proposed as well as the following two additional
circumstances: (1) When the issuer has filed at least one annual report
and has fewer than 300 holders of record; and (2) when the issuer has
filed at least three annual reports and has total assets that do not
exceed $10 million. Accordingly, under Rule 202(b), issuers will be
required to file the annual report until the earliest of the following
events occurs:
(1) The issuer is required to file reports under Exchange Act
Sections 13(a) or 15(d);
(2) the issuer has filed at least one annual report and has fewer
than 300 holders of record;
(3) the issuer has filed at least three annual reports and has
total assets that do not exceed $10 million;
(4) the issuer or another party purchases or repurchases all of the
securities issued pursuant to Section 4(a)(6), including any payment in
full of debt securities or any complete redemption of redeemable
securities; or
(5) the issuer liquidates or dissolves in accordance with state
law.
We believe the addition of the two termination events, which are
generally consistent with the suggestions of commenters,\486\ should
help alleviate commenters' concerns about related costs for certain
issuers that may not have achieved a level of financial success that
would sustain an ongoing reporting obligation. The 300 shareholder
threshold reflected in Rule 202(b)(2) is consistent with the threshold
used to determine whether an Exchange Act reporting company is eligible
to suspend its Section 15(d) \487\ or terminate its Section 13 \488\
reporting obligations. The option for an issuer to conclude ongoing
reporting after three annual reports as reflected in Rule 202(b)(3)
should help address concerns raised by some commenters that the
reporting obligation could potentially extend indefinitely, while still
requiring larger issuers with more than $10 million in total assets to
continue reporting. We chose the $10 million threshold in order to be
consistent with the total asset threshold in Section 12(g)(1) of the
Exchange Act.\489\ Under that provision, a company that has total
assets exceeding $10 million and a class of securities held of record
by a certain number of persons must register that class of securities
with the Commission.
---------------------------------------------------------------------------
\486\ See, e.g., ABA Letter; EY Letter (recommending the
reporting obligations terminate after a certain amount of time if
the issuer has 300 or fewer security holders); PBA Letter; RocketHub
Letter (recommending the reporting obligations terminate after three
consecutive annual reports).
\487\ See 17 CFR 240.12h-3.
\488\ 15 U.S.C. 78m.
\489\ 15 U.S.C. 78l(g)(1).
---------------------------------------------------------------------------
As proposed, Rule 203(b)(3) provides that any issuer terminating
its annual reporting obligations will be required to file with the
Commission, within five business days from the date on which the issuer
becomes eligible to terminate its reporting obligation, a notice that
it will no longer file and provide annual reports pursuant to the
requirements of Regulation Crowdfunding. The issuer also must check the
box for ``Form C-TR: Termination of Reporting'' on the cover of Form
C.\490\
---------------------------------------------------------------------------
\490\ See cover page of Form C.
---------------------------------------------------------------------------
We are not persuaded by the suggestion of one commenter \491\ that
ongoing reports should be a condition to the Section 4(a)(6) exemption.
As two commenters noted at the pre-proposal stage, under such an
approach, compliance with the exemption would not be known at the time
of the transaction.\492\ This, in turn, would create substantial
uncertainty for issuers because there would be an indefinite
possibility of a potential future violation of the exemption. We have
modified the final rules from the proposal to clarify that the
availability of the crowdfunding exemption is not conditioned on
compliance with the annual reporting, progress update or termination of
reporting obligations.\493\ Nevertheless, issuers offering and selling
securities in reliance on Section 4(a)(6) remain obligated to comply
with these reporting requirements. Moreover, as discussed in Section
II.A.4 above, the final rules deny issuers the benefit of relying on
the exemption under Section 4(a)(6) for future offerings until they
file, to the extent required, the two most recently required annual
reports.\494\ In addition, the final rules require the issuer to
disclose in its offering statement and annual report if it, or any of
its predecessors, previously failed to comply with the ongoing
reporting requirements of Regulation Crowdfunding.
---------------------------------------------------------------------------
\491\ See Parsont Letter.
\492\ See Letter from Andrea L. Seidt, Comm'r, Ohio Div. of Sec.
available at http://www.sec.gov/comments/jobs-title-iii/jobstitleiii-199.pdf; Letter from John R. Fahy, Partner, Whitaker
Chalk Swindle Schwartz, available at http://www.sec.gov/comments/jobs-title-iii/jobstitleiii-175.htm.
\493\ See Rule 100(b)(4) of Regulation Crowdfunding.
\494\ See Rule 100(b)(5) of Regulation Crowdfunding.
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3. Form C and Filing Requirements
a. Proposed Rules
Securities Act Section 4A(b)(1) requires issuers who offer or sell
securities in reliance on Section 4(a)(6) to ``file with the Commission
and provide to investors and the relevant broker or funding portal, and
make available to potential investors'' certain disclosures. The
statute does not specify a format that issuers must use to present the
required disclosures and file these disclosures with the Commission. We
proposed in Rule 203 of Regulation Crowdfunding to require issuers to
file the mandated disclosure using new Form C, which would require
certain disclosures to be presented in a specified format, while
allowing the issuer to customize the presentation of other disclosures
required by Section 4A(b)(1) and the related rules.
We proposed to require issuers to use an XML-based fillable form to
input certain information. Information not required to be provided in
text boxes in the XML-based fillable form would be filed as attachments
to Form C.
Under the proposed rules, Form C would be used for all of an
issuer's filings with the Commission related to the offering made in
reliance on Section 4(a)(6). The issuer would check one of the
following boxes on the cover of the Form C to indicate the purpose of
the Form C filing:
``Form C: Offering Statement'' for issuers filing the
initial disclosures required for an offering made in reliance on
Section 4(a)(6);
``Form C-A: Amendment'' for issuers seeking to amend a
previously-filed Form C for an offering;
``Form C-U: Progress Update'' for issuers filing a
progress update required by Section 4A(b)(1)(H) and the related rules;
``Form C-AR: Annual Report'' for issuers filing the annual
report required by Section 4A(b)(4) and the related rules; and
``Form C-TR: Termination of Reporting'' for issuers
terminating their reporting obligations pursuant to Section 4A(b)(4)
and the related rules.
EDGAR would automatically provide each filing with an appropriate
tag depending on which box the issuer checks so that investors could
distinguish among the different filings.\495\
---------------------------------------------------------------------------
\495\ EDGAR would tag the offering statement as ``Form C,'' any
amendments to the offering statement as ``Form C-A,'' progress
updates as ``Form C-U,'' annual reports as ``Form C-AR'' and
termination reports as ``Form C-TR.''
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Section 4A(b)(1) requires issuers to file the offering information
with the Commission, provide it to investors and the relevant
intermediary and make it available to potential investors.\496\
[[Page 71422]]
Under the proposed rules, issuers would satisfy the requirement to file
the information with the Commission by filing the Form C: Offering
Statement, including any amendments and progress updates, on EDGAR. To
satisfy the requirement to provide the disclosures to the relevant
intermediary, we proposed that issuers provide to the relevant
intermediary a copy of the disclosures filed with the Commission. To
satisfy the requirement to provide the disclosures, or make them
available, as applicable, to investors, we proposed that issuers
provide the information to investors electronically by referring
investors, such as through a posting on the issuer's Web site or by
email, to the information on the intermediary's platform. The proposed
rules would not require issuers to provide physical copies of the
information to investors.
---------------------------------------------------------------------------
\496\ Section 4A(b)(4) requires issuers to file with the
Commission and provide to investors, not less than annually, reports
of the results of operations and financial statements of the issuer.
As discussed above in Section II.B.2, to satisfy this requirement,
the rules require an issuer to post the annual report on its Web
site and file it with the Commission.
---------------------------------------------------------------------------
b. Comments on the Proposed Rules
Commenters generally supported the proposed Form C
requirement.\497\ Two commenters supported the proposal to use one form
with different EDGAR tags for each type of filing,\498\ while another
commenter recommended creating multiple forms in order to minimize the
length of the form.\499\ Two commenters recommended that the Commission
modify Form C and its variants to require an issuer to indicate the
jurisdictions in which the securities will be or are sold, with one of
those commenters recommending ongoing disclosure of the amount sold in
each state.\500\
---------------------------------------------------------------------------
\497\ See, e.g., Angel Letter 1 (specifically supporting the XML
requirements); CFIRA Letter 7; Consumer Federation Letter; Grassi
Letter; Hackers/Founders Letter; Traklight Letter; RocketHub Letter.
\498\ See Grassi Letter; RocketHub Letter.
\499\ See CFIRA Letter 7.
\500\ See, Commonwealth of Massachusetts Letter (recommending
Form C require an issuer to check boxes indicating the jurisdictions
in which securities will be sold); NASAA Letter (recommending Form
C-U (offering update form) and Form C-AR (annual report form)
require disclosure of the states where interests in the offering
have been sold and the amount sold in each state).
---------------------------------------------------------------------------
Commenters were divided on the EDGAR filing requirement. Some
commenters supported the filing requirement, with a few of those
specifically supporting the proposal that issuers file the Form C in
electronic format only.\501\ Some commenters generally opposed the
filing requirements or opposed specific aspects of the
requirements.\502\
---------------------------------------------------------------------------
\501\ For commenters supporting the EDGAR filings requirement
generally, see, e.g., CFIRA Letter 7; Traklight Letter. For those
specifically supporting the electronic filing proposal, see, e.g.,
Arctic Island Letter 5; CFIRA Letter 7; RocketHub Letter; Wilson
Letter.
\502\ See, e.g., Angel Letter 1; CFIRA Letter 1; CrowdCheck
Letter 1; Mollick Letter; Public Startup Letter 2; RocketHub Letter;
WealthForge Letter (recommending that the Commission require the
filing of a Form C within 15 days of the offering first receiving an
investment and at the completion of the offering).
---------------------------------------------------------------------------
A few commenters requested clarification whether all offering
material made available on the intermediary's platform must be filed on
Form C.\503\ Two commenters recommended that not all materials be
required to be filed as exhibits.\504\ A number of commenters noted
that issuers would likely use various types of media for their
offerings, some of which cannot be filed on EDGAR.\505\ A number of
commenters recommended that the Commission adopt other disclosure
formats, such as a question-and-answer format.\506\
---------------------------------------------------------------------------
\503\ See, e.g., CrowdCheck Letter 1; Grassi Letter; Stephenson
Letter.
\504\ See, e.g., CFIRA Letter 1 (recommending that only ``those
documents most suited to police against fraud'' be filed with the
Commission because the intermediary serves as the primary repository
of the offering materials); CrowdCheck Letter 1 (recommending the
Commission permit issuers to use ``free writing'' disclosure
materials in certain circumstances without having to file them with
the Commission).
\505\ See, e.g., CFIRA Letter 6; CFIRA Letter 7; CrowdCheck
Letter 1; Grassi Letter; Hackers/Founders Letter; RocketHub Letter;
Wefunder Letter; Wilson Letter.
\506\ See, e.g., Guzik Letter 1; Guzik Letter 2; Guzik Letter 3
(encouraging the Commission to provide an optional simplified
disclosure format, perhaps in a question and answer format);
Hackers/Founders Letter (encouraging the Commission to require a
standard format and to allow issuers to provide additional
information); Hamilton Letter (suggesting the Commission provide
prototypes of Form C and sample disclosures); RocketHub (seeking a
simple, standardized general form other than U-7 or A-1 to provide
legal certainty); Saunders Letter (proposing that Form C be
completed by selecting from a database of stock responses); SBA
Office of Advocacy Letter (describing recommendations from its
roundtable attendees to adopt a simple question and answer format
similar to that previously used in Regulation A or to provide
``standard boilerplate disclosures for some of the more complicated
nonfinancial disclosures, such as risk factors,'' that are not
required by the JOBS Act).
We also received several comments prior to the Proposing Release
on whether the Commission should require a specific format for the
required disclosure. Several commenters recommended that the
Commission require the disclosure on a form modeled after, or
require the use of NASAA's Small Company Offering Registration Form
(U-7). See, e.g., Coan Letter; Liles Letter 1; Vim Funding Letter;
NASAA Letter. One commenter suggested modeling the required
disclosure format after then-current Form 1-A, which is used for
securities offerings made pursuant to Regulation A, but which has
since been modified as a result of recently adopted amendments to
Regulation A. See 17 CFR 230.251 et seq.; Amendments to Regulation
A, Release No. 33-9741 (March 25, 2015) [80 FR 21805 (April 20,
2015)] Regulation A Adopting Release''); Commonwealth of
Massachusetts Letter.
---------------------------------------------------------------------------
A number of commenters generally supported the proposal to refer
investors to information on the intermediary's platform.\507\ With
respect to the proposed methods (Web site posting or email), one
commenter stated that issuers would not have investors' email
addresses,\508\ and another commenter noted that maintaining investors'
email addresses would require significant resources.\509\
---------------------------------------------------------------------------
\507\ See, e.g., Grassi Letter; Joinvestor Letter;
PeoplePowerFund Letter; Public Startup Letter 2; Wefunder Letter;
Wilson Letter.
\508\ See Wefunder Letter.
\509\ See Grassi Letter.
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c. Final Rules
We are adopting Form C and the related filing requirements \510\
with a few modifications from the proposed rules.\511\
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\510\ An issuer that does not already have EDGAR filing codes,
and to which the Commission has not previously assigned a user
identification number, which we call a ``Central Index Key (CIK)''
code, will need to obtain the codes by filing electronically a Form
ID [17 CFR 239.63; 249.446; 269.7 and 274.402] at https://www.filermanagement.edgarfiling.sec.gov. The applicant also will be
required to submit a notarized authenticating document as a Portable
Document Format (PDF) attachment to the electronic filing. The
authenticating document will need to be manually signed by the
applicant over the applicant's typed signature, to include the
information contained in the Form ID and to confirm the authenticity
of the Form ID. See 17 CFR 232.10(b)(2).
\511\ See Rule 203 of Regulation Crowdfunding. We have made some
technical changes in the final rules that do not affect their
substantive requirements. To maintain consistency with other
Commission rules and to keep electronic filing requirements
consolidated in Regulation S-T, we have deleted from proposed Rules
201, 202 and 203 the phrase ``on EDGAR'' where it appeared after
``file with the Commission.'' We also have deleted the instruction
to proposed Rule 203(a)(1) as the list of information set forth in
that instruction was duplicative of the XML-based portion of Form C
itself.
---------------------------------------------------------------------------
First, the final rules will amend Regulation S-T to permit an
issuer to submit exhibits to Form C in Portable Document Format
(``PDF'') as official filings.\512\ We appreciate the views of
commenters that issuers would likely use various types of media for
their offerings,\513\ and believe that permitting these materials to be
filed in PDF format will allow for more diverse presentations of
information to be reasonably available to investors through a
standardized, commonly available media. Under the final rules, issuers
may customize the presentation
[[Page 71423]]
of their non-XML disclosures and file those disclosures as exhibits to
the Form C. For example, an issuer may provide the required disclosures
by uploading to EDGAR, as an exhibit to Form C, a PDF version of the
relevant information presented on the intermediary's platform,
including charts, graphs, and a transcript or description of any video
presentation or any other media not reflected in the PDF. This approach
should provide key offering information in a standardized format and
give issuers flexibility in the presentation of other required
disclosures. We believe this flexibility is important given that we
expect that issuers engaged in offerings in reliance on Section 4(a)(6)
would encompass a wide variety of industries at different stages of
business development.
---------------------------------------------------------------------------
\512\ See Rule 101(a)(1)(xvii) of Regulation S-T. Regulation S-T
generally allows PDF documents to be filed only as unofficial
copies. See Rule 104 of Regulation S-T. However, Rule 101 provides
for certain exceptions to this restriction. See, e.g., Rule 101(ix)
(allowing a PDF attachment to Form ID); Rule 101(a)(xiv) (requiring
the filing of Form NRSRO and related exhibits in PDF as official
filings).
\513\ See, e.g., CFIRA Letter 6; CFIRA Letter 7; CrowdCheck
Letter 1; Grassi Letter; Hackers/Founders Letter; RocketHub Letter;
Wefunder Letter; Wilson Letter.
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We are adopting the XML-based fillable form as proposed with a few
modifications.\514\ As suggested by some commenters,\515\ the XML-based
portion of Form C will require issuers to indicate by checkbox the
jurisdictions in which securities are intended to be offered. We also
are changing the name of proposed Form C-A to Form C/A to be consistent
with the naming convention of our other amendment forms and adding Form
C-AR/A to allow, and facilitate identification of, the amendment of an
issuer's Form C-AR annual report. In addition, we are adding an
instruction to clarify that the issuer should mark the appropriate box
on the cover of Form C to indicate which form it is filing. We also are
splitting the ``Form, jurisdiction and date of organization'' field
into three fields to facilitate more accurate tracking of this data. We
also inserted the statement required by paragraph (g) of Rule 201
immediately following the data required by that paragraph, so that
statement appears together with the relevant data. Finally, we are
modifying certain other field names and the General Instructions to
Form C to clarify them or to reflect applicable changes to the
disclosure requirements discussed above.
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\514\ As discussed in Section II.B.1, issuers will input in the
proposed XML-based filing the following information: Name, legal
status and contact information of the issuer; name, SEC file number
and CRD number (as applicable) of the intermediary through which the
offering will be conducted; the amount of compensation paid to the
intermediary to conduct the offering, including the amount of
referral and other fees associated with the offering; any other
direct or indirect interest in the issuer held by the intermediary,
or any arrangement for the intermediary to acquire such an interest;
number of securities offered; offering price; target offering
amount; whether oversubscriptions will be accepted and, if so, how
they will be allocated; maximum offering amount (if different from
the target offering amount); deadline to reach the target offering
amount; current number of employees of the issuer; selected
financial data for the prior two fiscal years; and the jurisdictions
in which the issuer intends to offer the securities.
\515\ See, e.g., Commonwealth of Massachusetts Letter; NASAA
Letter.
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We believe that requiring certain information to be submitted in
XML format will support the assembly and transmission of those required
disclosures to EDGAR on Form C.\516\ It also will make certain key
information about each offering available to investors and market
observers in electronic format and allow the Commission to observe the
implementation of the crowdfunding exemption under Section 4(a)(6).
Information will be available about the types of issuers using the
exemption, including the issuers' size, location, securities offered
and offering amounts and the intermediaries through which the offerings
are taking place. We believe the addition of the requirement to
indicate the jurisdictions in which the issuer intends to offer the
securities, as suggested by several commenters, will facilitate
oversight by state regulators, who retain antifraud authority over
crowdfunding transactions, while imposing only minimal costs on
issuers.
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\516\ The Commission will make the information available via
EDGAR both in a traditional text-based format for reading and as
downloadable XML-tagged data for analysis.
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In addition, in a change from the proposed rules, the final Form C
includes an optional Question and Answer (``Q&A'') format that issuers
may elect to use to provide the disclosures that are not required to be
filed in XML format.\517\ Issuers opting to use this format would
prepare their disclosures by answering the questions provided and
filing that disclosure as an exhibit to the Form C. A number of
commenters noted that an optional format such as this would be less
burdensome for small issuers while still providing the Commission and
investors with the required information.\518\ We believe that this
option may help to facilitate compliance and ease burdens on by
providing a mechanism by which issuers can easily confirm that they
have provided all required information.
---------------------------------------------------------------------------
\517\ See Item 1 of General Instruction III to Form C of
Regulation Crowdfunding.
\518\ See, e.g., Guzik Letter 1; Guzik Letter 2; Guzik Letter 3;
Hackers/Founders Letter; Hamilton Letter; RocketHub Letter; Saunders
Letter; SBA Office of Advocacy Letter.
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Consistent with the proposal, we are adopting a single Form C for
all filings under Regulation Crowdfunding.\519\ We believe that the use
of one form will be more efficient than requiring multiple forms, will
not result in unduly lengthy forms, and will simplify the filing
process for issuers and their preparers. EDGAR will automatically
provide each filing with an appropriate tag depending on which box the
issuer checks so that investors can distinguish among the different
filings.
---------------------------------------------------------------------------
\519\ See Rule 203 of Regulation Crowdfunding.
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We also are adopting, largely as proposed, the requirements to
provide the offering information to investors and the relevant
intermediary and make it available to potential investors under Section
4A(b)(1).\520\ In addition, as discussed above in Section II.B., we
moved the definition of ``investor'' from proposed Rule 300(c)(4) to
Rule 100(d) to clarify that for purposes of all of Regulation
Crowdfunding, ``investor'' includes any investor or any potential
investor, as the context requires.\521\ In connection with this
clarifying change, we have deleted the phrase ``and make available to
potential investors'' each time it appeared in the rule text to avoid
redundancy.\522\
---------------------------------------------------------------------------
\520\ See Rule 203(a) of Regulation Crowdfunding.
\521\ See Rule 100(d) of Regulation Crowdfunding.
\522\ See Rule 203(a) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The final rules provide that issuers will satisfy the requirement
to file the offering information with the Commission and provide it to
the relevant intermediary by filing the Form C: Offering Statement and
any amendments and progress updates and providing to the relevant
intermediary a copy of the disclosures filed with the Commission.\523\
The initial offering statement should include all of the information
that is provided on the intermediary's Web site.\524\ We also are
adopting as proposed the requirements to file with the Commission and
provide, or make available, as applicable, to investors and the
relevant intermediary an amendment to the offering statement to
disclose any material changes, additions or updates to information
provided to investors through the intermediary's platform.\525\ Issuers
may, but are not required to, file an amendment to reflect other
changes, additions or updates to information provided to investors
through the
[[Page 71424]]
intermediary's platform that it considers not material.
---------------------------------------------------------------------------
\523\ See Instructions 1 and 2 to paragraph (a) of Rule 203 of
Regulation Crowdfunding. We anticipate that issuers seeking to
engage in an offering in reliance on Section 4(a)(6) may likely work
with an intermediary to prepare the disclosure that would be
provided on the intermediary's platform and filed with the
Commission. In some cases, intermediaries may offer, as part of
their service, to file the disclosure with the Commission on behalf
of the issuer.
\524\ See Rule 203(a)(1) of Regulation Crowdfunding.
\525\ See Rule 203(a)(2) of Regulation Crowdfunding.
---------------------------------------------------------------------------
To satisfy the requirement to provide the disclosures, or make them
available, as applicable, to investors, the final rules allow issuers
to provide the information to investors electronically by referring
investors to the information on the intermediary's platform through a
posting on the issuer's Web site or by email.\526\ As discussed in the
proposal and noted by commenters, many issuers may not have email
addresses for investors. Accordingly, the final rules permit issuers to
provide this information to investors through a Web site posting.\527\
However, to the extent email addresses for investors are available to
issuers, issuers may contact investors via email to direct them to the
posted information. We continue to believe that investors in this type
of Internet-based offering will be familiar with obtaining information
on the Internet and that providing the information in this manner will
be cost-effective for issuers. As discussed in the Proposing Release,
we believe Congress contemplated that crowdfunding would, by its very
nature, occur over the Internet or other similar electronic media that
is accessible to the public.\528\ Therefore, consistent with the
proposed rules, the final rules do not require issuers to provide
physical copies of the information to investors.
---------------------------------------------------------------------------
\526\ See Instruction 2 to Rule 203(a) of Regulation
Crowdfunding.
\527\ See, e.g., Grassi Letter; Wefunder Letter.
\528\ We note that Section 301 of the JOBS Act states that
``[Title III] may be cited as the `Capital Raising Online While
Deterring Fraud and Unethical Non-Disclosure Act of 2012'.'' See
Section 301 of the JOBS Act. See also 158 Cong. Rec. S1689 (daily
ed. March 15, 2012) (statement of Sen. Mark Warner) (``There is now
the ability to use the Internet as a way for small investors to get
the same kind of deals that up to this point only select investors
have gotten . . . , where we can now use the power of the Internet,
through a term called crowdfunding.''); id. at S-1717 (Statement of
Sen. Mary Landrieu) (``this crowdfunding bill--which is, in essence,
a way for the Internet to be used to raise capital . . .'').
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4. Prohibition on Advertising Terms of the Offering
a. Proposed Rules
Securities Act Section 4A(b)(2) provides that an issuer shall ``not
advertise the terms of the offering, except for notices which direct
investors to the funding portal or broker.'' Consistent with the
statute, proposed Rule 204 of Regulation Crowdfunding would allow an
issuer to publish a notice advertising the terms of an offering in
reliance on Section 4(a)(6) so long as the notice includes the address
of the intermediary's platform on which additional information about
the issuer and the offering may be found. The proposal did not impose
limitations on how the issuer distributes the notices. As proposed, the
notice could include no more than: (1) A statement that the issuer is
conducting an offering, the name of the intermediary through which the
offering is being conducted and a link directing the investor to the
intermediary's platform; (2) the terms of the offering; and (3) factual
information about the legal identity and business location of the
issuer, limited to the name of the issuer of the security, the address,
phone number and Web site of the issuer, the email address of a
representative of the issuer and a brief description of the business of
the issuer. Under the proposed rules, ``terms of the offering'' would
include: (1) The amount of securities offered; (2) the nature of the
securities; (3) the price of the securities; and (4) the closing date
of the offering period. The proposed rules would not, however, restrict
an issuer's ability to communicate other information that does not
refer to the terms of the offering.
The proposed rules also would allow an issuer to communicate with
investors about the terms of the offering through communication
channels provided by the intermediary on the intermediary's platform,
so long as the issuer identifies itself as the issuer in all
communications.
b. Comments Received
Commenters were mostly supportive of these provisions. Several
commenters expressed support for the proposed content of advertising
notices \529\ and the definition of ``terms of the offering.'' \530\ A
number of commenters also supported the proposal's absence of a
restriction on an issuer's ability to communicate information that does
not refer to the terms of the offering.\531\ Several commenters
requested clarification on various aspects of the proposal.\532\
---------------------------------------------------------------------------
\529\ See, e.g., CFIRA Letter 6; Commonwealth of Massachusetts
Letter; RocketHub Letter.
\530\ See, e.g., Arctic Island Letter 5; CFIRA Letter 6;
Heritage Letter; Joinvestor Letter; RocketHub Letter.
\531\ See, e.g., ABA Letter; CFIRA Letter 6; Consumer Federation
Letter; Hackers/Founders Letter; Public Startup Letter 2; RocketHub
Letter.
\532\ See, e.g., ABA Letter (recommending the rule text include
a safe harbor for regularly released factual business information so
long as it does not refer to the terms of the offering); CIFRA
Letter 6 (requesting more guidance on advertising formats and
content and the definition of ``terms of the offering'').
---------------------------------------------------------------------------
Several commenters recommended that, consistent with the proposal,
the Commission not restrict the media or format that may be used for
advertising notices,\533\ with some pointing to the changing nature of
social media and potential new user interfaces.\534\ Two commenters,
however, stated that communications about the offering should always be
conducted through the intermediary.\535\ A number of commenters also
supported allowing an issuer to communicate with investors about the
terms of the offering through communication channels provided by the
intermediary on the intermediary's platform, so long as the issuer
identifies itself in all communications.\536\
---------------------------------------------------------------------------
\533\ See, e.g., Arctic Island Letter 5; Joinvestor Letter;
Public Startup Letter 2; RoC Letter; RocketHub Letter.
\534\ See, e.g., Arctic Island Letter 5; Public Startup Letter
2; RocketHub Letter.
\535\ See Hackers/Founders Letter (supporting the issuer being
able to repost the communications elsewhere so long as it first
appeared through the intermediary); Joinvestor Letter.
\536\ See, e.g., ASSOB Letter; CFIRA Letter 6; Commonwealth of
Massachusetts Letter; Consumer Federation Letter; Hackers/Founders
Letter; Odhner Letter; Public Startup Letter 2; RoC Letter;
RocketHub Letter; Wefunder Letter. Some of these commenters also
recommended that all interested persons, such as officers, directors
and other agents, should identify themselves in all communications
on the intermediary's platform. See CIFRA Letter 6; Hackers/Founders
Letter.
---------------------------------------------------------------------------
Some commenters opposed the proposed advertising rules, with some
stating that the advertising restrictions are unnecessary because sales
must occur through an intermediary's platform, which would contain all
of the relevant disclosures and investor acknowledgments.\537\ One
commenter asked that an issuer be given broader leeway to publicize its
business or offering on its own Web site or social media platform so
long as the specific terms of the offering can be found only through
the intermediary's platform.\538\ One commenter recommended allowing
advertising notices to have a section for supplemental information
highlighting certain intangible purposes such as a particular social
cause.\539\
---------------------------------------------------------------------------
\537\ See, e.g., FundHub Letter 1; Seed&Spark Letter (noting the
proposed advertising restrictions will restrict the ability of
filmmakers to market and raise money for their films); Arctic Island
Letter 5; PeoplePowerFund Letter.
\538\ See Fryer Letter.
\539\ See RocketHub Letter.
---------------------------------------------------------------------------
Two other commenters recommended that any advertising notices be
filed with the Commission and/or the relevant intermediary.\540\
Several other commenters supported the proposed approach of not having
advertising notices filed with the Commission or the intermediary,
citing concerns about various formats of the communications, inability
to capture all third-party communications, and the costs
[[Page 71425]]
associated with trying to capture the data.\541\
---------------------------------------------------------------------------
\540\ See, e.g., Commonwealth of Massachusetts Letter; CFIRA
Letter 6.
\541\ See, e.g., Arctic Island Letter 5; ASSOB Letter; Public
Startup Letter 2; RocketHub Letter.
---------------------------------------------------------------------------
c. Final Rules
We are adopting the prohibition on advertising terms of the
offering substantially as proposed, with minor changes to the rule text
for clarity.\542\ Under the final rules, an advertising notice that
includes the terms of the offering can include no more than: (1) A
statement that the issuer is conducting an offering, the name of the
intermediary through which the offering is being conducted and a link
directing the investor to the intermediary's platform; (2) the terms of
the offering; and (3) factual information about the legal identity and
business location of the issuer, limited to the name of the issuer of
the security, the address, phone number and Web site of the issuer, the
email address of a representative of the issuer and a brief description
of the business of the issuer. Consistent with the proposal, the final
rules define ``terms of the offering'' to include: (1) The amount of
securities offered; (2) the nature of the securities; (3) the price of
the securities; and (4) the closing date of the offering period.\543\
---------------------------------------------------------------------------
\542\ See Rule 204 of Regulation Crowdfunding.
\543\ See Instruction to Rule 204 of Regulation Crowdfunding.
---------------------------------------------------------------------------
The permitted notices will be similar to ``tombstone ads'' under
Securities Act Rule 134,\544\ except that the notices will be required
to direct an investor to the intermediary's platform through which the
offering is being conducted, such as through a link directing the
investor to the platform.
---------------------------------------------------------------------------
\544\ 17 CFR 230.134.
---------------------------------------------------------------------------
Although at least one commenter recommended allowing advertising
notices to have a section for supplemental information highlighting
certain intangible purposes such as a particular social cause,\545\ we
do not believe a separate section is necessary. Instead, this type of
information may be included as part of the ``brief description of the
business.''
---------------------------------------------------------------------------
\545\ See RocketHub Letter.
---------------------------------------------------------------------------
Two commenters \546\ expressed concern that the proposed rule would
not allow enough flexibility for brief, informal social media
communications, but we disagree. A notice cannot include more than the
enumerated matters, but an issuer has the flexibility not to include
each of the enumerated matters in the notice, which may facilitate
certain types of social media communications. For example, an issuer
would be able to note on its own Web site or on social media that it is
conducting an offering and direct readers to the materials on the
intermediary's platform. There is no requirement for legends on these
notices because the issuer will be directing investors to the materials
on the intermediary's platform that will include those required
legends.
---------------------------------------------------------------------------
\546\ See FundHub Letter 1; Fryer Letter (``a rigid tombstone
approach is inconsistent with the structure and informality of
modern social media communication tools.'')
---------------------------------------------------------------------------
We believe that this approach will provide flexibility for issuers
while protecting investors by limiting the advertising of the terms of
the offering to the information permitted in the notice and directing
them to the intermediary's platform where they can access the
disclosures necessary for them to make informed investment decisions.
Consistent with the recommendation of several commenters,\547\ the
final rules do not impose limitations on how the issuer distributes the
notices. For example, an issuer could place notices in newspapers or
post notices on social media sites or the issuer's own Web site. We
believe the final rules will allow issuers to leverage social media to
attract investors, while at the same time protecting investors by
limiting the ability of issuers to advertise the terms of the offering
without directing them to the required disclosure. We are not adopting
a requirement that all notices be filed with the Commission or relevant
intermediary, as requested by some commenters.\548\ Other commenters
expressed concerns about the costs that would be associated with such a
requirement, and given that investors will be directed to the required
disclosure on the intermediary's platform, we believe the final rules
appropriately take these factors into account.\549\
---------------------------------------------------------------------------
\547\ See, e.g., Arctic Island Letter 5; Joinvestor Letter;
Public Startup Letter 2; RoC Letter; RocketHub Letter.
\548\ See, e.g., Hackers/Founders Letter; Joinvestor Letter.
\549\ See, e.g., ASSOB Letter; RocketHub Letter.
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Further, the final rules allow an issuer to communicate with
investors about the terms of the offering through communication
channels provided by the intermediary on the intermediary's platform,
so long as the issuer identifies itself as the issuer in all
communications. We believe that one of the central tenets of the
concept of crowdfunding is that the members of the crowd decide whether
or not to fund an idea or business after sharing information with each
other. As part of those communications, we believe it is important for
the issuer to be able to respond to questions about the terms of the
offering or even challenge or refute statements made through the
communication channels provided by the intermediary. Therefore, the
final rules do not restrict issuers from participating in those
communications so long as the issuer identifies itself as the issuer in
all communications.
Based on the suggestion of a few commenters,\550\ we are clarifying
in the final rules that the prohibition on advertising the terms of the
offering and related requirements apply to persons acting on behalf of
the issuer.\551\ For example, persons acting on behalf of the issuer
are required under Rule 204(c) to identify their affiliation with the
issuer in all communications on the intermediary's platform.\552\
---------------------------------------------------------------------------
\550\ See, e.g., CIFRA Letter 6; Hackers/Founders Letter.
\551\ See Rule 204 of Regulation Crowdfunding.
\552\ See also Section II.B.5 for disclosures required by
persons promoting the offering.
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In addition, the final rules do not restrict an issuer's ability to
communicate other information that might occur in the ordinary course
of its operations and that does not refer to the terms of the offering.
As stated in the Proposing Release, we believe that this is consistent
with the statute because Section 4A(b)(2) restricts the advertising of
the terms of the offer. The Commission has interpreted the term
``offer'' broadly, however, and has explained that ``the publication of
information and publicity efforts, made in advance of a proposed
financing which have the effect of conditioning the public mind or
arousing public interest in the issuer or in its securities constitutes
an offer. . .'' \553\ In this regard, we also note that Securities Act
Rule 169 \554\ permits non-Exchange Act reporting issuers engaged in an
initial public offering to continue to publish, subject to certain
exclusions and conditions, regularly released factual business
information that is intended for use by persons other than in their
capacity as investors.
---------------------------------------------------------------------------
\553\ Securities Offering Reform, Release No. 33-8591 (July 19,
2005) [70 FR 44722 (Aug. 3, 2005)] at 44731. The term ``offer'' has
been interpreted broadly and goes beyond the common law concept of
an offer. See, e.g., Diskin v. Lomasney & Co., 452 F.2d 871 (2d.
Cir. 1971).
\554\ 17 CFR 230.169.
---------------------------------------------------------------------------
While one commenter requested a safe harbor for regularly released
factual business information so long as it does not refer to the terms
of the offering,\555\ we do not believe that a safe harbor is
necessary. Ultimately, whether or not a communication is limited to
factual business information depends on the facts and circumstances of
that particular communication. However,
[[Page 71426]]
issuers may generally look to the provisions of Rule 169 for guidance
in making this determination in the Regulation Crowdfunding context.
---------------------------------------------------------------------------
\555\ See ABA Letter.
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5. Compensation of Persons Promoting the Offering
a. Proposed Rules
Consistent with Securities Act Section 4A(b)(3), proposed Rule 205
of Regulation Crowdfunding would prohibit an issuer from compensating,
or committing to compensate, directly or indirectly, any person to
promote the issuer's offering through communication channels provided
by the intermediary, unless the issuer takes reasonable steps to ensure
that the person clearly discloses the receipt (both past and
prospective) of compensation each time the person makes a promotional
communication. Further, a founder or an employee of the issuer that
engages in promotional activities on behalf of the issuer through the
communication channels provided by the intermediary would be required
to disclose, with each posting, that he or she is engaging in those
activities on behalf of the issuer.
Under the proposed rules, an issuer would not be able to compensate
or commit to compensate, directly or indirectly, any person to promote
its offerings outside of the communication channels provided by the
intermediary, unless the promotion is limited to notices that comply
with the proposed advertising rules.
b. Comments Received
Commenters were generally supportive of promoter disclosure and the
proposed rule.\556\ A number of commenters supported the broad
applicability of the proposed rules to persons acting on behalf of the
issuer.\557\ Some commenters recommended that the issuer or
intermediary bear more responsibility for ensuring that the identity of
the promoters be prominently disclosed.\558\
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\556\ See, e.g., CFA Institute Letter; Consumer Federation
Letter (supporting proposal but generally questioning the wisdom of
allowing paid promoters to participate in the communication channels
at all); NASAA Letter; NFIB Letter; Public Startup Letter 2.
\557\ See, e.g., CFA Institute Letter; CFIRA Letter 6;
Commonwealth of Massachusetts Letter; Consumer Federation Letter;
Hackers/Founders Letter; Joinvestor Letter; RocketHub Letter; MCS
Letter.
\558\ See, e.g., ASSOB Letter; Commonwealth of Massachusetts
Letter; Joinvestor Letter; MCS Letter; RoC Letter; RocketHub Letter.
---------------------------------------------------------------------------
A number of commenters also supported the requirement in the
proposal that an issuer not compensate or commit to compensate,
directly or indirectly, any person to promote its offerings outside of
the communication channels provided by the intermediary, unless the
promotion is limited to notices that comply with the proposed
advertising rules.\559\
---------------------------------------------------------------------------
\559\ See, e.g., ASSOB Letter; Consumer Federation Letter;
Joinvestor Letter; Public Startup Letter 2; RoC Letter; RocketHub
Letter.
---------------------------------------------------------------------------
c. Final Rules
We are adopting, as proposed, final rules about the compensation of
persons promoting the offering, with one clarifying change.\560\ We
anticipate that communication channels provided by the intermediary
will provide a forum through which investors could share information to
help the members of the crowd decide whether or not to fund the issuer.
We believe that it will be important for investors to know whether
persons using those communication channels are persons acting on behalf
of the issuer or persons receiving compensation from the issuer (or
from persons acting on behalf of the issuer), to promote the issuer's
offering because of the potential for self-interest or bias in
communications by these persons.
---------------------------------------------------------------------------
\560\ See Rule 205 of Regulation Crowdfunding.
---------------------------------------------------------------------------
A number of commenters supported the broad applicability of the
proposed rules to persons acting on behalf of the issuer.\561\ The text
of the proposed rule included a sentence stating that the disclosure
obligation would apply to ``a founder or an employee of the issuer that
engages in promotional activities on behalf of the issuer through the
communication channels.'' Based on comments received, we are removing
that sentence and adding an instruction to clarify that the requirement
applies broadly to all persons acting on behalf of the issuer,
regardless of whether or not the compensation they receive is
specifically for the promotional activities. The change is intended to
clarify that the disclosure requirement applies to persons hired
specifically to promote the offering as well as to persons (including,
but not limited to, founders, employees and directors) who are
otherwise employed by the issuer or who undertake promotional
activities on behalf of the issuer.
---------------------------------------------------------------------------
\561\ See, e.g., CFA Institute Letter; CFIRA Letter 6;
Commonwealth of Massachusetts Letter; Consumer Federation Letter;
Hackers/Founders Letter; Joinvestor Letter; RocketHub Letter; MCS
Letter.
---------------------------------------------------------------------------
While we appreciate the views of commenters who suggested that we
impose additional requirements on issuers or intermediaries to ensure
that the identity of promoters is prominently disclosed, we believe the
requirement that the issuer take reasonable steps to ensure that
promoters clearly disclose the receipt of compensation for
communications is sufficient to achieve the objectives of this
provision without being overly prescriptive. There are a number of
reasonable steps the issuer can take to ensure compliance. An issuer
could, for example, contractually require any promoter to include the
required statement about receipt of compensation, confirm that the
promoter is adhering to the intermediary's terms of use that require
promoters to affirm whether or not they are compensated by the issuer,
monitor communications made by such persons and take the necessary
steps to have any communications that do not have the required
statement removed promptly from the communication channels, or retain a
person specifically identified by the intermediary to promote all
issuers on its platform.
As proposed, the final rules also specify that the issuer shall not
compensate or commit to compensate, directly or indirectly, any person
to promote its offerings outside of the communication channels provided
by the intermediary, unless the promotion is limited to notices that
comply with the advertising rules discussed above in Section
II.B.4.\562\ This prohibition should prevent issuers from circumventing
the restrictions on advertising by compensating a third party to do
what the issuer cannot do directly.
---------------------------------------------------------------------------
\562\ See Rule 205(b) of Regulation Crowdfunding.
---------------------------------------------------------------------------
6. Other Issuer Requirements
a. Oversubscriptions
The proposed rules would not limit an issuer's ability to accept
investments in excess of the target offering amount, subject to the $1
million annual limit.\563\ Issuers would be required to disclose how
much they would be willing to accept in oversubscriptions, how the
oversubscriptions would be allocated, and the intended purpose of those
additional funds.
---------------------------------------------------------------------------
\563\ See proposed Rule 201(h) and Instruction to paragraph (i)
of Rule 201 of Regulation Crowdfunding, and cover page of Form C.
---------------------------------------------------------------------------
Commenters were generally supportive of this approach to
oversubscriptions.\564\ Some commenters supported the proposed
flexibility to allow issuers to determine how to allocate
oversubscribed offerings,\565\ while other commenters recommended that
the Commission require issuers to allocate oversubscriptions using a
prescribed method.\566\ Two commenters
[[Page 71427]]
recommended that the Commission limit the maximum oversubscription
amount to a certain percentage of the target offering amount,\567\
while two other commenters opposed such a limit.\568\ One commenter
recommended that the Commission revise the proposed rules to clarify
that issuers would be required to disclose the ``other'' basis upon
which oversubscriptions would be allocated.\569\
---------------------------------------------------------------------------
\564\ See, e.g., CFA Institute letter; EMKF letter; Jacobson
letter; Wefunder letter.
\565\ See, e.g., ASSOB Letter; CFA Institute Letter; EMKF
Letter; Public Startup Letter 2; RocketHub Letter; Wefunder letter.
\566\ See, e.g., Fund Democracy Letter (pro-rata); Consumer
Federation Letter (same as Fund Democracy); Joinvestor letter
(first-come, first-served or algorithmic random selection);
PeoplePowerFund Letter (first-come, first-served).
\567\ See Joinvestor Letter (10%); RFPIA Letter (20%).
\568\ See Jacobson Letter; Public Startup Letter 2.
\569\ See Fund Democracy Letter.
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We are adopting the rule relating to oversubscriptions as proposed,
with one clarifying change.\570\ We do not believe, as some commenters
suggested, that it is necessary to limit the maximum oversubscription
amount. Nor do we believe it is necessary to prescribe how to allocate
oversubscribed offerings so long as the issuer discloses, at the
commencement of the offering, how securities in such offerings will be
allocated, and the intended purpose of those additional funds. This
disclosure should provide investors with information they need to make
informed investment decisions while providing issuers flexibility to
structure the offering as they believe appropriate. In response to a
comment received,\571\ we are clarifying in the final rules that,
regardless of the structure, the issuer must describe how securities in
oversubscribed offerings will be allocated.
---------------------------------------------------------------------------
\570\ See Rule 201(h) to Regulation Crowdfunding.
\571\ See Fund Democracy Letter.
---------------------------------------------------------------------------
b. Offering Price
As discussed above in Section II.B.1.a.i.(e), proposed Rule 201(l)
would require an issuer to disclose the offering price of the
securities or, in the alternative, the method for determining the
price, provided that prior to any sale of securities, each investor is
provided in writing the final price and all required disclosure. The
proposed rules would not require issuers to set a fixed price or
prohibit dynamic pricing.
We received a few comments supporting the proposed approach or
expressing opposition to requiring a fixed price,\572\ while another
commenter suggested the Commission require issuers to set a fixed
price.\573\
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\572\ See, e.g., CFA Institute Letter (stating that disclosure
of changes and methods used to determine share prices, along with
investors' rights to cancel their investment commitments, provide
reasonable safeguards); Wilson Letter; Public Startup Letter 2.
\573\ See RocketHub Letter.
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We are adopting the final rules as proposed.\574\ While we
appreciate the view of at least one commenter \575\ that a fixed price
may be simpler for investors to understand, we believe that the statute
contemplated flexible pricing by providing that issuers may disclose
the method for determining the price, provided that the final price and
required disclosures are provided to each investor prior to any sales.
We also believe the cancellation rights in the final rules \576\ will
provide investors a reasonable opportunity to cancel their investment
commitment if they wish to do so after the price is fixed.
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\574\ See Rule 201(l) of Regulation Crowdfunding. See also
Section II.C.6 for a discussion of cancellation provisions.
\575\ See RocketHub Letter.
\576\ See Rules 201(j) and 201(k) of Regulation Crowdfunding.
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c. Types of Securities Offered and Valuation
The proposed rules would not limit the type of securities that may
be offered in reliance on Section 4(a)(6) nor prescribe a method for
valuing the securities. Issuers would be required to describe the terms
of the securities and the valuation method in their offering materials.
A number of commenters generally supported not limiting the types
of securities that may be offered and sold in reliance of Section
4(a)(6).\577\ Comments were more varied on valuation methodology. Some
commenters recommended that the Commission neither require nor prohibit
a specific valuation methodology,\578\ while others recommended that
the Commission prescribe a set of valuation standards that have
universal application for startups.\579\ Two commenters recommended
that the Commission require issuers to base the valuation of their
securities on the price at which the issuer previously sold
securities,\580\ and another commenter recommended that the Commission
consider whether additional standards are needed to ensure that
securities are fairly valued and that approaches to valuation that put
investors at a disadvantage be prohibited.\581\ One commenter generally
supported requiring issuers to describe how securities being offered
are being valued,\582\ while another commenter generally opposed such
requirement.\583\
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\577\ See, e.g., CFA Institute Letter; Concerned Capital Letter;
Crowdstockz Letter; Hackers/Founders Letter; Joinvestor Letter;
Public Startup Letter 2; RocketHub Letter; Tiny Cat Letter; Wilson
Letter.
\578\ See, e.g., Hackers/Founders Letter; Heritage Letter;
PeoplePowerFund Letter; Public Startup Letter 2; RocketHub Letter;
Wilson Letter.
\579\ See, e.g., 11 Wells Letter; Active Agenda Letter; Borrell
Letter; Ellenbogen Letter; Greer Letter; Mountain Hardwear Letter;
Moyer Letter; NaviGantt Letter; Vidal Letter.
\580\ See, e.g., Public Startup Letter 3; Wefunder Letter.
\581\ See Consumer Federation Letter.
\582\ See CFIRA Letter 7.
\583\ See Thomas Letter 2 (recommending that if issuers are
required to describe the valuation method in their offering
materials, the rule should provide ``safe harbor'' language that
issuers can use in providing such description.)
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We are adopting, as proposed, final rules that neither limit the
type of securities that may be offered in reliance on Section 4(a)(6)
nor prescribe a method for valuing the securities.\584\ We noted in the
proposal that the statute refers to ``securities'' and does not limit
the type of securities that could be offered pursuant to the exemption.
Issuers are required to describe the terms of the securities and the
valuation method in their offering materials.\585\ We believe this
approach is consistent with the statute and will provide flexibility to
issuers to determine the types of securities that they offer to
investors and how those securities are valued, while providing
investors with the information they need to make an informed investment
decision.
---------------------------------------------------------------------------
\584\ See Rule 201(m) of Regulation Crowdfunding.
\585\ See Rule 201(m)(1) and (4) of Regulation Crowdfunding.
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While some commenters suggested that the Commission should provide
specific valuation methods or standards for securities-based
crowdfunding transactions, we are not persuaded that there would be
sufficient benefits to being prescriptive in this regard. Methods and
valuations of early stage companies vary significantly, and any attempt
to choose a particular valuation methodology could limit flexibility
and have the result of endorsing one approach over another without
necessarily having a sound basis for doing so. We believe the
requirement that issuers describe the methods they use to value their
securities in their offering materials, including the requirement that
they describe examples of methods for how such securities may be valued
by the issuer in the future, will provide investors with the
information they need to make an informed investment decision.
The final rules do not limit the types of securities that may be
offered in reliance on Section 4(a)(6), and thus debt securities may be
offered and sold in crowdfunding transactions. As we stated in the
Proposing Release, in general, the issuance of a debt security
[[Page 71428]]
raises questions about the applicability of the Trust Indenture Act of
1939 (``Trust Indenture Act'').\586\ Although the Trust Indenture Act
applies to any debt security sold through the use of the mails or
interstate commerce, including debt securities sold in transactions
that are exempt from Securities Act registration, Trust Indenture Act
Section 304(b) provides an exemption for any transaction that is
exempted by Securities Act Section 4 from the provisions of Section 5
of the Act.\587\ An issuer offering debt securities in reliance on
Section 4(a)(6), therefore, would be able to rely on this
exemption.\588\ Based on the availability of this exemption, we are not
adopting a specific exemption from the requirements of the Trust
Indenture Act for offerings of debt securities made in reliance on
Section 4(a)(6).
---------------------------------------------------------------------------
\586\ 15 U.S.C. 77aaa et seq.
\587\ 15 U.S.C. 77ddd(b).
\588\ Trust Indenture Act Section 304(a)(8) [15 U.S.C.
77ddd(a)(8)] and Rule 4a-1 [17 CFR 260.4a-1] also provide an
exemption to issue up to $5 million of debt securities without an
indenture in any 12-month period.
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C. Intermediary Requirements
1. Definitions of Funding Portals and Associated Persons
a. Proposed Rules
Securities Act Section 4(a)(6)(C) requires a crowdfunding
transaction to be conducted through a broker or funding portal that
complies with the requirements of Securities Act Section 4A(a). The
term ``broker'' is generally defined in Exchange Act Section 3(a)(4) as
any person that effects transactions in securities for the account of
others. Exchange Act Section 3(a)(80) defines the term ``funding
portal'' as any person acting as an intermediary in a transaction
involving the offer or sale of securities for the account of others,
solely pursuant to Securities Act Section 4(a)(6), that does not: (1)
Offer investment advice or recommendations; (2) solicit purchases,
sales or offers to buy the securities offered or displayed on its Web
site or portal; (3) compensate employees, agents or other persons for
such solicitation or based on the sale of securities displayed or
referenced on its Web site or portal; (4) hold, manage, possess or
otherwise handle investor funds or securities; or (5) engage in such
other activities as the Commission, by rule, determines
appropriate.\589\
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\589\ Congress in the JOBS Act inadvertently created two
Sections 3(a)(80) in the Exchange Act, the other being the
definition of ``emerging growth company'' (added by Section 101(b)
of Title I of the JOBS Act).
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In the Proposing Release, we explained that because a funding
portal would be engaged in the business of effecting securities
transactions for the accounts of others through crowdfunding, it would
be a ``broker'' within the meaning of Section 3(a)(4) of the Exchange
Act.\590\ Accordingly, proposed Rule 300(c)(2) of Regulation
Crowdfunding would define ``funding portal'' consistent with the
statutory definition of ``funding portal,'' with the substitution of
the word ``broker'' for the word ``person.''
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\590\ See Proposing Release at 78 FR 66458. See also discussion
in Section II.D.2.
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We also stated in the Proposing Release that the proposed rules
would apply not only to funding portals, but also to their associated
persons in many instances. The terms ``person associated with a broker
or dealer'' and ``associated person of a broker or dealer'' are defined
in Exchange Act Section 3(a)(18).\591\ Proposed Rule 300(c)(1) of
Regulation Crowdfunding would similarly define the term ``person
associated with a funding portal or associated person of a funding
portal'' to mean any partner, officer, director or manager of a funding
portal (or any person occupying a similar status or performing similar
functions), any person directly or indirectly controlling or controlled
by a funding portal, or any employee of a funding portal, other than
persons whose functions are solely clerical or ministerial. The
proposed rules would provide, however, that persons who are excluded
from the definition of associated person of a funding portal because
their functions are solely clerical or ministerial would remain subject
to our sanctioning authority under Exchange Act Sections 15(b)(4) and
15(b)(6).\592\ This definition is consistent with, and modeled on, the
language of Exchange Act Section 3(a)(18).\593\
---------------------------------------------------------------------------
\591\ 15 U.S.C. 78c(a)(18).
\592\ Section 15(b)(4) (15 U.S.C. 78o(b)(4)) authorizes the
Commission to bring administrative proceedings for the imposition of
sanctions, up to and including the revocation of a broker's
registration, when the broker violates the federal securities laws
(and for other misconduct). Section 15(b)(6) (15 U.S.C. 78o(b)(6))
provides similar sanctioning authority with respect to persons
associated with a broker, including the ability to bar such persons
from associating with any Commission registrant.
\593\ We note, however, that the definition in proposed Rule
300(c)(1) does not include persons under common control with the
funding portal, unlike the definition in Exchange Act Section
3(a)(18) which includes such persons as associated persons of
broker-dealers.
---------------------------------------------------------------------------
In proposed Rule 300(c)(4), we also defined ``investor'' as any
investor or any potential investor, as the context requires.
b. Comments on the Proposed Rules
The Proposing Release requested comments on whether there were
funding portal activities, other than those in Exchange Act Section
3(a)(80), that we should prohibit, and whether any prohibitions should
be modified or removed. We also requested comments about whether
further guidance was necessary on the provisions of the Exchange Act
and the rules and regulations thereunder that would apply to funding
portals.
Some commenters stated that the Commission should not provide any
further guidance or prohibitions on funding portal activity in addition
to those required by statute.\594\ One of these commenters stated that
the proposed regulations for funding portal activities are ``sufficient
for investor protection and proper regulatory oversight.'' \595\
Another commenter opposed removing or modifying the statutory
limitations on funding portal activities, stating that if funding
portals wish to engage in the prohibited activities, they could do so
by registering, and being appropriately regulated as, broker-
dealers.\596\
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\594\ See, e.g., RocketHub Letter; Tiny Cat Letter (stating that
the proposed regulations provide a ``healthy level of investor
protection, but are not overly burdensome and we wholeheartedly
appreciate the [C]ommission's general attitude of restraint'').
Another commenter also opposed additional prohibitions, stating that
``to add prohibitions would be an illegal Rule not authorized by the
JOBS Act legislation.'' See Public Startup Letter 2. This commenter
made a similar argument with respect to various aspects of the rule.
We note, however, that the JOBS Act provides the Commission the
authority to provide other requirements for the protection of
investors and in the public interest. See, e.g., Securities Act
Section 4A(a)(12); 4A(b)(5).
\595\ See Tiny Cat Letter.
\596\ See Consumer Federation Letter.
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c. Final Rules
After considering the comments, we are adopting, as proposed, the
definitions of ``associated person of a funding portal or person
associated with a funding portal'' and ``funding portal'' in Rules
300(c)(1) and(2), respectively. In particular, we believe that, at the
present time, the statutory prohibitions on a funding portal in
Exchange Act Section 3(a)(80), as reflected in the final rule
definition of a funding portal, provide appropriate investor
protections.
We also are adopting the definition of ``investor'' from the
proposed rules but have moved the definition to Rule 100(d), and made a
modification to clarify that the definition applies to all of
Regulation Crowdfunding.\597\ Although commenters did not address
[[Page 71429]]
the definition of ``investor,'' we are making this change to address
any potential confusion about whether the definition is applicable to
all of Regulation Crowdfunding.
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\597\ See Section II.B.1.
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2. General Requirements for Intermediaries
a. Registration and SRO Membership
(1) Proposed Rules
Securities Act Section 4A(a)(1) requires that a person acting as an
intermediary in a crowdfunding transaction register with the Commission
as a broker or as a funding portal.\598\ Proposed Rule 300(a)(1) of
Regulation Crowdfunding would implement this requirement by providing
that a person acting as an intermediary in a transaction involving the
offer or sale of securities made in reliance on Section 4(a)(6) must be
registered with the Commission as a broker under Exchange Act Section
15(b), or as a funding portal pursuant to Section 4A(a)(1) and proposed
Rule 400 of Regulation Crowdfunding. As discussed below, we also
proposed to make the information that a funding portal provides on the
proposed registration form (i.e., Form Funding Portal), other than
personally identifiable information or other information with a
significant potential for misuse, accessible to the public.\599\
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\598\ As we noted in the Proposing Release, facilitating
crowdfunded transactions (which involve the offer or sale of
securities by an issuer and not secondary market activity) alone
would not require an intermediary to register as an exchange or as
an alternative trading system (i.e., registration as a broker-dealer
subject to Regulation ATS). See Proposing Release at 78 FR 66459
(discussing secondary market activity and exchange or ATS
registration).
\599\ See Section II.D.1 (discussing registration requirements).
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Securities Act Section 4A(a)(2) requires an intermediary to
register with any applicable self-regulatory organization (``SRO''), as
defined in Exchange Act Section 3(a)(26).\600\ Exchange Act Section
3(h)(1)(B) separately requires, as a condition of the exemption from
broker registration, that a funding portal be a member of a national
securities association that is registered with the Commission under
Exchange Act Section 15A. Proposed Rule 300(a)(2) would implement these
provisions by requiring an intermediary in a transaction involving the
offer or sale of securities made in reliance on Section 4(a)(6) to be a
member of FINRA or any other national securities association registered
under Exchange Act Section 15A. Currently, FINRA is the only registered
national securities association.
---------------------------------------------------------------------------
\600\ 15 U.S.C. 78c(a)(26). Exchange Act Section 3(a)(26)
defines an ``SRO'' to include, among other things, a ``registered
securities association.'' Id.
---------------------------------------------------------------------------
We also proposed definitions for the terms ``intermediary'' and
``SRO'' in proposed Rules 300(c)(3) and 300(c)(5) of Regulation
Crowdfunding, respectively. As proposed, intermediary would mean a
broker registered under Section 15(b) of the Exchange Act or a funding
portal registered under proposed Rule 400 of Regulation Crowdfunding
and would include, where relevant, an associated person of the
registered broker or registered funding portal. SRO was proposed to
have the same meaning as in Section 3(a)(26) of the Exchange Act.
(2) Comments on the Proposed Rules
Commenters generally supported FINRA being the appropriate SRO and
national securities association for intermediaries.\601\ In the
Proposing Release, we asked if we were to approve the registration of
another national securities association under Exchange Act Section 15A
in the future, in addition to FINRA, whether it would it be appropriate
for us to require membership in both the existing and new association.
Commenters urged that intermediaries be required to register with only
one such national securities association.\602\
---------------------------------------------------------------------------
\601\ See, e.g., Joinvestor Letter; RocketHub Letter. One
commenter stated that funding portals should not be required to
register with the Commission or become FINRA members because, unlike
brokers, they serve only as an ``information delivery service.'' See
Perfect Circle Letter. We note, however, that registration is a
statutory requirement under Securities Act Section 4A(a)(1).
\602\ See, e.g., Joinvestor Letter; Public Startup Letter 2;
RocketHub Letter; Vann Letter.
---------------------------------------------------------------------------
Certain commenters expressed concern about potential competitive
advantages of registered broker-dealers over funding portals,
suggesting that the Commission should prohibit brokers from engaging in
transactions conducted pursuant to Section 4(a)(6) until funding
portals can become registered,\603\ or provide funding portals a grace
period so they may be able to operate before their registration becomes
effective.\604\ Another commenter, however, suggested that licensed
broker-dealers should be immediately authorized to provide services
associated with a ``registered crowdfunding portal'' to any issuer
looking to self-host or to an issuer that has ``an offline mechanism
available for crowdfunding.'' \605\
---------------------------------------------------------------------------
\603\ See, e.g., RocketHub Letter.
\604\ See, e.g., Joinvestor Letter.
\605\ Public Startup Letter 2.
---------------------------------------------------------------------------
In response to our requests for comment in the Proposing Release,
commenters were also divided on whether the Commission should require
minimum qualification, testing and licensure requirements for funding
portals and their associated persons.\606\
---------------------------------------------------------------------------
\606\ Comments in support included Hakanson Letter; Reichman
Letter; RocketHub Letter. See also CrowdCorp Letter (stating that
the Commission should establish a separate licensing scheme for
persons who help prepare issuer disclosure documents and advise
issuers, but who are not brokers or funding portals). Comments
opposed included Public Startup Letter 2; Startup Valley Letter.
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(3) Final Rules
After considering the comments, we are adopting Rule 300(a)
generally as proposed but deleting specific references to FINRA in the
final rule, as well as the rest of Regulation Crowdfunding and Form
Funding Portal, when referring to a registered national securities
association. Although we recognize that FINRA is currently the only
registered national securities, we believe it is redundant to
specifically include its name when referring to registered national
securities associations in the rule text and Form Funding Portal.
We are cognizant of the fact that funding portals must register
with the Commission and become compliant with an entirely new set of
rules. The effective date for the final rules (which is 180 days after
publication in the Federal Register, except for Sec. 227.400, Form
Funding Portal, and the amendments to Form ID, which are effective
January 29, 2016) is designed to provide a sufficient amount of time
for funding portals to register and establish the necessary
infrastructure to comply with other requirements being imposed in
Regulation Crowdfunding before any intermediaries--either broker-
dealers or funding portals--may engage in crowdfunding activities. We
believe this should address commenters' concerns that broker-dealers
otherwise may gain a competitive advantage if they were able to engage
in crowdfunding activities before funding portals are able to comply
with the requirements needed to begin operation.\607\
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\607\ We note that broker-dealers may nonetheless have a
competitive advantage to the extent that they are able to provide a
wider range of services than those permitted funding portals under
the statute. However, we believe this competitive advantage is
balanced to a significant degree by a strong regulatory regime
tailored to that wider range of services.
---------------------------------------------------------------------------
While FINRA is the only registered national securities association
at present, we recognize that a new national securities association or
associations could register with us in the future. At that time, a
funding portal could choose to become a member of the new
association(s) instead of, or in
[[Page 71430]]
addition to, its FINRA membership. As we noted above, we requested
comment on whether we should require membership in both the existing
national securities association (FINRA) and a new national securities
association, if we were to approve another national securities
association in the future. We have considered commenters' views and
have determined not to require that funding portals be members of
multiple securities associations (should new associations be registered
in the future). Because all registered national securities associations
must satisfy the same statutory standards set forth in Exchange Act
Section 15A, we do not believe at this time that requiring membership
in additional associations would add significant investor protections.
After considering comments, we have determined not to impose any
licensing, testing or qualification requirements for associated persons
of funding portals. We believe that a registered national securities
association is well-positioned, given the requirements for registration
as a national securities association, as well as the statutory and
regulatory requirements that apply to such a registered entity, to
determine whether to propose additional requirements such as licensing,
testing or qualification requirements for associated persons of funding
portals.\608\
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\608\ All SROs are required to file proposed rules and rule
changes with us under Exchange Act Section 19(b) and Rule 19b-4. In
general, the Commission reviews proposed SRO rules and rule changes
and publishes them for comment. The Commission then approves or
disapproves them, or the rules become effective immediately or by
operation of law.
---------------------------------------------------------------------------
We also are adopting as proposed the definitions for the terms
``intermediary'' in Rule 300(c)(3). However, we are removing the
definition of ``self-regulatory organization'' and ``SRO'' from the
final rules because the term is already defined in Exchange Act Section
3(a)(26).
b. Financial Interests
(1) Proposed Rules
Securities Act Section 4A(a)(11) requires an intermediary to
prohibit its directors, officers or partners (or any person occupying a
similar status or performing a similar function) from having any
financial interest in an issuer using its services. In the Proposing
Release, we proposed to use our discretion to extend the prohibition to
the intermediary itself. Thus, proposed Rule 300(b) of Regulation
Crowdfunding would prohibit the intermediary, as well as its directors,
officers or partners (or any person occupying a similar status or
performing a similar function), from having: (1) A financial interest
in an issuer using its services; and (2) from receiving a financial
interest in the issuer as compensation for services provided to, or for
the benefit of, the issuer, in connection with the offer and sale of
its securities. Proposed Rule 300(b) defined ``a financial interest in
an issuer'' to mean a direct or indirect ownership of, or economic
interest in, any class of the issuer's securities.
(2) Comments on the Proposed Rules
In general, commenters supported the Commission's proposed
financial interest prohibition as it applies to an intermediary's
directors, officers or partners (or any person occupying a similar
status or performing a similar function),\609\ as well as the proposed
definition of financial interest.\610\ In contrast, however, many
commenters opposed the Commission's proposed prohibition on an
intermediary itself having or receiving a financial interest in the
issuer,\611\ while some supported this proposed prohibition.\612\
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\609\ See, e.g., CFA Institute Letter; Consumer Federation
Letter; Jacobson Letter.
\610\ See, e.g., Hackers/Founders Letter; Joinvestor Letter;
Tiny Cat Letter. See also Consumer Federation Letter (stating that
the Commission should ``monitor practices in this area once rules
are adopted to ensure that the intended limits appropriate to
intermediaries' gatekeeper functions are not being circumvented
through the use of other types of payments or financial
arrangements'').
\611\ See, e.g., AngelList Letter; Anonymous Letter 3; Arctic
Island Letter 6; EMKF Letter; Growthfountain Letter; Guzik Letter 1;
Hackers/Founders Letter; Heritage Letter; Milken Institute Letter;
Propellr Letter 1; Public Startup Letter 2; RoC Letter; RocketHub
Letter; Seyfarth Letter; Thomas Letter 1.
\612\ See, e.g., CFA Institute Letter; Clapman Letter; Consumer
Federation Letter; Jacobson Letter; Joinvestor Letter.
---------------------------------------------------------------------------
Commenters who supported our proposal to extend the prohibition on
financial interests to the intermediary suggested that such
prohibitions may help to mitigate conflicts of interests.\613\ One
commenter stated that an intermediary having a financial interest in
the issuer would skew the incentives of the intermediary toward its own
interests rather than the integrity of the transaction, and also stated
its view that disclosure of this interest could not cure this
problem.\614\
---------------------------------------------------------------------------
\613\ See, e.g., CFA Institute Letter; Consumer Federation
Letter (``An intermediary that is compensated through receipt of a
financial interest in an issuer may have an incentive to take steps
to ensure that the issuer reaches its funding target so that the
offering can move forward or engage in other practices designed to
artificially inflate the value of its securities.''); Jacobson
Letter.
\614\ See Jacobson Letter.
---------------------------------------------------------------------------
Several commenters who opposed the prohibition on an intermediary
having a financial interest in the issuer suggested that the
prohibition would reduce the number and types of intermediaries that
might otherwise participate in crowdfunding activities.\615\ These
commenters asserted that allowing an intermediary to take this
financial interest would provide an option through which issuers could
provide payment to the intermediary for its services, and also permit
co-investments, which would ultimately benefit investors.\616\ These
commenters also asserted that such a financial interest could align the
interests of intermediaries with those of investors.\617\ One commenter
suggested that ``by removing an upfront cost and incentivizing an
ongoing relationship between the intermediary and the issuer, equity
compensation for intermediaries fulfils the Commission's twin aims of
efficient capital markets and investor protection.'' \618\ Another
commenter noted that permitting the intermediary to take a financial
interest in the issuer would encourage the development of funding
portals that are sponsored by or affiliated with Community Development
Financial Institutions (``CDFIs'').\619\ Yet another
[[Page 71431]]
commenter suggested that permitting the intermediary to take a
financial interest in the issuer would incentivize intermediaries to
screen potential issuers for possible fraud or wrongdoing.\620\ Other
commenters supported permitting the intermediary to take a financial
interest in the issuer so long as the terms of the financial interests
taken by the intermediary are the same as or not more favorable than
those taken by investors in the offering.\621\ Commenters suggested
additional measures, such as adequate disclosure,\622\ a five percent
interest limitation,\623\ and restrictions on the ability of an
intermediary to transfer its interests in the issuer, could help to
address any conflicts of interest concerns.\624\
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\615\ See, e.g., Hackers/Founders Letter (``Furthermore, rules
that preclude the [i]ntermediary from holding any financial interest
would overly restrict the [i]ntermediary environment; for example,
such restrictions might prevent a diverse set of platforms from
developing that serve the specific needs of different communities.
The impact of which might disproportionately impact certain
communities, such as the not[hyphen]for[hyphen]profit community.'').
\616\ See, e.g., EMKF Letter (``The current proposed rules with
a fee-based system is a recipe for disaster. No credible startups
that have viable alternatives would choose to pay 5-15% of their
fundraising round in cash to an intermediary.'').
\617\ See, e.g., AngelList Letter (``So long as the program was
consistently applied without judgment by the intermediary, the net
effect would purely be to align the interests of the intermediary
with the investor.''). See also EMKF Letter; Hackers/Founders
Letter; Heritage Letter; Milken Institute Letter; RoC Letter; Thomas
Letter 1.
\618\ Seyfarth Letter.
\619\ See Concerned Capital Letter (suggesting the Commission
broaden the definition of intermediaries to encourage portals
sponsored by and/or affiliated with U.S. Treasury-recognized CDFIs
and exempt such portals from the prohibitions against having a
financial interest in issuers). See also City First Letter
(suggesting that the Commission allow CDFIs to act as co-lenders).
The Community Development Financial Institutions Fund, which
was established by the Riegle Community Development and Regulatory
Improvement Act of 1994, is a government program that promoted
access to capital and local economic growth by, among other things,
investing in, supporting and training CDFIs that provide loans,
investments, financial services and technical assistance to
underserved populations and communities. See generally http://www.cdfifund.gov/what_we_do/programs_id.asp?programID=9. A certified
Community Development Financial Institution (``CDFI'') is a
specialized financial institution that works in market niches that
are underserved by traditional financial institutions. CDFIs provide
a unique range of financial products and services in economically
distressed target markets, such as mortgage financing for low-income
and first-time homebuyers and not-for-profit developers, flexible
underwriting and risk capital for needed community facilities, and
technical assistance, commercial loans and investments to small
start-up or expanding businesses in low-income areas. CDFIs include
regulated institutions such as community development banks and
credit unions, and non-regulated institutions such as loan and
venture capital funds.
\620\ See Anonymous Letter 3.
\621\ See, e.g., Hackers/Founders Letter; Propellr 1 Letter;
Public Startup Letter 2; RocketHub Letter.
\622\ See, e.g., Growthfountain Letter; Hackers/Founders Letter;
Propellr Letter 1; RoC Letter; RocketHub Letter.
\623\ See RocketHub Letter.
\624\ See Hackers/Founders Letter.
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(3) Final Rules
After considering the comments, we are adopting Rule 300(b), as
proposed, with respect to an intermediary's directors, officers or
partners (or any person occupying a similar status or performing a
similar function). Rule 300(b), as adopted, prohibits an intermediary's
directors, officers or partners (or any person occupying a similar
status or performing a similar function) from having any financial
interest in an issuer using its services. Rule 300(b) also specifically
prohibits these persons from receiving a financial interest in the
issuer as compensation for services provided to, or for the benefit of,
the issuer, in connection with the offer and sale of its securities.
Consistent with the proposal, Rule 300(b), as adopted, defines ``a
financial interest in an issuer'' to mean a direct or indirect
ownership of, or economic interest in, any class of the issuer's
securities.\625\
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\625\ As we explained in the Proposing Release, the prohibition
is intended to protect investors from the conflicts of interest that
may arise when the persons facilitating a crowdfunding transaction
have a financial stake in the outcome. 78 FR at 66461. The
prohibition extends to ``any person occupying a similar status or
performing a similar function,'' and applies with respect to both
direct or indirect ownership of, or economic interest in, any class
of the issuer's securities. In addition, we note that Section 15(b)
of the Securities Act creates liability for persons who aid and abet
violations of the Securities Act or the rules and regulations
thereunder, such as would occur if a third person knowingly or
recklessly provided substantial assistance to a director, officer or
partner (or any person occupying a similar status or position), for
example, by accepting and holding, on the officer's behalf, a
financial interest in the issuer in circumvention of the
prohibition.
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We are not adopting, however, the proposed complete prohibition on
the intermediary itself having or receiving a financial interest in an
issuer using its services. Although intermediaries are generally
prohibited under the rule as adopted from having such a financial
interest, as discussed below, in response to comments, we have amended
the rule to permit an intermediary to have a financial interest in an
issuer that is offering or selling securities in reliance on Section
4(a)(6) through the intermediary's platform, provided that: (1) The
intermediary receives the financial interest from the issuer as
compensation for the services provided to, or for the benefit of, the
issuer in connection with the offer or sale of such securities being
offered or sold in reliance on Section 4(a)(6) through the
intermediary's platform; and (2) the financial interest consists of
securities of the same class and having the same terms, conditions and
rights as the securities being offered or sold in reliance on Section
4(a)(6) through the intermediary's platform.
We are mindful of concerns raised by commenters that a prohibition
could have a chilling effect on the ability of small issuers to use the
crowdfunding exemption. These issuers may be small businesses or
neighborhood establishments that may not have the liquid capital to
compensate intermediaries for services. As commenters noted, allowing
an intermediary to have or receive a financial interest in the issuer
could provide a method for the issuer to pay an intermediary for its
services, which may facilitate capital formation. This may, in turn,
encourage the development of funding portals that are, for example,
affiliated with CDFIs, as one commenter suggested.\626\ As commenters
further noted, permitting such a financial interest may also help to
align the interests of intermediaries and investors, and provide an
additional incentive to screen for fraud. We believe at this time the
interest of promoting capital formation for small businesses, and
developing a workable framework for securities-based crowdfunding,
counsels against extending the prohibition on financial interests to
the intermediary itself.
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\626\ See Concerned Capital Letter.
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However, we are cognizant of the potential conflicts of interest
that may arise, and therefore we are placing certain conditions on the
ability of intermediaries to have a financial interest in an issuer
that is offering or selling securities in reliance on Section 4(a)(6)
through the intermediary's platform.\627\ First, the intermediary must
receive the financial interest from the issuer as compensation for the
services provided to, or for the benefit of, the issuer in connection
with the offer or sale of such securities being offered or sold in
reliance on Section 4(a)(6).\628\ We believe that this limitation,
which will allow intermediaries to receive securities as payment for
services but not otherwise permit them to invest in the offering,
addresses commenters' concerns that a prohibition could have a
``chilling effect'' on the ability of small issuers to use the
crowdfunding exemption, while serving to mitigate concerns relating to
intermediaries taking steps to ``artificially inflate'' the value of
securities in the offerings.\629\ Second, we have considered the
comments in support of limiting an intermediary's financial interest by
requiring that such interest be the same as or not more favorable than
those taken by investors in the offering,\630\ and have determined to
prohibit intermediaries from receiving a financial interest unless it
is in securities that are of the same class, and that have the same
terms, conditions and rights as the securities in the offering. We
believe that this limitation will further serve to mitigate any
potential conflicts by helping to align
[[Page 71432]]
the interests of the intermediary with those of the investors in the
offering.\631\
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\627\ See notes 613-614 and accompanying text.
\628\ As noted above in Section II.C.2, an intermediary must be
either a registered funding portal or a registered broker-dealer,
and must be a member of a registered national securities
association. FINRA rules currently require that its broker-dealer
members charge reasonable fees for their services and observe just
and equitable principles of trade in the conduct of their business.
FINRA has also filed a proposed rule change with the Commission to
apply certain rules to funding portals, including requiring them to
observe high standards of commercial honor and just and equitable
principles of trade in the conduct of their businesses. See Proposed
Rule Change to Adopt the Funding Portal Rules and Related Forms and
FINRA Rule 4518, SR-FINRA-2015-040 (Oct. 9, 2015).
\629\ See Consumer Federation Letter.
\630\ See note 621.
\631\ The rule does not preclude an intermediary from receiving
securities as compensation for services from the same issuer for a
subsequent offering conducted by the issuer in reliance on Section
4(a)(6) as long as the securities received are compensation for
services provided during the subsequent offering and are of the same
class and have the same terms, conditions and rights as the
securities being offered in the subsequent offering.
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We are persuaded that the disclosures otherwise required by
Regulation Crowdfunding also will help to address any potential
conflicts of interest arising from an intermediary having or receiving
a financial interest in an issuer. Among other things, Rule 302(d)
requires an intermediary to clearly disclose the manner in which it
will be compensated in connection with offerings and sales of
securities made in reliance on Section 4(a)(6) at account opening and
Rule 303(f) requires disclosure of remuneration received by an
intermediary (including securities received as remuneration) on
confirmations.\632\ We believe that these disclosures will provide
investors with relevant information concerning any intermediary's
financial interests (including whether such interest was acquired on
the same terms that are available to investors), which, in turn, will
help investors to make better informed investment decisions. In
addition, the intermediary must comply with all other applicable
requirements of Regulation Crowdfunding, including the statutory
limitations on a funding portal's activities.\633\
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\632\ See Sections II.C.4.d and II.C.5.f. See also Rule 302(c)
of Regulation Crowdfunding (requiring intermediaries to inform
investors, at the time of account opening, that promoters must
clearly disclose in all communications on the platform the receipt
of compensation and the fact that he or she is engaging in
promotional activities on behalf of the issuer).
\633\ See Exchange Act Section 3(a)(80) (defining ``funding
portal'' and establishing certain limitations on their activities
consistent with the statute, such as prohibiting a funding portal
from offering investment advice or recommendation; soliciting
purchases, sales or offers to buy securities offered or displayed on
its Web site or portal; or holding, managing, possessing, or
otherwise handling investor funds or securities). In this regard,
compliance with disclosures required by Regulation Crowdfunding
generally would not cause a funding portal to provide investment
advice or recommendations. Nonetheless, a funding portal should seek
to ensure that disclosure of its financial interest(s) in an issuer
is not inconsistent with the statutory prohibition on providing
investment advice or recommendations. For example, a funding portal
must not present its financial interest in an issuer as a
recommendation or endorsement of that issuer. See Section II.D.3. We
also note that if a funding portal holds, owns or proposes to
acquire securities issued by an issuer, or multiple issuers, that
individually or in aggregate exceed more than 40% of the value of
the funding portal's total assets (excluding government securities
and cash items) on an unconsolidated basis, the funding portal may
fall within the definition of investment company under Section
3(a)(1)(C) of the Investment Company Act. We generally would expect,
however, that such funding portal would seek to rely on the
exclusion from the definition of investment company in Section
3(c)(2) of the Investment Company Act for (among other things) a
person primarily engaged in the business of acting as a broker.
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Commission staff expects to review the compensation structure of
intermediaries during the study of the federal crowdfunding exemption
it plans to undertake no later than three years following the effective
date of Regulation Crowdfunding.\634\
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\634\ See Section II.
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3. Measures To Reduce Risk of Fraud
Securities Act Section 4A(a)(5) requires an intermediary to ``take
such measures to reduce the risk of fraud with respect to [transactions
made in reliance on Section 4(a)(6)], as established by the Commission,
by rule, including obtaining a background and securities enforcement
regulatory history check on each officer, director, and person holding
more than 20 percent of the outstanding equity of every issuer whose
securities are offered by such person.'' As discussed below, after
considering the comments, we are adopting Rule 301 of Regulation
Crowdfunding substantially as proposed, with a few changes to Rule
301(c)(2).
a. Issuer Compliance
(1) Proposed Rule
We proposed in Rule 301(a) of Regulation Crowdfunding to require
that an intermediary have a reasonable basis for believing that an
issuer seeking to offer or sell securities though the intermediary's
platform complies with the requirements of Section 4(a)(6) and the
related requirements of Regulation Crowdfunding. For this requirement,
we proposed that an intermediary may reasonably rely on an issuer's
representations about compliance unless the intermediary has reason to
question the reliability of those representations.
(2) Comments on Proposed Rule
Commenters generally agreed that intermediaries play a significant
role in preventing and detecting fraud and should take measures to
reduce potential fraud. Some commenters, however, expressed concerns
about the proposed ``reasonable basis'' standard for an intermediary's
belief about an issuer's compliance with applicable laws stating that
the standard should be higher.\635\ Others commenters supported the
standard.\636\
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\635\ See, e.g., AFR Letter; ASTTC Letter; Computershare Letter;
Consumer Federation Letter; CSTTC Letter; Grassi Letter; Merkley
Letter; NYSSCPA Letter.
\636\ See, e.g., RocketHub Letter; STA Letter.
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A number of commenters expressed concern about the proposed
reliance on issuer representations.\637\ Some commenters suggested an
intermediary should be required to conduct some type of due diligence
on the issuer, as opposed to relying on issuer representations.\638\
Another commenter went further by suggesting that an intermediary
should also have an ongoing obligation to monitor communications by
issuers during the course of the offering to detect and prevent
violations of the securities laws and the regulations thereunder.\639\
Another commenter stated that an issuer's representation should not
suffice unless it is detailed enough to evidence a reasonable awareness
by the issuer of its key obligations and the ability to comply with
those obligations.\640\
---------------------------------------------------------------------------
\637\ See, e.g., AFR Letter; Computershare Letter; Consumer
Federation Letter; Merkley Letter.
\638\ See, e.g., CSTTC Letter; Grassi Letter; NYSSCPA Letter;
Consumer Federation Letter (stating that an intermediary's
responsibility is rendered meaningless without establishing specific
standards that require due diligence in order to reasonably conclude
the issuer is in compliance).
\639\ See AFR Letter (``[T]he Commission's proposal to allow
intermediaries to rely on self-certification by issuers makes a
mockery of its proposed requirement that intermediaries have `a
reasonable basis for believing that an issuer seeking to offer and
sell securities in reliance on Section 4(a)(6), through the
intermediary's platform, complies with the requirements in
Securities Act Section 4A(b) and the related requirements in
Regulation Crowdfunding.' '').
\640\ See STA Letter.
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One commenter argued that the language of the proposed rule was
contradictory because relying on representations made by the issuer is
not the same as establishing a reasonable basis for believing the
issuer is in compliance.\641\
---------------------------------------------------------------------------
\641\ See ABA Letter.
---------------------------------------------------------------------------
One commenter recommended that the Commission ``consider a tiered
approach to compliance obligations'' where, as the size of the offering
or other risk factors increased, intermediaries would be required to
conduct more rigorous compliance reviews.\642\ Under such an approach,
this commenter stated that for small offerings that cap investments at
a low level, $500 for example, and where there is no participation by
individuals with a history of security law violations, the intermediary
would be permitted to
[[Page 71433]]
rely on representations by issuers to satisfy its obligation to ensure
compliance. As the size of the offering, the size of permitted
investments, or other risk factors increase, the commenter stated that
the Commission should consider requiring intermediaries to conduct more
rigorous compliance reviews.
---------------------------------------------------------------------------
\642\ See IAC Recommendation; see also BetterInvesting Letter.
---------------------------------------------------------------------------
(3) Final Rule
Rule 301(a), as adopted, requires that an intermediary have a
reasonable basis for believing that an issuer seeking to offer and sell
securities in reliance on Section 4(a)(6) through the intermediary's
platform complies with the requirements in Securities Act Section 4A(b)
and the related requirements in Regulation Crowdfunding. While some
commenters argued for higher or different standards, such as requiring
intermediaries to conduct due diligence on issuers or monitor
communications by issuers during the course of the offering, we believe
that a reasonable basis standard is appropriate, particularly in view
of the issuer's own obligation to comply with the requirements in
Section 4A(b) and the related requirements in Regulation Crowdfunding.
We are mindful as well of the associated costs of a potentially higher
standard. Consistent with the proposal, Rule 301(a) also permits
intermediaries to reasonably rely on representations of the issuer,
unless the intermediary has reason to question the reliability of those
representations.
In satisfying the requirements of Rule 301(a), we emphasize that an
intermediary has a responsibility to assess whether it may reasonably
rely on an issuer's representation of compliance through the course of
its interactions with potential issuers.\643\ We agree with comments
that an intermediary seeking to rely on an issuer representation should
consider whether the representation is detailed enough to evidence a
reasonable awareness by the issuer of its obligations and its ability
to comply with those obligations. The specific steps an intermediary
should take to determine whether it can rely on an issuer
representation may vary, but should be influenced by and tailored
according to the intermediary's knowledge and comfort with each
particular issuer. We believe this approach is generally consistent
with the view of one commenter that suggested a tiered approach to
compliance obligations where intermediaries should conduct more
rigorous compliance reviews and background checks as risk factors
increase.\644\
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\643\ In addition, an intermediary's potential liability under
Securities Act Section 4A(c), as added by the JOBS Act, may
encourage intermediaries to develop adequate procedures to fully
assess whether reliance on an issuer's representation is reasonable.
We also note that Congress provided a defense to any such liability
if an intermediary did not know, and in the exercise of reasonable
care could not have known, of the untruth or omission. Therefore,
and as identified in the Proposing Release, we continue to believe
that there are appropriate steps that intermediaries might take in
exercising reasonable care in light of this liability provision. See
Section II.E.5 (discussing scope of statutory liability).
\644\ We also emphasize that when an intermediary seeks to rely
on the representations of others to form a reasonable basis, the
intermediary should have policies and procedures regarding under
what circumstances it can reasonably rely on such representations
and when additional investigative steps may be appropriate. See
Section II.D.4.
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b. Records of Securities Holders
(1) Proposed Rule
We proposed in Rule 301(b) of Regulation Crowdfunding a requirement
that an intermediary have a reasonable basis for believing that an
issuer has established means to keep accurate records of the holders of
the securities it would offer and sell through the intermediary's
platform. We proposed that an intermediary may reasonably rely on an
issuer's representations about compliance unless the intermediary has
reason to question the reliability of those representations. We did not
propose a particular form or method of recordkeeping of securities, nor
did we propose to require that an issuer use a transfer agent or other
third party.\645\ We noted, however, that requiring a registered
transfer agent to be involved after the offering could introduce a
regulated entity with experience in maintaining accurate shareholder
records,\646\ and we asked in the Proposing Release whether we should
require an issuer to use a regulated transfer agent to keep such
records and whether there were less costly means by which an issuer
could rely on a third party to assist with the recordkeeping.\647\
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\645\ Proposing Release, 78 FR at 66462.
\646\ Id.
\647\ Id. at 66464.
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(2) Comments on Proposed Rule
Commenters agreed that an intermediary should have a basis for
believing that an issuer has established a means to keep accurate
records.\648\ Commenters were divided, however, between those who
supported \649\ and those who opposed \650\ any requirement mandating
the use of a registered transfer agent. Commenters supporting the
required use of registered transfer agents cited potential benefits,
including reducing internal costs and providing corporate transparency;
\651\ having the transfer agent serve as the issuer's paying agent,
proxy agent, exchange agent, tender agent and mailing agent for ongoing
reports; \652\ providing a back-up and recovery system for records;
\653\ and conducting internal audits to protect against theft.\654\
Some commenters also highlighted potential problems when non-registered
transfer agents or the issuer maintains records, including improper
registration of multiple owners, duplicate records, missing certificate
numbers, inability to trace ownership, and inability to maintain
records; \655\ and incorrect handling of corporate actions, failure to
observe restrictions on transfers, and failure to follow abandoned
property reporting requirements.\656\ One commenter suggested that the
Commission should identify specific areas for an intermediary to
consider about an issuer's recordkeeping capabilities when determining
whether or not to provide access to that issuer.\657\ This commenter
also urged the Commission to create a safe harbor whereby an
intermediary would be deemed to have met the recordkeeping requirement
if the issuer has retained a registered transfer agent or registered
broker-dealer.\658\
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\648\ See, e.g., Arctic Island Letter 5; ASTTC Letter; CFIRA
Letter 8; Computershare Letter; CST Letter; CSTTC Letter; FAST
Letter; Grassi Letter; Joinvestor Letter; Public Startup Letter 2;
RocketHub Letter; STA Letter; Tiny Cat Letter.
\649\ See, e.g., ASTTC Letter; ClearTrust Letter; CST Letter;
CSTTC Letter; Empire Stock Letter; Equity Stock Letter; FAST Letter;
Sharewave Letter; Stalt Letter.
\650\ See, e.g., Arctic Island Letter 5; CapSchedule Letter;
CFIRA Letter 8; Computershare Letter; Grassi Letter; Joinvestor
Letter; NYSSCPA Letter; Public Startup Letter 2; RocketHub Letter;
Tiny Cat Letter.
\651\ See CST Letter.
\652\ See Empire Stock Letter.
\653\ See FAST Letter.
\654\ Id.
\655\ See, e.g., ClearTrust Letter; STA Letter; Stalt Letter.
\656\ See STA Letter.
\657\ Id.
\658\ Id. The commenter also stated that such a safe harbor
would encourage third-party recordkeepers to register as transfer
agents and thereby enhance protection to investors. The commenter
further stated that the safe harbor should not apply if a community
bank is utilized because it would not have similar recordkeeping
experience. See also Computershare Letter (stating that a safe
harbor should apply if another regulated entity, such as a broker-
dealer or a bank, is engaged to perform the services, which in turn
may encourage the use of professional regulated recordkeepers, thus
enhancing overall protection in the crowdfunding market).
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Commenters that opposed the mandatory use of a registered transfer
[[Page 71434]]
agent pointed to cost concerns.\659\ Some of these commenters stated
that alternatives to transfer agents will develop, including CPA
firms,\660\ registered broker-dealers \661\ and software applications
or other potential low-cost alternatives.\662\ Some commenters stated
that intermediaries should be permitted to provide the relevant
recording services to issuers.\663\ One commenter suggested funding
portals should only be permitted to do so with respect to securities
purchased on their platform or transferred among platforms, such that
they would not be permitted to act as ``full-fledged [b]rokerage firms
or transfer agents.'' \664\
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\659\ See, e.g., AICPA Letter; Arctic Island Letter 5;
CapSchedule Letter; CFIRA Letter 8; Computershare Letter; Grassi
Letter; Joinvestor Letter; RocketHub Letter; STA Letter; Tiny Cat
Letter.
\660\ See, e.g., Grassi Letter; NYSSCPA Letter.
\661\ See Public Startup Letter 2.
\662\ See Arctic Island Letter 5.
\663\ See, e.g., Joinvestor Letter; RocketHub Letter.
\664\ See RocketHub Letter.
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(3) Final Rules
After considering the comments, we are adopting Rule 301(b), as
proposed, with one modification. Rule 301(b) as adopted requires an
intermediary to have a reasonable basis for believing that an issuer
has established means to keep accurate records of the holders of the
securities it would offer and sell through the intermediary's platform,
and provides that in satisfying this requirement, an intermediary may
rely on the representations of the issuer concerning its means of
recordkeeping unless the intermediary has reason to question the
reliability of those representations. We also are adding a provision to
Rule 301(b) as adopted stating that an intermediary will be deemed to
have satisfied this requirement if the issuer has engaged the services
of a transfer agent that is registered under Section 17A of the
Exchange Act.\665\ As we noted in the Proposing Release, we believe
that the recordkeeping function may be provided by the issuer, a
broker, a transfer agent or some other (registered or unregistered)
person. We recognize that, as a commenter explained, recordkeeping
functions can be extensive and could include, for example, the ability
to (1) monitor the issuance of the securities the issuer offers and
sells through the intermediary's platform, (2) maintain a master
security holder list reflecting the owners of those securities, (3)
maintain a transfer journal or other such log recording any transfer of
ownership, (4) effect the exchange or conversion of any applicable
securities, (5) maintain a control book demonstrating the historical
registration of those securities, and (6) countersign or legend
physical certificates of those securities. While the use of a
registered transfer agent could introduce a regulated entity with
experience in maintaining accurate shareholder records, as noted in the
Proposing Release, we believe the issuer should have flexibility in
establishing such means, and that such flexibility may allow for
competition among service providers that could reduce operating costs
for funding portals. We continue to believe that accurate recordkeeping
can be accomplished by diligent issuers or through a variety of third
parties. We note also that, for investors to have confidence in
crowdfunding, issuers and intermediaries must have a shared interest in
ensuring stability and accuracy of records. Therefore, intermediaries
should consider the numerous obligations required of a record holder
when determining whether an issuer has established a reasonable means
to keep accurate records of the security holders being offered and sold
securities through the intermediary's platform.
---------------------------------------------------------------------------
\665\ 15 U.S.C. 78q-1(c). We also note that an issuer's
exemption from Section 12(g) is conditioned on, among other things,
that issuer engaging a registered transfer agent. See Section
II.E.4.
---------------------------------------------------------------------------
At the same time, mindful of the role that may be played by
registered transfer agents in maintaining accurate shareholder records,
we are providing a safe harbor for compliance with Rule 301(b) for
those issuers that use a registered transfer agent. While we do not
intend to provide regulated entities with a competitive advantage over
other recordkeeping options that comply with the rule's requirements,
we believe it is appropriate to provide certainty as to Rule 301(b)
compliance in instances in which an issuer has engaged the services of
a transfer agent that is registered under Section 17A of the Exchange
Act.
c. Denial of Platform Access
(1) Proposed Rule
We also proposed in Rule 301(c)(1) of Regulation Crowdfunding a
requirement that an intermediary deny access by an issuer to its
platform if it has a reasonable basis for believing that an issuer, or
any of its officers, directors or any person occupying a similar status
or performing a similar function, or any 20 Percent Beneficial Owner is
subject to a disqualification under proposed Rule 503.\666\ In
satisfying this requirement, we proposed to require an intermediary to,
at a minimum, conduct a background and securities enforcement
regulatory history check on each issuer whose securities are to be
offered by the intermediary and on each officer, director or 20 Percent
Beneficial Owner.
---------------------------------------------------------------------------
\666\ See Section II.E.6 (discussing Rule 503 of Regulation
Crowdfunding, which describes disqualification).
---------------------------------------------------------------------------
We further proposed in Rule 301(c)(2) to require an intermediary to
deny access to its platform if the intermediary believes the issuer or
offering presents the potential for fraud or otherwise raises concerns
about investor protection. In satisfying this requirement, the proposed
rule would require that an intermediary deny access if it believes that
it is unable to adequately or effectively assess the risk of fraud of
the issuer or its potential offering. In addition, we proposed in Rule
301(c)(2) that if an intermediary becomes aware of information after it
has granted access that causes it to believe the issuer or the offering
presents the potential for fraud or otherwise raises concerns about
investor protection, the intermediary would be required to promptly
remove the offering from its platform, cancel the offering, and return
(or, for funding portals, direct the return of) any funds that have
been committed by investors in the offering.
(2) Comments on Proposed Rule
Commenters generally supported proposed Rule 301(c).\667\
Commenters noted with approval the discretion the proposed rules would
provide intermediaries.\668\ The ``reasonable basis'' standard in
proposed Rule 301(c)(1) also garnered comments. One commenter suggested
that the reasonable basis standard was not strong enough.\669\ One
commenter stated that having a reasonable basis standard in the
disqualification determination would be ``difficult to imagine'' unless
the Commission maintains a database for intermediaries to search.\670\
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\667\ See, e.g., CFA Institute Letter; StartupValley Letter.
\668\ Id.
\669\ See NYSSCPA Letter (opposing the use of two different
standards within Rule 301(c) as it could lead to confusion and
presents vulnerability for fraud to occur through the ``weakest
link,'' and suggesting instead that a ``prudent care'' standard
should be used for both requirements).
\670\ See Public Startup Letter 2.
---------------------------------------------------------------------------
Commenters had varied views on the proposed requirement in Rule
301(c)(1) for an intermediary to perform a background check on the
issuer and certain of its affiliated persons. Several commenters
supported the requirement,
[[Page 71435]]
but a few commenters suggested ways to decrease costs.\671\ One
commenter stated that only low-cost, minimum requirements should be
implemented,\672\ while another commenter suggested that the background
checks be required only after an issuer has met its target offering
amount so as to prevent unnecessary expense to the intermediary.\673\
Representing a different view, one commenter opposed a requirement for
background checks to be conducted on all persons related to an
issuer.\674\ Another commenter noted that the checks would be
appropriate, but did not support the requirement.\675\
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\671\ See, e.g., AFR Letter; CFA Institute Letter; Grassi
Letter; Joinvestor Letter; NYSSCPA Letter.
\672\ See RocketHub Letter.
\673\ See Anonymous Letter 4.
\674\ See Zhang Letter.
\675\ See Public Startup Letter 2.
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Commenters were divided as to whether we should set specific
requirements for background checks. One commenter stated that the
proposal ``fails to set even the most general of standards for these
checks'' and ``instead relies on intermediaries to use their experience
and judgment to reduce the risk of fraud.'' \676\ The same commenter
stated that the proposed approach is flawed and as such the checks are
likely to be ineffective, especially because many intermediaries are
likely to be inexperienced.\677\ Several commenters requested further
clarification and specification about required checks.\678\ However,
other commenters stated that the Commission should not specify steps
for an intermediary to take in conducting checks.\679\
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\676\ See Consumer Federation Letter.
\677\ Id.
\678\ See, e.g., BetterInvesting Letter; Heritage Letter; IAC
Recommendation; Jacobson Letter; NSBA Letter. See also RocketHub
Letter (stating that intermediaries ``should be allowed to satisfy
their obligations by checking commonly used databases for criminal
background, bankruptcy filings, and tax liens, as well as cross
check against the Office of Foreign Assets Control (OFAC) sanctions
lists, and Specially Designated Nationals (SDN) and Blocked Persons
lists''); Bullock Letter (recommending fingerprinting for key issuer
personnel and noting that most sheriff's departments in most U.S.
counties can take fingerprints for a small fee).
\679\ See, e.g., StartupValley Letter; Vann Letter.
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With respect to our request for comment on whether intermediaries
should be required to make the results of background checks public,
several commenters opposed the requirement,\680\ while some supported
it.\681\ Another commenter stated its view that the results should not
be made public unless a regulator called them into question.\682\
Another commenter explained that issuers should be able to publish the
results if they choose, but no such requirement should be placed on
intermediaries.\683\ One commenter urged us to ``require that a summary
of the sources consulted as part of the background check be posted on
the [portal's] Web site.'' \684\
---------------------------------------------------------------------------
\680\ See, e.g., Grassi Letter; Joinvestor Letter; NYSSCPA
Letter; Public Startup Letter 2; StartupValley Letter.
\681\ See, e.g., AFR Letter; Consumer Federation Letter.
\682\ See Joinvestor Letter.
\683\ See Public Startup Letter 2.
\684\ IAC Recommendation (suggesting that ``[r]equiring posting
of information about the sources consulted in compiling the reports
would better enable investors to evaluate the thoroughness of the
background check, thus creating an incentive for intermediaries to
conduct thorough reviews in the absence of clear Commission
guidelines''); see also BetterInvesting Letter.
---------------------------------------------------------------------------
As to proposed Rule 301(c)(2) requiring a funding portal to deny
access if the intermediary believes the issuer or offering presents the
potential for fraud or otherwise raises concerns regarding investor
protection, one commenter stated that the proposed requirement
conflicts with the restrictions on a funding portal's ability to limit
the offerings on its platform in proposed Rule 402(b)(1).\685\
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\685\ See Guzik Letter 1 (noting that under the proposed rules,
an intermediary which is not a broker-dealer is prohibited from, at
least in that commenter's view, ``curating,'' that is, ``excluding
companies from its platform based upon qualitative factors, such as
quality of management, valuation of the company, market size, need
for additional capital, pending litigation, or other qualitative
factors which increase the risk to an investor'').
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Regarding the standard for denial based on potential fraud or
investor protection concerns in the proposed rule, one commenter
suggested a stronger standard,\686\ while another suggested a weaker
standard.\687\ Other commenters suggested that the standard for an
intermediary to deny access to its platform is unclear.\688\ One
commenter urged the Commission to require that a funding portal post on
its Web site a description of its standards for determining which
offerings present a risk of fraud.'' \689\
---------------------------------------------------------------------------
\686\ See note 669 (discussing the NYSSCPA Letter, which
suggested a ``prudent care'' standard for denying issuers under Rule
301(c)).
\687\ See Grassi Letter (stating that an intermediary ``should
not be required to vet issuers for potential fraud other than would
be done through the normal course of assessing whether they wish to
do business with a particular issuer'').
\688\ See, e.g., BetterInvesting Letter; Heritage Letter; IAC
Recommendation; Jacobson Letter; NSBA Letter.
\689\ See IAC Recommendation; see also BetterInvesting Letter.
---------------------------------------------------------------------------
One commenter stated the intermediaries should be required to
report denied issuers, noting that it would not only help prevent fraud
but also assist other intermediaries in excluding issuers already
discovered to be disqualified.\690\ Other commenters disagreed with
this suggestion,\691\ while one commenter stated that reporting should
be required only if the Commission or another agency created a database
for such information.\692\ One of these commenters suggested that
intermediaries should be required to notify a potential issuer when the
intermediary uses information from a third party to deny the
issuer.\693\
---------------------------------------------------------------------------
\690\ See Joinvestor Letter. See also ASSOB Letter and Vann
Letter.
\691\ See, e.g., Public Startup Letter 2 (opposing the
requirement but suggesting that the Commission maintain a database
of known bad actors).
\692\ See StartupValley Letter.
\693\ See Vann Letter.
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(3) Final Rules
After considering the comments, we are adopting Rule 301(c)(1) as
proposed. Rule 301(c)(1) requires an intermediary to deny access to its
platform if the intermediary has a reasonable basis for believing that
an issuer, or any of its officers, directors (or any person occupying a
similar status or performing a similar function), or any 20 Percent
Beneficial Owner is subject to a disqualification under Rule 503 of
Regulation Crowdfunding. We believe that a ``reasonable basis''
standard for denying access is an appropriate standard for Rule
301(c)(1), in part because this requirement on an intermediary is
buttressed by the fact that an issuer independently is subject to the
disqualification provisions under Rule 503, as discussed below.\694\ In
addition, Rule 301(c)(1) implements the requirement of Section 4A(a)(5)
that an intermediary conduct a background and securities enforcement
regulatory history check on each issuer whose securities are to be
offered by the intermediary, as well as on each of its officers,
directors (or any person occupying a similar status or performing a
similar function) and 20 Percent Beneficial Owners.
---------------------------------------------------------------------------
\694\ See Section II.E.6 (discussing issuer disqualification).
---------------------------------------------------------------------------
While we understand commenters' concerns about the cost of the
requirement that intermediaries conduct background checks on issuers
and certain affiliated persons, we are not eliminating or limiting the
requirement as suggested by commenters because we believe the
requirement is an important tool for intermediaries to employ when
determining whether or not they have a reasonable basis to allow
issuers on their platforms. Even though a number of commenters
requested that the
[[Page 71436]]
Commission provide specific requirements for background and securities
enforcement regulatory history checks, we are not establishing specific
procedures in the final rules. As we indicated in the Proposing
Release, we believe that the better approach is to allow an
intermediary to be guided by its experience and judgment to design
systems and processes to help reduce the risk of fraud in securities-
based crowdfunding.\695\ We also believe that such flexibility could
mitigate cost concerns related to conducting the background and
securities enforcement regulatory history checks.
---------------------------------------------------------------------------
\695\ We disagree with the commenter that suggested that this
method is ineffective because intermediaries lack experience. See
Consumer Federation Letter. Crowdfunding is a new form of capital
formation. We believe broker-dealers and funding portals will gain
the relevant experience that will appropriately position them to
develop requirements for conducting background checks required by
the rule. In addition, we believe that an intermediary's interest in
developing a successful platform will motivate it to conduct
rigorous background checks.
---------------------------------------------------------------------------
We are not developing a database of denied issuers as suggested by
some commenters because we do not believe it would significantly
increase investor protection. The requirement to deny an issuer access
to a crowdfunding platform under the final rules based on fraud or
other investor protection concerns is important to the viability of
crowdfunding, and the legitimacy of the intermediary. This obligation
is the responsibility of each intermediary, which must make a
determination about whether to deny access to an issuer. While a third
party may decide to create a database of denied issuers at some point
and an intermediary could use such a database to help make its
determination as to whether it was required to deny access to an
issuer, such a database could not be used as a substitute for an
intermediary making its own determination.
We also are not requiring an intermediary to make publicly
available the results of the background checks or the sources
consulted. We believe that the goal of the background check is
sufficiently served by the exclusion of an issuer from the
intermediary's platform. We do not believe that making the results or
sources publicly available adds a significant degree of investor
protection under these circumstances, given the potential problems that
could arise from such public disclosure of the results, such as the
risk of disclosing personally identifiable information or other
information with significant potential for misuse. In addition, we are
concerned that such requirements could add to the cost of
administration and could expose the individuals at the issuer that are
subject to a background check to harm, for example, if there were
errors in the information made publicly available.
We are adopting Rule 301(c)(2) substantially as proposed, but with
certain revisions. As adopted, Rule 301(c)(2) now contains a
``reasonable basis'' standard as opposed to the initially proposed
``believes'' standard. Rule 301(c)(2) requires denial of access to its
platform when the intermediary has a reasonable basis for believing
that the issuer or offering presents the potential for fraud or
otherwise raises concerns about investor protection.\696\ In a
conforming change, Rule 301(c)(2) also requires (i) an intermediary
deny access to an issuer if it reasonably believes that it is unable to
adequately or effectively assess the risk of fraud of the issuer or its
potential offering, and (ii) if the intermediary becomes aware of
information after it has granted the issuer access to its platform that
causes it to reasonably believe that the issuer or the offering
presents the potential for fraud or otherwise raises concerns regarding
investor protection, the intermediary must promptly remove the offering
from its platform, cancel the offering and return to investors any
funds they may have committed.
---------------------------------------------------------------------------
\696\ See Section II.D.2. (discussing modified Rule 402(b)(1),
which relates to a funding portal's ability to deny access to an
issuer).
---------------------------------------------------------------------------
We believe that a ``reasonable basis'' standard is appropriate for
Rule 301(c)(2) because it is a more objective standard.\697\ Under this
standard, an intermediary may not ignore facts about an issuer that
indicate fraud or investor protection concerns such that a reasonable
person would have denied access to the platform or cancelled the
offering. Rule 301(c)(2) is intended to give an intermediary an
objective standard regarding the circumstances in which it must act to
protect its investors from potentially fraudulent issuers or ones that
otherwise present red flags concerning investor protection. This
objective standard also will make it easier for an intermediary to
assess whether it would be compliant with Rule 301(c)(2) when deciding
if it should deny an issuer access or cancel its offering.\698\ Thus,
we believe these measures likely will promote compliance and help to
reduce the risk of fraud with respect to crowdfunding transactions, as
required by Section 4A(a)(5). This standard also will provide the
Commission with a clear basis to review whether an intermediary's
decision not to deny access to its platform or cancel an offering was
reasonable given the facts and circumstances.
---------------------------------------------------------------------------
\697\ Adding the reasonable basis standard to Rule 301(c)(2)
also provides a consistent standard across Rule 301, including Rules
301(a), (b) and (c)(1).
\698\ Aside from the requirement to deny access to issuers under
Rule 302(c)(2), it is important to note that intermediaries are
permitted to determine whether and under what terms to allow an
issuer to offer and sell securities in reliance on Section 4(a)(6)
of the Securities Act (15 U.S.C. 77d(a)(6)) through their platforms.
See Rule 402(b)(1) and Section II.D.3. The objective standard under
Rule 301(c)(2) also helps to clarify that a funding portal would not
be providing investment advice or recommendations, if it denies
access to or cancels an offering because it has a reasonable basis
for believing that there is a potential for fraud or other investor
protection concerns. See Rule 402(b)(10) of Regulation Crowdfunding
and Section II.D.3.i.
---------------------------------------------------------------------------
We are not requiring that an intermediary report the issuers that
have been denied access to its platforms, as some commenters suggested,
or that the intermediary post a summary of the sources consulted as
part of the background check on its platform along with a description
of the intermediary's standards for determining which offerings present
a risk of fraud. We also are not adopting a requirement, as suggested
by a commenter, that an intermediary notify a potential issuer when the
intermediary utilizes third-party information to deny access to the
issuer. As with background checks, discussed above, we believe that the
investor protection goal is sufficiently served by the exclusion of an
issuer from the intermediary's platform. In addition, we are concerned
that such requirements could add to the cost of administration and
could expose the issuers in question to harm, for example, if there
were errors in the information made publicly available. Likewise, we do
not believe that requiring an intermediary to post to its Web site a
summary of the sources consulted as part of the background check and a
description of the intermediary's standards for determining which
offerings present a risk of fraud would sufficiently increase investor
protection to justify the burdens, such as those outlined above, that
would be associated with imposing such requirements. We also note that
providing this information on an intermediary's Web site may give
potentially fraudulent issuers or those that otherwise present investor
protection concerns a roadmap to an intermediary's proprietary
procedures for screening for fraud that could assist such issuers with
impeding or obstructing intermediaries from detecting offerings that
present a risk of fraud.
[[Page 71437]]
4. Account Opening
a. Accounts and Electronic Delivery
(1) Proposed Rule
Proposed Rule 302(a)(1) of Regulation Crowdfunding would prohibit
an intermediary or its associated persons from accepting an investment
commitment in a transaction involving the offer or sale of securities
in reliance on Section 4(a)(6) unless the investor has opened an
account with the intermediary, and the intermediary has obtained from
the investor consent to electronic delivery of materials. Proposed Rule
302(a)(2) would require an intermediary to provide all information
required by Subpart C of Regulation Crowdfunding, including, but not
limited to, educational materials, notices and confirmations, through
electronic means.
Proposed Rule 302(a)(2) also would require an intermediary to
provide such information through an electronic message that either
contains the information, includes a specific link to the information
as posted on the intermediary's platform, or provides notice of what
the information is and that it is located on the intermediary's
platform or the issuer's Web site. As proposed, Rule 302(a)(2) stated
that electronic messages would include, but not be limited to, messages
sent via email.
(2) Comments on the Proposed Rule
One commenter suggested that intermediaries who are brokers should
not be required to open new accounts for persons who are existing
customers of the broker.\699\ In response to our request for comments
on whether an intermediary should be required to obtain specific
information from investors, and if so what type of information should
be required, some commenters generally supported requiring an
intermediary to gather specific information from investors,
particularly identifying information that could help prevent duplicate
or fraudulent accounts and information about other intermediary
accounts and investments.\700\ A few of these commenters supported the
Commission requiring intermediaries to collect investors' social
security numbers.\701\ One commenter opposed the Commission requiring
intermediaries to obtain particular information from investors.\702\
---------------------------------------------------------------------------
\699\ See Arctic Island Letter 2.
\700\ See, e.g., Consumer Federation Letter; Jacobson Letter;
RocketHub Letter.
\701\ See, e.g., Consumer Federation Letter; RocketHub Letter.
\702\ See Public Startup Letter 3.
---------------------------------------------------------------------------
With respect to electronic delivery, some commenters urged that it
should be sufficient for the intermediary simply to make Subpart C
materials, such as educational materials, notices and confirmations,
available on the intermediary's platform for investors to access.\703\
Other commenters broadly opposed permitting intermediaries to satisfy
their information delivery requirement by providing an electronic
message that informs an investor that information can be found on the
intermediary's platform or an issuer's Web site.\704\ One commenter
suggested that investors may not actually receive required disclosures
because they will not spend the time to find the information.\705\
Another commenter suggested that the Commission should ``continue to
rely instead on the strong and effective policy for electronic delivery
of disclosure adopted by the Commission in the mid-1990s.'' \706\ The
same commenter noted that it would be ``a simple matter to require that
any electronic message through which disclosures are delivered include,
at a minimum, the specific URL where the required disclosures can be
found.'' \707\
---------------------------------------------------------------------------
\703\ See, e.g., ASSOB Letter; CrowdCheck Letter 1; RocketHub
Letter; Wefunder Letter; Vann Letter.
\704\ See, e.g., BetterInvesting Letter; AFR Letter; IAC
Recommendation; Consumer Federation Letter (``The definition of
electronic delivery must be revised to ensure the disclosures
themselves, and not just notices of the availability of disclosures,
are delivered to investors.'').
\705\ See Consumer Federation Letter. See also Clapman Letter
(suggesting that all issuers and their materials must be ``publicly
accessible for all investors to have the same opportunity to
invest'' and stating that ``no clubs, or paid to view investment
style platforms would therefore be allowed'').
\706\ IAC Recommendation; see also BetterInvesting Letter.
\707\ IAC Recommendation; see also BetterInvesting Letter.
---------------------------------------------------------------------------
One commenter stated it was concerned that earlier Commission
policies on electronic delivery might be read as implying that paper
delivery might be permitted in certain circumstances.\708\ This
commenter did agree, however, that any electronic message through which
disclosures are delivered include, at a minimum, the specific URL where
the required disclosures can be found.\709\
---------------------------------------------------------------------------
\708\ See CFIRA Letter 12.
\709\ Id.
---------------------------------------------------------------------------
In response to our request for comments on whether exceptions to
the consent to electronic delivery should be allowed, one commenter
stated that account creation and delivery of communication should be
completed digitally and that there should be no exemption to allow
paper delivery as a substitute.\710\ Another commenter stated that
investors should be allowed to waive these delivery requirements
entirely.\711\
---------------------------------------------------------------------------
\710\ See RocketHub Letter.
\711\ See Public Startup Letter 3.
---------------------------------------------------------------------------
(3) Final Rules
After considering the comments, we are adopting as proposed the
account opening and electronic delivery requirements in Rule 302(a). We
are not prescribing particular requirements for account opening.
Rather, we believe that the final rule provides flexibility to
intermediaries given that intermediaries are better positioned than the
Commission to determine what information and processes it will require,
both as a business decision and to ensure compliance with all
applicable regulatory requirements. Therefore, for example, an
intermediary can decide whether or not to open a new account for an
existing customer. We also are not prescribing under the final rule, as
a commenter suggested, that an intermediary be required to collect
identifying information that could help prevent duplicative or
fraudulent accounts. We believe that even without prescribing
particular account opening requirements intermediaries should be able
to identify, by collecting basic account opening information, those
accounts that appear to be duplicative or present red flags of
potential fraud.
However, the final rules do not permit investors to waive the
electronic delivery requirements entirely, as one commenter
suggested.\712\ We believe that electronic delivery of materials in
connection with crowdfunding offerings serves an important and basic
investor protection function by conveying information, such as offering
materials, that will help investors to make better informed investment
decisions and by a method that is appropriately suited to the
electronic and Internet-based nature of crowdfunding transactions.
---------------------------------------------------------------------------
\712\ Id.
---------------------------------------------------------------------------
As explained in Section II.A.3, Rule 100(a)(3) of Regulation
Crowdfunding requires that crowdfunding transactions be conducted
exclusively through an intermediary's platform. Rule 302(a) implements
this requirement by requiring that investors consent to electronic
delivery of materials in connection with crowdfunding offerings.\713\
This requirement applies to
[[Page 71438]]
all investors, including an existing customer of a registered broker
that has not already consented to electronic delivery of materials.
Therefore, this requirement will prohibit intermediaries from accepting
an investment commitment in a Section 4(a)(6) offering from any
investor that has not consented to electronic delivery.
---------------------------------------------------------------------------
\713\ Certain requirements of Regulation Crowdfunding that
require timely actions by issuers and investors will be facilitated
by requiring consent to electronic delivery of documents. See, e.g.,
Section II.C.6 (discussing the five-day periods for investor
reconfirmations based on material changes and issuer cancellation
notices).
---------------------------------------------------------------------------
We are adopting substantially as proposed Rule 302(a)(2), which
requires that all information required to be provided by an
intermediary under Subpart C be provided through electronic means. We
have considered the comments but do not believe that it would be
sufficient--or consistent with our previous statements about electronic
media--for the intermediary simply to make Subpart C materials, such as
educational materials, notices and confirmations, available on the
intermediary's platform for investors to access.\714\ Rather, unless
otherwise indicated in the relevant rules of Subpart C,\715\ the
intermediary must provide the information either through (1) an
electronic message that contains the information, (2) an electronic
message that includes a specific link to the information as posted on
the intermediary's platform, or (3) an electronic message that provides
notice of what the information is and notifies investors that this
information is located on the intermediary's platform or on the
issuer's Web site.\716\ We have added to the rule text other examples
of electronic messages that are permissible in addition to email
messages--specifically text, instant messages, and messages sent using
social media.
---------------------------------------------------------------------------
\714\ See Use of Electronic Media, Release No. 34-42728 (Apr.
28, 2000) [65 FR 25843, 25853 (May 4, 2000)] (discussing the
``access equals delivery'' concept and citing Use of Electronic
Media for Delivery Purposes, Release No. 34-36345 (Oct. 6, 1995) [60
FR 53548, 53454 (Oct. 13, 1995)]).
\715\ For example, Rule 303(a) separately requires that an
intermediary must make issuer information publicly available on its
platform, and so we do not believe that it is necessary to further
require intermediaries to send an electronic message regarding the
posting of issuer materials.
\716\ As noted above, this electronic message could include a
specific link to the information as posted on the intermediary's
platform. However, we are not requiring intermediaries to provide a
link to direct investors to the intermediary's platform or the
issuer's Web site where the information is located. We believe that
the final rule provides some flexibility to intermediaries when
providing required information through electronic messages given
that intermediaries are well-positioned to determine how best to
ensure compliance with all applicable regulatory requirements. We
also believe that, because of the widespread use of the Internet, as
well as advances in technology that allow funding portals to send
various electronic messages, our final rule requires sufficient
notice to investors.
---------------------------------------------------------------------------
b. Educational Materials
(1) Proposed Rules
Securities Act Section 4A(a)(3) states that an intermediary must
``provide such disclosures, including disclosures related to risks and
other investor education materials, as the Commission shall, by rule,
determine appropriate,'' but it does not elaborate on the scope of this
requirement. As described in further detail below, proposed Rule
302(b)(1) of Regulation Crowdfunding would require intermediaries to
deliver to investors, at account opening, educational materials that
are in plain language and otherwise designed to communicate effectively
and accurately certain specified information. Proposed Rules
302(b)(1)(i)-(viii) would require the materials to include:
The process for the offer, purchase and issuance of
securities through the intermediary;
the risks associated with investing in securities offered
and sold in reliance on Section 4(a)(6);
the types of securities that may be offered on the
intermediary's platform and the risks associated with each type of
security, including the risk of having limited voting power as a result
of dilution;
the restrictions on the resale of securities offered and
sold in reliance on Section 4(a)(6);
the types of information that an issuer is required to
provide in annual reports, the frequency of the delivery of that
information, and the possibility that the issuer's obligation to file
annual reports may terminate in the future;
the limits on the amounts investors may invest, as set
forth in Section 4(a)(6)(B);
the circumstances in which the issuer may cancel an
investment commitment;
the limitations on an investor's right to cancel an
investment commitment;
the need for the investor to consider whether investing in
a security offered and sold in reliance on Section 4(a)(6) is
appropriate for him or her; and
that following completion of an offering, there may or may
not be any ongoing relationship between the issuer and intermediary.
Proposed Rule 302(b)(2) would further require intermediaries to
make the current version of the educational materials available on
their platforms, and to make revised materials available to all
investors before accepting any additional investment commitments or
effecting any further transactions in securities offered and sold in
reliance on Section 4(a)(6).
(2) Comments on Proposed Rules
Commenters generally supported distribution of educational
materials through intermediaries.\717\ Some stated that intermediaries
should be required to submit educational materials to the Commission or
to FINRA because oversight and review is needed for materials that will
be used by unsophisticated investors,\718\ while others stated that
intermediaries should not be required to submit educational materials
to the Commission or to FINRA because it would be cumbersome and
expensive.\719\ One commenter stated that the proposed requirements
should be modified to state that education must be done prior to an
investor's first investment in a Section 4(a)(6) offering, not at
account opening.\720\
---------------------------------------------------------------------------
\717\ See, e.g., Arctic Island Letter 6; CFA Institute Letter;
Cole Letter; Consumer Federation Letter; Gimpelson Letter 2;
Heritage Letter; Jacobson Letter; NSBA Letter; Patel Letter;
RocketHub Letter; STA Letter; StartupValley Letter; Wefunder Letter.
\718\ See, e.g., Consumer Federation Letter; Gimpelson Letter 2;
Jacobson Letter. See also RocketHub Letter (stating that ``if
educational materials are submitted to the Commission for approval,
such approval should act to limit liability of the Portal under the
Act'').
\719\ See, e.g., Arctic Island Letter 6; Joinvestor Letter;
StartupValley Letter; Wefunder Letter.
\720\ See Arctic Island Letter 6. The commenter also stated that
the educational material requirements should only apply to
unaccredited investors, but we note that the requirement under
Section 4A(a)(4) runs to ``each investor.'' As discussed above, we
believe that Congress intended for crowdfunding transactions under
Section 4(a)(6) to be available equally to all types of investors.
Consistent with that approach, we do not believe at this time it
would be appropriate to tailor the educational requirements for any
particular type of investor or to create an exemption for accredited
investors. Further, issuers can rely on other exemptions to offer
and sell securities to accredited investors or institutional
investors.
---------------------------------------------------------------------------
Some commenters suggested that additions be made to the scope of
information proposed to be required in an intermediary's educational
materials,\721\ to include information about exit strategies; \722\
principles of investing in crowdfunding and how to evaluate investment
opportunities in privately held companies; \723\ the risks associated
with crowdfunding investments; \724\ and reasons for investors to
maintain their own personal records concerning crowdfunding
investments.\725\ One commenter
[[Page 71439]]
suggested that educational materials ``should include an industry
standard disclosure document on the benefits and risks of crowdfunding
investments.'' \726\ This commenter indicated that ``having these
generic risk factors in the industry standard educational materials
will help focus the company specific disclosure on the factors that are
most important.'' \727\
---------------------------------------------------------------------------
\721\ See, e.g., Anonymous Letter 1; Gimpelson Letter 2;
RocketHub Letter; STA Letter; Angel Letter 1.
\722\ See Anonymous Letter 1.
\723\ See Gimpelson Letter 2.
\724\ See RocketHub Letter.
\725\ See STA Letter.
\726\ See Angel Letter 1.
\727\ Id. (suggesting an issuer-specific disclosure document).
---------------------------------------------------------------------------
Some commenters suggested that intermediaries should be required to
design questionnaires to increase investor knowledge and to monitor
whether investors actually access materials.\728\ One commenter
suggested that in addition to an ``interactive questionnaire,'' the
Commission should also ``require that investors reaffirm each time they
invest that they understand the risks associated with crowdfunding, can
afford to lose their entire investment, and do not expect to need the
funds being invested in the near term.'' \729\
---------------------------------------------------------------------------
\728\ See, e.g., AFR Letter; BetterInvesting Letter; Consumer
Federation Letter; IAC Recommendation. One commenter also suggested
requiring intermediaries to post a list of previous offerings on
their Web sites with information about the offerings. See Angel
Letter 1.
\729\ IAC Recommendation; see also BetterInvesting Letter.
---------------------------------------------------------------------------
Some commenters stated that we should develop model educational
materials for investors or specify the content for intermediaries.\730\
One commenter suggested that the Commission, state securities
regulators, and FINRA, together, should develop ``a sample guide''
designed to alert investors to the risks of crowdfunding including,
among other things, ``the high failure rate of small startup companies,
the fact that shares will not be set based on market data and may
therefore be mispriced, the lack of liquidity, and the risk that,
absent appropriate protections, the value of their shares could be
diluted.'' \731\ This commenter also suggested that the guide ``should
include explicit warnings that investors should not invest in
crowdfunding unless they can afford to lose the entire amount of their
investment or if they expect to have an immediate need for the funds.''
\732\ This commenter also stated that regulators should test the
materials with investors to ensure their effectiveness.\733\
---------------------------------------------------------------------------
\730\ See, e.g., CFA Institute Letter; Guzik Letter 1; Heritage
Letter; Jacobson Letter; Joinvestor Letter; NSBA Letter; STA Letter.
See also CfPA Letter (stating that guidance on the requirements for
educational materials and certification of compliance should be
created and administered by an industry-related body with approval
and oversight by the Commission).
\731\ IAC Recommendation; see also BetterInvesting Letter.
\732\ Id.
\733\ Id. (suggesting that the Commission should take additional
steps ``to strengthen requirements with regard to content and
delivery of educational materials in order to increase the
likelihood both that they will be read and that they will clearly
convey the essential information''); see also CFIRA Letter 12
(agreeing with IAC's suggestion that the Commission ``could
establish a set of standard educational requirements for the
industry that could be adopted by intermediaries'').
---------------------------------------------------------------------------
One commenter stated that we should not limit or specify the type
of electronic media being used to communicate educational
material.\734\ Finally, one commenter opposed all the educational
requirements for intermediaries, and suggested instead that the
Commission itself, rather than intermediaries, should provide investor
educational materials to both investors and issuers with funding
portals linking to, for example, the SEC Web page or an open source Web
site containing any Commission drafted educational materials.\735\
---------------------------------------------------------------------------
\734\ See Gimpelson Letter 2.
\735\ See Public Startup Letter 3.
---------------------------------------------------------------------------
(3) Final Rules
After considering the comments, we are adopting Rule 302(b)
relating to educational materials substantially as proposed, but adding
one further requirement as to the content of the materials. We believe
that, consistent with Section 4A(a)(3) it is appropriate that
intermediaries, rather than the Commission (as a commenter suggested),
be required to provide such disclosures, including disclosures related
to risks and other investor education materials as the Commission
determines to be appropriate. We believe that intermediaries are better
equipped and positioned, as compared to the Commission, to provide
educational materials to investors that are reasonably tailored to an
intermediary's offerings and investors, particularly in light of their
access to and interactions with investors.
We further believe that the scope of information that we are
requiring to be included in an intermediary's educational materials is
appropriate. In the Proposing Release we discussed our rationales for
requiring the different types of disclosures in the educational
materials. As we noted in the Proposing Release, we generally drew upon
the statutory provisions when including disclosures required in the
educational materials relating to the risks of investing in securities
offered and sold in reliance on Section 4(a)(6), investors'
cancellation rights, resale restrictions and issuer reporting.\736\ The
circumstances in which an investor can cancel an investment commitment
and obtain a return of his or her funds are particularly important to
an investor's understanding of the investment process and may affect an
investor's decision to consider any offerings made pursuant to Section
4(a)(6). The items required to be included, pursuant to Rule
302(b)(1)(i) through (viii), in the educational materials are basic
terms, relevant to transactions conducted in reliance on Section
4(a)(6), of which all investors should be aware before making an
investment commitment. Furthermore, information on the various types of
securities that can be available for purchase on the intermediary's
platform, any applicable resale restrictions, and the risks associated
with each type of security, including the risk of having limited voting
power as a result of dilution can affect an investor's decision to
consider any offerings made pursuant to Section 4(a)(6). In addition,
we are adding Rule 302(b)(1)(ix) to require the educational materials
to indicate that under certain circumstances an issuer may cease to
publish annual reports and, therefore, an investor may not continually
have current financial information about the issuer. We are adding this
requirement because we believe that it is important for investors to be
able to consider the ongoing availability of information about an
issuer's financial condition when they assess whether to invest in that
issuer.
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\736\ See Securities Act Sections 4A(a)(4), 4A(a)(7), 4A(e), and
4A(b)(4).
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The final rule provides each intermediary with sufficient
flexibility to determine: (1) The content of the educational materials,
outside of the minimum specified information required to be included
under Rule 302(b)(1)(i)-(viii), and (2) the overall format and manner
of presentation of the materials. We believe this flexibility will
allow the intermediary to prepare and present educational materials in
a manner reasonably tailored to the types of offerings on the
intermediary's platform and the types of investors accessing its
platform. While we have determined not to provide model educational
materials, impose additional content (beyond those proposed) or format
requirements, mandate particular language or manner of presentation, or
require that an intermediary design an investor questionnaire, as
suggested by commenters, the final rules do not prohibit an
intermediary from providing additional educational materials if they
[[Page 71440]]
choose. For example, because the final rules do not require an
intermediary to design a questionnaire, intermediaries maintain the
flexibility in meeting the rule's requirements to determine whether
such a disclosure format would be cost effective and appropriate
particularly in light of that intermediary's particular business model.
We further note the suggestion by some commenters that we require
additional information in the educational materials, including, for
example, requiring an intermediary to discuss exit strategies, how to
evaluate investment opportunities in privately held companies, and the
reasons for investors to maintain their own personal records concerning
crowdfunding investments. Although these suggestions may provide
investors with some useful information, we are not persuaded that
imposing such additional requirements in the final rule is necessary at
this time as it is unclear that those suggestions would significantly
strengthen the investor protections that will result from Rule 302(b)
as adopted. We also believe that adding such requirements may overly
complicate these educational materials and increase the costs
associated with preparing them. Therefore, we have determined to allow
intermediaries the flexibility to prepare educational materials
reasonably tailored to their offerings and investors, provided the
materials meet the standards and include the information required to be
provided under Rule 302(b).\737\
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\737\ We note that educational materials may be subject to
examination and inspection. See Section II.D.5. (describing the
recordkeeping obligations of funding portals).
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We also recognize that FINRA or any other registered national
securities association may implement additional educational materials
requirements. We are not, however, as one commenter suggested,\738\
requiring at this time that intermediaries submit their educational
materials to the Commission or to a registered national securities
association for review and approval. We note, however, that a
registered national securities association could propose such a
requirement as its oversight of intermediaries in this new market
evolves. Any such proposed requirement would be considered by the
Commission, and subject to public notice and opportunity for comment,
pursuant to Exchange Act Section 19(b) and Rule 19b-4.
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\738\ See RocketHub Letter (stating that ``if educational
materials are submitted to the Commission for approval, such
approval should act to limit liability of the Portal under the
Act'').
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Rule 302(b)(2) requires an intermediary to keep its educational
materials accurate. Accordingly, an intermediary must update the
materials as needed to keep them current. In addition, if an
intermediary makes a material revision to its educational materials,
the rule requires that the intermediary make the revised educational
materials available to all investors before accepting any additional
investment commitments or effecting any further crowdfunding
transactions. An intermediary will also be required to obtain a
representation that an investor has reviewed the intermediary's most
recent educational materials before accepting an investment commitment
from the investor.\739\
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\739\ See Rule 303(b)(2)(i) of Regulation Crowdfunding.
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We believe that these requirements will benefit investors by
helping to ensure that they receive information about key aspects of
investing through the intermediary's platform, including aspects that
may have changed since the last time they received the materials, prior
to making investment commitments, as that information can influence
their investment decisions. We also believe that requiring
intermediaries to update materials on an ongoing basis, rather than at
certain specified intervals, will help to ensure that those materials
are updated as circumstances warrant, which, in turn, will provide
investors with more current information and increase investor
protection.
c. Promoters
(1) Proposed Rule
Securities Act Section 4A(b)(3) provides that an issuer shall ``not
compensate or commit to compensate, directly or indirectly, any person
to promote its offerings through communication channels provided by a
broker or funding portal, without taking such steps as the Commission
shall, by rule, require to ensure that such person clearly discloses
the receipt, past or prospective, of such compensation, upon each
instance of such promotional communication.'' Under Rule 205 of
Regulation Crowdfunding, as discussed above, an issuer can compensate
persons to promote its offerings through communications channels
provided by the intermediary on its platform, where certain conditions
are met.\740\
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\740\ See Rule 205 of Regulation Crowdfunding and the discussion
in Section II.B.5.
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We separately proposed in Rule 302(c) of Regulation Crowdfunding to
require the intermediary to inform investors, at the account opening
stage, that any person who promotes an issuer's offering for
compensation, whether past or prospective, or who is a founder or an
employee of an issuer that engages in promotional activities on behalf
of the issuer on the intermediary's platform, must clearly disclose in
all communications on the platform the receipt of the compensation and
the fact that he or she is engaging in promotional activities on behalf
of the issuer.
(2) Comments on Proposed Rules
Some commenters suggested that the promoter disclosures should not
be made at account opening where they may be ignored.\741\ One
commenter proposed that the disclosures should be made ``prior to any
participant on the platform being able to post comments, reviews,
ratings, or other promotional activities.'' \742\
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\741\ See, e.g., Arctic Island Letter 6; Wefunder Letter.
\742\ See Arctic Island Letter 6.
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(3) Final Rules
We are adopting, as proposed, Rule 302(c) requiring intermediaries
to inform investors, at the time of account opening, that promoters
must clearly disclose in all communications on the platform the receipt
of the compensation and the fact that he or she is engaging in
promotional activities on behalf of the issuer. As noted in the
Proposing Release, in addition to the information required under Rule
302(c), promoters will also be required to comply with Section 17(b) of
the Securities Act, which requires promoters to fully disclose to
investors the receipt, whether past or prospective, of consideration
and the amount of that compensation.\743\ We believe that the
disclosures required by Rule 302(c) will help alert investors at the
outset, rather than after the account is opened, of the fact that
information about the promotional activities of issuers or
representatives of issuers will be disclosed at a later time on the
platform, pursuant to Rule 303(c)(4). We believe that the account
opening is the appropriate time for this disclosure because it gives
investors notice of potential promotional activities by issuers and
their representatives prior to making investment commitments. As
discussed below, Rule 303(c)(4) separately mandates that intermediaries
require any person, when posting a comment in the communication
channels, to clearly disclose with each
[[Page 71441]]
posting whether he or she is a founder or an employee of an issuer
engaging in promotional activities on behalf of the issuer, or receives
compensation, whether in the past or prospectively, to promote an
issuer's offering. We believe that the disclosure requirements of Rule
302(c), when coupled with the additional disclosure requirements in
Rule 303(c)(4), will promote a transparent information sharing process
whereby investors are able to discern the sources of information that
they are receiving and any potential conflicts of interest by those
sources.
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\743\ See Proposing Release at 78 FR 66467-68. See also Section
17(b) of the Securities Act (15 U.S.C. 77q(b)).
---------------------------------------------------------------------------
d. Compensation Disclosure
(1) Proposed Rule
Proposed Rule 302(d) of Regulation Crowdfunding would require that
intermediaries, when establishing an account for an investor, clearly
disclose the manner in which they will be compensated in connection
with offerings and sales of securities made in reliance on Section
4(a)(6). This requirement would help to ensure investors are aware of
any potential conflicts of interest that may arise from the manner in
which the intermediary is compensated. Rule 201(o) of Regulation
Crowdfunding, which is discussed in Section II.B.1, separately requires
an issuer to disclose in its offering materials, among other things,
the amount of compensation paid to the intermediary for conducting a
particular offering, including the amount of referral and any other
fees associated with the offering.
(2) Comments on Proposed Rule
Several commenters supported the disclosure of intermediary
compensation.\744\ One commenter stated that the account opening is not
an appropriate time to mention compensation, asserting that the account
opening stage should be dedicated to discussing the risk of startup
investing.\745\ One commenter suggested that the best way for an
intermediary to disclose compensation is through a ``Costs and Fees''
page on its Web site.\746\ Another commenter requested that the
Commission define compensation as any fees or compensation collected by
the intermediary in connection with a Section 4(a)(6) transaction,
subject to Commission and FINRA rules.\747\
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\744\ See, e.g., Arctic Island Letter 6; ASSOB Letter; CFA
Institute Letter; Commonwealth of Massachusetts Letter; Joinvestor
Letter; StartupValley Letter; Wefunder Letter.
\745\ See Wefunder Letter.
\746\ See StartupValley Letter.
\747\ See CFIRA Letter 4.
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(3) Final Rules
We are adopting Rule 302(d) as proposed. We believe that requiring
intermediaries to provide information to investors about the manner in
which they will be compensated at account opening, rather than at a
subsequent time, will provide investors with notice of how the
intermediary is being compensated at a threshold stage in the
relationship (i.e., account opening), which, in turn, will help
investors make better-informed decisions. We note that the final
rules--unlike the proposed rules--allow intermediaries to receive a
financial interest in the issuer as compensation, subject to certain
limitations.\748\ Therefore, an intermediary that receives or may
receive a financial interest in an issuer in the future as compensation
for its services is required to disclose that compensation at account
opening. We also note that Rule 201(o), which is discussed in Section
II.B.1 and separately requires an issuer to disclose in its offering
materials a description of the intermediary's interests in the issuer's
transaction, including the amount of compensation paid or to be paid to
the intermediary for conducting a particular offering, the amount of
referral and any other fees associated with the offering. We are not
defining compensation as one commenter suggested, as we believe the
final rule's requirement to clearly disclose the manner in which an
intermediary will be compensated in connection with offerings and sales
of securities made in reliance on Section 4(a)(6) is sufficiently
clear, and because we are also concerned that a definition of
compensation could be both under- and over-inclusive in a new and
evolving crowdfunding market.
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\748\ See Section II.C.2.b.
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5. Requirements With Respect to Transactions
a. Issuer Information
(1) Proposed Rule
Securities Act Section 4A(a)(6) requires each intermediary to make
available to the Commission and investors, not later than 21 days prior
to the first day on which securities are sold to any investor (or such
other period as the Commission may establish), any information provided
by the issuer pursuant to Section 4A(b).\749\ Accordingly, we proposed
Rule 303(a) of Regulation Crowdfunding to implement this provision by
requiring each intermediary in a transaction involving the offer or
sale of securities in reliance on Section 4(a)(6) to make available to
the Commission and to investors any information required to be provided
by the issuer under Rules 201 and 203(a) of proposed Regulation
Crowdfunding. As proposed, Rule 303(a) would require that this
information: (1) Be publicly available on the intermediary's platform,
in a manner that reasonably permits a person accessing the platform to
save, download or otherwise store the information; (2) be made publicly
available on the intermediary's platform for a minimum of 21 days
before any securities are sold in the offering, during which time the
intermediary may accept investment commitments; and (3) remain publicly
available on the intermediary's platform until the offer and sale of
securities is completed or cancelled (including any additional
information provided by the issuer). In addition, under Proposed Rule
303(a)(4), an intermediary would be prohibited from requiring any
person to establish an account with the intermediary in order to access
this information.
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\749\ As discussed in Section II.B, Securities Act Section 4A(b)
establishes the requirements for an issuer that offers or sells
securities in reliance on Section 4(a)(6).
---------------------------------------------------------------------------
(2) Comments on the Proposed Rule
Several commenters suggested that so long as issuer information is
made available on the intermediary's platform, the rules should not
mandate the delivery of this information, in addition to or in lieu of,
making the information available on the intermediary's platform.\750\
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\750\ See, e.g., Arctic Island Letter 6 (suggesting that an
electronic copy of the signed subscription agreement and risk
disclosures should be sent to the investor via email, and that
``[e]verything else can be referenced by the investor online at any
time''); ASSOB Letter; CrowdCheck Letter (suggesting that the
Commission remove the requirement in the proposed rules that would
effectively limit the presentation of information to only formats
that can be saved and downloaded by prospective investors);
RocketHub Letter; Wefunder Letter; Vann Letter (stating that no
particular means of delivery to investors should be required because
``technologies may change'' and intermediaries should be allowed to
use whatever means ``appropriate'').
---------------------------------------------------------------------------
One commenter stated that having information about a deal publicly
available on the intermediary's Web site will increase the potential
for fraud--specifically, potential fraud involving ``data scraping''
from Web sites (i.e., copying data from these Web sites in order to use
that data for fraudulent purposes).\751\ This same commenter suggested
that that there should be two levels of disclosure: The first, would be
available to all and would contain certain general information about
the
[[Page 71442]]
issuer and the terms of deal, and the second would be made available
only after investors proceed through a membership registration process
and would contain disclosure documents, financial information, legal
disclosures and further information.\752\
---------------------------------------------------------------------------
\751\ See StartupValley Letter.
\752\ Id. See also Early Shares Letter (suggesting a permission-
based system for the disclosure of certain ``sensitive'' information
about the offering).
---------------------------------------------------------------------------
As to the amount of time that an intermediary should display issuer
materials prior to the first day on which securities are sold to any
investor, some commenters supported the 21-day time frame as a
sufficient minimum period that offering information should be made
available through the intermediary's platform.\753\
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\753\ See, e.g., ASSOB Letter; RocketHub Letter.
---------------------------------------------------------------------------
Although one commenter objected to intermediaries displaying any
issuer materials,\754\ several commenters supported requiring
intermediaries to continue to display issuer materials for some period
of time after completion of the offering.\755\ One commenter, however,
stated that intermediaries should not be required to display issuer
materials for closed offerings.\756\ Another commenter stated that
``[o]nce an offering is complete, an issuer should have the right to
limit publicly available information.'' \757\
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\754\ See Public Startup Letter 3.
\755\ See, e.g., Arctic Island Letter 6 (stating that an
issuer's offering materials should be permanently displayed so it
can easily be referenced in the future); ASSOB Letter (suggesting a
period of at least two years after receiving funding from the
offering); Jacobson Letter (suggesting a period of at least six
years after an offering closes); RocketHub Letter (recommending that
issuer materials should remain displayed for an additional 30 days
after completion of the offering and further suggesting that
``[i]ntermediaries should have the right, at their own discretion,
to continue to display the entire offering, or parts of it, for as
long as they see fit'').
\756\ See Whitaker Chalk Letter (stating that removing such
materials from the intermediary's platform would prevent the public
from relying on ``stale'' information and opposing the requirement
that intermediaries keep public any such ``stale'' information so
long as the information remain subject to the intermediary's
recordkeeping requirements).
\757\ See RocketHub Letter.
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We also requested comments as to whether an intermediary should
make efforts to ensure that an investor has actually reviewed the
relevant issuer information. A few commenters expressed concern with
requiring intermediaries to ensure that an investor has reviewed the
relevant issuer information.\758\ Another commenter suggested that an
investor ``should demonstrate, through a representation of
acknowledgment, that they have reviewed all relevant issuer
information.'' \759\
---------------------------------------------------------------------------
\758\ See, e.g., Arctic Island Letter 6 (stating that such a
requirement ``could make things incredibly messy and expensive'');
Wefunder Letter.
\759\ RocketHub Letter.
---------------------------------------------------------------------------
(3) Final Rules
After considering the comments, we are adopting, as proposed, Rule
303(a). As stated in the Proposing Release, we believe that the
requirement in Rule 303(a) that the information must be made publicly
available on the intermediary's Web site satisfies the requirement
under Section 4A(d) for the Commission to ``make [available to the
states], or . . . cause to be made [available] by the relevant broker
or funding portal, the information'' issuers are required to provide
under Section 4A(b) and the rules thereunder. Moreover, this approach
should help investors, the Commission, FINRA (and any other applicable
registered national securities association) and other interested
parties, such as state regulators, to access information without
impediment. Therefore, we believe that this rule is not only consistent
with the statute but that it also enhances investor protection by
having issuer information about a crowdfunding security publicly
available on the intermediary's Web site. While we considered the
concern expressed by one commenter that having such information
available on the intermediary's Web site would increase the potential
for ``data scraping,'' \760\ we believe the expected benefits of the
requirement to investors and other interested persons, as discussed
above, justifies the risk of potential harm from such potential
activities.
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\760\ See StartupValley Letter.
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We note that commenters who addressed the issue generally supported
a 21-day time frame as the minimum period that offering information
should be made available through the intermediary's platform prior to
the first day on which securities are sold to any investor. Under the
final rules, the information must remain available on the platform
until the offering is completed or canceled. While some commenters
suggested that the rule should require intermediaries to continue to
display issuer materials for some period of time after completion of
the offering, we are not prescribing such a requirement nor are we
prohibiting intermediaries from doing so if they so choose. Although we
appreciate that historical issuer information may provide helpful
background for investors generally, we are concerned that imposing such
a requirement could potentially result in persons relying on
potentially stale issuer information particularly given the nature of
the crowdfunding market (i.e., we assume that each issuer generally
will conduct only one offering per year).\761\ We note that
intermediaries nonetheless are required to retain the information in
accordance with their obligation to make and preserve for a period of
time records with respect to any written materials that are used as
part of an intermediary's business, including issuer materials made
available on their platforms.\762\
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\761\ As discussed in Section IV.B.1, we assume, for purposes of
the Paperwork Reduction Act, that each issuer will conduct one
offering per year.
\762\ Registered brokers would have to maintain records pursuant
to Exchange Act Section 17 and the rules thereunder. See e.g., 15
U.S.C. 78q and 17 CFR 240a-3 and 17a-4. Funding portals would be
subject to the recordkeeping requirements of proposed Rule 404 of
Regulation Crowdfunding. See Section II.D.5 (discussing the
recordkeeping requirements we are adopting for funding portals).
---------------------------------------------------------------------------
While the intermediary plays an important gatekeeper function, the
investor has responsibility for his or her actions as well. To that
end, we are not requiring that an intermediary ensure that an investor
has actually reviewed the relevant issuer information. We believe that
the requirements of Rule 303(a) provide an investor with the relevant
issuer information and an adequate period of time in which to evaluate
the investment opportunity before investing. We are not at this time
imposing additional requirements on the intermediary in this regard.
b. Investor Qualification
(1) Compliance With Investment Limits
(a) Proposed Rule
Securities Act Section 4(a)(6)(B) limits the aggregate amount of
securities that can be sold by an issuer to an investor in reliance on
Section 4(a)(6) during a 12-month period. Securities Act Section
4A(a)(8) requires that intermediaries ``make such efforts as the
Commission determines appropriate, by rule'' to ensure that no investor
has made purchases in the aggregate, from all issuers, that exceed the
limits in Section 4(a)(6).
Proposed Rule 303(b)(1) of Regulation Crowdfunding would implement
this latter provision by requiring that, each time before accepting an
investment commitment on its platform (including any additional
investment commitment from the same person), an intermediary must have
a reasonable basis for believing that the investor satisfies the
investment limits established by Section 4(a)(6)(B). The proposed rule
would allow an intermediary to rely on an investor's representations
concerning
[[Page 71443]]
annual income, net worth and the amount of the investor's other
investments in securities sold in reliance on Section 4(a)(6) through
other intermediaries unless the intermediary has a reasonable basis to
question the reliability of the representation.
(b) Comments on the Proposed Rule
A number of commenters supported the proposed requirements for
enforcing investment limits and intermediary responsibility for
investor compliance,\763\ while a few commenters opposed the
requirements.\764\ Several commenters suggested ways to strengthen the
requirements, such as by: Requiring that an intermediary conduct more
stringent checks,\765\ having the Commission maintain a registry of
those who have purchased crowdfunding securities,\766\ requiring that
investors electronically upload financial documents for verification of
income or net worth,\767\ requiring notices detailing investment limits
and highlighting their importance,\768\ and precluding an investor who
violates the investment limits from bringing a cause of action against
an issuer.\769\ Some commenters suggested that the Commission require
intermediaries to create a tool for investors to use, such as a
questionnaire, to assemble the underlying data on which investment
limits are calculated and to perform those calculations
electronically.\770\ However, another commenter disagreed with this
suggestion.\771\ One commenter suggested intermediaries' platforms be
required to provide to investors prior to accepting an investment
commitment a detailed statement of the investment limits that are
applicable to investors that also includes a penalty of perjury
certification by the investor.\772\ A few commenters emphasized a need
to warn investors that the value of their primary residence should be
excluded for purposes of the net worth calculation.\773\ Commenters
also suggested that the Commission adopt an approach similar to that
under the capital gains tax rules that would limit benefits and loss
recovery for investors who invest outside of their limits.\774\
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\763\ See, e.g., BetterInvesting Letter; CFA Institute Letter;
CFIRA Letter 12; Finkelstein Letter; IAC Recommendation; Milken
Institute Letter. See also NAAC Letter (stating that unsophisticated
investors might not comply with the investment limits or be targets
for fraudulent schemes, and recommending ``verified and stringent
determinations as to the income and net worth qualifications of any
potential investors.'').
\764\ See, e.g., Moskowitz Letter (stating that select investors
on the secondary market could purchase shares in excess of the
investment limit and suggesting that the limits be removed
altogether); Phillips Letter.
\765\ See, e.g., Moskowitz Letter; NAAC Letter.
\766\ See Clapman Letter. See also CFA Institute Letter
(suggesting that the Commission require intermediaries to ``cross
check each investor's information against other files on record with
the Commission to ensure compliance with the law's limitations'').
\767\ See, e.g., Consumer Federation Letter; Finkelstein Letter.
\768\ See Milken Institute Letter.
\769\ Id.
\770\ See, e.g., CFA Institute Letter (suggesting that
``investors be required to complete online questionnaires denoting
the different classes of asset holdings permitted by the law, with a
specific and prominent notification that the value of one's primary
residence is excluded''); IAC Recommendation (stating that the tool,
such as an electronic work sheet, would assist investors in
identifying categories of assets and liabilities such as bank
accounts, investment accounts, and house value, for purposes of the
net worth calculation, and prompt them to deduct outstanding
liabilities and exclude the value of principle residence). See also
BetterInvesting Letter.
\771\ See CFIRA Letter 12 (disagreeing with IAC's suggestion
``that portals create a `tool' to walk investors through the
creation of what is essentially a personal balance sheet'').
\772\ See Milken Institute Letter (``This would underscore the
importance of the investor caps . . . and properly place the burden
of compliance on the actor who can verify income or wealth at the
lowest cost--the investor.'').
\773\ See, e.g., Brown J. Letter; CFA Institute Letter; Consumer
Federation Letter.
\774\ See, e.g., Milken Institute Letter (supporting the
proposed investment caps, but agreeing with precluding loss
recovery); Phillips Letter.
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Several commenters opposed the proposal to allow an intermediary to
rely on the representations of an investor.\775\ Some urged the
Commission to provide for verification through either a third-party
service or through the intermediaries themselves in lieu of reliance on
investor representations.\776\ Other commenters suggested that
intermediaries should be required to take certain affirmative steps to
verify investor representations.\777\ One commenter stated that the
strongest possible approach to a verification requirement should be
imposed for investments beyond $2,000.\778\ Another commenter suggested
that the Commission create penalties for intermediaries who fail to
meet their duties regarding investment limits.\779\ One commenter
suggested the Commission should require crowdfunding portals to collect
enough data from investors to avoid the most likely errors in
calculating the investment limit and to prevent evasion of those
limits. This commenter also suggested that the Commission should
require portals to collect social security numbers to help prevent
individuals from evading limits by opening multiple accounts under
false names.\780\
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\775\ See, e.g., Accredify Letter (stating that self-
certifications are not an effective way to implement the investment
limit requirements and suggesting that intermediaries be required to
use existing services to check individuals' investment limits); AFL-
CIO Letter; AFR Letter; Brown J. Letter; Commonwealth of
Massachusetts Letter; Consumer Federation Letter; Farnkoff Letter;
Letter Finkelstein Letter; Jacobson Letter; Merkley Letter (noting
that permitting self-certification would expose investors to
precisely the risks that the statute aimed to prevent, and should
not be permitted for investments over $2,000); Saunders Letter;
Verinvest Letter.
\776\ See, e.g., Accredify Letter; Commonwealth of Massachusetts
Letter; Farnkoff Letter (``A third-party verification regime
overseen by the SEC or FINRA would provide the safest protection
from fraudsters and reduce risks of liability for funding
portals.''); Saunders Letter; Verinvest Letter.
\777\ See, e.g., AFL-CIO Letter; Jacobson Letter.
\778\ See Merkley Letter (suggesting that the Commission could
reconsider possible options to relax any strict initial approach
after the first few years of the final rules being in effect, and
stating that ``it would be incredible if the verification
requirements for ordinary investors in crowdfunding were permitted
to be less than for accredited investors under Rule 506(c)'').
\779\ See Commonwealth of Massachusetts Letter.
\780\ See AFR Letter.
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Other commenters supported the proposal to allow an intermediary to
rely on the representations of an investor.\781\ Some of these
commenters warned against costly compliance requirements such as, for
example, requiring verification of investment limits by both the issuer
and the intermediary,\782\ or burdening a broker-dealer with a vetting
requirement for someone who may only want to invest a small amount,
such as $25.\783\
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\781\ See, e.g., Arctic Island Letter 6; ASSOB Letter; CFA
Institute Letter; Greenfield Letter; Heritage Letter; Joinvestor
Letter; Patel Letter; Public Startup Letter 3; RocketHub Letter.
\782\ See Heritage Letter.
\783\ See Arctic Island Letter 6.
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Several commenters supported requiring an intermediary to confirm
investment limits compliance using a centralized database, should one
become established.\784\ A number of these commenters suggested the
database be created and managed by the Commission with mandatory
intermediary participation \785\ to allow intermediaries to check an
investor's total year to date purchases across all platforms.\786\ One
commenter stated that the statute ``contemplates'' the development of a
central data repository and suggested that it could be established at
the relevant national
[[Page 71444]]
securities association.\787\ Another commenter suggested, in connection
with its support for the use of a centralized database, imposing a
three-to-five year time limit, after which intermediaries would no
longer be permitted to rely on investor representations about their
investments on other platforms.\788\ One commenter suggested the
Commission incentivize the private creation of a centralized
database.\789\ Another opposed the Commission imposing any obligation
on intermediaries until after such a centralized database is
established.\790\ Another commenter, supporting the creation of a
single, centralized database, warned that ``competing databases'' would
be incomplete.\791\
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\784\ See, e.g., BetterInvesting Letter; Arctic Island Letter 6;
Consumer Federation Letter; Finkelstein Letter; IAC Recommendation;
Merkley Letter; Verinvest Letter. See also CFA Institute Letter
(suggesting that ``the Commission require such intermediaries to
cross check each investor's information against other files on
record with the Commission to ensure compliance with the law's
limitations'').
\785\ See, e.g., Arctic Island Letter 6; Consumer Federation
Letter; Finkelstein Letter. See also CFA Institute Letter.
\786\ See Finkelstein Letter.
\787\ See Merkley Letter (noting that the proposal ``does not
establish such a repository or set forth any path towards its
establishment and thus fails to implement the plain meaning of the
statutory language'' and suggesting that ``[t]esting, supervisory
oversight, and other mechanisms to ensure investors are protected .
. . be more fully considered'').
\788\ See Consumer Federation Letter.
\789\ See IAC Recommendation (suggesting the Commission create
such an incentive by monitoring the effectiveness of the proposed
reasonable reliance approach and to end that approach if a cost-
effective and suitable cross-portal monitoring system is developed);
see also BetterInvesting Letter.
\790\ See Wefunder Letter.
\791\ See CFIRA Letter 12.
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Others commenters expressed concern that the proposed rule included
no mechanism to prevent investors from registering with multiple
platforms and investing far in excess of the statutory limits.\792\
Commenters who addressed the issue supported requiring intermediaries
to request information about any other intermediary accounts prior to
accepting an investment commitment.\793\ One of these commenters
suggested requiring intermediaries to add a text box to their site that
requires the investor to input the total dollar amount invested on
other platforms.\794\ The other commenter stated that an intermediary
should only be required to request additional information if there are
doubts about the investor's self-certification.\795\
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\792\ See, e.g., Finkelstein Letter; Vann Letter (stating that
intermediaries should be required to ``make it clear that the
aggregate limits apply across all such platforms, not just their
own'').
\793\ See, e.g., ASSOB Letter; Wefunder Letter.
\794\ See Wefunder Letter.
\795\ See ASSOB Letter.
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(c) Final Rules
After considering the comments, we are adopting Rule 303(b)(1) as
proposed. As a threshold matter, we note that a number of commenters
supported the proposed approach for establishing compliance with
investment limits. Although we appreciate some of the additional
suggestions provided by commenters, as outlined above, we believe the
approach in Rule 303(b)(1) for establishing compliance with investment
limits is an appropriate means of implementing the provisions of
Section 4A(a)(8), which is designed to help ensure that an investor has
not made purchases, in the aggregate from all issuers, that exceed
those limits during a 12-month period. We note, however, that
intermediaries can, in their discretion, take additional measures for
evaluating investors' compliance with investment limits, including
those suggested by commenters, such as: Using a centralized data
repository, to the extent that one is created; requiring verification
of income or net worth electronically by uploading financial documents;
or creating a tool for investors to use, such as a questionnaire, to
assemble the underlying data.
While several commenters opposed permitting an intermediary to rely
on the representations of an investor about investment limits and some
suggested requiring intermediaries to take certain affirmative steps to
verify compliance, we believe that it would be difficult for
intermediaries to monitor or independently verify whether each investor
remains within his or her investment limits where the investor may be
participating in offerings on multiple platforms. We note, however,
that reliance on investor representations must be reasonable. At a
minimum, it would not be reasonable, and therefore would be a violation
of the rule and potentially subject to an enforcement action by the
Commission, for an intermediary to ignore investments made by an
investor in other offerings on the intermediary's platform, to not
obtain information and take into account investments made by an
investor in other offerings (made in reliance on Section 4(a)(6)) on
platforms that are controlled by or under common control with the
intermediary, or to ignore other information or facts about an investor
within its possession.
Under the final rules, an intermediary will be permitted to
reasonably rely on a centralized data repository of investor
information, should one be created in the future. We are not mandating
the creation of such a database at this time, in part to help to
minimize the obstacles that intermediaries may face in getting this
newly formed marketplace up and running.\796\ We note, in response to
one commenter,\797\ that it is the Commission's normal practice to
review the effectiveness of all of its rules, particularly in light of
market developments, and consider changes as the Commission deems
appropriate. Commission staff expects to review the need for a
centralized database during the study of the federal crowdfunding
exemption that it plans to undertake no later than three years
following the effective date of Regulation Crowdfunding.\798\
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\796\ We do not believe that the statute requires the
establishment of a centralized database or repository of investor
information as one commenter suggested. See Merkley Letter. Instead,
the statute calls for intermediaries to ``make such efforts as the
Commission determines appropriate, by rule'' to ensure that no
investor exceeds the investment limits set forth in Section 4(a)(6).
\797\ See IAC Recommendation; see also BetterInvesting Letter.
\798\ See Section II. Further, we anticipate that, because of
the electronic nature of crowdfunding, many of the books and records
maintained by intermediaries will be in electronic format. We expect
this will enable the Commission to analyze data across the
crowdfunding industry as part of its ongoing oversight. We note that
Commission staff also expects to review the books and records
practices of intermediaries as part of its planned three-year
review.
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(2) Acknowledgment of Risk
(a) Proposed Rule
Securities Act Section 4A(a)(4) requires an intermediary to ensure
that each investor: (1) Reviews educational materials; (2) positively
affirms that the investor understands that he or she is risking the
loss of the entire investment and that the investor could bear such a
loss; and (3) answer questions demonstrating an understanding of the
level of risk generally applicable to investments in startups, emerging
businesses and small issuers, the risk of illiquidity and such other
matters as the Commission determines appropriate. As discussed above,
Rule 302(b) of Regulation Crowdfunding requires an intermediary to
provide to investors certain educational materials in connection with
the opening of an account. In addition, proposed Rule 303(b)(2) of
Regulation Crowdfunding would require an intermediary, each time before
accepting an investment commitment, to obtain from the investor a
representation that the investor has reviewed the intermediary's
educational materials, understands that the entire amount of his or her
investment may be lost and is in a financial condition to bear the loss
of the investment.\799\ The proposed rule would also require that an
intermediary obtain from the investor
[[Page 71445]]
answers to questions demonstrating the investor's understanding that
there are restrictions on the investor's ability to cancel an
investment commitment and obtain a return of his or her investment,
that it may be difficult for the investor to resell the securities, and
that the investor should not invest any funds in a crowdfunding
offering unless he or she can afford to lose the entire amount of his
or her investment.
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\799\ See Section II.C.4.b. (discussing Rule 302(b)(2) of
Regulation Crowdfunding).
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(b) Comments on the Proposed Rule
Several commenters supported the requirement that intermediaries
obtain investor acknowledgments.\800\ Some of these commenters,
however, opposed requiring investors to re-acknowledge or to re-certify
for each investment commitment.\801\
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\800\ See, e.g., Arctic Island Letter 6; CFA Institute Letter;
Greenfield Letter; Joinvestor Letter; RocketHub Letter; STA Letter;
Wefunder Letter.
\801\ See Wefunder Letter; RocketHub Letter (suggesting that
once an account has been created on an intermediary platform, an
investor should be able to invest in multiple offerings on the same
intermediary platform without having to re-certify and review the
educational materials).
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One commenter stated that investors should be required to complete
and sign ``subscription forms'' that set forth, in addition to what the
proposed rules would require, additional information concerning the
investor's level of investment experience, the identity of any person
from whom the investor acquired any information about the investment
and the percentage of the investor's liquid net worth represented by
the proposed investment.\802\
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\802\ See Greenfield Letter. See also STA Letter (stating that
investors should be required to acknowledge that they are aware that
``they may need to be diligent in notifying the issuer, or its
designee, of any changes that would affect their ability to receive
communications from the issuer''). We note, however, that issuers
are not obligated to contact investors directly.
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One commenter supported the Commission providing recommended forms
of questions and representations, noting that ``any material examples
provided by the Commission will be helpful to both the investor and the
intermediary.'' \803\ However, another commenter stated that it would
be opposed to the Commission providing recommended forms of questions
as a ``starting point'' because such recommended forms could be seen as
a safe harbor and constrain effectiveness.\804\ In contrast, a
different commenter stated that Commission-provided questions and
representations should serve as a safe harbor so there is an incentive
for issuers to use them.\805\
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\803\ See Joinvestor Letter.
\804\ See Wefunder Letter.
\805\ See Public Startup Letter 3.
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(c) Final Rules
After considering the comments, we are adopting Rule 302(b)(2) as
proposed. As noted in the Proposing Release, this rule is intended to
help ensure that investors engaging in transactions made in reliance on
Section 4(a)(6) are fully informed and reminded of the risks associated
with their particular investment before making any investment
commitment. While an intermediary cannot ensure that all investors
understand the risks involved, the rule requires intermediaries to
confirm that an investor: (1) Has reviewed the intermediary's
educational materials delivered pursuant to Rule 302(b); (2)
understands that the entire amount of his or her investment may be
lost, and is in a financial condition to bear the loss of the
investment; and (3) has completed a questionnaire demonstrating an
understanding of the risks of any potential investment and other
required statutory elements. In addition, the questionnaire required
under the rule may help to address, at least in part, the concerns
expressed by some commenters that Section 4A(a)(4) requires more than a
mere self-certification.\806\ We note, however, that the plain language
of Section 4A(a)(4)(B) seemingly requires only that the investor
positively affirms his or her understanding of the risk of loss.
---------------------------------------------------------------------------
\806\ See, e.g., Accredify Letter; Commonwealth of Massachusetts
Letter; Farnkoff Letter; Saunders Letter; Verinvest Letter.
---------------------------------------------------------------------------
Our final rule does not provide a model form of acknowledgment or
questionnaire. Rather, the rule permits an intermediary to develop the
representation and questionnaire in any format that is reasonably
designed to demonstrate the investor's receipt of the information and
compliance with the other requirements under the final rules. As with
the educational material requirements, we continue to believe that
rather than providing sample content or a model form of acknowledgment
or questionnaire, intermediaries should be provided with sufficient
flexibility to choose both the content, within the requirements of Rule
302(b), and the format used to present the required materials.
Likewise, we also believe that an intermediary's familiarity with its
business and likely investor base make it best able to determine the
format in which to present the required materials. We note that any
format used must be reasonably designed to demonstrate receipt and
understanding of the information. There are many ways, especially on a
Web-based system, to convey information to, and obtain effective
acknowledgment from, investors. As explained in the Proposing Release,
the requirements of the rule would not be satisfied if, for example, an
intermediary were to pre-select answers for an investor.
Further, an intermediary in its discretion may require additional
information, such as information concerning the investor's level of
investment experience, the identity of any person from whom the
investor acquired any information about the investment and the
percentage of the investor's liquid net worth represented by the
proposed investment, or impose additional requirements on prospective
investors, such as imposing express acknowledgments of the investor's
responsibilities with respect to compliance.
Finally, although several commenters suggested that once an account
has been created on an intermediary's platform, an investor should be
able to invest in multiple offerings on the same intermediary platform
without having to re-certify and review the educational material, we
continue to believe that, in order to realize the statute's investor
protection goals, it is prudent to require an intermediary to obtain an
investor representation and completed questionnaire each time an
investor seeks to make an investment commitment. Accordingly, under
Rule 303(b), an intermediary will be required to obtain these items
each time an investor seeks to make an investment commitment.
c. Communication Channels
(1) Proposed Rule
Proposed Rule 303(c) of Regulation Crowdfunding would require an
intermediary to provide, on its platform, channels through which
investors can communicate with one another and with representatives of
the issuer about offerings made available on the intermediary's
platform. An intermediary that is a funding portal would be prohibited
from participating in communications in these channels.\807\ Proposed
Rule 303(c) also would require the intermediary to: (1) Make the
communications channels publicly available; (2) permit only those
persons who have opened accounts to
[[Page 71446]]
post comments; and (3) require any person posting a comment in the
communication channels to disclose whether he or she is a founder or an
employee of an issuer engaging in promotional activities on behalf of
the issuer, or is otherwise compensated, whether in the past or
prospectively, to promote the issuer's offering.
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\807\ See Rule 303(c)(1) (an intermediary that is a funding
portal cannot ``participate in these communications, other than to
establish guidelines for communication and remove abusive or
potentially fraudulent communications''). See also Exchange Act
Section 3(a)(80) (defining the term ``funding portal'' as any person
acting as an intermediary in a transaction involving the offer or
sale of securities for the account of others, solely pursuant to
Securities Act Section 4(a)(6), that does not, among other things,
``offer investment advice or recommendations'').
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(2) Comments on the Proposed Rule
We received comments both supporting \808\ and opposing the
proposed rules on communications channels.\809\ Several commenters
agreed that posting in communication channels should be limited to
registered investors on an intermediary's platform.\810\
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\808\ See, e.g., PeoplePowerFund Letter; RocketHub Letter; Vann
Letter (stating that intermediaries should be allowed to decide who
may post on the channels).
\809\ See, e.g., Cromwell Letter (claiming that ``[a]s [a]
venture investor, you cannot judge the abilities of the management
team over the Internet. Real venture capitalists do not make their
investments over the Internet--they spend hours and hours
interviewing the founders/management team, in person. Small
investors cannot successfully invest over the Internet, either.'');
Public Startup Letter 3; Moskowitz Letter (stating that the proposed
rules do not prevent an accredited investor from, for example,
posting a solicitation within the communication channels for more
securities than he or she could purchase in the offering within his
or her investment limits).
\810\ See, e.g., PeoplePowerFund Letter; RocketHub Letter;
Wefunder Letter.
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Some commenters stated there should be more privacy or control in
the manner in which comments are posted to the communications channels,
such as submitting comments to intermediaries to review prior to
posting or restricting the publicly viewable comments.\811\ One
commenter stated that he interprets the proposed rule to permit issuers
to post videos and other promotional content (similar to marketing
content used on non-securities-based crowdfunding sites like
Kickstarter), and that he supported this approach as it would permit
the issuer to ``communicate freely and creatively . . . while giving
the crowd a forum to ask questions or offer criticism.'' \812\ Another
commenter encouraged the Commission ``to provide an investor `hotline',
where investors can report concerns relating to crowdfunding
communications or transactions, and that intermediaries be required to
provide notice on their platforms of how to access this hotline.''
\813\
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\811\ See, e.g., ASSOB Letter (stating that ``random unmoderated
comments'' in communication channels should not be permitted,
because it would allow for unacceptable solicitations or claims of
return on investment); RocketHub Letter (expressing concern that
certain confidential information may be disclosed between registered
investors and the issuer, which would not be suitable for a public
forum).
\812\ See Odhner Letter.
\813\ See CFA Institute Letter.
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Several commenters generally supported the disclosure requirement
on communications by issuers or intermediaries and agreed that these
communications should be made transparent to investors.\814\
---------------------------------------------------------------------------
\814\ See, e.g., CFA Institute Letter; RocketHub Letter
(suggesting that intermediaries should be able to assist posters in
disclosing their relationship to issuer).
---------------------------------------------------------------------------
One commenter generally supported the proposed rule requiring each
promotional communication to be accompanied by disclosure of the
receipt of past or prospective compensation.\815\ Another commenter
suggested that the proposed rules should be amended to require that
intermediaries prominently post the online identities of the issuer's
paid promoters in the communication channels.\816\ One commenter,
however, stated that the Commission should not mandate the exact
methods by which an intermediary achieves compliance with the
requirement for promoters to disclose their relationship with an
issuer.\817\
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\815\ See CFA Institute Letter.
\816\ See MCS Letter.
\817\ See Wefunder Letter (suggesting that the disclosures at
the account opening stage are better devoted to the discussion of
the risk of startup investing).
---------------------------------------------------------------------------
In response to our request for comments, several commenters
supported requiring intermediaries to keep the communication channels
available to investors post-offering.\818\ Another commenter, however,
stated that the communication channels should be closed after stock
certificates are issued and received by investors.\819\ This commenter
further noted that the continued maintenance of a communication channel
after the end of a campaign would be an unnecessary cost. The same
commenter suggested that the issuer's Web site is a better place for
communication between investors and issuers.\820\
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\818\ See, e.g., PeoplePowerFund Letter (suggesting that the
posting forum should be live and accessible to all Web site members
not less than 30 days after the issue has been completed); RocketHub
Letter; StartupValley Letter (suggesting that intermediaries should
open a private channel of communication between investors and
issuers for the post offering period and not use the same public
channel that was used for the pre-offering and funding periods).
\819\ See RFPIA Letter.
\820\ Id. See also CfPA Letter (stating that ongoing
communication between issuers and investors should be an obligation
of issuers alone).
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(3) Final Rule
After considering the comments, we are adopting Rule 303(c) as
proposed. We considered commenters' suggestions that the issuer's Web
site is a better place for communication between investors and issuers
and that ongoing communication between issuers and investors should be
an obligation of issuers alone. We believe, however, that communication
channels on the intermediary's platform will provide a centralized and
transparent means for members of the public that have opened an account
with an intermediary to share their views about investment
opportunities and to communicate with representatives of the issuer to
better assess the issuer and investment opportunity.\821\ While the
JOBS Act does not impose this requirement, we believe it is consistent
with the legislative intent that such a mechanism be in place for
offerings made in reliance on Section 4(a)(6).\822\ Also, though
communications among investors may occur outside of the intermediary's
platform, communications by an investor with a crowdfunding issuer or
its representatives about the terms of the offering are required to
occur through these channels \823\ on the single platform through which
the offering is conducted.\824\ This requirement is expected to provide
transparency and accountability, and thereby further the protection of
investors.
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\821\ See also discussion in Section II.B.5.
\822\ See 158 Cong. Rec. S2231 (daily ed. Mar. 29, 2012)
(statement of Sen. Scott Brown) (``In addition to facilitating
communication between issuers and investors, intermediaries should
allow fellow investors to endorse or provide feedback about issuers
and offerings, provided that these investors are not employees of
the intermediary. Investors' credentials should be included with
their comments to aid the collective wisdom of the crowd.'').
\823\ See Rule 204 of Regulation Crowdfunding and discussion in
Section II.B.4.
\824\ See Rule 100(a)(3) of Regulation Crowdfunding and
discussion in Section II.A.3.
---------------------------------------------------------------------------
Although one commenter stated that it interpreted the proposed rule
to permit issuers to post videos and other promotional content, aside
from Rule 303(c)(4) and its requirements for promotional activity, Rule
303(c) itself does not address the content or form used by issuers when
communicating with investors through the channels provided on an
intermediary's platform. Rather, Rule 204 of Regulation Crowdfunding
sets forth the advertising requirements for issuers and, as explained
above, Rule 204 allows an issuer to communicate with investors about
the terms of the offering through communication channels provided by
the intermediary on the intermediary's platform, so long as the issuer
identifies
[[Page 71447]]
itself as the issuer in all communications.\825\
---------------------------------------------------------------------------
\825\ See Section II.B.4 (discussing Rule 204).
---------------------------------------------------------------------------
We are requiring intermediaries to make the communications on the
channels publicly available for viewing. We believe that this
requirement is consistent with the concept of crowdfunding, as it
provides for transparent crowd discussions about a potential investment
opportunity. We also are requiring in Rule 303(c)(3) that
intermediaries limit the posting in communication channels to those
individuals who have opened an account with the intermediary on its
platform. As stated in the Proposing Release, while we recognize that
this requirement could narrow the range of views represented by
excluding posts by anyone who has not opened an account with the
intermediary, we believe that it will help to establish accountability
for comments made in the communication channels. We continue to believe
that, without this measure, there would be greater risk of the
communications including unfounded, potentially abusive or biased
statements intended to promote or discredit the issuer and improperly
influence the investment decisions of members of the crowd.
With respect to one commenter's suggestion that the Commission
provide an investor ``hotline'' where investors can report concerns
relating to crowdfunding communications or transactions, we note that
the Commission has an existing ``Tips, Complaints and Referrals
Portal'' available on its Web site,\826\ where the public may provide
the Commission with information about potential fraud or wrongdoing
involving alleged violations of the securities laws.
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\826\ See Enforcement Tips and Complaints, available at https://www.sec.gov/complaint/tipscomplaint.shtml.
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We are mindful of the cost associated with the communications
channel, and, therefore, we are not requiring that intermediaries keep
the communication channels available to investors post-offering, as
suggested by some commenters.\827\ However, an intermediary in its
discretion can choose to maintain the communication channels post-
offering.\828\
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\827\ See, e.g., PeoplePowerFund Letter; RocketHub Letter;
StartupValley Letter.
\828\ It is important to note that an intermediary would still
have to maintain records of such communications to satisfy the books
and records requirements of the crowdfunding rules. See Rule
404(a)(3).
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Consistent with the prohibition on a funding portal offering
investment advice or recommendations,\829\ the rule as adopted will
prohibit an intermediary that is a funding portal from participating in
any communications in these channels, apart from establishing
guidelines for communication and removing abusive or potentially
fraudulent communications. A funding portal can, for example, establish
guidelines pertaining to the length or size of individual postings in
the communication channels and can remove postings that include
offensive or incendiary language. Also, although we understand the
reasons for commenters' suggestions that there should be more privacy
or control in the manner in which comments are posted, we believe that
aside from intermediaries removing abusive or potentially fraudulent
communications, investor protection is better served by providing the
opportunity for uncensored and transparent crowd discussions about a
potential investment opportunity.
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\829\ See Rule 300(c)(2)(i). Exchange Act Section 3(a)(80)
defines the term ``funding portal'' as any person acting as an
intermediary in a transaction involving the offer or sale of
securities for the account of others, solely pursuant to Securities
Act Section 4(a)(6), that does not, among other things, ``offer
investment advice or recommendations.''
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Finally, under the rule as adopted an intermediary must require any
person posting on the communication channel to clearly and prominently
disclose with each posting whether he or she is a founder or an
employee of an issuer engaging in promotional activities on behalf of
the issuer, or is otherwise compensated, whether in the past or
prospectively, to promote the issuer's offering. This disclosure will
apply to officers, directors and other representatives of the issuer,
and also will be required of an intermediary that is a broker and its
associated persons. We continue to believe that intermediaries, as the
hosts of the communication channels, are well placed to take measures
to ensure that promoters clearly identify themselves in their
communication channels, in accordance with Securities Act Section
4A(b)(3).
d. Notice of Investment Commitment
(1) Proposed Rule
Proposed Rule 303(d) of Regulation Crowdfunding would require an
intermediary, upon receipt of an investment commitment from an
investor, to promptly give or send to the investor a notification
disclosing: (1) The dollar amount of the investment commitment; (2) the
price of the securities, if known; (3) the name of the issuer; and (4)
the date and time by which the investor may cancel the investment
commitment. Pursuant to proposed Rule 302(a)(2) of Regulation
Crowdfunding, this notification would be provided by email or other
electronic media, and would be documented in accordance with applicable
recordkeeping rules.\830\
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\830\ See Section II.C.4 (discussing Rule 100(a)(3)) and Section
II.D.5 (discussing the recordkeeping rules applicable to funding
portals). See also note 1114 (discussing the recordkeeping rules
applicable to brokers and intermediaries).
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(2) Comments on the Proposed Rule
Commenters generally supported the requirement that intermediaries
send these notifications to investors.\831\ One of these commenters
stated that, in its view, the notice should be submitted twice: first,
when an investor has made a commitment, and again when the cancellation
period is over.\832\ One commenter stated that, in its view, investors
also should be notified of whether a campaign has been successful or
not, both when the campaign is near completion and when the campaign
has been closed.\833\ However, one commenter opposed all notice
requirements.\834\
---------------------------------------------------------------------------
\831\ See, e.g., CFA Institute Letter; Joinvestor Letter;
RocketHub Letter.
\832\ See RocketHub Letter.
\833\ See Joinvestor Letter.
\834\ See Public Startup Letter 3.
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(3) Final Rules
After considering the comments, we are adopting Rule 303(d) as
proposed. As stated in the Proposing Release, the notification is
intended, among other things, to provide the investor with a written
record of the basic terms of the transaction, as well as a reminder of
his or her ability to cancel the investment commitment. We believe that
the adopted notification requirements will be useful to investors and
provide transparency. We also believe that requiring that this
notification be sent once--promptly upon receipt of an investment
commitment from an investor--rather than multiple times as commenters
suggested--will help to minimize the costs associated with providing
additional notification, while still providing the investor with, among
other things, an important reminder about the ability to cancel the
investment commitment. Although an intermediary can decide, in its
discretion, to provide additional notifications to its customers as a
business decision, we believe at this time that adopting additional
notification requirements could hamper flexibility in the evolving
crowdfunding market and potentially impair the development of best
practices that are
[[Page 71448]]
tailored to this unique form of raising capital.
e. Maintenance and Transmission of Funds
(1) Proposed Rule
Securities Act Section 4A(a)(7) requires that an intermediary
``ensure that all offering proceeds are only provided to the issuer
when the aggregate capital raised from all investors is equal to or
greater than a target offering amount, . . . as the Commission shall,
by rule, determine appropriate.'' Proposed Rule 303(e)(1) of Regulation
Crowdfunding would implement this provision and address the maintenance
and protection of investor funds, pending completion of a transaction
made in reliance on Section 4(a)(6), by requiring an intermediary that
is a registered broker to comply with established requirements in
Exchange Act Rule 15c2-4 \835\ for the maintenance and transmission of
investor funds.
---------------------------------------------------------------------------
\835\ 17 CFR 240.15c2-4.
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Proposed Rule 303(e)(2) would establish separate requirements for
an intermediary that is a funding portal. Because a funding portal
cannot receive any funds, it would be required to direct investors to
transmit money or other consideration directly to a ``qualified third
party'' that has agreed in writing to hold the funds for the benefit of
the investors and the issuer and to promptly transmit or return the
funds to the persons entitled to such funds. Proposed Rule 303(e)(2)
would define ``qualified third party'' to mean a bank \836\ that has
agreed in writing to either: (i) Hold the funds in escrow for the
persons who have the beneficial interests in the funds and to transmit
or return the funds directly to the persons entitled to them when the
appropriate event or contingency has occurred; or (ii) establish a bank
account (or accounts) for the exclusive benefit of investors and the
issuer.
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\836\ See Exchange Act Section 3(a)(6) [15 U.S.C. 78c(a)(6)]
(defining ``bank'').
---------------------------------------------------------------------------
Proposed Rule 303(e)(3) would require an intermediary that is a
funding portal to promptly direct transmission of funds from the
qualified third party to the issuer when the aggregate amount of
investment commitments from all investors is equal to or greater than
the target amount of the offering and the cancellation period for each
investor has expired, provided that in no event may the funding portal
direct this transmission of funds earlier than 21 days after the date
on which the intermediary makes publicly available on its platform the
information required to be provided by the issuer under Rules 201 and
203(a) of proposed Regulation Crowdfunding.
(2) Comments on the Proposed Rule
Several commenters generally supported the proposed fund
maintenance and transmission requirements.\837\ One commenter suggested
that intermediaries be allowed to reject an investor's investment
commitment if that investor does not have a correlating balance in an
account with the intermediary.\838\ Another commenter suggested that
the Commission require that such accounts be interest bearing and that
either (1) the investors' funds be returned to them with their pro rata
portion of the interest in the event the offering is canceled, or (2)
the funds and the accrued interest be dispersed to the issuer upon the
offering's successful closing.\839\ Another commenter suggested that
qualified third parties should be registered and verified for
``reputations [of] integrity''; complaints against those entities
should be made public; and ``drawdown'' schedules should be submitted
at the onset of projects and subsequently control issuer access to
``project funds.'' \840\
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\837\ See, e.g., Arctic Island Letter 6; ASTTC Letter; CSTTC
Letter; Greenfield Letter (suggesting that the issuer should be
required to certify in writing under penalty of perjury to the
escrow bank that the offering has been completed pursuant to the
terms in the offering statement and that there have been no material
changes of circumstances that would render the representations in
the offering statement false or misleading); Joinvestor Letter; STA
Letter.
\838\ See Zhang Letter.
\839\ See MCS Letter.
\840\ See Otherworld Letter.
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In the Proposing Release, we requested comment on various
alternatives to the proposed rules. As to whether the proposed rules
should prohibit any variations of a contingency offering, such as
minimum-maximum, offerings, one commenter stated that the target amount
of a crowdfunding campaign ``should represent the minimum to avoid
investor confusion'' and that ``oversubscription should be allowed.''
\841\ This commenter noted that these conditions would allow companies
to ``choose to set their own minimum and maximum range.'' \842\ Another
commenter suggested that we permit contingency offers based on a
maximum amount of funds being raised or other benchmarks if the maximum
is not met or, alternatively, permit ``all-or-none'' offerings.\843\
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\841\ See Joinvestor Letter.
\842\ Id.
\843\ See PeoplePowerFund Letter (suggesting also that any
oversubscribed issues be allocated on a ``first come first served''
basis in connection with ``all-or-none'' offerings).
---------------------------------------------------------------------------
As to whether other types of custody arrangements should be
permitted, one commenter requested clarification that a carrying broker
would not be deemed to accept any part of the sale price of any
security for purposes of Exchange Act Rule 15c2-4 under specific
circumstances.\844\
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\844\ See FOLIOfn Letter. Although this commenter stated its
belief that the proposed procedure is consistent with Rule 15c2-4 on
the basis that the carrying broker would not be ``accept[ing] any
part of the sale price'' until closing, at which time funds would be
promptly transferred to the issuer, it stated that additional
clarity would be helpful to ensure that the Proposing Release does
not introduce confusion if read by some as containing an implication
to the contrary.
---------------------------------------------------------------------------
As to whether there should be a fixed deadline for transmission of
funds (such as three business days), one commenter stated that ``fixed
deadlines should be set to protect investor and issuer interests.''
This commenter suggested that ``one week (7 days) should be sufficient
to disburse collected funds.'' \845\ Another commenter suggested a
three-day deadline.\846\
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\845\ See Joinvestor Letter.
\846\ See Public Startup Letter 3.
---------------------------------------------------------------------------
As to whether SRO and staff guidance on Exchange Act Rule 15c2-4
should be expressly incorporated into the rules, one commenter
suggested that there was no need for incorporation of prior guidance
about Rule 15c2-4 into the proposed rules.\847\
---------------------------------------------------------------------------
\847\ See Arctic Island Letter 6.
---------------------------------------------------------------------------
As to whether the definition of ``qualified third party'' should be
expanded to include entities other than a bank, one commenter stated
that the Commission should ``consider [permitting] non-bank custodians,
such as internet services that specialize in escrow and payment
transfer.'' \848\ Another commenter suggested that ``qualified third
parties'' should include credit unions, savings and loans and other
institutions that offer similar protections to banks.\849\ Similarly,
another commenter suggested that credit unions should be included.\850\
One commenter suggested that banks should not be a qualified third
party.\851\ One
[[Page 71449]]
commenter suggested that the definition of ``qualified third party'' be
expanded to include certain broker-dealers that ``hold funds and
securities on behalf of customer accounts pursuant to [Exchange Act]
Rule 15c3-3 and maintain net capital pursuant to [Exchange Act] Rule
15c3-1(a)(2)(i)''.\852\ The commenter also suggested that funding
portals and other brokers should be able to utilize these brokers ``to
the identical degree they would be able to utilize banks under Rule
15c2-4.'' \853\
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\848\ See Joinvestor Letter.
\849\ See Growthfountain Letter.
\850\ See Vann Letter.
\851\ See Public Startup Letter 3 (claiming that ``[b]anks are
unable to serve as the `qualified third party' '' and that no
entities other than registered broker-dealers should serve this
function in connection with Regulation Crowdfunding sales.). But see
Computershare Letter (supporting the ``inclusion of a requirement
that Funding Portals use a qualified third party, which is a bank,
to hold investor funds as escrow agent and transmit the funds to the
issuer once the offering requirements are met''); ASTTC Letter
(stating that it ``strongly supports the Proposed Rule's requirement
that Funding Portals be required to utilize qualified escrow agents
to hold the investor assets prior to transmittal to issuers and that
``[q]ualified escrow agents are generally regulated banks''); STA
Letter (stating that ``[it] is pleased that the Proposed Rules
contain a requirement that Funding Portals transmit investor assets
to qualified escrow agents, which are banks, prior to their release
to the issuer.'').
\852\ See FOLIOfn Letter. See also Arctic Island Letter 8
(suggesting that the rules permit a $250,000 net capital broker-
dealer to act as trustee for an omnibus escrow account at an FDIC
insured bank); Ex 24 Letter.
\853\ See FOLIOfn Letter (stating also its belief that the
brokers ``should be distinguished from other broker-dealers in the
context of Regulation Crowdfunding and not be subject to the
requirements of SEC Rule 15c2-4(b)'').
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Commenters generally agreed with our proposed approach not to
require funding portals to maintain net capital, noting among other
things that imposing ``net capital requirements would increase the cost
of starting a new funding portal and reduce the potential number of
intermediaries, while providing little additional protection to
investors and issuers.''\854\
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\854\ See Tiny Cat Letter (stating that ``[f]unding portals are
already prohibited from handling funds and securities, and are also
subject to a fidelity bond in the proposed regulations''). See also
Joinvestor Letter (suggesting that since funding portals will not be
monetary custodians, there should be no net capital requirement
instituted); Vann Letter (stating that a ``capital requirement would
unnecessarily restrict competition'').
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As to whether certain methods of payment for the purchase of
securities should either be required or prohibited, one commenter
suggested that the types of payment methods not be limited in any
way.\855\ However, some commenters stated, generally, that credit cards
should be prohibited as a form of payment for securities in connection
with crowdfunding.\856\
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\855\ See Public Startup Letter 3.
\856\ See, e.g., Arctic Island Letter 6 (suggesting that, given
the chargeback periods for credit cards, broker-dealers should only
be permitted to accept credit card payments from investors if the
broker-dealer ``directly and unconditionally guarantees the amounts
obtained thereby to both the issuer and the escrow agent'');
Consumer Federation Letter (suggesting that allowing payment via
credit card increases the risk that investors will make crowdfunding
investments that they cannot afford); Joinvestor Letter; RocketHub
Letter (stating that ``[p]ermitting debt-based payment vehicles,
such as credit cards, which have their own rescission policies,
(i.e., charge backs) is problematic'').
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(3) Final Rule
After considering the comments, we are adopting Rule 303(e)
substantially as proposed, but with certain revisions in response to
comments. Rule 303(e)(1), as adopted, requires an intermediary that is
a registered broker-dealer to comply with established requirements in
Exchange Act Rule 15c2-4 for the maintenance and transmission of
investor funds. Rule 15c2-4 requires, in relevant part, that in
connection with a contingency offering of a security, any money or
other consideration received by a broker-dealer participating in the
distribution must be promptly deposited in a separate bank account, as
agent or trustee for the persons who have the beneficial interest
therein, until the appropriate event or contingency has occurred, and
thereafter promptly transmitted or returned to the persons entitled
thereto; \857\ or alternatively, that all such funds must be promptly
transmitted to a bank that has agreed in writing to hold such funds in
escrow for the persons who have the beneficial interests therein and to
transmit or return such funds directly to the persons entitled thereto
when the appropriate event or contingency has occurred.\858\ When the
Commission adopted Rule 15c2-4, the Commission explained that the rule
was designed to prevent fraud by a broker-dealer ``either upon the
person on whose behalf the distribution is being made or upon the
customer to whom the payment is to be returned if the distribution is
not completed.'' \859\ As such, consistent with Securities Act Section
4A(a)(7), the intermediary may transmit the proceeds to the issuer only
if the target offering amount is met or exceeded.
---------------------------------------------------------------------------
\857\ See Exchange Act Rule 15c2-4(b)(1). We note, however, that
any broker-dealer seeking to hold such investor funds in a separate
bank account as agent or trustee for the persons who have a
beneficial interest therein are still subject to net capital
requirements pursuant to Exchange Act Rule 15c3-1.
\858\ See Exchange Act Rule 15c2-4(b)(2).
\859\ Adoption of Rule 15c2-4 under the Securities Exchange Act
of 1934, Release No. 34-6737 (Feb. 21, 1962) [27 FR 2089 (Mar. 3,
1962)].
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Rule 303(e)(2) as adopted establishes separate requirements for an
intermediary that is a funding portal (as compared to an intermediary
that is a broker-dealer) because a funding portal cannot, by statute,
hold, manage, possess, or otherwise handle investor funds or
securities.\860\ Therefore, Rule 303(e)(2) requires a funding portal to
direct investors to transmit money or other consideration directly to a
qualified third party that has agreed in writing \861\ to hold the
funds for the benefit of the investors and the issuer and to promptly
transmit or return the funds to the persons entitled to such
funds.\862\
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\860\ See Exchange Act Section 3(a)(80)(D).
\861\ This written agreement is required to be maintained by the
funding portal pursuant to proposed Rule 404 of Regulation
Crowdfunding. See Section II.D.5.
\862\ In the crowdfunding context, we expect that the
intermediary will make the determination as to whether the
contingency (i.e., the target offering amount) has been met. See
Securities Act Section 4A(a)(7) (requiring that an intermediary
``ensure that all offering proceeds are only provided to the issuer
when the aggregate capital raised from all investors is equal to or
greater than a target offering amount, . . . as the Commission
shall, by rule, determine appropriate.'').
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We are revising the definition of a ``qualified third party'' to
include for purposes of the final rule: a registered broker or dealer
that carries customer or broker or dealer accounts and holds funds or
securities for those persons,\863\ a bank, or a credit union insured by
the National Credit Union Administration (``NCUA'').\864\ We had
proposed to define ``qualified third party'' to mean a bank \865\
because investors, as well as intermediaries and issuers, would then be
afforded the protections of existing regulations that apply to banks,
in particular those pertaining to the safeguarding of customer
funds.\866\ However, after considering the comments, we agree with
those commenters who suggested that the definition of ``qualified third
party'' should be expanded to include entities other than a bank and
should include, as one commenter suggested, credit unions provided that
these entities offer similar protections to banks.\867\ We also
[[Page 71450]]
made a corresponding change to the language of the rule text to
indicate that a qualified third party arrangement may involve either a
bank or credit union account (or accounts) established for the
exclusive benefit of investors and the issuer.
---------------------------------------------------------------------------
\863\ Broker-dealers that may serve as qualified third parties
under Rule 303(e) include only those broker-dealers that are
required to maintain minimum net capital of $250,000 or a higher
minimum amount depending on their status under Appendix E of Rule
15c3-1 under the Exchange Act. See Exchange Act Rules 15c3-
1(a)(2)(i) and 15c3-1(a)(7)(i).
\864\ The NCUA was established by the Federal Credit Union Act
of 1934. See Federal Credit Union Act of 1934, as amended, 12 U.S.C.
1752 et seq. The NCUA administers the National Credit Union Share
Insurance Fund (``NCUSIF''), which is backed by the full faith and
credit of the U.S. government. NCUSIF protection covers the deposits
in federal credit unions, as well as a majority of state-chartered
credit unions. See NCUA Share Insurance Fund Information, Reports,
and Statements, Frequently Asked Questions, National Credit Union
Administration, http://www.ncua.gov/DataApps/Pages/SI-FAQs.aspx.
\865\ See Proposing Release, at 182-83 [78 FR 66427, at 66473].
See also Exchange Act Section 3(a)(6) [15 U.S.C. 78c(a)(6)]
(defining ``bank'').
\866\ For example, bank deposit accounts at FDIC-insured banks
are protected by FDIC deposit insurance. See Federal Deposit
Insurance Corp., Deposit Insurance FAQs, available at http://www.fdic.gov/deposit/deposits/faq.html.
\867\ We do not believe that the definition of qualified third
party should be extended to include Internet service providers that
specialize in escrow and payment transfer, as suggested by one
commenter, because we do not believe that such entities are governed
by a regulatory scheme designed to provide similar protections as
the other entities that we are defining as qualified third parties
under Rule 303(e). We note that another commenter suggested the
addition of savings and loan associations. We believe that certain
savings and loan associations are covered by the definition of
``bank'' under Exchange Act Section 3(a)(6), and as such, are
qualified third parties under Rule 303(e). We note that the Federal
Deposit Insurance Corp. extended its authority to cover savings and
loan associations in 1989. See Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 (FIRREA) (creating the Savings
Association Insurance Fund (SAIF)).
---------------------------------------------------------------------------
After considering the comments, we further believe that the
definition of ``qualified third party'' should be expanded to include
certain types of registered broker-dealers. We are expanding the
definition to include registered broker-dealers that carry customer or
broker or dealer accounts and holds funds or securities for those
persons. We believe such brokers-dealers are appropriate entities to
serve as qualified third parties as they are subject to various
regulatory obligations, which are designed to provide enhanced
protection of investor funds through the imposition of capital and
other requirements.\868\ We note that we are not amending the
requirements of Rule 15c2-4 through this release and not distinguishing
broker-dealers that participate in offerings made in reliance on
Securities Act Section 4(a)(6), either as a qualified third party or an
intermediary, from broker-dealers in any other contingency offerings.
As such, broker-dealers participating in offerings made in reliance on
Section 4(a)(6), either as an intermediary or as a qualified third
party, are still subject to Rule 15c2-4.\869\ Further, we believe that
existing Commission and staff guidance on Rule 15c2-4 is extensive and
clear and does not warrant incorporation into the final rule or
clarification.
---------------------------------------------------------------------------
\868\ See, e.g., Exchange Act Rule 15c3-1 and Rule 15c2-4.
\869\ Under existing Rule 15c2-4, the qualified third party
broker-dealer will be required to promptly deposit the funds in a
separate bank account, as agent or trustee for the persons who have
the beneficial interest therein, until the appropriate event or
contingency has occurred, and thereafter promptly transmit or return
the funds to the persons entitled thereto. See Rule 15c2-4(b)(1).
---------------------------------------------------------------------------
The statute does not limit or require a particular payment
mechanism, and we are not imposing such a restriction because we
believe that the rules should provide reasonable flexibility regarding
the payment mechanisms intermediaries employ. We believe that
restrictions on particular payment mechanisms would not serve to
significantly increase investor protection, particularly in light of
the established investment limits. We note, however that an
intermediary can, in its discretion, decline to accept certain payment
methods, such as credit cards, or accept them only in certain
circumstances.\870\
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\870\ We note, for example, that an intermediary can, in its
discretion, decline to accept credit cards given that, as at least
one commenter suggested, an investor's use of his or her right to
dispute credit card charges can inhibit the ability of an issuer to
meet its target or to provide accurate disclosures to investors and
the Commission regarding the progress it has made toward, and
whether it has, reached the target offering amount. This potential
impact will affect offerings conducted through brokers and funding
portals alike. We also note that pursuant to Exchange Act Section
3(a)(80)(D) (15 U.S.C. 78c(a)(80)(D)), a funding portal is
statutorily prohibited from extending credit or margin to customers.
---------------------------------------------------------------------------
We also are not adopting additional requirements that would, for
example, (1) prohibit variations of a contingency offering, such as
minimum-maximum offerings; (2) establish a fixed deadline for
transmission of funds as compared to the proposed requirement to
transmit funds ``promptly''; or (3) require funding portals to maintain
a certain amount of net capital. We believe that additional
restrictions, such as prohibiting variations of a contingency offering
or establishing a fixed deadline for the transmission of funds could
hamper flexibility in the nascent crowdfunding market and prohibit the
development of best practices specifically tailored to this unique form
of capital raising. Finally, we are not requiring in the final rule net
capital standards for funding portals. As noted above, funding portals
are prohibited from handling, managing or possessing investor funds or
securities.\871\ We continue to believe that the requirements relating,
in particular, to transmission of proceeds under the final rules will
help ensure that investor funds are protected, without requiring
funding portals to maintain net capital.
---------------------------------------------------------------------------
\871\ See Exchange Act Section 3(a)(80)(D) [15 U.S.C.
78c(a)(80)(D)] and discussion in Section II.C.1.
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f. Confirmation of Transactions
(1) Proposed Rule
As proposed, Rule 303(f)(1) of Regulation Crowdfunding would
require that an intermediary, at or before the completion of a
transaction made pursuant to Section 4(a)(6), give or send to each
investor a notification disclosing: (1) The date of the transaction;
(2) the type of security that the investor is purchasing; (3) the
identity, price and number of securities purchased by the investor, as
well as the number of securities sold by the issuer in the transaction
and the price(s) at which the securities were sold; (4) certain
specified terms of the security, if it is a debt or callable security;
and (5) the source and amount of any remuneration received or to be
received by the intermediary in connection with the transaction,
whether from the issuer or from other persons. This notification would
be required to be provided by email or other electronic media,\872\ and
to be documented in accordance with applicable recordkeeping
rules.\873\ Pursuant to proposed Rule 303(f)(2), an intermediary that
gives or sends to each investor the notification described above would
be exempt from the requirements of Exchange Act Rule 10b-10 \874\ for
the subject transaction.
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\872\ See proposed Rule 302(a)(2) (requiring an intermediary to
provide all information electronically). See also Section II.C.4.a
(discussing electronic delivery requirements).
\873\ Intermediaries that are brokers are subject to the
recordkeeping requirements of Exchange Act Rules 17a-3 and 17a-4,
and intermediaries that are funding portals are subject to
recordkeeping requirements under Rule 404 of Regulation
Crowdfunding. See note 1114 (discussing the recordkeeping rules
applicable to brokers and intermediaries). See also Section II.D.5.
\874\ See note 882 (discussing Exchange Act Rule 10b-10 (17 CFR
240.10b-10) generally).
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(2) Comments on the Proposed Rule
Commenters generally supported the proposed confirmation
requirements.\875\ One commenter, however, stated its view that
permitting intermediaries to satisfy the delivery requirement for
transaction confirmations through delivery of a message that contains a
notice that the information is available on the intermediary's Web site
would not be sufficient.\876\
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\875\ See, e.g., CFA Institute Letter; Joinvestor Letter.
\876\ See Consumer Federation Letter (stating that ``[w]hile
most if not all intermediaries would be likely to deliver the actual
confirmation to investors, the rule would not guarantee this'').
---------------------------------------------------------------------------
(3) Final Rule
After considering the comments, we are adopting Rule 303(f), as
proposed, but with one clarifying change. As proposed, Rule
303(f)(1)(vi) would have required an intermediary to give or send to
each investor a notification disclosing: ``[t]he source and amount of
any remuneration received or to be received by the intermediary in
connection with the transaction, including the amount and form of any
remuneration that is received, or will be received, by the intermediary
from persons other than the issuer. We are
[[Page 71451]]
revising Rule 303(f)(1)(vi) to require disclosure as well of the form
of any remuneration received or to be received by the intermediary in
connection with the transaction, including any remuneration received or
to be received by the intermediary from persons other than the issuer.
This edit is intended to clarify the rule by placing ``source, form and
amount'' together, rather than having ``form'' listed out separately as
proposed.
As explained in the Proposing Release, we believe that transaction
confirmations serve an important and basic investor protection function
by, among other things, conveying information and providing a reference
document that allows investors to verify the terms of their
transactions, acting as a safeguard against fraud and providing
investors a means by which to evaluate the costs of their
transactions.\877\ Each of the required items of information is
intended to assist investors in memorializing and assessing their
transactions. Furthermore, the requirement that an intermediary
disclose to an investor the source, form and amount of any remuneration
received or to be received is designed to help to highlight potential
conflicts of interest if, for example, an intermediary has a financial
interest in an issuer using its services.\878\
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\877\ See Proposing Release at 78 FR 66475. See also
Confirmation of Transactions, Release No. 34-34962 (Nov. 10, 1994)
[59 FR 59612, 59613 (Nov. 17, 1994)].
\878\ Although Securities Act Section 4A(a)(11) requires an
intermediary to prohibit its directors, officers or partners (or any
person occupying a similar status or performing a similar function)
from having any financial interest in an issuer using its services,
the final rules do not include a complete prohibition on the
intermediary, itself, having a financial interest in an issuer using
its services. The intermediary may have a financial interest in an
issuer using its services, subject to certain limitations. See Rule
300(b). See also Section II.C.2.b.
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As for the concern raised by one commenter about the delivery
requirements for transaction confirmations,\879\ we note, as we did in
the Proposing Release, that the confirmation is required to be provided
by email or other electronic media, consistent with the Commission's
long-standing policies on the use of electronic media for delivery
purposes.\880\ This is also consistent with the requirement for an
intermediary to provide all information electronically. We believe that
this delivery requirement is appropriate for crowdfunding transactions
and satisfies our obligation that requirements under Securities Act
Section 4A(a)(12) be for the protection of investors and in the public
interest. As to the same commenter's view that the rule would not
guarantee delivery of a confirmation to investors,\881\ although we
acknowledge that statutes and rules cannot guarantee compliance, there
is a robust regulatory scheme in place that is designed to promote
compliance and that is coupled with supervision and enforcement by both
the Commission and the registered national securities association.
---------------------------------------------------------------------------
\879\ See Consumer Federation Letter.
\880\ See Proposing Release, at 189 [78 FR 66427, at 66475]. See
also Use of Electronic Media, note 714 at 25853 (discussing the
``access equals delivery'' concept and citing Use of Electronic
Media for Delivery Purposes, Release No. 34-36345 (Oct. 6, 1995) [60
FR 53548, 53454 (Oct. 13, 1995)])).
\881\ See Consumer Federation Letter.
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In addition, under Rule 303(f)(2) as adopted, an intermediary that
gives or sends to each investor the notification described above is
exempt from the requirements of Exchange Act Rule 10b-10 for the
subject transaction.\882\ The confirmation terms under Rule 303(f)(2)
are similar to, but not as extensive as, those broker-dealers are
subject to under Rule 10b-10. We believe that this difference is
appropriate given the more limited scope of an intermediary's role in
crowdfunding transactions. Rule 10b-10, for example, requires
disclosure about such matters as payment for order flow, riskless
principal transactions, payment of odd-lot differentials and asset-
backed securities. These items generally would not be relevant to
crowdfunding securities transactions or an intermediary's participation
in such transactions, and their inclusion in a crowdfunding securities
confirmation may be confusing to investors. Therefore, we believe that
if an intermediary satisfies the notification requirements of the final
rules, the intermediary will have provided investors with sufficient
relevant information about the crowdfunding security, and so should not
be required to meet the additional requirements of Rule 10b-10.
---------------------------------------------------------------------------
\882\ Exchange Act Rule 10b-10 (17 CFR 240.10b-10) generally
requires a broker-dealer effecting a customer transaction in
securities (other than U.S. savings bonds or municipal securities)
to provide a notification to its customer, at or before completion
of a securities transaction, that discloses certain information
specific to the transaction. Specifically, Rule 10b-10 requires the
disclosure of the date, time, identity, prices and number of
securities bought or sold; the capacity in which the broker-dealer
acted (e.g., as agent or principal); yields on debt securities; and
under specified circumstances, the amount of remuneration the
broker-dealer will receive from the customer and any other parties.
With regard to the specified circumstances mentioned above, the
remuneration disclosures of Rule 10b-10 generally are required, but
certain exclusions apply. For example, the remuneration disclosures
are generally required where a broker or dealer is acting as agent
for a customer or some other person. In the case where remuneration
is received or to be received by the broker from such customer in
connection with the transaction, the disclosures are not required
where the remuneration paid by such customer is determined pursuant
to written agreement with such customer, otherwise than on a
transaction basis. 17 CFR 240.10b-10(a)(2)(i)(B). In contrast, the
remuneration disclosure requirements of Rule 303(f)(2)(vi) are
required across all crowdfunding transactions where remunerations
are received or are to be received. Given the limits on the dollar
amount of securities that can be offered, as well as the limits on
individual investment amounts, in transactions relying on Section
4(a)(6), we do not expect investors to negotiate individualized
compensation agreements.
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6. Completion of Offerings, Cancellations and Reconfirmations
a. Proposed Rule
Under Securities Act Section 4A(a)(7), an intermediary is required
to allow investors to cancel their commitments to invest as the
Commission shall, by rule, determine appropriate. Securities Act
Section 4A(b)(1)(G) requires an issuer, prior to sale, to provide
investors ``a reasonable opportunity to rescind the commitment to
purchase the securities.'' We proposed, therefore, in Rule 304(a) of
Regulation Crowdfunding, to give investors an unconditional right to
cancel an investment commitment for any reason until 48 hours prior to
the deadline identified in the issuer's offering materials. Under this
approach, an investor could reconsider his or her investment decision
with the benefit of the views of the crowd and other information, until
the final 48 hours of the offering. Thereafter, an investor would not
be able to cancel any investment commitments made within the final 48
hours of the offering (except in the event of a material change to the
offering, as discussed below).\883\
---------------------------------------------------------------------------
\883\ See proposed Rule 304(c).
---------------------------------------------------------------------------
We also proposed in Rule 304(b) that if an issuer reached the
target offering amount prior to the deadline identified in its offering
materials, it could close the offering once the target offering amount
was reached, provided that: (1) The offering had been open for a
minimum of 21 days; (2) the intermediary provided notice about the new
offering deadline at least five business days prior to the new offering
deadline; (3) investors would be given the opportunity to reconsider
their investment decision and to cancel their investment commitment
until 48 hours prior to the new offering deadline; and (4) at the time
of the new offering deadline, the issuer continued to meet or exceed
the target offering amount.
In addition, we proposed in Rule 304(c) that if there was a
material
[[Page 71452]]
change \884\ to the terms of an offering or to the information provided
by the issuer about the offering, the intermediary would be required to
give or send to any investors who have made investment commitments
notice of the material change, stating that the investor's investment
commitment will be cancelled unless the investor reconfirms his or her
commitment within five business days of receipt of the notice.\885\ As
proposed, if the investor failed to reconfirm his or her investment
within those five business days, the intermediary would be required,
within five business days thereafter, to: (1) Provide or send the
investor a notification disclosing that the investment commitment was
cancelled, the reason for the cancellation and the refund amount that
the investor should expect to receive; and (2) direct the refund of
investor funds.\886\ This notification, like other notifications from
an intermediary, would be required to be provided by email or other
electronic media, and to be documented in accordance with applicable
recordkeeping rules.\887\
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\884\ In the Proposing Release, we noted that in those instances
where an issuer had previously disclosed in its offering materials
only the method for determining the price of the securities offered
and not the final price of those securities, setting of the final
price would be considered a material change. We also noted that if
the change involved closing the offering once the target offering
amount is reached, which would be prior to the deadline identified
in the offering materials, then the procedures required under
proposed Rule 304(b), and not those in Rule 304(c), would apply.
\885\ The proposed rules also required that an issuer extend an
offering to allow for a five business day period in instances where
material changes to the offering or to the information provided by
the issuer occurred within five business days of the maximum number
of days that an offering was to remain open. See proposed Rule
304(c)(2) of Regulation Crowdfunding. See also Rule 302(a)(2)
(requiring that notification be provided by email or through other
electronic media).
\886\ See proposed Rule 304(c)(1) of Regulation Crowdfunding.
\887\ Intermediaries that are brokers would be subject to the
recordkeeping requirements of Exchange Act Rules 17a-3 and 17a-4,
and intermediaries that are funding portals would be subject to
recordkeeping requirements under proposed Rule 404 of Regulation
Crowdfunding. See note 1114 (discussing the recordkeeping rules
applicable to brokers and intermediaries). See also Section II.D.5;
Section II.C.4. (discussing an intermediary's electronic delivery
requirements and Rule 302(a)(2)).
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Finally, we proposed in Rule 304(d) that if an issuer did not
complete an offering, for example, because the target was not reached
or the issuer decided to terminate the offering, the intermediary would
be required, within five business days, to: (1) Give or send to each
investor who had made an investment commitment a notification
disclosing the cancellation of the offering, the reason for the
cancelation, and the refund amount that the investor should expect to
receive; (2) direct the refund of investor funds; and (3) prevent
investors from making investment commitments with respect to that
offering on its platform. This notification, like other notifications
from an intermediary, would be required to be provided by email or
other electronic media, and to be documented in accordance with
applicable recordkeeping rules.\888\
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\888\ See note 1114 (discussing the recordkeeping rules
applicable to brokers and intermediaries).
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b. Comments on the Proposed Rule
One commenter supported the unconditional right of investors to
cancel an investment commitment for any reason until 48 hours prior to
the close of an offering.\889\ Other commenters, however, expressed
concern over the potential for misconduct regarding cancellations,\890\
such as scenarios where investors commit and then withdraw at the last
minute.\891\
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\889\ See CFA Institute Letter.
\890\ See, e.g., Joinvestor Letter (suggesting the lock-in-date
should be fourteen days prior to the closing date to prevent any
misconduct surrounding the approach of a target, or the limit of
oversubscription, near to the close of the round); Consumer
Federation Letter; RocketHub Letter.
\891\ See, e.g., RocketHub Letter (recommending a 24-hour
cancellation period in order to protect investors from `` `pump &
rescind' schemes'' and minimize an issuer's exposure to the risk of
`` `short fall' situations''); Consumer Federation Letter (noting
the risk that ``individuals associated with the issuer will commit
money to the offering early in the process in order to stimulate
interest and create a sense of urgency about investing, only to
withdraw at the last minute''). The same commenter suggested that
potential gamesmanship by investors associated with the issuer has
the potential to discredit crowdfunding and recommended that the
Commission consider more meaningful restrictions on issuer
participation.
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One commenter stated that the rule on early closure of an offering
should be more narrowly defined.\892\ This commenter requested that the
Commission clarify whether, under such circumstances, an offering
should be closed from accepting more funds or keep accepting
commitments until the end of the five business day period, even if this
puts an offering over set limits.\893\
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\892\ See RFPIA Letter (stating that ``[i]f the issuer reaches
the target offering amount prior to the deadline the current
proposed regulation require[s] a funding portal to give a 5 day
notice to investors of the new closing date. Since funding portals
have no crystal balls, this process needs to be more narrowly
defined'').
\893\ Id.
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Some commenters supported the proposal that existing disclosure
materials can be modified in the event of a material change, with the
original offering remaining open,\894\ while one commenter also
suggested that no changes should be allowed within 21 days of the close
date.\895\ Several commenters generally agreed that an investor should
have to reconfirm the commitment to invest when a material change
occurs.\896\ One commenter stated that many investors would prefer not
to have to re-confirm their investments and recommended allowing
investors to decide how to handle material changes.\897\ Another
commenter opposed any reconfirmation requirement because it believed
there should be a presumption that any changes made would be in the
best interest of the issuer and all of its stakeholders.\898\
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\894\ See, e.g., Arctic Island Letter 6; Joinvestor Letter;
Wales Capital Letter 2.
\895\ See Joinvestor Letter.
\896\ See, e.g., CFA Institute Letter; Wales Capital 2 Letter.
\897\ See Wefunder Letter.
\898\ See Public Startup Letter 3.
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Some commenters supported the proposed five-day reconfirmation
period for investors.\899\ Some commenters, however, stated that five
business days is not enough time for an investor to decide whether to
reconfirm an investment commitment after a material change is made by
the issuer.\900\ One commenter suggested a shorter reconfirmation time
period.\901\ Another commenter recommended that the Commission clarify
when the five-day reconfirmation period begins.\902\ One commenter
suggested material revisions made to the offering should restart the
21-day minimum period for the campaign, though generally agreed that a
five-business day notification is sufficient in the event that an
offering is cancelled.\903\
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\899\ See, e.g., CFA Institute Letter; Wales Capital 2 Letter.
\900\ See, e.g., Arctic Island Letter 6 (advocating that the
time period be ``indefinite'' so as to give investors more time to
consider the changes and to give issuers more time to answer
questions of individual investors and provide clarifications or make
subsequent changes as needed); CfPA Letter (recommending that any
change in offering documents on a Web site after initial posting
restart the 21-day period (or at least half of that) during which
offerings cannot close and prospective or pledged investors can
reconsider and rescind their commitments).
\901\ See RFPIA Letter (suggesting eliminating the requirement
or reducing it to 72 hours).
\902\ See ODS Letter.
\903\ See Wales Capital Letter 2.
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c. Final Rules
We are adopting Rule 304 as proposed, with a technical change to
correct a cross-cite in the rule text. We believe that the final rule
appropriately takes into consideration the needs of investors to be
able to consider material
[[Page 71453]]
changes to the terms of the offering and new views expressed by the
crowd, while allowing issuers to have certainty about their ability to
close an offering at the end of the offering period. We have considered
the comments outlined above about concerns with cancellation generally
and those suggesting other types of cancellation or lock-in periods.
However, we continue to believe that allowing investors to cancel any
investment commitments for any reason until 48 hours prior to the
deadline identified in the issuer's offering materials is an
appropriate cancellation period because it is consistent with the
requirement of Section 4A(b)(1)(G) that investors have a ``reasonable
opportunity'' to rescind investment commitments, while also providing
issuers with certainty within a reasonable amount of time about whether
they have indeed received investment commitments. Although we
acknowledge commenters' concerns about potential misconduct in
connection with cancellations of investment commitments, we note that
issuers and investors, including investors associated with the issuer,
are subject to the antifraud provisions of the securities laws. We also
note that, as we discussed above, an intermediary is required to
promptly remove an offering from its platform if it becomes aware of
information that causes it to believe that the issuer or the offering
presents the potential for fraud or otherwise raises concerns about
investor protection.\904\
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\904\ See Section II.C.3.
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In regards to one commenter's request for clarification as to
whether an intermediary may continue to receive investment commitments
during the five business day period prior to an early closure of an
offering (even if the commitment may be oversubscribed), we note that
intermediaries are permitted to continue to receive investment
commitments during that time period, provided that the intermediary
informs investors about the continuation of such acceptance in
accordance with Rule 304(b).\905\
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\905\ However, the issuer will still have to comply with the
rules regarding oversubscriptions. See Section II.B.6.a. This same
commenter expressed uncertainty about how an issuer will communicate
early closure to a funding portal so that the funding portal can
provide appropriate notice to investors about the new offering
deadline. The final rules do not prescribe the mechanics for how
funding portals must communicate with issuers as we believe the
better course is to provide for flexibility in this regard so that
intermediaries and issuers can arrive at efficient working
arrangements.
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In addition, we believe that when material changes arise during the
course of an offering, an investor who had made a prior investment
commitment should have a reasonable period during which to review the
new information and to decide whether to invest by reconfirming the
investment commitment. Despite some commenters' concerns outlined
above, we continue to believe that a five business day period is
appropriate because it reasonably reflects the need to allow an
investor sufficient time to consider material changes to the terms of
the offering while giving issuers certainty about their ability to
close an offering. For the same reasons noted above, we also believe
that five business days is a sufficient amount of time for
intermediaries to notify investors about offerings that are not
completed or terminated. Finally, we believe that requiring an investor
to reconfirm his or her investment commitment within five business days
of receipt of the notice of a material change is sufficiently clear as
to when the reconfirmation period begins and provides additional
investor protection and is therefore an appropriate requirement for the
final rule.
7. Payments to Third Parties
a. Proposed Rule
Securities Act Section 4A(a)(10) provides that an intermediary in a
transaction made in reliance on Section 4(a)(6) shall not compensate
``promoters, finders, or lead generators for providing the broker or
funding portal with the personal identifying information of any
potential investor.''
We proposed in Rule 305(a) of Regulation Crowdfunding to prohibit
an intermediary from compensating any person for providing it with the
``personally identifiable information'' \906\ of any investor. As
explained in the Proposing Release, we believe that any person
compensated for providing the personally identifiable information of
investors would be acting as a promoter, finder or lead generator
within the meaning of Securities Act Section 4A(a)(10).
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\906\ As proposed, the term ``personally identifiable
information'' would mean any information that can be used to
distinguish or trace an individual's identity, either alone or when
combined with other personal or identifying information that is
linked or linkable to a specific individual. See proposed Rule
305(c) of Regulation Crowdfunding. As explained in the Proposing
Release, personally identifiable information could include any
information that can be used to identify an individual, such as
name, social security number, date or place of birth, mother's
maiden name or biometric records, as well as any other information
that is linked directly to an individual, such as financial,
employment, educational or medical information.
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Proposed Rule 305(b), however, would permit an intermediary to
compensate a person for directing issuers or investors to the
intermediary's platform if: (1) The person does not provide the
intermediary with the personally identifiable information of any
investor, and (2) the compensation, unless it is paid to a registered
broker or dealer, is not based, directly or indirectly, on the purchase
or sale of a security offered in reliance on Securities Act Section
4(a)(6) on or through the intermediary's platform.\907\
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\907\ We note that the receipt of direct or indirect
transaction-based compensation would strongly indicate that the
recipient is acting as a broker. As such, the party receiving the
compensation in the scenario described needs to consider whether it
would be required to register as a broker.
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b. Comments on the Proposed Rule
Some commenters generally supported the portion of the proposed
rule that allows intermediaries to compensate third parties for
directing investors to the platform.\908\ Some of these comments also
agreed that intermediaries should be permitted to compensate third
parties for general business advertising including, for example, web
search engine direction or other standard Internet marketing
techniques.\909\ In response to our request for comment as to whether
disclosures should be required when an intermediary compensates third
parties for directing investors to its platform, one commenter
suggested the Commission should not require disclosure of ``standard
Internet marketing [practices]'' that ``inform investors of companies
they may be interested in.'' \910\ Another commenter stated that
compensation should only be allowed under limited circumstances, albeit
without providing examples of those limited circumstances.\911\ We did
not receive comments related to the definition of the term ``personally
identifiable information'' as proposed in Rule 305(c).
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\908\ See, e.g., RoC Letter; RocketHub Letter; Wefunder Letter.
\909\ See, e.g., RocketHub Letter; Wefunder Letter. See also ABA
Letter (discussing the practice of so-called ``passive bulletin
boards'').
\910\ Wefunder Letter.
\911\ See Joinvestor Letter (``We believe such compensation
should be allowed under extremely limited circumstances, as
promotion will be a central issue to these campaigns.'').
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c. Final Rules
We are adopting Rule 305 with modifications. Rule 305(a), like the
proposed rule, states that an intermediary may not compensate any
person for providing the intermediary with the personally identifiable
information of any investor in securities offered and sold in reliance
on Section 4(a)(6) of the Securities Act. However, we are not including
in the final rule
[[Page 71454]]
what was proposed in paragraph (b), which stated that an intermediary
may compensate a person for directing issuers to the intermediary's
platform, provided that unless the compensation is made to a registered
broker or dealer, the compensation is not based, directly or
indirectly, on the purchase or sale of a security offered in reliance
on Section 4(a)(6) of the Securities Act on or through the
intermediary's platform. Upon further consideration, we believe this
provision would be duplicative of Rule 402(b)(6), which addresses
referral payments that funding portals are permitted to pay to third
parties.\912\ In addition, registered broker-dealers are already
subject to limitations on the types of compensation that they may pay
to third parties, and as we explained in the Proposing Release, are
subject to an established regulatory and oversight regime that provides
important safeguards for investors.
---------------------------------------------------------------------------
\912\ See Section II.D.3.
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We agree with those commenters who believe intermediaries should be
permitted to compensate third parties for general business advertising
including, for example, web search engine direction or other standard
Internet marketing techniques so long as that compensation is not
based, directly or indirectly, on the purchase or sale of a security
offered in reliance on Securities Act Section 4(a)(6).\913\ We believe
permitting compensation for these types of general business advertising
does not raise the same privacy concerns as those implicated by the
provision of personally identifiable information and is generally
consistent with the statutory scheme for crowdfunding promotional
activities. Therefore, under the rules, an intermediary may pay a
person a flat fixed fee \914\ to direct persons to the intermediary's
platform through, for example, hyperlinks or search term results or
make payments to a person to advertise its existence.\915\ The
intermediary, however, cannot pay to receive personally identifiable
information in under any circumstances pursuant to the prohibition in
Rule 305(a).
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\913\ See, e.g., 158 Cong. Rec. S5474-03 (daily ed. July 26,
2012) (statement of Sen. Jeff Merkley) (``[T]he limitation on off-
platform advertising is intended to prohibit issuers--including
officers, directors, and 20 percent shareholders--from promoting or
paying promoters to express opinions outside the platform that would
go beyond pointing the public to the funding portal.'').
\914\ A flat fixed fee is one that is not based on the success
of the offering, and so would not be transaction-based compensation.
We note that the receipt of direct or indirect transaction-based
compensation would strongly indicate that the recipient is acting as
a broker. As such, the party receiving this kind of compensation
needs to consider whether it would be required to register as a
broker.
\915\ See also Rule 402 of Regulation Crowdfunding and
discussion in Section II.D.3 (discussing advertising and marketing
activities in which a funding portal may engage under the
Regulation's safe harbor).
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Finally, we are adopting as proposed the definition of personally
identifiable information, which will be renumbered as Rule 305(b).
D. Additional Funding Portal Requirements
1. Registration Requirement
a. Generally
(1) Proposed Rules
Securities Act Section 4A(a)(1) requires that an intermediary
facilitating a transaction made in reliance on Securities Act Section
4(a)(6) register with the Commission as a broker or a funding portal.
The statute does not, however, prescribe the manner in which a funding
portal would register with the Commission.\916\ Securities Act Section
4A(a)(12) requires intermediaries to comply with requirements as the
Commission may, by rule, prescribe for the protection of investors and
in the public interest. Exchange Act Section 3(h)(1)(C) also permits
the Commission to impose, as part of its authority to exempt funding
portals from broker registration, ``such other requirements under [the
Exchange Act] as the Commission determines appropriate.''
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\916\ Compare Exchange Act Section 15(b) [15 U.S.C. 78o(b)]
(prescribing the manner of registration of broker-dealers).
---------------------------------------------------------------------------
We proposed to establish a streamlined registration process under
which a funding portal would register with the Commission by filing a
form with information consistent with, but less extensive than, the
information required for broker-dealers on the Uniform Application for
Broker-Dealer Registration (``Form BD'').\917\ Under proposed Rule
400(a), a funding portal would register by completing a Form Funding
Portal, which would include information concerning the funding portal's
principal place of business, its legal status and its disciplinary
history, if any; business activities, including the types of
compensation the funding portal would receive; control affiliates of
the funding portal and disclosure of their disciplinary history, if
any; FINRA membership or membership with any other registered national
securities association; and the funding portal's Web site address(es)
or other means of access.\918\ Proposed Rule 400(a) also would require
a funding portal to become a member of FINRA or another applicable
national securities association registered under Exchange Act Section
15A. As proposed in Rule 400(a), the funding portal's registration
would become effective the later of: (1) 30 calendar days after the
date that the registration is received by the Commission; or (2) the
date the funding portal is approved for membership in FINRA or any
other registered national securities association.
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\917\ Brokers currently register with the Commission using Form
BD. Information on that form regarding the broker's credentials,
including current registrations or licenses and employment and
disciplinary history, is publicly available on FINRA's BrokerCheck.
\918\ We discuss in Section II.D.1.b the information required to
be included in Form Funding Portal.
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Proposed Rule 400(b) would require a funding portal to file an
amendment to Form Funding Portal within 30 days of any of the
information previously submitted on the form becoming inaccurate for
any reason.
In addition, proposed Rule 400(c)(1) would permit a funding portal
that succeeds to and continues the business of a registered funding
portal to also succeed to the registration of the predecessor on Form
Funding Portal. As proposed in Rule 400(c)(1), the registration would
remain effective as the registration of the successor if the successor,
within 30 days after such succession, files a registration on Form
Funding Portal and the predecessor files a withdrawal on Form Funding
Portal.\919\ Proposed Rule 400(c)(1), therefore, would not apply where
the predecessor funding portal intends to continue to engage in funding
portal activities.
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\919\ Under the proposed rules, the registration of the
predecessor funding portal would be deemed withdrawn 45 days after
the notice registration on Form Funding Portal was filed by the
successor. See proposed Rule 400(c)(1). A similar process exists for
registered broker-dealers under Exchange Act Rule 15b1-3 (17 CFR
240.15b1-3).
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In certain circumstances, proposed Rule 400(c)(2) would allow the
successor to file an amendment to the predecessor's Form Funding Portal
rather than requiring the successor and predecessor, respectively, to
follow the registration filing and withdrawal process under Rule
400(c)(1) described above. Specifically, proposed Rule 400(c)(2)
provides that, if the succession is based solely on a change of the
predecessor's date or state of incorporation, form of organization or
composition of a partnership, the successor may, within 30 days after
the succession, amend the notice registration of the predecessor on
Form Funding Portal to reflect these changes. Successions by amendment
would be limited to those successions that
[[Page 71455]]
resulted from a formal change in the structure or legal status of the
funding portal but did not result in a change in control.
The instructions to the proposed Form Funding Portal would limit
the term ``successor'' to an entity that assumed or acquired
substantially all of the assets and liabilities of the predecessor
funding portal's business.
We also proposed in Rule 400(d) to require a funding portal to
promptly file a withdrawal of registration on Form Funding Portal upon
ceasing to operate as a funding portal. The withdrawal would be
effective on the later of 30 days after receipt by the Commission,
after the funding portal was no longer operational, or within a longer
period of time consented to by the funding portal or that the
Commission, by order, determined as necessary or appropriate in the
public interest or for the protection of investors.\920\
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\920\ A similar process exists for registered broker-dealers
under Exchange Act Section 15(b)(5) (15 U.S.C. 78o(b)(5)) and Rule
15b6-1 (17 CFR 240.15b6-1) thereunder.
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Proposed Rule 400(e) would provide that each application for
registration, amendment thereto, successor registration or withdrawal
would be considered filed when a complete Form Funding Portal was
submitted with the Commission or its designee. Proposed Rule 400(e)
also would require duplicate originals of the application to be filed
with surveillance personnel designated by the registered national
securities association of which the funding portal is a member.
(2) Comments on the Proposed Rule
We received some comments generally supporting the proposed
registration method,\921\ while one commenter generally opposed the
proposed registration method, stating the Commission is requiring too
stringent a registration process and financial overhead for funding
portals.\922\ One commenter encouraged the Commission to require
broker-dealers to register on the same form as funding portals.\923\
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\921\ See, e.g., Joinvestor Letter; DreamFunded Letter (favoring
the proposed rules which provide a ``high barrier to entry'' to
funding portals, as it will ``stop anyone from potentially creating
a funding portal over a weekend'').
\922\ See PeoplePowerFund Letter (suggesting that the Commission
should consider, ``a simple registration detailing the owners and
operators of a web portal, the legal domicile and registration
contact information etc. and the portals [sic] commitment to
adherence of the rules of the [C]ommission'').
\923\ See RocketHub Letter. The commenter also stated that it
has ``a serious concern with [broker-dealers] having an unfair
advantage in the market, by already being regulated and registered
with the Commission as well as FINRA. Therefore, they may be able to
service the market well ahead of [funding] [p]ortals.''
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In the Proposing Release, we requested comments on whether we
should impose other restrictions or prohibitions on affiliations of the
funding portal, such as affiliation with a registered broker-dealer or
registered transfer agent. Some commenters opposed the imposition of
other restrictions or prohibitions on affiliations of the funding
portal.\924\ One of these commenters stated that affiliations and
partnerships with brokers or transfer agents should be optional.\925\
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\924\ See, e.g., Joinvestor Letter; Tiny Cat Letter.
\925\ See Tiny Cat Letter.
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(3) Final Rules
We are adopting Rule 400(a)-(e) generally as proposed with one
change. We are deleting from Rule 400(e) as proposed the language
stating that Form Funding Portal may be filed with a Commission
designee, as we have determined not to designate this function. Rather,
these filings will be made through the EDGAR system as explained in
more detail below.
Rule 400 establishes a streamlined registration process for a
funding portal to register with the Commission. We have considered the
general comment suggesting that the registration requirement for
funding portals is too stringent and creates financial overhead. We
believe, however, that the rules as adopted provide a reasonable
approach to funding portal registration--they are based on broker-
dealer registration requirements, which we believe have been effective
in providing investor protection and allowing the Commission to perform
its oversight function. At the same time, the registration requirement
takes into account the more limited activities of funding portals as
compared to broker-dealers. As such, the registration requirements we
are imposing on funding portals are generally consistent with those
imposed on broker-dealers, while not as extensive in every aspect. As
we note in Section III.B.5, we have considered the costs of funding
portal registration and believe that the anticipated costs to funding
portals are justified in light of the expected benefits investors will
receive from utilizing funding portals that are subject to registration
requirements, which include public disclosure of registration
information on Form Funding Portal in EDGAR, as described in more
detail in Section II.D.1.b below. We believe that having such a
registration system will promote investor confidence in this new and
emerging market, while providing us and FINRA (and any other applicable
national securities association registered pursuant to Exchange Act
Section 15A) with information integral to effective oversight.
Finally, consistent with the proposal, we are not imposing
additional restrictions or prohibitions on affiliations of the funding
portal in the final rules. We note, however, that Form Funding Portal,
which will be publicly available, requires a funding portal to disclose
information about its control relationships and the disciplinary
history of associated persons.\926\
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\926\ See Item 4--Control Relationship of Form Funding Portal
and Item 5--Disclosure Information of Form Funding Portal.
``Control'' is defined for the purposes of Form Funding Portal as
``[t]he power, directly or indirectly, to direct the management or
policies of the funding portal, whether through contract, or
otherwise. A person is presumed to control a funding portal if that
person: (1) IS A director, general partner or officer exercising
executive responsibility (or has a similar status or functions); (2)
directly or indirectly has the right to vote 25 percent or more of a
class of a voting security or has the power to sell or direct the
sale of 25 percent or more of a class of voting securities of the
funding portal; or (3) in the case of a partnership, has
contributed, or has a right to receive, 25 percent or more of the
capital of the funding portal.'' See Instructions to Form Funding
Portal.
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b. Form Funding Portal
(1) Proposed Rules
As noted above, proposed Rule 400(a) requires a funding portal
seeking to register with the Commission, through an initial
application, to file a completed Form Funding Portal with the
Commission. As proposed, Rule 400(b)-(d) would have also required
funding portals to use proposed Form Funding Portal to amend any part
of the funding portal's most recent Form Funding Portal, including
certain successor registrations, or to withdraw from registration as a
funding portal with the Commission.\927\ We proposed to make a blank
Form Funding Portal available through the Commission's Web site or such
other electronic database, as determined by the Commission in the
future.
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\927\ As noted in Section II.D.1.a., a successor funding portal
may amend the registration of its predecessor on Form Funding
Portal, within 30 days after succession, if the succession is based
solely on a change of the predecessor's date of incorporation, state
of incorporation, form of organization, or composition of a
partnership. Otherwise, a successor must file a registration
statement on Form Funding portal within 30 days after succession and
a predecessor must file a withdrawal on Form Funding Portal. See
Rule 400(c).
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As proposed, Form Funding Portal appropriately considered the need
to provide efficiency in completing the
[[Page 71456]]
form while requesting sufficient information from funding portals to
allow for effective regulatory oversight. The proposed form would have
consisted of eight sections, including items related to: Identifying
information, form of organization, successions, control persons,
disclosure information, non-securities related business, escrow,
compensation arrangements, and withdrawal. These items would require an
applicant to provide certain basic identifying and contact information
concerning its business; list its direct owners and executives;
identify persons that directly or indirectly control the funding
portal, control the management or policies of the funding portal and
persons the funding portal controls; and supply information about its
litigation and disciplinary history and the litigation and disciplinary
history of its associated persons.\928\ Under proposed Form Funding
Portal, a funding portal would be able to operate multiple Web site
addresses under a single funding portal registration, provided the
funding portal disclosed on Form Funding Portal all the Web sites and
names under which it did business.\929\ In addition, the proposed form
would have required an applicant to describe any non-securities related
business activities and supply information about its escrow
arrangements, compensation arrangements with issuers and fidelity bond.
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\928\ This information would be used to determine whether to
approve an application for registration, to decide whether to revoke
registration, to place limitations on the applicant's activities as
a funding portal and to identify potential problem areas on which to
focus during examinations. If an applicant or its associated person
has a disciplinary history, then the applicant could be required to
complete the appropriate Disclosure Reporting Page (``DRP''), either
Criminal, Regulatory, Civil Judicial, Bankruptcy, Bond or Judgment
on proposed Form Funding Portal.
\929\ See proposed Form Funding Portal, Item 1; 17 CFR 249.2000.
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Upon a filing to withdraw from registration, a funding portal would
be required to provide certain books and records information. In
addition, as discussed in detail in Section II.D.1.d. below, applicants
that are incorporated in or organized under the laws of a jurisdiction
outside of the United States or its territories, or whose principal
place of business is not in the United States or its territories, would
have been required to complete Schedule C to Form Funding Portal, which
would require information about the applicant's arrangements to have an
agent for service of process in the United States, as well as a
certification and an opinion of counsel addressing the ability of the
applicant to provide the Commission and the national securities
association of which it is a member with prompt access to its books and
records and to submit to onsite inspection and examination by the
Commission and the national securities association.
We also proposed that a person duly authorized to bind the funding
portal be required to sign Form Funding Portal in order to execute the
documents.\930\ As proposed, the funding portal also would have been
required to consent to service of process to its contact person on the
form.\931\
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\930\ See execution statement of proposed Form Funding Portal.
We proposed requiring a person executing Form Funding Portal and
Schedule C (if applicable) to represent that the person has executed
the form on behalf of, and is duly authorized to bind, the funding
portal; the information and statements contained in the form and
other information filed are current, true and complete; and if the
person is filing an amendment, to the extent that any information
previously submitted is not amended, such information is currently
accurate and complete.
\931\ See execution statement of proposed Form Funding Portal.
Specifically, we proposed requiring the funding portal to consent
that service of any civil action brought by, or notice of any
proceeding before, the Commission or any national securities
association of which it is a member, in connection with the funding
portal's investment-related business, may be given by registered or
certified mail to the funding portal's contact person at the main
address, or mailing address, on the form.
---------------------------------------------------------------------------
Finally, we proposed to make all current Forms Funding Portal,
including amendments and registration withdrawal requests, immediately
accessible and searchable by the public, with the exception of certain
personally identifiable information or other information with
significant potential for misuse (including the contact employee's
direct phone number and email address and any IRS Employer
Identification Number, social security number, date of birth, or any
other similar information).\932\
---------------------------------------------------------------------------
\932\ See proposed Instructions to Form Funding Portal.
---------------------------------------------------------------------------
(2) Comments on Proposed Rules
We received one comment in support of using EDGAR for all funding
portal filing and registration requirements.\933\ Some commenters also
generally supported allowing a funding portal to file one registration
application to operate multiple Web sites.\934\ One commenter, however,
expressed concern about allowing funding portals to file one
registration form for multiple Web sites. This commenter suggested the
Commission ``clearly address Portals that register with the Commission,
and then subsequently license out or sell their registration.'' \935\
The same commenter stated that ``[s]ome entrepreneurs have indicated
that they intend to operate a `parent' funding [p]ortal, which allows
other sites to operate under its umbrella, (leveraging the parent's
systems, architecture, design, infrastructure, etc.).'' \936\
---------------------------------------------------------------------------
\933\ See Public Startup Letter 3.
\934\ See, e.g., Joinvestor Letter; Tiny Cat Letter (stating
that requiring new applications for each Web site would be
unnecessary as it ``would not provide any new information for either
the commission or the public'' so long as the expansion involves no
material changes to information in the initial application).
\935\ RocketHub Letter.
\936\ Id.
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(3) Final Rules
We are adopting Form Funding Portal generally as proposed,\937\
with the following changes:
---------------------------------------------------------------------------
\937\ We also made minor non-substantive technical changes and
changes to increase the clarity of the information being requested
in the form.
---------------------------------------------------------------------------
The final rules amend Regulation S-T to permit a funding
portal to file PDF exhibits and attachments to Form Funding Portal on
EDGAR as ``official filings.'' \938\
---------------------------------------------------------------------------
\938\ See Rule 101(a)(1)(xviii) of Regulation S-T. As we noted
in Section II.B.3, Regulation S-T generally allows PDF documents to
be filed only as unofficial copies. See Rule 104 of Regulation S-T.
However, Rule 101 provides for certain exceptions to this
restriction. The PDF documents must be in the format required by the
EDGAR Filer Manual, as defined in Rule 11 of Regulation S-T.
---------------------------------------------------------------------------
The following has been added to the title of the form:
``Application or Amendment to Application for Registration or
Withdrawal from Registration as Funding Portal'' to clarify that the
form will be used for all funding portal registration applications,
amendments and withdrawals;
Amendments to Form Funding Portal will require a narrative
explaining the amendment, which we believe will clarify to investors
and potential investors the particular information being amended by the
funding portal in its filing;
Form Funding Portal will not require information about
fidelity bonds since we are not adopting the fidelity bond requirement
in the proposed rules; \939\
---------------------------------------------------------------------------
\939\ See Section II.D.1.c.
---------------------------------------------------------------------------
Item 1 also will require information about Web site URL
changes on the most recent Form Funding Portal, title of the contact
employee and the month the applicant funding portal's fiscal year ends;
The title of Item 4 is changed from ``Control Persons,''
as proposed, to ``Control Relationships,'' as adopted, to clarify that
Item 4 may capture information not being captured in Schedules A and B;
The language in Item 5 ``to determine whether to approve
an
[[Page 71457]]
application for registration'' has been deleted;\940\
---------------------------------------------------------------------------
\940\ We note, however, that failure to answer a question in
Item 5 will result in an incomplete application for registration.
---------------------------------------------------------------------------
Item 7, as adopted, references ``qualified third party
arrangements'' rather than ``escrow arrangements,'' as proposed, to
indicate that, in addition to holding the funds in escrow, a qualified
third party may also hold investor funds in an account for the benefit
of investors and the issuer;\941\
---------------------------------------------------------------------------
\941\ See Section II.C.5.e.
---------------------------------------------------------------------------
``G--Other (general partner, trustee, or elected member)''
has been added as an ownership code in Schedule A;
Schedules A and B have been changed from the proposal to
clarify that the Schedules are collecting information about whether
direct owners and executive officers are ``control'' persons;
The language to Schedule C of Form Funding Portal has been
changed to track more closely the requirements of Rule 400(f) for
nonresident funding portals and to add an execution section for these
entities; and
Withdrawal information for funding portals proposed to be
collected under Item 8 will instead be collected in a new ``Schedule
D''.\942\
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\942\ There have been no substantive changes to the withdrawal
information to be collected on Schedule D. The instructions to Form
Funding Portal have been modified from the proposal to (1) include
IRS Tax Identification Number and the contact employee's fax number
as information that will be redacted on Form Funding Portal by the
Commission and, therefore, not disseminated to the public by the
form; and (2) inform funding portals that they should manually
redact certain personally identifiable information or other
information with significant potential for misuse (including the
contact employee's direct phone number, fax number and email address
and any IRS Employer Identification Number, IRS Tax Identification
Number, social security number, or any other similar information)
from any PDF attachments they file as part of their Form Funding
Portal submission due to privacy concerns. The instructions have
also been modified to amend the definition of SRO to delete the
reference to Section 3 of the Exchange Act and clarify that the
phrase ``any national securities association registered with the
Commission'' in the definition encompasses any national securities
association registered under Section 15A of the Exchange Act, in
order to alleviate any confusion by funding portals when completing
the form.
---------------------------------------------------------------------------
We continue to believe that the information required by Form
Funding Portal is important for our oversight of funding portals and to
allow us to assess a funding portal's application for registration and
perform examinations of funding portals. We also note that the
information required by the Form will be available to investors and
potential investors and will provide transparency regarding
intermediaries. Although we generally modeled Form Funding Portal on
Form BD, we have tailored the questions to the activities of funding
portals. For example, Form Funding Portal, in contrast to Form BD, does
not include any questions about holding customer funds and securities
because funding portals are statutorily prohibited from holding or
maintaining customer funds or securities. We also included questions in
Form Funding Portal to address specific restrictions that are imposed
upon funding portals but not upon broker-dealers. For example, Form
Funding Portal requires specific information about a funding portal's
qualified third party arrangements because a funding portal is
prohibited from holding and maintaining customer funds.
In developing these requirements, we have taken into account that
funding portals are limited purpose brokers that are conditionally
exempt from registration as broker-dealers, and accordingly have sought
to require appropriate information from these entities, while, at the
same time, not making the process of completing and filing the required
form inappropriately burdensome for funding portals.
As noted above, we proposed to make a blank Form Funding Portal
available through our Web site or another electronic database. At the
time of the Proposing Release, we had not yet determined the
appropriate database through which to access and electronically file
Form Funding Portal. We requested comments in the Proposing Release on
the type of web-based registration that funding portals should use for
accessing and filing Form Funding Portal, and as noted above, received
one comment in support of using EDGAR for funding portal filing and
registration requirements.\943\ We have determined to require funding
portals to access and file Form Funding Portal through the Commission's
EDGAR system. Before a funding portal will be able to access EDGAR and
electronically file Form Funding Portal, it will have to obtain EDGAR
access codes and a central index key (``CIK'') by creating and
submitting a Form ID with the Commission for authorization to access
EDGAR. The applicant will be required to fill out general user
information fields on Form ID, including filer type name, address,
phone number, email address, organization name and employer
identification number and file a signed, notarized version of the
document. To facilitate this process, we are amending Form ID to add
``Funding Portal'' as a filer type and are also revising the
instructions to the form to include the definition of ``funding
portal'' (as defined by Rule 300(c)(2)). Once the application has been
accepted by the Commission, the funding portal will receive an email
with a CIK, which it can use (along with a passphrase that it has
previously created) to generate EDGAR access codes, and access the
system and Form Funding Portal.
---------------------------------------------------------------------------
\943\ See Public Startup Letter 3.
---------------------------------------------------------------------------
As proposed, a funding portal will be required to check a box
indicating the purpose for which the funding portal was filing the
form:
To register as a funding portal with the Commission,
through an initial application;
to amend any part of the funding portal's most recent Form
Funding Portal, including a successor registration; or
to withdraw from registration as a funding portal with the
Commission.
The funding portal will receive an SEC file number after it files
its Form Funding Portal initial application, and thereafter must
provide us that file number when submitting an amendment or withdrawal
from registration on Form Funding Portal. We will use this number to
cross-reference amendments and withdrawals to the original
registration.
When a funding portal's registration becomes effective, the
information on Form Funding Portal will be made available to the public
through EDGAR, with the exception of certain personally identifiable
information or other information with significant potential for misuse
(including the contact employee's direct phone number, fax number and
email address and any IRS Employer Identification Number, IRS Tax
Identification Number, social security number, date of birth or any
other similar information). In addition to current versions of Form
Funding Portal, investors and potential investors also will be able to
access historical versions of a funding portal's filings on EDGAR. We
believe that making these documents publicly available and searchable
will provide the public with information about the registration process
and the funding portal industry, thereby increasing transparency into
this developing market.
The final rule permits a funding portal to operate multiple Web
site addresses under a single funding portal registration. As we noted
in the Proposing Release, we believe that allowing a funding portal to
utilize more than one Web site address, if it chooses to do so, may
allow the portal to minimize its regulatory costs while having the
flexibility to customize each Web site to fit its specific needs, such
as appealing to certain industries or
[[Page 71458]]
investors. We have considered one commenter's concern about funding
portals licensing or selling their registrations, and note that
registrations are not transferrable among entities; rather, each
funding portal is required to register with the Commission, pursuant to
Rule 400(a). As explained above, an entity may succeed to and continue
the business of a registered funding portal, but the successor must
file a registration on Form Funding Portal within 30 days after any
succession resulting in a change of control.\944\
---------------------------------------------------------------------------
\944\ See Section II.D.1.a.
---------------------------------------------------------------------------
c. Fidelity Bond
(1) Proposed Rule
Proposed Rule 400(f) would have required that funding portals, as a
condition of registration, have in place, and thereafter maintain for
the duration of such registration, a fidelity bond that: (1) Has a
minimum coverage of $100,000; (2) covers any associated person of the
funding portal unless otherwise excepted in the rules set forth by
FINRA or any other registered national securities association of which
it is a member; and (3) meets any other applicable requirements set
forth by FINRA or any other registered national securities association
of which it is a member. While fidelity bond coverage was not mandated
by statute, the proposed requirement was intended to help insure
against the loss of investor funds that might occur if a funding portal
were to violate the express prohibition set forth in Exchange Act
Section 3(a)(80) on holding, managing, possessing or otherwise handling
investor funds or securities.
(2) Comments on Proposed Rule
We received comments both in support of,\945\ and opposition
to,\946\ the proposed requirement for funding portals to maintain
fidelity bonds. One commenter stated its view that a fidelity bond may
be necessary as a preventative measure to protect the interests of
investors and issuers.\947\ Another commenter noted that although
fidelity bond coverage may be ``indirect'' to customers, they are
protected under such coverage because the insured entity may recover
its losses due to theft or embezzlement by its employees and meet the
obligations of its customers.\948\ The same commenter, however,
suggested that the Commission may find a surety bond more appropriate
in the crowdfunding context than a fidelity bond because investors
would be able to make a direct claim under it for losses due to a
funding portal's violation of the rules, and the insurer would be able
to seek indemnity for that amount from the funding portal.\949\ One
commenter stated that it is not appropriate to require that the
fidelity bond cover associated persons, and that the requirement is a
``hangover from a non-transparent financial services sector,'' unlike
the transparent crowdfunding model.\950\ Another commenter noted that a
fidelity bond would protect a funding portal from employee theft or
embezzlement, and suggested that there is a low risk of this occurring
since a funding portal not does hold cash or customer funds.\951\ The
commenter further stated that ``[o]btaining a bond is simply one more
expense that the portal must incur and it is necessary to control
compliance costs if crowdfunding is to be a success.'' \952\
---------------------------------------------------------------------------
\945\ See, e.g., Joinvestor Letter; Public Startup 3 Letter;
RocketHub Letter; SFAA Letter.
\946\ See, e.g., ASSOB Letter; Heritage Letter; PeoplePowerFund
Letter; RoC Letter.
\947\ See Joinvestor Letter.
\948\ See SFAA Letter.
\949\ See id.
\950\ See ASSOB Letter.
\951\ See Heritage Letter
\952\ Id.
---------------------------------------------------------------------------
(3) Final Rules
After taking into account the comments and upon further
consideration, we have determined not to adopt a fidelity bond
requirement for funding portals. We have been persuaded by the comments
that such a requirement may not be appropriate. We believe that the
statutory protections and prohibitions set forth in Exchange Act
Section 3(a)(80) on holding, managing, possessing or otherwise handling
investor funds or securities provide substantial protections to
investors. We recognize, as some commenters observed, that there may be
potential risks to investors if a funding portal were to violate the
prohibitions in Regulation Crowdfunding, including the potential loss
of investor funds. As we discussed in the Proposing Release, funding
portals will not be members of the Securities Investor Protection
Corporation (``SIPC'') and their customers, therefore, will not receive
SIPC protection.\953\ Furthermore, consistent with the proposed rules,
the final rules also do not subject funding portals to minimum net
capital requirements. Despite these vulnerabilities, we note that the
potential burden associated with the requirement of a fidelity bond (or
any bond) may not be justified by the benefits that could be derived
from requiring that a funding portal obtain such a bond. In particular,
we are concerned that a fidelity bond requirement could create a
potential barrier to entry for some funding portals that could be
detrimental to our mission of capital formation, as well as the
feasibility of crowdfunding. At the same time, we are mindful of the
potentially limited benefits of requiring such bonds to be obtained by
funding portals, when taking into account the statutory restrictions on
funding portals' permissible activities. Instead, we believe at this
time that the prohibition on a funding portal from handling customer
funds and securities as well as the general anti-fraud provisions of
our statutes and rules provide significant investor protections that do
not need to be supplemented by a fidelity bond requirement. This
decision is consistent with our approach generally to the regulation of
funding portals in which we have sought to structure rules tailored to
the business of funding portals that address the risks posed by such
activities while considering the impact that our rules may have on this
emerging market.
---------------------------------------------------------------------------
\953\ See Proposing Release at 78 FR at 66482. Membership in
SIPC applies only to persons registered as brokers or dealers under
Section 15(b) of the Exchange Act. See 15 U.S.C. 78ccc(a)(2).
---------------------------------------------------------------------------
d. Requirements for Nonresident Funding Portals
(1) Proposed Rules
Under proposed Rule 400(g), registration pursuant to Rule 400 of
Regulation Crowdfunding by a ``nonresident funding portal'' \954\ would
be first conditioned upon there being an information sharing
arrangement in place between the Commission and the competent regulator
in the jurisdiction under the laws of which the nonresident funding
portal is organized or where it has its principal place of business
that is applicable to the nonresident funding portal. The proposed rule
would further require a nonresident funding portal registered or
applying for registration to: (1) Obtain a written consent and power of
attorney appointing an agent for service of process in the United
States (other than the Commission or a Commission member, official or
employee), upon whom may be served any process, pleadings, or other
papers in any action; \955\ (2) furnish the Commission with the name
and address of its agent for services of process on
[[Page 71459]]
Schedule C of Form Funding Portal; \956\ and (3) certify on Schedule C
of Form Funding Portal and provide an opinion of counsel that it can,
as a matter of law, provide the Commission and any national securities
association of which it is a member with prompt access to its books and
records and can, as a matter of law, submit to onsite inspection and
examination by the Commission and such national securities
association.\957\
---------------------------------------------------------------------------
\954\ See proposed Rule 400(g)(1) of Regulation Crowdfunding
(defining ``nonresident funding portal'' as ``a funding portal
incorporated in or organized under the laws of any jurisdiction
outside of the United States or its territories, or having its
principal place of business in any place not in the United States or
its territories'').
\955\ See proposed Rule 400(g)(2)(i) of Regulation Crowdfunding.
\956\ See proposed Rule 400(g)(2)(ii) of Regulation
Crowdfunding.
\957\ See proposed Rule 400(g)(3)(i) of Regulation Crowdfunding.
Exchange Act Section 3(h)(1)(C) permits us to impose, as part of our
authority to exempt funding portals from broker registration, ``such
other requirements under [the Exchange Act] as the Commission
determines appropriate.''
---------------------------------------------------------------------------
Proposed Rule 400(g)(2)(iv) would require a registered nonresident
funding portal to promptly appoint a successor agent if it discharges
its identified agent for service of process or if its agent for service
of process is unwilling or unable to accept service on its behalf. In
addition, proposed Rule 400(g)(2)(iii) would require a registered
funding portal to promptly amend Schedule C to its Form Funding Portal
if its agent, or the agent's name or address, changes. Finally,
proposed Rule 400(g)(2)(v) would require the registered nonresident
funding portal to maintain, as part of its books and records, the
agreement with the agent for service of process for at least three
years after termination of the agreement.
In addition, we proposed in Rule 400(g)(3)(ii) to require a
registered nonresident funding portal to re-certify, on Schedule C to
Form Funding Portal, within 90 days after any changes in the legal or
regulatory framework that would affect: (1) Its ability to provide (or
the manner in which it provides) the Commission, or the national
securities association of which it is a member, with prompt access to
its books and records; or (2) the ability of the Commission or the
national securities association to inspect and examine the nonresident
funding portal. The re-certification would be accompanied by a revised
opinion of counsel describing how, as a matter of law, the entity can
continue to meet its obligations to provide the Commission and the
national securities association with prompt access to its books and
records and to be subject to inspection and examination.\958\
---------------------------------------------------------------------------
\958\ See proposed Rule 400(g)(3)(ii) of Regulation
Crowdfunding.
---------------------------------------------------------------------------
(2) Comments on the Proposed Rule
One commenter stated its view that the definition of a nonresident
funding portal will create a competitive advantage for foreign
intermediary platforms.\959\ Another commenter stated its view that
nonresident funding portals should be subject to the same rules as
domestic funding portals.\960\
---------------------------------------------------------------------------
\959\ See Public Startup Letter 3 (stating its view that the
definition of nonresident funding portal is ``flawed'' because it
believes these foreign entities could choose to act as
intermediaries for U.S. issuers and U.S. investors in crowdfunding
transactions without relying on Section 4(a)(6) and, therefore, gain
a competitive advantage by not having to comply with the
requirements of the rules under Regulation Crowdfunding in the same
manner as domestic funding portals). But see Joinvestor Letter
(stating its belief that ``nonresident funding portal is properly
defined'').
\960\ See Wales Capital Letter 3. The commenter also recommended
using the term `` `foreign' funding portal'' to be consistent with
the treatment of corporations incorporated in another jurisdiction
under various state laws. According to the commenter, a foreign
corporation must file a notice of doing business in any state or
nation in which it does substantial regular business, and must name
an `` `agent for acceptance of service' '' in that nation (or the
Secretary of State as agent) to allow people doing business with a
foreign corporation to be able bring legal actions locally.
---------------------------------------------------------------------------
In the Proposing Release, we requested comments about other actions
or requirements that could address our concern that the Commission and
the applicable national securities association be able to have direct
access to books and records and be able to adequately examine and
inspect a nonresident funding portal, if it would be impossible or
impractical for such funding portal to obtain the required opinion of
counsel. In response, a commenter suggested an arrangement between a
nonresident funding portal and a domestic funding portal in which the
nonresident funding portal would be required to make and keep current
books and records, but the domestic funding portal would have the
ability to obtain and be responsible for the accuracy of such books and
records.\961\
---------------------------------------------------------------------------
\961\ Id.
---------------------------------------------------------------------------
One commenter suggested that nonresident funding portals be
required to clearly indicate on their Web sites that they are organized
and operating outside of the U.S. and indicate whether a U.S. or non-
U.S. bank will be used to process investors' funds.\962\ One commenter
suggested that a nonresident funding portal should be required to
appoint a U.S. agent for all potential proceedings,\963\ while another
commenter suggested that a nonresident funding portal should be
required to have a resident legal representative to handle any matters
between issuers or investors and the portal.\964\
---------------------------------------------------------------------------
\962\ See Zhang Letter.
\963\ Wales Capital Letter 3.
\964\ See Joinvestor Letter.
---------------------------------------------------------------------------
(3) Final Rules
We are adopting Rule 400(g) as proposed with certain minor changes,
and renumbering it as Rule 400(f) due to the elimination of the
fidelity bond requirement proposed as subparagraph (f).\965\ We are
changing the language of the rule as adopted applicable to a
nonresident funding portal to:
---------------------------------------------------------------------------
\965\ We also added ``Inspections and Examinations'' to the
heading of Rule 400(f)(3); this modification does not change the
requirements from those proposed. In addition, we changed a cross-
cite in the rule text to reflect the renumbering.
---------------------------------------------------------------------------
Add the term ``registered'' to any references to national
securities association in the Rule to be more consistent with the
terminology in the Exchange Act; and
Require the nonresident funding portal also to certify
that it ``will'' provide the Commission and any national securities
association of which it ``becomes'' (rather than ``is'') a member with
prompt access to the books and records and ``will'' submit to onsite
inspection and examination by the Commission and such national
securities association.\966\
---------------------------------------------------------------------------
\966\ The language in the proposed rule required a certification
that the funding portal ``can'' meet such obligations but did not
require a certification that it ``will'' meet them.
---------------------------------------------------------------------------
As we noted in the Proposing Release, the rule aims to help ensure
that we and any applicable registered national securities association
can access the books and records of, conduct examinations and
inspections of, and enforce U.S. laws and regulations with respect to,
funding portals that are not based in the United States, or that are
subject to laws other than those of the United States. We believe that
these rules will further our goal of promoting the ability of the
Commission and any applicable national securities association to
conduct effective regulatory oversight of funding portals.
We have considered the comments and believe that the final rule
appropriately takes into consideration the need to provide more choices
for U.S. issuers seeking to use intermediaries or access investors
outside of the United States, while meeting the challenges associated
with supervising, examining, and enforcing rules regarding activities
of intermediaries based outside the United States. For example, as we
noted in the Proposing Release, the requirement for an information
sharing arrangement is designed to provide us with greater assurance
that we will be able to obtain information about a nonresident funding
portal necessary for our oversight of the funding portal. The ability
to obtain information and secure
[[Page 71460]]
the cooperation of the home country regulator according to established
practices and protocols is expected to help to address the increased
challenges that may arise from oversight of entities located outside of
the United States. We note that nonresident funding portals are subject
to the same registration requirements as other funding portals under
Rule 400.\967\
---------------------------------------------------------------------------
\967\ We have considered the commenter's view that there would
be a potential competitive advantage for foreign intermediaries
choosing to operate outside of the Section 4(a)(6) exemption. See
Public Startup Letter 3. However, we note that any entities (foreign
or domestic) intermediating offerings of securities between U.S.
issuers and investors generally will be broker-dealers, either
required to register under the Exchange Act or to be exempt from
registration. See 15 U.S.C. 78o(a). We also note that the offer and
sale of securities in the United States or to U.S. persons must be
registered unless an exemption is available.
---------------------------------------------------------------------------
We have also considered the comment submitted in response to our
question about the use of books and records arrangements in situations
where it would be impossible or impractical for a nonresident funding
portal to obtain the required opinion of counsel.\968\ We have
determined not to adopt an alternative to the opinion of counsel
requirement for nonresident funding portals in Regulation Crowdfunding.
The opinion of counsel requirement is consistent with our approach to
other nonresident registered entities and we believe it is an
appropriate mechanism to use here, as well.\969\ As we stated in the
Proposing Release, we believe that the certification and supporting
opinion of counsel requirements are important to confirm that each
nonresident funding portal is in a position to provide the Commission
and FINRA (or the applicable national securities association registered
under Exchange Act Section 15A) with information that is necessary for
us and the national securities association to effectively fulfill
regulatory oversight responsibilities.\970\ We do not believe that the
books and records arrangement suggested by the commenter would provide
assurance that we or FINRA would be able to consistently obtain such
information, which could hinder our ability to fulfill our regulatory
oversight responsibilities.
---------------------------------------------------------------------------
\968\ See Wales Capital Letter 3.
\969\ We note that the opinion of counsel requirement is
generally consistent with the requirement for nonresident security-
based swap dealers and major security-based swap participants, as
well as those for nonresident municipal advisors. See Exchange Act
Rule 15Fb2-4 and Rule 15Ba1-6.
\970\ See Exchange Act Section 3(h)(1)(A). Failure to make this
certification or re-certification or to provide an opinion of
counsel or revised opinion of counsel will result in an incomplete
application for registration.
---------------------------------------------------------------------------
We have also considered the comment suggesting that a nonresident
funding portal be required to clearly indicate on its Web site that it
is organized and operating outside of the United States and whether it
will use a U.S. or non-U.S. bank to process investors' funds.\971\
However, in light of the other disclosure requirements we are adopting,
we are not persuaded that such a requirement is necessary. We note that
the information required to be filed on Form Funding Portal (and that
will be publicly disclosed) will include information about the
qualified third party for the maintenance and transmission of
investors' funds under Rule 303(e), including the name and address of
the qualified third party.\972\ In addition, a nonresident funding
portal will be required to publicly disclose information on Schedule C
to Form Funding Portal. Since Schedule C is required to be completed by
nonresident funding portals only, investors will be able to discern
easily whether or not the entity is a nonresident funding portal and,
among other things, has certified (and provided an attached opinion of
counsel indicating) that it is able to provide the Commission and any
national securities association prompt access to its books and records
and will submit to onsite inspection and examination by the same.
---------------------------------------------------------------------------
\971\ See Zhang Letter.
\972\ See Form Funding Portal, Item 7--Qualified Third Party
Arrangements; Compensation Arrangements.
---------------------------------------------------------------------------
Finally, we have considered the comments suggesting that a
nonresident funding portal should be required to have a U.S. agent for
potential proceedings,\973\ or a resident legal representative to
handle any matters between issuers or investors, and the portal.\974\
We note that, as discussed above, we are requiring funding portals to
execute a written consent and power of attorney appointing an agent in
the United States. The agent will be the representative of the funding
portal for service of any process, pleadings or other papers in any
action to enforce the Exchange Act, Securities Act or any rule or
regulation promulgated thereunder. As we noted above, we have limited
the types of actions for which a nonresident funding portal will be
required to have an agent for service of process, pleadings, or other
papers in order to remain generally consistent with recent requirements
that we have imposed on other types of nonresident entities. The
funding portal will be required to disclose the name and address of its
U.S. agent in Schedule C to its Form Funding Portal, and amend the
Schedule promptly upon any change to the agent, agent's name or agent's
address. We are not, however, requiring that nonresident funding
portals have a resident legal representative to handle any matters
between the portal and issuers or investors, which is consistent with
our approach to other nonresident registered entities.\975\
---------------------------------------------------------------------------
\973\ See Wales Capital Letter 3.
\974\ See Joinvestor Letter.
\975\ For example, we note that requiring a U.S. agent for
service of process but not requiring a U.S. legal representative to
handle any matters between a funding portal and issuers or investors
is generally consistent with the requirements for nonresident
security-based swap dealers and major security-based swap
participants, as well as those for nonresident municipal advisors.
See Exchange Act Rule 15Fb2-4 and Rule 15Ba1-6.
---------------------------------------------------------------------------
2. Exemption From Broker-Dealer Registration
a. Proposed Rule
Exchange Act Section 3(h)(1), which was added by Section 304(a) of
the JOBS Act, directs the Commission by rule to exempt, conditionally
or unconditionally, a registered funding portal from the requirement to
register as a broker or dealer under Exchange Act Section 15(a),
provided that the funding portal: (1) Remains subject to the
examination, enforcement and other rulemaking authority of the
Commission; (2) is a member of a registered national securities
association; and (3) is subject to other requirements that the
Commission determines appropriate.
As explained earlier, the role contemplated by Title III of the
JOBS Act for an entity acting as an intermediary in a crowdfunding
transaction would bring that entity within the definition of ``broker''
under Exchange Act Section 3(a)(4).\976\ A funding portal would be
``effecting transactions in securities for the account of others'' by,
among other things, ensuring that investors comply with the conditions
of Securities Act Section 4A(a)(4) and (8), making the securities
available for purchase through the funding portal, and ensuring the
proper transfer of funds and securities as required by Securities Act
Section
[[Page 71461]]
4A(a)(7).\977\ In addition, a funding portal's receipt of compensation
linked to the successful completion of the offering also would be
indicative of acting as a broker in connection with these transactions.
Thus, absent an exemption or exception, a funding portal would be
required to register as a broker under the Exchange Act.
---------------------------------------------------------------------------
\976\ See Exchange Act Section 3(a)(4)(A) [15 U.S.C.
78c(a)(4)(A)] (defining ``broker'' as ``any person engaged in the
business of effecting transactions in securities for the account of
others''). An entity acting as an intermediary in the offer and sale
of securities pursuant to Section 4(a)(6), as contemplated in Title
III of the JOBS Act, would not come within the meaning of
``dealer,'' which is defined in Exchange Act Section 3(a)(5)(A) (15
U.S.C. 78c(a)(4)(A)), because it would not be engaging in the
business of buying and selling securities for its own account. See
also Exchange Act Section 15(a) [15 U.S.C. 15o(a)].
\977\ At the same time, there are statutory restrictions on the
scope of services that a funding portal could provide. See Section
II.C.1 (discussing Exchange Act Section 3(a)(80)).
---------------------------------------------------------------------------
We proposed Rule 401(a) to provide an exemption for registered
funding portals from the broker registration requirements of Exchange
Act Section 15(a)(1) in connection with its activities as a funding
portal. Consistent with the JOBS Act, the funding portal would remain
subject to the full range of our examination and enforcement authority,
even though it is not registered as a broker.\978\ In this regard,
proposed Rule 403 would require that a funding portal permit the
examination and inspection of all of its business and business
operations that related to its activities as a funding portal, such as
its premises, systems, platforms and records, by representatives of the
Commission and of the national securities association of which it is a
member.\979\ Proposed Rule 404 also would impose certain recordkeeping
requirements on funding portals.\980\
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\978\ See Exchange Act Section 3(h)(1)(C). See also Securities
Act Section 20 [15 U.S.C. 77t] and Exchange Act Sections 21 and 21C
[15 U.S.C. 78u and 78u-3]. In addition, we highlighted in the
Proposing Release that Exchange Act Sections 15(b)(4) and 15(b)(6)
(15 U.S.C. 78o(b)(4) and 78o(b)(6)) apply to brokers (including
funding portals) regardless of whether or not they are registered
with the Commission as brokers. Exchange Act Section 15(b)(4)
authorizes the Commission to bring administrative proceedings
against a broker when the broker violates the federal securities
laws (and for other misconduct) and provides for the imposition of
sanctions, up to and including the revocation of a broker's
registration. Exchange Act Section 15(b)(6) provides similar
enforcement authority against the persons associated with a broker,
including barring persons from associating with any Commission
registrant.
\979\ See Section II.D.4.
\980\ See Section II.D.5.
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We had further proposed in Rule 401(b) that, notwithstanding the
exemption from broker registration, for purposes of Chapter X of Title
31 of the Code of Federal Regulations, a funding portal would be a
broker or dealer ``required to be registered'' with the Commission
under the Exchange Act, thereby requiring funding portals to comply
with Chapter X, including certain anti-money laundering (``AML'')
provisions thereunder.\981\
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\981\ See 31 CFR 1010.100(h) and 1023.100(b) (defining broker or
dealer for purposes of the applicability of AML requirements). See
Currency and Foreign Transactions Reporting Act of 1970 (commonly
referred to as the Bank Secrecy Act (``BSA'')) [12. U.S.C. 1829b, 12
U.S.C. 1951-1959, 31 U.S.C. 5311-5330].
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b. Comments on the Proposed Rule
Commenters generally agreed with the funding portal exemption from
registration as a broker-dealer.\982\ One commenter stated that funding
portals that provide no advice, make no warranties as to the
suitability of an investment and do not handle share transfers or
money, should not be required to register as a broker-dealer and
requiring them to do so would provide no benefit to the public.\983\
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\982\ See, e.g., Heritage Letter; Joinvestor Letter;
PeoplePowerFund Letter; RocketHub Letter.
\983\ See, e.g., PeoplePowerFund Letter (stating that requiring
funding portals ``to register as broker dealers thus crushing the
very idea of crowd sourced funding as a people driven force for the
good of the `everyman' '').
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One commenter stated that the exemption from broker-dealer
registration actually precludes funding portals from becoming members
of FINRA,\984\ and asserted that funding portals should not have to
comply with the same requirements as broker-dealers for purposes of
Chapter X of Title 31 of the CFR.\985\ Another commenter, however,
stated that it ``supports the Commission's interpretation of the
exemption, and believes that AML compliance is necessary.'' \986\
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\984\ See Vann Letter (reasoning that, because a funding portal
is ``not registered as a `broker dealer,' '' and because ``the
Securities Exchange Act of 1934 states `A registered securities
association shall deny membership to any person who is not a
registered broker or dealer,' '' then funding portals cannot become
members of FINRA).
\985\ Id. (arguing that such requirements would be ``overly
burdensome'' because funding portals ``do not, by law, handle any
money'').
\986\ See RocketHub Letter.
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c. Final Rules
We are adopting, as proposed, paragraph (a) under Rule 401, but
renumbering it as Rule 401 as we not adopting proposed Rule 401(b). We
note, however, that the exemption from broker registration is
applicable only to funding portals that are registered under Rule 400.
Therefore, a funding portal that ceases to be registered under Rule 400
will no longer be exempt from broker registration under Rule 401. In
response to the comment that this exemption precludes funding portals
from becoming members of FINRA, as we noted above, because a funding
portal will be engaged in the business of effecting securities
transactions for the accounts of others through crowdfunding, it will
be a ``broker'' within the meaning of Section 3(a)(4) of the Exchange
Act. We also note that Exchange Act Section 3(h)(2) states that for
purposes of sections 15(b)(8) and 15A, the term ``broker or dealer''
includes a funding portal and the term ``registered broker or dealer''
includes a registered funding portal. Therefore, funding portals are
explicitly permitted by statute to become members of FINRA.
We are not, however, adopting proposed Rule 401(b). As described in
more detail in Section II.D.4.b. below, we have determined that the
imposition of AML requirements on funding portals should be addressed
outside of the rules that we are adopting in this release.
3. Safe Harbor for Certain Activities
Under Exchange Act Section 3(a)(80), which was added by Section
304(b) of the JOBS Act, a funding portal is defined as an intermediary
that does not: (i) Offer investment advice or make recommendations;
(ii) solicit purchases, sales or offers to buy the securities offered
or displayed on its platform or portal; (iii) compensate employees,
agents or other persons for such solicitation or based on the sale of
securities displayed or referenced on its platform or portal; (iv)
hold, manage, possess or otherwise handle investor funds or securities;
or (v) engage in such other activities as the Commission, by rule,
determines appropriate. As noted in the Proposing Release, commenters
have raised questions about the scope of permissible activities for
funding portals consistent with these prohibitions.\987\ To provide
regulatory clarity, we proposed Rule 402, which would provide a non-
exclusive conditional safe harbor for funding portals under which
certain limited activities would be deemed consistent with the
statutory prohibitions on funding portals. The permissible activities
in the proposed safe harbor involved: (i) Limiting offerings on the
platform; (ii) highlighting and displaying offerings on the platform;
(iii) providing communication channels; (iv) providing search
functions; (v) advising issuers; (vi) compensating others for referring
persons to the funding portal; (vii) paying or offering to pay
compensation to registered brokers or dealers; (viii) receiving
compensation from a registered broker or dealer; (ix) advertising the
funding portal and offering; (x) denying access to, or cancelling,
offerings due to fraud or investor protection concerns; (xi) accepting
investment commitments on behalf of the issuer; (xii) directing the
transmission of investor funds; and (xiii) directing a qualified third
party's transmission of investor funds.
---------------------------------------------------------------------------
\987\ See Proposing Release, 78 FR 66484-66485.
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[[Page 71462]]
Proposed Rule 402(a) also stated that no presumption shall arise
that a funding portal has violated the prohibitions under Section
3(a)(80) of the Exchange Act or Regulation Crowdfunding by reason of
the funding portal or its associated persons engaging in activities in
connection with the offer or sale of securities in reliance on Section
4(a)(6) of the Securities Act that do not meet the conditions specified
in the safe harbor, and that the antifraud provisions and all other
applicable provisions of the federal securities laws continue to apply
to the activities described in the safe harbor.
Commenters strongly supported the idea of a safe harbor for funding
portals,\988\ but they also suggested additional examples for the safe
harbor. We are adopting the safe harbor in Rule 402 with certain
changes as discussed further below. Each activity of the safe harbor is
addressed below.
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\988\ See, e.g., CFIRA Letter 1; Joinvestor Letter; Merkley
Letter (stating that the proposed safe harbor ``strikes the right
balance''). But see Public Startup 3 Letter (stating that the safe
harbor should cover any activity by a funding portal not directly
related to the sale of securities for the account of others).
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a. Limiting Offerings
(1) Proposed Rule
Proposed Rule 402(b)(1) would permit a funding portal to apply
objective criteria to limit the securities offered in reliance on
Section 4(a)(6) of the Securities Act through the funding portal's
platform where: (i) The criteria are reasonably designed to result in a
broad selection of issuers offering securities through the funding
portal's platform, are applied consistently to all potential issuers
and offerings and are clearly displayed on the funding portal's
platform; and (ii) the criteria could include, among other things, the
type of securities being offered (for example, common stock, preferred
stock or debt securities), the geographic location of the issuer and
the industry or business segment of the issuer, provided that a funding
portal may not deny access to an issuer based on the advisability of
investing in the issuer or its offering, except to the extent described
in proposed Rule 402(b)(10) for fraud and investor protection concerns.
(2) Comments on Proposed Rule
We received a significant number of comments on the ability of a
funding portal to limit the offerings on its platform. Many of these
comments suggested a broader standard than the standard that we
proposed. Several commenters expressed concern that the proposed safe
harbor placed funding portals at a competitive disadvantage to
registered brokers because it did not provide funding portals with the
flexibility to limit the offerings on their platforms,\989\ even if
they have legitimate concerns about offerings aside from fraud or
investor protection.\990\ For example, commenters suggested that a
funding portal should be permitted to reject offerings based on
whatever factors the portal deems appropriate without automatically
triggering regulation as a broker-dealer,\991\ especially if it deems
the offering to have tangible shortcomings that could be detrimental to
investors or overly risky.\992\
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\989\ See, e.g., EMKF Letter; SBA Office of Advocacy Letter.
\990\ See, e.g., ABA Letter; CfPA Letter; CrowdCheck 2 Letter;
Graves Letter; Seyfarth Letter (stating that ``even with a lower
liability threshold, curation is an essential tool for investor
protection'').
\991\ See, e.g., IAC Recommendation (suggesting that ``[o]ne of
the most cost-effective ways to reduce the risk of serious
compliance violations is to give crowdfunding intermediaries a free
hand to reject any offering they believe could pose an undue
compliance or fraud risk''); see also CFIRA Letter 12 (agreeing with
IAC's suggestion ``that all intermediaries . . . should have greater
latitude in their ability to curate offerings. . . . All
intermediaries (including non-BD portals) should be allowed to use
their discretion as to whether or not any particular offering is
suitable for their service''). See also BetterInvesting Letter.
\992\ See Graves Letter.
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Commenters asserted that a funding portal's ability to limit the
offerings on its platform is important for investor protection. They
stated that funding portals should be permitted to screen out clearly
unprepared or ill-conceived offerings,\993\ and should be permitted to
limit offerings on their platforms to issuers that are ``crowdfund-
ready.''\994\ Commenters drew a distinction between the permissibility
of applying internal screening standards to limited offerings on the
platform versus the prohibition on providing investment advice or
recommendations.\995\ Some commenters suggested that having a
disclaimer that ``curation'' (or limiting offerings on a platform) does
not constitute a recommendation on the advisability of any investment
displayed on the platform;\996\ or that the funding portal does not
advertise or make statements that the offerings listed on its platform
are safer or better investments than those listed on other
platforms,\997\ would mitigate regulatory concerns. Some commenters
also suggested that the criteria used to limit offerings should be
clearly displayed on a funding portal's platform.\998\
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\993\ See EMKF Letter.
\994\ See SBEC Letter.
\995\ See, e.g., Angel 1 Letter (``Forcing portals to become the
equivalent of common carriers that have to take every offering, no
matter how foolish, will make crowdfunding more likely to fail.'');
Consumer Federation Letter; Saunders Letter.
\996\ See, e.g., EarlyShares Letter; EMKF Letter; SBA Office of
Advocacy Letter.
\997\ See Milken Institute Letter.
\998\ See, e.g., ABA Letter; CFIRA Letter 1.
---------------------------------------------------------------------------
In addition, some commenters pointed to a tension in the statute
under which a funding portal is potentially subject to liability for
material misstatements and omissions in the issuer's offering materials
but, at the same time, may be limited in its ability to deny access to
its platform.\999\ These commenters argued that it was not equitable
for a funding portal to have such liability if it cannot determine
whether and under what circumstances to permit an issuer or offering
access to its platform.
---------------------------------------------------------------------------
\999\ See, e.g., CrowdCheck 2 Letter; Milken Institute Letter;
RocketHub Letter.
---------------------------------------------------------------------------
(3) Final Rules
In view of the comments, and upon further consideration, we are
modifying Rule 402(b)(1) to expressly provide that a funding portal
may, consistent with the prohibitions under Exchange Act Section
3(a)(80) (including the prohibition against offering investment advice
or recommendations in Section 3(a)(80)(A)), determine whether and under
what terms to allow an issuer to offer and sell securities in reliance
on Securities Act Section 4(a)(6) through its platform.\1000\
---------------------------------------------------------------------------
\1000\ See also Rule 402(b) (limiting permissible activities to
those consistent with the prohibitions under Exchange Act Section
3(a)(80)). The discretion a funding portal has to limit offerings on
its platform is in addition to the requirement under Rule 301 to
deny access, and cancel offerings, based on fraud and investor
protection concerns.
---------------------------------------------------------------------------
We agree with commenters that the ability of a funding portal to
determine which issuers may use its platform is important for the
protection of investors, as well as to the viability of the funding
portal industry, and thus the crowdfunding market. We acknowledge the
concerns raised by commenters that the proposed rules could otherwise
have unduly restricted a funding portal's ability to limit offerings
conducted on its platform, and we are modifying the safe harbor
contained in Rule 402(b)(1) to address these concerns. Specifically, we
are revising Rule 402(b)(1) to read that a funding portal may
``[d]etermine whether and under what terms to allow an issuer to offer
and sell securities in reliance on Section 4(a)(6) of the Securities
Act (15 U.S.C. 77d(a)(6)) through its platform, provided that the
funding portal otherwise complies with Regulation Crowdfunding
(Sec. Sec. 227.100 et se.).'' The new language is designed to
[[Page 71463]]
make it clear that a funding portal may exercise its discretion,
subject to the prohibition in the statute on providing investment
advice or recommendations, to limit the offerings and issuers that it
allows on its platform under the safe harbor, as long as it complies
with all other provisions of Regulation Crowdfunding.
In making this change, we recognize that the activities in which a
funding portal may engage are, by definition, far more limited than the
activities in which a registered broker-dealer may engage. At the same
time, we believe that the JOBS Act established an important role for
intermediaries, both broker-dealers and funding portals, to play in
crowdfunding offerings. While we are providing funding portals with
broad discretion to determine whether and under what circumstances to
allow an issuer to offer and sell securities through its platform in
reliance on Section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)), a funding portal must comply with all applicable provisions
of Regulation Crowdfunding, including the prohibition on providing
investment advice or recommendations. In this regard and as more fully
discussed below, among other things, a funding portal cannot advertise,
make statements or otherwise represent that the offerings listed on its
platform are safer or better investments than those listed on other
platforms. Given this statutory restriction, we are not, as some
commenters suggested, requiring a funding portal to provide a
disclaimer stating that limiting the offerings on its platform does not
constitute investment advice or a recommendation, nor are we requiring
that its criteria for limiting offerings on its platform be publicly
displayed. We do not believe that requiring a funding portal to display
its criteria for limiting offerings on its platform will add
significant investor protection. While a funding portal may decide to
make such criteria public, we caution that a funding portal must avoid
any appearance that it is giving investment advice or recommendations
or that the funding portal believes its offerings are investment
worthy.
b. Highlighting Issuers and Offerings
(1) Proposed Rule
Proposed Rule 402(b)(2) would permit a funding portal to apply
objective criteria to highlight offerings on the funding portal's
platform where: (i) The criteria are reasonably designed to highlight a
broad selection of issuers offering securities through the funding
portal's platform, are applied consistently to all issuers and
offerings and are clearly displayed on the funding portal's platform;
(ii) the criteria may include, among other things, the type of
securities being offered (for example, common stock, preferred stock or
debt securities); the geographic location of the issuer; the industry
or business segment of the issuer; the number or amount of investment
commitments made, progress in meeting the issuer's target offering
amount or, if applicable, the maximum offering amount; and the minimum
or maximum investment amount; provided that a funding portal may not
highlight an issuer or offering based on the advisability of investing
in the issuer or its offering; and (iii) the funding portal does not
receive special or additional compensations for highlighting one or
more issuers or offerings on its platform.
(2) Comments on Proposed Rule
Several commenters suggested additional criteria for the safe
harbor, including for example: (i) How long the issuer has been
operational or profitable;\1001\ (ii) historical and projected revenue
and earnings before interest, taxes, depreciation and amortization
(EBITDA); \1002\ (iii) the size of the issuer's management team; \1003\
(iv) relevant experience and length of experience of the issuer's
management;\1004\ (v) the type of corporate structure of the
issuer;\1005\ (vi) the stage and operating history of the issuer;
\1006\ (vii) valuation methodology; \1007\ (viii) results of securities
and background checks;\1008\ (ix) ``trending''; \1009\ and (x) most
money raised, soonest offering to close, most money invested, least
money invested, or on a purely random basis (so long as none of the
bases are value-driven--that is, which investment is a safer or better
investment).\1010\ Another commenter questioned whether, under the safe
harbor, funding portals would be permitted to highlight offerings based
on their discretion or the use of metrics, such as topic, media
coverage, or momentum.\1011\ However, another commenter suggested that
a funding portal should not have discretion regarding which objective
criteria it can use to highlight issuers or offerings because it may
result in the portal implicitly recommending securities.\1012\ This
commenter suggested that the Commission should create a specific list
of acceptable objective criteria that a funding portal may apply.\1013\
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\1001\ See, e.g., CFIRA Letter 1; CFIRA Letter 2.
\1002\ Id.
\1003\ Id.
\1004\ See, e.g., CFIRA Letter 2.
\1005\ See RocketHub Letter.
\1006\ Id.
\1007\ Id.
\1008\ Id.
\1009\ See Seyfarth Letter.
\1010\ See ASSOB Letter.
\1011\ See RocketHub Letter.
\1012\ See Commonwealth of Massachusetts Letter; c.f. ABA Letter
(requesting Commission guidance that a portal engaging in activities
covered by the safe harbor will not trigger the application of the
Investment Advisers Act).
\1013\ See Commonwealth of Massachusetts Letter. See also ABA
Letter (requesting explicit Commission guidance as to permissible
criteria).
---------------------------------------------------------------------------
Several commenters stated that the criteria used to highlight
offerings should be clearly displayed on the platform.\1014\ However,
one commenter stated that algorithms should not be required to be
disclosed on the platform.\1015\
---------------------------------------------------------------------------
\1014\ See, e.g., ABA Letter; CFIRA Letter 1.
\1015\ See Joinvestor Letter.
---------------------------------------------------------------------------
Several commenters suggested that the safe harbor should include
the ability of a funding portal to provide mechanisms by which
investors can rate an issuer or an offering, which then could be
highlighted on the platform.\1016\ However, one of these commenters
stated that any such rating must be mathematical rather than value-
driven or it would amount to ``enticement.''\1017\
---------------------------------------------------------------------------
\1016\ See, e.g., ASSOB Letter; CFIRA Letter 1; Joinvestor
Letter.
\1017\ See ASSOB Letter.
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(3) Final Rules
After considering the comments, we are adopting Rule 402(b)(2) as
proposed. Specifically, Rule 402(b)(2) allows a funding portal to
highlight particular issuers or offerings of securities made in
reliance on Section 4(a)(6) on its platform based on objective criteria
where the criteria are reasonably designed to highlight a broad
selection of issuers offering securities through the funding portal's
platform, are applied consistently to all issuers and offerings and are
clearly displayed on the funding portal's platform. Consistent with the
proposal, the final rule specifies in subparagraph (b)(2)(ii) that
objective criteria may include, for example: The type of securities
being offered (e.g., common stock, preferred stock or debt securities);
the geographic location of the issuer; the industry or business segment
of the issuer; the number or amount of investment commitments made; the
progress in meeting the target offering amount or, if applicable, the
maximum offering amount; and the minimum or maximum investment amount.
It is important to note that the criteria must be reasonably
designed to highlight a broad selection of issuers and offerings, so as
not to recommend
[[Page 71464]]
or implicitly endorse one issuer or offering over another, and must be
applied consistently to all potential issuers and offerings.\1018\ This
highlighting of issuers or offerings that have been admitted to a
funding portal's platform can, depending on relevant facts and
circumstances, involve providing investment advice that violates the
prohibition on a funding portal providing such advice. To that end, the
rule provides a safe harbor only when a funding portal is using
objective criteria and such criteria are clearly displayed on its
platform to inform investors why certain issuers or offerings are being
highlighted.\1019\ To reiterate, a funding portal may not highlight an
issuer or offering based on the advisability of investing in the issuer
or offering or give the impression that the funding portal is providing
an implicit (or explicit) recommendation on whether to invest in the
issuer or offering.
---------------------------------------------------------------------------
\1018\ See Rule 402(b)(2) and (b)(2)(i).
\1019\ Id.
---------------------------------------------------------------------------
To help prevent conflicts of interest and incentives for funding
portals to favor certain issuers over others, the final rule also
prohibits a funding portal from receiving any special or additional
compensation for highlighting (or offering to highlight) one or more
issuers or offerings on its platform.\1020\
---------------------------------------------------------------------------
\1020\ See Rule 402(b)(2)(iii) of Regulation Crowdfunding. This
rule prohibits paid placements of the kind suggested by one
commenter. See Earlyshares Letter.
---------------------------------------------------------------------------
Although some commenters suggested that we include additional
criteria in subparagraph (b)(2)(ii), we emphasize that the rule does
not establish an exclusive list. The listed criteria are intended as
examples, and the safe harbor is non-exclusive. Crowdfunding is a new
and evolving market, and we believe that providing principles in the
safe harbor by which a funding portal can highlight offerings on its
platform will provide it with the flexibility to adapt to the
crowdfunding market as it develops while maintaining investor
protection. In this regard, the examples listed in Rule 402(b)(2)(ii)
are intended to provide guidance to funding portals as they develop
their platform and related tools.
Although we are not including additional criteria in Rule
402(b)(2)(ii) at this time, we note that certain of the suggested
highlighting criteria are covered by the criteria listed in the rule,
such as the issuer's industry; the type of securities being offered;
and the geographic location of the issuer's business. Others, while not
listed in the final rule, we believe are based on objective criteria,
such as the amount of money being raised or size of the offering;
soonest offering to close; most or least money invested; how long the
issuer has been operational or profitable; the size of the management
team of the issuer; the stage and operating history of the issuer;
valuation methodology; ``trending''; earnings before interest, taxes,
depreciation and amortization (EBITDA); and highlighting on a purely
random basis. However, we caution that a funding portal must be
cognizant not to present highlighted issuers in a manner that, directly
or implicitly, results in the provision of investment advice or
recommendations.\1021\
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\1021\ For example, a funding portal may provide the EBITDA of
an issuer but it cannot insinuate or state on its platform that the
EBITDA corresponds to the advisability of investing in an issuer.
---------------------------------------------------------------------------
c. Providing Search Functions
(1) Proposed Rule
Proposed Rule 402(b)(3) would permit a funding portal to provide
search functions or other tools that investors can use to search, sort,
or categorize the offerings available through the funding portal's
platform according to objective criteria where: (i) The objective
criteria may include, among other things, the type of securities being
offered (for example, common stock, preferred stock or debt
securities); the geographic location of the issuer; the industry or
business segment of the issuer; the number or amount of investment
commitments made, progress in meeting the issuer's target offering
amount or, if applicable, the maximum offering amount; and the minimum
or maximum investment amount; and (ii) the objective criteria may not
include, among other things, the advisability of investing in the
issuer or its offering, or an assessment of any characteristic of the
issuer, its business plan, its key management or risks associated with
an investment.
(2) Comments on Proposed Rule
Several commenters suggested that the safe harbor be broadened to
include additional criteria.\1022\ One commenter suggested that funding
portals should be permitted to sort offerings based on an algorithmic
score that takes into account any objective numerical data that is
reasonably likely to correlate to successful investments, such as
numeric ratings by accredited and unaccredited investors, number of
investment commitments weighted by investor portfolio valuation, and
number of page views.\1023\ Another commenter stated that the use of
the word ``assessment'' in the proposed safe harbor \1024\ is
inappropriately vague when applied to technology, as it could
effectively prohibit the use of any computational sorting algorithm
using objective searching and sorting criteria. This commenter
suggested that the word ``assessment'' be substituted with the word
``opinion,'' and also that the term ``objective criteria'' be removed
so that the safe harbor would prohibit the use of subjective criteria--
such as the advisability of investing or an opinion of any
characteristic of the issuer, its business plan, its key management or
risks associated with an investment--``generated exclusively by the
portal,'' excepting instances of peer review and feedback generated by
users.\1025\
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\1022\ See, e.g., EMKF Letter; EquityNet Letter.
\1023\ See EMKF Letter.
\1024\ Rule 402(b)(3)(ii) states in part that the ``objective
criteria may not include . . . an assessment of any characteristic
of the issuer, its business plan, its key management or risks . . .
''
\1025\ See EquityNet Letter (noting that ``[a]llowing investors
the ability to sort through each other's comments or opinions
becomes an integral part of any site where commenting is allowed on
products'' and that ``[b]ecause sorting comments would require a
technological assessment of subjective data, we believe an explicit
carve out in the safe harbor provisions is necessary'').
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(3) Final Rules
After considering comments, we are adopting Rule 402(b)(3)
substantially as proposed. The final rule permits a funding portal to
provide search functions or other tools on its platform that users
could use to search, sort or categorize available offerings according
to objective criteria.\1026\ The final rule also permits search
functions that, for example, will allow an investor to sort through
offerings based on a combination of different criteria, such as by the
percentage of the target offering amount that has been met, geographic
proximity to the investor and number of days remaining before the
closing date of an offering.\1027\ However, the final rule makes clear
that the search criteria may not include the advisability of investing
in the issuer or its offering, or an assessment of any characteristic
of the issuer, its business plan, its management or risks associated
with an investment. In this regard, we are
[[Page 71465]]
making minor changes from proposed Rule 402(b)(3)(i) and (ii) by
deleting the word ``objective'' in the final rules because the term is
redundant to the requirement in Rule 402(b)(3) that the criteria be
``objective.'' Further, we are persuaded by one commenter's observation
that the use of the word objective in the subparts could be
misleading.\1028\ The new sentence structure also makes Rule 402(b)(3)
consistent with Rule 402(b)(2), which we believe provides additional
clarity and consistency for funding portals when complying with the
rules.
---------------------------------------------------------------------------
\1026\ See Rule 402(b)(3) Regulation Crowdfunding. See also 158
Cong. Rec. 2231 (daily ed. Mar. 29, 2012) (statement of Sen. Scott
Brown) (``Funding portals should be allowed to organize and sort
information based on certain criteria. This will make it easier for
individuals to find the types of companies in which they can
potentially invest. This type of capability--commonly referred to as
curation--should not constitute investment advice.'').
\1027\ See Rule 402(b)(3) of Regulation Crowdfunding. Rule
402(b)(3)(i) provides examples of search criteria that are
consistent with those listed in the Rule 402(b)(2)(ii) safe harbor
for highlighting issuers and offerings.
\1028\ See EquityNet Letter. However, we do not agree with the
commenter's assertion that using the word ``assessment'' in Rule
402(b)(3) equates to a prohibition on the use of computational
sorting algorithms using objective searching and sorting criteria
because, in this context, assessment is used to refer to subjective
criteria.
---------------------------------------------------------------------------
Rule 402(b)(3) does not preclude the use of computational sorting
algorithms using objective searching and sorting criteria.\1029\
However, a funding portal must take care not to indicate that the
platform's search results or tools, directly or indirectly, correlate
to successful investments. Likewise, we believe that the more
particular, biased or weighted a funding portal's algorithm or
assessment is, the less likely the criteria as a whole will be
objective. However, this does not preclude a funding portal from
permitting investors with access to its communication channels from
rating issuers or offerings (e.g., a star rating) on its platform or
searching such ratings, as long as a funding portal (including its
associated persons, such as its employees) does not participate in the
rating process.\1030\
---------------------------------------------------------------------------
\1029\ In response to one commenter's suggestion that a funding
portal should be permitted to use algorithmic scores, the final rule
does not preclude the use of algorithms as long as the criteria used
by the algorithm are objective. See EMKF Letter. Thus, a ``score''
based on an algorithm may be used as long as it does not involve
subjective criteria.
\1030\ See Rule 402(b)(4)(i).
---------------------------------------------------------------------------
d. Providing Communication Channels
(1) Proposed Rule
Proposed Rule 402(b)(4) would address the terms under which a
funding portal could provide communication channels by which investors
can communicate with one another and with representatives of the issuer
through the funding portal's platform about offerings conducted through
the platform, as required by Rule 303(c). Under the terms of Rule
402(b)(4) as proposed, the safe harbor would apply so long as the
funding portal (and its associated persons): (i) Does not participate
in these communications, other than to establish guidelines for
communication and remove abusive or potentially fraudulent
communications; (ii) permits public access to view the discussions made
in the communication channels; (iii) restricts posting of comments in
the communication channels to those persons who have opened an account
on its platform; and (iv) requires that any person posting a comment in
the communication channels clearly disclose with each posting whether
he or she is a founder or an employee of an issuer engaging in
promotional activities on behalf of the issuer, or is otherwise
compensated, whether in the past or prospectively, to promote an
issuer's offering.
(2) Comments on Proposed Rule
Several commenters supported permitting a funding portal to provide
communication channels on its platform through which investors can make
comments, rate issuers and provide other feedback, and through which
issuers can respond to investor comments.\1031\ One of these commenters
stated that these capabilities could enable a funding portal to share
with investors information related to issuers, capital raised by an
issuer, crowd investing, or the crowd-based rating of specific
issuers.\1032\ Another commenter suggested that funding portals allow
investors to assign a quantifiable indicator to each other's comments,
so that users can search out the best and worst of the comments and
issuers have a chance to respond to investor comments in an open
forum.\1033\ One commenter recommended that permission to rate issuers
or offerings should only be given to investors who actually invested in
or committed to invest in the offering.\1034\
---------------------------------------------------------------------------
\1031\ See, e.g., CFIRA Letter 1; EquityNet Letter; Milken
Institute Letter.
\1032\ See Milken Institute Letter.
\1033\ See EquityNet Letter.
\1034\ See CFIRA Letter 1.
---------------------------------------------------------------------------
(3) Final Rules
We are adopting, as proposed, Rule 402(b)(4) to address the terms
under which a funding portal can provide communication channels by
which investors can communicate with one another and with
representatives of the issuer through the funding portal's platform
about offerings conducted through the platform, as required by Rule
303(c).\1035\ The safe harbor specifies that a funding portal
(including its associated persons, such as its employees) may not
participate in these communications, other than to establish guidelines
about communication and to remove abusive or potentially fraudulent
communications. Under Rule 402(b)(4), a funding portal must make
communication channels available to the general public and restrict the
posting of comments on those channels to those who have accounts on the
funding portal's platform. In addition, the funding portal must require
each person posting comments to disclose clearly with each posting in
the channel whether he or she is a founder or an employee of an issuer
engaging in promotional activities on behalf of the issuer, or is
otherwise compensated or will receive any compensation for promoting an
issuer.\1036\
---------------------------------------------------------------------------
\1035\ See Section II.C.5.b(3) for a discussion of Rule 303(c).
\1036\ See Rule 402(b)(4)(iv).
---------------------------------------------------------------------------
We agree with commenters that investors should be permitted to
communicate with one other, and with representatives of the issuer,
over communication channels on the platform provided by the funding
portal.\1037\ The communication channel is meant to strengthen and
foster the ability of the crowd to communicate. We believe that the
capabilities within the communication channel will develop and evolve
over time. For example, as noted above, a communication channel may
permit investors to rate or comment on an issuer or offering, or to
assign quantifiable indicators to one other's comments. Also, a funding
portal must make communication channels available for viewing by the
general public, and permit anyone who has opened an account on its
platform to post comments on the channel.\1038\ As we stated in the
Proposing Release, requiring investors to have accounts with the
funding portal before posting a comment should provide a measure of
control over these communications that could aid in promoting
accountability for comments made and help ensure that interested
persons, such as those associated with the issuer or receiving
compensation to promote the issuer, are properly identified.
---------------------------------------------------------------------------
\1037\ As discussed in Section II.C.5, an issuer, its agents and
promoters must identify themselves in all communications through the
communication channel.
\1038\ See Rule 402(b)(4)(i) and (ii).
---------------------------------------------------------------------------
We reiterate that while a funding portal must provide for a
communication channel and may develop certain features or tools as a
part of that channel (such as a crowd-based rating system), a funding
portal (including its associated persons, such as its employees) may
not engage or participate in such communications.\1039\
[[Page 71466]]
In addition, a funding portal should consider whether the tools or
features of the communication channels it develops and the guidelines
it establishes for the channel would constitute the funding portal
providing impermissible investment advice or recommendations. For
example, the funding portal may not establish a guideline that permits
a person to rate an offering only if the person provides a positive
rating, or otherwise incentivizes persons to give positive ratings.
However, contrary to what one commenter suggested, we do not believe a
funding portal may limit the rating capability to those account holders
who have made investment commitments to the relevant offering.\1040\ We
believe that limiting ratings capability to persons that invest in an
offering is likely to skew the ratings, and therefore, we would view
such a limitation as inappropriate. Further, such a limitation could
prevent persons with relevant and important information about the
investment from contributing their views to the crowd.
---------------------------------------------------------------------------
\1039\ See Rule 402(b)(4)(i). See also Rule 303(c).
\1040\ See CFIRA Letter 1.
---------------------------------------------------------------------------
e. Advising Issuers
(1) Proposed Rule
Proposed Rule 402(b)(5) would permit a funding portal to advise an
issuer about the structure or content of the issuer's offering,
including assisting the issuer in preparing offering documentation.
(2) Final Rules
We did not receive any comments that specifically addressed the
ability of a funding portal to advise issuers and are adopting Rule
402(b)(5) as proposed. The rule permits a funding portal to advise an
issuer about the structure or content of the issuer's offering,
including preparing offering documentation. We believe funding portals
will be in a position to provide experience and assistance to issuers
relatively efficiently, and should be able to leverage their expertise
to increase the viability of crowdfunding.
We believe that funding portals, as well as broker-dealers, should
be permitted to provide certain services to issuers to facilitate the
offer and sale of securities in reliance on Section 4(a)(6). Without
these services, crowdfunding as a method to raise capital might not be
viable. Rule 404(b)(5) permits funding portals to advise an issuer
about the structure and content of the issuer's offering in a number of
ways. A funding portal can, for example, provide pre-drafted templates
or forms for an issuer to use in its offering that will help it comply
with its proposed disclosure obligations. Other examples of permissible
assistance can include advice about the types of securities the issuer
can offer, the terms of those securities and the procedures and
regulations associated with crowdfunding.
f. Paying for Referrals
(1) Proposed Rule
Proposed Rule 402(b)(6) would permit a funding portal to compensate
a third party for referring a person to the funding portal, so long as
the third party does not provide the funding portal with personally
identifiable information of any investor and the compensation, other
than that paid to a registered broker or dealer, is not based, directly
or indirectly, on the purchase or sale of a security in reliance on
Section 4(a)(6) of the Securities Act offered on or through the funding
portal's platform.
(2) Comment on Proposed Rule
One commenter requested clarification as to: (i) Whether and when
compensation paid to a non-broker-dealer will be deemed improperly
based on the purchase or sale of a security; (ii) whether a funding
portal may pay a registered broker-dealer a referral fee without a
formal agreement; and (iii) whether a funding portal may charge issuers
fees based on the success of the offering.\1041\
---------------------------------------------------------------------------
\1041\ See ABA Letter.
---------------------------------------------------------------------------
(3) Final Rules
We are adopting Rule 402(b)(6) as proposed. Rule 402(b)(6) permits
a funding portal to compensate a third party for referring a person to
the funding portal if the third party does not provide the funding
portal with personally identifiable information about any investor and
the compensation, other than that paid to a registered broker or
dealer, is not based, directly or indirectly, on the purchase or sale
of a security in reliance on Section 4(a)(6) of the Securities Act
offered on or through the funding portal's platform. We believe the
safe harbor in this regard addresses the prohibition in Rule 305
against an intermediary compensating any person for providing the
intermediary with the personally identifiable information of any
investor in securities offered and sold in reliance on Section 4(a)(6).
We also believe that Rule 402(b)(6)'s prohibition on funding portals
paying transaction-based compensation to third parties, other than that
paid to a registered broker or dealer, will help to minimize the
incentive for high-pressure sales tactics and other abusive practices
in this area. One commenter requested additional guidance as to what
types of compensation would equate to compensation based on the offer
or sale of a security.\1042\ The Commission and courts have interpreted
the definition of transaction-based compensation broadly,\1043\ and
whether compensation is transaction-based is a facts and circumstances
determination. Thus, we do not believe that additional guidance is
necessary or appropriate in this context.
---------------------------------------------------------------------------
\1042\ Id.
\1043\ See, e.g., Applicability of Broker-Dealer Registration to
Banks, Exchange Act Rel. No. 20,357 at n.14 (Nov. 8, 1983).
---------------------------------------------------------------------------
In response to a commenter's inquiry, a funding portal may not pay
a registered broker-dealer a referral fee without a written agreement
under the safe harbor. Such an arrangement would be covered by Rule
402(b)(7), which is discussed below.
g. Compensation Arrangements With Registered Broker-Dealers
(1) Proposed Rule
Proposed Rule 402(b)(7) would permit a funding portal to pay or
offer to pay any compensation to a registered broker or dealer for
services in connection with the offer or sale of securities by the
funding portal in reliance on Section 4(a)(6) of the Act, provided
that: (i) Such services are provided pursuant to a written agreement
between the funding portal and the registered broker or dealer; (ii)
such services and compensation are permitted under Regulation
Crowdfunding and are not otherwise prohibited under Rule 305; and (iii)
such compensation complies with and is not prohibited by the rules of
any registered national securities association of which the funding
portal is required to be a member.
Proposed Rule 402(b)(8) would permit a funding portal to receive
any compensation from a registered broker or dealer for services
provided by the funding portal in connection with the offer or sale of
securities by the funding portal in reliance on Section 4(a)(6) of the
Act, provided that: (i) Such services are provided pursuant to a
written agreement between the funding portal and the registered broker
or dealer; (ii) such compensation is permitted under Regulation
Crowdfunding; and (iii) such compensation complies with and is not
prohibited by the rules of any registered national securities
association of which the funding portal is required to be a member.
[[Page 71467]]
(2) Comments on Proposed Rule
Several commenters expressed concerns about the permitted
relationships between funding portals and broker-dealers.\1044\ One of
these commenters stated that the proposed safe harbor is ``overly
broad'' and creates ``unmanageable conflicts between funding portals
and broker dealers,'' and suggested the Commission prevent these
conflicts by prohibiting funding portals from paying broker-dealers any
type of compensation in connection with the offer or sale of securities
under the crowdfunding exemption.\1045\ Another of these commenters
suggested that the Commission require relationships between funding
portals and brokers to be arms-length and, if they are not, require
that the funding portal activity be operated by the broker-dealer
entity.\1046\
---------------------------------------------------------------------------
\1044\ See, e.g., Commonwealth of Massachusetts Letter;
RocketHub Letter.
\1045\ See Commonwealth of Massachusetts Letter.
\1046\ See RocketHub Letter (expressing concern over broker-
dealers creating entities that would register as funding portals so
as to evade FINRA oversight as a broker-dealer).
---------------------------------------------------------------------------
(3) Final Rules
We are adopting Rule 402(b)(7) generally as proposed, but with
minor modifications for clarity and consistency. Rule 402(b)(7)
specifies that a funding portal may pay or offer to pay compensation to
a registered broker or dealer for services, including for referring a
person to the funding portal, in connection with the offer or sale of
securities by the funding portal in reliance on Section 4(a)(6) of the
Securities Act, provided that (i) such services are provided pursuant
to a written agreement between the funding portal and the registered
broker or dealer; (ii) such compensation is permitted under Regulation
Crowdfunding; and (iii) such compensation complies with the rules of
any registered national securities association of which the funding
portal is a member. As discussed above, proposed Rule 402(b)(7) did not
contain a reference to ``referrals,'' while proposed Rule 402(b)(6)
included the language ``for referring a person to the funding portal.''
We have added a reference to ``referrals pursuant to [Rule 402](b)(7)''
to make clear that all payment arrangements with a broker-dealer,
including paying a broker-dealer for referrals as permitted under
subparagraph (b)(6), must be in writing.
Proposed Rule 402(b)(7)(ii) had also stated that ``such
compensation is permitted under this part and is not otherwise
prohibited under Sec. 227.305''; and subparagraph (b)(7)(iii) stated
``such compensation complies with and is not prohibited by-the rules of
any registered national securities association of which the funding
portal is required to be a member.'' We are deleting the phrases ``and
is not otherwise prohibited under Sec. 227.305'' and ``and is not
prohibited by'' to make the language in Rule 402(b)(7) and Rule
402(b)(8) consistent, and because the phrases are redundant. Also, we
are deleting the phrase ``required to be a member'' and replacing it
with ``is a member'' in recognition of the fact that additional
national securities associations may exist in the future and that a
funding portal would only have to be a member of one such association.
Consistent with Rule 402(b)(7), a funding portal may, for example,
pay a broker-dealer for certain services, such as information
technology services, qualified third party services or referral
services, pursuant to a written agreement. Each party to this type of
arrangement will need to comply with all applicable regulations,
including the rules of the registered national securities association
of which it is a member.
Similarly, we are adopting Rule 402(b)(8) as proposed with minor
modifications. Rule 402(b)(8) permits a funding portal to provide
services to, and receive compensation from, a registered broker-dealer
in connection with the funding portal's offer or sale of securities in
reliance on Section 4(a)(6), provided that: (i) Such services are
provided pursuant to a written agreement between the funding portal and
the registered broker or dealer; (ii) such compensation is permitted
under Regulation Crowdfunding; and (iii) such compensation complies
with the rules of any registered national securities association of
which the funding portal is a member. The proposed rules had stated
that ``such compensation complies with and is not prohibited by the
rules of any registered national securities association of which the
funding portal is required to be a member.'' For the reasons discussed
above with regard to Rule 402(b)(7)(ii), we are deleting the phrase
``and is not prohibited'' because it is redundant and deleting the
phrase ``required to be a member'' and replacing it with ``is a
member.''
Pursuant to Rule 402(b)(8), a funding portal may receive
compensation, including transaction-based compensation, from a broker-
dealer for providing referrals to that broker-dealer relating to an
offering made pursuant to Section 4(a)(6). It is important to emphasize
that the safe harbor does not permit a funding portal to receive
transaction-based compensation for referrals of investors in other
types of offerings, such as Rule 506 offerings, that are effected by a
registered broker-dealer.\1047\ Further, these arrangements must be
compliant with Rule 305, which prohibits, with certain exceptions, an
intermediary from compensating any person for providing the
intermediary with the personally identifiable information of any
investor.\1048\ As we stated in the Proposing Release, the safe harbor
is intended to facilitate intermediaries' cooperation with each other
and promote the use of the Section 4(a)(6) exemption to raise capital,
while maintaining a written record of compensation payments.
---------------------------------------------------------------------------
\1047\ Receipt of transaction-based compensation in connection
with such referrals can cause a funding portal to be a broker
required to register with us under Exchange Act Section 15(a)(1) (15
U.S.C. 78o(a)(1)).
\1048\ See Section II.C.7 (discussing Rule 305).
---------------------------------------------------------------------------
We disagree with the commenter who suggested that Rules 402(b)(7)
and (8) create an unmanageable conflict between funding portals and
broker-dealers.\1049\ We believe that any potential conflict of
interest between broker-dealers and funding portals as a result of
compensation arrangements is mitigated due to the fact that both
entities are registered with the Commission and members of FINRA and
because permissible activities under Rule 402(b)(7) and (8) are limited
by Regulation Crowdfunding. We also are not prohibiting a registered
broker-dealer and a registered funding portal from being affiliated,
nor are we requiring that any crowdfunding operation be performed by
the registered broker-dealer in such an affiliation.\1050\ Because
funding portals and broker-dealers are each registered with the
Commission and required to be members of a registered national
securities association with the attendant rules and oversight, we
believe concerns about conflicts of interests among affiliated funding
portals and broker-dealers are sufficiently mitigated by this
regulatory framework.
---------------------------------------------------------------------------
\1049\ See Commonwealth of Massachusetts Letter.
\1050\ See RocketHub Letter (expressing concern over broker-
dealers creating entities that would register as funding portals, so
as to evade FINRA oversight as a broker-dealer).
---------------------------------------------------------------------------
While a commenter questioned whether a funding portal may pay
introducing brokers a fee for referring persons to the funding portal
without a formal written arrangement,\1051\ we emphasize that Rule
402(b)(7) requires all such arrangements to be in writing.
---------------------------------------------------------------------------
\1051\ See ABA Letter.
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[[Page 71468]]
h. Advertising
(1) Proposed Rule
Proposed Rule 402(b)(9) would permit a funding portal to advertise
the existence of the funding portal and identify one or more issuers or
offerings available on the portal on the basis of objective criteria,
as long as: (i) The criteria are reasonably designed to identify a
broad selection of issuers offering securities through the funding
portal's platform and are applied consistently to all potential issuers
and offerings; (ii) the criteria may include, among other things, the
type of securities being offered (for example, common stock, preferred
stock or debt securities); the geographic location of the issuer; the
industry or business segment of the issuer; the expressed interest by
investors, as measured by number or amount of investment commitments
made, progress in meeting the issuer's target offering amount or, if
applicable, the maximum offering amount; and the minimum or maximum
investment amount; and (iii) the funding portal does not receive
special or additional compensation for identifying the issuer or
offering in this manner.
(2) Comments on Proposed Rule
Several commenters supported the proposed safe harbor on funding
portal advertising.\1052\ However, commenters were divided on whether
funding portals should be permitted to advertise current offerings and
issuers in their advertisements. One commenter was supportive of
allowing funding portals to ``advertise more generally, as well as
highlight ongoing offerings through various communication channels.''
\1053\ The same commenter stated that a portal's decision to feature or
highlight issues available should not be viewed by the Commission as
investment advice, a recommendation, or a solicitation.\1054\ This
commenter nonetheless cautioned that ``[p]ortals should be barred from
language that implicates the level of risk involved in the investment
or the overall quality of the investment opportunity'' as well as
``from soliciting investments for any specific campaign by providing
offering details outside of the Portal itself.'' \1055\ Another
commentator expressed opposition to ``a limitation on the funding
portal to only advertise its past offerings,'' stating that such a
limitation ``would be overly restrictive.'' \1056\
---------------------------------------------------------------------------
\1052\ See, e.g., CFIRA Letter 1; Commonwealth of Massachusetts
Letter; ABA Letter.
\1053\ See RocketHub Letter.
\1054\ Id.
\1055\ Id.
\1056\ See CFIRA Letter 1.
---------------------------------------------------------------------------
In contrast, one commenter stated that, while funding portals
should be allowed to advertise, funding portals should not be able to
display specific issuers in their advertising materials.\1057\ This
commenter stated that ``[t]he concern with displaying individual
issuers is that investors will interpret this as a recommendation and
endorsement of the issuer.'' \1058\ The commenter noted that the
prohibition on providing recommendations can be easily circumvented by
manipulating otherwise seemingly objective criteria, and that funding
portals could advertise offerings based on certain criteria, such as
high target offerings, that may generate more money for the funding
portal (i.e., a funding portal can mask self-interest by using
objective criteria).\1059\ This same commenter suggested that the
Commission could allow descriptions of the portals themselves and the
specific business segments featured on their Web sites, without
mentioning specific issuers currently registered with the portal.\1060\
---------------------------------------------------------------------------
\1057\ See Commonwealth of Massachusetts Letter.
\1058\ Id.
\1059\ Id.
\1060\ Id.
---------------------------------------------------------------------------
One commenter suggested the Commission clarify that it would be
inappropriate for a funding portal to send out soliciting emails
recommending investment in particular companies to investors who have
signed up with that portal.\1061\ Another commenter stated that a
funding portal should not be permitted to advertise or otherwise make
statements that offerings listed are somehow safer or better than other
platforms.\1062\
---------------------------------------------------------------------------
\1061\ See ABA Letter.
\1062\ See Milken Institute Letter.
---------------------------------------------------------------------------
(3) Final Rules
We are adopting Rule 402(b)(9) as proposed. Rule 402(b)(9) permits
a funding portal to advertise its existence and identify one or more
issuers or offerings available on the portal on the basis of objective
criteria, as long as: (i) The criteria are reasonably designed to
identify a broad selection of issuers offering securities through the
funding portal's platform and are applied consistently to all potential
issuers and offerings; (ii) the criteria may include, among other
things, the type of securities being offered (for example, common
stock, preferred stock or debt securities); the geographic location of
the issuer; the industry or business segment of the issuer; the
expressed interest by investors, as measured by number or amount of
investment commitments made, progress in meeting the issuer's target
offering amount or, if applicable, the maximum offering amount; and the
minimum or maximum investment amount; and (iii) the funding portal does
not receive special or additional compensation for identifying the
issuer or offering in this manner. However, a funding portal may not
base its decision as to which issuers to include in its advertisements
on whether it has a financial interest in the issuer,, and any
advertising may not directly or indirectly favor issuers in which the
funding portal has invested or will invest.
After considering the comment letters, we believe that the
requirements of the safe harbor, including the requirement for
objective criteria designed to result in a broad selection of
highlighted issuers or offerings, will result in advertisements that
are focused on the funding portal itself, as opposed to recommending a
particular offering or offerings.\1063\ Funding portals continue to be
subject to the statutory prohibition on providing investment advice and
recommendations.\1064\ An advertisement by a funding portal must not be
an implicit (or explicit) recommendation as to whether to invest in the
issuer or offering or advice on the advisability of investing in the
issuer or offering. Therefore, consistent with the views of one
commenter, a funding portal may not advertise in such a way that
expresses the funding portal's view that, for example, certain
offerings on its platform are of a higher quality, safer or more worthy
than others, or that otherwise gives a recommendation.\1065\
---------------------------------------------------------------------------
\1063\ The safe harbor is limited to identifying one or more
issuers. More detailed information about an issuer should be
provided on the funding portal's platform.
\1064\ See Exchange Act Section 3(a)(80)(A).
\1065\ See Milken Institute Letter.
---------------------------------------------------------------------------
We recognize that advertisements can take many varied forms,
including non-traditional means, such as blogs, emails through social
media or other methods. We believe that these types of communications,
when made by a funding portal to investors can be a permissible means
of advertising within the scope of Rule 402(b)(9). We agree, however,
with a commenter's statement that it would be inconsistent with the
statutory prohibition on providing investment advice or recommendations
for a funding portal to send out soliciting emails recommending
investments in particular companies as part of its advertising.\1066\
---------------------------------------------------------------------------
\1066\ See ABA Letter.
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[[Page 71469]]
i. Deny Access to Platform
(1) Proposed Rule
Proposed Rule 402(b)(10) would permit a funding portal to deny
access to its platform to, or cancel an offering of, an issuer that the
funding portal believes may present the potential for fraud or
otherwise raises investor protection concerns.
(2) Comments on Proposed Rule
Some commenters asserted that the proposed rules are ambiguous, and
that the lack of specificity exposes funding portals to potential
liability. The commenters were concerned that the perceived lack of
specificity may also lead funding portals to unintentionally violate
the ban on providing investment advice with their attempts to mitigate
liability.\1067\
---------------------------------------------------------------------------
\1067\ See, e.g., RocketHub Letter and Seyfarth Letter.
---------------------------------------------------------------------------
(3) Final Rules
We are adopting Rule 402(b)(10) substantially as proposed with
modifications to make it consistent with Rule 301(c)(2), which requires
an intermediary to deny access if it has a reasonable basis for
believing that the issuer or the offering presents the potential for
fraud or otherwise raises concerns about investor protection.\1068\ In
satisfying this requirement, an intermediary must deny access if it
reasonably believes that it is unable to adequately or effectively
assess the risk of fraud of the issuer or its potential offering. In
addition, if an intermediary becomes aware of information after it has
granted access that causes it to reasonably believe that the issuer or
the offering presents the potential for fraud or otherwise raises
concerns about investor protection, the intermediary must promptly
remove the offering from its platform, cancel the offering, and return
(or, for funding portals, direct the return of) any funds that have
been committed by investors in the offering. Rule 402(b)(10) requires a
funding portal to deny access to its platform to, or cancel an offering
of an issuer, pursuant to Rule 301(c)(2), if the funding portal has a
reasonable basis for believing that the issuer or the offering presents
the potential for fraud or otherwise raises concerns.
---------------------------------------------------------------------------
\1068\ See Section II.C.3 discussing the change to Rule 301(c)
to include a ``reasonable basis'' standard.
---------------------------------------------------------------------------
We changed the standard in Rule 402(b)(10) to a ``reasonable basis
for believing''--rather than ``believes''--to conform the safe harbor
to the requirements of Rule 301(c)(2) as adopted. Thus, the standard in
Rule 402(b)(10) is consistent with the modifications that we made to
the standard in Rule 301(c)(2).\1069\ We believe this change also
should help to address commenters' concerns about the perceived lack of
specificity in the proposed safe harbor by providing an objective
``reasonable belief'' standard for the required determinations. Under
this standard a funding portal may not ignore facts about an issuer
that indicate fraud or investor protection concerns such that a
reasonable person would have denied access to the platform. At the same
time, a funding portal can also feel assured in its decision to deny an
issuer access or cancel an offering if it has a reasonable basis for
such a determination. We also believe that including a ``reasonable
basis'' standard adds objectivity to a funding portal's determinations
regarding which issuers must be denied access to (or removed from) its
platform, which is expected to help to address concerns regarding the
clarity of the standard under the proposed rule.
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\1069\ See Section II.C.3.
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j. Accepting Investor Commitments
(1) Proposed Rule
Proposed Rule 402(b)(11) would permit a funding portal to accept,
on behalf of an issuer, an investment commitment for securities offered
in reliance on Section 4(a)(6) of the Securities Act by that issuer on
the funding portal's platform.
(2) Comments on Proposed Rule
One commenter noted that the statute prohibits funding portals from
handling investor funds or securities, and that the proposed rule
requiring the use of third-party entities would create additional
transaction costs for funding portals.\1070\ Another commenter stated
that the safe harbor for accepting investor commitments should permit a
funding portal to assist issuers in handling a direct registration
system (DRS) between issuers and investors.\1071\
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\1070\ See Stephenson, et al., Letter.
\1071\ See RocketHub (suggesting that a portal should be
permitted to provide DRS support to issuers and investors). A DRS
allows investors to transfer a security that is registered in the
investor's name on the issuer's books, and either the company or its
transfer agent holds the security for the investor in book-entry
form.
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(3) Final Rules
We are adopting Rule 402(b)(11) as proposed. Rule 402(b)(11)
permits a funding portal, on behalf of an issuer, to accept investment
commitments from investors for securities offered in reliance on
Section 4(a)(6) by that issuer on the funding portal's platform. We are
not broadening the safe harbor to permit funding portals to handle
customer funds, as suggested by one commenter. Although we recognize
that the requirement to use a third party entity to handle customer
funds imposes an additional expense on a funding portal, Exchange Act
Section 3(a)(80)(D) explicitly prohibits funding portals from handling
customer funds and securities. Similarly, we believe it would be
inconsistent with the statute for a funding portal to facilitate a
securities registration system for issuers and investors because such
activity implicitly requires funding portals to handle customer funds
and securities, which is prohibited by the statute. In this regard, we
note that the activities that a funding portal is permitted to engage
in are limited in scope, and as such are subject to a more limited
regulatory scheme as compared to registered broker-dealers.
k. Directing Transmission of Funds
(1) Proposed Rule
Proposed Rule 402(b)(12) would permit a funding portal to direct
investors where to transmit funds or remit payment in connection with
the purchase of securities offered and sold in reliance on Section
4(a)(6) of the Securities Act.
Proposed Rule 402(b)(13) would permit a funding portal to direct a
qualified third party, as required by Rule 303(e), to release proceeds
to an issuer upon completion of a crowdfunding offering or to return
proceeds to investors in the event an investment commitment or an
offering is cancelled.
(2) Final Rules
We did not receive comments on the ability of a funding portal to
direct investment funds and are adopting Rules 402(b)(12) and (13) as
proposed. Rules 402(b)(12) and (13) provide that a funding portal can
fulfill its obligations with respect to the maintenance and
transmission of funds and securities, as set forth in Rule 303, without
violating the prohibition in Exchange Act Section 3(a)(80)(D).
Specifically, a funding portal can direct investors where to transmit
funds or remit payment in connection with the purchase of securities
offered and sold in reliance on Section 4(a)(6),\1072\ and as required
by Rule 303(e), a funding portal can direct a qualified third party to
release the proceeds of an offering to the issuer upon completion of
the offering or to return investor proceeds when an
[[Page 71470]]
investment commitment or offering is cancelled.\1073\
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\1072\ See Rule 402(b)(12) of Regulation Crowdfunding.
\1073\ See Rule 402(b)(13) of Regulation Crowdfunding.
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l. Posting News
In the Proposing Release, we asked whether we should adopt a safe
harbor that permits a funding portal to post news, such as market news
and news about a particular issuer or industry, on its platform. In
response to our request for comment, some commenters stated that the
safe harbor should permit funding portals to post third party news
related to issuers or offerings on their platform.\1074\ One commenter
cautioned that objective criteria should be used to ensure, for
example, that funding portals are not picking out the most flattering
or positive news.\1075\ Another commenter suggested that funding
portals should be aware of the content of materials posted on their
portal and held responsible for inappropriate information that is
posted.\1076\
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\1074\ See, e.g., CFIRA Letter 1; RoC Letter; StartupValley
Letter. But see Joinvestor Letter; Wefunder Letter.
\1075\ See CFIRA Letter 1.
\1076\ See RoC Letter.
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While we believe it is possible for funding portals to post news on
their platforms in a manner that would not violate the prohibitions in
Exchange Act Section 3(a)(80), we are not including such activities
within the safe harbor because we believe the permissibility of posting
news should be a facts and circumstances determination. When posting
news, funding portals will need to ensure that they do not violate the
prohibition on giving investment advice and recommendations. For
example, if a funding portal selectively determines which news articles
to post or posts only flattering or positive news, then the funding
portal is more likely to be giving impermissible investment advice or
recommendations.
m. No Presumption and Anti-Fraud Provisions
(1) Proposed Rule
Proposed Rule 402(a) also stated that no presumption shall arise
that a funding portal has violated the prohibitions under Section
3(a)(80) of the Exchange Act or Regulation Crowdfunding by reason of
the funding portal or its associated persons engaging in activities in
connection with the offer or sale of securities in reliance on Section
4(a)(6) of the Securities Act that do not meet the conditions specified
in the safe harbor and that the antifraud provisions and all other
applicable provisions of the federal securities laws continue to apply
to the activities described in the safe harbor.
(2) Final Rules
We did not receive any comments on the proposed ``no presumption''
and anti-fraud provisions and are adopting Rule 402(a) as proposed. We
also reiterate that Rule 402(b) is a non-exclusive safe harbor. Rule
402(a) expressly provides that the failure of a funding portal to meet
the conditions of the safe harbor does not give rise to a presumption
that the funding portal is in violation of the statutory prohibitions
of Exchange Act Section 3(a)(80) or Regulation Crowdfunding.\1077\
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\1077\ See Rule 402(a) of Regulation Crowdfunding.
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Further, the safe harbor under Rule 402 does not prohibit funding
portals from engaging third party service providers to assist the
funding portal in operating its platform, such as providers of
software, Web site maintenance and development, communication channel
applications, recordkeeping systems, and other technology.\1078\
However, the funding portal remains responsible for its activities and
the operation of its platform and for compliance with Regulation
Crowdfunding and other applicable federal securities laws.
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\1078\ One commenter asked whether funding portals could engage
third party service providers consistent with Regulation
Crowdfunding. See CFIRA Letter 1.
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4. Compliance
a. Policies and Procedures
(1) Proposed Rule
As proposed, Rule 403(a) would require a funding portal to
implement written policies and procedures reasonably designed to
achieve compliance with the federal securities laws and the rules and
regulations thereunder, relating to its business as a funding
portal.\1079\
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\1079\ As a condition to exempting funding portals from the
requirement to register as a broker or a dealer under Exchange Act
Section 15(a)(1) (15 U.S.C. 78o(a)(1)), Exchange Act Section
3(h)(1)(C) provides that registered funding portals must comply with
such other requirements as the Commission determines appropriate.
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(2) Comments on the Proposed Rules
One commenter agreed that the Commission should not specify
requirements for a funding portal's policies and procedures, while
another commenter thought the Commission should provide guidance
concerning the policies and procedures.\1080\ Another commenter
suggested that all changes to a funding portal's policies and
procedures should be disclosed within 30 days and publicly
announced.\1081\ Yet another commenter suggested requiring the SRO to
mandate that broker-dealers and funding portals follow the same
policies.\1082\
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\1080\ See ASSOB Letter; Consumer Federation of America (``[The
Commission] fails to address at all the areas that should be covered
by such policies and procedures, or what a funding portal's
responsibilities to monitor compliance would be.'').
\1081\ See Joinvestor Letter.
\1082\ See Rockethub Letter.
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(3) Final Rules
We are adopting Rule 403(a) as proposed. We believe that the
requirement to implement written policies and procedures will provide
important investor protections as it will necessitate that funding
portals remain aware of the various regulatory requirements to which
they are subject and take appropriate steps for complying with such
requirements. We recognize, however, that funding portals may have
various business models and, therefore, consistent with the views of
one commenter, we are not imposing specific requirements for a funding
portal's policies and procedures, provided the policies and procedures
are reasonably designed to achieve compliance with the federal
securities laws and the rules relating to their business as funding
portals. Rather, we are providing a funding portal with discretion to
establish, implement, maintain and enforce its policies and procedures
based on its relevant facts and circumstances.
We note, however, that a funding portal may rely on the
representations of others when meeting certain requirements under
Regulation Crowdfunding, unless the funding portal has reason to
question the reliability of those representations. For example, a
funding portal may rely on an issuer's representation to establish a
reasonable basis for believing that an issuer seeking to offer and sell
securities in reliance on Section 4(a)(6) through its platform complies
with the requirements in Securities Act Section 4A(b) and the related
requirements in Regulation Crowdfunding, unless the funding portal has
reason to question the reliability of that representation.\1083\ A
funding portal may also rely on an investor's representation to
establish a reasonable basis for believing that an investor satisfies
the investment limits established by Section 4(a)(6)(B), unless the
funding portal has reason to question the reliability of that
representation.\1084\ We believe that when a funding portal relies on
the representations of others to form a reasonable basis, the funding
portal
[[Page 71471]]
should have policies and procedures regarding under what circumstances
it can reasonably rely on such representations and when additional
investigative steps may be appropriate. We further believe that a
funding portal's policies and procedures should cover not only
permitted activities, but also address prohibited activities. For
example, a funding portal should have policies and procedures on the
criteria used to limit, highlight and advertise issuers and offerings.
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\1083\ See Rule 301(a).
\1084\ See Rule 303(b)(1).
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We note one commenter's suggestion that we require funding portals
to update their policies and procedures to reflect changes in
applicable rules and regulations within a specified time period after
the change occurs. However, as explained in the Proposing Release, we
believe that the requirement for reasonably designed policies and
procedures includes an ongoing obligation for a funding portal to
promptly update its policies and procedures if necessary to reflect
changes in applicable rules and regulations, a funding portal's
business practices, and/or the marketplace.\1085\ Finally, in response
to one commenter's suggestion that we require SROs to mandate that
broker-dealers and funding portals follow the same policies, as noted
above, we believe that funding portals should have flexibility to
implement policies and procedures suited to their own facts and
circumstances. Moreover, we note that any proposed SRO rules relating
to policies and procedures of either broker-dealers or funding portals
will be subject to the Exchange Act Section 19(b) SRO rule filing
process.\1086\
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\1085\ Consistent with our requirements for broker-dealers, we
are not requiring that a funding portal's policies and procedures be
made public, as suggested by a commenter.
\1086\ Pursuant to Exchange Act Section 19(b) and Rule 19b-4,
SROs are required to file proposed new rules and rule changes with
the Commission.
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Commission staff expects to review intermediaries' compliance
policies and procedures relating to their activities in connection with
the offer or sale of securities in reliance on Section 4(a)(6) during
the study of the federal crowdfunding exemption that it plans to
undertake no later than three years following the effective date of
Regulation Crowdfunding.\1087\
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\1087\ See Section II.
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b. Anti-Money Laundering
(1) Proposed Rule
Proposed Rule 403(b) would require that funding portals comply with
certain AML provisions,\1088\ as set forth in Chapter X of Title 31 of
the Code of Federal Regulations. The BSA and its implementing
regulations establish the basic framework for AML obligations imposed
on financial institutions.\1089\ The BSA is intended to facilitate the
prevention, detection and prosecution of money laundering, terrorist
financing and other financial crimes.
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\1088\ See also Section II.D.2. (discussing proposed Rule
401(b)).
\1089\ See BSA, note 981; 31 CFR Chapter X.
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Among other things, the BSA and its implementing regulations
require a ``broker or dealer in securities'' (sometimes referred to in
the regulations as a ``broker-dealer'') to: (1) Establish and maintain
an effective AML program;\1090\ (2) establish and maintain a Customer
Identification Program; \1091\ (3) monitor for and file reports of
suspicious activity (SARs); \1092\ and (4) comply with requests for
information from the Financial Crimes Enforcement Network
(``FinCEN'').\1093\ For purposes of the BSA obligations, a ``broker or
dealer in securities'' is defined as a ``broker or dealer in
securities, registered or required to be registered with the Securities
and Exchange Commission under the Securities Exchange Act of 1934,
except persons who register pursuant to [S]ection 15(b)(11) of the
Securities Exchange Act of 1934.'' \1094\ As explained above, Exchange
Act Section 3(h) expressly directs the Commission, conditionally or
unconditionally, to exempt funding portals from the requirement to
register as a broker or dealer under Section 15(a). As such, a funding
portal is not a broker ``registered or required to be registered'' if
it registers as a funding portal with the Commission. We proposed that,
notwithstanding this exemption from broker registration, under Rule
401(b) a funding portal would be ``required to be registered'' as a
broker or dealer with the Commission under the Exchange Act solely for
purposes of Chapter X of Title 31 of the Code of Federal Regulations,
thus subjecting funding portals to the AML requirements of Chapter X of
Title 31.
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\1090\ See 31 U.S.C. 5318(h). See also 31 CFR 1023.210; FINRA
Rule 3310.
\1091\ See 31 CFR 1023.220.
\1092\ See 31 CFR 1023.320. See also FINRA Rule 3310.
\1093\ See 31 CFR 1010.520.
\1094\ See 31 CFR 1010.100(h). As noted above, certain FinCEN
regulations apply to a ``broker-dealer,'' which is defined as a
``person registered or required to be registered as a broker or
dealer with the Commission under the Securities Exchange Act of 1934
(15 U.S.C. 77a et seq.), except persons who register pursuant to 15
U.S.C. 78o(b)(11).'' 31 CFR 1023.100(b). Such broker-dealers also
would meet the definition of ``broker or dealers in securities''
above.
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(2) Comments on the Proposed Rule
A few commenters generally suggested that since funding portals are
prohibited from handling customer funds and securities they should not
be required to comply with AML provisions.\1095\ Some commenters,
however, generally supported requiring funding portals to comply with
AML provisions.\1096\ One commenter, noting that non-U.S. investors may
participate in crowdfunding and use U.S.-based funding portals,
requested that the Commission provide advice and suggestions on ``how
to prevent anti-money laundering.'' \1097\
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\1095\ See PeoplePowerFund Letter; Public Startup 3 Letter;
RFPIA Letter; Vann Letter.
\1096\ See RocketHub Letter (stating that it ``supports the
Commissions [sic] interpretation of the exemption, and believes that
AML compliance is necessary''); Berlingeri Letter (supporting
funding portal ``compliance with existing anti-money laundering
provisions and the requirement to report suspicious activity'').
\1097\ See Zhang Letter.
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(3) Final Rules
Upon further consideration, we have determined not to adopt
proposed Rule 403(b). The BSA requirements play a critical role in
detecting, preventing, and reporting money laundering and other illicit
financing, such as market manipulation and fraud. However, after
careful consideration, we believe that AML obligations for funding
portals are better addressed outside of the rules that we are currently
adopting in this release, and that it would be more appropriate to work
with other regulators to develop consistent and effective AML
obligations for funding portals.\1098\ We note, however, that broker-
dealers continue to have their own AML obligations, as do certain other
parties involved in transactions
[[Page 71472]]
conducted pursuant to Section 4(a)(6), such as a bank acting as a
qualified third party to hold investor funds.
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\1098\ FinCEN within the Department of Treasury has primary
regulatory responsibility for administering the BSA. We note that
FinCEN has included in the Unified Agenda and Regulatory Plan an
item that states: ``FinCEN . . . is proposing amendments to the
regulatory definitions of `broker or dealer in securities' under the
regulations implementing the Bank Secrecy Act. The proposed changes
are intended to expand the current scope of the definitions to
include funding portals. In addition, these amendments would require
funding portals to implement policies and procedures reasonably
designed to achieve compliance with all of the Bank Secrecy Act
requirements that are currently applicable to brokers or dealers in
securities.'' See Office of Mgmt. & Budget, Exec. Office of the
President, Office of Info. & Regulatory Affairs, Amendments of the
Definition of Broker or Dealer in Securities, RIN 1506-AB29,
available at http://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201504&RIN=1506-AB29. In addition, the
Commission has adopted its own rules that require broker-dealers to
comply with certain requirements of the BSA's implementing
regulations, such as books and records requirements. See Exchange
Act Rule 17a-8. See also Section II.D.5.
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c. Privacy
(1) Proposed Rule
Section 4A(a)(9) of the Securities Act requires intermediaries to
take such steps to protect the privacy of information collected from
investors as the Commission shall, by rule, determine appropriate.
Proposed Rule 403(c) would implement the requirements of Section
4A(a)(9) by subjecting funding portals to the same privacy rules as
those applicable to brokers. Proposed Rule 403(c), therefore, would
have required funding portals to comply with Regulation S-P (Privacy of
Consumer Financial Information and Safeguarding Personal
Information),\1099\ Regulation S-AM (Limitations on Affiliate
Marketing),\1100\ and Regulation S-ID (Identity Theft Red Flags) \1101\
(collectively, the ``Privacy Rules'').\1102\
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\1099\ See Privacy of Consumer Financial Information (Regulation
S-P), Release No. 34-42974 (June 22, 2000) [65 FR 40334 (June 29,
2000)].
\1100\ See Regulation S-AM: Limitations on Affiliate Marketing,
Release No. 34-60423 (Aug. 4, 2011) [74 FR 40398 (Aug. 11, 2009)].
\1101\ See Identity Theft Red Flags Rules, Release No. 34-69359
(Apr. 10, 2013) [78 FR 23637 (Apr. 19, 2013)] (adopted jointly with
the Commodity Futures Trading Commission).
\1102\ See 17 CFR part 248.
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Regulation S-P governs the treatment of nonpublic personal
information by brokers, among others.\1103\ It generally requires a
broker to provide notice to investors about its privacy policies and
practices; describes the conditions under which a broker may disclose
nonpublic personal information about investors to nonaffiliated third
parties; and provides a method for investors to prevent a broker from
disclosing that information to most nonaffiliated third parties by
``opting out'' of that disclosure, subject to certain exceptions.
Regulation S-AM allows a consumer, in certain limited situations, to
block affiliates of covered persons (i.e., brokers, dealers, investment
companies and both investment advisers and transfer agents registered
with the Commission) from soliciting the consumer based on eligibility
information (i.e., certain financial information, such as information
about the consumer's transactions or experiences with the covered
person) received from the covered person.\1104\ Regulation S-ID
generally requires brokers to develop and implement a written identity
theft prevention program that is designed to detect, prevent and
mitigate identity theft in connection with certain existing accounts or
the opening of new accounts.\1105\
---------------------------------------------------------------------------
\1103\ See 17 CFR part 248, subpart A.
\1104\ See 17 CFR part 248, subpart B.
\1105\ See 17 CFR part 248, subpart C.
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(2) Comments and Final Rules
We are adopting Rule 403(c) as proposed, but renumbering it as Rule
403(b).\1106\ One commenter opposed Proposed Rule 403(c), which would
impose the Privacy Rules on funding portals, stating that in its view,
funding portals do not raise privacy concerns.\1107\ We disagree. We
believe that privacy is a concern as it relates to funding portals
given that funding portals will collect and maintain sensitive personal
information about the investors using their platforms.
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\1106\ The rule is being renumbered to account for the
elimination of the proposed AML provision in proposed Rule 403(b),
which is discussed in Section II.D.4.b above.
\1107\ See Public Startup Letter 3.
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d. Inspections and Examinations
(1) Proposed Rule
Exchange Act Section 3(h)(1)(A) specifies that funding portals must
remain subject to our examination authority to, among other things,
rely on any exemptions from broker-dealer registration that we impose.
Under proposed Rule 403(d) of Regulation Crowdfunding, a funding portal
would be required to permit the examination and inspection of all of
its business and business operations that relate to its activities as a
funding portal, such as its premises, systems, platforms and records,
by our representatives and by representatives of the registered
national securities association of which it is a member.
(2) Comment and Final Rules
We are adopting Rule 403(d) as proposed, but renumbering it as
403(c).\1108\ One commenter opposed the Commission's proposed
inspections and examinations rules as unnecessary.\1109\ As a condition
to exempting funding portals from the requirement to register as
broker-dealers under Exchange Act Section 15(a)(1), Exchange Act
Section 3(h)(1)(A) requires that registered funding portals remain
subject to, among other things, our examination authority. We believe
that inspections and examinations are an important aspect of our
oversight function of funding portals as they will assist us in
monitoring the activities of funding portals in light of applicable
statutory and regulatory requirements. Therefore, we are adopting Rule
403(c) to implement the statute and retain examination authority over
funding portals.
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\1108\ The Rule is being renumbered to account for the
elimination of the proposed anti-money laundering provision in
proposed Rule 403(b), which is described in more detail in Section
II.D.4.b. We are also adding the word ``registered'' to ``national
securities association'' to be consistent with the rest of the rule
text and with Exchange Act Section 3(h)(1)(B).
\1109\ See Public Startup Letter 3.
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5. Records To Be Created and Maintained by Funding Portals
a. Proposed Rule
As proposed, Rule 404(a) would require funding portals to make and
preserve certain records for five years, with the records retained in a
readily accessible place for at least the first two years. The required
records would include the following:
All records relating to investors who purchase or attempt
to purchase securities through the funding portal; \1110\
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\1110\ This would include information relating to educational
materials provided to investors, account openings and transactions,
including notices of investment commitments and reconfirmations.
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All records relating to issuers that offer and sell, or
attempt to offer and sell, securities through the funding portal and to
persons having control with respect to those issuers;
Records of all communications that occur on or through its
platform;
All records related to persons that use communication
services provided by a funding portal to promote an issuer's securities
or to communicate with potential investors;
All records demonstrating a funding portal's compliance
with requirements of Subparts C (intermediary obligations) and D
(additional funding portal requirements); \1111\
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\1111\ This requirement alone would not, however, require the
creation of any records or proscribe the format or manner of any
records. However, without records, it would be difficult for a
funding portal to demonstrate compliance with Subparts C and D to
examiners.
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All notices provided by the funding portals to issuers and
investors generally through the funding portal's platform or otherwise;
\1112\
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\1112\ These would include, but not be limited to: (1) Notices
addressing hours of funding portal operations (if any); (2) funding
portal malfunctions; (3) changes to funding portal procedures; (4)
maintenance of hardware and software; (5) instructions pertaining to
access to the funding portal; and (6) denials of, or limitations on,
access to the funding portal.
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All written agreements (or copies thereof) entered into by
a funding portal, relating to its business as such;
All daily, monthly and quarterly summaries of transactions
effected through the funding portal; \1113\ and
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\1113\ These would include: (1) Issuers for which the target
offering amount has been reached and funds distributed; and (2)
transaction volume, expressed in number of transactions, number of
securities involved in a transaction and total amounts raised by and
distributed to issuers, as well as total dollar amounts raised
across all issuers, expressed in U.S. dollars.
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[[Page 71473]]
A log reflecting the progress of each issuer who offers
and sells securities through the funding portal toward meeting the
target offering amount.
As proposed, Rule 404(b) would require that a funding portal make
and preserve its organizational documents during its operation as a
funding portal and also those of any successor funding portal. These
would include, but not be limited to: (1) Partnership agreements; (2)
articles of incorporation or charter; (3) minute books; and (4) stock
certificate books (or other similar type documents).
We also proposed in Rule 404(c) that the records required to be
maintained and preserved pursuant to Rule 404(a) be produced,
reproduced, and maintained in the original, non-alterable format in
which they were created or as permitted under Section 17a-4(f) of the
Exchange Act. We proposed in Rule 404(d) to allow third parties to
prepare or maintain the required records on behalf of the funding
portal, provided that there is a written undertaking in place between
the funding portal and the third party stating that the required
records are the property of the funding portal and will be surrendered
promptly, on request by the funding portal, to the Commission or the
national securities association of which the funding portal is a
member.\1114\ The funding portal also would have been required to file,
with the registered national securities association of which it is a
member, this written undertaking, signed by a duly authorized
representative of the third party. As proposed, an agreement between a
funding portal and a third party would not relieve the funding portal
of its responsibility to prepare and maintain records, as required
under Rule 404 of Regulation Crowdfunding.
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\1114\ The written undertaking would be required to include the
following provision:
With respect to any books and records maintained or preserved
on behalf of [name of funding portal], the undersigned hereby
acknowledges that the books and records are the property of [name of
funding portal], and hereby undertakes to permit examination of such
books and records at any time, or from time to time, during business
hours by representatives of the Securities and Exchange Commission,
and the national securities association of which the funding portal
is a member, and to promptly furnish to the Commission and national
securities association of which the funding portal is a member, a
true, correct, complete and current hard copy of any, all, or any
part of, such books and records.
This provision is consistent with the recordkeeping provisions
applicable to brokers under Exchange Act Rules 17a-4(f) (17 CFR 17a-
4(f)) and 17a-4(j) (17 CFR 240.17a-4(j)), but has been scaled to be
more appropriate for funding portals.
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As proposed, Rule 404(e) would require all records of a funding
portal to be subject at any time, or from time to time, to such
reasonable periodic, special or other examination by our
representatives and representatives of the registered national
securities association of which the funding portal is a member.
Finally, we proposed in Rule 404(f) that funding portals would be
required to comply with the reporting, recordkeeping and record
retention requirements of Chapter X of Title 31 of the Code of Federal
Regulations. Where Chapter X of Title 31 and proposed rules 404(a) and
404(b) would require the same records or reports to be preserved for
different periods of time, we proposed requiring the records or reports
to be preserved for the longer period of time.
b. Comments on Proposed Rule
Commenters generally did not object to the proposed recordkeeping
requirements. Some commenters suggested that the cost for a funding
portal to maintain the proposed books and records would not be
significant.\1115\ A few commenters suggested that funding portals
should maintain required records for a longer period of time. One of
these commenters recommended a retention period of 10 years,\1116\
while the other suggested that issuer data should be kept permanently
accessible by the funding portal.\1117\ Another commenter suggested
that the Commission should require intermediaries, rather than the
issuers, to maintain records (or arrange for third-party recordkeeping)
of the offering materials used by the issuers, thereby reducing the
burden on issuers by no longer requiring them to transcribe offering
materials into something that can be filed with EDGAR.\1118\
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\1115\ See, e.g., CFIRA Letter 1, Joinvestor Letter.
\1116\ See Joinvestor Letter.
\1117\ Mollick, et al Letter. See also Public Startup Letter 5
(suggesting that the Commission should improve ``forensic record-
keeping obligations of a funding portal'' by requiring portals to
``maintain the URLs and Web site content in perpetuity for all
issuers who use the portal to raise capital from the public.'').
\1118\ CFIRA Letter 1.
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c. Final Rules
We are adopting Rule 404 as proposed, with a modification to
subparagraph (e) to require that books and records subject to review
under the subsection be produced promptly to representatives of the
Commission and the national securities association of which the funding
portal is a member,\1119\ and a minor modification to subparagraph (f)
related to anti-money laundering related records.\1120\ We also made a
modification to state that, in addition to being furnished to
representatives of the Commission, books and records would have to be
furnished to the Commission itself. We are also adding the word
``registered'' to ``national securities association'' to be consistent
with the rest of the rule text and with Exchange Act Section
3(h)(1)(B).\1121\
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\1119\ We are making this change to remain consistent with the
prompt production standard that is required for third party
recordkeeping undertakings pursuant to Rule 404(d).
\1120\ In the Proposing Release and as noted in this section, we
have provided examples of the types of information that would be
required to be maintained under each of the specified records. The
same guidance applies with respect to application of the final
rules.
\1121\ Conforming changes were made to both Rules 404(d) and
(e).
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We believe that it is important for funding portals to be subject
to the recordkeeping requirements in order to create a meaningful
record of crowdfunding transactions and communications. For example, we
are requiring records of all notices provided by the funding portals to
issuers and investors generally through the funding portal's platform
or otherwise. We believe that, in addition to the list of examples
provided in the rule, this encompasses any notices relating to the
funding portal's business as such, including communications in
electronic form sent from an associated person of a funding portal to
issuers or investors (including potential investors). Every funding
portal is required under Rule 404 to furnish promptly to the Commission
and its representatives, and the registered national securities
association of which the funding portal is a member, legible, true,
complete and current copies of such records of the funding portal that
are requested by the representatives of the Commission and the national
securities association.\1122\
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\1122\ The Commission generally interprets the term ``promptly''
or ``prompt'' to mean making reasonable efforts to produce records
that are requested by the staff during an examination without delay.
The Commission believes that in many cases a funding portal could,
and therefore will be required to, furnish records immediately or
within a few hours of a request. The Commission expects that only in
unusual circumstances would a funding portal be permitted to delay
furnishing records for more than 24 hours. Accord Security-Based
Swap Data Repository Registration, Duties, and Core Principles,
Exchange Act Release No. 74246 (Feb. 11, 2015), 80 FR 14438, 14500
n. 846 (Mar. 19, 2015) (similarly interpreting the term ``promptly''
in the context of Exchange Act Rule 13n-7(b)(3)); Registration of
Municipal Advisors, Exchange Act Release No. 70462 (Sept. 20, 2013),
78 FR 67468, 67578-67579 n. 1347 (Nov. 12, 2013) (similarly
interpreting the term ``prompt'' in the context of Exchange Act Rule
15Ba1-8(d)).
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[[Page 71474]]
The requirements will enable regulators to more effectively gather
information about the activities in which a funding portal has been
engaged, as well as about the other parties involved in crowdfunding
(e.g., issuers, promoters, and associated persons), to discern whether
the funding portals and the other parties are in compliance with the
requirements of Regulation Crowdfunding and any other applicable
federal securities laws. We believe the requirements will assist
regulators' compliance examinations because, without these records, the
Commission and any registered national securities association of which
the funding portal is a member may have difficulty examining a funding
portal for compliance with the requirements of Regulation Crowdfunding
and the federal securities laws.\1123\ Therefore, we believe the record
retention requirements should be mandatory rather than voluntary as
suggested by one commenter. Although we are not requiring that funding
portals utilize the record retention services of broker-dealers, as
suggested by one commenter, we note that a funding portal may find it
cost-effective or otherwise appropriate to use the recordkeeping
services of a third party, and the final rules provide the necessary
flexibility to allow funding portals to utilize these options.
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\1123\ See, supra, note 798.
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While some commenters suggest a longer record retention period, we
believe the requirement that funding portals preserve their records for
five years, with the records retained in a readily accessible place for
at least the first two years, provides sufficient investor protection,
while not imposing overly burdensome recordkeeping costs.\1124\ We are
not adopting, as commenters recommended, a requirement that funding
portals be required to keep issuer data permanently accessible or
maintain URLs and Web site content in perpetuity for all issuers, as we
believe the permanent storage of such information could be unduly
burdensome and is unnecessary.
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\1124\ We note that the record retention period requirement
continues for a funding portal after it withdraws its registration.
Schedule D of Form Funding Portal requests information about the
location(s) of where a funding portal will keep its books and
records after withdrawal.
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Because permissible funding portal activity is far more limited
than that of broker-dealers and a relatively high proportion of funding
portals will be new market entrants that have not been subject to
regulation before (rather than broker-dealers switching their business
models to become funding portals) and, therefore, may not have formal
recordkeeping practices in place, the recordkeeping requirements for
funding portals are relatively streamlined compared to those for
broker-dealers. Funding portals are intended to be subject to less
regulation than broker-dealers, and recordkeeping requirements adopted
in the final rules are consistent with this intent.
Finally, as described above, we are not adopting the proposed
requirement that a funding portal comply with the BSA.\1125\
Nevertheless, we are revising the final recordkeeping rule to require a
funding portal to maintain books and records related to BSA
requirements, should funding portals become subject to the requirements
of the BSA.\1126\
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\1125\ See Section II.D.4.b.
\1126\ 15 U.S.C. 5311 et seq. To the extent that funding portals
become subject to the requirements of the BSA and are required to
comply with BSA recordkeeping requirements, we believe that this
recordkeeping requirement will be valuable to our regulatory
oversight function of funding portals' compliance with such BSA
requirements. See generally Recordkeeping by Brokers and Dealers,
Release No. 34-18321 (Dec. 10, 1981) [46 FR 61454 (Dec. 17, 1981)]
(noting the effectiveness of on-site examinations of broker-dealers
by the Commission and SROs in enforcing compliance with reporting
and recordkeeping requirements when adopting Exchange Act Rule 17a-
8). Rule 17a-8 (17 CFR 240.17a-8) requires broker-dealers to comply
with the reporting, recordkeeping and record retention rules adopted
under the BSA.
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Commission staff expects to review the books and records practices
of intermediaries during the study of the federal crowdfunding
exemption that it plans to undertake no later than three years
following the effective date of Regulation Crowdfunding.\1127\
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\1127\ See Section II.
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E. Miscellaneous Provisions
1. Insignificant Deviations From Regulation Crowdfunding
a. Proposed Rules
We proposed Rule 502 of Regulation Crowdfunding to provide issuers
a safe harbor for insignificant deviations from a term, condition or
requirement of Regulation Crowdfunding. As proposed in Rule 502(a), to
qualify for the safe harbor, the issuer relying on the exemption would
have to show that: (1) The failure to comply with a term, condition or
requirement was insignificant with respect to the offering as a whole;
and (2) the issuer made a good faith and reasonable attempt to comply
with all applicable terms, conditions and requirements of Regulation
Crowdfunding; and (3) the issuer did not know of the failure to comply,
where the failure to comply with a term, condition or requirement was
the result of the failure of the intermediary to comply with the
requirements of Section 4A(a) and the related rules, or such failure by
the intermediary occurred solely in offerings other than the issuer's
offering. As proposed in Rule 502(b), notwithstanding this safe harbor,
any failure to comply with Regulation Crowdfunding would nonetheless be
actionable by the Commission.
b. Comments on the Proposed Rules
Commenters were generally in favor of the proposed safe
harbor.\1128\ However, some commenters representing state securities
regulators suggested that the safe harbor is unnecessary, would be
detrimental to state enforcement efforts and would be a burden on
regulators when issuers assert the safe harbor, whether or not they
were operating in good faith.\1129\ These commenters also recommended
that the proposed safe harbor, if adopted, should not be a defense to
an enforcement action by the states.\1130\
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\1128\ See, e.g., Arctic Island Letter 7; CFIRA Letter 1;
Heritage Letter; Joinvestor Letter; Parsont Letter; Schwartz Letter.
\1129\ See Commonwealth of Massachusetts Letter; NASAA Letter.
\1130\ Id.
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c. Final Rules
We are adopting the Rule 502(a) safe harbor as proposed.\1131\ The
first two prongs of the safe harbor provision in Rule 502(a) are
modeled after a similar provision in Rule 508 of Regulation D,\1132\
and we believe a similar safe harbor is appropriate for offerings made
in reliance on Section 4(a)(6). We believe that provisions for
insignificant deviations serve an important function by allowing for
certain errors that can occur in the offering process without causing
the issuer to lose the exemption and incur certain consequences,
including potential private rights of action for rescission for
violations of Section 5 of the Securities Act,\1133\ and loss of
preemption for state securities law registration requirements. The
offering exemption in Section 4(a)(6) was designed to help alleviate
the funding gap and the accompanying regulatory challenges faced by
startups and small businesses, many of which may not be familiar with
the federal securities laws. We continue to believe that issuers should
not lose the Section 4(a)(6) exemption because of insignificant
deviations from a term,
[[Page 71475]]
condition or requirement of Regulation Crowdfunding, so long as the
issuer, in good faith, attempted to comply with the rules. We note that
whether a deviation from the requirements would be significant to the
offering as a whole will depend on the facts and circumstances of the
offering and the deviation. While such determinations will be based on
the particular facts and circumstances, we believe that a deviation
from certain fundamental requirements in the rules, such as a failure
to adhere to the aggregate offering limit under Rule 100(a)(1),
presumptively would not be an insignificant deviation that would allow
reliance on this safe harbor.
---------------------------------------------------------------------------
\1131\ See Rule 502 of Regulation Crowdfunding.
\1132\ 17 CFR 230.508.
\1133\ See Securities Act Section 12(a)
---------------------------------------------------------------------------
We are adopting the third prong of the safe harbor in Rule 502(a)
because, under the statute, an issuer could lose the exemption and
potentially violate Section 5 because of the failure of the
intermediary to comply with the requirements of Section 4A(a). We
believe that an issuer should not lose the offering exemption due to a
failure by the intermediary, which likely will be out of the issuer's
control, if the issuer did not know of such failure or such failure
related to offerings other than the issuer's offering. Absent this safe
harbor, we believe that issuers may be hesitant to participate in
offerings in reliance on Section 4(a)(6) due to uncertainty about their
ability to rely on, and to control their ongoing eligibility for, the
exemption, which could undermine the facilitation of capital raising
for startups and small businesses.
We believe that the potential harm to investors that might result
from the applicability of this safe harbor would be minimal because the
deviations must be insignificant to the offering as a whole for the
safe harbor to apply. We also believe the safe harbor appropriately
protects an issuer who made a diligent attempt to comply with the rules
from losing the exemption as a result of insignificant deviations from
Regulation Crowdfunding.
We also are adopting Rule 502(b) largely as proposed to set forth
clearly that the safe harbor for insignificant deviations in Rule
502(a) does not preclude the Commission from bringing an enforcement
action seeking appropriate relief for an issuer's failure to comply
with all applicable terms, conditions, and requirements of Regulation
Crowdfunding. Despite the suggestion of two commenters,\1134\ we are
not extending Rule 502(b) to enforcement actions by the states. While
we recognize the concerns of certain state securities regulators that
the safe harbor could be detrimental to state enforcement efforts, we
believe that a state's review as to whether there is an insignificant
deviation from our rules would create undue uncertainty for issuers
seeking to rely on the Section 4(a)(6) exemption.\1135\ We note that,
irrespective of the scope of the safe harbor, states retain antifraud
authority in all cases.
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\1134\ See Commonwealth of Massachusetts Letter; NASAA Letter.
\1135\ Securities Act Section 18(b)(4)(C), as amended by the
JOBS Act, preempts state securities laws' registration and
qualification requirements for offerings made pursuant to Section
4(a)(6). 15 U.S.C. 77r(b)(4)(C).
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2. Restrictions on Resales
a. Proposed Rules
Section 4A(e) provides that securities issued in reliance on
Section 4(a)(6) may not be transferred by the purchaser for one year
after the date of purchase, except when transferred: (1) To the issuer
of the securities; (2) to an accredited investor; (3) as part of an
offering registered with the Commission; or (4) to a family member of
the purchaser or the equivalent, or in connection with certain events,
including death or divorce of the purchaser, or other similar
circumstances, in the discretion of the Commission. Section 4A(e)
further provides that the Commission may establish additional
limitations on securities issued in reliance on Section 4(a)(6).
Proposed Rule 501 largely tracked the provisions of Section 4A(e).
We also proposed definitions of ``accredited investor'' and a ``member
of the family of the purchaser or the equivalent.'' Under the proposed
rules, the term ``accredited investor'' would have the same definition
in Rule 501 of Regulation D.\1136\
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\1136\ 17 CFR 230.501(a).
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The statute does not define ``member of the family of the purchaser
or the equivalent.'' We proposed to define the phrase to include a
``child, stepchild, grandchild, parent, stepparent, grandparent, spouse
or spousal equivalent, sibling, mother-in-law, father-in-law, son-in-
law, daughter-in-law, brother-in-law, or sister-in-law of the
purchaser, and shall include adoptive relationships.'' This definition
tracks the definition of ``immediate family'' in Exchange Act Rule 16a-
1(e),\1137\ but with the addition of ``spousal equivalent.''
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\1137\ 17 CFR 240.16a-1(e).
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b. Comments on the Proposed Rules
Two commenters supported the proposed restrictions on
resales,\1138\ while several other commenters opposed any resale
restrictions.\1139\ Two commenters expressed support for the proposal
that to sell securities purchased in a transaction made in reliance on
Section 4(a)(6) to an accredited investor during the restricted period,
the seller of such securities would need to have a reasonable belief
that the purchaser is an accredited investor.\1140\
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\1138\ See Arctic Island Letter 7; Joinvestor Letter.
\1139\ See, e.g., Amram Letter 2 (stating resale restrictions
prevent trading liquidity and impede price discovery); Crowdstockz
Letter; Hamman Letter; Kickstarter Coaching Letter; Public Startup
Letter 2 (recommending a six-month holding period so long as the
issuer is current in its filing requirements, except that purchasers
who self-certify that they are low-income investors would not be
subject to a holding period); Public Startup Letter 3 (also opposing
accredited investors having an advantage over other buyers).
\1140\ See Joinvestor Letter; Public Startup Letter 3.
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One commenter noted that the investors who are eligible to purchase
securities from the initial purchasers in the first year would be able
to circumvent the investment limits of the proposed rules by purchasing
securities from the initial purchasers in an amount greater than they
would be able to purchase through intermediaries.\1141\ Another
commenter noted that the restrictions on resale appear only to cover
the sale by the initial purchaser, thus creating the possibility that
securities of a particular issuer could become widely traded within the
first year if the initial purchaser sells the securities to an eligible
purchaser who then resells them to the public within the first
year.\1142\
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\1141\ See Moskowitz Letter.
\1142\ CrowdCheck Letter 3 (recommending several alternatives:
(1) Designate the securities as ``restricted'' within the meaning of
Rule 144; (2) mirror some or all of the issuer's resale
restrictions; (3) impose a one-year obligation on the issuer not to
register the transfer of securities by any person, except in the
four permitted types of transfers; or (4) remove the words ``by the
purchaser'' from the first sentence of proposed Rule 501(a)).
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c. Final Rules
We are adopting the restrictions on resales in Rule 501 as
proposed, with certain revisions as described below.\1143\ We are
concerned that, as noted by several commenters, the restrictions on
resales would cover only the sale by the initial purchaser, which
creates the possibility that securities of a particular issuer could
become widely traded within the first year if the initial purchaser
sells the securities to an eligible purchaser who subsequently resells
them to the public within the
[[Page 71476]]
first year. Further, the proposed rule could allow, as one commenter
noted,\1144\ investors to circumvent the investment limits in the first
year by purchasing securities from the initial purchasers. In response
to these concerns, we have modified Rule 501 from the proposal so that
the one-year resale restriction will apply to any purchaser during the
one-year period beginning when the securities were first issued, not
just the initial purchaser. In addition, we have modified the
definition to track more closely the language in Securities Act Rule
501(a) to clarify that the person reselling the securities must have a
reasonable belief that the purchaser qualifies as an accredited
investor.
---------------------------------------------------------------------------
\1143\ See Rule 501 of Regulation Crowdfunding.
\1144\ See Moskowitz Letter.
---------------------------------------------------------------------------
As adopted, the rule provides that securities issued in a
transaction pursuant to Section 4(a)(6) may not be transferred by any
purchaser of such securities during that one-year period unless such
securities are transferred: (1) To the issuer of the securities; (2) to
an accredited investor; (3) as part of an offering registered with the
Commission; or (4) to a member of the family of the purchaser or the
equivalent, to a trust controlled by the purchaser, to a trust created
for the benefit of a member of the family of the purchaser or the
equivalent, or in connection with the death or divorce of the purchaser
or other similar circumstance. We recognize that several commenters
expressed concerns about the exception for resales to accredited
investors and the potential unfair advantage this could provide to such
investors. While we appreciate these concerns, we note that this
treatment will provide some measure of liquidity for holders of these
securities within the first year of the offering without undermining
the investor protections otherwise provided by the statute and our
rules.
3. Information Available to States
Under Section 4A(d), the Commission shall make available, or shall
cause to be made available by the relevant intermediary, the
information required under Section 4A(b) and such other information as
the Commission, by rule, determines appropriate to the securities
commission (or any agency or office performing like functions) of each
state and territory of the United States and the District of Columbia.
We proposed to require issuers to file on EDGAR the information
required by Section 4A(b) and the related rules. Information filed on
EDGAR is publicly available and would, therefore, be available to each
state, territory and the District of Columbia. As we stated in the
Proposing Release, we believe this approach will satisfy the statutory
requirement to make the information available to each state and
territory of the United States, and the District of Columbia.
Commenters who addressed this issue agreed with our proposed
approach,\1145\ and we are adopting this provision as proposed.
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\1145\ See, e.g., CFIRA Letter 9; Public Startup Letter 3.
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4. Exemption From Section 12(g)
a. Proposed Rule
Section 303 of the JOBS Act amended Exchange Act Section 12(g) to
provide that ``the Commission shall, by rule, exempt, conditionally or
unconditionally, securities acquired pursuant to an offering made under
[S]ection 4[(a)](6) of the Securities Act of 1933 from the provisions
of this subsection.'' As amended by the JOBS Act, Section 12(g)
requires, among other things, that an issuer with total assets
exceeding $10,000,000 and a class of securities held of record by
either 2,000 persons, or 500 persons who are not accredited investors,
register such class of securities with the Commission.\1146\
Crowdfunding contemplates the issuance of securities to a large number
of holders, which could increase the likelihood that Section 4(a)(6)
issuers would exceed the thresholds for triggering reporting
obligations under Section 12(g). As discussed in the Proposing Release,
Section 303 could be read to mean that securities acquired in a
crowdfunding transaction would be excluded from the record holder count
permanently, regardless of whether the securities continue to be held
by a person who purchased in the crowdfunding transaction. An
alternative reading could provide that securities acquired in a
crowdfunding transaction would be excluded from the record holder count
only while held by the original purchaser in the Section 4(a)(6)
transaction, as a subsequent purchaser of the securities would not be
considered to have ``acquired [the securities] pursuant to an offering
made under [S]ection 4[(a)](6).''
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\1146\ See Section 501 of the JOBS Act. In the case of an issuer
that is a bank or a bank holding company, Exchange Act Section
12(g)(1)(B) (15 U.S.C. 78l(g)(1)(B)) requires, among other things,
that the issuer, if it has total assets exceeding $10,000,000 and a
class of securities held of record by 2,000 persons, register such
class of securities with the Commission. See Section 601 of the JOBS
Act.
---------------------------------------------------------------------------
Consistent with the statute, the Commission's proposed Rule 12g-6
would provide that securities issued pursuant to an offering made under
Section 4(a)(6) would be permanently exempted from the record holder
count under Section 12(g). An issuer seeking to exclude a person from
the record holder count would have the responsibility for demonstrating
that the securities held by the person were initially issued in an
offering made under Section 4(a)(6).
b. Comments on the Proposed Rules
Commenters generally supported the permanent exemption from the
record holder count under Section 12(g).\1147\ One commenter
recommended that the exemption from the record holder count under
Section 12(g) apply to different securities issued in a subsequent
restructuring, recapitalization or similar transaction that is exempt
from, or otherwise not subject to, the registration requirements of
Section 5, if the parties to the transaction are affiliates of the
original issuer.\1148\ A few commenters recommended conditioning the
exemption from the record holder count under Section 12(g) on the
issuer's asset value,\1149\ while a few others opposed such
concept.\1150\ Another commenter recommended that issuers that fail to
comply with Regulation Crowdfunding's ongoing reporting requirements be
disqualified from relying on the exemption from the record holder count
under Section 12(g),\1151\ while two commenters opposed such
concept.\1152\
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\1147\ See, e.g., ABA Letter; Arctic Island Letter 7; Craw
Letter; Heritage Letter; Joinvestor Letter; PeoplePowerFund Letter;
Public Startup Letter 3; Wefunder Letter.
\1148\ See Arctic Island Letter 7. See also ABA Letter
(recommending that the Commission, at a minimum, exempt from the
Section 12(g) record holder count securities issued in a statutory
merger to change the domicile of the issuer, in reliance on
Securities Act Rule 145(a)(2)).
\1149\ See, e.g., ABA Letter ($25 million); PeoplePowerFund
Letter.
\1150\ See, e.g., Arctic Island Letter 7; Public Startup Letter
3.
\1151\ See Joinvestor Letter.
\1152\ See Arctic Island Letter 7; Public Startup Letter 3.
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c. Final Rules
In response to comments received, we are adopting Rule 12g-6 with
certain modifications.\1153\ The rule provides that securities issued
pursuant to an offering made under Section 4(a)(6) are exempted from
the record holder count under Section 12(g), provided that the issuer
is current in its ongoing annual reports required pursuant to Rule 202
of Regulation Crowdfunding, has total assets as of the end of its last
fiscal year not in excess of $25 million, and has engaged the services
of a transfer agent
[[Page 71477]]
registered with the Commission pursuant to Section 17A of the Exchange
Act.\1154\
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\1153\ 17 CFR 240.12g-6.
\1154\ Id.
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An issuer that exceeds the $25 million total asset threshold, in
addition to exceeding the thresholds in Section 12(g), will be granted
a two-year transition period before it will be required to register its
class of securities pursuant to Section 12(g), provided it timely files
all its ongoing reports pursuant to Rule 202 of Regulation Crowdfunding
during such period.\1155\ Section 12(g) registration will be required
only if, on the last day of the fiscal year the company has total
assets in excess of the $25 million total asset threshold, the class of
equity securities is held by more than 2,000 persons or 500 persons who
are not accredited investors.\1156\ In such circumstances, an issuer
that exceeds the thresholds in Section 12(g) and has total assets of
$25 million or more will be required to begin reporting under the
Exchange Act the fiscal year immediately following the end of the two-
year transition period.\1157\ An issuer entering Exchange Act reporting
will be considered an ``emerging growth company'' to the extent the
issuer otherwise qualifies for such status.\1158\
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\1155\ Id.
\1156\ 15 U.S.C. 78l(g).
\1157\ 17 CFR 240.12g-6.
\1158\ Under Section 2(a)(19) of the Securities Act, an
``emerging growth company'' is defined as, among other things, an
issuer that had total annual gross revenues of less than $1 billion
during its most recently completed fiscal year. 15 U.S.C.
77b(a)(19). See also Section 3(a)(80) of the Exchange Act (which
repeats the same definition). 15 U.S.C. 78c(a)(80).
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An issuer seeking to exclude a person from the record holder count
has the responsibility for demonstrating that the securities held by
the person were initially issued in an offering made under Section
4(a)(6). As noted in the proposal, we believe that allowing issuers to
sell securities pursuant to Section 4(a)(6) without becoming Exchange
Act reporting issuers is consistent with the intent of Title III.\1159\
In this regard, we note that Title III provides for an alternative
reporting system under which issuers using the crowdfunding exemption
are required to file annual reports with the Commission.\1160\ We
believe that conditionally exempting securities issued in reliance on
Section 4(a)(6) from the record holder count under Section 12(g), and
thereby from the more extensive reporting obligations under the
Exchange Act, is appropriate in light of the existence of the
alternative ongoing reporting requirements that are tailored to the
types of issuers and offerings we anticipate under Regulation
Crowdfunding.
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\1159\ See 158 CONG. REC. S1829 (daily ed. Mar. 20, 2012)
(statement of Sen. Jeff Merkley) (``It also provides a very
important provision so the small investors do not count against the
shareholder number that drives companies to have to become a fully
public company. That is critical and interrelates with other parts
of the [crowdfunding] bill before us.'').
\1160\ See Section II.B.2 for a discussion of the requirement to
file annual reports.
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In determining to provide a conditional exemption from the
provisions of Section 12(g), we have considered a number of factors.
First, we believe that conditioning the exemption on the issuer being
current in its ongoing reporting requirements is consistent with the
intent behind the original enactment of Section 12(g) because this
condition requires that relevant, current information about issuers
will be made routinely available to investors and the
marketplace.\1161\ Second, we believe that conditioning the 12(g)
exemption on crowdfunding issuers using a registered transfer agent
will provide an important investor protection in this context. As
discussed in Section II.C.3 above, regarding the need for an issuer to
establish means to keep accurate records of its securities holders, we
received a number of comments about the benefits of using a registered
transfer agent. As noted above, we are not mandating the use of a
transfer agent for all crowdfunding offerings, for both flexibility and
cost reasons. However, we believe that requiring the use of a transfer
agent is appropriate for those issuers that are seeking to have their
crowdfunding securities exempted from the record holder count under
Section 12(g). We expect that issuers at a stage at which they are
seeking to rely on the Section 12(g) exemption are likely to be larger
and thus better able to incur the costs of a transfer agent. In the
absence of a conditional exemption from the provisions of Section
12(g), the use of a transfer agent registered under the Exchange Act
would be required of issuers when they register under the Exchange
Act.\1162\ We note that a registered transfer agent is a regulated
entity with experience in maintaining accurate shareholder records, and
its use will help to ensure that security holder records and secondary
trades will be handled accurately. Third, we believe that the condition
of total assets not exceeding $25 million will result in phasing out
the Section 12(g) exemption once companies grow and expand their
shareholder base and is consistent with the intent behind Title III of
the JOBS Act, which was enacted to facilitate smaller company capital
formation.
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\1161\ Section 12(g) was enacted by Congress as a way to ensure
that investors in over-the-counter securities about which there was
little or no information, but which had a significant shareholder
base, were provided with ongoing information about their investment.
See, generally, Report of the Special Study of Securities Markets of
the Securities and Exchange Commission. House Document No. 95, House
Committee on Interstate and Foreign Commerce, 88th Cong., 1st Sess.
(1963), at 60-62.
\1162\ Section 3(a)(25) of the Exchange Act provides that a
``transfer agent'' is any person who engages on behalf of an issuer
of securities or on behalf of itself as an issuer of securities in:
(A) Countersigning such securities upon issuance; (B) monitoring the
issuance of such securities with a view to preventing unauthorized
issuance (i.e., a registrar); (C) registering the transfer of such
securities; (D) exchanging or converting such securities; or (E)
transferring record ownership of securities by bookkeeping entry
without the physical issuance of securities certificates. 15 U.S.C.
78c(a)(25). Section 17A(c)(1) of the Exchange Act generally requires
any person performing any of these functions with respect to any
security registered pursuant to Section 12 of the Exchange Act to
register with the Commission or other appropriate regulatory agency.
15 U.S.C. 78q-1(c)(1).
---------------------------------------------------------------------------
Rule 12g-6 does not extend the exclusion from the Section 12(g)
record holder count to different securities issued in exchange for
Section 4(a)(6)-issued securities in a subsequent restructuring,
recapitalization or similar transaction. While some commenters
requested such an extension in instances where the parties to the
transaction are affiliates of the original issuer, or in certain
restructuring transactions, we do not believe that such an expansion in
the context of shares initially issued using Regulation Crowdfunding
would be appropriate because certain restructuring and recapitalization
transactions could change the pool of holders of the securities beyond
those who initially acquired the securities in a crowdfunding
transaction, denying those holders the protections of Section 12(g)
registration.
5. Scope of Statutory Liability
Securities Act Section 4A(c) provides that an issuer will be liable
to a purchaser of its securities in a transaction exempted by Section
4(a)(6) if the issuer, in the offer or sale of the securities, makes an
untrue statement of a material fact or omits to state a material fact
required to be stated or necessary in order to make the statements, in
light of the circumstances under which they were made, not misleading,
provided that the purchaser did not know of the untruth or omission,
and the issuer does not sustain the burden of proof that such issuer
did not know, and in the exercise
[[Page 71478]]
of reasonable care could not have known, of the untruth or omission.
Section 4A(c)(3) defines, for purposes of the liability provisions of
Section 4A, an issuer as including ``any person who offers or sells the
security in such offering.''
In describing the statutory liability provision in the Proposing
Release, the Commission noted that it appears likely that
intermediaries would be considered issuers for purposes of the
provision. Several commenters agreed that Section 4A(c) liability
should apply to intermediaries noting that it ``may serve as a
meaningful backstop against fraud'' \1163\ and would create a ``true
financial incentive'' for intermediaries to conduct checks on issuers
and their key personnel.\1164\
---------------------------------------------------------------------------
\1163\ See, e.g., Farnkoff Letter.
\1164\ See, e.g., BackTrack Letter. See also Patel Letter.
---------------------------------------------------------------------------
However, a large number of other commenters disagreed that Section
4A(c) liability should apply to intermediaries.\1165\ Some of these
commenters stated their views that applying statutory liability to
intermediaries would have a chilling effect on intermediaries'
willingness to facilitate crowdfunding offerings.\1166\ Others cited
the cost of being subject to this liability as overly burdensome on
funding portals, to the extent that they may not be able to conduct
business.\1167\ Several commenters also explained that the nature of
funding portals, as intended by Congress, is distinct from that of
registered broker-dealers.\1168\ According to these commenters, a
funding portal's role is not to offer and sell securities, but rather
to provide a platform through which issuers may offer and sell
securities. As such, these commenters asserted that it would not be
appropriate to hold them liable for statements made by issuers.\1169\
In addition, one commenter suggested that applying statutory liability
to funding portals, while precluding their ability to limit the
offerings that they facilitate, is an ``untenable'' framework.\1170\
Some commenters stated that the statutory construct could unnecessarily
lead to lawsuits against funding portals,\1171\ with one of these
commenters asserting that such suits would arise ``for any deal that
loses money'' because the burden of proof is on the funding portal to
prove it could not have known of material misstatements.'' \1172\ One
commenter stated that risk disclosures should require an explanation to
investors that lawsuits by investors are only potentially viable if
based on claims sounding in fraud or negligence and that ``lawsuits
cannot be filed just because the retail investor loses their risk
capital.'' \1173\
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\1165\ See, e.g., ABA Letter; AngelList Letter; BetterInvesting
Letter; CFIRA Letter 10; City First Letter; EarlyShares Letter; EMKF
Letter; FSI Letter; Graves Letter; Guzik Letter 1; IAC
Recommendation; Inkshares Letter; Milken Institute Letter; PPA
Letter; RocketHub Letter; SBA Office of Advocacy Letter; SBEC
Letter; SeedInvest Letter 3; Seyfarth Letter; StartupValley Letter;
Wefunder Letter; Winters Letter.
\1166\ See, e.g., Guzik Letter 1; Inkshares Letter; RocketHub
Letter; StartupValley Letter.
\1167\ See, e.g., City First Letter; Guzik Letter 1; SeedInvest
Letter 3; Wefunder Letter; Winters Letter.
\1168\ See, e.g., Inkshares Letter (likening funding portals to
``impartial engineers of transactions'' similar to online service
providers under the Digital Millennium Copyright Act, that exist
``for the transmission of information, and with it securities,
between third parties''); RocketHub Letter; SeedInvest Letter 3;
Seyfarth Letter.
\1169\ Id.
\1170\ AngelList Letter. See also, e.g., Graves Letter (stating
that ``to achieve the appropriate balance of creating a usable
crowdfunding model for small businesses while providing adequate
protections for investors, the Commission should remove the
liability placed on funding portals in the proposed rules or permit
them to curate offerings. . . . Otherwise it is highly improbable
that any rational business would establish a web portal in a heads-
you-win, tails-I-lose environment''); Milken Institute Letter
(noting also that funding portals should be permitted to make
subjective judgments in deciding which offerings to list, including
based on an assessment of the merits or shortcomings of an
offering); Wefunder Letter. See also Section II.D.3.a (discussing
Rule 402(b)(1)).
\1171\ See, e.g., Inkshares Letter; SeedInvest Letter3.
\1172\ See SeedInvest Letter 3.
\1173\ See CarbonTech Letter.
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One commenter suggested that the Commission retract its statement
in the Proposing Release that ``it appears likely that intermediaries,
including funding portals, would be considered issuers for purposes of
this liability provision.'' \1174\ Other commenters suggested that the
Commission should take action, such as: (i) Exempting funding portals
from liability, provided conditions are met such as compliance with
Regulation Crowdfunding \1175\ or disclosure of the specific steps the
funding portal has taken in its due diligence; \1176\ (ii) providing a
safe harbor for activities funding portals can undertake in posting
issuer materials on their platforms,\1177\ and (iii) providing a list
of reasonable steps funding portals can take in reviewing an offering
in order to rely on the reasonable care defense.\1178\
---------------------------------------------------------------------------
\1174\ See SeedInvest Letter 3.
\1175\ CFIRA Letter 10; SeedInvest Letter 3 (stating also that
directors and officers of funding portals should be excluded from
the definition of ``issuer'' for purposes of the statutory
provision); StartupValley Letter.
\1176\ EarlyShares Letter.
\1177\ CFIRA Letter 10; StartupValley Letter.
\1178\ CFIRA Letter 10; Milken Institute Letter (stating that
funding portals ``should not be required to `look behind' every
material statement in an offering, but rather should be held to a
standard of satisfying the statute's and proposed rule's steps for
ensuring that an offering does not invoke concerns of fraud or
investor protection''); StartupValley Letter.
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We have considered the comments both in support of and against
funding portals being considered issuers for purposes of Section 4A(c)
liability. Specifically, we acknowledge commenters' concerns that
statutory liability may adversely affect funding portals, and
suggestions that, under the statutory scheme, funding portals and
broker-dealers engage in different activities that do not warrant a
funding portal being subject to statutory liability. One difference
commenters highlighted was the inability of a funding portal to limit
the offerings on its platform under the proposed rules, and the
untenable position of imposing statutory liability while precluding
funding portals' ability to limit the offerings on their platforms. In
response to this comment, as described above, we have modified the
language of the Rule 402 safe harbor from the proposal to permit
funding portals to exercise discretion to limit the offerings and
issuers that they allow on their platforms.\1179\ We believe this will
avoid the ``untenable'' framework that commenters described. We are
specifically declining to exempt funding portals (or any
intermediaries) from the statutory liability provision of Section 4A(c)
or to interpret this provision as categorically excluding such
intermediaries. We do not believe that we should preclude the ability
of investors to bring private rights of action against funding portals
(or any intermediaries). Such a categorical exemption or exclusion
could pose undue risks to investors by providing insufficient
incentives for intermediaries to take steps to prevent their platforms
from becoming vehicles for fraud.
---------------------------------------------------------------------------
\1179\ See Rule 402(b)(1); Section II.D.3.a.
---------------------------------------------------------------------------
Accordingly, we believe that the determination of ``issuer''
liability for an intermediary under Section 4A(c) will turn on the
facts and circumstances of the particular matter in question. While we
acknowledge the concerns of commenters about the potential application
of Section 4A(c) liability, we note that Congress provided a defense to
any such liability if an intermediary did not know, and in the exercise
of reasonable care could not have known, of the untruth or omission. We
continue to believe, as we identified in the Proposing Release, that
there are appropriate steps that intermediaries might take in
exercising reasonable care in light of this liability provision. These
steps may include establishing policies
[[Page 71479]]
and procedures \1180\ that are reasonably designed to achieve
compliance with the requirements of Regulation Crowdfunding, and
conducting a review of the issuer's offering documents, before posting
them to the platform, to evaluate whether they contain materially false
or misleading information.
---------------------------------------------------------------------------
\1180\ With respect to intermediaries that are funding portals,
see Rule 403(a) of Regulation Crowdfunding and the discussion in
Section II.D.4.
---------------------------------------------------------------------------
6. Disqualification Provisions
Section 302(d) of the JOBS Act requires the Commission to establish
disqualification provisions under which an issuer would not be eligible
to offer securities pursuant to Section 4(a)(6) and an intermediary
would not be eligible to effect or participate in transactions pursuant
to Section 4(a)(6). Section 302(d)(2) specifies that the
disqualification provisions must be ``substantially similar'' to the
``bad actor'' disqualification provisions contained in Rule 262 of
Regulation A \1181\ and they also must cover certain actions by state
regulators enumerated in Section 302(d)(2).
---------------------------------------------------------------------------
\1181\ 17 CFR 230.262.
---------------------------------------------------------------------------
The disqualification provisions included in Section 302(d) of the
JOBS Act are modeled on the disqualification provisions included in
Section 926 of the Dodd-Frank Act, which also required the Commission
to adopt rules ``substantially similar'' to Rule 262 of Regulation A
that disqualify securities offerings involving certain ``felons and
other `bad actors' '' from reliance on Rule 506 of Regulation D. On
July 10, 2013, we adopted rules to implement Section 926 of the Dodd-
Frank Act to disqualify certain securities offerings from reliance on
Rule 506 of Regulation D.\1182\ On March 25, 2015, we adopted
amendments to Rule 262 of Regulation A \1183\ that made those
provisions substantially similar to those adopted under Rule 506 of
Regulation D.
---------------------------------------------------------------------------
\1182\ See Disqualification of Felons and Other ``Bad Actors''
from Rule 506 Offerings, Release No. 33-9414 (July 10, 2013) [78 FR
44729 (July 24, 2013)] (``Disqualification Adopting Release'').
\1183\ See Rule 506(c) Adopting Release, supra, note 5.
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a. Issuers and Certain Other Associated Persons
(1) Proposed Rules
As described in more detail below, the proposed disqualification
rules as they relate to issuers and certain other associated persons
would have been substantially similar to the disqualification rules in
Rules 262 and 506. Under those rules, disqualification arises only with
respect to events occurring after effectiveness of the rules and
disqualified persons may seek a waiver from the Commission from
application of the disqualification provisions.
(2) Comments on Proposed Rules
Commenters were generally supportive of the proposed
disqualification rules.\1184\ A few commenters recommended that pre-
existing events should be subject to the disqualification rules,\1185\
although another supported the proposed approach of imposing
disqualification only for events after effectiveness.\1186\ One
commenter recommended that the Commission expand the list of covered
persons to include transfer agents and lawyers who are subject to
certain disqualifications.\1187\
---------------------------------------------------------------------------
\1184\ See, e.g., ABA Letter (expressing general support and
recommending the Commission provide guidance on the term ``voting
securities'' and regarding the waiver process); Commonwealth of
Massachusetts Letter; Consumer Federation Letter (expressing an
understanding of why the proposed disqualification rules are
consistent with those under Regulation D, but noting their belief
that those rules were weak when adopted); FundHub Letter 1 (stating
that the proposed disqualification rules ``are, to a certain degree,
overkill'' and too costly, but that disqualifying bad actors is good
for the future of equity crowdfunding); Joinvestor (supporting the
proposed look-back periods and waiver rules). But see Public Startup
Letter 3 (stating the proposed rules are unconstitutional without
explaining its reasoning); Public Startup Letter 5 (recommending the
Commission establish an ``offender registry'' that requires issuers
to maintain a ``public profile'' containing information about
potential issuers in a standardized format, similar to FINRA's
BrokerCheck).
\1185\ See, e.g., Guzik Letter 1; NASAA Letter.
\1186\ See Joinvestor Letter.
\1187\ See Brown J. Letter (also recommending the Commission
adopt similar bad actor provisions under Rule 504).
---------------------------------------------------------------------------
(3) Final Rules
We are adopting bad actor disqualification provisions for
Regulation Crowdfunding \1188\ substantially as proposed with the
exception of several modifications to further align the final rules
with similar provisions in Rules 262 and 506. We believe that the final
rules are appropriate in light of the JOBS Act Section 302(d) mandate.
We further believe that creating a uniform set of bad actor standards
for all exemptions that include bad actor disqualification is likely to
simplify due diligence, particularly for issuers that may engage in
different types of exempt offerings.
---------------------------------------------------------------------------
\1188\ See Rule 503 of Regulation Crowdfunding.
---------------------------------------------------------------------------
Under the final disqualification rules, covered persons include the
issuer and any predecessor of the issuer or affiliated issuer;
directors, officers, general partners or managing members of the
issuer; beneficial owners of 20% or more of the issuer's outstanding
voting equity securities (which we believe should be calculated based
on the present right to vote for the election of directors,
irrespective of the existence of control or significant influence); any
promoter connected with the issuer in any capacity at the time of such
sale; compensated solicitors of investors; and general partners,
directors, officers or managing members of any such solicitor.\1189\ We
have not expanded the list of covered persons, as suggested by a
commenter, because we believe that the limited additional investor
protection that such an expansion may provide would not justify the
costs that would result from inconsistent bad actor disqualification
rules.
---------------------------------------------------------------------------
\1189\ See Rule 503(a) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The disqualifying events include:
Felony and misdemeanor convictions within the last five
years in the case of issuers, their predecessors and affiliated
issuers, and 10 years in the case of other covered persons in
connection with the purchase or sale of a security, involving the
making of a false filing with the Commission; or arising out of the
conduct of the business of an underwriter, broker, dealer, municipal
securities dealer, investment adviser, funding portal or paid solicitor
of purchasers of securities; \1190\
---------------------------------------------------------------------------
\1190\ See Rule 503(a)(1) of Regulation Crowdfunding.
---------------------------------------------------------------------------
injunctions and court orders within the last five years
against engaging in or continuing conduct or practices in connection
with the purchase or sale of securities; involving the making of any
false filing with the Commission; or arising out of the conduct of the
business of an underwriter, broker, dealer, municipal securities
dealer, investment adviser, funding portal or paid solicitor of
purchasers of securities; \1191\
---------------------------------------------------------------------------
\1191\ See Rule 503(a)(2) of Regulation Crowdfunding.
---------------------------------------------------------------------------
certain final orders and bars of certain state and other
federal regulators; \1192\
---------------------------------------------------------------------------
\1192\ See Rule 503(a)(3) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Commission cease-and-desist orders relating to violations
of scienter-based anti-fraud provisions of the federal securities laws
or Section 5 of the Securities Act; \1193\
---------------------------------------------------------------------------
\1193\ See Rule 503(a)(5) of Regulation Crowdfunding.
---------------------------------------------------------------------------
filing, or being named as an underwriter in, a
registration statement or Regulation A offering statement that is the
subject of a proceeding to determine whether a stop order or
[[Page 71480]]
suspension should be issued, or as to which a stop order or suspension
was issued within the last five years; \1194\
---------------------------------------------------------------------------
\1194\ See Rule 503(a)(7) of Regulation Crowdfunding.
---------------------------------------------------------------------------
United States Postal Service false representation orders
within the last five years; \1195\ and
---------------------------------------------------------------------------
\1195\ See Rule 503(a)(8) of Regulation Crowdfunding.
---------------------------------------------------------------------------
for covered persons other than the issuer:
[cir] Being subject to a Commission order:
[ssquf] revoking or suspending their registration as a broker,
dealer, municipal securities dealer, investment adviser or funding
portal;
[ssquf] placing limitations on their activities as such;
[ssquf] barring them from association with any entity; or
[ssquf] barring them from participating in an offering of penny
stock; \1196\ or
---------------------------------------------------------------------------
\1196\ See Rule 503(a)(4) of Regulation Crowdfunding.
---------------------------------------------------------------------------
[cir] being suspended or expelled from membership in, or suspended
or barred from association with a member of, a registered national
securities exchange or national securities association for conduct
inconsistent with just and equitable principles of trade.\1197\
---------------------------------------------------------------------------
\1197\ See Rule 503(a)(6) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Consistent with Rules 262 and 506 and the proposal, we also are
adopting provisions allowing for a waiver from and a reasonable care
exception to the disqualification provisions.\1198\ Under the final
rules, an issuer will not lose the benefit of the Section 4(a)(6)
exemption if it is able to show that it did not know, and in the
exercise of reasonable care could not have known, of the existence of a
disqualification.\1199\ Further, persons that are disqualified from
relying on the exemption may request a waiver of disqualification from
the Commission.\1200\
---------------------------------------------------------------------------
\1198\ See Rule 503(b) of Regulation Crowdfunding.
\1199\ See Rule 503(b)(4) of Regulation Crowdfunding.
\1200\ See Rule 503(b)(2) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The final rules also specify that triggering events that pre-date
effectiveness of the final rules will not cause disqualification, but
instead must be disclosed on a basis consistent with Rules 262 and
506(e).\1201\ Specifically, issuers will be required to disclose in
their offering materials matters that would have triggered
disqualification had they occurred after the effective date of proposed
Regulation Crowdfunding.\1202\ In a change from the proposal, Rule
201(u) does not include the word ``timely'' as is included in Rule
506(e) of Regulation D, because unlike the disclosure associated with
Rule 506(e), the disclosure required by Rule 201(u) must be included in
an issuer's offering statement and thus is required to be timely to the
offering.
---------------------------------------------------------------------------
\1201\ See Rules 201(u) and 503(b)(1) of Regulation
Crowdfunding.
\1202\ See Rule 201(u) of Regulation Crowdfunding.
---------------------------------------------------------------------------
We believe this disclosure will put investors on notice of events
that would, but for the timing of such events, have disqualified the
issuer from relying on Section 4(a)(6). We also believe that this
disclosure is particularly important because, as a result of the
implementation of Section 302(d), investors may have the impression
that all bad actors are disqualified from participating in offerings
under Section 4(a)(6). If disclosure of a pre-existing, otherwise
disqualifying event is required and not provided to an investor, we
would not view this as an insignificant deviation from Regulation
Crowdfunding under Rule 502.
Consistent with the proposal and with Rule 506, the final
disqualification rules provide that events relating to certain
affiliated issuers are not disqualifying if the events pre-date the
affiliate relationship. Specifically, Rule 503(c) provides that events
relating to any affiliated issuer that occurred before the affiliation
arose will be not considered disqualifying if the affiliated entity is
not (1) in control of the issuer or (2) under common control with the
issuer by a third party that was in control of the affiliated entity at
the time of such events.\1203\
---------------------------------------------------------------------------
\1203\ See Rule 503(c) of Regulation Crowdfunding.
---------------------------------------------------------------------------
We also have modified the final rules to expressly include funding
portals in the list of entities that could be subject to felony and
misdemeanor convictions, injunctions and court orders that would
constitute disqualifying events.\1204\ As proposed, funding portals
would have been included because they meet the definition of broker;
however, for clarity, the final rule expressly includes them.
---------------------------------------------------------------------------
\1204\ See Rules 503(a)(1)(iii) and 503(a)(2)(iii) of Regulation
Crowdfunding. Because funding portals are brokers within the meaning
of Exchange Act Section (3)(a)(4) (albeit exempt from registration
as such), we believe that they would be covered by the term
``broker'' in the final rule. Nevertheless, for clarity, we are
adding funding portals to the final rule text to avoid any confusion
in this regard.
---------------------------------------------------------------------------
b. Intermediaries and Certain Other Associated Persons
(1) Proposed Rules
Section 302(d)(1)(B) requires the Commission to establish
disqualification provisions under which an intermediary would not be
eligible to effect or participate in transactions conducted pursuant to
Securities Act Section 4(a)(6). Section 302(d)(2) requires that the
disqualification provisions be substantially similar to the provisions
of Securities Act Rule 262, which applies to issuers. Exchange Act
Section 3(a)(39) \1205\ currently defines the circumstances in which a
broker would be subject to a ``statutory disqualification'' with
respect to membership or participation in a self-regulatory
organization such as FINRA or any other registered national securities
association. We believe that the definition of ``statutory
disqualification'' under Section 3(a)(39) is substantially similar to,
while somewhat broader than, the provisions of Rule 262.\1206\
---------------------------------------------------------------------------
\1205\ 15 U.S.C. 78c(39).
\1206\ See the Proposing Release at note 812 for a discussion of
differences between Exchange Act Section 3(a)(39) and Rule 262.
Despite the differences, we believe that Section 3(a)(39) and Rule
262 are substantially similar, in particular with regard to the
persons and events they cover, their scope and their purpose.
---------------------------------------------------------------------------
As proposed, Rule 503(d) would have prohibited any person subject
to a statutory disqualification as defined in Exchange Act Section
3(a)(39) from acting as, or being an associated person of, an
intermediary unless permitted to do so by Commission rule or order. The
term ``subject to a statutory disqualification'' has an established
meaning under Exchange Act Section 3(a)(39) and defines circumstances
that subject a person to a statutory disqualification with respect to
membership or participation in, or association with a member of, a
self-regulatory organization.\1207\ Because funding portals, like
broker-dealers, are required to be members of FINRA or any other
applicable registered national securities association, we anticipate
that funding portals will take appropriate steps to check the
background of any person seeking to become associated with them,
including whether such
[[Page 71481]]
person is subject to a statutory disqualification.
---------------------------------------------------------------------------
\1207\ Events that could result in a statutory disqualification
for an associated person under Section 3(a)(39) include, but are not
limited to: Certain misdemeanor and all felony criminal convictions;
temporary and permanent injunctions issued by a court of competent
jurisdiction involving a broad range of unlawful investment
activities; expulsions (and current suspensions) from membership or
participation in an SRO; bars (and current suspensions) ordered by
the Commission or an SRO; denials or revocations of registration by
the CFTC; and findings by the Commission, CFTC or an SRO that a
person: (1) ``willfully'' violated the federal securities or
commodities laws, or the Municipal Securities Rulemaking Board
(MSRB) rules; (2) ``willfully'' aided, abetted, counseled,
commanded, induced or procured such violations; or (3) failed to
supervise another who commits violations of such laws or rules. 15
U.S.C. 78c(a)(39).
---------------------------------------------------------------------------
In addition, we proposed to clarify that associated persons of
intermediaries engaging in transactions in reliance on Section 4(a)(6)
must comply with Exchange Act Rule 17f-2,\1208\ relating to the
fingerprinting of securities industry personnel. Under the proposal,
Exchange Act Rule 17f-2 would have applied to all brokers, including
registered funding portals. The proposed instruction to Rule 503(d)
would have clarified that Rule 17f-2 generally requires the
fingerprinting of every person who is a partner, director, officer or
employee of a broker, subject to certain exceptions.
---------------------------------------------------------------------------
\1208\ 17 CFR 240.17f-2.
---------------------------------------------------------------------------
(2) Final Rules
We are adopting Rule 503(d) as proposed. We received two comments
on the proposed rule. One commenter was in favor,\1209\ while another
commenter was opposed.\1210\ The Section 3(a)(39) standard is an
established one among financial intermediaries and their regulators.
For this reason, we believe the Section 3(a)(39) standard is more
appropriate for intermediaries than Rule 262 or the issuer
disqualification rules under Regulation Crowdfunding. We are concerned
that if we imposed a new or different statutory disqualification
standard only for those intermediaries that engage in transactions in
reliance on Section 4(a)(6), we may create confusion and unnecessary
burdens on market participants. We note that such a divergence in
standards would cause brokers that act as intermediaries in reliance on
Section 4(a)(6) (and their associated persons) to become subject to two
distinct standards for disqualification. Instead, we believe that
intermediaries should be subject to the same statutory disqualification
standard regardless of whether or not they are engaging in transactions
involving the offer or sale of securities in reliance on Section
4(a)(6), and note that applying consistent standards for all brokers
and funding portals will also assist FINRA or any other registered
national securities association in its oversight of its members.
Further, Exchange Act Rule 19h-1 prescribes the form and content of,
and establishes the mechanism by which the Commission reviews,
proposals submitted by SROs (such as FINRA) for its members, to allow a
member or associated person subject to a statutory disqualification to
become or remain a member or be associated with a member (``notice of
admission or continuance notwithstanding a statutory
disqualification,'' as described in Rule 19h-1(a)). Among other things,
Rule 19h-1 provides for Commission review of notices filed by SROs
proposing to admit any person to, or continue any person in, membership
or association with a member notwithstanding a statutory
disqualification as defined in Section 3(a)(39). Because intermediaries
are required to be members of a registered national securities
association (which is an SRO), actions taken by the SRO with respect to
a proposed admission or continuance with respect to an intermediary or
its associated persons will be subject to Rule 19h-1. Thus, the
``pursuant to Commission rule'' provision in Rule 503(d) will be
satisfied if the admission or continuance request was subject to the
requirements and process of Exchange Act Rule 19h-1. We also are
adopting, as proposed, the instruction to Rule 503(d) clarifying that
the Rule 17f-2 fingerprinting requirements are applicable to all
associated persons of intermediaries engaging in transactions in
reliance on Section 4(a)(6).
---------------------------------------------------------------------------
\1209\ See NASAA Letter.
\1210\ See Public Startup Letter 3.
---------------------------------------------------------------------------
7. Secondary Market Trading
In addition to the actions the Commission is taking today to permit
the offer and sale of securities in reliance on Section 4(a)(6), the
Commission also recently adopted rules that exempt from the
registration requirements of the Securities Act certain offerings of up
to $50 million of securities annually,\1211\ and rules to eliminate the
prohibition against general solicitation in certain offerings pursuant
to Regulation D under the Securities Act.\1212\ The Commission is
mindful of the need for market participants to have updated information
in connection with the secondary market trading of securities issued
pursuant to these rules.\1213\
---------------------------------------------------------------------------
\1211\ See Regulation A Adopting Release, supra, note 506.
\1212\ See Rule 506(c) Adopting Release, supra, note 5.
\1213\ As discussed in Section II.E.2, Rule 501 imposes a one-
year restriction on the transfer of securities issued in a
transaction exempt from registration pursuant to Section 4(a)(6) of
the Securities Act, other than to the issuer, an accredited
investors, or to a family member of the purchaser or the equivalent
in connection with certain specified events.
---------------------------------------------------------------------------
The anti-fraud provisions of the federal securities laws, and rules
adopted thereunder, apply to the secondary market trading of
securities, including securities offered and sold in reliance on
Section 4(a)(6). For example, Exchange Act Rule 15c2-11 governs broker-
dealers' publication of quotations for certain over-the-counter
securities in a quotation medium other than a national securities
exchange.\1214\ The Commission adopted Rule 15c2-11 to prevent
fraudulent and manipulative trading schemes that had arisen in
connection with the distribution and trading of certain unregistered
securities.\1215\ The rule prohibits broker-dealers from publishing
quotations (or submitting quotations for publication) in a ``quotation
medium'' \1216\ for covered over-the-counter securities without first
reviewing basic information about the issuer, subject to certain
exceptions.\1217\ A broker-dealer also must have a reasonable basis for
believing that the issuer information is accurate in all material
respects and that it was obtained from a reliable source.\1218\
---------------------------------------------------------------------------
\1214\ 17 CFR 240.15c2-11.
\1215\ See generally Initiation or Resumption of Quotations by a
Broker or Dealer Who Lacks Certain Information, Exchange Act Release
No. 9310 (Sept. 13, 1971), 36 FR 18641 (Sept. 18, 1971). See also
Publication or Submission of Quotations Without Specified
Information, Exchange Act Release No. 39670 (Feb. 17, 1998), 63 FR
9661, 9662 (Feb. 25, 1998).
\1216\ 17 CFR 240.15c2-11(e)(1) (defining quotation medium as
``any `interdealer quotation system' or any publication or
electronic communications network or other device which is used by
brokers or dealers to make known to others their interest in
transactions in any security, including offers to buy or sell at a
stated price or otherwise, or invitations of offers to buy or
sell'').
\1217\ 17 CFR 240.15c2-11(a). See Publication or Submission of
Quotations Without Specified Information, Exchange Act Release No.
34-39670 (Feb. 17, 1998), 63 FR 9661 (Feb. 25, 1998).
\1218\ Id.
---------------------------------------------------------------------------
To be clear, the rules adopted today do not affect the obligations
of a broker-dealer under Exchange Rule 15c2-11 to have a reasonable
basis under the circumstances for believing that the information
required by Rule 15c2-11 is accurate in all material respects, and that
the sources of the information are reliable, prior to publishing any
quotation, absent an exception,\1219\ for a covered security in any
quotation medium.\1220\ The staff is directed to
[[Page 71482]]
begin promptly an evaluation of the operation of Rule 15c2-11, both
historically and in light of recent market developments, including
Regulation Crowdfunding and earlier proposals for amendments to Rule
15c2-11,\1221\ to assess how the rule is meeting regulatory objectives
and to recommend any appropriate changes. In addition, and not
withstanding any changes which may be made to Rule 15c2-11 in the
interim, the staff is also directed to review the development of
secondary market trading in these securities during the study it plans
to undertake within three years following the effective date of
Regulation Crowdfunding, and to recommend to the Commission such
additional actions with respect to Rule 15c2-11, as may be
warranted.\1222\
---------------------------------------------------------------------------
\1219\ See 17 CFR 240.15c2-11(f). For example, the rule includes
an exception for unsolicited orders. 17 CFR 240.15c2-11(f)(2). We
remind broker-dealers that such unsolicited orders must be made by a
customer (other than a person acting as or for a dealer) and that
broker-dealers should be prepared to demonstrate that a customer
initiated the order. 17 CFR 240.15c2-11(b)(1).
\1220\ Rule 15c2-11(c) further requires that broker-dealers keep
the documents that they reviewed to establish this reasonable basis
for believing that the required information is accurate in all
material respects for a period of not less than three years. 17 CFR
240.15c2-11(c). The lack of documents used at the time the broker-
dealer established the reasonable basis for its belief or
presentation of incomplete or non-responsive documents, including
later-dated filings, would not be sufficient to demonstrate that the
broker-dealer had satisfied its obligations in this regard. See
Initiation or Resumption of Quotations Without Specified
Information, Exchange Act Release No 27247 (Sept. 14, 1989), 54 FR
39194, 39196 (Sept. 25, 1989) (``Subject to certain exceptions, the
Rule prohibits a broker or dealer from submitting a quotation for a
security in a quotation medium unless it has in its records
specified information concerning the security and the issuer . .
.'').
\1221\ See Exchange Act Release No. 41110 (Feb. 25, 1999), 64 FR
11124 (Mar. 8, 1999).
\1222\ See Section II.
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III. Economic Analysis
Title III sets forth a comprehensive regulatory structure for
startups and small businesses to raise capital through securities-based
crowdfunding transactions using the Internet. In particular, Title III
provides an exemption from registration for certain offerings of
securities by adding Securities Act Section 4(a)(6). In addition, Title
III:
Adds Securities Act Section 4A, which requires, among
other things, that issuers and intermediaries that facilitate
transactions between issuers and investors provide certain information
to investors, take certain actions and provide notices and other
information to the Commission;
adds Exchange Act Section 3(h), which requires the
Commission to adopt rules to exempt, either conditionally or
unconditionally, funding portals from having to register as broker-
dealers or dealers pursuant to Exchange Act Section 15(a)(1);
mandates that the Commission adopt disqualification
provisions under which an issuer would not be able to avail itself of
the exemption for crowdfunding if the issuer or other related parties,
including an intermediary, were subject to a disqualifying event; and
adds Exchange Act Section 12(g)(6), which requires the
Commission to adopt rules to exempt from Section 12(g), either
conditionally or unconditionally, securities acquired pursuant to an
offering made in reliance on Section 4(a)(6).
As discussed in detail above, we are adopting Regulation
Crowdfunding to implement the requirements of Title III. The final
rules implement the new exemption for the offer and sale of securities
pursuant to the requirements of Section 4(a)(6) and provide a framework
for the regulation of issuers and intermediaries, which include broker-
dealers and funding portals engaging in such transactions. The final
rules also permanently exempt securities offered and sold in reliance
on Section 4(a)(6) from the record holder count under Exchange Act
Section 12(g).
We are mindful of the costs imposed by, and the benefits to be
obtained from, our rules. Securities Act Section 2(a) and Exchange Act
Section 3(f) require us, when engaging in rulemaking that requires us
to consider or determine whether an action is necessary or appropriate
in the public interest, to consider, in addition to the protection of
investors, whether the action will promote efficiency, competition and
capital formation. Exchange Act Section 23(a)(2) requires us, when
adopting rules under the Exchange Act, to consider the impact that any
new rule would have on competition and to not adopt any rule that would
impose a burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Exchange Act. The discussion below
addresses the economic effects of the final rules, including the likely
costs and benefits of Regulation Crowdfunding, as well as the likely
effect of the final rules on efficiency, competition and capital
formation. Given the specific language of the statute and our
understanding of Congress's objectives, we believe that it is
appropriate for the final rules generally to follow the statutory
provisions. We nonetheless also rely on our discretionary authority to
adopt certain additional provisions and make certain other adjustments
to the final rules. While the costs and benefits of the final rules in
large part stem from the statutory mandate of Title III, certain costs
and benefits are affected by the discretion we exercise in connection
with implementing this mandate. For purposes of this economic analysis,
we address the costs and benefits resulting from the mandatory
statutory provisions and our exercise of discretion together because
the two types of benefits and costs are not separable.
A. Baseline
The baseline for our economic analysis of Regulation Crowdfunding,
including the baseline for our consideration of the effects of the
final rules on efficiency, competition and capital formation, is the
situation in existence today, in which startups and small businesses
seeking to raise capital through securities offerings must register the
offer and sale of securities under the Securities Act unless they can
rely on an existing exemption from registration under the federal
securities laws. Moreover, under existing requirements, intermediaries
intending to facilitate such transactions generally are required to
register with the Commission as broker-dealers under Exchange Act
Section 15(a).
1. Current Methods of Raising Up to $1 Million of Capital
The potential economic impact of the final rules, including their
effects on efficiency, competition and capital formation, will depend
on how the crowdfunding method of raising capital compares to existing
methods that startups and small businesses currently use for raising
capital. Startups and small businesses can potentially access a variety
of external financing sources in the capital markets through registered
or unregistered offerings of debt, equity and hybrid securities and
bank loans.
Issuers seeking to raise capital must register the offer and sale
of securities under the Securities Act or qualify for an exemption from
registration. Registered offerings, however, are generally too costly
to be viable alternatives for startups and small businesses. Issuers
conducting registered offerings incur Commission registration fees,
legal and accounting fees and expenses, transfer agent and registrar
fees, costs associated with periodic reporting requirements and other
regulatory requirements and various other fees. Two surveys concluded
that the average initial compliance cost associated with conducting an
initial public offering is $2.5 million, followed by an ongoing
compliance cost for issuers, once public, of $1.5 million per
year.\1223\ Hence, for
[[Page 71483]]
an issuer seeking to raise less than $1 million, a registered offering
may not be economically feasible.\1224\ Moreover, issuers conducting
registered offerings also usually pay underwriter fees, which are, on
average, approximately 7% of the proceeds for initial public offerings,
approximately 5% for follow-on equity offerings and approximately 1-
1.5% for issuers raising capital through public bond issuances.\1225\
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\1223\ See IPO Task Force, Rebuilding the IPO On-Ramp, at 9
(Oct. 20, 2011) for the two surveys, available at http://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf
(``IPO Task Force''). These estimates should be interpreted with the
caveat that most firms in the IPO Task Force surveys likely raised
more than $1 million. The IPO Task Force surveys do not provide a
breakdown of costs by offering size. However, compliance related
costs of an initial public offering and subsequent compliance
related costs of being a reporting company likely have a fixed cost
component that would disproportionately affect small offerings.
Title I of the JOBS Act provided certain accommodations to
issuers that qualify as emerging growth companies (EGCs). According
to a recent working paper, the underwriting, legal and accounting
fees of EGC and non-EGC initial public offerings were similar (based
on a time period from April 5, 2012 to April 30, 2014). For a median
EGC initial public offering, gross spread comprised 7% of proceeds
and accounting and legal fees comprised 2.4% of proceeds. See Susan
Chaplinsky, Kathleen W. Hanley, and S. Katie Moon, The JOBS Act and
the Costs of Going Public, Working Paper (2014), available at http://ssrn.com/abstract_id=2492241.
\1224\ Id.
\1225\ See, e.g., Hsuan-Chi Chen and Jay R. Ritter, The Seven
Percent Solution, 55 J. Fin. 1105-1131 (2000); Mark Abrahamson, Tim
Jenkinson, and Howard Jones, Why Don't U.S. Issuers Demand European
Fees for IPOs? 66 J. Fin. 2055-2082 (2011); Shane A. Corwin, The
Determinants of Underpricing for Seasoned Equity Offers, 58 J. Fin.
2249-2279 (2003); Lily Hua Fang, Investment Bank Reputation and the
Price and Quality of Underwriting Services, 60 J. Fin. 2729-2761
(2005); Rongbing Huang and Donghang Zhang, Managing Underwriters and
the Marketing of Seasoned Equity Offerings, 46 J. Fin. Quant.
Analysis 141-170 (2011); Stephen J. Brown, Bruce D. Grundy, Craig M.
Lewis and Patrick Verwijmeren, Convertibles and Hedge Funds as
Distributors of Equity Exposure, 25 Rev. Fin. Stud. 3077-3112
(2012).
---------------------------------------------------------------------------
An alternative to raising capital through registered offerings is
to offer and sell securities by relying on an existing exemption from
registration under the federal securities laws. For example, startups
and small businesses could rely on current exemptions from registration
under the Securities Act, such as Section 3(a)(11),\1226\ Section
4(a)(2),\1227\ Regulation D,\1228\ and Regulation A.\1229\ While we do
not have complete data on offerings relying on an exemption under
Section 3(a)(11) or Section 4(a)(2), certain data available from
Regulation D and Regulation A filings allow us to gauge how frequently
issuers seeking to raise up to $1 million use these exemptions.
---------------------------------------------------------------------------
\1226\ Securities Act Section 3(a)(11), generally known as the
``intrastate offering exemption,'' provides an exemption from
registration for issuers doing business within a particular state or
territory. To qualify for this exemption, the offering must be
``part of an issue offered and sold only to persons resident within
a single State or Territory, where the issuer of such security is a
person resident and doing business within, or, if a corporation,
incorporated by and doing business within, such State or
Territory.''
\1227\ Securities Act Section 4(a)(2) provides that the
registration provisions of the Securities Act shall not apply to
``transactions by an issuer not involving a public offering.''
\1228\ Regulation D provides exemptions and a nonexclusive safe
harbor from registration for certain types of securities offerings.
\1229\ Regulation A provides a conditional exemption from
registration for certain small issuances.
---------------------------------------------------------------------------
Based on Regulation D filings by issuers that are not pooled
investment vehicles from 2009 to 2014,\1230\ a substantial number of
issuers chose to raise capital by relying on Rule 506, even though
their offering size would qualify for an exemption under Rule 504 or
Rule 505.\1231\ The 2013 amendment to Rule 506 of Regulation D permits
an issuer to engage in general solicitation and general advertising in
offering and selling securities pursuant to Rule 506(c), subject to
certain conditions,\1232\ which can enable issuers to reach a
potentially broader base of accredited investors. As shown in the table
below, although issuers can raise unlimited amounts of capital relying
on the Rule 506(c) exemption, most of the issuers made offers for
amounts of up to $1 million.
---------------------------------------------------------------------------
\1230\ See Scott Bauguess, Rachita Gullapalli, and Vladimir
Ivanov, Capital Raising in the U.S.: An Analysis of the Market for
Unregistered Securities Offerings, 2009-2014 (October 2015)
(``Unregistered Offerings White Paper''), available at: http://www.sec.gov/dera/staff-papers/white-papers/unregistered-offering10-2015.pdf.
\1231\ This tendency could, in part, be attributed to two
features of Rule 506: preemption from state registration (``blue
sky'') requirements and an unlimited offering amount. See also U.S.
Government Accountability Office, Factors That May Affect Trends in
Regulation A Offerings, GAO-12-839 (Jul. 3, 2012), available at
http://www.gao.gov/products/GAO-12-839 (``GAO Report'').
\1232\ In particular, all purchasers of securities sold in any
offering under the exemption must be accredited investors, and the
issuer must take reasonable steps to verify that purchasers of
securities sold in any offering are accredited investors (17 CFR
230.506). See Rule 506(c) Adopting Release, supra, note 5.
----------------------------------------------------------------------------------------------------------------
Offering size
Regulation D exemption ---------------------------------------------------------------
<=$1 Million $1-5 Million $5-50 Million >$50 Million
----------------------------------------------------------------------------------------------------------------
Rule 504........................................ 3,643
Rule 505........................................ 501 774
Rule 506(b)..................................... 27,106 25,746 18,670 2,733
Rule 506(c)..................................... 588 531 419 89
---------------------------------------------------------------
Total....................................... 31,838 27,051 19,089 2,822
----------------------------------------------------------------------------------------------------------------
Regulation A.................................... 5 33
----------------------------------------------------------------------------------------------------------------
Note: Data based on Form D, excluding issuers that are pooled investment vehicles, and Form 1-A filings from
2009 to 2014. We consider only new offerings and exclude offerings with amounts sold reported as $0 on Form D.
Data on Rule 506(c) offerings covers the period from September 23, 2013 (the day the rule became effective) to
December 31, 2014. We also use the maximum amount indicated in Form 1-A to determine offering size for
Regulation A offerings.\1233\
Based on the table above, from 2009 to 2014, almost no issuers in
offerings of up to $1 million relied on Regulation A. This data does
not reflect the recent changes to Regulation A adopted by the
Commission on March 25, 2015. Those changes allow issuers to raise up
to $50 million over a 12-month period and exempt certain Regulation A
offerings (Tier 2 offerings) from state registration requirements.
Because these changes are so recent, more time is needed to observe how
the amendments to Regulation A will affect capital raising by small
issuers.\1234\
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\1233\ We only consider Regulation A offerings that have been
qualified by the Commission. For purposes of counting filings, we
exclude amendments or multiple Form 1-A filings by the same issuer
in a given year. For purposes of determining the offering size for
Regulation A offerings, we use the maximum amount indicated on the
latest pre-qualification Form 1-A or amended Form 1-A. We reclassify
two offerings that are dividend reinvestment plans with unclear
offering amounts as having the maximum permitted offering amount.
\1234\ See Regulation A Adopting Release.
---------------------------------------------------------------------------
Each of these exemptions, however, includes restrictions that may
limit its suitability for startups and small businesses. The table
below lists the main requirements of these exemptions. For example, the
exemption under Securities Act Section 3(a)(11) is limited
[[Page 71484]]
to intrastate offerings.\1235\ Issuers conducting a Regulation A
offering may be required to register their offerings with states or
meet additional regulatory requirements, such as investment limitations
(if the investor is not an accredited investor), audited financial
statements and ongoing reporting. In addition, issuers in all
Regulation A offerings are required to file with the Commission an
offering document on Form 1-A. Such compliance related costs may be a
more significant constraint on issuers in offerings of up to $1
million.\1236\ Issuers of securities pursuant to Securities Act Section
4(a)(2) and Rules 504, 505 and 506(b) under Regulation D generally may
not engage in general solicitation and general advertising to reach
investors, which also can place a significant limitation on offerings
by startups and small businesses. While Rule 506 under Regulation D
preempts the applicability of state registration requirements and new
Rule 506(c) permits general solicitation and general advertising, an
issuer seeking to rely on Rule 506(c) is limited to selling securities
only to accredited investors.\1237\
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\1235\ See note 1226.
\1236\ See Rutheford B. Campbell, Jr., Regulation A: Small
Businesses' Search for ``A Moderate Capital'', 31 Del. J. Corp. L.
77, 106 (2006). See also GAO Report, note 1231.
\1237\ See Rule 506(c) Adopting Release, note 5.
---------------------------------------------------------------------------
The table below summarizes the main features of each exemption.
---------------------------------------------------------------------------
\1238\ Aggregate offering limit on securities sold within a
twelve-month period.
\1239\ Although Section 3(a)(11) does not have explicit resale
restrictions, the Commission has explained that ``to give effect to
the fundamental purpose of the exemption, it is necessary that the
entire issue of securities shall be offered and sold to, and come to
rest only in the hands of residents within the state.'' See SEC Rel.
No. 33-4434 (Dec. 6, 1961) [26 FR 11896 (Dec. 13, 1961)]. State
securities laws, however, may have specific resale restrictions.
Securities Act Rule 147, a safe harbor under Section 3(a)(11),
limits resales to persons residing in-state for a period of nine
months after the last sale by the issuer. [17 CFR 230.147].
\1240\ Section 4(a)(2) of the Securities Act provides a
statutory exemption for ``transactions by an issuer not involving
any public offering.'' See SEC v. Ralston Purina Co. 346 U.S. 119
(1953) (holding that an offering to those who are shown to be able
to fend for themselves is a transaction ``not involving any public
offering.'')
--------------------------------------------------------------------------------------------------------------------------------------------------------
Offering limit Issuer and investor Resale Blue sky law
Type of offering \1238\ Solicitation requirements Filing requirement restrictions preemption
--------------------------------------------------------------------------------------------------------------------------------------------------------
Section 3(a)(11)........ None............... All offerees must All issuers and None.............. No \1239\......... No
be resident in investors must be
state. resident in state.
Section 4(a)(2)......... None............... No general Transactions by an None.............. Restricted No
solicitation. issuer not involving securities.
any public offering
\1240\.
Regulation A............ Tier 1: $20 million Testing the waters U.S. or Canadian File testing the No................ Tier 1: No
with $6 million permitted both issuers, excluding waters materials Tier 2: Yes
limit on secondary before and after investment companies, and Form 1-A for
sales by filing the blank-check companies, Tiers 1 and 2;
affiliates of the offering statement. reporting companies, file annual, semi-
issuer; and issuers of annual, and
Tier 2: $50 million fractional undivided current reports
with $15 million interests in oil or gas for Tier 2; file
limit on secondary rights, or similar exit report for
sales by interests in other Tier 1 and to
affiliates of the mineral rights \1241\. suspend or
issuer. terminate
reporting for
Tier 2.
Rule 504 Regulation D... $1 million......... General Excludes investment File Form D \1243\ Restricted in some No
solicitation companies, blank-check cases \1244\.
permitted in some companies, and Exchange
cases \1242\. Act reporting companies.
Rule 505 Regulation D... $5 million......... No general Unlimited accredited File Form D \1245\ Restricted No
solicitation. investors and up to 35 securities.
non-accredited
investors.
Rule 506(b) Regulation D None............... No general Unlimited accredited File Form D \1246\ Restricted Yes
solicitation. investors and up to 35 securities.
non-accredited
investors.
Rule 506(c) Regulation D None............... General Unlimited accredited File Form D \1248\ Restricted Yes
solicitation is investors; no non- securities.
permitted subject accredited investors.
to certain
conditions \1247\.
--------------------------------------------------------------------------------------------------------------------------------------------------------
2. Current Sources of Funding for Startups and Small Businesses That
Could Be Substitutes or Complements to Crowdfunding
At present, startups and small businesses can raise capital from
several sources that could be close substitutes for or complements to
crowdfunding transactions that rely on Section 4(a)(6). This capital
raising generally is conducted through unregistered securities
offerings, involves lending by financial institutions or derives from
family and friends.
---------------------------------------------------------------------------
\1241\ The Regulation A exemption also is not available to
companies that have been subject to any order of the Commission
under Exchange Act Section 12(j) entered within the past five years;
have not filed ongoing reports required by the regulation during the
preceding two years, or are disqualified under the regulation's
``bad actor'' disqualification rules.
\1242\ No general solicitation or advertising is permitted
unless the offering is registered in a state requiring the use of a
substantive disclosure document or sold under a state exemption for
sales to accredited investors with general solicitation.
\1243\ Filing is not a condition of the exemption, but it is
required under Rule 503.
\1244\ Restricted unless the offering is registered in a state
requiring the use of a substantive disclosure document or sold under
a state exemption for sale to accredited investors.
\1245\ Filing is not a condition of the exemption, but it is
required under Rule 503.
\1246\ Filing is not a condition of the exemption, but it is
required under Rule 503.
---------------------------------------------------------------------------
a. Family and Friends
Family and friends are sources through which startups and small
businesses can raise capital. This source of capital is usually
available early in the lifecycle of a small business, before the
business engages in arm's-length and more formal funding
channels.\1249\ Among other things, family and friends may donate
funds, loan funds or acquire an equity stake in the business. A recent
study of the financing choices of startups finds that most of the
capital supplied by friends and family is in the form of loans.\1250\
In contrast to a commercial lender that, for example, would need to
assess factors such as the willingness and ability of a borrower to
[[Page 71485]]
repay the loan and the viability of its business, family and friends
may be willing to provide capital based primarily or solely on personal
relationships. Family and friends, however, may be able to provide only
a limited amount of capital compared to other sources. In addition,
financial arrangements with family and friends may not be an optimal
source of funding if any of the parties is not knowledgeable about the
structuring of loan agreements, equity investments or related areas of
accounting. We do not have data available on these financing sources
that allow us to quantify their magnitude and compare them to other
current sources of capital.
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\1247\ General solicitation and general advertising are
permitted under Rule 506(c), provided that all purchasers are
accredited investors and the issuer takes reasonable steps to verify
accredited investor status.
\1248\ Filing is not a condition of the exemption, but it is
required under Rule 503.
\1249\ See Paul Gompers and Josh Lerner, The Venture Capital
Cycle (MIT Press 2006) (``Gompers''); Alicia M. Robb and David T.
Robinson, The Capital Structure Decisions of New Firms, 27 Rev. Fin.
Stud. 153-179 (2014) (``Robb'').
\1250\ See Robb, note 1249.
---------------------------------------------------------------------------
b. Commercial Loans, Peer-to-Peer Loans and Microfinance
Startups and small businesses also may seek loans from financial
institutions.\1251\ A 2014 study of the financing choices of startups
suggests that they resort to bank financing early in their
lifecycle.\1252\ The study finds that businesses rely heavily in the
first year after being formed on external debt sources such as bank
financing, mostly in the form of personal and commercial bank loans,
business credit cards and credit lines. Another recent report, however,
suggests that bank lending to small businesses fell by $100 billion
from 2008 to 2011 and that, by 2012, less than one-third of small
businesses reported having a business bank loan.\1253\ Trends in small
business lending by FDIC-insured depository institutions are
illustrated in the figure below. As of June 2014, business loans of up
to $1 million amounted to approximately $590 billion, approximately 17%
lower than the 2008 level.\1254\
---------------------------------------------------------------------------
\1251\ Using data from the 1993 Survey of Small Business
Finance, one study indicates that financial institutions account for
approximately 27% of small firms' borrowings. See Allen N. Berger
and Gregory F. Udell, The Economics of Small Business Finance: The
Roles of Private Equity and Debt Markets in the Financial Growth
Cycle, 22 J. Banking & Fin. 613 (1998). See also 1987, 1993, 1998
and 2003 Surveys of Small Business Finances, available at http://www.federalreserve.gov/pubs/oss/oss3/nssbftoc.htm. The Survey of
Small Business Finances was discontinued after 2003. Using data from
the Kauffman Foundation Firm Surveys, one study finds that 44% of
startups use loans from financial institutions. See Rebel A. Cole
and Tatyana Sokolyk, How Do Start-Up Firms Finance Their Assets?
Evidence from the Kauffman Firm Surveys (2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2028176.
\1252\ See Robb, note 1249.
\1253\ See The Kauffman Foundation, 2013 State of
Entrepreneurship Address (Feb. 5, 2013), available at http://www.kauffman.org/uploadedFiles/DownLoadableResources/SOE%20Report_2013pdf. The report cautions against prematurely
concluding that banks are not lending enough to small businesses as
the sample period of the study includes the most recent recession.
\1254\ We define small business loans to include commercial and
industrial loans to U.S. addressees of up to $1 million and loans
secured by nonfarm nonresidential properties. See Federal Deposit
Insurance Corporation, Statistics on Depository Institutions Report,
available at http://www2.fdic.gov/SDI/SOB/ (``FDIC Statistics'').
[GRAPHIC] [TIFF OMITTED] TR16NO15.149
Additionally, although covering the pre-recessionary period, a
Federal Reserve Board staff study analyzing data from the 2003 Survey
of Small Business Finance suggests that 60 percent of small businesses
have outstanding credit in the form of a credit line, a loan or a
capital lease.\1255\ These loans were borrowed from two types of
financial institutions--depositary and non-depositary institutions
(e.g., finance companies, factors or leasing companies).\1256\ Lines of
credit were the most widely used type of credit.\1257\ Other types
included mortgage loans, equipment loans and motor vehicle loans.\1258\
---------------------------------------------------------------------------
\1255\ See Federal Reserve Board, Financial Services Used by
Small Businesses: Evidence from the 2003 Survey of Small Business
Finances (October 2006), available at http://www.federalreserve.gov/pubs/bulletin/2006/smallbusiness/smallbusiness.pdf (``2003
Survey'').
\1256\ See Rebel Cole, What Do We Know About the Capital
Structure of Privately Held Firms? Evidence from the Surveys of
Small Business Finance, 42 Fin. Management 777-813 (2013).
\1257\ See 2003 Survey, note 1255 (estimating that 34% of small
businesses use lines of credit).
\1258\ Id.
---------------------------------------------------------------------------
Various loan guarantee programs of the Small Business
Administration (``SBA'') make credit more accessible to small
businesses by either lowering the interest rate of the loan or enabling
a market-based loan that a lender would not be willing to provide
absent a guarantee.\1259\ Although the SBA does
[[Page 71486]]
not itself act as a lender, the agency guarantees a portion of loans
made and administered by lending institutions. SBA loan guarantee
programs include 7(a) loans \1260\ and CDC/504 loans.\1261\ For
example, in SBA fiscal year 2014, the SBA supported approximately $28.7
billion in 7(a) and CDC/504 loans distributed to approximately 51,500
small businesses.\1262\ SBA-guaranteed loans, however, currently
account for a relatively small share (18 percent) of the balances of
small business loans outstanding.\1263\ The SBA also offers the
Microloan program, which provides funds to specially designated
intermediary lenders that administer the program for eligible
borrowers.\1264\
---------------------------------------------------------------------------
\1259\ Numerous states also offer a variety of small business
financing programs, such as Capital Access Programs, collateral
support programs and loan guarantee programs. These programs are
eligible for support under the State Small Business Credit
Initiative, available at http://www.treasury.gov/resource-center/sb-programs/Pages/ssbci.aspx.
\1260\ 15 U.S.C. 631 et se. The 7(a) loans provide small
businesses with financing guarantees for a variety of general
business purposes through participating lending institutions.
\1261\ 15 U.S.C. 695 et se. The CDC/504 loans are made available
through ``certified development companies'' or ``CDCs,'' typically
structured with the SBA providing 40% of the total project costs, a
participating lender covering up to 50% of the total project costs
and the borrower contributing 10% of the total project costs.
\1262\ See U.S. Small Business Administration, FY 2016
Congressional Budget Justification and FY 2014 Annual Performance
Report, available at https://www.sba.gov/content/fiscal-year-2016-congressional-budget-justificationannual-performance-report (``2014
Annual Performance Report'').
\1263\ As of the end of SBA fiscal year 2014, the SBA-guaranteed
business loans outstanding (including 7(a) and 504 loans) equaled
$107.5 billion. See Small Business Administration Unpaid Loan
Balances by Program, available at https://www.sba.gov/sites/default/files/files/WDS_Table1_UPB_Report.pdf. This comprises approximately
18% of the approximately $590 billion in outstanding small business
loans for commercial real estate and commercial and industrial loans
discussed above. In 2014 the SBA expanded eligibility for loans
under its business loan programs. See SBA 504 and 7(a) Loan Programs
Updates (Mar. 21, 2014) [79 FR 15641 (Apr. 21, 2014)]. In addition
to loan guarantees, the SBA program portfolio also includes direct
business loans, which are mainly microloans (outstanding direct
business loans equaled $137.1 billion), and disaster loans.
\1264\ 15 U.S.C. 631 et se. The Microloan program provides
small, short-term loans to small businesses and certain types of
not-for-profit childcare centers. The maximum loan amount is
$50,000, but the average microloan is about $13,000. Intermediaries
are nonprofit community-based organizations with experience in
lending, as well as management and technical assistance.
Intermediaries set their own lending requirements and generally
require some type of collateral as well as the personal guarantee of
the business owner. See Microloan Program, U.S. Small Business
Administration, available at http://www.sba.gov/content/microloan-program.
As of the end of SBA fiscal year 2014, the SBA Microloans
outstanding equaled $136.7 billion. See Small Business
Administration Unpaid Loan Balances by Program, available at https://www.sba.gov/sites/default/files/files/WDS_Table1_UPB_Report.pdf.
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Many startups and small businesses may find loan requirements
imposed by financial institutions difficult to meet and may not be able
to rely on these institutions to secure funding. For example, financial
institutions generally require a borrower to provide collateral and/or
a guarantee,\1265\ which startups, small businesses and their owners
may not be able to provide. Collateral and/or a guarantee may similarly
be required for loans guaranteed by the SBA.
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\1265\ Approximately 92% of all small business debt to financial
institutions is secured, and about 52% of that debt is guaranteed,
primarily by the owners of the firm. See Berger, note 1251.
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Another source of debt financing for startups and small businesses
is peer-to-peer lending, which began developing in 2005.\1266\ Such
debt transactions are facilitated by online platforms that connect
borrowers and lenders and potentially offer small businesses additional
flexibility on pricing, repayment schedules, collateral or guarantee
requirements, and other terms. Some market participants offer a
secondary market for loans originated on their own sites.\1267\ At
least one of the platforms sells third-party issued securities to
multiple individual investors, thus improving the liquidity of these
securities.\1268\ Like in any traditional lending arrangement, however,
borrowers are required to make regular payments to their lenders. This
requirement could make it a less attractive option for small businesses
with negative cash flows and short operating histories, both of which
may make it more difficult for such businesses to demonstrate their
ability to repay loans. According to some estimates, the global volume
of ``lending-based'' crowdfunding, which includes peer-to-peer lending
to consumers and businesses, had risen to approximately $11.08 billion
in 2014.\1269\
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\1266\ See Ian Galloway, Peer-to-Peer Lending and Community
Development Finance, Federal Reserve Bank of San Francisco, Working
Paper (2009), available at http://www.frbsf.org/publications/community/wpapers/2009/wp2009-06.pdf.
\1267\ Id.
\1268\ Id. We note that under current law, this activity would
require broker-dealer registration.
\1269\ See Massolution, 2015CF Crowdfunding Industry Report:
Market Trends, Composition and Crowdfunding Platforms, available at
http://reports.crowdsourcing.org/index.php?route=product/product&product_id=54 (``Massolution 2015'') at 56. The Massolution
2015 report refers to peer-to-peer lending to consumers and peer-to-
business lending to small businesses as ``lending-based''
crowdfunding. The discussion in this economic analysis refers to
peer-to-peer business lending more broadly in a sense synonymous
with ``lending-based'' crowdfunding.
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Technology has facilitated the growth of alternative models of
small business lending. According to one study,\1270\ the outstanding
portfolio balance of online lenders has doubled every year, although
this market represents less than $10 billion in outstanding loan
capital as of the fourth quarter of 2013. Several models of online
small business lending have emerged: Online lenders raising capital
from institutional investors and lending on their own account (for
example, short-term loan products similar to a merchant cash advance);
peer-to-peer platforms; and ``lender[hyphen]agnostic'' online
marketplaces that facilitate small business borrower access to various
loan products (such as term loans, lines of credit, merchant cash
advances and factoring products) from traditional and alternative
lenders.\1271\ According to the 2014 Small Business Credit
survey,\1272\ 18% of all small businesses surveyed applied for credit
with an online lender. The survey also showed differences in the use of
online lenders by type of borrower: 22% of small businesses categorized
in the survey as ``startups'' (i.e., businesses that have been in
business for less than five years) applied for credit with online
lenders. By comparison, 8% of small businesses categorized in the
survey as ``growers'' (i.e., businesses that were profitable and
experienced an increase in revenue) applied with online lenders, and 3%
of small businesses categorized in the survey as ``mature firms''
(i.e., businesses that have been in business for more than five years,
had over ten employees, and had prior debt) applied with an online
lender. The latter two categories of small businesses were more likely
to apply for credit with bank lenders than with online lenders.
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\1270\ See Karen Gordon Mills and Brayden McCarthy, The State of
Small Business Lending: Credit Access during the Recovery and How
Technology May Change the Game, Harvard Business School Working
Paper 15-004 (2014), available at http://ssrn.com/abstract=2470523.
\1271\ Id.
\1272\ The survey was conducted by the Federal Reserve Banks of
New York, Atlanta, Cleveland, and Philadelphia between September and
November of 2014. It focused on credit access among businesses with
fewer than 500 employees in Alabama, Connecticut, Florida, Georgia,
Louisiana, New Jersey, New York, Ohio, Pennsylvania, and Tennessee.
The survey authors note that since the sample is not a random
sample, results were reweighted for industry, age, size, and
geography to reduce coverage bias. See Federal Reserve Banks of New
York, Atlanta, Cleveland and Philadelphia, Joint Small Business
Credit Survey Report (2014), available at http://www.newyorkfed.org/smallbusiness/SBCS-2014-Report.pdf.
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Microfinance is another source of debt financing for startups and
small businesses. Microfinance consists of small, working capital loans
provided by microfinance institutions (``MFIs'') that are invested in
microenterprises or
[[Page 71487]]
income-generating activities.\1273\ The typical users of microfinance
services and, in particular, of microcredit are family-owned
enterprises or self-employed, low-income entrepreneurs, such as street
vendors, farmers, service providers, artisans and small producers, who
live close to the poverty line in both urban and rural areas.\1274\
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\1273\ See Craig Churchill and Cheryl Frankiewicz, Making
Microfinance Work: Managing for Improved Performance, Geneva
International Labor Organization (2006).
\1274\ See Joanna Ledgerwood, Microfinance Handbook: An
Institutional and Financial Perspective, Washington DC, World Bank
Publications (1999).
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The microfinance market has evolved and grown considerably in the
past decades. While data on the size of the overall industry is sparse,
according to one report, in fiscal year 2012, the U.S. microfinance
industry was estimated to have disbursed $292.1 million across 36,936
microloans and was estimated to have $427.6 million in outstanding
microloans (across 45,744 in microloans).\1275\ As of 2013, this report
identified 799 microenterprise programs that provide loans, training,
technical assistance and other microenterprise services directly to
micro-entrepreneurs.\1276\
---------------------------------------------------------------------------
\1275\ See FIELD at the Aspen Institute, U.S. Microenterprise
Census Highlights, FY 2012, available at http://fieldus.org/Publications/CensusHighlightsFY2012.pdf.
\1276\ Id. See also note 1264 (describing the SBA Microloan
program).
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c. Venture Capitalists and Angel Investors
Startups and small businesses also may seek funding from venture
capitalists (``VCs'') and angel investors. Entrepreneurs seek VC and
angel financing usually after they have exhausted sources of capital
that generally do not require the entrepreneurs to relinquish control
rights (e.g., personal funds from family and friends).
According to data from the National Venture Capital Association, in
calendar year 2014, VCs invested approximately $49.3 billion in 4,361
transactions involving 3,665 companies, which included seed, early-
stage, expansion, and late-stage companies. Seed and early-stage deals
represented 1.5% and 32.2%, respectively, of the dollar volume of deals
and 4.4% and 49.7%, respectively of the overall number of VC
deals.\1277\
---------------------------------------------------------------------------
\1277\ See National Venture Capital Association, 2015 National
Venture Capital Association Yearbook, available at http://nvca.org/?ddownload=1868 (``NVCA'').
---------------------------------------------------------------------------
Some startups, however, may struggle to attract funding from VCs
because VCs tend to invest in startups with certain characteristics. A
defining feature of VCs is that they tend to focus on startup companies
with high-growth potential and a high likelihood of going public after
a few years of financing. VCs also tend to invest in companies that
have already used some other sources of financing, tend to be
concentrated in certain geographic regions (e.g., California and
Massachusetts) and often require their investments to have an
attractive business plan, meet certain growth benchmarks or fill a
specific portfolio or industry niche.\1278\ In addition, when investing
in companies, VCs tend to acquire significant control rights (e.g.,
board seats, rights of first refusal, etc.), which they gradually
relinquish as the company approaches an initial public offering.\1279\
In 2014, according to an industry source, information technology and
medical/health/life sciences deals attracted the largest dollar volume
of VC financing.\1280\ According to a 2012 academic study, VCs appear
to focus on scale or potential for scale rather than short-term
profitability in their selection of targets, and firms that receive VC
financing tend to be significantly larger than non-VC firms, based on
employment and sales.\1281\
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\1278\ See Gompers, note 1249.
\1279\ See Steven N. Kaplan and Per Stromberg, Financial
Contracting Meets the Real World: An Empirical Analysis of Venture
Capital Contracts, 70 Rev. Econ. Stud. 281-316 (2003).
\1280\ See NVCA, note 1277.
\1281\ See Manju Puri and Rebecca Zarutskie, On the Life Cycle
Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms,
67 J. Fin., 2247-2293 (2012) (``Puri'').
[GRAPHIC] [TIFF OMITTED] TR16NO15.150
According to a recent report, angel investments amounted to $24.1
billion in 2014, with approximately 73,400 entrepreneurial ventures
receiving angel funding and approximately 316,600 active angel
investors.\1282\ In 2014, angel
[[Page 71488]]
investments were concentrated in software, healthcare, and IT services.
The average angel deal size was approximately $328,500. Seed/startup
stage deals accounted for 25% and early stage deals accounted for
46%.\1283\ As suggested by an academic study, angel investors tend to
invest in younger companies than VCs.\1284\
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\1282\ See Jeffrey Sohl, The Investor Angel Market in 2014: A
Market Correction in Deal Size, Center for Venture Research, May 14,
2015, available at https://paulcollege.unh.edu/sites/paulcollege.unh.edu/files/webform/2014%20Analysis%20Report.pdf
(``Sohl'').
\1283\ Id.
\1284\ See Gumpers, note 1249.
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3. Current Crowdfunding Practices
A recent crowdfunding industry report \1285\ defines the current
crowdfunding activity in the United States generally as ``lending-
based,'' \1286\ ``reward-based,'' ``donation-based,'' ``royalty-
based,'' ``equity-based,'' \1287\ and ``hybrid.'' We note that the
definitions of crowdfunding types used in this industry report and the
characteristics of crowdfunding activity currently in existence are not
directly comparable to the contours of security-based crowdfunding
transactions contemplated by the rules being adopted today. Thus,
considerable caution must be exercised when generating projections of
future crowdfunding volume from current activity broadly attributed to
the ``crowdfunding'' industry. In particular, the industry report
defines reward-based crowdfunding as a model where funders receive a
``reward,'' such as a perk or a pre-order of a product, and it defines
donation-based crowdfunding as a model where funders make philanthropic
donations to causes that they want to support, with no return on their
investment expected.\1288\ According to the industry report, royalty-
based crowdfunding, which involves a percentage of revenue from a
license or a usage-based fee for the other parties' right to the
ongoing use of an asset, continues to grow.\1289\
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\1285\ See Massolution 2015.
\1286\ Id. In this industry report, ``lending-based''
crowdfunding includes peer-to-peer lending to consumers and peer-to-
business lending.
\1287\ The report does not identify which jurisdictions were
represented in the survey. For example, France, Italy, Japan, and
the UK have adopted specialized equity crowdfunding regimes. It
should be noted that ``equity-based'' crowdfunding is not a one-
size-fits-all model. The crowdfunding regimes in these four
countries differ on a number of dimensions (e.g., securities allowed
to be sold by issuers, or types of issuers allowed to use the
exemption), amongst themselves and when compared to Regulation
Crowdfunding. Some number also allow equity crowdfunding through
their general securities laws. See Eleanor Kirby and Shane Worner,
Crowd-funding: An Infant Industry Growing Fast, Staff Working Paper
of the IOSCO Research Department, available at http://www.iosco.org/research/pdf/swp/Crowd-funding-An-Infant-Industry-Growing-Fast.pdf.
\1288\ See Massolution 2015 at 42. Many of the current domestic
crowdfunding offerings relate to individual projects and may not
have a defined or sustained business model commensurate with typical
issuers of securities.
\1289\ Id. at 43. The Massolution 2015 report did not provide
separate statistics on royalty-based and hybrid crowdfunding models
prior to the 2013 report.
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The industry report indicates that, in 2014, crowdfunding platforms
raised approximately $16.2 billion globally, which represented a 167%
increase over the amount raised in 2013.\1290\ These amounts include
various types of crowdfunding: lending-based crowdfunding accounted for
the largest share of volume (approximately $11.08 billion) followed by
equity-based crowdfunding (approximately $1.11 billion), reward-based
crowdfunding (approximately $1.33 billion), donation-based crowdfunding
(approximately $1.94 billion), royalty-based crowdfunding
(approximately $273 million), and hybrid crowdfunding (approximately
$487 million).\1291\ In 2014, North American crowdfunding volume was
approximately $9.46 billion, which represented a 145% increase over the
amount raised in 2013 \1292\ (including approximately $1.23 billion in
reward-based crowdfunding, approximately $959 million in donation-based
crowdfunding, and approximately $787.5 million in equity-based
crowdfunding, with the remainder comprised of lending-based, royalty-
based, and hybrid models \1293\). The industry report further indicates
that global equity-based crowdfunding volume grew by 182% in
2014.\1294\ According to the report, this rapid growth in equity-based
crowdfunding has been driven largely by North America and Europe.\1295\
---------------------------------------------------------------------------
\1290\ Id. at 13.
\1291\ Id. at 14.
\1292\ Id. at 53.
\1293\ Id. at 55.
\1294\ Id. at 14. By comparison, in 2014, ``reward-based''
crowdfunding grew by 84%, ``lending-based'' crowdfunding by 223%;
``donation-based'' crowdfunding by 45%; ``royalty-based''
crowdfunding by 336%; and ``hybrid'' crowdfunding by 290%.
\1295\ Id. at 55. ``Equity-based'' crowdfunding in North America
($787.5 million) and Europe ($177.5 million) grew by 301% and 145%,
respectively.
---------------------------------------------------------------------------
The industry report further indicates that, in 2014 the worldwide
average size of a funded campaign was less than $4,000 for consumer
lending-based, reward-based, and donation-based crowdfunding
types.\1296\ Crowdfunded business loans and equity-based campaigns,
however, were substantially higher. In 2014, the global average size of
a funded peer-to-business lending-based crowdfunding campaign was
$103,618.\1297\ In 2014, a typical equity-based campaign was larger,
with the global average size of $275,461.\1298\ These figures suggest
that the types of ventures financed through equity-based crowdfunding
could be different than those financed through other crowdfunding
methods. In 2014, the average size of a funded equity-based campaign in
North America was $175,000.\1299\
---------------------------------------------------------------------------
\1296\ Id. at 59.
\1297\ Id. at 60.
\1298\ Id. at 60.
\1299\ Id. at 60. The report does not provide the average size
of North American donation-based, reward-based, or lending-based
crowdfunding campaigns. The report notes that, in 2014, the average
funded North American donation-based and reward-based campaigns were
56% and 54%, respectively, of the average size of funded European
donation-based and reward-based campaigns. Id. at 60.
---------------------------------------------------------------------------
Since the passage of the JOBS Act, many U.S. states have made
changes to their securities laws to accommodate intrastate securities-
based crowdfunding transactions. Based on information from NASAA, as of
September 2015, 29 states and the District of Columbia have enacted
state crowdfunding provisions that rely, at the federal level, on the
intrastate offering exemptions under Securities Act Section 3(a)(11)
and Rule 147 or on Rule 504 of Regulation D. These state crowdfunding
rules allow businesses in a state to use securities-based crowdfunding
to raise capital from investors within that state.\1300\ There is
limited information available to us about the scope of domestic
crowdfunding activity in reliance on the intrastate exemptions. Since
December 2011, when the first state (Kansas) enacted its crowdfunding
provisions, 118 state crowdfunding offerings have been reported to be
filed with the respective state regulator and 102 were reported to be
approved or cleared, as of August 1, 2015.\1301\
---------------------------------------------------------------------------
\1300\ See NASAA's Intrastate Crowdfunding Resource Center at
http://www.nasaa.org/industry-resources/corporation-finance/instrastate-crowdfunding-resource-center/, accessed in September
2015. See also NASAA's State Crowdfunding Update, available at:
http://nasaa.cdn.s3.amazonaws.com/wp-content/uploads/2014/12/Intrastate-Crowdfunding-Overview-2015.pdf.
\1301\ Based on information provided by NASAA. The jurisdictions
included in the estimate are Alabama, District of Columbia, Georgia,
Idaho, Indiana, Kansas, Maine, Maryland, Massachusetts, Michigan,
Oregon, Texas, Vermont, Washington, and Wisconsin.
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4. Survival Rates for Startups and Small Businesses
Startups and small businesses that lack tangible assets or business
experience needed to obtain conventional financing might turn to
[[Page 71489]]
securities-based crowdfunding in reliance on Section 4(a)(6) as an
attractive potential source of financing. There is broad evidence that
many of these potential issuers are likely to fail after receiving
funding. For example, a 2010 study reports that of a random sample of
4,022 new high-technology businesses started in 2004, only 68% survived
by the end of 2008.\1302\
---------------------------------------------------------------------------
\1302\ See Alicia Robb, E.J. Reedy, Janice Ballou, David
DesRoches, Frank Potter and Zhanyun Zhao, An Overview of the
Kauffman Firm Survey: Results from the 2004-2008 Data, Kauffman
Foundation, available at http://www.kauffman.org/uploadedFiles/kfs_2010_report.pdf (``Kauffman Firm Survey'').
---------------------------------------------------------------------------
Similarly, other studies suggest that startups and small businesses
financed by venture capitalists also tend to have high failure rates.
One study finds that for 16,315 VC-backed companies that received their
first institutional funding round between 1980 and 1999, approximately
one-third failed after the first funding round.\1303\ Additionally,
another study of more than 2,000 companies that received at least $1
million in venture funding, from 2004 through 2010, finds that almost
three-quarters of these companies failed.\1304\ Another study, based on
a sample ending in 2005, found cumulative failure rates of 34.1% for
VC-financed firms and 66.3% for non-VC-financed firms, with the
difference driven by lower failure rates of VC-financed firms in the
initial years after receiving VC financing.\1305\
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\1303\ See Yael V. Hochberg, Alexander Ljungqvist and Yang Lu,
Whom You Know Matters: Venture Capital Networks and Investment
Performance, 62 J. of Fin. 251-301 (2007).
\1304\ See Deborah Gage, The Venture Capital Secret: 3 Out of 4
Start-Ups Fail, Wall St. J., Sept. 19, 2012.
\1305\ See Puri, note 1281. According to this study, the
difference in the outcomes of VC-financed and non-VC-financed firms
decreases after accounting for observable differences in firm
characteristics, but it does not disappear. However, as the study
notes, in evaluating the remaining differences in the outcomes of
VC-financed and non-VC-financed firms, it is not possible to fully
differentiate the effects of superior selection on the basis of
unobservable firm characteristics from the effects of VC monitoring
and expertise.
---------------------------------------------------------------------------
Taken all together, the failure rates documented in these studies
are high for startups and small businesses, even with the involvement
of sophisticated investors like VCs. Because we expect that issuers
that will engage in offerings made in reliance on Section 4(a)(6) will
be in an earlier stage of business development than the businesses
included in the above studies, we believe that issuers that engage in
securities-based crowdfunding may have higher failure rates than those
in the studies cited above.
5. Market Participants
The final rules will have their most significant impact on the
market for the financing of startups and small businesses. The number
of participants in this market and the amounts raised through
alternative sources indicate that this is a large market. In 2013,
there were more than 5 million small businesses, defined by the U.S.
Census Bureau as having fewer than 500 paid employees.\1306\ As of June
2014, FDIC-insured depositary institutions held approximately $590
billion in approximately 23.4 million small business loans.\1307\
According to the SBA's fiscal year 2014 annual performance report,
approximately 51,500 small businesses received funding in 2014 through
SBA's main lending programs, 7(a) and 504 loans.\1308\ In 2014, VCs
invested $49.3 billion of capital in in 4,361 transactions involving
3,665 startups, according to an industry source.\1309\ In 2014, angel
investors contributed $24.1 billion, with approximately 73,400
entrepreneurial ventures receiving angel funding.\1310\
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\1306\ See U.S. Department of Commerce, United States Census
Bureau, Business Dynamics Statistics, Data: Firm Characteristics
(2013), available at http://www.census.gov/ces/dataproducts/bds/data_firm.html.
\1307\ For the purposes of this figure, small business loans are
defined as loans secured by nonfarm nonresidential properties and
commercial and business loans of $1,000,000 or less. See FDIC
Statistics, note 1254.
\1308\ See 2014 Annual Performance Report, note 1262.
\1309\ See NVCA, note 1277.
\1310\ See Sohl, note 1282.
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Below, we analyze the economic effect of the final rules on the
following parties: (1) Issuers, typically startups and small
businesses, that seek to raise capital by issuing securities; (2)
intermediaries through which issuers seeking to engage in transactions
in reliance on Section 4(a)(6) will offer and sell their securities;
(3) investors who purchase or may consider purchasing securities in
such offerings; and (4) other capital providers, broker-dealers and
finders who currently participate in private offerings. The potential
economic impact of the final rules will depend on how these market
participants respond to the final rules. Each of these parties is
discussed in further detail below.
a. Issuers
The final rules will permit certain entities to raise capital by
issuing securities for the first time. The number, type and size of the
potential issuers that will seek to use crowdfunding to offer and sell
securities in reliance on Section 4(a)(6) is uncertain, but data on
current market practices may help identify the number and
characteristics of potential issuers.
It is challenging to precisely predict the number of future
securities offerings that might rely on Section 4(a)(6), particularly
because rules governing the process are being adopted today.\1311\
---------------------------------------------------------------------------
\1311\ See also Section IV.B.1.
---------------------------------------------------------------------------
According to filings made with the Commission, from 2009 to 2014,
there were approximately 4,559 issuers per year in new Regulation D
offerings with offer sizes of up to $1 million (excluding issuers that
are pooled investment vehicles), including approximately 1,020 (22%)
per year that reported having no revenue and approximately 861 (19%)
per year that reported revenues of up to $1 million.\1312\ Among
issuers in new Regulation D offerings with offer sizes of up to $1
million (excluding issuers that are pooled investment vehicles) during
this period, the overwhelming majority of issuers (approximately 80%)
are younger than 5 years old, with the median age of approximately one
year. Approximately 92% of these issuers were organized as either a
corporation or a limited liability company.
---------------------------------------------------------------------------
\1312\ In addition, in an average year, approximately 50% of
issuers in new Regulation D offerings with offer sizes of up to $1
million (excluding issuers that are pooled investment vehicles)
declined to disclose their revenues. It is also possible that some
issuers in Regulation D offerings that report revenues in excess of
$1 million may participate in offerings in reliance on Section
4(a)(6).
---------------------------------------------------------------------------
It is expected that many future issuers of securities in
crowdfunding offerings would have otherwise raised capital from one of
the alternative sources of financing discussed above, while others
would have been financed by friends and family or not financed at all.
Due to the differences between small business loans (including SBA-
guaranteed loans) and securities-based crowdfunding offerings that can
be conducted under the final rules, we are not able to estimate how
many small businesses utilizing these forms of financing may instead
pursue an offering in reliance on Section 4(a)(6). Similarly, due to
the differences between the terms of crowdfunding campaigns in
existence today and the provisions of the final rules, is not clear how
many current campaigns can instead become offerings in reliance on
Section 4(a)(6).\1313\
[[Page 71490]]
Hence, while some of the businesses using these alternative funding
sources may become issuers offering and selling securities in reliance
on Section 4(a)(6) in the future, we cannot know how many of these
businesses will elect securities-based crowdfunding in reliance on
Section 4(a)(6) once it becomes available, nor can we know how many
future businesses may not be financed at all.
---------------------------------------------------------------------------
\1313\ A recent industry report estimated that the equity-based
crowdfunding volume in North America in 2014 was $787.5 million and
the average size of a successful equity-based crowdfunding campaign
was $175,000. See Massolution 2015 at 55 and 60. This allows us to
estimate approximately 4,500 successful equity-based crowdfunding
campaigns for North America in 2014. The report does not provide
statistics for the United States alone. Equity-based crowdfunding
campaigns in the United States are currently limited to accredited
investors or intrastate offerings in certain jurisdictions. Further,
the industry report does not provide information that would allow us
to estimate the number of crowdfunding campaigns of other types
(such as reward-based or donation-based) in North America or the
United States in 2014. We note that many such campaigns,
particularly those that relate to individual projects, may not have
a defined or sustained business model commensurate with typical
issuers of securities. In particular, many of the current reward-
based or donation-based crowdfunding projects likely entail
endeavors that may not be suitable to a long-lived securities
issuance (e.g., certain artistic endeavors or artistic projects).
---------------------------------------------------------------------------
We believe that many potential issuers of securities through
crowdfunding will be startups and small businesses that are close to
the ``idea'' stage of the business venture and that have business plans
that are not sufficiently well-developed or do not offer the growth
potential or business model to attract VCs or angel investors. In this
regard, a study of one large platform revealed that relatively few
companies on that platform operate in technology sectors that typically
attract VC investment activity.\1314\
---------------------------------------------------------------------------
\1314\ See Ethan R. Mollick, The Dynamics of Crowdfunding: An
Exploratory Study, Working Paper (June 26, 2013), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2088298.
---------------------------------------------------------------------------
b. Intermediaries
Section 4(a)(6)(C) requires that an offer and sale of securities in
reliance on Section 4(a)(6) be conducted through a registered funding
portal or a broker. Registered broker-dealers, both those that are
already registered with the Commission and those that will register,
might wish to facilitate securities-based crowdfunding transactions.
New entrants that do not wish to register as broker-dealers might
decide to register as funding portals to facilitate securities-based
crowdfunding transactions in reliance on Section 4(a)(6). Donation-
based or reward-based crowdfunding platforms with established customer
relationships might seek to leverage these relationships and register
as funding portals, or register as or associate with registered broker-
dealers. Although the number of potential intermediaries that will fill
these roles is uncertain, practices of existing broker-dealers and
crowdfunding platforms provide insight into how the market might
develop.
Based on FOCUS Reports filed with the Commission, as of December
2014, there were 4,267 broker-dealers registered with the Commission,
with average total assets of approximately $1.1 billion per broker-
dealer. The aggregate total assets of these registered broker-dealers
are approximately $4.9 trillion. Of these registered broker-dealers,
816 also are dually registered as investment advisers.
Existing crowdfunding platforms are diverse and actively involved
in financing, allowing thousands of projects to search for capital. A
recent industry report estimates that, as of 2014, 1,250 crowdfunding
platforms were operating worldwide, including 375 platforms operating
in North America.\1315\ Globally, approximately 19% (236) of platforms
were engaged in equity-based crowdfunding, 18.3% in lending-based
crowdfunding, 22.6% in donation-based crowdfunding, 28.9% in reward-
based crowdfunding, with the remainder engaged in royalty-based and
hybrid crowdfunding.\1316\ An earlier industry report indicated that
crowdfunding platforms typically charge entrepreneurs a ``transaction
fee'' that is based on how large the target amount is and/or upon
reaching the target and that fees from survey participants worldwide
ranged from 2% to 25%, with an average of 7% in North America and
Europe.\1317\ The 2012 industry report provides one case study of fees
for a ``large-securities-based CFP'' stating ``[t]here are no
management fees for uncommitted capital, but a ``2 and 20'' arrangement
is set on deals funded.'' \1318\
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\1315\ See Massolution 2015 at 84. The report does not provide
separate statistics for the United States.
\1316\ Id. at 89.
\1317\ See Massolution Crowdfunding Industry Report: Market
Trends, Composition and Crowdfunding Platforms (May 2012)
(``Massolution 2012'') at 38.
\1318\ Id.
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We do not know at present which market participants will become
intermediaries under Section 4(a)(6) and Regulation Crowdfunding, but
we believe that existing crowdfunding platforms might seek to leverage
their already-existing Internet-based platforms, brand recognition and
user bases to facilitate offerings in reliance on Section
4(a)(6).\1319\
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\1319\ For example, the Massolution 2012 industry report
suggests that funding portal reputation is important in the
crowdfunding market, especially for equity-based crowdfunding. See
Massolution 2012 at 46.
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Under the statute and the final rules, funding portals are
constrained in the services they can provide, and persons (or entities)
seeking the ability to participate in activities unavailable to funding
portals, such as offering investment advice or holding, managing,
possessing or otherwise handling investor funds, would instead need to
register as broker-dealers or investment advisers, depending on their
activities. Although we expect that initially, upon adoption of the
final rules, more new registrants will register as funding portals than
as broker-dealers given the less extensive regulatory requirements
imposed on funding portals, it is possible that market competition to
offer broker-dealer services as part of intermediaries' service
capabilities might either drive more broker-dealer growth in the longer
term or provide registered funding portals with the incentive to form
long-term partnerships with registered broker-dealers. One commenter
suggested that funding portals may find it beneficial to cooperate with
registered broker-dealers and transfer agents.\1320\ Other commenters
on the proposal did not provide additional information on this issue.
There is anecdotal evidence that such partnerships are already forming
under existing regulations in crowdfunding transactions involving
accredited investors.\1321\ The final rules provide that intermediaries
will be deemed to have satisfied the requirement to have a reasonable
basis for believing that an issuer has established means to keep
accurate records of the holders of the securities it would offer and
sell through the
[[Page 71491]]
intermediary's platform if the issuer has engaged the services of a
registered transfer agent.\1322\ This registered transfer agent safe
harbor may lead intermediaries to encourage issuers to use a registered
transfer agent.
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\1320\ See TinyCat Letter (but noting that such partnerships
should be optional).
\1321\ See David Drake, Rich Man's Crowd Funding, Forbes, Jan.
15, 2013, available at http://www.forbes.com/sites/groupthink/2013/01/15/rich-mans-crowd-funding/. See also Mohana Ravindranath, For
broker/dealers, crowdfunding presents new opportunity, Wash. Post,
Mar. 29, 2013, available at http://www.washingtonpost.com/business/on-small-business/for-brokerdealers-crowdfunding-presents-new-opportunity/2013/03/28/bb835942-8075-11e2-8074-b26a871b165a_story.html; J.J. Colao, In the Crowdfunding Gold Rush,
This Company Has a Rare Edge, Forbes, June 5, 2013, available at
http://www.forbes.com/sites/jjcolao/2013/06/05/in-the-crowdfunding-gold-rush-this-company-has-a-rare-edge/; Arina Shulga, Crowdfunding
Right Now (Fund Model, Broker-Dealer Model, Lending Platforms and
Intrastate Offerings), LexisNexis.com, Aug. 7, 2014, available at
http://www.lexisnexis.com/legalnewsroom/banking/b/venture-capital/archive/2014/08/07/crowdfunding-right-now-fund-model-broker-dealer-model-lending-platforms-and-intrastate-offerings.aspx; Alessandra
Malito, Broker-dealer expands crowdfunding reach with new
partnership, InvestmentNews, Apr. 14, 2015, available at http://www.investmentnews.com/article/20150414/FREE/150419972/broker-dealer-expands-crowdfunding-reach-with-new-partnership.
\1322\ See Rule 301(b) of Regulation Crowdfunding.
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c. Investors
It is unclear what types of investors will participate in offerings
made in reliance on Section 4(a)(6), but given the investment
limitations in the final rules, we believe that many investors affected
by the final rules will likely be individual retail investors who
currently do not have broad access to investment opportunities in
early-stage ventures. Offerings made in reliance on Section 4(a)(6) may
provide retail investors with additional investment opportunities,
although the extent to which they invest in such offerings will likely
depend on their view of the potential return on investment as well as
the risk for fraud.
In contrast, larger, more sophisticated or well-funded investors
may be less likely to invest in offerings made in reliance on Section
4(a)(6). The relatively low investment limits set by the statute for
crowdfunding investors may make these offerings less attractive for
professional investors, including VCs and angel investors.\1323\ While
an offering made in reliance on Section 4(a)(6) can bring an issuer to
the attention of these investors, it is possible that professional
investors will prefer, instead, to invest in offerings in reliance on
Rule 506, which are not subject to the investment limitations
applicable to offerings made in reliance on Section 4(a)(6).
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\1323\ An observer suggests that, unlike angels, VCs may be less
interested in crowdfunding because, if VCs rely on crowdfunding
sites for their deal flow, it would be difficult to justify charging
a 2% management fee and 20% carried interest to their limited
partners. See Ryan Caldbeck, Crowdfunding--Why Angels, Venture
Capitalists And Private Equity Investors All May Benefit, Forbes,
Aug. 7, 2013.
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d. Other Capital Providers, Broker-Dealers and Finders in Private
Offerings
The final rules may affect other parties that provide sources of
capital, such as small business lenders, VCs, family and friends and
angel investors that currently finance small private businesses. The
current scope of financing provided by these capital providers is
discussed above. As discussed below, the magnitude of the final rules'
economic impact will depend on whether crowdfunding in reliance on
Section 4(a)(6) emerges as a substitute or a complement to these
financing sources.
In addition, issuers conducting private offerings may, outside of
offerings in reliance on Section 4(a)(6), currently use broker-dealers
to help them with various aspects of the offering and to help ensure
compliance with the ban on general solicitation and advertising that
exists for most private offerings. Private offerings also could involve
finders who connect issuers with investors for a fee.\1324\ These
private offering intermediaries also may be affected by the final
rules, because once issuers can undertake offerings in reliance on
Section 4(a)(6), some issuers might no longer need the services of
those broker-dealers and finders.
---------------------------------------------------------------------------
\1324\ Depending on their activities, these persons may need to
be registered as broker-dealers.
---------------------------------------------------------------------------
Although we are unable to predict the exact size of the market for
broker-dealers and finders in private offerings that are comparable to
those that the final rules permit, data on the use of broker-dealers
and finders in the Regulation D markets suggest that they may not
currently play a large role in private offerings. Based on a staff
study, only 21% of all new Regulation D offerings from 2009 to 2014
used an intermediary such as a broker-dealer or a finder.\1325\ The use
of a broker-dealer or a finder increased with offering size; they
participated in approximately 17% of offerings for up to $1 million and
30% of offerings for more than $50 million. Moreover, the fee tends to
decrease with offering size. Unlike the gross spreads in registered
offerings, the differences in fees for Regulation D offerings of
different sizes are large: the average total fee (commission plus
finder fee) paid by issuers conducting offerings of up to $1 million
(6.4% in 2014) is almost three times larger on a percentage basis than
the average total fee paid by issuers conducting offerings of more than
$50 million (1.9% in 2014).\1326\ These estimates, however, only
reflect practices in the Regulation D market. It is possible that
issuers engaging in other types of private offerings (e.g., those
relying on Section 4(a)(2)), for which we do not have data, may use
broker-dealers and finders more frequently and have different fee
structures.
---------------------------------------------------------------------------
\1325\ See Unregistered Offerings White Paper, note 1230.
\1326\ ID.
---------------------------------------------------------------------------
B. Analysis of Final Rules
As noted above, we are mindful of the costs and benefits of the
final rules, as well as the impact that the final rules may have on
efficiency, competition and capital formation. In enacting Title III,
Congress established a framework for a new type of exempt offering and
required us to adopt rules to implement that framework. To the extent
that crowdfunding rules are successfully utilized, the crowdfunding
provisions of the JOBS Act are expected to provide startups and small
businesses with the means to raise relatively modest amounts of
capital, from a broad cross section of investors, through securities
offerings that are exempt from registration under the Securities Act.
They also are expected to permit small investors to participate in a
wider range of securities offerings than may be currently
available.\1327\ Specifically, the statutory provisions and the final
rules address several challenges specific to financing startups and
small businesses, including, for example, accessing a large number of
investors, the regulatory requirements associated with issuing a
security, protecting investors and making such securities offerings
cost-effective for the issuer.
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\1327\ See, e.g., 158 Cong. Rec. S1781 (daily ed. Mar. 19, 2012)
(statement of Sen. Carl Levin) (``Right now, the rules generally
prohibit a company from raising very small amounts from ordinary
investors without significant costs.'').
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In the sections below, we analyze the costs and benefits associated
with the crowdfunding regulatory regime, as well as the potential
impacts of such a regulatory regime on efficiency, competition and
capital formation, in light of the baseline discussed above.
1. Broad Economic Considerations
In this release, we discuss the potential costs and benefits of the
final rules. Many of these costs and benefits are difficult to quantify
or estimate with any degree of certainty, especially considering that
Section 4(a)(6) provides a new method for raising capital in the United
States. Some costs are difficult to quantify or estimate because they
represent transfers between various participants in a market that does
not yet exist. For instance, costs to issuers can be passed on to
investors and costs to intermediaries can be passed on to issuers and
investors. These difficulties in estimating and quantifying such costs
are exacerbated by the limited public data that indicates how issuers,
intermediaries and investors will respond to these new capital raising
opportunities.
The discussion below highlights several general areas where
uncertainties about the new crowdfunding market might affect the
potential costs and benefits of the final rules, as well as our ability
to quantify those costs and benefits. It also highlights the potential
effects on
[[Page 71492]]
efficiency, competition and capital formation.
The extent to which the statute and the final rules affect capital
formation and the cost of capital to issuers depends in part on the
issuers that choose to participate. In particular, if offerings in
reliance on Section 4(a)(6) only attract issuers that are otherwise
able to raise capital through another type of exempt offering, the
statute and the final rules may result in a redistribution of capital
flow, which may enhance allocative efficiency but have a limited impact
on the aggregate level of capital formation.\1328\
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\1328\ For example, a 2012 GAO report on Regulation A offerings
suggests that a significant decline in the use of this funding
alternative after 1997 could be partially attributed to a shift to
Rule 506 offerings under Regulation D, as a result of the preemption
of state law registration requirements for Rule 506 offerings that
occurred in 1996. See GAO Report, note 1231.
---------------------------------------------------------------------------
Notwithstanding the existence of these alternative methods of
capital raising, we believe that offerings pursuant to Section 4(a)(6)
will likely represent a new source of capital for many small issuers
that currently have difficulty raising capital. Startups and small
businesses usually have smaller and more variable cash flows than
larger, more established companies, and internal financing from their
own business operations tends to be limited and unstable. Moreover,
these businesses tend to have smaller asset bases \1329\ and, thus,
less collateral for traditional bank loans. As discussed above,
startups and small businesses, which are widely viewed to have more
financial constraints than publicly-traded companies and large private
companies, could therefore benefit significantly from a securities-
based crowdfunding market. Some small businesses may not qualify for
traditional bank loans and may find alternative debt financing too
costly or incompatible with their financing needs. While some small
businesses may attract equity investments from angel investors or VCs,
other small businesses, particularly, businesses at the seed stage may
have difficulty obtaining external equity financing from these sources.
We believe that the statute, as implemented by the final rules, may
increase both capital formation and the efficiency of capital
allocation among small issuers by expanding the range of methods of
external financing available to small businesses and the pool of
investors willing to finance such types of businesses. The extent to
which such issuers will use the Section 4(a)(6) offering exemption,
however, is difficult to assess.
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\1329\ See, e.g., John Asker, Joan Farre-Mensa and Alexander
Ljungqvist, Corporate Investment and Stock Market Listing: A Puzzle?
European Corporate Governance Institute Finance Working Paper (June
2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1603484.
---------------------------------------------------------------------------
If startups and small businesses find other capital raising options
more attractive than securities-based crowdfunding, the impact of
Section 4(a)(6) on capital formation may be limited. Even so, the
availability of securities-based crowdfunding as a financing option may
increase competition among suppliers of capital, resulting in a
potentially lower cost of capital for all issuers, including those that
choose not to use securities-based crowdfunding.
For issuers that pursue offerings in reliance on Section 4(a)(6),
establishing an initial offering price might be challenging. Offerings
relying on Section 4(a)(6) will not involve an underwriter who, for
larger offerings, typically assists the issuer with pricing and placing
the offering. Investors in offerings relying on Section 4(a)(6) may
lack the sophistication to evaluate the offering price. Thus, the
involvement of these investors, who are likely to have a more limited
capacity for conducting due diligence on deals, may contribute to less
accurate valuations.
Moreover, because of the investment limitations in securities-based
crowdfunding transactions, there may not be a strong incentive, even
assuming adequate knowledge and experience, for an investor to perform
a thorough analysis of the issuer disclosures. To the extent that these
potential information asymmetries resulting from the lack of a thorough
analysis of the disclosures are anticipated by prospective investors,
investor participation in offerings made in reliance on Section 4(a)(6)
may decline and the associated benefits of capital formation may be
lower.
Uncertainty surrounding exit strategies for investors in
crowdfunding offerings also may limit the benefits. In particular, it
is unlikely that purchasers in crowdfunding transactions will be able
to follow the typical path to liquidity that investors in other exempt
offerings follow. For instance, investors in a VC-backed startup may
eventually sell their securities in an initial public offering on a
national securities exchange or to another company in an
acquisition.\1330\ We anticipate that most businesses engaging in
offerings in reliance on Section 4(a)(6) will be unlikely to progress
directly to an initial public offering on a national securities
exchange given their small size,\1331\ and investors may lack adequate
strategies or opportunities to eventually divest their holdings.\1332\
A sale of the business will require the issuer to have a track record
in order to attract investors with the capital willing to buy the
business.
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\1330\ See Gompers, note 1249.
\1331\ As noted, under the statute and the final rules, issuers
relying on Section 4(a)(6) would be limited to raising an aggregate
of $1 million during a 12-month period. By contrast, as noted in the
IPO Task Force, the size of an initial public offering generally
exceeds $50 million. See IPO Task Force, note 1223.
\1332\ In contrast, given the required investor qualifications
and offering limit amounts, Regulation D offerings may generally
attract issuers that are more experienced and better capitalized.
Moreover, such offerings are likely to have a larger proportion of
accredited investors because, in contrast to securities-based
crowdfunding, there are no limitations on individual investment
amounts. As a result, we believe that Regulation D issuers and
investors are more likely to have potential exit strategies in
place.
---------------------------------------------------------------------------
Further, the likely broad geographical dispersion of crowdfunding
investors may make shareholder coordination difficult. It may also
exacerbate information asymmetries between issuers and investors, if
the distance between them diminishes the ability for investors to
capitalize on local knowledge that may be of value in assessing the
viability of the issuer's business. The use of electronic means may
mitigate some of these difficulties. Even if an issuer can execute a
sale or otherwise offer to buy back or retire the securities, it might
be difficult for investors to determine whether the issuer is offering
a fair market price. These uncertainties may limit the use of the
Section 4(a)(6) exemption.
The potential benefits of the final rules also may depend on how
investors respond to potential liquidity issues unique to the
securities-based crowdfunding market. It is currently unclear how
securities offered and sold in transactions conducted in reliance on
Section 4(a)(6) will be transferred in the secondary market after the
one-year restricted period ends, and investors who purchased securities
in transactions conducted in reliance on Section 4(a)(6) and who seek
to divest their securities may not find a liquid market.\1333\ Assuming
a secondary market develops, securities may be quoted on the over-the-
counter market or on trading platforms for shares of private
companies.\1334\ Nevertheless, it
[[Page 71493]]
is possible that secondary trading costs for investors may be
substantial, effective and quoted spreads may be wide, trading volume
may be low, and price volatility may be high compared to those of
listed securities.\1335\ Illiquidity, to different degrees, remains a
concern for other exempt offerings and for registered offerings by
small issuers. However, because investors purchasing securities sold in
reliance on Section 4(a)(6) may be less sophisticated than investors in
other private offerings due to the fact that there are no investor
qualification requirements, they may face additional challenges in
addressing the impact of illiquidity, either in finding a suitable
trading venue or negotiating with the issuer for an alternative
liquidity option. The potentially high degree of illiquidity associated
with securities purchased in reliance on Section 4(a)(6) may discourage
some investors from investing in issuers through such offerings, thus
limiting the potential efficiency, competition and capital formation
benefits of the final rules.
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\1333\ Academic studies have shown that the over-the-counter
market is less liquid than the national exchanges. See Nicolas
Bollen and William Christie, Market Microstructure of the Pink
Sheets, 33 J. Banking & Fin. 1326-1339 (2009); Andrew Ang, Assaf
Shtauber and Paul Tetlock, Asset Pricing in the Dark: The Cross
Section of OTC Stocks, 26 Rev. Fin. Stud. 2985-3028 (2013).
\1334\ Given the services that funding portals are permitted to
provide under the statute and the final rules, investors will not be
able to use funding portals to trade in securities offered and sold
in reliance on Section 4(a)(6) in the secondary market.
\1335\ Academic studies show that reducing the information
transparency about an issuer increases the effective and quoted
spreads of its shares, reduces share price and increases price
volatility. Specifically, percentage spreads triple and volatility
doubles when NYSE issuers are delisted to the Pink Sheets. See
Jonathan Macey, Maureen O'Hara and David Pompilio, Down and Out in
the Stock Market: The Law and Finance of the Delisting Process, 51
J.L. & Econ 683-713 (2008). When NASDAQ issuers delist and
subsequently trade on the OTC Bulletin Board and/or the Pink Sheets,
share volume declines by two-thirds, quoted spreads more than
double, effective spreads triple and volatility triples. See Jeffrey
H. Harris, Venkatesh Panchapagesan and Ingrid M. Werner, Off But Not
Gone: A Study of NASDAQ Delistings, Fisher College of Business
Working Paper No. 2008-03-005 and Dice Center Working Paper No.
2008-6 (Mar. 4, 2008), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=628203. One factor that may alleviate
transparency concerns is the fact that issuers that sold securities
in an offering made in reliance on Section 4(a)(6) will have an
ongoing reporting obligation, so disclosure of information about the
issuer will continue to be required.
---------------------------------------------------------------------------
Even with the mandated disclosures, unsophisticated investors
purchasing securities issued in reliance on Section 4(a)(6) may face
certain expropriation risks, potentially limiting the upside of their
investment, even when they select investments in successful ventures.
This can occur if issued securities include certain features (e.g.,
callable securities or securities with differential control rights) or
if issuers conduct insider-only financing rounds or financing rounds at
reduced prices (so-called ``down rounds'') that have the effect of
diluting an investor's interest or otherwise diminishing the value of
the securities offered and sold in reliance on Section 4(a)(6).
Investors purchasing securities issued in reliance on Section 4(a)(6)
may not have the experience or the market power to negotiate various
anti-dilution provisions, right of first refusal, tag-along rights,
superior liquidation preferences and rights upon a change in control
that have been developed by institutional and angel investors as
protections against fundamental changes in a business.\1336\ Moreover,
the disperse ownership stakes of investors in securities-based
crowdfunding offerings may weaken their incentives to monitor the
issuer to minimize the risk of expropriation. The ensuing expropriation
risk may discourage some investors from participating in offerings made
in reliance on Section 4(a)(6), potentially limiting the efficiency,
competition and capital formation benefits of the final rules.
---------------------------------------------------------------------------
\1336\ See Kaplan, note 1279.
---------------------------------------------------------------------------
The final rules also may have an effect on broker-dealers and
finders participating in private offerings. Some issuers that
previously relied on broker-dealers and finders to assist with raising
capital through private offerings may, instead, begin to rely on the
Section 4(a)(6) exemption to find investors. The precise impact of the
final rules on these intermediaries will depend on whether (and, if so,
to what extent) issuers switch from using existing exemptions to using
the exemption provided by Section 4(a)(6) or whether the final rules
primarily attract new issuers. The impact of the final rules on
registered broker-dealers will also depend on the extent to which
broker-dealers participate as intermediaries in the securities-based
crowdfunding market. If a significant number of issuers switch from
raising capital under existing private offering exemptions to relying
on the exemption provided by Section 4(a)(6), this may negatively
affect the revenue of finders and broker-dealers in the private
offerings market. While this may disadvantage existing private offering
market intermediaries, the new competition may ultimately lead to more
efficient allocation of capital.
If securities-based crowdfunding primarily attracts new issuers to
the market, the impact on broker-dealers and finder revenue may be
negligible and the final rules may even have a positive effect on their
revenues by revealing more potential clients for them, particularly to
the extent that they chose to operate a funding portal. Additionally,
greater investor interest in private company investment may increase
capital formation, creating new opportunities for broker-dealers and
finders that otherwise would have been unavailable.
The final rules also may encourage current participants in the
crowdfunding market to diversify their funding models to attract a
broader group of companies and to provide additional investment
opportunities for investors. For example, donation-based crowdfunding
platforms that currently offer investment opportunities in micro-loans
generally do not permit donors to collect interest on their investments
because of concerns that this activity will implicate the federal
securities laws unless an exemption from registration is
available.\1337\ Under the final rules, these platforms may choose to
register as funding portals and permit businesses to offer securities
that provide investors with the opportunity to obtain a return on
investment. This can broaden their user base and attract a group of
investors different from those already participating in reward-based or
donation-based crowdfunding. It is likely that some registered broker-
dealers will find it profitable to enter the securities-based
crowdfunding market and operate funding portals as well. Such an entry
will increase the competition among intermediaries and likely lead to
lower issuance costs for issuers.
---------------------------------------------------------------------------
\1337\ See, e.g., Deutsche Bank Microcredit Development Fund,
Inc., SEC No-Action Letter (Apr. 8, 2012).
---------------------------------------------------------------------------
However, many projects that are well suited for reward-based or
donation-based crowdfunding (e.g., because they have finite lives,
their payoffs to investors could come before the project is completed
or could be contingent on the project's success, etc.) may have little
in common with startups and small businesses that are well suited for
an offering in reliance on Section 4(a)(6). As a result,
diversification among existing platforms may not always be optimal or
preferred, particularly if complying with the final rules proves
disproportionately costly compared to the potential amount of capital
to be raised.
2. Crowdfunding Exemption
a. Limitation on Capital Raised
The statute imposes certain limitations on the total amount of
securities that may be sold by an issuer during the 12-month period
preceding the date of the transaction made in reliance on Section
4(a)(6). Specifically, Section 4(a)(6)(A) provides for a maximum
aggregate amount of $1 million sold in reliance on the exemption during
a 12-month
[[Page 71494]]
period.\1338\ The final rules preserve the $1 million limit. The
limitation on the amount that may be raised is expected to benefit
investors by reducing the potential loss from dilution or fraud \1339\
in the securities-based crowdfunding market. However, we recognize that
this limit on the amount that may be sold in reliance on Section
4(a)(6) also can prevent certain issuers from raising all the capital
they need to make their businesses viable, which in turn can result in
lost opportunities, as indicated by various commenters.\1340\ It also
is likely to limit efficiency to the extent that capital cannot be
channeled to the most productive use. Due to the lack of data, however,
we are not able to quantify the unrealized efficiency or capital
formation associated with the adoption of the $1 million limit instead
of the alternative of a higher limit. Since issuers in securities-based
crowdfunding offerings bear certain fixed costs, as discussed in
Section III.B.3., offering costs as a percentage of offering proceeds
will be larger under the $1 million limit than under the alternative of
a higher limit.
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\1338\ See also Rule 100(a)(1) of Regulation Crowdfunding.
\1339\ While we lack information to predict the potential
incidence of fraud in securities-based crowdfunding offerings made
in reliance on Section 4(a)(6) and note that current crowdfunding
practices differ significantly from the securities-based
crowdfunding market that may develop upon effectiveness of the final
rules, some concern has been expressed about the potential for fraud
in this area. See, e.g., NASAA Enforcement Report: 2015 Report on
2014 data, September 2015, available at http://nasaa.cdn.s3.amazonaws.com/wp-content/uploads/2011/08/2015-Enforcement-Report-on-2014-Data_FINAL.pdf (listing Internet fraud
(including social media and crowdfunding) among the products and
schemes that are frequently investigated by states, without
statistics specific to securities-based crowdfunding).
\1340\ See, e.g., Advanced Hydro Letter; Bushroe Letter; Cole D.
Letter; Concerned Capital Letter; Hamman Letter; Harrison Letter;
Hillside Letter; Jazz Letter; Kickstarter Coaching Letter; McCulley
Letter; McGladrey Letter; Meling Letter; Miami Nation Enterprises
Letter; Multistate Tax Service Letter; Peers Letter; Pioneer Realty
Letter; Public Startup Letter 2; Qizilbash Letter; Rosenthal O.
Letter; Sarles Letter; SBM Letter; Taylor R. Letter; Taylor T.
Letter; Wales Capital Letter 1; Wales Capital Letter 3; WealthForge
Letter; Wear Letter; Wilhelm Letter; Winters Letter; Yudek Letter.
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As an alternative, we could have defined the $1 million limit to be
net of intermediary fees, as suggested by some commenters.\1341\ If a
funding portal announces in advance the fees it charges for a given
transaction (fixed or variable), the economic effects of such an
alternative definition would be qualitatively similar to the effects of
raising the offering limit. If the funding portal fees are not known in
advance, then this alternative may also create uncertainty for issuers
about how much capital they would be able to raise. Several commenters
opposed such an alternative.\1342\
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\1341\ See, e.g., Benjamin Letter; FundHub Letter 1; Hackers/
Founders Letter; Joinvestor Letter; Odhner Letter; Omara Letter;
Public Startup Letter 2; RFPIA Letter; RoC Letter; RocketHub Letter;
Seed&Spark Letter; Thomas Letter 1; Wales Capital Letter 1; Whitaker
Chalk Letter; Wilson Letter.
\1342\ See, e.g., Arctic Island Letter 4; ASSOB Letter;
Commonwealth of Massachusetts Letter; MCS Letter; PeoplePowerFund
Letter.
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The costs associated with not increasing the investment limit above
$1 million are mitigated in part by the ability of issuers to
concurrently seek additional financing in reliance on another type of
exempt offering, such as Regulation D or Regulation A, in addition to
the offering in reliance on Section 4(a)(6). In this release, we
provide guidance clarifying our view that issuers may conduct other
exempt offerings without having those offerings integrated with the
offering made in reliance on Section 4(a)(6), provided that each
offering complies with the applicable exemption relied upon for that
particular offering. Several commenters opposed this approach on the
ground that it could result in fewer investor protections than if the
offerings were integrated. Some commenters noted that a potential cost
to investors associated with not requiring integration is a reduction
in investor protection due to the possibility of an issuer's use of
advertising for one offering to indirectly promote another exempt
offering that would have been subject to more stringent advertising
restrictions.\1343\ While we recognize this concern, we note that the
final rules do not provide a blanket exemption from integration with
other private offerings that are conducted simultaneously with, or
around the same time as, a Section 4(a)(6) offering. Rather, we provide
guidance that an offering made in reliance on Section 4(a)(6) is not
required to be integrated with another exempt offering made by the
issuer to the extent that each offering complies with the requirements
of the applicable exemption that is being relied upon for that
particular offering. As mentioned earlier, an issuer conducting a
concurrent exempt offering for which general solicitation is not
permitted will need to be satisfied that purchasers in that offering
were not solicited by means of the offering made in reliance on Section
4(a)(6). Alternatively, an issuer conducting a concurrent exempt
offering for which general solicitation is permitted, for example,
under Rule 506(c), cannot include in any such general solicitation an
advertisement of the terms of an offering made in reliance on Section
4(a)(6), unless that advertisement otherwise complies with Section
4(a)(6) and the final rules. This may partly alleviate some of
commenters' concerns because each offering will have the investor
protections of the offering exemption upon which it relies.
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\1343\ See AFR Letter; BetterInvesting Letter; Consumer
Federation Letter; Fund Democracy Letter; IAC Recommendation; MCS
Letter.
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As an alternative, in line with the suggestions of some
commenters,\1344\ we could have provided guidance that the amounts
offered in reliance on Section 4(a)(6) should be integrated with the
amounts offered pursuant to other exempt offerings. Under such an
alternative, the amounts raised in other exempt offerings would count
toward the maximum offering amount under Section 4(a)(6). Such an
alternative would potentially limit the amount of capital raised by
issuers, including the set of issuers eligible to conduct an exempt
offering relying on Section 4(a)(6), and thus potentially limit the
capital formation benefits of the final rules. Compared to this
alternative, the ability of issuers to conduct other exempt offerings
that do not count toward the maximum offering amount under Section
4(a)(6) may alleviate some of the concerns that certain issuers will
not be able to raise sufficient capital. The net effect on capital
formation will also depend on whether issuers seeking an aggregate
exempt offering amount in excess of $1 million elect to rely on
Regulation Crowdfunding as part of their capital raising or elect to
rely on a different exemption, such as Rule 506 of Regulation D. These
considerations and the relative differences in the investor protections
associated with the different offering exemptions will determine the
net effect on the amount of information about issuers available to
market participants and the level of investor protection.
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\1344\ See, e.g., AFL-CIO Letter; Brown J. Letter; Consumer
Federation Letter; Fund Democracy Letter; MCS Letter; NASAA Letter.
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b. Investment Limitations
Since offering documents for offerings made in reliance on Section
4(a)(6) will not be subject to review by Commission staff prior to the
sale of securities, we are sensitive to potential investor protection
concerns arising from the participation of less sophisticated investors
in these exempt offerings. Some commenters \1345\ raised concerns that
the ``wisdom of the crowd'' will not result in investors pooling
information so as to lead to better informed
[[Page 71495]]
investment decisions.\1346\ While we acknowledge these concerns, we
note that, by adding Section 4(a)(6) to the Securities Act, Congress
made an express determination to facilitate securities-based
crowdfunding transactions under the federal securities laws, subject to
certain specified investor protections.
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\1345\ See, e.g., AFR Letter; Brown J. Letter; Consumer
Federation Letter.
\1346\ Predictions in research studies regarding the impact of
social interaction on investor decisions are mixed. On the one hand,
a recent study of opinions that were posted on the Internet Web site
http://seekingalpha.com finds evidence of predictability of earnings
surprises and returns that is interpreted as potentially suggesting
the value relevance of user opinions rather than a na[iuml]ve
investor reaction. See Hailiang Chen, Prabuddha de, Yu Hu, and
Byoung-Hyoun Hwang, Wisdom of Crowds: The Value of Stock Opinions
Transmitted Through Social Media, 27 Rev. Fin. Stud. 1367-1403
(2014). An earlier theoretical paper shows that word-of-mouth can,
under some circumstances, result in superior decisions. See Glenn
Ellison and Drew Fudenberg, Word-of-Mouth Communication and Social
Learning, 110 Quarterly J. Econ. 93-125 (1995). On the other hand,
some behavioral finance literature examines irrational herding and
contagion of thought and behavior through social interaction, such
as the propagation of investing memes, which need not be predictive
of superior trading performance. For example, one article
characterizes memes as ``mental representation (such as an idea,
proposition, or catchphrase) that can be passed from person to
person''. The article provides an example of investors using
``verbal `reasons' to decide how to trade'' and notes that these
reasons ``are often not cogent''. The article notes that such
reasons, or financial memes, can be simple or can be elaborate
structures of analysis, examples, terminology, catchphrases, and
modeling. See for example, David A. Hirshleifer and Siew Hong Teoh,
Thought and Behavior Contagion in Capital Markets, Handbook of
Financial Markets: Dynamics and Evolution (2009). Another article
compares the investment decisions of stock clubs and individuals. It
finds that while both individuals and clubs are more likely to
purchase stocks that are associated with ``good reasons'' (such as a
company that is featured on a list of ``most-admired'' companies),
stock clubs favor such stocks more than individuals, despite the
fact that such reasons do not improve performance. The article
analyzes social dynamics that may make ``good reasons'' more
important for groups than individuals. See Brad Barber, Chip Heath,
and Terrance Odean, Good Reasons Sell: Reason-Based Choice Among
Group and Individual Investors in the Stock Market, 49 Management
Science 1636-1652 (2003).
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Consistent with the statute, the final rules incorporate several
important investor protections, including limits on the amount that can
be raised, issuer eligibility criteria, and issuer and intermediary
requirements, including statutorily mandated investor education
requirements. The statute and the final rules also impose certain
limitations on the aggregate dollar amount of securities in offerings
in reliance on Section 4(a)(6) that may be sold to an investor during a
12-month period.\1347\ These provisions are designed to limit the
potential investment and, consequently, the potential losses for any
single investor, thus providing downside protection for investors.
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\1347\ See Section 4(a)(6)(B). See also Rule 100(a)(2) of
Regulation Crowdfunding.
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We recognize that these provisions also will limit the potential
upside for investors. This may particularly affect the decisions of
investors with large portfolios who might be able to absorb losses and
understand the risks associated with risky investments and who may have
more expertise and stronger incentives to acquire and analyze
information about an issuer. For these investors, the $100,000
aggregate limit may reduce their incentive to participate in the
securities-based crowdfunding market, compared to other types of
investments, potentially depriving the securities-based crowdfunding
market of more experienced and knowledgeable investors and impeding
capital formation. Moreover, limiting the participation of such
investors may negatively affect the informational efficiency of the
securities-based crowdfunding market because sophisticated investors
are better able to accurately price such offerings. These investors
also can add value to the discussions taking place through an
intermediary's communication channels about a potential offering by
providing their views on the issuer's financial viability and potential
for fraud. Persons with larger portfolios are also likely to be in a
better position to monitor the issuer's insiders, which can reduce the
extent of moral hazard and the risk of fraud on the part of the issuer
and the issuer's insiders, yielding benefits for all investors. Such
investors also can add value by advising the issuer and contributing
strategic expertise, which can be particularly beneficial for early-
stage issuers. Some of these potential benefits, however, may still be
available to issuers that seek to attract such investors through
another type of exempt offering, such as a Regulation D offering.
The aggregate limit on crowdfunding investments also can impede the
ability of investors to diversify within the securities-based
crowdfunding market. As securities-based crowdfunding investments might
have inherently high failure rates,\1348\ investors who do not or
cannot diversify their investments across a number of offerings can
face an increased risk of incurring large losses, relative to their
investments, even when they investigate offerings thoroughly. By
comparison, VC firms typically construct highly diversified portfolios
with the understanding that many ventures fail, resulting in a complete
loss of some investments, but with the expectation that those losses
will be offset by the large upside of the relatively fewer investments
that succeed.\1349\ The securities-based crowdfunding market is
expected to involve earlier-stage financing compared to venture capital
financing, and therefore, the chances of investment success may be
lower.\1350\ The statutory caps on aggregate securities-based
crowdfunding investments under Section 4(a)(6) may limit an investor's
ability to choose a sufficiently large number of investments to offset
this risk and to recover the due diligence costs of sufficiently
investigating individual investments. One potential solution to this
diversification problem is to invest smaller amounts in a greater
number of ventures. However, such a strategy has limited benefit to the
extent that there is a fixed cost to the due diligence associated with
identifying and reviewing each investment opportunity, making it more
costly to implement than a strategy that relies on the selection of
fewer investment opportunities.
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\1348\ See discussion in Section III.A.4 above.
\1349\ See, e.g., John Cochrane, The Risk and Return of Venture
Capital, 75 J. of Fin. Econ. 3 (2005).
\1350\ See Rajshree Agarwal and Michael Gort, Firm and Product
Life Cycles and Firm Survival, 92 Am. Econ. Rev. 184-190 (2002).
---------------------------------------------------------------------------
In a change from the proposed rules, both the investor's annual
income and net worth must be above $100,000 for the 10 percent
limitation to apply. This change is intended to strengthen investor
protections for investors whose annual income or net worth is below
$100,000. Such investors may not be as well situated to bear the risk
of loss (e.g., in the event of fraud on the part of an issuer) as
investors with both income and net worth of $100,000 or more. According
to Commission staff analysis of the data in the 2013 Survey of Consumer
Finances, approximately 17% of U.S. households have both income and net
worth of $100,000 or higher. By comparison, 39% of U.S. households have
either income or net worth of $100,000 or higher.\1351\ Thus,
approximately 22% of households will be subject to a lower investment
limit under the final rules than under the proposal. We note that these
figures are only available at the household level rather than at the
individual level. We further note that these figures do not account for
the fact that only some households might seek to invest in an offering
in reliance on Section 4(a)(6). Thus, we are not able to determine the
[[Page 71496]]
actual percentage of investors affected by this change in the final
rules relative to the proposal.
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\1351\ Based on data from the 2013 Survey of Consumer Finances,
a triennial survey sponsored by the Federal Reserve Board, available
at http://www.federalreserve.gov/econresdata/scf/scfindex.htm.
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Within each investment limitation tier, the investment limitation
percentage is multiplied by the ``lesser of'' an investor's annual
income or net worth in the investment limitation calculation, which was
suggested by several commenters.\1352\ This change from the proposal is
expected to reduce the permitted investment limit for each individual
investor because most investors are unlikely to have annual income and
net worth amounts that are identical.\1353\
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\1352\ See, e.g., AFR Letter; BetterInvesting Letter; Consumer
Federation Letter; Fund Democracy Letter; Fryer Letter;
Growthfountain Letter; IAC Recommendation (but also stating that the
``greater of'' approach would be appropriate for accredited
investors); Merkley Letter; NASAA Letter; Schwartz Letter; Zhang
Letter (recommending that net worth not be used to calculate the
investment limit).
\1353\ Although we lack information to determine the average
change in the applicable investment limit resulting from this
change, based on Commission staff analysis of the 2013 Survey of
Consumer Finances, a larger percentage of households exceeded a
particular dollar threshold, such as $100,000 or $200,000, based on
the net worth standard than the percentage of households that
exceeded the same dollar threshold based on the income standard.
---------------------------------------------------------------------------
Investment limitations will likely have a negative effect on
capital formation. For example, investment limitations may make it more
difficult for some issuers to reach their funding targets. However,
these limits also are expected to reduce the risk and impact of
potential loss for investors that accompany the high failure rates
associated with investments in small businesses and startups, thus
potentially improving investor protection. There is no available market
data that would allow us to empirically evaluate the magnitude of these
effects.
Consistent with the proposed rules, the final rules allow an issuer
to rely on the efforts that an intermediary is required to undertake in
order to determine that the aggregate amount of securities purchased by
an investor will not cause the investor to exceed the investor limits,
provided that the issuer does not have knowledge that the investor had
exceeded, or would exceed, the investor limits as a result of
purchasing securities in the issuer's offering, which was supported by
various commenters.\1354\ This may result in aggregate verification
cost savings since a given intermediary may be involved in and have
information on crowdfunding transactions pertaining to the offerings of
multiple issuers, which makes it potentially less costly to identify
investors that exceed the investment limitation. As a potential
alternative, we could have imposed more extensive verification
requirements on issuers, which would have resulted in larger compliance
costs for issuers but could have potentially increased investor
compliance with the investment limitations, with corresponding investor
protection benefits. As noted above, we believe the final rules
appropriately consider investor protection and facilitating capital
formation.
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\1354\ See, e.g., Arctic Island Letter 4; CFA Institute Letter;
Consumer Federation Letter; CrowdBouncer Letter; EarlyShares Letter;
EMKF Letter; Finkelstein Letter; Fund Democracy Letter; Heritage
Letter; Joinvestor Letter; Public Startup Letter 2; RoC Letter;
RocketHub Letter; Vann Letter; Wefunder Letter; Whitaker Chalk
Letter.
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c. Issuer Eligibility
Section 4A(f) of the statute excludes certain categories of issuers
from eligibility to engage in securities-based crowdfunding
transactions in reliance on Section 4(a)(6). The final rules exclude
those categories of issuers.\1355\ The final rules also exclude two
additional categories of issuers, beyond those identified in the
statute, from being eligible to rely on Section 4(a)(6) to engage in
crowdfunding transactions. First, the final rules exclude issuers that
sold securities in reliance on Section 4(a)(6) and have not filed with
the Commission and provided to investors the ongoing annual reports
required by Regulation Crowdfunding during the two years immediately
preceding the filing of the required offering statement,\1356\ which is
generally consistent with suggestions from several commenters.\1357\
This additional exclusion is not expected to impose any additional
burdens and costs on an issuer that it would not have already incurred
had it complied with the ongoing reporting requirements as they came
due. Further, the requirement that a delinquent issuer prepare and file
up to two annual reports at one time in order to become eligible to
rely on Section 4(a)(6) is expected to incentivize issuers to provide
updated and current information to investors, if they intend to rely
again on Section 4(a)(6) to raise additional capital, without
necessarily requiring an issuer to become fully current in its
reporting obligations. We recognize that conditioning an issuer's
Section 4(a)(6) eligibility on the requirement that issuers provide
ongoing reports for only the previous two years may result in less
information being available to investors in some periods, with
potential adverse effects on the price formation and liquidity of the
securities in the secondary market. The potential damage to an issuer's
reputation resulting from being delinquent along with potential
enforcement action for failure to comply with a regulatory reporting
obligation and the modification from the proposed rules to require an
issuer to disclose in its offering statement if it or any of its
predecessors previously failed to comply with the ongoing reporting
requirements of Rule 203 of Regulation Crowdfunding, however, may help
to mitigate these potential adverse effects. As an alternative, we
could have chosen not to impose this exclusion or adopted a shorter
look-back period, as suggested by some commenters.\1358\ Compared to
the provisions in the final rules, either of these alternatives could
result in less information being available to investors and reduced
informational efficiency of securities prices or possibly increased
likelihood of issuer misconduct in offerings made in reliance on
Section 4(a)(6).
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\1355\ These categories of issuers are: (1) Issuers that are not
organized under the laws of a state or territory of the United
States or the District of Columbia; (2) issuers that are subject to
Exchange Act reporting requirements; (3) investment companies as
defined in the Investment Company Act or companies that are excluded
from the definition of investment company under Section 3(b) or 3(c)
of the Investment Company Act. See Section 4A(f). See also Rule
100(b) of Regulation Crowdfunding.
\1356\ See discussion in Section II.A.4 above.
\1357\ See, e.g., ASSOB Letter; Commonwealth of Massachusetts
Letter; Consumer Federation Letter; Fund Democracy Letter; Grassi
Letter; Joinvestor Letter; NASAA Letter; Wefunder Letter.
\1358\ See, e.g., ABA Letter; Parsont Letter; Projectheureka
Letter; Public Startup Letter 2; RocketHub Letter.
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Second, the final rules exclude a company that has no specific
business plan or has indicated that its business plan is to engage in a
merger or acquisition with an unidentified company or companies, as
suggested by several commenters.\1359\ This requirement is intended to
help ensure that investors have adequate information about the issuer's
proposed business plan to make an informed investment decision, which
may increase investor protection in some instances. As an alternative,
we could have chosen not to impose this exclusion or to impose a less
restrictive exclusion, as suggested by several commenters.\1360\
Although these alternatives might increase capital formation by
allowing a subset of additional issuers to rely on Section 4(a)(6),
they may also result in less
[[Page 71497]]
informed investor decisions in such offerings.
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\1359\ See, e.g., Anonymous Letter 2; CFA Institute Letter;
CFIRA Letter 7; Commonwealth of Massachusetts Letter; Consumer
Federation Letter; NASAA Letter; ODS Letter; Traklight Letter;
Whitaker Chalk Letter.
\1360\ See, e.g., ABA Letter; FundHub Letter 1; Projectheureka
Letter; Public Startup Letter 2; RoC Letter; RocketHub Letter; SBM
Letter; Wilson Letter.
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Overall, categories of issuers that are excluded from eligibility
under the final rules may be at a competitive disadvantage relative to
those that are eligible to offer securities under the final rules, to
the extent that excluded issuers may raise less external capital or
incur a higher direct or indirect cost of financing, or additional
restrictions, when seeking financing from alternative sources.
3. Issuer Requirements
a. Issuer Costs
We recognize that there are benefits and costs associated with
Regulation Crowdfunding's requirements pertaining to issuers, including
the final rule's disclosure requirements. In the Proposing Release, we
provided cost estimates for each of these requirements and requested
comment on our estimates.\1361\ In response, we received several
comment letters providing alternative cost estimates, some of which
were lower and some of which were higher than the cost estimates in the
Proposing Release.\1362\ For example, one commenter \1363\ provided the
following cost estimates: Portal fees of 6% to 15% \1364\; accounting
review fees of $1,950 to $9,000; accounting audit fees of $3,100 to
$9,000; financial statements/projections costs of $2,000 to $5,000;
Title III disclosure/compliance costs of $1,000 to $4,000; and
corporate formation costs of $300 to $500.\1365\ In addition, the
commenter estimated the total cost to raise $99,000 of capital under
the proposed rules to be $9,300 to $24,500 (9.4% to 24.7%); to raise
$499,000 of capital to be $33,240 to $84,750 (6.7% to 17%); and to
raise $1 million of capital to be $72,800 to $168,500 (7.3% to 16.9%).
The commenter stated that the entry of new vendors into the market and
ensuing competition may lead to a decline in some of these costs over
time. Another commenter \1366\ estimated that a $200,000 offering will
incur the following average costs: Legal fees of $10,000; intermediary
fees of $20,000 (10%); accounting fees of $5,000; accounting review
fees of $8,000; and other fees (transfer agent, campaign development,
filing and other) of $7,000. A different commenter estimated that the
cost to issuers could range from 26% to 601% of the offering amount
over a five-year period, depending on the size of the offering, which
does not account for additional estimated opportunity costs of internal
personnel time of $35,000 to $85,000 over a five-year period.\1367\
Some commenters referred to estimates of total costs without estimating
individual components of those costs.\1368\ Other commenters provided
additional analysis of costs under different scenarios and offering
sizes based on the estimates in the Proposing Release.\1369\
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\1361\ See Proposing Release, Section III.B.3.
\1362\ See, e.g., StartEngine Letter 2; FundHub Letter 2;
Heritage Letter; SeedInvest Letter 1; SeedInvest Letter 2; Traklight
Letter.
\1363\ See StartEngine Letter 2.
\1364\ The commenter does not specify whether these fees are
expressed as a percentage of the amount sought or raised in the
offering.
\1365\ We do not consider the costs associated with the
incorporation or formation of the business itself to be part of the
incremental costs of Regulation Crowdfunding, as these are costs
associated with forming any business endeavor that relies on outside
sources of capital.
\1366\ See Grassi Letter.
\1367\ See SeedInvest Letter 1.
\1368\ See, e.g., WealthForge Letter (suggesting that the costs
associated with completing a crowdfunding transaction under the
current regulations can be as high as one hundred thousand dollars,
including audit fees, intermediary fees, legal fees and other
offering costs); Berlingeri Letter (suggesting that the total cost
would amount to between 15% and 20% of the offering); Traklight
Letter (suggesting that the total cost would amount to between 15%
and 20% of the offering for offerings above $100,000); FundHub
Letter 1 (referring to potential costs, based on the Commission's
estimates and the commenter's assumptions, of between $15,000 and
$25,000 associated with raising $100,000); Harrison Letter and
Ramsey Letter (referencing a Forbes estimate that the costs of
disclosure documents, engaging an intermediary, performing
background checks, and filing annual reports with the Commission
might be upwards of $100,000). See also SEC Proposes Crowdfunding
Rules, Forbes, Oct. 23, 2013, http://www.forbes.com/sites/deborahljacobs/2013/10/23/sec-proposes-crowdfunding-rules/.
\1369\ See, e.g., EarlyShares Letter; RocketHub Letter;
SeedInvest Letter 1.
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In general, commenters identified the following as the main costs
for issuers in securities-based crowdfunding offerings: The
intermediary fees; the costs of preparing, ensuring compliance with,
and filing of Form C and Form C-AR; and the cost of accounting review
or audit of financial statements.\1370\ Below we discuss the comments
received on each of these costs and any revisions to our estimates made
in response.
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\1370\ But see Growthfountain Letter (suggesting that
crowdfunding issuers will also incur investor relations costs). We
do not consider investor relations costs to be incremental to
Regulation Crowdfunding, as these costs may be incurred by any
business that relies on outside sources of capital and a widely
dispersed investor base. However, to the extent that investment
limitations in crowdfunding offerings increase the number of
investors in a typical offering and to the extent that some investor
relations costs are variable, issuers in crowdfunding offerings may
incur higher investor relations costs than issuers in types of
offerings that typically have fewer investors.
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With regard to intermediary fees, the estimates of the commenters
that quantified these fees \1371\ were generally very close to our
estimates in the Proposing Release (5% to 15%). We agree with the
commenter that suggested that there is likely to be a fixed component
to these costs that reflects a certain necessary level of due diligence
and background screening, which will result in these costs as a
percentage of offering size being higher for smaller offerings.\1372\
Thus, we have revised our intermediary fee estimates in the following
way: We project (as a percentage of offering proceeds) 5% to 15% for
offerings of $100,000 or less, 5% to 10% for offerings between $100,000
and $500,000, and 5% to 7.5% for offerings above $500,000. Data on
Regulation D offerings that involve intermediaries suggests that
offerings of up to $1 million have an intermediary fee (commission and/
or finder fee) of approximately 6.5% on average, which is within the
range we estimate for larger crowdfunding offerings. Although
crowdfunding intermediaries are not expected to provide issuers with
services commensurate with those provided by underwriters in registered
offerings (and, in fact, funding portals would be prohibited from doing
so), the fees charged in a crowdfunding offering can be significantly
larger on a percentage basis relative to the underwriting fees for
registered offerings, which range from as high as 7% for initial public
offerings to less than 1% for certain bond issuances.\1373\ In general,
to the extent that a significant component of these fees is fixed, the
transaction costs for issuers will make smaller offerings more
[[Page 71498]]
expensive on a percentage basis. As previously discussed, we believe
that competition among crowdfunding venues and the potential
development of new products and services may have a significant impact
on these estimates over time.
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\1371\ See StartEngine Letter 2 (estimating portal fees of 6-
15%). See also Grassi Letter (estimating an intermediary fee of
$20,000 for a $200,000 offering, which amounts to 10% of the
offering). But see Wefunder Letter (noting that, in contrast to the
assumption in the Proposing Release, ``good startups will pay a
maximum of $0'' and citing three accredited investor crowdfunding
platforms that use a ``carried interest'' model for Rule 506
offerings, including the example of the commenter itself that does
not charge a fee to startups but that charges investors a $25 fee
and 10% carried interest (share of profits upon acquisition or
initial public offering)).
\1372\ See Heritage Letter.
\1373\ See, e.g., Hsuan-Chi Chen and Jay R. Ritter, The Seven
Percent Solution, 55 J. Fin. 1105-1131 (2000); Mark Abrahamson, Tim
Jenkinson, and Howard Jones, Why Don't U.S. Issuers Demand European
Fees for IPOs? 66 J. Fin. 2055-2082 (2011); Shane A. Corwin, The
Determinants of Underpricing for Seasoned Equity Offers, 58 J. Fin.
2249-2279 (2003); Lily Hua Fang, Investment Bank Reputation and the
Price and Quality of Underwriting Services, 60 J. Fin. 2729-2761
(2005); Rongbing Huang and Donghang Zhang, Managing Underwriters and
the Marketing of Seasoned Equity Offerings, 46 J. Fin. Quant.
Analysis 141-170 (2011); Stephen J. Brown, Bruce D. Grundy, Craig M.
Lewis and Patrick Verwijmeren, Convertibles and Hedge Funds as
Distributors of Equity Exposure, 25 Rev. Fin. Stud. 3077 -3112
(2012).
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The next major cost driver for issuers in securities-based
crowdfunding offerings, as suggested by commenters, is the cost of
preparing and filing disclosure documents and the internal burden of
ensuring compliance with the disclosure requirements of the final
rules. Issuers will incur costs to comply with the disclosure
requirements and file the information in the new Form C: Offering
Statement and Form C-U: Progress Update before the offering is funded.
Thus, issuers will incur those costs regardless of whether their
offerings are successful. In addition, for successful offerings,
issuers will incur costs to comply with the ongoing reporting
requirements and file information in the new Form C-AR: Annual
Report.\1374\
---------------------------------------------------------------------------
\1374\ See Rule 203(b) of Regulation Crowdfunding. See also
Section II.B.3 above.
---------------------------------------------------------------------------
Several commenters provided estimates of these costs. One commenter
stated that Form C could be prepared by third-party service providers,
such as itself, at much lower costs than those estimated by the
Commission, noting that it can prepare Form C and other required
disclosure documents, perform ``bad actor'' checks, verify investor
status and fulfill other compliance requirements for an estimated total
cost of $2,500 for an offering of $100,000 and that, in most cases, its
services and associated legal fees will cost an issuer between $2,500
and $5,000 for an offering up to $500,000 and between $5,000 and
$10,000 for an offering between $500,000 and $1,000,000.\1375\
---------------------------------------------------------------------------
\1375\ See FundHub Letter 2.
---------------------------------------------------------------------------
Other commenters indicated that the compliance costs for issuers
are likely to be higher than the Commission's estimates. One commenter
indicated that the burden of completing Form C would likely exceed the
60 burden hours estimated by the Commission in the proposed rules and
that the sum of attorney and accounting fees and management and
administrative time and other costs to prepare these required
disclosures will likely exceed $10,500, except in cases of start-ups
with no operating history.\1376\ The commenter also noted that most
Regulation D offerings, which tend to be less complex than crowdfunding
offerings, based on the requirements in the proposed rules, incur
accounting and legal fees above $2,500.\1377\ Another commenter noted
that issuers and intermediaries will likely incur higher attorney and
accounting fees and financial and administrative burdens than estimated
in the proposed rules but did not provide estimates.\1378\
---------------------------------------------------------------------------
\1376\ See Heritage Letter.
\1377\ Id.
\1378\ See NSBA Letter.
---------------------------------------------------------------------------
One commenter submitted several estimates of the compliance costs
associated with the final rules' disclosure requirements. In one
comment letter, the commenter estimated the upfront compliance costs of
the proposed rules to be potentially hundreds of hours in internal
company time and $20,000 to $50,000 in outside professional costs and
noted that such costs will likely be a significant deterrent to
crowdfunding.\1379\ In a different comment letter,\1380\ this commenter
stated that, based on an informal survey of potential vendors, it
believes the costs of preparing a Form C-AR would range from $6,000 to
$20,000, with the median being roughly $10,000. The commenter \1381\
further estimated that an additional $15,000 worth of internal burden
per year would be required to prepare Form C-AR and an additional
$5,000 to $10,000 worth of internal burden would be required to prepare
financial statements. In yet another comment letter,\1382\ this
commenter estimated the cost of ongoing disclosure obligations and
ongoing requirements to file financial statements under the proposed
rules to be upwards of $10,000 to $40,000 per year.
---------------------------------------------------------------------------
\1379\ See SeedInvest Letter 2.
\1380\ See SeedInvest Letter 1.
\1381\ Id.
\1382\ See SeedInvest Letter 4.
---------------------------------------------------------------------------
Based on these comments, we have revised our estimates of the
compliance costs associated with the disclosure requirements of the
final rules and Forms C and C-AR. On the lower end of the spectrum, one
commenter suggested that the cost of preparing and filing these forms
and the associated compliance costs would range from $3,000 to
$9,000.\1383\ Another commenter estimated preparation and compliance
costs of $2,500 for an offering of $100,000, between $2,500 and $5,000
for an offering between $100,000 and $500,000, and between $5,000 and
$10,000 for an offering between $500,000 and $1,000,000.\1384\ We rely
on this commenter's estimates of the costs of preparing and filling
Form C for offerings of up to $100,000 and offerings between $100,000
and $500,000. Another commenter presented higher estimates, ranging
from $6,000 to $20,000, with a median cost of $10,000, but did not
provide estimates for different offering sizes.\1385\ Given commenters'
estimates, we think that the $6,000 to $20,000 estimate is more
appropriate for larger offerings (of more than $500,000). Thus, to
estimate the costs of preparing, filing, and complying with Form C for
large offerings, we combine the cost ranges provided by the two
commenters for these types of offerings, resulting in a cost estimate
between $5,000 and $20,000. As in the Proposing Release, we estimate
that the cost of preparing and complying with the requirements related
to Form C-AR will be approximately two-thirds of that for Form C. We
base this estimate on the fact that no offering-specific information
will be required in Form C-AR and issuers may thus be able to update
disclosure previously provided on Form C. Our estimates of the costs of
Forms C and C-AR are exclusive of the costs of an accounting review or
audit, which are discussed separately below.
---------------------------------------------------------------------------
\1383\ See StartEngine Letter 2.
\1384\ See FundHub Letter 2.
\1385\ See SeedInvest Letter 1.
---------------------------------------------------------------------------
We expect that the cost of preparing and filing Forms C and C-AR
will vary based on the characteristics of issuers, but we do not have
the information to quantify such variation. For example, issuers with
little operating activity may have less to disclose than issuers with
more complex operations. Further, some issuers may rely to a greater
extent on the services of outside professionals in preparing the
required filings,\1386\ while other issuers may choose to prepare and
file the required forms without seeking the assistance of outside
professionals.\1387\ We also recognize the possibility that many if not
all of the filing requirements may ultimately be performed by funding
portals on behalf of issuers using their platforms.
---------------------------------------------------------------------------
\1386\ See, e.g., McGladrey Letter (suggesting that issuers that
are startups may rely on outside professional services to a greater
extent, which would increase costs).
\1387\ For purposes of the PRA, we estimate that, for the
average issuer, 25 percent of the burden associated with preparing
and filing Form C and Form C-AR will be carried by outside
professionals. See Section IV.C.1.a below.
---------------------------------------------------------------------------
The other significant cost for crowdfunding issuers, as identified
by commenters, is the cost of an independent accounting review or
audit. As discussed above, reviewed financial statements will be
required in offerings of more than $100,000 but not more than $500,000,
unless the issuer has audited statements otherwise available. Audited
financial statements
[[Page 71499]]
are required in offerings of more than $500,000.
In a change from the proposal, issuers that have not previously
sold securities in reliance on Section 4(a)(6) will be permitted to
provide reviewed financial statements in offerings of more than
$500,000 but not more than $1,000,000, unless the issuer has audited
statements otherwise available. This change is expected to greatly
reduce the initial costs associated with providing financial statements
for first-time crowdfunding issuers offering more than $500,000 but not
more than $1,000,000. According to one commenter, the difference in
cost for reviewed versus audited financial statements could easily run
into tens of thousands of dollars.\1388\
---------------------------------------------------------------------------
\1388\ See FundHub Letter 1. The comment letter also cites the
commenter's article, which notes that ``while a review could be in
the range of $1000 in some cases, a formal audit by a CPA typically
starts at $5,000 and could be much more.'' See Kendall Almerico, Has
The SEC Made Equity Crowdfunding Economically Unfeasible? Crowdfund
Insider (Nov. 21, 2014), available at http://www.crowdfundinsider.com/2013/11/26291-sec-made-equity-crowdfunding-economicallyunfeasible.
---------------------------------------------------------------------------
Some commenters argued that the cost of reviewed or audited
financial statements of startup companies, which is the type of
companies expected to use Regulation Crowdfunding, would be lower than
our estimates because such companies would be less complex and because
a competitive industry would develop to support the compliance and
disclosure needs of securities-based crowdfunding issuers.\1389\
Commenters provided estimates for the cost of an accounting review of
financial statements that generally ranged from $1,500-$10,000.\1390\
One commenter suggested that the cost of an accounting review is
approximately 60% of the cost of an audit.\1391\ Consistent with this
comment, we also use an alternative way to estimate the cost of an
accounting review: indirectly, from the cost of an audit.
---------------------------------------------------------------------------
\1389\ See, e.g., CrowdFunding Network Letter; dbbmckennon
Letter; Denlinger Letter 2; FundHub Letter 2; Holm Letter;
StartEngine Letter 1; StartEngine Letter 2.
\1390\ See, e.g., Grassi Letter (estimating the cost of
accounting review for a $200,000 offering as $8,000); NPCM Letter
(suggesting that the minimum cost to obtain an audit, or even a
review, would be $5,000); StartEngine Letter 1 (estimating
accounting review and audit costs of $1,500-$10,000 for smaller,
newer companies); StartEngine Letter 2 (estimating accounting review
costs of $1,950-$9,000).
\1391\ See Traklight Letter.
---------------------------------------------------------------------------
Commenters provided several estimates of the cost of an audit for
securities-based crowdfunding issuers, most of which ranged from $2,500
to $10,000.\1392\ Other commenters, however, provided higher annual
audit cost estimates of up to $20,000-$30,000.\1393\ Based on a
compilation of audit fee data from reporting companies for fiscal year
2014, the average cost of an audit for an issuer with less than $1
million in market capitalization and less than $1 million in revenues
is approximately $20,000.\1394\ We estimate the audit cost to be
approximately $2,500 to $30,000. In the Proposing Release, we estimated
the audit cost to be $28,700, which falls within this range. Assuming
that, as suggested by one commenter,\1395\ the accounting review cost
is approximately 60% of the audit cost, this range of audit costs
yields an estimate of the accounting review cost of approximately
$1,500 to $18,000. In the Proposing Release, we estimated the
accounting review cost to be $14,350, which falls within this range.
Estimates of the cost of an accounting review that we received from
commenters also fall within this range. In light of the wide range of
estimates provided by commenters for the cost of a review or audit of
financial statements, we use in this release a range of estimates
($1,500-$18,000 for the accounting review cost and $2,500-$30,000 for
the audit cost) instead of a single point estimate for these
anticipated costs for offerings.
---------------------------------------------------------------------------
\1392\ See, e.g., dbbmckennon Letter (estimating audit costs of
$4,000-$9,000 for new companies with limited historical operations);
Denlinger Letter 2 (noting that audit costs may be in the range of
$2,000-$4,000 for a pre-revenue startup); FundHub Letter 2 (noting
the emergence of CPA firms willing to perform a complete audit for a
startup for $2,500 or less); NPCM Letter (suggesting that the
minimum cost to obtain an audit, or even a review, would be $5,000);
StartEngine Letter 1 (estimating accounting review and audit costs
of $1,500-$10,000 for smaller, newer companies); StartEngine Letter
2 (estimating audit costs of $3,100-$9,000).
\1393\ See, e.g., Frutkin Letter (suggesting a ``rough estimate
of $30,000 per audit''); Graves Letter (suggesting that audit costs
can be upwards of $18,000 to $25,000); Startup Valley Letter
(suggesting that audit fees can be up to $10,000 for small startups
with no financials and can exceed $20,000 for companies that have
been in business for a few years); Traklight Letter (suggesting that
audit costs can be up to $20,000).
\1394\ See Audit Analytics, Auditor-Fees, available at http://www.auditanalytics.com/0002/audit-data-company.php. The auditor fee
database contains fee data disclosed by Exchange Act reporting
companies in electronic filings since January 1, 2001. For purposes
of our calculation, we averaged the auditor fee data for companies
with both market capitalization and revenues of greater than zero
and less than $1 million (the smallest subgroup of companies for
which data is compiled). We note that the cost of an audit for many
issuers conducting a securities-based crowdfunding offering in
reliance on Section 4(a)(6) is likely to be lower than for the
subset of Exchange Act reporting companies referenced above, because
they likely would be at an earlier stage of development than issuers
that file Exchange Act reports with us and, thus, could be less
complex to audit.
\1395\ See Traklight Letter.
---------------------------------------------------------------------------
As discussed below, in a change from the proposal, the final rules
do not require issuers to provide reviewed or audited financial
statements in the annual report, unless such statements are otherwise
available, which is expected to yield cost savings on an annual basis
compared with the proposal.
The table below presents the main adjusted cost estimates for the
final rules.\1396\
---------------------------------------------------------------------------
\1396\ In addition to the compliance costs outlined in the
table, issuers also will incur costs to (1) obtain EDGAR access
codes on Form ID; (2) prepare and file progress updates on Form C-U;
and (3) prepare and file Form C-TR to terminate ongoing reporting.
These additional compliance costs are discussed further below. In
addition, for purposes of the Paperwork Reduction Act (``PRA''), we
provide burden estimates for each of these filings obligations in
Section IV.C.1, below.
\1397\ For purposes of the table, we estimate the range of fees
that an issuer would pay the intermediary assuming the following:
(1) The fees would be calculated as a percentage of the offering
amount ranging from 5% to 15% of the total offering amount for
offerings of $100,000 or less, 5% to 10% for offerings between
$100,000 and $500,000, and 5% to 7.5% for offerings of more than
$500,000; and (2) the issuer is offering $50,000, $300,000 and
$750,000, which are the mid-points of the offering amounts under
each of the respective columns. The fees paid to the intermediary
may, or may not, cover services to an issuer in connection with the
preparation and filing of the forms identified in this table.
----------------------------------------------------------------------------------------------------------------
Offerings of more than
Offerings of $100,000 $100,000, but not more Offerings of more than
or less than $500,000 $500,000
----------------------------------------------------------------------------------------------------------------
Fees paid to the $2,500-$7,500......... $15,000-$30,000....... $37,500-$56,250.
intermediary.\1397\.
Costs per issuer for preparation $2,500................ $2,500-$5,000......... $5,000-$20,000.
and filing of Form C for each
offering and related compliance
costs.
----------------------------------------------------------------------------------------------------------------
[[Page 71500]]
----------------------------------------------------------------------------------------------------------------
Offerings of more than
Offerings of $100,000 $100,000, but not more Offerings of more than
or less than $500,000 $500,000
----------------------------------------------------------------------------------------------------------------
Costs per issuer for preparation $1,667................ $1,667-$3,333......... $3,333-$13,333.
and filing of annual report on
Form C-AR \1398\ and related
compliance costs.
Costs per issuer for review or Not required.......... $1,500-$18,000........ $2,500-$30,000.
audit of financial statements. ($1,500-$18,000 for first-
time issuers raising more
than $500,000 but not more
than $1,000,000.) \1399\
----------------------------------------------------------------------------------------------------------------
We do not have additional data on the costs likely to be incurred
by crowdfunding issuers to prepare the required disclosures beyond the
information discussed above. Overall, we recognize that cost estimates
may vary from issuer to issuer and from service provider to service
provider. However, even with the additional accommodations provided in
the final rules, the costs of compliance may be significant for some
issuers.
---------------------------------------------------------------------------
\1398\ As noted above, we estimate that these costs are
approximately two-thirds of the costs for preparation and filing of
Form C.
\1399\ First-time crowdfunding issuers within this offering
range will be permitted to provide reviewed financial statements.
---------------------------------------------------------------------------
b. General Disclosure Requirements
The statute and the final rules related to issuer disclosures are
intended to reduce the information asymmetries that currently exist
between small businesses and investors. Small private businesses
typically do not disclose information as frequently or as extensively
as public companies, if at all. Moreover, unlike public companies,
small private businesses generally are not required to hire an
independent accountant to review financial statements. When information
about a company is difficult to obtain or the quality of the
information is uncertain, investors are at risk of making poorly-
informed investment decisions about that company.
Such information asymmetries may be especially acute in the
securities-based crowdfunding market because the market includes
startups and small businesses that have significant risk factors and
other characteristics that may have led them to be rejected by other
potential funding sources, including banks, VCs and angel investors. In
addition, the securities-based crowdfunding market may attract
unsophisticated investors who may not have the resources necessary to
gather and analyze information about issuers before investing or to
effectively monitor issuers after investing. Moreover, investment
limits in securities-based crowdfunding offerings in reliance on
Section 4(a)(6) will likely lead to investors having smaller stakes in
the firm, which may reduce their incentives to monitor or gather
information for a given investor. These considerations may give rise to
adverse selection and moral hazard in offerings in reliance on Section
4(a)(6). For instance, some issuers may use capital to fund riskier
projects than what was disclosed to investors, or they may not pursue
their stated business objectives. If investors in securities-based
crowdfunding have limited information about issuers or a limited
ability to monitor such issuers, they may seek higher returns for their
investment or choose to withdraw from the securities-based crowdfunding
market altogether, which would increase the cost of capital to issuers
and limit the capital formation benefits of the final rules. In
addition, investors in offerings made in reliance on Section 4(a)(6)
may make relatively small investments, due in part to the application
of investment limitations. This potential dispersed investor base may
make it difficult for investors to solve collective action problems in
monitoring the issuer.
The statute and the final rules seek to reduce information
asymmetries by requiring issuers to file specified disclosures with the
Commission for offerings made in reliance on Section 4(a)(6) during the
offering and on an annual basis thereafter.\1400\ Issuers also are
required to provide these disclosures to investors and, in the case of
offering documents, to investors and the relevant intermediary. The
disclosure requirements, which are described above,\1401\ are more
extensive than those required under some other existing exemptions from
registration. For example, although the current requirements of Tier 1
Regulation A offerings include similar initial financial disclosures,
issuers in Tier 1 offerings are not required to file ongoing
reports.\1402\ Issuers using the Rule 504 exemption under Regulation D
to raise up to $1 million are not required to provide audited financial
statements, and there are no periodic disclosure requirements.
Regulation D offerings under Rules 505 and 506 for up to $2 million
require issuers to provide audited current balance sheets (and
unaudited statements of income, cash flows and changes in stockholders'
equity) to non-accredited investors, but there are no periodic
reporting requirements. The disclosure requirements in Regulation
Crowdfunding are expected to benefit investors by enabling them to
better evaluate the issuer and the offering, monitor how the issuer is
performing over time and be aware of when the issuer may terminate its
ongoing reporting obligations. This will allow investors with various
risk preferences to invest in the offerings best suited for their risk
tolerance, thus improving allocative efficiency.
---------------------------------------------------------------------------
\1400\ See Section 4A(b). See also Rules 201, 202 and 203 of
Regulation Crowdfunding.
\1401\ See Section II.B.1 above.
\1402\ However, issuers in Tier 1 Regulation A offerings are
required to provide information about sales in such offerings and to
update certain issuer information by electronically filing a Form 1-
Z exit report with the Commission not later than 30 calendar days
after the termination or completion of an offering. Further, Tier 1
offerings must be qualified by the Commission and are subject to
state registration requirements. Issuers in Tier 2 offerings are
subject to annual, semiannual and current reporting requirements.
See Regulation A Adopting Release.
---------------------------------------------------------------------------
The disclosure requirements also may improve informational
efficiency in the market. Specifically, the required disclosure may
provide investors with a useful benchmark to evaluate the issuer and
compare the issuer to other private issuers both within and outside of
the securities-based crowdfunding market.\1403\ Additionally,
disclosure by issuers engaging in crowdfunding transactions in reliance
on Section 4(a)(6) may inform financial markets more generally about
new consumer trends and new products, thus creating externalities that
benefit other types of investors and issuers.
---------------------------------------------------------------------------
\1403\ See Christian Leuz and Peter Wysocki, Economic
Consequences of Financial Reporting and Disclosure Regulation: A
Review and Suggestions for Future Research, (Working Paper,
University of Chicago) (2008), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1105398.
---------------------------------------------------------------------------
[[Page 71501]]
We recognize, however, that the disclosure requirements also will
have associated limitations and costs, including the direct costs of
preparation, certification, independent accounting review (when
necessary) and dissemination of the disclosure documents. As noted
above, the disclosure requirements for offerings made in reliance on
Section 4(a)(6) are more extensive, in terms of breadth and frequency,
than those for other exempt offerings. The statute also provides us
with the discretion to impose additional requirements on issuers
engaging in crowdfunding transactions, and in some cases, the final
rules require issuers to disclose information beyond what is
specifically mandated by the statute.\1404\ We recognize that these
additional discretionary disclosure provisions may impose additional
compliance costs on issuers compared with the proposal. However, we
believe these provisions will improve investor decision-making and may
ultimately benefit issuers by improving price efficiency in the
securities-based crowdfunding market. Although requiring less
disclosure could impose lower compliance costs, we believe that the
disclosure requirements we are adopting appropriately consider the need
to enhance the ability of issuers relying on Section 4(a)(6) to raise
capital while enabling investors to make informed investment decisions.
In response to the suggestion by some commenters that issuers not be
required to disclose information in multiple places,\1405\ under the
final rules, an issuer is not required to repeat disclosure that is
already provided in the issuer's financial statements. This may help to
mitigate the cost of compliance for issuers.
---------------------------------------------------------------------------
\1404\ See Section 4A(b)(5). See also Section II.B.1.a.i(g) for
a description of the additional disclosure requirements.
\1405\ See, e.g., EY Letter (noting that certain required
disclosure would be included in an issuer's financial statements);
Grassi Letter (same).
---------------------------------------------------------------------------
We note that the disclosure requirements may have indirect costs to
the extent that information disclosed by issuers relying on Section
4(a)(6) can be used by their competitors, resulting in a potential loss
of a competitive advantage or intellectual property, particularly for
high-growth issuers and issuers engaged in significant research and
development. Requiring significant levels of disclosure at an early
stage of an issuer's lifecycle may affect an issuer's competitive
position and may limit the use of the exemption in Section 4(a)(6) by
issuers who are especially concerned with confidentiality. These
disclosure costs also may make other types of private offerings more
attractive to potential securities-based crowdfunding issuers. For
example, the 2013 changes to Rule 506 of Regulation D,\1406\ which
allow for general solicitation, subject to certain conditions, may make
it a more attractive option for small business financing and, thus, may
divert potential issuers from crowdfunding.
---------------------------------------------------------------------------
\1406\ See Rule 506(c) Adopting Release, note 5.
---------------------------------------------------------------------------
In addition, under the statute and the final rules, issuers that
complete a crowdfunding offering in reliance on Section 4(a)(6) are
subject to ongoing reporting requirements,\1407\ which will increase
compliance costs. The ongoing reporting, however, may provide a
liquidity benefit for secondary sales of securities issued in
crowdfunding transactions and make the prices of such securities more
informationally efficient, should a secondary market develop.
---------------------------------------------------------------------------
\1407\ See Rule 202 of Regulation Crowdfunding.
---------------------------------------------------------------------------
c. Financial Condition and Financial Statement Disclosure Requirements
Consistent with the statute, the final rules require narrative
disclosure about the issuer's financial condition, including, to the
extent material, liquidity, capital resources and the issuer's
historical results of operations.\1408\ We expect that this discussion
will inform investors about the financial condition of the issuer,
without imposing significant costs on issuers, because issuers likely
will already have such information readily available. In addition, the
final rules do not prescribe the content or format for this
information.
---------------------------------------------------------------------------
\1408\ See Rule 201(s) of Regulation Crowdfunding. See also
Section II.B.1.a.(ii)(a) above.
---------------------------------------------------------------------------
With respect to the requirement to provide financial statements,
the final rules implement tiered financial disclosure requirements
based on the aggregate amount of securities offered and sold in
reliance on Section 4(a)(6) during the preceding 12-month period,
inclusive of the offering amount in the offering for which disclosure
is being provided.\1409\ The disclosure requirements will provide
investors with more information than might otherwise be obtained in
private offerings, but also may create additional costs for those
issuers that have limited financial and accounting expertise necessary
to produce the financial disclosures envisioned by the statute and the
final rules.
---------------------------------------------------------------------------
\1409\ See Rule 201(t) of Regulation Crowdfunding. See also
Section II.B.1.a.(ii)(b) above.
---------------------------------------------------------------------------
The final rules, consistent with the proposed rules, require
issuers to provide a complete set of their financial statements
(balance sheets, statements of comprehensive income, statements of cash
flows and statement of changes in stockholders' equity) that are
prepared in accordance with U.S. GAAP and cover the shorter of the two
most recently completed fiscal years or the period since
inception.\1410\ We could have chosen an alternative that allows
financial statements to be prepared in accordance with other
comprehensive bases of accounting, as some commenters suggested.\1411\
Such an alternative may have mitigated costs for some issuers,
especially those smaller issuers that historically have prepared their
financial statements in accordance with other comprehensive bases of
accounting rather than U.S. GAAP. However, as we discussed above, this
alternative would reduce the comparability of financial statements
across issuers and might not provide investors with a fair
representation of a company's financial position and results of
operations. Further, it may be difficult for investors to determine
whether the issuer complied with such basis of accounting.\1412\
---------------------------------------------------------------------------
\1410\ See Instruction 3 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\1411\ See, e.g., ABA Letter (for offerings of $100,000 or less,
but stating that the Commission could require providing U.S. GAAP
financial statements if available); AICPA Letter; CFIRA Letter 5;
CFIRA Letter 7; CrowdCheck Letter 4; EarlyShares Letter; EY Letter
(for offerings of $100,000 or less, unless U.S. GAAP financial
statements are available); Grassi Letter; Graves Letter (for issuers
with less than $5 million in revenue); Mahurin Letter (stating that
simple Excel spreadsheets accompanied by bank records should meet
the financial statement requirements); Milken Institute Letter (for
early-stage issuers); NFIB Letter; SBEC Letter; StartupValley
Letter; Tiny Cat Letter (for offerings of less than $500,000);
Whitaker Chalk Letter (for offerings of less than $500,000 if the
issuer has an asset or income level below a certain level).
\1412\ See Section II.B.1.a.(ii)(b) above.
---------------------------------------------------------------------------
The final rules also specify that an issuer may conduct an offering
in reliance on Section 4(a)(6) using financial statements for the
fiscal year prior to the most recently completed fiscal year, provided
that not more than 120 days have passed since the end of the issuer's
most recently completed fiscal year, and financial statements for the
most recently completed fiscal year are not otherwise available.\1413\
This may impose a cost on investors to the extent that the investors do
not have more current financial information about the issuer. However,
this concern is somewhat mitigated by the requirement that issuers
include a discussion of any material changes or trends known to
management in the financial condition and results of
[[Page 71502]]
operations subsequent to the period for which financial statements are
provided.\1414\
---------------------------------------------------------------------------
\1413\ See Instruction 10 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\1414\ See Rule 201(s) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Requiring financial statements covering the two most recently
completed fiscal years is expected to benefit investors by providing a
basis for comparison against the most recently completed fiscal year
and by allowing investors to identify changes in the development of the
business. Compared to an alternative that we could have selected, that
of requiring financial statements covering only the most recently
completed fiscal year, as some commenters suggested,\1415\ requiring a
second year of financial statements will to some degree increase the
cost for the issuer. Also, to the extent that the issuer had little or
no operations in the prior year, the benefit of comparability may not
be realized. We recognize that many crowdfunding issuers may not have
any financial history, and investors may make investment decisions
without a track record of issuer performance, relying largely on the
belief that an issuer can succeed based on their business plan and
other factors. Nevertheless, for those issuers that do have a financial
history, we believe this disclosure can contribute to better informed
investment decisions and improve the overall allocative efficiency of
the securities-based crowdfunding market.
---------------------------------------------------------------------------
\1415\ See, e.g., Denlinger Letter 1; EY Letter; Fryer Letter;
Grassi Letter; Joinvestor Letter; Public Startup Letter 2; RFPIA
Letter; RocketHub Letter.
---------------------------------------------------------------------------
For offerings of $100,000 or less, the final rules require the
issuer to provide financial statements that are certified by the
principal executive officer to be true and complete in all material
respects.\1416\ The final rules include a form of certification for the
principal executive officer to provide in the issuer's offering
statement, which we believe will help issuers comply with the
certification required by the statute and the final rules.\1417\
However, if reviewed financial statements or audited financial
statements are otherwise available, they must be provided.\1418\
---------------------------------------------------------------------------
\1416\ See Section 4A(b)(1)(D)(i). See also Rule 201(t)(1) of
Regulation Crowdfunding.
\1417\ See Instruction 4 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\1418\ See Rule 201(t)(1) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The proposed rules would have required income tax returns for the
most recently completed year (if any). In a change from the proposed
rules, consistent with the suggestions of some commenters and to
respond to privacy concerns,\1419\ the final rules do not require
complete tax returns and instead require that an issuer disclose its
total income, taxable income and total tax, or the equivalent line
items from the applicable form, and have the principal executive
officer certify that those amounts reflect accurately the information
in the issuer's federal income tax returns.\1420\ We believe that the
requirement to provide selected items from the return, rather than the
return itself, will alleviate some of the privacy concerns for issuers.
This change may increase record keeping costs for issuers and give rise
to potential transcription errors. It also may reduce the amount of
information available to investors, but as we noted in the Proposing
Release, it is not clear to what extent all of the information
presented in a tax return would be useful for an investor evaluating
whether or not to purchase securities from the issuer. Finally,
although principal executive officers will incur some incremental
liability for their certification that these amounts reflect accurately
the information in the issuer's federal income tax return, we do not
expect this change from the proposal to impose substantial additional
costs on officers or issuers given the limited scope of the required
certification.
---------------------------------------------------------------------------
\1419\ See, e.g., AICPA Letter (stating that disclosure of an
issuer's tax return ``. . . has the potential to cause serious
problems. Tax returns are intended to be confidential and should
remain so.''); Public Startup Letter 2; RocketHub Letter; SBM
Letter; Wilson Letter (suggesting that personal income tax
information should be on a voluntary basis only); Zhang Letter.
\1420\ See Rule 201(t)(1) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Moreover, the final rules specify that if an issuer is offering
securities in reliance on Section 4(a)(6) before filing a tax return
for the most recently completed fiscal year, the issuer may use
information from the tax return filed for the prior year, on the
condition that the issuer provides information from the tax return for
the most recently completed fiscal year when it is filed, if it is
filed during the offering period.\1421\ This accommodation is expected
to benefit issuers by enabling them to engage in transactions during
the time period between the end of their fiscal year and when they file
their tax return for that year. This may impose a cost on investors
because they might not receive the most up-to-date tax information
about the issuer.
---------------------------------------------------------------------------
\1421\ See Instruction 6 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
The proposed rules would have required financial statements for
offerings exceeding $100,000 but not exceeding $500,000 to be reviewed
by a public accountant independent of the issuer and financial
statements for offerings exceeding $500,000 to be audited by a public
accountant independent of the issuer. The final rules specify that the
required financial statements must be reviewed by a public accountant
that is independent of the issuer for offerings exceeding $100,000 but
not exceeding $500,000.\1422\ If, however, financial statements of the
issuer are available that have been audited by a public accountant that
is independent of the issuer, the issuer must provide those financial
statements instead and need not include the reviewed financial
statements.\1423\
---------------------------------------------------------------------------
\1422\ See Rule 201(t)(2) of Regulation Crowdfunding.
\1423\ Id.
---------------------------------------------------------------------------
Similar to the proposal, issuers in offerings exceeding $500,000
must provide audited financial statements. In a change from the
proposal, the final rules specify that issuers that have not previously
sold securities in reliance on Section 4(a)(6) and are conducting
offerings with a target offering amount exceeding $500,000 but not
exceeding $1,000,000 can provide reviewed financial statements, unless
audited financial statements are otherwise available.\1424\ Audited
financial statements can benefit investors in evaluating offerings by
issuers with substantive prior business activity by providing them with
potentially higher-quality financial statements. However, as noted by a
number of commenters \1425\ and discussed above, requiring audited
financial statements could significantly increase the cost to issuers
compared to requiring reviewed financial statements.\1426\ Further, for
issuers that are newly formed, with no or very limited operations, and
for small issuers, the benefit of the audit may not justify its cost.
---------------------------------------------------------------------------
\1424\ See Rule 201(t)(3) of Regulation Crowdfunding. See also
Section II.B.1.a.ii.
\1425\ See, e.g., AEO Letter; Angel Letter 1; AWBC Letter; CFIRA
Letter 5; CfPA Letter; CrowdFundConnect Letter; EarlyShares Letter;
EMKF Letter; EY Letter; Finkelstein Letter; FundHub Letter 1;
Generation Enterprise Letter; Grassi Letter; Graves Letter; Guzik
Letter 1; Hakanson Letter; Holland Letter; Johnston Letter;
Kickstarter Coaching Letter; McGladrey Letter; Milken Institute
Letter; NACVA Letter; NFIB Letter; NPCM Letter; NSBA Letter; PBA
Letter; Reed Letter; RocketHub Letter; Saunders Letter; SBA Office
of Advocacy Letter; SBEC Letter; SBM Letter; Seyfarth Letter;
Verrill Dana Letter; WealthForge Letter; Wefunder Letter; Woods
Letter; Zeman Letter.
\1426\ See also Section III.B.3.a.
---------------------------------------------------------------------------
As discussed above \1427\ the approach in the final rules of
requiring reviewed financial statements rather than audited financial
statements, unless otherwise
[[Page 71503]]
available, for first-time crowdfunding issuers that undertake offerings
of more than $500,000 but not more than $1,000,000 is expected to
reduce the costs associated with financial statements for such first-
time issuers compared to the proposed requirement of audited financial
statements for all issuers in offerings of more than $500,000. This
accommodation is expected to alleviate the significant upfront cost of
an audit for first-time issuers that have not yet raised capital in a
crowdfunding offering and may be more financially constrained. To the
extent that their financing needs have not been met through alternative
financing methods, first-time crowdfunding issuers are likely to be
more financially constrained than issuers that have already established
a track record of successful crowdfunding offerings. We recognize,
however, that there are costs associated with this accommodation. Not
requiring audited financial statements for offerings of more than
$500,000 but not more than $1,000,000 by first-time issuers may reduce
the quality of financial disclosure, which may be a more significant
concern for new crowdfunding issuers due to the fact that their more
limited track record may translate into a higher level of information
asymmetry between issuers and investors. The potentially reduced
quality of financial disclosure associated with offerings of more than
$500,000 by first-time issuers may affect the likelihood of detecting
fraud, which would decrease investor protection. To the extent that
investors anticipate such increased risks, issuers may face a higher
cost of capital or be unable to raise the entire amount offered, which
would diminish the capital formation benefits of the final rule. We
note that some first-time issuers in offerings of more than $500,000
but not more than $1,000,000 may have audited statements otherwise
available, which could partly mitigate the described effects. We also
note that some first-time issuers concerned about investor confidence
in the quality of their financial statements may voluntarily provide
audited financial statements.
---------------------------------------------------------------------------
\1427\ Id.
---------------------------------------------------------------------------
Tiered disclosure requirements aim to partially mitigate the impact
of the fixed component of compliance costs on issuers in smaller
securities-based crowdfunding offerings. However, it is possible that
the thresholds may have an adverse competitive effect on some issuers.
For example, the cost of reviewed financial statements may cause
issuers in offerings exceeding but close to $100,000 to incur
significantly higher offering costs as a percentage of the amount
offered compared to issuers offering less than but close to $100,000.
Similarly, the cost of audited financial statements may cause issuers
in follow-on crowdfunding offerings exceeding but close to $500,000 to
incur significantly higher offering costs as a percentage of the amount
offered compared to issuers in offerings of less than but close to
$500,000. We note, however, that the issuer has the ability to select
its offering amount, and since the choice of offering amount determines
which financial statement requirements will apply to its offering, the
issuer, by choosing its offering amount, effectively also chooses its
financial statement requirements.
We considered the alternative of exempting issuers with no
operating history or issuers that have been in existence for fewer than
12 months from the requirement to provide financial statements. We
believe that financial statements contain valuable information that can
aid investors in making better informed decisions, particularly, when
evaluating early-stage issuers characterized by a high degree of
information asymmetry. We also expect that other accommodations in the
final rules will help alleviate some of these issuer compliance costs.
Similar to the proposed rules, financial statements must be
reviewed in accordance with SSARS issued by the AICPA.\1428\ Although
we could have chosen to develop a new review standard for purposes of
the final rules, we believe that issuers will benefit from using the
AICPA's widely-utilized review standard. We believe that many
accountants reviewing financial statements of issuers raising capital
in reliance on Section 4(a)(6) are familiar with the AICPA's standards
and procedures for review, which should help to partly mitigate review
costs.
---------------------------------------------------------------------------
\1428\ See Rule 201(t)(2) of Regulation Crowdfunding. See also
Instruction 8 to paragraph (t) of Rule 201 of Regulation
Crowdfunding.
---------------------------------------------------------------------------
As described above, the final rules require certain financial
statements to be reviewed or audited by a public accountant that is
independent of the issuer.\1429\ In a change from the proposed rules,
the final rules permit the use of independence standards set forth in
Rule 2-01 of Regulation S-X or the independence standards of the
AICPA.\1430\ This change to allow the use of AICPA standards may reduce
issuer compliance costs to the extent that there are higher costs
associated with engaging an accountant that satisfies the independence
standards set forth in Rule 2-01 of Regulation S-X. The change also
will increase the number of public accountants able to perform the
reviews or audits, which may lead to a decrease in the price of their
services and thus a decrease in the direct issuance costs to issuers
compared with the proposal. The benefit from this change will accrue to
issuers making offerings of $100,000 to $1,000,000. To the extent that
the AICPA independence standards impose fewer restrictions with respect
to potential conflicts of interest than the independence standards in
Rule 2-01 of Regulation S-X, however, this accommodation may weaken
investor protection. Moreover, any decrease in investor confidence in
the reliability of financial statements as a result of this change will
limit the capital formation benefits of the final rules.
---------------------------------------------------------------------------
\1429\ See Section II.B.1 above.
\1430\ See Instruction 10 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
---------------------------------------------------------------------------
In addition, the final rules require an issuer to file a signed
review report or audit report, whichever is applicable, and notify the
public accountant of the issuer's intended use of the report in the
offering.\1431\ This can impose an additional cost on issuers to the
extent that the accountant or auditor increases the fee associated with
the review or audit to compensate for any additional liability that may
result from the requirement to file the report. As discussed
above,\1432\ in a change from the proposal, the final rules do not
permit qualified audit reports. This change may impose an additional
cost on issuers, which we are not able to quantify. However, this
change is expected to provide investors with more reliable financial
statements, which should enable investors to better evaluate the
prospects of issuers relying on Section 4(a)(6) and thus make better
informed investment decisions. By providing investors with a greater
degree of confidence in the reliability of the financial information,
audited financial statements will reduce the information asymmetry
about the issuer's financial condition that exists between issuers and
potential investors. This decrease in information asymmetry may lead to
greater capital formation.
---------------------------------------------------------------------------
\1431\ See Instructions 8 and 9 to paragraph (t) of Rule 201 of
Regulation Crowdfunding.
\1432\ See Section II.B.1.a.(ii)(b) above.
---------------------------------------------------------------------------
In a change from the proposed rules, the final rules do not require
financial statements in the annual report that meet a standard of
review equal to the highest standard provided in a prior
offering.\1433\ The final rules require an annual report to include
financial statements of the issuer to be certified
[[Page 71504]]
by the principal executive officer of the issuer as true and complete
in all material respects.\1434\ Issuers that otherwise have available
financial statements that have been reviewed or audited by an
independent certified public accountant, must provide them and will not
be required to have the principal executive officer
certification.\1435\ As discussed above, these changes will reduce the
compliance costs to issuers compared with the proposal.\1436\ At the
same time, they may reduce the quality of the ongoing financial
statements, resulting in a potential decrease in investor protection
and investor confidence in the quality of these financial statements.
We note that some issuers may have reviewed or audited financial
statements otherwise available, which would partly mitigate this
concern. In addition, an issuer is able to voluntarily provide
financial statements that meet a higher standard, so if an issuer is
concerned about investor confidence in the quality of financial
statements, it can choose to provide reviewed or audited financial
statements.
---------------------------------------------------------------------------
\1433\ See Section II.B.2.c above.
\1434\ See Rule 202(a) of Regulation Crowdfunding.
\1435\ Id.
\1436\ See Section III.B.3.a. above.
---------------------------------------------------------------------------
d. Issuer Filing Requirements
As discussed above, issuers will incur costs to prepare and file
the various disclosures required under Regulation Crowdfunding.\1437\
The statute requires issuers to file and provide to investors certain
specified information at the time of offering, such as information
about the issuer, officers and directors, and certain shareholders, a
description of the business, a description of the purpose and intended
use of proceeds, target offering amount and the deadline to reach it,
offering price (or the method for determining the price) and other
terms of the offering, a description of the financial condition of the
issuer, as well as certain other disclosures.\1438\ These disclosure
requirements are expected to strengthen investor protection and enable
investors to make better informed investment decisions. The statute
does not specify a format that issuers must use to present the required
disclosures to the Commission. As noted above, the final rules require
issuers to file the mandated disclosure on EDGAR using new Form
C.\1439\
---------------------------------------------------------------------------
\1437\ See Section III.B.3.a. above.
\1438\ See Rule 201 of Regulation Crowdfunding. See also Section
II.B.1 above.
\1439\ See Rule 203(a) of Regulation Crowdfunding. See also
Section II.B.3 above.
---------------------------------------------------------------------------
Form C requires certain disclosures to be submitted using an XML-
based filing,\1440\ while allowing the issuer to customize the
presentation of other required disclosures. This approach provides
issuers with the flexibility to present the required disclosures in a
cost-effective manner, while also requiring the disclosure of certain
key offering information in a standardized format, which we believe
will benefit investors and help facilitate capital formation.
---------------------------------------------------------------------------
\1440\ See Instruction to paragraph (a)(1) of Rule 203 of
Regulation Crowdfunding. See also Section II.B.3 above.
---------------------------------------------------------------------------
We expect that requiring certain disclosures to be submitted using
XML-based filings will produce benefits for issuers, investors and the
Commission. For instance, using information filed pursuant to these
requirements, investors can track capital generated through
crowdfunding offerings without manually inspecting each filing. The
ability to efficiently collect information on all issuers also can
provide an incentive for data aggregators or other market participants
to offer services or analysis that investors can use to compare and
choose among different offerings. For example, reporting key financial
information using XML-based filings will allow investors, analysts and
data aggregators to more easily compile, analyze and compare
information about the capital structure and financial position of
various issuers. XML-based filings also will provide the Commission
with data about the use of the new crowdfunding exemption that will
allow the Commission to evaluate whether the rules implementing the
exemption include appropriate investor protections and are effectively
facilitating capital formation.
Certain provisions of the filing requirements in the final rules
provide flexibility and potentially reduce the compliance burden
compared with the proposal. The final rules allow issuers to customize
the presentation of their non-XML disclosures and file those
disclosures as exhibits to Form C in PDF format as official filings,
consistent with the suggestions of some commenters.\1441\ In addition,
the final rules include an optional Question and Answer (``Q&A'')
format that issuers may opt to use to provide the disclosures that are
not required to be filed in XML format.\1442\ Relative to some other
possible formats, this Q&A format may facilitate the preparation of the
Form C disclosures by crowdfunding issuers. To the extent that this
provision lowers the compliance cost for issuers, it may encourage
greater use of Regulation Crowdfunding for raising capital.
---------------------------------------------------------------------------
\1441\ See, e.g., CFIRA Letter 6; CFIRA Letter 7; CrowdCheck
Letter 1; Grassi Letter; Hackers/Founders Letter; RocketHub Letter;
Wefunder Letter; Wilson Letter.
\1442\ See Item 1 of General Instruction III to Form C.
---------------------------------------------------------------------------
The final rules require that issuers file a Form C-U: Progress
Update to describe the progress of the issuer in meeting the target
offering amount.\1443\ In a change from the proposed rules, based on
concerns expressed by commenters, the final rules permit issuers to
satisfy the progress update requirement by relying on the relevant
intermediary to make publicly available on the intermediary's platform
frequent updates about the issuer's progress toward meeting the target
offering amount. This change is expected to mitigate some of the direct
cost for the issuer without reducing the amount of contemporaneous
information available to investors. However, an issuer relying on the
intermediary to make publicly available frequent progress updates must
still file a Form C-U at the end of the offering to disclose the total
amount of securities sold in the offering.\1444\ Although the final
offering information likely will be available on the registered
intermediary's Web site, having the information available on EDGAR will
allow comparisons across platforms and provide ongoing access to
historical information for future investor analyses that may otherwise
be difficult or impossible to perform by accessing information from
each individual portal. We expect the costs of preparing updates on
Form C-U to vary among issuers but to be relatively small.\1445\
---------------------------------------------------------------------------
\1443\ See Rule 203(a)(3) of Regulation Crowdfunding. See also
Sections II.B.1.b and II.B.3 above.
\1444\ See Rule 203(a)(3)(iii) of Regulation Crowdfunding.
\1445\ For purposes of the PRA, we estimate that an issuer's
compliance with the Form C-U requirement will result, on average, in
approximately 0.50 burden hours per issuer. See Section IV.C.1.a
below.
---------------------------------------------------------------------------
As noted above, the statute also requires an issuer to file and
provide to investors information about the issuer's financial condition
on at least an annual basis, as determined by the Commission.\1446\
Ongoing disclosure requirements are expected to strengthen investor
protection. Ongoing disclosure requirements are also expected to
facilitate better informed investment decisions in secondary market
transactions and enhance the informational efficiency of prices of
crowdfunding securities, should a secondary market for such securities
develop. To implement this statutory requirement, the final rules
require any
[[Page 71505]]
issuer that has sold securities in a crowdfunding transaction in
reliance on Section 4(a)(6) to file annually with the Commission a new
Form C-AR: Annual Report, no later than 120 days after the end of each
fiscal year covered by the report.\1447\ We believe that annual reports
will inform investors in their portfolio decisions and can enhance
price efficiency. Moreover, as discussed above, under the statute and
the final rules, the securities will be freely tradable after one
year,\1448\ and therefore, this information also will benefit potential
future holders of the issuer's securities by enabling them to update
their assessments as new information is made available through the
annual updates, potentially allowing for more efficient pricing. More
generally, these continued disclosures also may help facilitate the
transfer of securities in secondary markets after the one-year
restricted period ends, which can mitigate some of the potential
liquidity issues that are unique to the securities-based crowdfunding
market, as discussed above.
---------------------------------------------------------------------------
\1446\ See Section 4A(b)(4).
\1447\ See Rule 202(a) of Regulation Crowdfunding. See also
Section II.B.2 above for a discussion of the disclosure requirements
of Form C-AR.
\1448\ See Section 4A(e). See also Rule 501 of Regulation
Crowdfunding.
---------------------------------------------------------------------------
As an alternative, we could have added a current reporting
requirement, consistent with the view of some commenters that there may
be major events that occur between annual reports about which investors
would want to be updated.\1449\ Such an alternative could result in
better informed investment decisions. We are concerned, however, that
the benefits of a current reporting requirement may not justify the
additional compliance costs associated with such a requirement,
especially given the size and early stage of development of the issuers
likely to be involved in offerings in reliance on Section 4(a)(6).
---------------------------------------------------------------------------
\1449\ See, e.g., ABA Letter; Angel Letter 1; Denlinger Letter
1; EY Letter; Grassi Letter; Hackers/Founders Letter; RocketHub
Letter.
---------------------------------------------------------------------------
Any issuer terminating its annual reporting obligations will be
required to file a notice under cover of Form C-TR: Termination of
Reporting to notify investors and the Commission that it will no longer
file and provide annual reports pursuant to the requirements of
Regulation Crowdfunding.\1450\ The final rules enable issuers to
terminate reporting if: (1) The issuer becomes a reporting company
required to file reports under Exchange Act Sections 13(a) or 15(d);
(2) the issuer or another party repurchases all of the securities
issued pursuant to Securities Act Section 4(a)(6), including any
payment in full of debt securities or any complete redemption of
redeemable securities; or (3) the issuer liquidates or dissolves its
business in accordance with state law.\1451\ We expect the costs of
preparing Form C-TR to vary among issuers but to be relatively
small.\1452\
---------------------------------------------------------------------------
\1450\ See Rule 203(b)(3) of Regulation Crowdfunding.
\1451\ See Rule 202(b) of Regulation Crowdfunding.
\1452\ For the purposes of the PRA, we estimate that issuers
will spend, on average, approximately 1.5 burden hours to complete
this task. See Section IV.C.1.a below.
---------------------------------------------------------------------------
In a change from the proposed rules, after considering the
comments, the final rules also permit termination of ongoing reporting
in two additional circumstances: (1) The issuer has filed at least one
annual report and has fewer than 300 holders of record, or (2) the
issuer has filed annual reports for at least the three most recent
years and has total assets not exceeding $10,000,000.\1453\ This change
is expected to mitigate some of the compliance cost for small issuers
and make the final rules a more attractive option for capital formation
among small issuers, and at the same time, help to ensure that larger
issuers with a significant number of investors continue to provide
relevant disclosure.
---------------------------------------------------------------------------
\1453\ Id.
---------------------------------------------------------------------------
This change may, however, make relevant information about the
financial condition of certain issuers no longer available to
investors, resulting in less informed investor decisions. This change
may affect a large number of securities-based crowdfunding offerings,
since it is likely that many crowdfunding issuers will either have
fewer than 300 holders of record or assets below $10 million.
Termination of ongoing reporting may result in a decrease in investor
protection, particularly in the presence of an investor base with a
limited degree of sophistication. Allowing issuers to terminate ongoing
reporting can make monitoring of the issuer more difficult for
investors and can potentially make it more difficult to detect fraud.
We note, however, that the investment limits in the final rules serve
to limit the amount of each investor's capital that is exposed to these
and other risks of securities-based crowdfunding offerings. We further
note that the investment amounts involved in these transactions might
limit a typical investor's incentives to analyze the information
contained in ongoing disclosures and to monitor issuers, even if all
issuers are required to provide ongoing disclosures.
Nevertheless, the risk that an issuer in a securities-based
crowdfunding offering may terminate ongoing reporting in the future may
discourage prospective investors from making an initial investment in
offerings in reliance on Section 4(a)(6) or may cause issuers to obtain
lower valuations for the securities they offer, which may limit some of
the capital formation benefits of the final rules. We note that issuers
who believe that increased investor confidence justifies the cost of
annual reporting would be able to continue ongoing reporting
voluntarily.
Termination of ongoing reporting may also reduce the informational
efficiency of prices and secondary market liquidity, making it more
difficult for investors to exit their holdings after the expiration of
resale restrictions. A lack of ongoing reporting may reduce the
likelihood that a secondary market for such securities develops. We
recognize, however, that a secondary market for securities in offerings
in reliance on Section 4(a)(6) may not develop even if all issuers are
required to provide ongoing reports.
The asset size cap in one of the termination thresholds may create
adverse competitive effects for issuers close to but above the
termination threshold.
e. Advertising--Notice of Offering
The statute and the final rules prohibit an issuer from advertising
the terms of the offering, except for notices that direct investors to
an intermediary's platform.\1454\ The terms of the offering include the
amount offered, the nature of the securities, price of the securities
and length of the offering period.\1455\ The final rules allow an
issuer to publish a notice about the terms of the offering made in
reliance on Section 4(a)(6), subject to certain limitations on the
content of the notice.\1456\ The notices are similar to the ``tombstone
ads'' permitted under Securities Act Rule 134,\1457\ except that the
final rules require the notices to direct investors to the
intermediary's platform, through which the offering made in reliance on
Section 4(a)(6) is being conducted.
---------------------------------------------------------------------------
\1454\ See Section 4A(b)(2). See also Rule 204 of Regulation
Crowdfunding.
\1455\ See Instruction to Rule 204 of Regulation Crowdfunding.
\1456\ See Rule 204(b) of Regulation Crowdfunding. See also
Section II.B.4 above.
\1457\ 17 CFR 230.134.
---------------------------------------------------------------------------
We believe this approach will allow issuers to generate interest in
offerings and to leverage the power of social media to attract
investors, potentially resulting in enhanced capital formation. At the
same time, we believe it also will protect investors by limiting the
ability of issuers to provide certain advertising materials without
also directing
[[Page 71506]]
investors to the disclosures, available on the intermediary's platform,
that are required for an offering made in reliance on Section 4(a)(6).
Moreover, this requirement is not expected to impose costs on market
participants.
As an alternative, we could have required communications about the
offering to be conducted through the intermediary, as suggested by some
commenters.\1458\ To the extent that an issuer might be able to inform
more investors about its offering if it is not limited to
communications through the intermediary's platform, this alternative
might limit the issuer's ability to inform a wide range of investors
about its offering. Limited recognition among prospective investors
might be a particularly significant hurdle for early-stage or small
issuers. As another alternative, we could have required issuers to file
advertising notices with the Commission and/or the relevant
intermediary, as suggested by other commenters.\1459\ While this could
increase the likelihood of issuer compliance with advertising
restrictions, it also would impose an additional cost on the issuer.
Overall, in light of the restrictions on advertising already in place,
it is not clear to what extent, if any, additional restrictions would
enhance investor protection.
---------------------------------------------------------------------------
\1458\ See Hackers/Founders Letter (supporting the issuer being
able to repost the communications elsewhere so long as it first
appeared through the intermediary); Joinvestor Letter.
\1459\ See, e.g., Commonwealth of Massachusetts Letter; CFIRA
Letter 6.
---------------------------------------------------------------------------
Some commenters, suggesting that advertising restrictions are
unnecessary because sales must occur through an intermediary's
platform,\1460\ recommended allowing the issuer more leeway to
publicize its business or offering on its own Web site or social media
platform so long as the specific terms of the offering could be found
only through the intermediary's platform,\1461\ and recommended
allowing advertising notices to have a section for supplemental
information highlighting certain intangible purposes such as a
particular social cause.\1462\ The alternative of relaxing or
eliminating restrictions on advertising could enhance capital formation
efforts of issuers. However, it might also result in a cost to
investors if they make less informed investment decisions based on
incomplete or selectively presented information about the offering
contained in advertising materials.
---------------------------------------------------------------------------
\1460\ See, e.g., FundHub Letter 1; Seed&Spark Letter (noting
the proposed advertising restrictions will restrict the ability of
filmmakers to market and raise money for their films); Arctic Island
Letter 5; PeoplePowerFund Letter.
\1461\ See Fryer Letter.
\1462\ See RocketHub Letter.
---------------------------------------------------------------------------
f. Compensation of Persons Promoting the Offering
The statute and the final rules prohibit an issuer from
compensating, or committing to compensate, directly or indirectly, any
person to promote the issuer's offering through communication channels
provided by the intermediary unless the issuer takes reasonable steps
to ensure that such person clearly discloses the receipt of such
compensation (both past and prospective) each time a promotional
communication is made.\1463\
---------------------------------------------------------------------------
\1463\ See Section 4A(b)(3). See also Rule 205 of Regulation
Crowdfunding and Section II.B.5 above.
---------------------------------------------------------------------------
We believe this requirement will benefit the securities-based
crowdfunding market by allowing investors to make better informed
investment decisions. Although the requirement to take steps to ensure
disclosure of compensation paid to persons promoting the offering will
impose compliance costs on issuers, we believe that investors will
benefit from knowing if the comments about the investment they are
considering are being made by a promoter who is compensated by the
issuer and therefore may not be providing an independent, disinterested
perspective.
The final rules also require that an issuer not compensate or
commit to compensate, directly or indirectly, any person to promote its
offerings outside of the communication channels provided by the
intermediary, unless the promotion is limited to notices that comply
with the advertising rules.\1464\ We believe this will similarly serve
to improve investors' ability to make informed judgments about the
information they encounter through various communication channels about
the issuer, and thus, to make better informed investment decisions.
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\1464\ See Rule 205 of Regulation Crowdfunding. See also Section
II.B.5 above.
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g. Oversubscription and Offering Price
The final rules permit an issuer to accept investments in excess of
the target offering amount, subject to the $1 million limitation, but
require the issuer to disclose the maximum amount the issuer will
accept and how shares in oversubscribed offerings will be
allocated.\1465\ We continue to believe that permitting
oversubscriptions will provide flexibility to issuers so that they can
raise the amount of capital they deem necessary to finance their
businesses. Given the uncertainty on the part of the issuer about
potential market demand for the issuer's securities, we believe it is
valuable for issuers to have the option to permit oversubscriptions.
For example, permitting oversubscriptions will allow an issuer to raise
more funds, while lowering compliance costs as a proportion of the
amount raised, if the issuer discovers during the offering process that
there is greater investor interest in the offering than initially
anticipated or if the cost of capital is lower than initially
anticipated. As an alternative, we could have limited the maximum
oversubscription amount to a certain percentage of the target offering
amount, as suggested by one commenter.\1466\ However, such a
restriction might reduce valuable flexibility and potentially limit
capital formation without appreciably enhancing investor protection.
---------------------------------------------------------------------------
\1465\ See Rule 201(h) of Regulation Crowdfunding. See also
Section II.B.6.a above.
\1466\ See Joinvestor Letter; RFPIA Letter.
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The final rules do not require issuers to set a fixed price, as
suggested by one commenter.\1467\ While such an alternative might
reduce an investor's cost of evaluating the investment, it would reduce
flexibility for issuers while providing only limited benefits to
investors in light of other disclosures required in the final rules.
Further, the required disclosure of the pricing method used and the
final prices for the securities before an offering closes,\1468\
coupled with the investor's ability to cancel his or her investment
commitment,\1469\ can mitigate potential concerns that dynamic pricing
can be used to provide preferential treatment to certain investors
(e.g., when an issuer offers better prices to relatives or insiders).
We also believe that the cancellation rights afforded by the rules will
help to address the concerns about time pressure on the investment
decision because investors will have the opportunity to cancel their
investment commitments if they decide to do so.
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\1467\ See RocketHub Letter.
\1468\ See Rule 201(l) of Regulation Crowdfunding.
\1469\ See Rule 201(j) of Regulation Crowdfunding.
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h. Types of Securities Offered and Valuation
The final rules do not limit the type of securities that may be
offered in reliance on Section 4(a)(6). This provision gives issuers
the flexibility to offer the types of securities that are most
compatible with their desired capital structure and financing needs.
Such flexibility may benefit issuers to the extent that capital
structure decisions can be relevant for an issuer's firm value.
[[Page 71507]]
The final rules do not prescribe a method for valuing the
securities but instead require issuers to describe the terms of the
securities and the valuation method in their offering materials. The
required disclosure of valuation method is intended to facilitate
informed investment decisions. As an alternative, as suggested by
commenters, we could have prescribed the use of particular valuation
standards,\1470\ required issuers to base the valuation of their
securities on the price at which the issuer previously sold
securities,\1471\ or considered other standards designed to ensure that
securities are fairly valued and that approaches to valuation that put
investors at a disadvantage are prohibited.\1472\ If we required a
specific valuation methodology, such as one of the suggested
alternatives, and it were appropriate for a particular issuer, it could
mitigate the likelihood of inaccurate valuations and result in more
informed decisions by investors. However, specific valuation
requirements that do not accommodate inherent differences among
companies, particularly in light of the uncertainty related to the
valuation of early-stage companies, might result in inaccurate
valuations and less informed investor decisions. Also, potential
additional calculations and analysis that might be required to
implement a prescribed valuation methodology could impose additional
costs on issuers, compared to letting issuers select a valuation method
that fits the particular circumstances of their offering.
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\1470\ See, e.g., 11 Wells Letter; Active Agenda Letter; Borrell
Letter; Ellenbogen Letter; Greer Letter; Mountain Hardwear Letter;
Moyer Letter; NaviGantt Letter; Vidal Letter.
\1471\ See, e.g., Public Startup Letter 3; Wefunder Letter.
\1472\ See Consumer Federation Letter.
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i. Restrictions on Resales
The statute and the final rules include restrictions on the
transfer of securities for one year, subject to limited exceptions
(e.g., for transfers to the issuer of the securities, in a registered
offering, to an accredited investor or to certain family
members).\1473\ As we discussed in the proposal, we believe that
including such proposed restrictions is important for investor
protection. By restricting the transfer of securities for a one-year
period, the final rules give investors in a business a defined period
to observe the performance of the business and to potentially obtain
more information about the potential success or failure of the business
before trading occurs. The final rules permit transfers to trusts
controlled by, or held for the benefit of, covered family
members.\1474\ In a change from the proposed rules, the restrictions
apply to any purchasers and not only to the initial purchasers,
consistent with the suggestions of commenters.\1475\ This change
addresses the possibility of the initial purchaser selling securities
to an eligible purchaser and such eligible purchaser reselling them to
the public within the first year, resulting in the securities becoming
widely traded within the first year.
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\1473\ See Section 4A(e). See also Rule 501(a) of Regulation
Crowdfunding.
\1474\ See Rule 501(a)(4) of Regulation Crowdfunding.
\1475\ See CrowdCheck Letter 3; Moskowitz Letter.
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We recognize that resale restrictions will impose costs. The one-
year restriction on transfers of securities purchased in a transaction
conducted in reliance on Section 4(a)(6) may impede price discovery,
raise capital costs to issuers and limit investor participation,
particularly among investors who are unable or unwilling to risk
locking up their investments for this period. The illiquidity cost
resulting from the resale restriction may be mitigated, in part, by
provisions that allow investors to transfer the securities within one
year of issuance by reselling the securities to accredited investors,
back to the issuer or in a registered offering or transferring them to
certain family members or trusts of those family members. The effect of
resale restrictions on the extent to which investors make informed
investment decisions is unclear. While resale restrictions may
disincentivize investors from continuing to gather and analyze
information about the issuer after investing while the resale
restrictions are in effect, resale restrictions may also strengthen the
incentive to conduct due diligence on the issuer and gather and analyze
information before the initial investment. Nevertheless, at the
investment amounts involved in these transactions, a typical
purchaser's incentives to gather and analyze information before or
after investing likely will remain limited, regardless of the presence
of resale restrictions.
4. Intermediary Requirements
The statute and the final rules require that offerings in reliance
on Section 4(a)(6) be conducted through an intermediary that is a
registered broker-dealer or registered funding portal. The use of a
registered intermediary to match issuers and investors will cause
issuers to incur certain transaction costs associated with the
intermediation activity \1476\ but also will provide centralized venues
for crowdfunding activities that are expected to lower investor and
issuer search costs. As discussed earlier, existing lending-based,
reward-based, and donation-based crowdfunding platforms already engage
in a large volume of transactions in North America,\1477\ demonstrating
that the use of platforms for crowdfunding may be familiar to investors
and issuers.
---------------------------------------------------------------------------
\1476\ See Section III.B.3.a above for a discussion of
intermediary fees.
\1477\ See Section III.A.3 above.
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We believe that existing non-securities-based crowdfunding
platforms will initially be the primary funding portals in the
securities-based crowdfunding market. The entry of registered broker-
dealers and new funding portals in the securities-based crowdfunding
market will increase competition among existing non-securities-based
crowdfunding intermediaries and potentially lower the cost of
intermediation to issuers. One commenter stated that it has ``a serious
concern with Broker/Dealers having an unfair advantage in the market,
by already being regulated and registered with the Commission as well
as FINRA. Therefore, they may be able to service the market well ahead
of Portals.'' \1478\
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\1478\ See RocketHub Letter. Several other commenters expressed
concern about funding portals being at a competitive disadvantage to
registered broker-dealers. See, e.g., Joinvestor Letter; City First
Letter; Seed&Spark Letter; Guzik Letter 1.
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We acknowledge that, to the extent that it may take less time and
cost for registered broker-dealers to comply with the requirements of
Regulation Crowdfunding as compared to funding portals, registered
broker-dealers may be at a competitive advantage compared to new
entities that seek to register as funding portals and enter the
crowdfunding market. However, as we discuss below, the registration
requirements for funding portals are tailored to the more limited scope
of funding portal activities and are thus expected to result in a lower
compliance cost for these entities. Further, the effective dates of the
final rules are expected to provide time for funding portals to
register and comply with the other requirements of Regulation
Crowdfunding before crowdfunding offerings can occur.\1479\ We
recognize, however, that registered broker-dealers can retain a
competitive advantage relative to funding portals due to their
[[Page 71508]]
ability to engage in a wider range of activities in the securities-
based crowdfunding market.\1480\ In this regard we note that the final
rules permit funding portals to compensate a registered broker-dealer
and to receive compensation from a registered broker-dealer for
services in connection with the funding portal's offer or sale of
securities in reliance on Section 4(a)(6),\1481\ which may enable
funding portals to partly mitigate the impact of restrictions on
funding portal activities in the statute and final rules. Moreover,
even if funding portals remain at a competitive disadvantage to
registered broker-dealers in the securities-based crowdfunding market,
overall the expected participation of multiple registered broker-
dealers as intermediaries in offerings in reliance on Section 4(a)(6)
may nevertheless result in a considerable level of competition in the
securities-based crowdfunding marketplace.
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\1479\ The time period between the effective date of the final
rules pertaining to funding portal registration as compared to the
later effective date for rules governing crowdfunding offerings is
expected to mitigate some of these effects. See also Section
II.C.2.a above.
\1480\ See also note 607.
\1481\ See Rule 402(b)(7) and Rule 402(b)(8) of Regulation
Crowdfunding. See also Section II.D.3.g.
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Both existing non-securities-based crowdfunding platforms and
registered broker-dealers will need to invest resources to comply with
the requirements of the statute and final rules. In addition,
registered broker-dealers will need to develop Internet-based
crowdfunding platforms while existing non-securities-based crowdfunding
platforms will need to register as funding portals or broker-dealers
and modify their existing platforms to conform to the requirements of
the statute and the final rules. Although the eventual extent of
broker-dealer involvement in the securities-based crowdfunding market
is difficult to estimate, we believe that some broker-dealers may
acquire or form partnerships with funding portals to obtain access to a
new and diverse investor base. In addition, some existing non-
securities-based crowdfunding platforms may eventually form
partnerships with registered broker-dealers or funding portals. It is
challenging to exactly predict the future number of persons (or
entities) who will register as either broker-dealers or funding portals
to act as intermediaries in securities-based crowdfunding transactions.
For purposes of the PRA,\1482\ we estimate that intermediaries will
number approximately 110, including approximately 10 intermediaries
that will register as broker-dealers in order to engage in securities-
based crowdfunding; approximately 50 intermediaries that are already
registered as broker-dealers and that will choose to serve as
crowdfunding intermediaries; and approximately 50 intermediaries that
are not already registered as broker-dealers and that will register as
funding portals.\1483\ It is possible that the actual number of
participants will deviate significantly from these estimates, and it is
likely that there will be significant competition between existing
crowdfunding venues and new entrants that may result in further changes
in the number and types of intermediaries as the market develops and
matures. It also is likely that there will be significant developments
in the types and ranges of crowdfunding products and services offered
by intermediaries to potential issuers and investors, particularly as
competitors gain additional experience in this new marketplace.
Moreover, the business models of successful crowdfunding intermediaries
are likely to change over time as they grow in size or market share or
if they are forced to differentiate from other market participants in
order to maintain their position in the market.
---------------------------------------------------------------------------
\1482\ See Section IV.B.2 and Section IV.B.3 below.
\1483\ These estimates are based, in part, on recent indications
of interest, which may change as the market develops. According to
FINRA, as of October 3, 2013, approximately 36 entities have
submitted the voluntary Interim Form for Funding Portals to FINRA to
indicate their intention to act as funding portals under Title III
of the JOBS Act. See Press Release, Financial Industry Regulatory
Authority, FINRA Issues Voluntary Interim Form for Crowdfunding
Portals (Jan. 10, 2013), available at http://www.finra.org/Newsroom/NewsReleases/2013/P197636; Financial Industry Regulatory Authority,
Crowdfunding Portals, available at http://www.finra.org/industry/issues/crowdfunding. Based on these recent indications of interest,
we expect that the number of funding portals that will ultimately
register with the Commission will be approximately 50.
We note that these estimates are the same as the estimates of
potential crowdfunding intermediaries set forth in the Proposing
Release. We did not receive comments about these estimates.
---------------------------------------------------------------------------
As a result of the uncertainty over how the market may develop, any
estimates of the potential number of market participants, their
services or fees charged are subject to significant estimation error.
While we recognize that there are benefits as well as costs associated
with the statutory requirements and the final rules pertaining to
intermediaries, there are significant limitations to our ability to
estimate these potential benefits and costs.
The statute requires that the offer or sale of securities in
reliance on Securities Act Section 4(a)(6) be conducted through a
broker-dealer or a funding portal that complies with the requirements
of Securities Act Section 4A(a).\1484\ Among other things, the
intermediary must register with the Commission as a broker-dealer or a
funding portal, and it also must register with a registered national
securities association.\1485\ The final rules implement these statutory
requirements, including by requiring an intermediary to be a member of
FINRA or any other applicable registered national securities
association.
---------------------------------------------------------------------------
\1484\ See Section 4(a)(6)(C).
\1485\ See Section 4A(a)(2).
---------------------------------------------------------------------------
While the benefits and costs are described in further detail below,
the following tables summarize the estimated direct costs to
intermediaries, including broker-dealers and funding portals. Some of
the direct costs of the rules will be incurred by all intermediaries,
while others are specific to whether the intermediary is a new entrant
(registering as a broker-dealer or a funding portal) or is already
registered as a broker-dealer.
Although we have attempted to estimate the direct costs of the
statute and the final rules on intermediaries, we recognize that some
costs can vary significantly across intermediaries, and within
categories of intermediaries. For example, some intermediaries may
choose to leverage existing platforms or systems and so may not need to
incur significant additional expenses to develop a platform or comply
with specific requirements of Regulation Crowdfunding. In the Proposing
Release we provided cost estimates for the various intermediary
requirements and requested comment on our estimates. Several commenters
discussed the estimates of the costs associated with intermediaries or
provided cost estimates of their own.\1486\ Below we discuss the
comments received on each of these costs and any revisions to our
estimates made in response.
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\1486\ See, e.g., ASSOB Letter (suggesting that the cost to
establish a funding portal would run at least $480,000); Arctic
Island Letter 8 (referring to the cost of establishing and managing
escrow accounts); CapSchedule Letter (citing costs of managing
securityholder records); Joinvestor Letter (suggesting in reference
to records to be kept by funding portals that ``[u]nder the
expectation that crowdfunding portals will be online operations and
will almost certainly retain records through digital methods, the
burden of collection should be minimal'' but not providing a
specific estimate of the cost of compliance). Various commenters
expressed concern with the cost imposed on intermediaries. See,
e.g., Heritage Letter (suggesting that the ``costs incurred by the
intermediary in dealing with an issuer, doing the required due
diligence and background screening, establishing a Web page
describing the offering and so on do not vary linearly with the
offering size''); Seed&Spark Letter; SBEC Letter (suggesting that
there will be ``extensive staff, technology and operational costs''
in addition to the compliance costs estimated in the Proposing
Release).
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[[Page 71509]]
We estimate that the cost for an entity to register as a broker-
dealer and become a member of a national securities association in
order to engage in crowdfunding pursuant to Section 4(a)(6) will be
approximately $275,000, with an ongoing annual cost of approximately
$50,000 to maintain this registration and membership.\1487\ In
addition, we estimate that the cost to comply with the various
requirements that apply to registered broker-dealers engaging in
transactions pursuant to Section 4(a)(6) for these new registrants will
be approximately $245,000 initially and approximately $180,000 in each
year thereafter. In making this estimate, we assume that broker-dealers
acting as intermediaries in transactions pursuant to Section 4(a)(6)
will provide a full range of brokerage services in connection with
these transactions, including certain services such as providing
investment advice and recommendations, soliciting investors, and
managing and handling customer funds and securities, that funding
portals cannot provide.\1488\
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\1487\ We recognize that the cost of registering and becoming a
member of a national securities association varies significantly
among broker-dealers, depending on facts and circumstances. The cost
can vary, among other factors, based on the number of associated
persons of the broker-dealer entity and their licensing
requirements, the scope of the brokerage activities, and the means
by which the broker-dealer administers the registration process
(e.g., it may choose to hire outside counsel to assist with the
process). We also recognize that the time required for a broker-
dealer to become a member of a national securities association
varies and can take six months to one year. We estimate the range of
this cost to be between $50,000 and $500,000, and so we have chosen
the average amount of $275,000 for purposes of this analysis.
\1488\ Among other things, a broker-dealer providing
recommendations and investment advice is required to comply with
FINRA rules on suitability. See FINRA Rule 2111. A broker-dealer
soliciting through advertisements is required to comply with FINRA
rules relating to communications with the public. See FINRA Rule
2210. Broker-dealers handling customer funds and securities also are
required to maintain net capital, segregate customer funds and
comply with Exchange Act Rule 15c2-4. See Exchange Act Rules 15c3-1,
15c3-3 and 15c2-4 [17 CFR 240.15c3-1, 15c3-3 and 15c2-4].
---------------------------------------------------------------------------
If instead an entity were to register as a funding portal and
become a funding portal member of a national securities association, we
estimate the initial registration and membership cost will be
approximately $100,000, with an ongoing cost of approximately $10,000
in each year thereafter to maintain this registration and
membership.\1489\ We estimate that the initial cost for a registered
funding portal to comply with the requirements of the final rules will
be approximately $67,000, with an ongoing cost of approximately $40,000
in each year thereafter.
---------------------------------------------------------------------------
\1489\ In making these estimates, we assume that the membership
process will take approximately sixty days and that there will be no
related licensing requirement for associated persons of the funding
portal. In the Proposing Release, we estimated that the membership
process will take approximately one month. While it does not affect
our estimate of direct costs, we note that a longer membership
process can result in incremental indirect costs to funding portals
(e.g., opportunity costs due to not being able to serve as an
intermediary in crowdfunding offerings while registration
requirements are not met and competitive costs due to requiring
additional time to register compared to registered broker-dealers.
The time period between the effective date of the final rules
pertaining to funding portal registration as compared to the later
effective date for rules governing crowdfunding offerings is
expected to mitigate these effects.
We also only include domestic entities in these estimates, which
do not need to comply with the requirements in Regulation
Crowdfunding that apply to nonresident funding portals. Nonresident
funding portals are subject to an additional cost of completing
Schedule C to Form Funding Portal, hiring and maintaining an agent
for service of process and providing the required opinion of
counsel. See Section IV.C.2.a. below (discussing burden estimates of
these additional requirements for purposes of the PRA).
---------------------------------------------------------------------------
Finally, we estimate that the incremental initial cost for an
intermediary that is already registered as a broker-dealer to comply
with the requirements of the final rules will be approximately $45,000,
with an ongoing cost of approximately $30,000 in each year thereafter.
These estimated costs are consistent with those set forth in the
Proposing Release and are exclusive of the cost of establishing and
maintaining a platform and related functionality. For purposes of the
PRA, we estimate that for the average intermediary, the mid-range
initial external platform development cost will be approximately
$425,000 and the ongoing cost will be approximately $85,000 per
year.\1490\ However, we anticipate considerable variation among
intermediaries depending on whether they already have in place
platforms and systems that can be adapted to meet the requirements of
the final rules. We expect that intermediaries (whether broker-dealers
or funding portals) that already have in place platforms and related
systems that will need only to tailor their existing platform and
systems to comply with the requirements of Regulation Crowdfunding,
resulting in a lower initial cost on average of $250,000. We expect the
ongoing cost to remain approximately $85,000 per year for an
intermediary that already has in place a platform and related systems.
Commenters did not provide estimates of the cost of establishing a
platform or tailoring an existing platform to comply with the
requirements of Title III. One commenter suggested that the cost of
operating a funding portal and regulatory compliance would be at least
$480,000 per year but did not break out this estimate into separate
cost components.\1491\
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\1490\ These estimates are based on intermediaries that use a
third party to develop the platform. Intermediaries that develop the
platform in-house may incur lower costs. For purposes of the PRA, we
estimate that intermediaries that develop the platform in-house
instead of using a third-party provider will spend an average of
1,500 hours for initial planning, programming and implementation and
300 hours per year in ongoing internal burden. For purposes of the
PRA we estimate that approximately half of the intermediaries will
use a third party to develop the platform and the other half will
develop their platforms in-house. See Section IV.C.2.b below.
\1491\ See ASSOB Letter.
\1492\ As discussed above, these costs include, among others,
the costs to the broker-dealer of having associated persons who have
licensing requirements, suitability requirements, requirements
relating to advertisements, net capital requirements, and compliance
with Exchange Act Rule 15c2-4 (17 CFR 240.15c2-4), as well as the
costs of complying with Subpart C of Regulation Crowdfunding. See
Section IV.C.2 below for further detail on our estimates, for PRA
purposes, of the costs associated with the requirements under
Subpart C.
\1493\ See Section IV.C.2.b below for further detail on our
estimates, for PRA purposes, of the costs of developing a platform.
Estimated Costs of Final Rules for Intermediaries That Register as
Broker-Dealers
------------------------------------------------------------------------
Estimated costs
-------------------------------
Initial cost Ongoing cost
(year 1) per year
------------------------------------------------------------------------
Form BD Registration and National $275,000 $50,000
Securities Association Membership......
Complying with Requirements to Act as an 245,000 180,000
Intermediary in, and to Engage in
Broker-Dealer Activities Related to,
Transactions pursuant to Section
4(a)(6) \1492\.........................
Platform Development \1493\............. 425,000 85,000
-------------------------------
Total............................... 945,000 315,000
------------------------------------------------------------------------
[[Page 71510]]
Estimated Costs of Final Rules for Intermediaries That Register as
Funding Portals
------------------------------------------------------------------------
Estimated costs
-------------------------------
Initial cost Ongoing cost
(year 1) per year
------------------------------------------------------------------------
Form Funding Portal Registration and $100,000 $10,000
National Securities Association
Membership \1494\......................
Complying with Requirements to Act as an 67,000 40,000
Intermediary \1495\ in Transactions
pursuant to Section 4(a)(6)............
Platform Development \1496\............. 425,000 85,000
-------------------------------
Total............................... 592,000 135,000
------------------------------------------------------------------------
Estimated Incremental Costs of Final Rules for Intermediaries Already
Registered as Broker-dealers
------------------------------------------------------------------------
Estimated costs
-------------------------------
Initial cost Ongoing cost
(year 1) per year
------------------------------------------------------------------------
Complying with Requirements to Act as an $45,000 $30,000
Intermediary in Transactions pursuant
to Section 4(a)(6) \1497\..............
Platform Development \1498\............. 425,000 85,000
-------------------------------
Total............................... 470,000 115,000
------------------------------------------------------------------------
Commenters suggested that funding portals should not be required to
register with the Commission or become FINRA members (or members of any
other registered national securities association), because unlike
broker-dealers, they serve only as an ``information delivery service.''
\1499\ One commenter stated that the Commission's estimates in initial
costs of registration as a funding portal and for ongoing expenses
create a significant burden given that potential funding portals
operate on modest budgets and with thin margins.\1500\ As we note
above, however, registration is a statutory requirement under
Securities Act Section 4A(a)(1).\1501\ While the registration
requirements will necessarily impose costs on intermediaries, we
believe they also will be effective in providing investor protection
for the crowdfunding market while taking into account the more limited
activities of funding portals. Among other things, in addition to the
Commission's oversight and rulemaking functions with regard to broker-
dealers, FINRA currently is responsible for conducting most broker-
dealer examinations, mandating certain disclosures by its members,
writing rules governing the conduct of its members and associated
persons, and informing and educating the investing public. Similarly,
we believe that in addition to the benefits of the Commission's
oversight with regard to funding portals, the regulatory framework that
a registered national securities association--initially FINRA--will be
required to create for funding portals will play an important role in
the oversight of these entities.
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\1494\ As described above, this estimate reflects a streamlined
process of becoming a member of a national securities association,
which we assume will take approximately sixty days and not involve
application or licensing of associated persons.
\1495\ This includes the costs of complying with the
requirements of Subparts C and D of Regulation Crowdfunding. See
Section IV.C.2 below for further detail on our estimates, for PRA
purposes, of these costs.
\1496\ See Section IV.C.2.b below for further detail on our
estimates, for PRA purposes, of the costs of developing a platform.
\1497\ This includes the incremental costs of complying with the
requirements of Subpart C of Regulation Crowdfunding, but it
excludes any registration or membership requirements. See Section
IV.C.2 below for further detail on our estimates, for PRA purposes,
of these costs.
\1498\ See Section IV.C.2.b below for further detail on our
estimates, for PRA purposes, of the costs of developing a platform.
\1499\ See Perfect Circle Letter.
\1500\ See Seed&Spark Letter.
\1501\ See Section II.C.2.a above.
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The estimated costs in the tables above reflect the direct costs
that intermediaries will incur in connection with registering as a
broker-dealer on Form BD or as a funding portal on Form Funding Portal,
submitting amendments to registrations and withdrawing registrations.
For the purposes of the PRA, we estimate that approximately 50
intermediaries will be broker-dealers that have already registered with
the Commission \1502\ and, as such, these broker-dealers will not incur
additional SEC registration costs associated with the final rules.
Additionally, intermediaries that are not otherwise registered with
FINRA or any other registered national securities association will need
to register, and the estimated cost for such registration is included
in the tables above. We anticipate that the cost for a funding portal
to become a member of a registered national securities association will
be lower than the cost for a broker-dealer to do so because of the more
limited nature of a funding portal's permissible activities and the
streamlined set of rules that an association is likely to impose on
funding portals. In this regard, we note that FINRA has solicited
public comment on a set of proposed rules and related forms for
registered funding portals that become FINRA members pursuant to the
crowdfunding provisions of the JOBS Act.\1503\
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\1502\ See Section IV.C.2 below.
\1503\ See Proposed Funding Portal Rules, available at http://www.finra.org/sites/default/files/NoticeAttachment/p369763.pdf. See
also FINRA Requests Comment on Proposed Funding Portal Rules and
Related Forms, FINRA Regulatory Notice 13-34, available at http://www.finra.org/sites/default/files/NoticeDocument/p370743.pdf. (``The
rule is based on the current NASD Rule 1010 Series membership rules
that apply to broker-dealers. However, the process for funding
portals is simplified to reflect the limited nature of their
business.'')
---------------------------------------------------------------------------
The final rules also require that an intermediary execute
transactions exclusively through its online platform. This requirement
may lower the potential for abusive sales practices. However, it may
also prevent investors who lack Internet access from investing through
crowdfunding, as suggested by one commenter.\1504\ We believe that the
use of an online platform will enhance the ability of issuers and
investors to communicate transparently as compared to the alternative
of allowing transactions to occur offline. This requirement also is
expected to help issuers gain exposure to a wide range of investors,
who also may benefit from
[[Page 71511]]
having numerous investment opportunities aggregated in one place,
resulting in lower search costs or burdens related to identifying
suitable investment opportunities.
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\1504\ See, e.g., Projecteureka Letter.
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The final rules further require that an issuer conduct an offering
or concurrent offerings in reliance on Section 4(a)(6) using a single
intermediary.\1505\ We recognize that this requirement may impose costs
by limiting the set of investors, as well as communication about a
transaction, to the extent that some investors do not use a specific
crowdfunding platform.\1506\ However, it may also enhance communication
between issuers and investors, as suggested by some commenters,\1507\
and enable investors to access investor discussions about a particular
transaction on a single platform. This requirement may also reduce the
risk of issuers circumventing the aggregate offering limit.
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\1505\ See Instruction 1 to Rule 100(a)(3) of Regulation
Crowdfunding. See also Section II.A.3.
\1506\ See, e.g., Graves Letter.
\1507\ See, e.g., CFA Institute Letter; RocketHub Letter.
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Some commenters suggested that the statutory and rule requirements
for establishing a funding portal and ongoing maintenance and
compliance expenses create a significant burden on funding
portals.\1508\ Among other concerns, commenters highlighted potential
liability for intermediaries \1509\ under Securities Act Section 4A(c)
and the cost of conducting background checks \1510\ pursuant to Rule
301(c) as particularly burdensome for funding portals. We are mindful
of the potentially significant costs as a percentage of offering size
incurred by intermediaries, especially funding portals, in securities-
based crowdfunding offerings. However, intermediary requirements are
designed to provide a measure of investor protection from the risk of
fraud in small offerings by relatively unknown issuers. Concentration
of certain due diligence tasks at the intermediary level may yield
efficiency gains relative to having each small investor incur the cost
to perform such tasks. In addition, although funding portals may be
subject to issuer liability, the changes we have implemented in the
final rules will give them greater ability to control which issuers
conduct offerings on their platforms and thus to mitigate to some
degree the risks of liability arising from such offerings.
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\1508\ See, e.g., ASSOB Letter (suggesting that the cost to
establish a funding portal could be at least $480,000).
\1509\ See, e.g., ABA Letter; AngelList Letter; BetterInvesting
Letter; CFIRA Letter 10; City First Letter; EarlyShares Letter; EMKF
Letter; FSI Letter; Graves Letter; Guzik Letter 1; IAC
Recommendation; Inkshares Letter; Milken Institute Letter; PPA
Letter; RocketHub Letter; SBA Office of Advocacy Letter; SBEC
Letter; SeedInvest Letter 3; Seyfarth Letter; StartupValley Letter;
Wefunder Letter; Winters Letter. See also Section II.E.5.
\1510\ See, e.g., RocketHub Letter; Anonymous Letter 4; Zhang
Letter. See also Section II.C.3.c above.
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a. Disclosure and Dissemination Requirements
The statute and final rules include disclosure and dissemination
provisions designed to provide information to security-based
crowdfunding investors. These provisions, together with the issuer
disclosure provisions discussed above, are expected to limit
information asymmetries and promote the efficient allocation of capital
amongst crowdfunding offerings. These provisions also will provide
information intended to ensure that investors are aware of the risks
associated with their investment, which can enhance investor
protection. As discussed above, many of the costs and benefits of these
provisions are difficult to quantify or estimate with any degree of
certainty, especially considering that securities-based crowdfunding
will constitute a new method for raising capital in the United States.
Although we are not able to quantify the direct costs specifically
associated with each of these requirements, these costs are reflected
in our general estimates of the initial and ongoing costs for
intermediaries to register, comply with their obligations under the
final rules and develop a crowdfunding platform, as reflected in the
tables above.
The final rules prohibit an intermediary or its associated persons
from accepting an investment commitment until the investor has opened
an account with the intermediary and the intermediary has obtained the
investor's consent to electronic delivery of materials.\1511\ This
requirement will help ensure that certain basic information about the
investor is on file with the intermediary and that all investors are on
notice of the primary method of delivery for communications from the
intermediary. To the extent that an intermediary uses a third party to
establish account opening functionality, the costs relevant to this
requirement will be incorporated into the cost to develop the
platform.\1512\
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\1511\ See Rule 302(a) of Regulation Crowdfunding.
\1512\ See also Section IV.C.2.d below.
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The statute requires intermediaries to provide disclosures related
to risks and other investor education materials. The final rules
implement this statutory mandate by requiring intermediaries to deliver
educational materials that explain how the offering process works and
the risks associated with investing in crowdfunding securities.\1513\
The educational requirements will help make investors aware of the
limits and risks associated with purchasing crowdfunding securities and
facilitate the selection of investments suited to their level of risk
tolerance. They also may help ensure that offerings proceed more
efficiently as investors will be better informed by the time they
decide to make their investment commitments and receive required
notices. However, we recognize that the effectiveness of the
educational materials in enhancing investor protection will vary
depending upon the quality of the educational materials and the
education and experience of retail investors.\1514\ In addition,
materials that highlight the risks of securities-based crowdfunding can
discourage investor participation, which may limit potential capital
formation.
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\1513\ See Rule 302(b) of Regulation Crowdfunding.
\1514\ See Jennifer E. Bethel and Allen Ferrell, Policy Issues
Raised by Structured Products, Harv. L. & Econ. Discussion Paper No.
560, 2007, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=941720.
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Under the final rules, the educational materials can be in any
electronic format, including video format, and the intermediary will
have the flexibility to determine how best to communicate the contents
of the educational material. Accordingly, the cost for intermediaries
to develop educational materials is expected to vary widely. For
purposes of the PRA, we estimate that the initial cost for an
intermediary using a third-party firm to develop and produce
educational materials will be approximately $10,000 to $30,000 and the
ongoing cost will be approximately $5,000 to $15,000 per year.\1515\
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\1515\ For the purposes of the PRA, we estimate that development
of educational materials in-house will be associated with an average
initial burden of approximately 20 hours and an average annual
burden of approximately 10 hours. See Section IV.C.2.e below.
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The final rules also require that intermediaries obtain
representations from investors about their review of the investor
education materials and their understanding of the risks.\1516\ This
requirement is expected to improve investors' understanding of
investments in securities-based crowdfunding offerings. The direct
costs of this requirement to an intermediary are reflected in the
tables above as part of the costs of developing a crowdfunding
platform, and we believe that the
[[Page 71512]]
ongoing burden to comply will be minimal after the intermediary has
systems in place to obtain such representations. This requirement also
may limit capital formation to the extent that it deters investors from
making investment commitments or otherwise participating in offerings
made in reliance on Section 4(a)(6).
---------------------------------------------------------------------------
\1516\ See Rule 303(b)(2) of Regulation Crowdfunding.
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Under the final rules, an intermediary must clearly disclose the
manner in which the intermediary is compensated in connection with
offers and sales of securities in reliance on Section 4(a)(6).\1517\ As
explained above, we believe that investors will benefit by having
information about how intermediaries are compensated, such as through
compensation arrangements with affiliates. We believe that the costs of
complying with this requirement generally will be included in the
overall cost for intermediaries to develop their platforms, as it will
entail adding an item of disclosure to the functionality of their
platforms.\1518\ While the requirement to disclose compensation
arrangements may give rise to indirect costs due to the intermediary's
competitors learning about the compensation arrangements, we do not
expect such indirect costs to be significant since the intermediary's
competitors can generally infer information about the intermediary's
compensation arrangements from other sources.
---------------------------------------------------------------------------
\1517\ See Rule 302(d) of Regulation Crowdfunding.
\1518\ See also Section IV.C.2.f below.
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The statute and the final rules further require that intermediaries
make available certain issuer-provided information.\1519\ We recognize
that requiring intermediaries to provide prospective investors with
information about the issuer will impose costs. We expect that
intermediaries will incur costs to develop the functionality that will
allow the uploading and downloading of issuer information. We believe
that the direct costs of complying with this requirement will be
included in the overall cost to intermediaries to develop their
platforms and that this requirement will impose only nominal
incremental costs on intermediaries on an ongoing basis, primarily
because the functionality necessary to upload the required issuer
disclosure information is a standard feature offered on many Web sites
and would not require frequent updates.\1520\
---------------------------------------------------------------------------
\1519\ See Rule 303(a) of Regulation Crowdfunding.
\1520\ See also Section IV.C.2.g below.
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The issuer disclosure requirements are expected to benefit
investors by enabling them to better evaluate the issuer and the
offering. Requiring intermediaries to make the issuer information
publicly available and easily accessible on their platforms will reduce
information asymmetries between issuers and investors and will enhance
both transparency and efficiency of the crowdfunding market. Greater
accessibility of issuer information may reduce incremental costs to
investors of locating issuer information and may increase their
willingness to participate in a securities-based crowdfunding offering,
thereby enhancing capital formation.
The final rules also require an intermediary to provide
communication channels on its platform, meeting certain conditions,
which will allow investors who have opened accounts with intermediaries
and representatives of the issuer to interact and exchange comments
about the issuer's offering on that intermediary's platform, and which
will be publicly available for viewing (i.e., by those who may not have
opened accounts with the intermediary).\1521\
---------------------------------------------------------------------------
\1521\ See Rule 303(c) of Regulation Crowdfunding.
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Compared with the alternative of not requiring intermediaries to
provide communication channels, we believe this requirement will allow
investors, particularly those who may be less familiar with online
social media, to participate in online discussions about ongoing
offerings without having to actively search for such discussions on
external Web sites. Moreover, the requirement that promoters be clearly
identified on these channels will enhance transparency, allowing those
investors that draw information from an intermediary's online platform
to make potentially better informed investment decisions. The direct
costs of this requirement are reflected in the tables above as part of
costs of developing a crowdfunding platform, and we believe that once
the platform has been set up, the ongoing burden to comply will be
minimal. We recognize, however, that this requirement will not assure
that participants in online discussions on the intermediary's online
platform convey accurate or relevant information in their postings, and
it will not preclude investors from participating in discussions on
external Web sites or other external social media.
The final rules also require intermediaries, upon receipt of an
investment commitment from an investor, promptly to provide or send to
the investor a notification of that investment commitment.\1522\ This
requirement will provide investors with key information about their
investment commitments, including notice of the opportunity, as
relevant, to cancel their investment commitments. Investors will
benefit from these requirements because they will be provided with
additional information with which to evaluate their investment
commitments, their securities transactions and the intermediaries that
are effecting those transactions. The direct costs of these
requirements are reflected in the tables above as part of the costs of
developing a crowdfunding platform.\1523\
---------------------------------------------------------------------------
\1522\ See Rule 303(d) of Regulation Crowdfunding.
\1523\ See also Section IV.C.2.h below.
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The final rules implement the statutory requirement for
intermediaries to allow investors to cancel their commitments to
invest, by requiring investors to have until 48 hours prior to the
deadline identified in the issuer's offering materials to cancel their
investment commitments.\1524\ If an issuer reaches its target offering
amount prior to the target offering deadline, the final rules permit
early closing of the offering under certain conditions, including a
requirement that the intermediary send notices to investors informing
them of the closing and the deadline for the opportunity to
cancel.\1525\ The final rules also set forth notice requirements and
requirements related to the intermediary directing payments in the
event of cancellations and material changes to offerings.\1526\
Additionally, the final rules impose specific obligations on
intermediaries related to informing investors about their right to
cancel an investment commitment.\1527\
---------------------------------------------------------------------------
\1524\ See Rule 304(a) of Regulation Crowdfunding.
\1525\ See Rule 304(b) of Regulation Crowdfunding.
\1526\ See Rule 304(c) and Rule 304(d) of Regulation
Crowdfunding.
\1527\ See Rule 302(b) of Regulation Crowdfunding.
---------------------------------------------------------------------------
We believe that investors will benefit from receiving these notices
because the notifications and accompanying information will keep
investors informed about the status of the offering and thereby
facilitate better investment decisions. This approach also will benefit
investors by providing them with a specified period of time to review
and assess information and communications about the issuer.
We recognize that allowing investors to cancel their investment
commitments up to 48 hours prior to the deadline identified in the
issuer's offering materials may impose a cost on issuers who, because
of investors cancelling commitments late in the offering period, may
fall below the target offering amount and so decide to cancel the
offering or to extend the offering period. Accordingly, we recognize
that this requirement may reduce the overall amount of capital raised
in offerings in
[[Page 71513]]
reliance on Section 4(a)(6) and thus have an adverse effect on capital
formation. Intermediaries are expected to incur direct costs in
developing and maintaining systems to send the relevant notices to
investors. These costs are reflected in the tables above as part of the
cost of developing a crowdfunding platform.\1528\
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\1528\ See also Section IV.C.2.h below.
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b. Measures To Reduce the Risk of Fraud
The statute and final rules require intermediaries to have a
reasonable basis for believing that an issuer seeking to offer and sell
securities in reliance on Section 4(a)(6) through the intermediary's
platform complies with the requirements in the final rules \1529\ and
has established means to keep accurate records of holders of the
securities.\1530\ Under the final rules, an intermediary must deny
access to an issuer if it has a reasonable basis for believing that the
issuer or the offering presents the potential for fraud or otherwise
raises concerns about investor protection \1531\ or that the issuer or
any of its officers, directors (or any person occupying a similar
status or performing a similar function) or 20 Percent Beneficial
Owners was subject to a disqualification under the final rules.\1532\
The intermediary also must conduct a background and securities
enforcement check on each of these persons.\1533\ We believe that these
requirements will increase investor protection in connection with the
offering.\1534\
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\1529\ See Rule 301(a) of Regulation Crowdfunding.
\1530\ See Rule 301(b) of Regulation Crowdfunding.
\1531\ See Rule 301(c)(2) of Regulation Crowdfunding.
\1532\ See Rule 301(c)(1) of Regulation Crowdfunding.
\1533\ Id.
\1534\ See also Section II.C.3 above.
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As noted above, the specific costs and benefits of these provisions
are difficult to quantify or estimate with any degree of certainty.
However, we have attempted to reflect the direct costs of these
provisions in the tables above as part of our general estimates for the
cost of complying with requirements to act as an intermediary in
transactions pursuant to Section 4(a)(6). For purposes of the PRA, the
cost for an intermediary to fulfill the required background checks and
securities enforcement regulatory history checks is estimated to be
approximately $13,818 to $34,546 in the first year and approximately
the same in subsequent years.\1535\
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\1535\ See Section IV.C.2.c below.
---------------------------------------------------------------------------
Each of these requirements is intended to help reduce the risk of
fraud in securities-based crowdfunding. As a result of these
requirements, investors will be able to rely on the efforts of the
intermediary that conducted a background and securities enforcement
check, solving a collective action problem that would be prohibitively
costly if left to individual investors. To the extent that these checks
help prevent fraudulent activity, they may increase investor
willingness to participate in crowdfunding offerings, thereby
facilitating capital formation. We anticipate that most intermediaries
will employ third parties to perform these background checks.
We received several suggestions from commenters aimed at reducing
or scaling the costs of the proposed requirements. One commenter
suggested that the checks be required only after an issuer has met its
target offering amount, so as to prevent unnecessary expense to the
intermediary.\1536\ Requiring a background check only after an issuer
has reached its target may reduce the total cost of performing
background checks for intermediaries; however, it also may result in
intermediaries having to cancel offerings by issuers who fail the
background checks, resulting in additional transactional and
reputational costs for the intermediary. Overall, relative to this
alternative, we believe that an intermediary performing a background
check on an issuer prior to the securities offering will improve
investor confidence in using a given intermediary.
---------------------------------------------------------------------------
\1536\ Anonymous Letter 4.
---------------------------------------------------------------------------
While intermediaries are required to take certain steps to reduce
the risk of fraud, the final rules provide intermediaries with the
flexibility to decide the specific steps to take, consistent with some
of the commenters' suggestions.\1537\ We believe this may reduce
intermediary costs relative to establishing a more stringent or more
specific standard for intermediaries. For example, deeming an
intermediary to have satisfied the Rule 301(b) requirement if the
issuer has engaged the services of a transfer agent that is registered
under Section 17A of the Exchange Act will reduce the intermediary cost
while at the same time potentially improving investor protection.\1538\
In addition, intermediaries may rely on the representations of the
issuer unless they have reason to question the reliability of those
representations. Overall, a more rigorous review requirement represents
a tradeoff between enhanced investor confidence in the portal and
higher compliance costs for intermediaries. We recognize that
permitting an intermediary to rely on an issuer's representations
unless the intermediary has reason to question the reliability of the
representations can potentially lessen the incentive for an
intermediary to thoroughly investigate the issuers and securities to be
offered on its platform. Such an outcome may result in higher levels of
fraud compared to a requirement that intermediaries perform an
independent investigation to ensure that the issuer complied with all
the requirements. A higher level of fraud will negatively affect both
investors in crowdfunding offerings and non-fraudulent issuers. While
we recognize this potential adverse effect, we note that intermediaries
may be subject to liability as ``issuers,'' and this liability,
together with potential reputational harm, is expected to provide
significant incentives for intermediaries to monitor and investigate
the offerings on their platforms. We also note that the communication
channels provided on these platforms can provide a potential source of
information for intermediaries, further facilitating their evaluation
of prospective issuers.
---------------------------------------------------------------------------
\1537\ See, e.g., StartupValley Letter; Vann Letter.
\1538\ We note that while for purposes of this provision, the
issuer is not required to continue to engage the services of a
registered transfer agent on an ongoing basis, since the use of a
registered transfer agent is a condition for the Section 12(g)
exemption, issuers with a large number of shareholders of record are
expected to have an incentive to continue to engage the services of
a registered transfer agent. See Section III.B.8. below.
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c. Other Limitations on Intermediaries
The statute and final rules place certain limitations on
intermediaries. These limitations are expected to increase investor
protection in the securities-based crowdfunding market.
The final rules require an intermediary before accepting an
investment commitment to have a reasonable basis for believing that an
investor has not exceeded the final rules' investment limits but permit
an intermediary to rely on investor representations concerning
compliance unless the intermediary has reason to question the
reliability of the representations.\1539\ While we realize that
investors may make inaccurate representations, we believe that this
provision represents a reasonable approach to implement the statutory
requirement, appropriately considering the need for investors to adhere
to investment limitations while mitigating the costs incurred by
intermediaries.
[[Page 71514]]
The cost to update the required functionality for processing issuer
disclosure and investor acknowledgment information is reflected in the
tables above as part of the costs to develop a crowdfunding platform,
and we believe that the ongoing burden to comply would be minimal.
---------------------------------------------------------------------------
\1539\ See Rule 303(b)(1) of Regulation Crowdfunding. See also
Section II.C.5.b above.
---------------------------------------------------------------------------
Under the final rules, intermediaries must require any person, when
posting a comment in the communication channels, to clearly disclose
with each posting whether he or she is a founder or an employee of an
issuer engaging in promotional activities on behalf of the issuer or a
compensated promoter \1540\ We believe that these disclosure
requirements will benefit investors by promoting a transparent
information sharing process. We further believe that intermediaries are
in an appropriate position to take such steps as part of designing
communication channels on their platform.
---------------------------------------------------------------------------
\1540\ See Rule 303(c)(4) of Regulation Crowdfunding. See also
Section II.C.5.c above.
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Under the final rules, intermediaries will incur direct costs in
complying with the requirements to disclose compensation to promoters,
and certain additional costs from time to time to ensure continued
compliance. These costs are reflected in the table above as part of the
costs of complying with the requirements to act as an intermediary in a
Section 4(a)(6) transaction. In addition, if this requirement
discourages the use of promoters by issuers, it may limit the investor
pool for an offering made in reliance on Section 4(a)(6), thus limiting
the ability of an issuer to raise capital.\1541\
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\1541\ See Rule 300(b) of Regulation Crowdfunding and Section
II.C.2.b.
---------------------------------------------------------------------------
The statute prohibits the directors, officers or partners of an
intermediary, or any person occupying a similar status or performing a
similar function, from having any financial interest in an issuer that
uses the services of the intermediary. The final rules implement this
statutory requirement. In a change from the proposed rules, the final
rules provide exceptions to the prohibition on an intermediary having a
financial interest in a crowdfunding issuer. The intermediary may hold
a financial interest in the crowdfunding issuer if the financial
interest represents compensation for the services provided to or for
the benefit of the issuer in connection with the offer or sale of
securities in a crowdfunding offering and consists of securities of the
same class and having the same terms, conditions and rights as the
securities being offered or sold in the crowdfunding offering through
the intermediary's platform. By not extending the prohibition from
having any financial interest in an issuer to intermediaries in all
instances, the final rules allow for more flexibility in the payment
arrangements between issuers and intermediaries. This additional option
by which the issuer may pay an intermediary for its services may be
beneficial for issuers by allowing them to use more of the capital
raised in an offering for future investments rather than paying a
portion of it as a fee to the intermediaries. It also allows funding
portals to share in the upside of successful issuers, generating
potentially larger revenue than the offering fee. While allowing
intermediaries to have a financial interest in issuers can align
incentives between intermediaries and investors,\1542\ it can
alternatively lead to potential conflicts of interest between
intermediaries and investors.\1543\ While we believe that such
conflicts of interest are possible and may reduce investor protection,
they will be significantly mitigated by the requirement that an
intermediary's financial interest in an issuer consist of securities of
the same class and having the same terms, conditions and rights as the
securities being offered or sold in the crowdfunding offering through
the intermediary's platform. Such limitations on an intermediary's
financial interest, combined with reputational concerns and the
accompanying disclosure requirements, will likely curb the incentives
of intermediaries to act in a way that harms the interests of
crowdfunding investors.
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\1542\ See, e.g., AngelList Letter (``So long as the program was
consistently applied without judgment by the intermediary, the net
effect would purely be to align the interests of the intermediary
with the investor.''). See also EMKF Letter; Hackers/Founders
Letter; Heritage Letter; Milken Institute Letter; RoC Letter;
RocketHub Letter; Thomas Letter 1.
\1543\ See Jacobson Letter.
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The statute requires that intermediaries ensure that all offering
proceeds are provided to the issuer only when the aggregate capital
raised from all investors is equal to or greater than a target offering
amount.\1544\ The final rules implement this requirement by requiring
intermediaries that are registered as broker-dealers to comply with the
existing requirements of Exchange Act Rule 15c2-4 and by requiring
intermediaries that are registered funding portals to direct investors
to transmit the funds or other consideration directly to a qualified
third party that has agreed in writing to hold the funds for the
benefit of the investors and the issuer and to promptly transmit or
return the funds to the persons entitled to such funds.\1545\ Based on
several commenters' suggestions,\1546\ we modified the proposed
definition of qualified third parties in Rule 303(e) also to include
registered broker-dealers that carry customer or broker or dealer
accounts and hold funds or securities for those persons and credit
unions insured by the NCUA.\1547\ The final rules also require a
funding portal to direct the qualified third party to transmit funds to
the issuer once the target offering amount is reached and the
cancellation period has elapsed; to return funds to an investor when an
investment commitment has been cancelled; and to return funds to
investors when the offering has not been completed.
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\1544\ See Section 4A(a)(7).
\1545\ See Rule 303(e) of Regulation Crowdfunding.
\1546\ See, e.g., Growthfountain Letter; Vann Letter; Ex24
Letter; FOLIOfn Letter.
\1547\ See Rule 303(e) of Regulation Crowdfunding. See also
Section II.C.5.b above.
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These requirements will benefit investors and issuers by helping
ensure that funds are appropriately refunded or transmitted in
accordance with the terms of the offering. In particular, the
requirement that the account in which funds are deposited be
exclusively for the benefit of investors and the issuer will help
prevent the intermediary or other parties from claiming or otherwise
unlawfully appropriating funds from that account. Expanding the
definition of ``qualified third parties'' will increase the number of
third parties available to hold funds in an escrow or in an account for
the benefit of investors and the issuer, potentially reducing the cost
of the service due to increased competition. We do not expect any
significant costs due to this change from the proposed rules because
credit unions insured by the NCUA offer similar protections to banks
while registered broker-dealers that carry customer or broker or dealer
accounts and hold funds or securities for those persons are subject to
various regulatory obligations, which are designed to provide
protection of investor funds through the imposition of capital and
other requirements.\1548\
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\1548\ See note 868.
---------------------------------------------------------------------------
Under the statute, intermediaries may not compensate promoters,
finders or lead generators for providing broker-dealers or funding
portals with the personally identifiable information of any potential
investor. The final rules implement this statutory requirement by
prohibiting an intermediary from
[[Page 71515]]
compensating any person for providing the personally identifiable
information of any crowdfunding investor to intermediaries.\1549\
Investors will benefit from the privacy protection provided by this
prohibition. Intermediaries will incur a cost because the rule will not
allow them to use personally identifiable information to target and
seek out specific investors, thus reducing the potential investor pool
for certain offerings. However, subject to this restriction, the final
rules permit an intermediary to compensate a person for directing
issuers or investors to the intermediary's platform in certain
situations.\1550\ This provision will provide intermediaries with an
alternative means to attract more investors to their crowdfunding
platforms, thereby mitigating some of the costs associated with the
restriction on paying for personally identifiable information.
---------------------------------------------------------------------------
\1549\ See Rule 305(a) of Regulation Crowdfunding.
\1550\ See Rule 305(b).
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5. Additional Funding Portal Requirements
Under the final rules, a funding portal must register with the
Commission by filing a complete Form Funding Portal with information
concerning the funding portal's operation.\1551\ The final rules also
include the statutory requirement that a funding portal be a member of
a registered national securities association. In the table above, we
estimate the costs that intermediaries will incur related to
registering as a funding portal on Form Funding Portal and becoming a
member of a national securities association to be approximately
$100,000 in the initial year and $10,000 thereafter.
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\1551\ See Rule 400(a) of Regulation Crowdfunding.
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The requirement that funding portals register with the Commission
and become a member of a national securities association will benefit
investors by providing regulatory oversight for these new entities,
which will help to reduce the risk for fraud. Although there are costs
associated with this requirement, we believe that the protections
deriving from this requirement will benefit investors, issuers and
potentially intermediaries by helping to create a marketplace in which
investors are more willing to participate and issuers are more
comfortable using this method of capital formation.
The final rules also require that funding portals use Form Funding
Portal to provide updates whenever information on file becomes
inaccurate for any reason, to register successor funding portals and to
withdraw from funding portal registration. Although funding portals
would incur time and compliance costs to update Form Funding Portal, we
expect funding portals will have experience with the filing process for
Form Funding Portal from their registration and, as a result, will be
familiar with the filing process by the time they update the form. In
the tables above, this cost is reflected in the $10,000 annual
compliance cost associated with registering on Form Funding Portal and
becoming a member of a registered national securities association.
The final rules allow nonresident funding portals to register with
the Commission, provided that certain conditions are met.\1552\ The
final rules require a nonresident funding portal to appoint an agent
for service of process in the United States and to certify both that it
can, as a matter of law, and will provide the Commission and any
national securities association of which it becomes a member with
prompt access to its books and records and submit to onsite inspection
and examination by the Commission and the national securities
association. The funding portal also must provide an opinion of counsel
attesting to the funding portal's ability to comply with these
requirements under home country law. As discussed above, the final
rules condition nonresident funding portal registration on the presence
of an information sharing arrangement between the Commission and the
regulator in the funding portal's jurisdiction.\1553\ This provision is
expected to facilitate Commission oversight of registered nonresident
funding portals, with the potential benefit of stronger protection of
investors in offerings conducted on such portals. However, it may limit
the ability of some nonresident funding portals to register,
potentially resulting in adverse competitive effects on nonresident
portals in jurisdictions without an information sharing agreement.
---------------------------------------------------------------------------
\1552\ See Rule 400(f) of Regulation Crowdfunding.
\1553\ See Rule 400(f) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Compared to the alternative of not allowing nonresident entities to
operate as funding portals in the U.S. crowdfunding market, the final
rules may increase competition among crowdfunding intermediaries, which
in turn may reduce the fees that intermediaries charge to issuers.
Lower costs of raising capital can also attract more potential issuers
to the crowdfunding market, thus enhancing capital formation. Due to
lack of data, we are not able to estimate the magnitude of these
potential effects.
Although the requirements with respect to the appointment of an
agent for service of process, a certification and a legal opinion will
impose costs on nonresident funding portals, these requirements are
expected to enhance investor protection by requiring steps designed to
ensure that the books and records of funding portals that are not based
in the United States, or that are subject to laws other than those of
the United States, nevertheless are accessible to the Commission and
other relevant regulators for purposes of conducting examinations of,
and enforcing U.S. laws and regulations against these entities. For PRA
purposes, we estimate that nonresident intermediaries will face an
additional cost for outside professional services of $25,179 per
intermediary to retain an agent for service of process and provide an
opinion of counsel to register as a nonresident funding portal.\1554\
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\1554\ For the purposes of the PRA, we estimate that entities
that register as nonresident funding portals also will incur an
additional internal burden of half an hour to complete Schedule C,
half an hour to hire an agent for the service of process, and one
hour to provide an opinion of counsel. See Section IV.C.2.a.
---------------------------------------------------------------------------
The statute also provides an exemption from broker-dealer
registration for funding portals. The final rules implement the
statutory requirement by stating that a registered funding portal is
exempt from the broker-dealer registration requirements of Exchange Act
Section 15(a)(1) in connection with its activities as a funding
portal.\1555\ We believe this approach of exempting funding portals
from broker-dealer registration and its accompanying regulations will
benefit the market and its participants. The activities of funding
portals will be more limited than those of broker-dealers. Thus, the
final rules require funding portals to comply with registration
requirements that are more appropriate for their limited, permissible
activities, rather than the more extensive and higher cost requirements
that accompany broker-dealer registration. Lower registration costs for
funding portals may translate into lower fees charged to issuers that
use these portals, thus possibly benefiting issuers of crowdfunding
securities and potentially increasing capital formation. Due to lack of
data, we are unable to quantify these potential benefits.
---------------------------------------------------------------------------
\1555\ See Rule 401 of Regulation Crowdfunding.
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[[Page 71516]]
a. Safe Harbor for Certain Activities
Exchange Act Section 3(a)(80) prohibits funding portals from (1)
offering investment advice or recommendations, (2) soliciting
purchases, sales or offers to buy securities offered or displayed on
the funding portal's platform, (3) compensating employees, agents or
other such persons for solicitation or based on the sale of securities
displayed or referenced on the funding portal's platform, or (4)
holding, managing, possessing or otherwise handling investor funds or
securities. The final rules give funding portals, their associated
persons, affiliates and business associates, a measure of clarity on
activities that are permissible without violating these statutory
prohibitions, while also helping to protect investors from activities
that create potential conflicts of interest.\1556\ Thus, compared with
the alternative that we could have chosen, that of not providing the
safe harbor, the safe harbor provisions in the final rules may
facilitate regulatory compliance for funding portals, potentially with
corresponding benefits for both issuers and investors. Some safe harbor
provisions have additional benefits and costs, which we discuss below.
Other safe harbor provisions may facilitate the implementation of other
provisions of the final rules in instances where the crowdfunding
intermediary is a funding portal, in which case the benefits and costs
of such safe harbor provisions will be inseparable from the benefits
and costs of the other provisions of the final rules as applied to
instances where the crowdfunding intermediary is a funding portal.
---------------------------------------------------------------------------
\1556\ See Rule 402 of Regulation Crowdfunding.
---------------------------------------------------------------------------
The safe harbor for a funding portal to provide communication
channels on its platform \1557\ will facilitate the realization of the
benefits of the provision in the final rules that requires the
intermediary to provide communication channels on its platform \1558\
in instances where the crowdfunding intermediary is a funding portal.
The provision of communication channels by the funding portal has the
potential to attract a greater number of investors to crowdfunding
transactions through funding portals than otherwise would be the case,
thereby encouraging capital formation. The provision of communication
channels may enhance information sharing among investors, although the
relevance and accuracy of the information shared by investors on these
communication channels will likely vary from offering to offering.
---------------------------------------------------------------------------
\1557\ See Rule 402(b)(4) of Regulation Crowdfunding.
\1558\ See Rule 303(c) of Regulation Crowdfunding.
---------------------------------------------------------------------------
In a change from the proposal, the final rules include a
conditional safe harbor that will permit funding portals, consistent
with the prohibitions under Exchange Act Section 3(a)(80), to determine
whether and under what circumstances to allow an issuer to offer and
sell securities in reliance on Section 4(a)(6) of the Securities Act
(15 U.S.C. 77d(a)(6)) through their platforms.\1559\ Allowing funding
portals to decide which securities to offer through their platforms
will potentially decrease compliance costs for funding portals because
limiting the offerings available on their platform can help decrease
the risk of statutory liability under Section 4A(c) of the Securities
Act, consistent with the suggestions of some commenters.\1560\ The
ability to determine which issuers may offer and sell securities
through their platforms may also make it easier for funding portals to
bar potentially fraudulent offerings from their platforms, thereby
potentially enhancing investor protection, consistent with the
suggestions of various commenters,\1561\ as well as screen out
offerings by issuers that are unprepared or not ``crowdfund-ready.''
\1562\ A reduction in the prevalence of potentially fraudulent
offerings, in turn, may increase investor confidence and facilitate
capital formation in the securities-based crowdfunding market. However,
we recognize that, depending on the funding portal, the ability to
exercise discretion with respect to which offerings to include on the
platform may result in the exclusion of some issuers that do not pose a
risk of fraud, potentially limiting capital formation and investor
access to crowdfunding investment opportunities in those instances.
This concern is expected to be mitigated, in part, by the reputational
incentives of intermediaries and competition within the crowdfunding
market. We also recognize that, while funding portals remain subject to
more limitations concerning their activities in the crowdfunding market
relative to registered broker-dealers, the ability to exercise
discretion with respect to which offerings to include on their
platforms is expected to partly mitigate the competitive disadvantage
of funding portals relative to registered brokers, as suggested by
several commenters.\1563\
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\1559\ See Rule 402(b)(1) of Regulation Crowdfunding.
\1560\ See e.g., CrowdCheck 2 Letter; Milken Institute Letter;
RocketHub Letter. See also Section II.D.3.a.
\1561\ See e.g., ABA Letter; CrowdCheck 2 Letter; Graves Letter;
Seyfarth Letter.
\1562\ See EMKF Letter; SBEC Letter.
\1563\ See e.g., BetterInvesting Letter; EMKF Letter; SBA Office
of Advocacy Letter; ABA Letter; CfPA Letter; CrowdCheck 2 Letter;
Graves Letter; Seyfarth Letter; IAC Recommendation; CFIRA Letter 12.
---------------------------------------------------------------------------
The final rules also allow a funding portal to highlight particular
issuers or offerings of securities made in reliance on Section 4(a)(6)
on its platform based on objective criteria, for example: (1) The type
of securities being offered (e.g., common stock, preferred stock or
debt securities); (2) the geographic location of the issuer; (3) the
industry or business segment of the issuer; (4) the number or amount of
investment commitments made; (5) the progress in meeting the target
offering amount or, if applicable, the maximum offering amount, and (6)
the minimum or maximum investment amount.\1564\ The final rules require
that these criteria be objective and reasonably designed to highlight a
broad selection of issuers and offerings and be applied consistently to
all potential issuers and offerings. They also specify that such
criteria may not be related to the advisability of investing in the
issuer or offering and may not give the impression of an investment
recommendation.\1565\ Under the final rules, funding portals may
provide search functions or other tools on its platform that users may
use to search, sort or categorize available offerings according to
objective criteria.\1566\
---------------------------------------------------------------------------
\1564\ See Rule 402(b)(2) of Regulation Crowdfunding.
\1565\ Id.
\1566\ See Rule 402(b)(3) Regulation Crowdfunding.
---------------------------------------------------------------------------
A funding portal may choose to categorize offerings into general
subject areas or provide search functions that, for example, allowing
an investor to sort through offerings based on a combination of
different objective criteria. We believe that these safe harbor
provisions will benefit investors by facilitating investor access to
information about offerings characterized by certain broad, objective
criteria, to the extent that funding portals provide such features and
tools in reliance on the final rules. By enabling issuers to utilize
technology to lower the costs of each investor to search for
information about a particular category of offerings, these provisions
also may enhance efficiency. To the extent that the availability of
these features and tools encourages investor participation in
crowdfunding offerings, these provisions may have a beneficial effect
on capital formation in the crowdfunding market.
The final rules prohibit a funding portal from receiving any
special or additional compensation for
[[Page 71517]]
highlighting (or offering to highlight) one or more issuers or
offerings on its platform.\1567\ This prohibition is expected to
benefit investors by helping prevent conflicts of interest and
incentives for funding portals to favor certain issuers over others.
The final rules also make clear that such objective criteria may not
include the advisability of investing in the issuer or its offering or
an assessment of any characteristic of the issuer, its business plan,
its management, or risks associated with an investment.\1568\
---------------------------------------------------------------------------
\1567\ See Rule 402(b)(2) of Regulation Crowdfunding.
\1568\ See Rule 402(b)(2) and Rule 402(b)(3) of Regulation
Crowdfunding.
---------------------------------------------------------------------------
Under the final rules, funding portals are permitted to provide
advice to an issuer on the structure and content of its offerings,
including assistance to the issuer in preparing offering
documentation.\1569\ This will allow issuers to obtain guidance that
may not typically be available to them and thereby help to lower
funding costs. Many potential issuers seeking to offer and sell
crowdfunding securities are unlikely to be familiar with how to
structure offerings so as to raise capital in the most cost effective
manner, and they may not have the capital, knowledge or resources to
hire outside advisors. Given that an issuer will be required to conduct
its securities-based crowdfunding offerings through an intermediary, we
believe that permitting funding portals to provide these services to
issuers will lower overall transaction costs for issuers, as they will
not need to engage additional parties to provide these services. This
effect will in turn help enhance market efficiency.
---------------------------------------------------------------------------
\1569\ See Rule 402(b)(5) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The final rules also provide a safe harbor for a funding portal to
compensate a third party for referring a person to the funding portal
in certain circumstances.\1570\ This enables funding portals to realize
the benefits of the provision in the final rules that permits an
intermediary to compensate a person for directing issuers or investors
to the intermediary's platform in certain circumstances.\1571\ This
provision is expected to benefit intermediaries by providing them with
a means to attract more investors to their crowdfunding platforms,
thereby encouraging capital formation. Investors also will benefit from
the condition of this safe harbor prohibiting transaction-based
compensation (other than to registered broker-dealers), which is
expected to reduce the incentive for abusive practices.
---------------------------------------------------------------------------
\1570\ See Rule 402(b)(6) of Regulation Crowdfunding.
\1571\ See Rule 305(b) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The final rules also provide a safe harbor for a funding portal to
pay or offer to pay compensation to a registered broker-dealer for
services provided in connection with the offer or sale of securities in
reliance on Section 4(a)(6), subject to conditions set forth in the
rule.\1572\ Similarly, a funding portal can, subject to certain
conditions, receive compensation from a registered broker-dealer for
services provided in connection with the offer or sale of securities by
the funding portal in reliance on Section 4(a)(6).\1573\ We note that
some commenters expressed concern that such relationships between
funding portals and broker-dealers could create conflicts of
interest.\1574\ However, funding portals are expected to benefit from
being able to enter into these types of arrangements with registered
broker-dealers who can provide services that the funding portals
otherwise are prohibited from providing, such as engaging a broker-
dealer to serve as a qualified third party for the transmission of
investor funds. Broker-dealers also will benefit from the additional
business that funding portals may be able to attract through the
funding portals' platforms, as well as from services, such as those
related to technology, that funding portals can provide. We anticipate
that these types of service arrangements will ultimately benefit
investors.
---------------------------------------------------------------------------
\1572\ See Rule 402(b)(7) of Regulation Crowdfunding.
\1573\ See Rule 402(b)(8) of Regulation Crowdfunding.
\1574\ See e.g., Commonwealth of Massachusetts Letter; RocketHub
Letter.
---------------------------------------------------------------------------
The final rules permit a funding portal to advertise its existence
and identify one or more issuers or offerings available through its
platform subject to certain conditions.\1575\ This provision will
benefit funding portals by allowing them to potentially attract more
investors to their crowdfunding platforms. This provision also may
enhance market efficiency as investors become more aware of available
offerings through advertisements by funding portals and are thus able
to better match their investments with projects that are better suited
to their risk preferences and investment strategies. The conditions on
advertising by funding portals in the final rules aim to consider
informational benefits and investor protection concerns. For instance,
while a funding portal advertising its existence may also identify one
or more issuers or offerings available on its platform, it must do so
on the basis of objective criteria that are reasonably designed to
identify a broad selection of issuers and offerings and are applied
consistently to all potential issuers and offerings. In addition,
advertisements sent by a funding portal must not suggest that it is a
recommendation to purchase a security or advice as to the advisability
in investing in any security.\1576\ While we believe these conditions
are appropriate to protect the integrity of the crowdfunding market, we
recognize that they may impose costs on funding portals. For example
these conditions may limit the utility of advertising for the funding
portal while the prohibition on special or additional compensation for
identifying the offering in an advertisement may reduce the funding
portal's revenue.
---------------------------------------------------------------------------
\1575\ See Rule 402(b)(9) of Regulation Crowdfunding.
\1576\ See Section II.D.3.h.
---------------------------------------------------------------------------
As discussed above, the final rules require an intermediary to deny
access to its platform to an issuer that the intermediary has a
reasonable basis for believing presents the potential for fraud or
otherwise raises concerns about investor protection.\1577\ The final
rules also provide a conditional safe harbor to intermediaries that are
funding portals to deny access to the platform or cancel an offering in
such instances.\1578\ These provisions are expected to enhance investor
protection by giving funding portals greater ability to deny
potentially fraudulent offerings. Funding portals are expected to
benefit from the ability to deny access to certain issuers to protect
the integrity of the offering process and the market reputation of
their crowdfunding platforms, without fear of violating the statutory
prohibition on providing investment advice.
---------------------------------------------------------------------------
\1577\ See Rule 301(c) of Regulation Crowdfunding.
\1578\ See Rule 402(b)(10) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The final rules specify that a funding portal may accept, on behalf
of an issuer, investment commitments for crowdfunding offerings from
investors.\1579\ Under the final rules funding portals also can direct
investors where to transmit funds or remit payment in connection with
the purchase of securities offered and sold in reliance on Section
4(a)(6).\1580\ Similarly, a funding portal can direct a qualified third
party to release proceeds of a successful offering to the issuer upon
completion of the offering or to return investor proceeds when an
investment commitment or offering is
[[Page 71518]]
cancelled.\1581\ These provisions will facilitate the implementation of
the requirements of the final rules regarding the maintenance and
transmission of investor funds \1582\ for intermediaries that are
funding portals and give both funding portals and entities with which
they do business a measure of legal certainty that funding portals
accepting investment commitments for crowdfunding offerings and
providing direction for funds to and from qualified third parties in
compliance with the final rules will not be in violation of the
statutory prohibitions on holding, managing, possessing or otherwise
handling investor funds or securities. While we agree with the
commenter that stated that the requirement to use a qualified third
party to handle customer funds creates an additional cost,\1583\
Section 3(a)(80)(D) of the Exchange Act explicitly prohibits funding
portals from handling customer funds and securities.
---------------------------------------------------------------------------
\1579\ See Rule 402(b)(11) of Regulation Crowdfunding.
\1580\ See Rule 402(b)(12) of Regulation Crowdfunding.
\1581\ See Rule 402(b)(13) of Regulation Crowdfunding.
\1582\ See Rule 303(e) of Regulation Crowdfunding.
\1583\ See Stephenson, et al., Letter.
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b. Compliance Requirements
The final rules require that a funding portal implement written
policies and procedures, reasonably designed to achieve compliance with
the federal securities laws and the rules and regulations thereunder,
relating to its business as a funding portal.\1584\ This requirement
will provide a benefit to investors and funding portals alike, as
written policies and procedures will enhance compliance with the final
rules. Funding portals will incur costs associated with the requirement
to develop their own procedures and implement written policies and
procedures, as well as to update and enforce them. These costs are
reflected in the tables above as part of the costs to comply with
requirements to act as an intermediary in transactions pursuant to
Section 4(a)(6).
---------------------------------------------------------------------------
\1584\ See Rule 403(a) of Regulation Crowdfunding.
---------------------------------------------------------------------------
In contrast to the proposal, the final rules do not impose anti-
money laundering (AML) obligations for funding portals. Some commenters
generally suggested that since funding portals are prohibited from
handling customer funds and securities, they should not be required to
comply with AML provisions.\1585\ As noted above, we believe it would
be appropriate to work with other regulators to develop consistent and
effective AML obligations for funding portals.\1586\ By not imposing
AML requirements in the final rules, we may avoid the possibility of
conflicting or overlapping requirements. Registered broker-dealers that
serve as intermediaries in securities-based crowdfunding transactions
continue to have AML obligations, as do certain other parties involved
in transactions conducted pursuant to Section 4(a)(6), such as a bank
acting as a qualified third party to hold investor funds.\1587\ To the
extent that this difference in compliance obligations between funding
portals and registered broker-dealers affects compliance costs and
persists in the future, it may place funding portals at a relative
competitive advantage. If this difference in compliance obligations
between funding portals and registered broker-dealers persists in the
future, it may also potentially expose investors in those securities-
based crowdfunding offerings for which the intermediary is a funding
portal to additional risks.
---------------------------------------------------------------------------
\1585\ See, e.g., PeoplePowerFund Letter; Public Startup Letter
3; RFPIA Letter.
\1586\ See Section II.D.4.b.
\1587\ Id.
---------------------------------------------------------------------------
Additionally, the statute requires that intermediaries take such
steps to protect the privacy of information collected from investors as
we determine appropriate. In the final rules, we implement this
statutory provision by requiring a funding portal to comply with
Regulation S-P, S-ID and Regulation S-AM, as they apply to broker-
dealers.\1588\ We recognize that compliance with these privacy
requirements will impose costs on funding portals. However, we believe
that requiring a funding portal to comply with privacy obligations will
help protect the personally identifiable information of investors,
consistent with how it is required to be protected by other financial
intermediaries. These privacy protections can give investors the
confidence to participate in offerings made in reliance on Section
4(a)(6), which will facilitate capital formation and benefit the
markets generally. As an alternative, we could have developed a more
limited privacy regime applicable only to funding portals. Such an
alternative would result in inconsistent treatment of funding portals
and broker-dealers with respect to privacy obligations and could reduce
the willingness of investors to participate in securities-based
crowdfunding offerings. This alternative might also affect competition
between funding portals and registered broker-dealers in the market for
securities-based crowdfunding offerings.
---------------------------------------------------------------------------
\1588\ See Rule 403(b) of Regulation Crowdfunding.
---------------------------------------------------------------------------
As a condition to exempting funding portals from the requirement to
register as broker-dealers under Exchange Act Section 15(a)(1),
Exchange Act Section 3(h)(1)(A) requires that registered funding
portals remain subject to, among other things, the Commission's
examination authority. Under the final rules, a funding portal is
required to permit the examination and inspection of all its business
and business operations relating to its activities as a funding portal,
such as its premises, systems, platforms and records, by Commission
representatives and by representatives of the registered national
securities association of which it becomes a member.\1589\ Although
funding portals will face time and compliance costs in submitting to
Commission and registered national securities association examinations,
inspections or investigations, and potentially responding to any issues
identified, funding portals, investors and issuers will benefit from
the enhanced compliance with legal obligations due to this oversight,
as well as the sanctions or other disciplinary actions that may follow
upon findings of violations through such inspections, examinations or
investigations.
---------------------------------------------------------------------------
\1589\ See Rule 403(c) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Further, the final rules require a registered funding portal to
maintain and preserve certain books and records relating to its
business for a period of not less than five years and in an easily-
accessible place for the first two years.\1590\ Recordkeeping
requirements can assist registrants with compliance. They are a well-
established and important element of the approach to broker-dealer
regulation, as well as the regulation of investment advisers and
others, and are designed to maintain the effectiveness of our
inspection program for regulated entities, facilitating our review of
their compliance with statutory mandates and with our rules. These
requirements will enable the Commission and registered national
securities organizations to more effectively gather information about
the activities in which a funding portal has been engaged to discern
whether the funding portal and the other parties are in compliance with
the requirements of Regulation Crowdfunding and other relevant
regulatory requirements. Standardized recordkeeping practices for
intermediaries will enable regulators to perform more efficient,
targeted inspections and examinations and thereby increase the
likelihood of
[[Page 71519]]
identifying improper conduct at earlier stages of the inspection or
examination, which ultimately will benefit investors and the
marketplace as a whole. To the extent that these requirements result in
better regulatory oversight, they may increase investor confidence in
funding portals and may also benefit funding portals by promoting
issuer reliance on funding portals in crowdfunding offerings.
---------------------------------------------------------------------------
\1590\ See Rule 404(a) of Regulation Crowdfunding. We note that
registered broker-dealers already are required to comply with
Exchange Act Rules 17a-3 and 17a-4 pertaining to books and records
(17 CFR 240.17a-3 and 17a-4). Thus, all intermediaries, whether
registered as broker-dealers or as funding portals, are required to
make and preserve books and records.
---------------------------------------------------------------------------
Funding portals may incur costs in establishing the systems
necessary to comply with the books and records requirements. We note
that the records required to be made and preserved under the final
rules are those that would ordinarily be made and preserved in the
ordinary course of business by a regulated broker-dealer engaging in
these activities. Entities that newly register as broker-dealers will
be subject to the recordkeeping requirements of Rules 17a-3 and 17a-4.
While these costs will constitute part of the cost of compliance for
entities that choose to become intermediaries in crowdfunding
transactions by registering as broker-dealers, the cost of broker-
dealer compliance with recordkeeping requirements of Rules 17a-3 and
17a-4 is not by itself a result of the final rule. Entities solely
intending to serve as intermediaries in crowdfunding transactions for
which the cost of compliance with broker-dealer recordkeeping
requirements is too high may elect to register as funding portals.
Funding portals will be required to make and keep records related to
their activities to facilitate transactions in reliance on Section
4(a)(6), which we estimate for the purposes of the PRA to result in an
initial burden of 325 hours and an initial cost of $5,350 per funding
portal. We estimate that ongoing recordkeeping burden and cost will be
similar to the initial burden and cost.\1591\ We also note that some
commenters stated that the cost burden for a funding portal to maintain
the proposed books and records would not be significant.\1592\ We
recognize that there may be a slight competitive advantage for funding
portals over broker-dealers to the extent that the recordkeeping rule
for funding portals is less burdensome for than the requirements
applicable to broker-dealers. At the same time, we believe that the
recordkeeping rule for funding portals is consistent with the narrow
range of their permitted activities.
---------------------------------------------------------------------------
\1591\ See Section IV.C.2.n.
\1592\ See CFIRA Letter 1; Joinvestor Letter.
---------------------------------------------------------------------------
6. Insignificant Deviations
We are providing a safe harbor for issuers for certain
insignificant deviations from a term, condition or requirement of
Regulation Crowdfunding.\1593\ This safe harbor will provide that
insignificant deviations from a term, condition or requirement of
Regulation Crowdfunding will not result in a loss of the exemption, so
long as the issuer relying on the exemption can show that: (1) The
failure to comply was insignificant with respect to the offering as a
whole; (2) the issuer made a good faith and reasonable attempt to
comply with all applicable terms, conditions and requirements of
Regulation Crowdfunding; and (3) the issuer did not know of the failure
to comply, where the failure to comply with a term, condition or
requirement was the result of the failure of the intermediary to comply
with the requirements of Section 4A(a) and the related rules, or such
failure by the intermediary occurred solely in offerings other than the
issuer's offering.
---------------------------------------------------------------------------
\1593\ See Rule 502(a) of Regulation Crowdfunding.
---------------------------------------------------------------------------
The safe harbor is expected to decrease the costs incurred by
issuers compared to the alternative of not providing a safe harbor. In
the absence of a safe harbor, issuers might be hesitant to participate
in this new marketplace for fear of inadvertently violating an
applicable regulatory requirement, thereby reducing the benefits of
Regulation Crowdfunding on efficiency, competition and capital
formation. We recognize that providing a safe harbor can impose costs
on investors, intermediaries and regulators, compared with the
alternative of not providing a safe harbor, to the extent that issuers
lessen the vigor with which they develop and implement systems and
controls to achieve compliance with the requirements of Regulation
Crowdfunding, which may result in a decrease in investor protection.
Accordingly, we have designed the conditions of the safe harbor--
specifically, the issuer must show that the failure to comply was
insignificant with respect to the offering as a whole; it made a good
faith and reasonable attempt to comply; and it did not know of the
failure or such failure occurred solely in offerings other than the
issuer's offering--to lessen the potential impact on investor
protection.
Several commenters suggested that the safe harbor for insignificant
deviations should not apply with respect to state regulatory
enforcement actions.\1594\ Adopting such an alternative could have
significantly undermined the utility of the Section 4(a)(6) exemption
by subjecting issuers to loss of state law preemption \1595\ and
potential state enforcement action for insignificant deviations from
Regulation Crowdfunding's requirements.
---------------------------------------------------------------------------
\1594\ See, e.g., Commonwealth of Massachusetts Letter; NASAA
Letter.
\1595\ See Section III.B.7.
---------------------------------------------------------------------------
7. Relationship With State Law
Section 305 of the JOBS Act amended Securities Act Section 18(b)(4)
\1596\ to preempt the ability of states to regulate certain aspects of
crowdfunding conducted pursuant to Section 4(a)(6). This statutory
amendment will benefit issuers by preempting any registration
requirements in states in which they offer or sell securities in
reliance on Section 4(a)(6), thereby reducing the costs for these
transactions. It also can benefit investors because these cost savings
ultimately may be passed on to investors. Absent preemption of state
registration requirements, an offering made through the Internet in
reliance on Section 4(a)(6) and the final rules could result in an
issuer potentially violating state securities laws. Some evidence in
donation-based and reward-based crowdfunding campaigns suggests that
contributions are not exclusively local.\1597\ The statutory preemption
of state registration requirements will reduce issuer uncertainty about
the necessity of state registration. On the other hand, state
registration requirements may provide an additional layer of investor
protection, and their preemption will remove a potential layer of
review that may help to deter fraud. This potential cost of state law
preemption, however, may be offset by some of the statutory and final
rule requirements that are designed to protect investors, such as
public disclosure,\1598\ investment limits,\1599\ the use of a
registered intermediary,\1600\ provisions regarding measures to reduce
the risk of fraud,\1601\ and disqualification provisions.\1602\ The
requirement in the final rules that issuers file information on EDGAR
also helps to ensure that information about
[[Page 71520]]
issuers is available to individual state regulators, which retain the
authority to bring enforcement actions for fraud.
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\1596\ 15 U.S.C. 77r(b)(4).
\1597\ For example, in crowdfunding campaigns for early stage
musical projects, the average distance between artist-entrepreneurs
and contributors was 3,000 miles. See Ajay Agrawal, Christian
Catalini and Avi Goldfarb, The Geography of Crowdfunding, NET
Institute Working Paper No. 10-08 (Oct. 29, 2010), available at
http://ssrn.com/abstract=1692661.
\1598\ See Rule 201 of Regulation Crowdfunding.
\1599\ See Rule 100(a)(2) of Regulation Crowdfunding.
\1600\ See Rule 100(a)(3) of Regulation Crowdfunding.
\1601\ See Rule 301 of Regulation Crowdfunding.
\1602\ See Rule 503 of Regulation Crowdfunding.
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8. Exemption From Section 12(g)
Rule 12g-6 provides that securities issued pursuant to an offering
made under Section 4(a)(6) are exempted from the record holder count
under Section 12(g) provided the issuer is current in its ongoing
annual reports required pursuant to Rule 202 of Regulation
Crowdfunding, has total assets as of the end of its last fiscal year
not in excess of $25 million, and has engaged the services of a
transfer agent registered with the Commission pursuant to Section 17A
of the Exchange Act. The issuer size test is broadly consistent with
some commenters' suggestions.\1603\
---------------------------------------------------------------------------
\1603\ See, e.g., ABA Letter ($25 million); PeoplePowerFund
Letter.
---------------------------------------------------------------------------
An issuer that exceeds the $25 million total asset threshold in
addition to exceeding the thresholds in Section 12(g) will be granted a
two-year transition period before it is required to register its class
of securities pursuant to Section 12(g), provided it timely files all
its ongoing reports due pursuant to Rule 202 of Regulation Crowdfunding
during such period.\1604\ Section 12(g) registration will be required
only if, on the last day of the fiscal year in which the company
exceeded the $25 million total asset threshold, the company has total
assets of more than $10 million and the class of equity securities is
held by more than 2,000 persons or 500 persons who are not accredited
investors.\1605\ In such circumstances, an issuer that exceeds the
thresholds in Section 12(g) and has total assets of $25 million or more
is required to begin reporting under the Exchange Act the fiscal year
immediately following the end of the two-year transition period.\1606\
An issuer entering Exchange Act reporting will be considered an
``emerging growth company'' to the extent the issuer otherwise
qualifies for such status.
---------------------------------------------------------------------------
\1604\ Id.
\1605\ 15 U.S.C. 78l(g).
\1606\ 17 CFR 240.12g-6.
---------------------------------------------------------------------------
The conditional 12(g) exemption will defer the more extensive
Exchange Act reporting requirements until the issuer either sells
securities in a registered transaction or registers a class of
securities under the Exchange Act. Consequently, smaller issuers will
not be required to become an Exchange Act reporting company as a result
of a Section 4(a)(6) offering. These offerings may have a large number
of investors due to the limits on the amount each investor may invest
and the absence of investor eligibility restrictions, or as a result of
secondary market transactions in crowdfunding securities after the
expiration of resale restrictions. Given the $1 million offering
limitation, the potential cost of becoming an Exchange Act reporting
company could have made many offerings in reliance on Section 4(a)(6)
prohibitively costly.
The condition that the issuer remain current in its ongoing
reporting, as suggested by one commenter,\1607\ is intended to provide
sufficient disclosure to help investors make informed decisions. We
believe that the ongoing disclosures required of crowdfunding issuers
in the final rules accomplish this objective and provide an appropriate
consideration of investor protection and capital formation. This
condition is expected to increase the level of investor protection by
strengthening the incentives of securities-based crowdfunding issuers
that exceed the Section 12(g) thresholds related to issuer size and the
number of shareholders of record to comply with the ongoing reporting
requirements of Regulation Crowdfunding. The extent of additional
investor protection benefits from this condition is difficult to
estimate, given a separate provision in the final rules that conditions
the use of the Section 4(a)(6) exemption for future offerings on
compliance with Regulation Crowdfunding's ongoing reporting
requirements.
---------------------------------------------------------------------------
\1607\ See Joinvestor Letter.
---------------------------------------------------------------------------
The issuer size limit condition is designed to be broadly
consistent with the crowdfunding exemption being tailored to facilitate
small company capital formation and the likely small size of a typical
issuer in the crowdfunding market. This condition is expected to
strengthen investor protection by reducing the likelihood that an
issuer will grow and accumulate a significant number of investors as a
result of multiple offerings in reliance on Section 4(a)(6) while
remaining permanently exempt from the more extensive reporting
requirements of the Exchange Act that would otherwise be required
pursuant to Section 12(g) (unless the issuer registers a class of
securities). The size limit condition will require larger issuers to
provide investors with the more extensive disclosures required by the
Exchange Act for reporting companies. However, we recognize that this
condition also may subject crowdfunding issuers that are larger than
the size threshold or that have a higher rate of growth, and are thus
more likely to exceed the size threshold in the future, to the costs of
Section 12(g) registration and Exchange Act reporting, potentially
placing them at a competitive disadvantage to issuers that are close to
but below the size threshold. It may also discourage some high-growth
issuers from relying on Section 4(a)(6) or may lead issuers approaching
the size threshold to divest assets to remain under the threshold,
potentially resulting in inefficient investment decisions.
While the condition requiring an issuer to use a registered
transfer agent to rely on the exemption will impose costs on
issuers,\1608\ it is designed to provide investor protection benefits
by introducing a regulated entity with experience in maintaining
accurate shareholder records, thus helping to ensure that security
holder records and secondary trades will be handled accurately.
---------------------------------------------------------------------------
\1608\ See STA Letter (stating that strong competition in the
registered transfer agent industry may result in monthly fees of
$75-$300 for transfer agent services, depending on a number of
factors). See also CapSchedule Letter (stating that there exist
cost-effective ways to keep records of security holders, such as
``Software-As-A-Service'' products, that costs $0 to set up initial
records regardless of the number of investors, then pricing from $5
per month for up to 100 investors, $15 per month up to 1,000
investors and $25 per month for over 1,000 investors).
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9. Disqualification
The statute and the final rules impose disqualification provisions
under which an issuer is not eligible to offer securities pursuant to
Section 4(a)(6) and an intermediary is not eligible to effect or
participate in transactions pursuant to Section 4(a)(6).\1609\ The
disqualification provisions for issuers are substantially similar to
those imposed under Rule 262 of Regulation A and Rule 506 of Regulation
D,\1610\ while the disqualification provisions for intermediaries under
Section 3(a)(39), which is an established standard for broker-dealers,
are substantially similar to the provisions of Rule 262.
---------------------------------------------------------------------------
\1609\ See Section 302(d) of the JOBS Act and Rule 503 of
Regulation Crowdfunding. See also discussion in Section II.E.6
above.
\1610\ See Disqualification Adopting Release, note 1182. See
also Regulation A Adopting Release, note 506.
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a. Issuers
The final rules are expected to induce issuers to implement
measures to restrict bad actor participation in offerings made in
reliance on Section 4(a)(6). This will help reduce the potential for
fraud in the market for such offerings, which in turn may reduce the
cost of raising capital to issuers that rely on Section 4(a)(6), to the
extent that disqualification standards lower the risk premium
associated with the presence of bad
[[Page 71521]]
actors in securities offerings. In addition, the requirement that
issuers determine whether any covered persons are subject to
disqualification may obviate the need for investors to do their own
investigations and eliminate redundancies that may exist in otherwise
separate investigations. This is expected to help reduce information-
gathering costs to investors, to the extent that issuers are at an
advantage in accessing much of the relevant information and to the
extent that issuers can do so at a lower cost than investors.
The final rules will, however, impose costs on some issuers, other
covered persons and investors. If issuers are disqualified from relying
on Section 4(a)(6) to make their offerings, they may experience
increased costs in raising capital through alternative methods that do
not require bad actor disqualification, if available, or they may be
precluded from raising capital altogether. This can result in negative
effects on capital formation. In addition, issuers may incur costs in
connection with internal personnel changes that issuers may make to
avoid the participation of those covered persons who are subject to
disqualifying events. Issuers also may incur costs associated with
restructuring share ownership positions to avoid having 20 Percent
Beneficial Owners who are subject to disqualifying events. Finally,
issuers may incur costs in connection with seeking waivers of
disqualification from the Commission or determinations by other
authorities that existing orders do not give rise to disqualification.
The final rules provide a reasonable care exception whereby an
issuer will not lose the benefit of the Section 4(a)(6) exemption if it
is able to show that it did not know, and in the exercise of reasonable
care could not have known, of the existence of a
disqualification.\1611\ A reasonable care exception may encourage
capital formation by eliminating any hesitation issuers may otherwise
experience under a strict liability standard. However, such an
exception also may encourage issuers to take fewer steps to inquire
about the existence of a disqualification than they would if a strict
liability standard applied, increasing the potential for fraud in the
market for offerings made in reliance on Section 4(a)(6). Nevertheless,
some issuers, in exercising reasonable care, may incur costs associated
with conducting and documenting their factual inquiry into possible
disqualifications. The lack of specificity in the rule, while providing
flexibility to the issuer to tailor its factual inquiry as appropriate
to a particular offering, may increase these costs because uncertainty
can drive issuers to do more than necessary under the rule.
---------------------------------------------------------------------------
\1611\ See Rule 503(b)(4) of Regulation Crowdfunding. See also
Section II.E.6.a.iii.
---------------------------------------------------------------------------
The requirement under the final rules that issuers disclose matters
that would have triggered disqualification, had they occurred after the
effective date of Regulation Crowdfunding,\1612\ also will impose costs
and benefits. The disclosure requirement will reduce costs associated
with covered persons who would be disqualified under the final rules
but for the fact that the disqualifying event occurred prior to the
effective date of the rules. However, this approach will allow the
participation of past bad actors, whose disqualifying events occurred
prior to the effective date of the final rules, which can expose
investors to the risks that arise when bad actors are associated with
an offering. Nevertheless, investors will benefit by having access to
such information that can inform their investment decisions. Issuers
also may incur costs associated with the factual inquiry, preparing the
required disclosure and making any internal or share ownership changes
to avoid the participation of covered persons that trigger the
disclosure requirement. Disclosure of triggering events also may make
it more difficult for issuers to attract investors, and issuers may
experience some or all of the impact of disqualification as a result.
---------------------------------------------------------------------------
\1612\ See Rule 201(u) of Regulation Crowdfunding. See also
Section II.E.6.a.v.
---------------------------------------------------------------------------
We believe the inclusion of Commission cease-and-desist orders in
the list of disqualifying events will not impose a significant,
incremental cost on issuers and other covered persons because many of
these actors may already be subject to disqualifying orders issued by
the states, federal banking regulators and the National Credit Union
Administration.\1613\
---------------------------------------------------------------------------
\1613\ See Disqualification Adopting Release, note 1182.
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Under the final rules, orders issued by the CFTC will trigger
disqualification to the same extent as orders of the regulators
enumerated in Section 302(d)(2)(B)(i) of the JOBS Act (e.g., state
securities, insurance and banking regulators, federal banking agencies
and the National Credit Union Administration). We believe that
including orders of the CFTC will result in the similar treatment, for
disqualification purposes, of comparable sanctions. In this regard, we
note that the conduct that will typically give rise to CFTC sanctions
is similar to the type of conduct that will result in disqualification
if it were the subject of sanctions by another financial services
industry regulator. This is likely to enable the disqualification rules
to more effectively screen out bad actors.
As discussed above, the baseline for our economic analysis of
Regulation Crowdfunding, including the baseline for our consideration
of the effects of the final rules on efficiency, competition and
capital formation, is the situation in existence today, in which
startups and small businesses seeking to raise capital through
securities offerings must register the offer and sale of securities
under the Securities Act unless they can comply with an existing
exemption from registration under the federal securities laws. Relative
to the current baseline, we believe that the disqualification
provisions will not impose significant incremental costs on issuers and
other covered persons because the final rules are substantially similar
to the disqualification provisions under existing exemptions.
As an alternative, we could have specified that pre-existing events
are subject to the disqualification rules, as suggested by some
commenters.\1614\ As another alternative, we could have expanded the
list of covered persons to include transfer agents and lawyers, as
suggested by one commenter.\1615\ By expanding the range and categories
of potentially disqualified persons, both of these alternatives could
have the benefit of strengthening investor protection. At the same
time, they would increase the compliance costs for issuers and
disqualified persons described above. Overall, we believe that
preserving consistency with the disqualification criteria of Rule 262
and Rule 506, as we do in the final rules, can potentially yield
compliance cost savings for issuers that undertake multiple types of
exempt offerings while still maintaining appropriate investor
protections.
---------------------------------------------------------------------------
\1614\ See, e.g., Guzik Letter 1; NASAA Letter.
\1615\ See Brown J. Letter (also recommending the Commission
adopt similar bad actor provisions under Rule 504).
---------------------------------------------------------------------------
b. Intermediaries
With regard to intermediaries, the final rules apply the
disqualification provisions under Section 3(a)(39) of the Exchange Act,
rather than a standard based on Rule 262.\1616\ The Section 3(a)(39)
standard is an established one among broker-dealers and their
regulators, and we believe that, despite the differences, Section
3(a)(39) and Rule 262 are substantially similar with
[[Page 71522]]
regard to the persons and events they cover, their scope and their
purpose.\1617\ We believe that imposing any new or different standard,
including one based on Rule 262, for those intermediaries that engage
in crowdfunding transactions would likely create confusion and
unnecessary burdens, as currently-registered broker-dealers and their
associated persons would become subject to two distinct standards for
disqualification. Moreover, adopting a more stringent disqualification
standard may reduce the number of intermediaries eligible under the
final rules and decrease competition among intermediaries in the
securities-based crowdfunding market. By contrast, consistent standards
for all broker-dealers and funding portals will assist a registered
national securities association in monitoring compliance and enforcing
its rules.
---------------------------------------------------------------------------
\1616\ See Rule 503(d) of Regulation Crowdfunding.
\1617\ See discussion in Section II.E.6.b above.
---------------------------------------------------------------------------
The final rules implement the statutory requirement for
intermediaries by providing that a person subject to a statutory
disqualification, as defined in Exchange Act Section 3(a)(39), may not
act as, or be an associated person of, an intermediary in a transaction
involving the offer or sale of securities in reliance on Section
4(a)(6) unless so permitted by Commission rule or order. While this
requirement will potentially reduce the number of intermediaries for
Section 4(a)(6) transactions, we expect that it will strengthen
investor protection by preventing bad actors from entering the
securities-based crowdfunding market, thereby reducing the potential
for fraud and other abuse.
As discussed above, the baseline for our economic analysis of
Regulation Crowdfunding, including the baseline for our consideration
of the effects of the final rules on efficiency, competition and
capital formation, is the situation in existence today, in which
intermediaries intending to facilitate securities transactions are
required to register with the Commission as broker-dealers under
Exchange Act Section 15(a). Relative to this baseline, we believe that
the disqualification provisions will not impose significant incremental
costs to broker-dealers because the final rules include the same
disqualification provisions that are already imposed on broker-dealers.
IV. Paperwork Reduction Act
A. Background
Certain provisions of the final rules contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\1618\ We published a notice requesting
comment on the collection of information requirements in the Proposing
Release, and we submitted the proposal to the Office of Management and
Budget (``OMB'') for review in accordance with the PRA.\1619\
---------------------------------------------------------------------------
\1618\ 44 U.S.C. 3501 et seq.
\1619\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
---------------------------------------------------------------------------
In the Proposing Release, we solicited comment on the assumptions
and estimates in our PRA analysis. We received no comments on our
estimates of and assumptions about the number of issuers and
intermediaries that will participate in securities-based crowdfunding
transactions or the size and frequency of those transactions. We
received several comments on our estimates of the time and expense
required of issuers to meet their filing obligations.\1620\ We also
received several comments on our estimates of the costs incurred by
intermediaries.\1621\ One commenter recommended a lessened paperwork
burden in general.\1622\ These comments are discussed in further detail
below, and where appropriate, we have revised our burden estimates in
response to commenters' suggestions and to reflect changes in the final
rules, as adopted.
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\1620\ See, e.g., Angel Letter 1; Heritage Letter; SeedInvest
Letter 1.
\1621\ See, e.g., Arctic Island Letter 8; CapSchedule Letter;
Heritage Letter; Joinvestor Letter; SBEC Letter; Seed & Spark
Letter; STA Letter.
\1622\ Peers Letter.
---------------------------------------------------------------------------
The titles for the collections of information are:
(1) ``Form ID'' (OMB Control Number 3235-0328);
(2) ``Form C'' (OMB Control Number 3235-0716) (a new collection of
information);
(3) ``Form BD'' (OMB Control Number 3235-0012); and
(4) ``Crowdfunding Rules 300-304--Intermediaries'' (OMB Control
Number 3235-0726) \1623\ (a new collection of information) and
---------------------------------------------------------------------------
\1623\ This includes burdens for compliance with privacy rules
(Reg. S-P, Reg. S-AM and Reg S-ID) as required by Rule 403(b).
---------------------------------------------------------------------------
(5) ``Crowdfunding Rules 400-404--Funding Portals'' (OMB Control
Number 3235-0727) \1624\ (a new collection of information).
---------------------------------------------------------------------------
\1624\ This includes burdens for Form Funding Portal.
---------------------------------------------------------------------------
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid OMB control number. We applied for OMB control numbers
for the new collections of information in accordance with 44 U.S.C.
3507(j) and 5 CFR 1320.13, and as of the date of this release, OMB has
assigned a control number to each new collection as specified above.
Responses to these new collections of information will be mandatory for
issuers raising capital under Regulation Crowdfunding and
intermediaries participating in offerings under Regulation
Crowdfunding.
The hours and costs associated with preparing disclosure, filing
forms, and retaining records constitute reporting and cost burdens
imposed by the collections of information. In deriving estimates of
these hours and costs, we recognize that the burdens likely will vary
among individual issuers and intermediaries based on a number of
factors, including the stage of development of the business, the amount
of capital an issuer seeks to raise, the number of offerings an
intermediary hosts on its platform, and the number of years since
inception of the business. We believe that some issuers and
intermediaries will experience costs in excess of the average and some
issuers and intermediaries may experience less than the average costs.
B. Estimate of Issuers and Intermediaries
1. Issuers
The number, type and size of the issuers that will participate in
securities-based crowdfunding transactions are uncertain, but data on
current market practices may help identify the number and
characteristics of potential issuers that may offer and sell securities
in reliance on Section 4(a)(6).\1625\ While it is not possible to
predict the number of future offerings made in reliance on Section
4(a)(6), particularly because rules governing securities-based
crowdfunding are not yet in effect, for purposes of this analysis, we
estimate that approximately 1,900 issuers will seek to offer and sell
securities in reliance on Section 4(a)(6) per year. We base this
estimate on the average number of issuers (excluding issuers that are
pooled investment vehicles) per year that conducted a new Regulation D
offering of up to $1 million from 2009 to 2014 and had no revenues or
less than $1 million in revenues.\1626\ We
[[Page 71523]]
believe those issuers will be similar in size to the potential issuers
that may participate in securities-based crowdfunding, and we assume
that each issuer will conduct one offering per year.
---------------------------------------------------------------------------
\1625\ See Section III.A.5.a for a discussion of the data
regarding current market practices.
\1626\ Id. This estimate differs from our estimate in the
proposal. It uses more recent data than the proposal and is based on
the average number of issuers per year rather than the average
number of unique issuers. According to filings made with the
Commission, an average of approximately 4,559 issuers per year
conducted new Regulation D offerings of up to $1 million from 2009
to 2014. 22%, or 1,003, of those issuers reported having no
revenues. (0.22 x 4,559 = 1,003). 19%, or 866, of those issuers
reported having less than $1 million in revenues. (0.19 x 4,559 =
866). Therefore, the average number of issuers per year is 1,003 +
866 = 1,869, or approximately 1,900 issuers.
---------------------------------------------------------------------------
We received no comments on our estimate of the number of issuers
expected to participate in securities-based crowdfunding transactions
or the number of offerings in reliance on Section 4(a)(6) we expect
those issuers to conduct. In developing the estimate for the number of
issuers in the final rule, we refined the methodology used in the
Proposing Release and applied that methodology to more recent data,
resulting in an updated estimate that we believe is reasonable and
appropriate.
2. Intermediaries That Are Registered Brokers
The final rules require intermediaries to register with us as
either a broker-dealer or as a funding portal. Consistent with the
Proposing Release, we estimate that the collection of information
requirements in the final rules will apply to approximately 10
intermediaries per year that are not currently registered with the
Commission and that will choose to register as brokers, rather than as
funding portals, to act as intermediaries for offerings made in
reliance on Section 4(a)(6). However, we believe that, given the cost
that an unregistered entity will incur to register as a broker compared
with the lower cost of becoming a funding portal, unregistered entities
that choose to act as crowdfunding intermediaries will generally be
more likely to register as funding portals than as brokers.
Consistent with the Proposing Release, we further estimate that
approximately 50 intermediaries per year that are already registered as
brokers with the Commission will choose to add to their current service
offerings by also serving as crowdfunding intermediaries. These
entities will not have to file a new application for registration with
us, and if currently doing business with the public, they will already
be members of FINRA (the applicable national securities association
registered under Exchange Act Section 15A). We note, however, that
given the nascent nature of the equity-based crowdfunding market, we do
not have any data or other evidence indicating the number of currently-
registered brokers that will be interested in becoming crowdfunding
intermediaries. Therefore, we recognize that the number of brokers per
year that may engage in crowdfunding activities could differ
significantly from our current estimate. We received no comments on our
estimates of the number of broker-dealers that will act as
intermediaries.
3. Funding Portals
Consistent with the Proposing Release, we estimate that on average
approximately 50 intermediaries per year that are not already
registered as brokers will choose to be registered as funding portals
during the first three years following effectiveness of the final
rules. This estimate assumes that, upon effectiveness of the final
rules, about 15% of the approximately 200 U.S.-based crowdfunding
portals \1627\ currently in existence will participate in securities-
based crowdfunding and that the number of crowdfunding portals will
grow at 60% per year over the next three years.\1628\ Therefore, we
estimate that an average of approximately 50 respondents will be
registered as funding portals annually.\1629\ Of those 50 funding
portals, we estimate that two will be nonresident funding portals.
These estimates are based in part on indications of interest expressed
in responses to FINRA's voluntary interim form for funding portals. We
received no comments on our estimates on the number of funding portals
that will act as intermediaries
---------------------------------------------------------------------------
\1627\ This estimate is based in part on an industry estimate
that, as of April 2012, there were approximately 200 non-securities-
based crowdfunding portals operating in the United States. See
Massolution 2012 at 16. We did not receive comment on these
estimates and therefore continue to believe our estimates in the
Proposing Release are appropriate. See also Massolution 2015 at 84
(estimating that, as of December 2014, there were approximately 375
crowdfunding portals operating in North America, not just the United
States).
\1628\ A worldwide survey of crowdfunding portals indicated
that, in 2011, approximately 14.8% of the surveyed crowdfunding
portals (mostly based in Europe) participated in ``equity-based''
crowdfunding. Id. Also, the total number of crowdfunding portals
worldwide grew by an estimated 60% from 2011 to 2012. Id. at 13. We
did not receive comment on these estimates and therefore continue to
believe our estimates in the Proposing Release are appropriate. See
also Massolution 2015 at 82-83 (estimating that, as of December
2014, there were approximately 1250 crowdfunding portals worldwide
compared to 813 worldwide in 2012, which represents an increase of
approximately 54%).
\1629\ 200 U.S.-based crowdfunding portals x 15% (estimated
percentage of crowdfunding portals that will participate in
securities-based crowdfunding) = 30 funding portals that will
participate in securities-based crowdfunding. Assuming 60% growth
over three years, the number of registered funding portals will be
30 during the first year, 48 during the second year and 77 during
the third year. The average number of registered funding portals
over three years is (30 + 48 + 77)/3 = 52 funding portals (or
approximately 50 funding portals per year).
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C. Estimate of Burdens
1. Issuers
a. Form C: Offering Statement and Progress Update
Under the final rules, an issuer conducting a transaction in
reliance on Section 4(a)(6) will be required to file with us specified
disclosures on a Form C: Offering Statement.\1630\ An issuer also will
be required to file with us amendments to Form C to disclose any
material change in the offer terms or disclosure previously provided to
investors.\1631\ Form C is similar to the Form 1-A offering statement
under Regulation A, but it requires fewer disclosure items (e.g., it
does not require disclosure about the plan of distribution, the
compensation of officers and directors, litigation or a discussion of
federal tax aspects). We note that offerings made in reliance on
Regulation A allow issuers to offer up to $50 million, involve review
by SEC staff and, in the case of Tier 1 offerings, require filings at
the state level.\1632\ In light of these factors, we expect that
issuers seeking to raise capital pursuant to a Regulation A offering
generally will be at a more advanced stage of development than issuers
likely to raise capital pursuant to Section 4(a)(6), so the complexity
of the required disclosure and, in turn, the burden of compliance with
the requirements of Form C will be significantly less than for Form 1-
A.\1633\ In the Proposing Release we estimated that the burden to
prepare and file Form C would be approximately 60 hours per issuer,
which represented approximately 10% of the burden to prepare then-
existing Form 1-A.\1634\ We estimated that 75% of the burden, or 45
hours, would be carried internally and the remaining 25% of the burden
would be carried by outside professionals at a cost of $6,000 per
issuer.
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\1630\ See Rule 203(a)(1) of Regulation Crowdfunding.
\1631\ See Rule 203(a)(2) of Regulation Crowdfunding.
\1632\ See Rule 256 of Regulation A; Regulation A Adopting
Release, note 506.
\1633\ We currently estimate the average burden per response for
preparing and filing a Form 1-A to be approximately 750 hours.
\1634\ See Proposing Release at 78 FR 66540.
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As discussed in more detail in the Economic Analysis, above, we
received a number of comments concerning the burdens and costs of the
proposed rules.\1635\ Many of these commenters
[[Page 71524]]
provided monetary estimates without distinguishing between internal
burden hours and outside professional costs. Some commenters suggested
that the Proposing Release underestimated the time and expense that
would be required to prepare and file Form C.\1636\ In contrast, one
commenter stated that it was a third-party service provider that could
prepare Form C at much lower costs than those estimated by the
Commission.\1637\ Another commenter suggested that the cost of
preparing and filing these forms and the associated compliance costs
would range from $3,000 to $9,000.\1638\ Additionally, we received a
number of comments about the costs of the audit and review of financial
statements, as proposed. We believe that these costs would be a
component of the outside professional costs associated with Form C. In
the Economic Analysis, we have set forth our monetized estimates of the
various cost components, grouped into categories based on the size of
the offering. Our Form C estimates range from $2,500 for the smallest
offerings (up to $100,000); to a range of $2,500 to $5,000 for somewhat
larger offerings (more than $100,000 but not more than $500,000) and a
range of $5,000 and $20,000 for the largest offerings (more than
$500,000). Additionally, our estimates of the cost of financial
statement review or audit range from $0 for the smallest offerings; to
between $1,500 and $18,000 for larger offerings and for first-time
crowdfunding issuers conducting offerings between $500,000 and
$1,000,000; and $2,500 to $30,000 for other issuers that are conducting
an offering in the largest offering amount category. Accordingly, in
our Economic Analysis we estimate a cost range estimate for Form C and
the financial statement review of: $2,500 for the smallest offerings,
$4,000 to $23,000 for the larger offerings, $6,500 to $38,000 for
first-time crowdfunding issuers conducting offerings between $500,000
and $1,000,000, and $7,500 to $50,000 for other issuers conducting an
offering in the largest offering amount category. For purposes of the
PRA, however, we must provide a single estimate, comprised of both
burden hours and outside professional costs, for an average issuer.
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\1635\ See Section III.B.3.a.
\1636\ See, e.g., Heritage Letter (stating that the costs to
prepare the required disclosures will likely exceed $10,500, except
in cases of start-ups with no operating history); NSBA Letter
(stating that issuers and intermediaries will likely incur higher
attorney and accounting fees and financial and administrative
burdens than estimated in the proposed rules but without providing
estimates); SeedInvest Letter 2 (estimating upfront compliance costs
to be ``potentially hundreds of hours [in internal company time] and
$20,000 to $50,000 [in outside professional costs]'').
\1637\ FundHub Letter 2 (stating that the commenter will prepare
Form C and all disclosure documents, do all bad actor checks, verify
investor status and perform all other necessary compliance measures
for a $100,000 offering for $2,500 total, and that, in most cases,
its services and associated legal fees will cost an issuer between
$2,500 and $5,000 for an offering up to $500,000 and between $5,000
and $10,000 for an offering between $500,000 and $1,000,000).
\1638\ See StartEngine Letter 2.
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Based on these comments and our Economic Analysis, we have revised
our estimate of the burden associated with the preparation and filing
of Form C. We acknowledge that a number of commenters suggested that we
underestimated the burdens of the proposed rule, but believe that
changes in the final rule, particularly with respect to the financial
statement requirements for first-time crowdfunding issuers, may
mitigate the impact of those costs. Accordingly, we estimate that the
average total burden to prepare and file the Form C, including any
amendment to disclose any material change, will be approximately 100
hours, which, while higher than our proposed estimate, is still
substantially less than the burden to prepare a Form 1-A for an
offering under Regulation A, as recently amended. We continue to
estimate that 75 percent of the burden of preparation will be carried
by the issuer internally and that 25 percent will be carried by outside
professionals \1639\ retained by the issuer at an average cost of $400
per hour.\1640\ This reflects 75 internal burden hours per issuer and
$10,000 in external professional costs. While for PRA purposes, we must
present this estimate in terms of hours and costs, we believe that this
estimate is consistent with the monetary ranges that we set forth in
the Economic Analysis.
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\1639\ For example, an issuer could retain an outside
professional to assist in the preparation of the financial
statements, but could decide to address the remaining disclosure
requirements internally.
\1640\ We estimate the average external cost of preparing Form C
to be 0.25 x 100 hours x $400 per hour = $10,000.
We recognize that the costs of retaining outside professionals
may vary depending on the nature of the professional services, but
for purposes of this PRA analysis, we estimate that such costs would
be an average of $400 per hour. This is the rate we typically
estimate for outside legal services used in connection with public
company reporting.
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Under the final rules, the issuer also will be required to file
with us regular updates on the progress of the issuer in meeting the
target offering amount.\1641\ In a change from the proposal, the rules
permit issuers to satisfy the progress update requirement by relying on
the relevant intermediary to make publicly available on the
intermediary's platform frequent updates about the issuer's progress
toward meeting the target offering amount. Nevertheless, an issuer
relying on the intermediary's reports of progress must still file a
progress update at the end of the offering to disclose the total amount
of securities sold in the offering. The issuer is required to make the
filing under cover of a Form C-U: Progress Update. Form C-U is similar
to a Form D Notice of Exempt Offering of Securities under Regulation
D.\1642\ Form C-U will require significantly less disclosure than the
Form D, however, as it will require disclosure only of the issuer's
progress in meeting the target offering amount, rather than
compensation and use of proceeds disclosures or other information about
the issuer and the offering. Thus, the complexity of the required
disclosure and the burden to prepare and file Form C-U will be
significantly less than for Form D. We continue to estimate that the
burden to prepare and file each progress update will be 0.50 hours. In
light of the change from the proposal, we expect most issuers will rely
on the relevant intermediary to provide interim progress updates and
therefore will be required to file an average of one progress update
during each offering rather than the two progress updates that we
estimated in the Proposing Release.\1643\ As in the Proposing Release,
we estimate that the entirety of this burden will be borne internally
by the registrant.
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\1641\ See Rule 203(a)(3) of Regulation Crowdfunding.
\1642\ We currently estimate the burden per response for
preparing and filing a Form D to be 4.00 hours.
\1643\ See Rule 203(a)(3) of Regulation Crowdfunding.
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Overall, we estimate that compliance with the requirements of a
Form C filed in connection with offerings made in reliance on Section
4(a)(6) will require 190,000 burden hours (1,900 offering statements x
100 hours/offering statement) in aggregate each year, which corresponds
to 142,500 hours carried by the issuer internally (1,900 offering
statements x 100 hours/offering statement x 0.75) and costs of
$19,000,000 (1,900 offering statements x 100 hours/offering statement x
0.25 x $400) for the services of outside professionals. We also
estimate that compliance with the requirements of Form C-U filed during
an offering will require 950 burden hours (1,900 offering statements x
1 progress update per offering x 0.50 hours per progress update) in
aggregate each year.
b. Form C-AR: Annual Report
Under the final rules, unless the reporting has been terminated,
any
[[Page 71525]]
issuer that sells securities in a transaction made pursuant to Section
4(a)(6) will be required to file annually with us an annual report on
Form C-AR: Annual Report.\1644\ Form C-AR will require disclosure
substantially similar to the disclosure provided in the Form C:
Offering Statement, except that offering-specific disclosure will not
be required and the issuer may be able to update disclosure previously
provided in the Form C. In addition, in a change from the proposal,
instead of requiring financial statements in the annual report that
meet the highest standard of review previously provided (either
reviewed or audited), the final rules require financial statements of
the issuer certified by the principal executive officer of the issuer
to be true and complete in all material respects.\1645\ Therefore, we
estimate that the burden to prepare and file Form C-AR will be less
than that required to prepare and file Form C.
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\1644\ See Rule 202 of Regulation Crowdfunding.
\1645\ See Rule 202(a) of Regulation Crowdfunding. However,
issuers that have available financial statements that have been
reviewed or audited by an independent certified public accountant
because they prepare them for other purposes shall provide them and
will not be required to have the principal executive officer
certification. Id.
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As discussed in the Economic Analysis, we received some comments on
the costs of Form C-AR.\1646\ One commenter that submitted comments
concerning both Form C and Form C-AR provided several cost estimates or
ranges for Form C-AR that varied but were ranges or amounts that were
lower than the commenter's estimates for Form C.\1647\ Our analysis of
the cost of Form C-AR in our Economic Analysis reflects these comments,
and in that analysis, we estimate that the cost of Form C-AR represents
two-thirds of the cost of Form C (exclusive of the financial statement
review).
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\1646\ See Section III.B.3.a.
\1647\ See SeedInvest Letter 1; SeedInvest Letter 4.
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Additionally, in light of the change to the final rules for Form C-
AR to require financial statements that are certified by the principal
executive officer of the issuer to be true and complete in all material
respects, rather than requiring financial statements that meet the
highest level of review previously provided, we estimate that for Form
C-AR there will be a further reduction of PRA burden compared with the
burden of Form C. Accordingly, we estimate that compliance with Form C-
AR will be approximately one-half of the burden of Form C, resulting in
a burden of 50 hours per response. We further estimate that 75 percent
of the burden of preparation will be carried by the issuer internally
and that 25 percent will be carried by outside professionals \1648\
retained by the issuer at an average cost of $400 per hour.\1649\
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\1648\ See note 1639.
\1649\ See note 1640.
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We estimate that compliance with the requirements of Form C-AR in
the first year after issuers sell securities pursuant to Section
4(a)(6) will require 95,000 burden hours (1,900 issuers x 50 hours/
issuer) in the aggregate, which corresponds to 71,250 hours carried by
the issuer internally (1,900 issuers x 50 hours/issuer x 0.75) and
costs of $9,500,000 (1,900 issuers x 50 hours/issuer x 0.25 x $400) for
the services of outside professionals.
c. Form C-TR: Termination of Reporting
Under the final rules, any issuer terminating its annual reporting
obligations will be required to file a notice under cover of Form C-TR:
Termination of Reporting to notify investors and the Commission that it
no longer will file and provide annual reports pursuant to the
requirements of Regulation Crowdfunding.\1650\ We estimate that eight
percent of the issuers that sell securities pursuant to Section 4(a)(6)
will file a notice under cover of Form C-TR during the first
year.\1651\ The Form C-TR will be similar to the Form 15 that issuers
file to provide notice of termination of the registration of a class of
securities under Exchange Act Section 12(g) or to provide notice of the
suspension of the duty to file reports required by Exchange Act
Sections 13(a) or 15(d).\1652\ Therefore, we estimate that compliance
with the Form C-TR will result in a similar burden as compliance with
Form 15, that is, a burden of 1.50 hours per response. We estimate that
compliance with Form C-TR will result in a burden of 228 hours (1,900
issuers x 0.08 issuers filing Form C-TR x 1.50 hours/issuer) in the
aggregate during the first year for issuers terminating their reporting
obligations. As in the Proposing Release, we estimate that the entirety
of this burden will be borne internally by the registrant. We received
no comments on our estimates with respect to Form C-TR and continue to
believe that these estimates are reasonable.
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\1650\ See Rule 203(b)(2) of Regulation Crowdfunding.
\1651\ For purposes of this PRA analysis, we estimate that eight
percent of issuers will not survive past their first year, based on
a recent study that found that of a random sample of 4,022 new high-
technology businesses started in 2004, 92.3% survived past their
first year. See Kauffman Firm Survey, note 1302 at 13.
\1652\ We currently estimate the burden per response for
preparing and filing a Form 15 to be 1.50 hours.
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d. Form ID Filings
Under the final rules, an issuer will be required to file specified
disclosures with us on EDGAR.\1653\ We anticipate that the majority of
first-time issuers seeking to offer and sell securities in reliance on
Section 4(a)(6) will not previously have filed an electronic submission
with us and so will need to file a Form ID. Form ID is the application
form for access codes to permit filing on EDGAR. The final rules will
not change the form itself, but we anticipate that the number of Form
ID filings will increase due to new issuers seeking to offer and sell
securities in reliance on Section 4(a)(6). One commenter stated that it
would take approximately 70 minutes to complete a Form ID, considerably
more time than the estimated 0.15 hours.\1654\ However, the information
required by Form ID is very limited, primarily the name and address of
the filer, so we continue to believe the estimated 0.15 hours per
response is appropriate. For purposes of this PRA analysis, we estimate
that all of the issuers who will seek to offer and sell securities in
reliance on Section 4(a)(6) will not have filed an electronic
submission with us previously and will, therefore, be required to file
a Form ID. As noted above, we estimate that approximately 1,900 issuers
per year will seek to offer and sell securities in reliance on Section
4(a)(6), which will correspond to 1,900 additional Form ID filings. As
a result, we estimate the additional annual burden associated with this
form will be approximately 285 hours (1,900 filings x 0.15 hours/
filing).\1655\
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\1653\ See Rules 201-203 of Regulation Crowdfunding.
\1654\ Angel Letter 1.
\1655\ We currently estimate the burden per response for
preparing and filing with Form ID to be 0.15 hours.
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2. Brokers and Funding Portals
Below, we discuss our estimates of the internal burdens and
professional costs associated with the collections of information
required under the final rules as they relate to intermediaries. Where
relevant, we discuss any comments received on these estimates and any
changes to estimates, including changes made in response to comments on
them.
a. Registration Requirements
(1) Time Burden
The final rules will require intermediaries to register with us as
either a broker or as a funding portal. As noted above, we believe that
some intermediaries for transactions made in
[[Page 71526]]
reliance on Section 4(a)(6) and Regulation Crowdfunding will already be
registered as brokers. Therefore, this registration requirement will
impose no new requirement on these entities and no additional burden
for purposes of this PRA analysis. Entities that are not already
registered as brokers may decide to register either as brokers or as
funding portals and to become members of a registered national
securities association (if they are not already a member) pursuant to
the final rules. We estimate that each year, on average, approximately
10 entities may decide to be registered as brokers and approximately 50
entities may decide to be registered as funding portals by filing Form
Funding Portal.\1656\ In addition, we estimate that of those 50
entities that register as funding portals, two will be nonresident
funding portals and subject to the additional requirements under Rule
400(f) of completing Schedule C (including the required
certifications), requirements related to the agent for service of
process in the United States, and obtaining an opinion of counsel.
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\1656\ As noted above, funding portals will have to complete and
file Form ID in order to obtain access codes to file on EDGAR. Based
on our estimates, 50 funding portals per year will newly register
through EDGAR, which will correspond to 50 additional Form ID
filings. As a result, we estimate the additional annual burden
associated with this form will be approximately 7.5 hours (50
filings x 0.15 hours/filing).
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We estimate the burden for registering with the Commission as a
broker based upon the existing burdens for completing and filing Form
BD, currently estimated as 2.75 hours.\1657\ Consequently, we estimate
that the total annual burden hours required for all crowdfunding
intermediaries, including brokers and funding portals, to register with
us under the final rules will be approximately 165 hours (2.75 hours/
respondent x (10 brokers + 50 funding portals)). In addition, those
entities that register as nonresident funding portals will face an
additional burden of half an hour to complete Schedule C and make the
required certifications, half an hour to document the appointment of an
agent for the service of process, and one hour to obtain an opinion of
counsel. Consequently, we estimate that, of the 50 registered funding
portals, two will each face an additional burden of two hours to
register, for a total additional annual burden of four hours.
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\1657\ While it is likely that the time necessary to complete
Form BD varies depending on the nature and complexity of the
entity's securities business, we currently estimate the average time
necessary for a broker-dealer to complete and file an application
for broker-dealer registration on Form BD to be approximately 2.75
hours. We also estimate that the time burden to register as a
funding portal on Form Funding Portal will be, for purposes of this
PRA analysis, the same as the time required to complete and file
Form BD because the information required for that form is similar.
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We have taken into consideration that brokers that register to
engage in crowdfunding transactions conducted in reliance on Section
4(a)(6) may eventually decide to withdraw their registration.
Withdrawal requires an entity to complete and file with us a Form
BDW.\1658\ We further estimate that approximately 430 broker-dealers
withdraw from Commission registration annually \1659\ and, therefore,
file a Form BDW. Of them, we estimate that approximately one broker who
had registered in order to facilitate crowdfunding offerings made in
reliance on Section 4(a)(6) will decide to withdraw in each year
following adoption of the rules.\1660\ Therefore, the one broker-dealer
that withdraws from registration by filing Form BDW will incur an
aggregate annual reporting burden of approximately 0.25 hours (0.25
hours/respondent x 1 broker). Similarly, we estimate that approximately
five funding portals will choose to withdraw from registration each
year \1661\ and that each withdrawal, as with Form BDW, will take
approximately 0.25 hours. This will result in an aggregate annual
reporting burden of approximately 1.25 hours (0.25 hours/respondent x 5
funding portals).
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\1658\ The time necessary to complete Form BDW varies depending
on the nature and complexity of the applicant's securities business.
We currently estimate that it takes a broker-dealer approximately
0.25 burden hours to complete and file a Form BDW to withdraw from
Commission registration, as required by Exchange Act Rule 15b6-1 (17
CFR 240.15b6-1).
\1659\ This estimate is based on Form BDW data collected over
the past five years and may be high as a result of the impact of the
financial crisis on broker-dealers. For the past five fiscal years
(from 10/1 through 9/30), the number of broker-dealers that withdrew
from registration was as follows: 524 in 2011 and 428 in 2012, 434
in 2013, 454 in 2014 and 306 by September 15, 2015. We thus estimate
the number of broker-dealers that withdraw from the Commission
annually to be 430 ((524+428+434+454+306)/5).
\1660\ As of September 2015, there were 4,213 broker-dealers
registered with the Commission. An average of 430 broker-dealers per
year withdraw from registration, or 10% of the number of registered
broker-dealers (430 withdrawing broker-dealers/4,213 registered
broker-dealers). We assume that the same percentage of broker-
dealers that withdraw from registration will apply to the population
of registered broker-dealers participating in offerings in reliance
on Section 4(a)(6). Of our estimate of 10 registered broker-dealers
per year registering to participate in crowdfunding transactions in
reliance on Section 4(a)(6), we estimate that approximately one
broker-dealer per year (10 registered broker-dealers x 0.10) will
withdraw from registration.
\1661\ We estimate that the percentage of registered funding
portals participating in crowdfunding transactions in reliance on
Section 4(a)(6) that will withdraw from registration annually would
be the same as the percentage of broker dealers that withdraw from
registration annually because of the similarity of these entities'
businesses. Of our estimate of 50 registered funding portals
participating in crowdfunding transactions in reliance on Section
4(a)(6), we estimate that approximately five funding portals per
year (50 registered funding portals x 0.10) will withdraw from
registration. For funding portals, a decision to withdraw
registration will be required to be reported to us in the same way
as an amendment; however, for brokers, withdrawal requires the
filing of Form BDW.
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In the Proposing Release, we also included an estimate of PRA
burdens and costs for newly-registered intermediaries to become members
of FINRA or any other registered national securities association.
Specifically, the Proposing Release included a discussion of an
estimate of the paperwork burdens and costs that would be incurred by
an intermediary to register with a national securities association as
well as an estimate of the ongoing fees (e.g., FINRA annual assessment
fees) that would be incurred by an intermediary to remain registered
with a national securities association. However, after further
consideration, we do not believe the hour burdens and costs associated
with FINRA's membership constitute paperwork burdens and costs
attributable to the Commission's rules. Accordingly, we are not
providing estimates of burdens and costs resulting from membership in a
registered national securities association in this PRA analysis. We
have, however, considered the costs of such membership, both initial
and ongoing, in our Economic Analysis above.\1662\
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\1662\ See Section III.B.4.
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Once registered, a broker must promptly file an amended Form BD
when information originally reported on Form BD changes or becomes
inaccurate. Similarly, a registered funding portal must file amendments
relating to changes in information filed in a Form Funding Portal
filing.\1663\ Based on the number of amended Forms BD that we received
from October 1, 2011 through September 15, 2015, we estimate that the
total number of amendments that we will receive on Form BD from the 10
brokers that register under Regulation Crowdfunding will be
approximately 32.\1664\ Therefore,
[[Page 71527]]
we estimate that the total additional annual burden hours necessary for
broker-dealers to complete and file amended Forms BD will be
approximately 10.6 hours (32 amended Forms BD per year x 0.33 hours).
Using the same ratios, we estimate that the total annual burden hours
for funding portals to complete and file amended Forms Funding Portal
will be approximately 52.8 hours (50 funding portals x 3.2 amendments
per year x 0.33 hours per amendment).
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\1663\ We currently estimate that the average time necessary to
complete an amended Form BD to be approximately 20 minutes, or 0.33
hours. We estimate that an amendment to Form Funding Portal will
take the same amount of time as an amendment to Form BD because the
forms are similar.
\1664\ We received 15,491, 13,271, 12,902, 14,330 and 10,848
amended Forms BD during the fiscal years ending 2011, 2012, 2013,
2014 and 2015, respectively, reflecting an average of 13,368
amendment filings per year (15,491 + 13,271+12,902+ 14,330+10,848)/5
years). As of September 15, 2015, there were 4,213 broker-dealers
registered with the Commission. Therefore, we estimate that there
are approximately 3.17 amendments (13,368 amended Forms BD/4,213
broker-dealers) per registered broker-dealer per year. We therefore
estimate that the 10 broker-dealers who register under Regulation
Crowdfunding will file, on aggregate, approximately 32 amendments
per year.
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(2) Cost
We estimate that two intermediaries will face a cost per
intermediary of $25,179 to retain an agent for service of process and
provide an opinion of counsel to register as a nonresident funding
portal.\1665\
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\1665\ We have altered our cost estimates slightly from the
Proposing Release (from $25,130 to $25,179) and note that the
amended estimates are consistent with our recent estimates of what
it would cost other types of nonresident entities to retain an agent
for service of process and provide an opinion of counsel. See
Registration Process for Security-Based Swap Dealers and Major
Security-Based Swap Participants, Exchange Act Release No. 34-75611,
80 FR 48964, 48994 (Aug. 14, 2015). We inadvertently included the
costs to non-resident funding portals of completing Schedule C in
the Proposing Release. We anticipate, however, that nonresident
funding portals will incur a time burden rather than a cost burden
to complete Schedule C.
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b. Development of Intermediary Platform
(1) Time Burden
The final rules envision that intermediaries will develop
electronic platforms to offer securities to the public in reliance on
Section 4(a)(6). We anticipate that an intermediary's platform will
incorporate related systems functionality to comply with our final
rules (including the collection of information associated with, for
example, the requirements of Rules 302, 303 and 304) as well as execute
other platform capabilities and system operations. The estimated time
burdens and costs for platform development discussed in this section
include the estimated time burdens and costs for the functionalities
that will allow funding portals to comply with their disclosure,
communication channel, and investor notification requirements.\1666\
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\1666\ See Sections IV.C.2.g. and IV.C.2.h.
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Intermediaries that develop their platforms in-house will incur an
initial time burden associated with setting up their systems. Based on
our discussions with potential intermediaries prior to the publication
of our proposed rules, we estimate that intermediaries creating the
initial platform in-house will typically have a team of approximately
four to six developers that will work on all aspects of platform
development, including, but not limited to, front-end programming, data
management, systems analysis, communication channels, document
delivery, and Internet security.\1667\ We estimate, based on our
discussions with potential intermediaries prior to the publication of
our proposed rules, that in developing a platform in-house,
intermediaries will spend an average of 1,500 hours for planning,
programming, and implementation.\1668\
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\1667\ See Sections IV.C.2.g. and IV.C.2.h.
\1668\ This average takes into account intermediaries that will
develop a brand new platform and those that will modify an existing
platform to function in accordance with Regulation Crowdfunding.
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It is difficult to estimate the number of intermediaries that will
develop their initial platforms in-house, but assuming that half of the
110 newly-registered intermediaries \1669\ do so, the total initial
time burden on those intermediaries will be 82,500 hours (55
intermediaries x 1,500 hours = 82,500 hours).
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\1669\ As discussed above, we anticipate that 10 intermediaries
will newly register as brokers, 50 intermediaries will be brokers
that are already registered, and 50 intermediaries will register as
funding portals.
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We estimate that annually updating the features and functionality
of an intermediary's platform will require approximately 20% of the
hours required to initially develop the platform, for an average burden
of 300 hours per year. If we assume that half of the 110 crowdfunding
intermediaries update their systems accordingly each year, the total
ongoing time burden will be 16,500 hours per year (55 intermediaries x
300 hours = 16,500 hours).
(2) Cost
There will be a cost associated with developing a platform for an
intermediary that hires a third-party to develop its platform rather
than developing it in-house. Based on our discussions with potential
intermediaries prior to the publication of our proposed rules, we
estimate that it will cost an intermediary approximately $250,000 to
$600,000 \1670\ to build a new Internet-based crowdfunding portal and
all of its basic functionality.\1671\ Assuming that half of the 110
newly-registered intermediaries hire outside developers to build or to
tailor their platforms, the total initial cost will range from
$13,750,000 to $33,000,000 (55 intermediaries x $250,000 = $13,750,000;
55 intermediaries x $600,000 = $33,000,000). For purposes of this PRA
analysis, we estimate the cost to be $23,375,000 (the average of
$13,750,000 and $33,000,000).
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\1670\ See, e.g., ASSOB Letter (suggesting that the cost to
establish a funding portal would run at least $480,000, which is
within the range of our estimate).
\1671\ We anticipate that some percentage of intermediaries will
already have in place platforms and related systems that will need
to be tailored to comply with the requirements of Title III of the
JOBS Act and Regulation Crowdfunding. We anticipate that these
intermediaries will hire outside developers to tailor their
platforms. We estimate an average cost of approximately $250,000 in
the first year in order to tailor the current systems for an
intermediary that already has in place a platform and related
systems. Thus, this amount is already covered in our range of costs
above--$250,000 to $600,000.
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We estimate that it will typically cost an intermediary
approximately one-fifth of the initial development cost per year to use
a third-party developer to provide annual maintenance on an Internet-
based crowdfunding portal, including updating and basic functionality,
or $85,000 per year on average.\1672\ If we assume that half of the 110
crowdfunding intermediaries updated their systems accordingly, the
total ongoing cost will be $4,675,000 per year (55 intermediaries x
$85,000 = $4,675,000).
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\1672\ Our estimate of the average initial external cost per
intermediary to develop a crowdfunding platform is the average of
the cited range of $250,000 to $600,000, or $425,000 (($250,000 +
$600,000)/2). One-fifth of the cost of $425,000 is $85,000.
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c. Measures To Reduce the Risk of Fraud
(1) Time Burden
The final rules will require intermediaries to have a reasonable
basis for believing that an issuer seeking to offer and sell securities
in reliance on Section 4(a)(6) through the intermediary's platform
complies with the requirements in Section 4A(b) and the related
requirements in Regulation Crowdfunding.\1673\ The final rules will
also require intermediaries to have a reasonable basis for believing
that an issuer has established means to keep accurate records of the
holders of the securities it will offer and sell through the
intermediary's platform.\1674\ For both requirements, an intermediary
may reasonably rely on the representations of the issuer, unless the
intermediary has reason to question the reliability of those
representations. For the purposes
[[Page 71528]]
of this PRA analysis, we expect that 100% of intermediaries will rely
on the representations of issuers. Based on our industry knowledge and
discussions with participants prior to the publication of our proposed
rules, we calculate that this requirement will impose a time burden in
the first year of five hours per intermediary to establish standard
representations it will request from issuers, and six minutes per
intermediary per issuer to obtain the issuer representation, which is
consistent with estimates we have used for other regulated entities to
obtain similar documentation, such as consents, from customers.
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\1673\ See Rule 301(a) of Regulation Crowdfunding.
\1674\ See Rule 301(b) of Regulation Crowdfunding.
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Based on our estimate that there will be approximately 1,900
offerings per year, that each issuer will conduct one offering per
year, and that there will be 110 intermediaries, we estimate that each
intermediary will facilitate an average of approximately 17 offerings
per year (1,900 offerings/(10 newly registered broker-dealers + 50
previously registered broker-dealers + 50 funding portals)). Therefore,
we estimate that the total initial burden hours will be approximately
740 hours ((5 hours/intermediary x (10 newly-registered broker-dealers
+ 50 previously-registered broker-dealers + 50 funding portals)) + (0.1
hours/issuer x 17 offerings x 110 intermediaries).
We believe that the ongoing time burdens for this requirement will
be approximately one hour per intermediary per year to review and
confirm that the standard representations it requests from issuers
remain appropriate, and six minutes (0.1 hours) per intermediary per
issuer to obtain an issuer's representation. Therefore, we estimate
that the ongoing total burden hours necessary for intermediaries to
rely on the representations of the issuers will be approximately 300
hours per year ((1 hour/intermediary x (10 newly-registered broker-
dealers + 50 previously-registered broker-dealers + 50 funding
portals)) + (0.1 hours/issuer x 17 offerings x 110 intermediaries).
(2) Cost
The final rules will require intermediaries to conduct a background
and securities enforcement regulatory history check on each issuer and
each officer, director or 20 Percent Beneficial Owner of an issuer to
determine whether the issuer or such person is subject to a
disqualification. We anticipate that most intermediaries will employ
third parties to perform background and securities enforcement
regulatory history checks in light of the costs of developing an in-
house capability to conduct such checks. Therefore, for the purposes of
this PRA analysis, we assume that 100% of intermediaries will use these
third-party service providers.
The cost for a third party to perform a background check is
estimated to be between $200 and $500, depending on the nature and
extent of the information provided.\1675\ We recognize that some
issuers will require more than one background check (e.g., for officers
or directors of the issuer), and we estimate that intermediaries will
perform four background checks per issuer, on average. We base this
number on the assumption that most crowdfunding issuers will be
startups and small businesses with small management teams and few
owners. Assuming an average of approximately 1,900 offerings made in
reliance on Section 4(a)(6) per year, the total estimated initial cost
for all intermediaries to fulfill the required background and
securities enforcement regulatory history checks will range from
approximately $1,520,000 to $3,800,000 per year,\1676\ or approximately
$13,818 to $34,546 per intermediary per year.\1677\ For purposes of
this PRA analysis, we average this cost to $24,182 per intermediary per
year.
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\1675\ See, e.g., A Matter of Fact, Background Check FAQ:
Frequently Asked Questions, available at http://www.amof.info/faq.htm (Matter of Fact is a background check provider accredited by
the National Association of Professional Background Screeners and
the Background Screening Credentialing Council. This source states
that the cost for a comprehensive background check is $200 to $500).
\1676\ 1,900 securities-based offerings made in reliance on
Section 4(a)(6) per year x ($200 to $500 per background and
securities enforcement regulatory history check) x 4 checks per
offering = $1,520,000 to $3,800,000 per year.
\1677\ $1,520,000/110 intermediaries = approximately $13,818 per
intermediary; $3,800,000/110 intermediaries = approximately $34,546
per intermediary.
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One commenter noted, as a general matter, that the ``costs incurred
by the intermediary in dealing with an issuer, doing the required due
diligence and background screening, establishing a Web page describing
the offering and so on do not vary linearly with the offering size. As
a percentage of the offering amount, they will be disproportionately
high for smaller offerings.'' \1678\ This commenter did not, however,
question our underlying assumptions or our estimates of these costs.
For purposes of this PRA analysis and as discussed above, we believe
that these cost estimates are reasonable. We also believe that
intermediaries are in a better position to make their own business
decisions as to whether such costs would be disproportionately high for
smaller offerings.\1679\
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\1678\ Heritage Letter.
\1679\ As noted above, we agree with the commenter's suggestion
that there is likely to be a fixed component to these costs that
reflects a certain necessary level of due diligence and background
screening, which will result in these costs, as a percentage of
offering size, being higher for smaller offerings.
---------------------------------------------------------------------------
We believe that, on an ongoing basis, intermediaries will continue
to use third-party services to conduct background and securities
enforcement regulatory history checks. We also believe that the total
estimated ongoing cost for all intermediaries to fulfill the required
background and securities enforcement regulatory history checks will be
the same as the estimated initial cost, or on average $24,182 per
intermediary per year.
d. Account Opening: Accounts and Electronic Delivery
The final rules provide that no intermediary or associated person
of an intermediary may accept an investment commitment in a transaction
involving the offer or sale of securities made in reliance on Section
4(a)(6) until an investor has opened an account with the intermediary
and consented to electronic delivery of materials.\1680\ This
requirement will impose certain information gathering and recordkeeping
burdens on intermediaries. For the purposes of this PRA analysis, we
expect that the functionality required to allow an investor to open an
account with an intermediary and obtain consents will result in an
initial time burden of approximately 10 hours per intermediary in the
first year. Therefore, we estimate that the total initial burden hours
resulting from this functionality will be approximately 1,100 hours (10
hours/intermediary x (10 newly-registered broker-dealers + 50
previously-registered broker-dealers + 50 funding portals)).
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\1680\ See Rule 302(a) of Regulation Crowdfunding.
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We believe that the ongoing time burdens for this requirement will
be significantly less than the initial time burden, and thus we
estimate approximately two hours per intermediary per year to review
and assess the related processes. Therefore, we estimate that the
ongoing total burden hours necessary for this functionality will be
approximately 220 hours per year (2 hours/intermediary x (10 newly-
registered broker-dealers + 50 previously-registered broker-dealers +
50 funding portals)).
[[Page 71529]]
e. Account Opening: Educational Materials
(1) Time Burden
The final rules require intermediaries to provide educational
materials to investors,\1681\ about the risks and costs of investing in
securities offered and sold in reliance on Section 4(a)(6). Because the
intermediary will determine what electronic format will prove most
effective in communicating the requisite contents of the educational
material, the expected costs for intermediaries to develop the
educational material are expected to vary widely and are difficult to
estimate. For the purposes of this PRA analysis, we assume that half of
the intermediaries will develop their educational materials in-house,
potentially including online presentations and written documents, and
that the other half will employ third parties to produce educational
materials, such as professional-quality online video presentations. We
estimate that to develop their educational materials in-house, each
intermediary will incur an initial time burden of approximately 20
hours. Therefore, the total initial burden will be approximately 1,100
hours (55 intermediaries x 20 hours/intermediary).\1682\
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\1681\ See Rule 302(b) of Regulation Crowdfunding.
\1682\ In the Proposing Release we did not take into account in
our estimated time burden and cost calculations our assumption that
half of the intermediaries would develop educational materials in-
house. Therefore, we have re-calculated the estimated total initial
and ongoing time burdens and costs for the development of in-house
materials in this release based on 55 (rather than 110)
intermediaries.
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Assuming that half of the intermediaries will develop their
educational materials in-house, we also expect that these
intermediaries will update their educational materials in-house, as
needed. We estimate that to update their educational materials in-
house, each intermediary will incur an ongoing time burden of
approximately 10 hours per year. Therefore, the total ongoing burden
will be approximately 550 hours per year (55 intermediaries x 10 hours/
intermediary).
(2) Cost
As stated above, for the purposes of this PRA analysis, we assume
that half of the intermediaries will employ third-party firms to
produce educational materials, such as professional-quality online
video presentations, instead of developing materials in-house. Public
sources indicate that the typical cost to produce a professional
corporate training video ranges from approximately $1,000 to $3,000 per
production minute.\1683\ Based on discussions with industry
participants prior to the publication of our proposed rules, we assume
that, on average, each intermediary will produce a series of short
educational videos that will cover all of the requirements of the final
rules and that the video material will be 10 minutes long in total.
Based on this assumption, we estimate that the average initial cost for
an intermediary to develop and produce educational materials will range
from approximately $10,000 to $30,000. The total initial cost across
all intermediaries estimated to employ a third party per year will be
$550,000 to $1,650,000.\1684\ For purposes of this PRA analysis, we
average the cost to $20,000 per intermediary per year. We note that the
estimated initial cost may be significantly lower, because not all
intermediaries that outsource the development of educational materials
may choose to produce professional-quality online video presentations;
others may produce videos of shorter length or use other types of
educational materials.
---------------------------------------------------------------------------
\1683\ See, e.g., Lee W. Frederiksen, What Is the Cost of Video
Production for the Web?, Hinge Marketing, available at http://www.hingemarketing.com/library/article/what-is-the-cost-of-video-production-for-the-web.
\1684\ 55 intermediaries x $10,000 production cost = $550,000.
55 intermediaries x $30,000 production cost = $1,650,000.
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We estimate that, on an ongoing basis, when using a third-party
company to update their video educational materials, each intermediary
will spend approximately half of the initial average cost. We estimate,
therefore, that the average ongoing annual cost for an intermediary to
update its video educational materials will range from approximately
$5,000 to $15,000 and that the total ongoing annual cost across all
intermediaries will range from approximately $275,000 to $825,000 per
year.\1685\ For purposes of this PRA analysis, we average the cost to
$10,000 per intermediary per year.
---------------------------------------------------------------------------
\1685\ $550,000 total cost x 0.50 = $275,000. $1,650,000 total
cost x 0.50 = $825,000.
---------------------------------------------------------------------------
f. Account Opening: Promoters
The final rules require an intermediary, at the account opening
stage, to disclose to users of its platform that any person who
receives compensation to promote an issuer's offering, or who is a
founder or employee of an issuer engaging in promotional activities on
behalf of the issuer, must clearly disclose the receipt of compensation
and his or her engagement in promotional activities on the
platform.\1686\ We expect that this requirement will result in an
estimated time burden of five hours per intermediary in the first year,
to prepare this particular disclosure and incorporate it into the
account opening process. Therefore, we estimate that the total initial
burden hours necessary for intermediaries to comply with this
requirement will be approximately 550 hours (5 hours/intermediary x (10
newly-registered broker-dealers + 50 previously-registered broker-
dealers + 50 funding portals)).
---------------------------------------------------------------------------
\1686\ See Rule 302(c) of Regulation Crowdfunding.
---------------------------------------------------------------------------
We believe that the ongoing time burdens for this requirement will
be approximately one hour per intermediary per year to review and check
that the disclosures remain appropriate. Therefore, we estimate that
the ongoing total burden hours necessary for intermediaries to comply
with this requirement will be approximately 110 hours per year (1 hour/
intermediary x (10 newly-registered broker-dealers + 50 previously-
registered broker-dealers + 50 funding portals)).
g. Issuer Disclosures To Be Made Available
(1) Time Burden
The final rules require an intermediary to make publicly available
on its platform the information that an issuer of crowdfunding
securities is required to provide to investors, in a manner that
reasonably permits a person accessing the platform to save, download or
otherwise store the information, until the offer and sale of securities
is completed or cancelled.\1687\
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\1687\ See Rule 303(a) of Regulation Crowdfunding.
---------------------------------------------------------------------------
For purposes of the PRA, our estimate of the hourly burdens related
to the public availability of the issuer information is included in our
estimate of the hourly burdens associated with overall platform
development, discussed above in Section IV.C.2.b. We note that the
platform functionality will include not only the ability to display,
upload and download issuer information as required under the final
rules, but also the ability to provide users with required online
disclosures
We recognize that, over time, intermediaries may need to update
their systems that allow issuer information to be uploaded to their
platforms. We do not expect a significant ongoing burden related to the
requirement for providing issuer disclosures, primarily because the
functionality required for required issuer disclosure information to be
uploaded is a standard feature offered
[[Page 71530]]
on many Web sites and will not require frequent or significant updates.
(2) Cost
We do not expect a significant ongoing cost for providing issuer
disclosures, primarily because the functionality required to upload
required issuer disclosure information is a standard feature offered on
many Web sites and will not require frequent updates. To the extent an
intermediary uses a third party to develop the functionality for this
requirement, the initial costs relevant to this requirement will be
incorporated into the cost of hiring a third party to develop the
platform, discussed above in subsection IV.C.2.b.2.
h. Other Disclosures to Investors
(1) Time Burden
Intermediaries will be required to implement and maintain systems
to comply with the information disclosure, communication channels, and
investor notification requirements of Regulation Crowdfunding,
including providing disclosure about compensation at account opening,
obtaining investor acknowledgments to confirm investor qualifications
and review of educational materials, providing investor questionnaires,
maintaining communication channels with third parties and among
investors, notifying investors of investment commitments, confirming
completed transactions and confirming or reconfirming offering
cancellations.
For purposes of the PRA analysis, our estimate of the hourly
burdens related to these information disclosure, communication channel
and investor notification requirements of Regulation Crowdfunding is
included in our estimate of the hourly burdens associated with overall
platform development, discussed above in Section IV.C.2.b. Based on our
discussions with industry participants, we expect that these
functionalities will generally be part of the overall platform
development process and costs. We discuss the burdens of platform
development above, and note that these will include developing the
functionality that will allow intermediaries to comply with disclosure
and notification requirements.\1688\
---------------------------------------------------------------------------
\1688\ See Section IV.C.2.b.1.
---------------------------------------------------------------------------
We do not expect a significant ongoing burden for providing
disclosures, as required by the final rules, because the functionality
required to provide information and communication channels will likely
not require frequent updates. We incorporate the total burden to update
the required functionality for processing investor disclosures and
investor acknowledgment information in the total burden estimates
relating to platform development discussed above.\1689\
---------------------------------------------------------------------------
\1689\ See Section IV.C.2.b.1.
---------------------------------------------------------------------------
(2) Cost
We recognize that some intermediaries may implement the required
functionality for processing investor disclosures and investor
acknowledgments by using a third-party developer. The total cost for
issuers to use third-party developers to add the required functionality
for processing investor disclosures and investor acknowledgments, as
well as to update the required functionality for processing investor
disclosures and investor acknowledgments, is incorporated into our
discussion of the total cost estimates relating to platform development
in Section IV.C.2.b.
We also do not expect there to be a significant ongoing cost for
developing the functionality to process these disclosures and
acknowledgments, primarily because this functionality will likely not
require frequent updates by third-party developers.
i. Maintenance and Transmission of Funds
The final rules contain requirements related to the maintenance and
transmission of funds. A registered broker will be required to comply
with the requirements of Rule 15c2-4 of the Exchange Act (Transmission
or Maintenance of Payments Received in Connection with
Underwritings).\1690\ A registered funding portal will be required to
enter into a written agreement with a qualified third party that has
agreed in writing to hold the client funds.\1691\ It also will be
required to send directions to the qualified third party depending on
whether an investing target is met or if an investment commitment or
offering is cancelled. For purposes of the PRA, we are providing an
estimate for the hour burden that a funding portal will incur to enter
into a written agreement with the qualified third party on an initial
basis, and to review and update that agreement on an ongoing basis.
---------------------------------------------------------------------------
\1690\ See Rule 303(e)(1) of Regulation Crowdfunding. See also
17 CFR 240.15c2-4. For purposes of this PRA discussion, any burdens
associated with Rule 15c2-4, as well as for any other rule to which
brokers are subject regardless of whether they engage in
transactions pursuant to Section 4(a)(6), are not addressed here;
rather, they are included in any OMB approvals for the relevant
rules.
\1691\ See Rule 303(e)(2) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Based on discussion with industry participants, we estimate that
funding portals will incur an initial burden of approximately 20 hours
each to comply with these requirements, for a total burden of 1,000
hours (20 hours per funding portal x 50 funding portals). We expect
that the burden associated with the Web site functionality required to
send directions to third parties will be included as part of the
platform development discussed above.\1692\
---------------------------------------------------------------------------
\1692\ See Section IV.C.2.b.
---------------------------------------------------------------------------
We expect that, on an ongoing basis, a registered funding portal
will have to periodically review and update its written agreement with
the qualified third party to hold its client funds. A registered
funding portal will also be required to send directions on an ongoing
basis to a qualified third party depending on whether an investing
target is met or an investment commitment or offering is cancelled.
Based on discussion with industry participants, we estimate that
funding portals will incur an ongoing annual burden of approximately 5
hours each to comply with these requirements, or 250 hours total (5
hours per funding portal x 50 funding portals).
j. Compliance: Policies and Procedures
The final rules require a funding portal to implement written
policies and procedures reasonably designed to achieve compliance with
the federal securities laws and the rules and regulations thereunder,
relating to its business as a funding portal. We anticipate that
funding portals will comply with this requirement by using internal
personnel and internal information technology resources integrated into
their platforms. Based on discussion with industry participants, we
estimate that a funding portal will spend approximately 40 hours to
establish written policies and procedures to achieve compliance with
these requirements. This will result in a total aggregate initial
recordkeeping burden of 2,000 hours (40 hours x 50 funding portals).
We estimate that, on an ongoing basis, funding portals will spend
approximately 5 hours per year updating, as necessary, the policies and
procedures required by the final rules. This will result in an
aggregate ongoing recordkeeping burden of 250 hours (5 hours x 50
funding portals).
k. Compliance: Privacy
Funding portals will be required to comply with the Privacy Rules
as they
[[Page 71531]]
apply to broker-dealers, including Regulation S-P, S-AM and S-ID.\1693\
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\1693\ See Rule 403(b) of Regulation Crowdfunding.
---------------------------------------------------------------------------
Under Rule 403(b), a funding portal will be required to comply with
Regulation S-P, which will require the funding portal to provide notice
to investors about its privacy policies and practices; describe the
conditions under which a broker may disclose nonpublic personal
information about investors to nonaffiliated third parties; and provide
a method for investors to prevent a funding portal from disclosing that
information to most nonaffiliated third parties by ``opting out'' of
that disclosure, subject to certain exceptions. For funding portals, we
expect that the privacy and opt-out notices will be delivered
electronically, thereby reducing the delivery burden as compared to
paper delivery.
We estimate that under the final rules all 50 funding portals will
be subject to the requirements of Regulation S-P pursuant to Rule
403(b). In developing an estimate of the burden relating to the
Regulation S-P requirements under Rule 403(b), we have considered: (1)
The minimal recordkeeping burden imposed by Regulation S-P; \1694\ (2)
the summary fashion in which information must be provided to investors
in the privacy and opt-out notices required by Regulation S-P; \1695\
and (3) the availability of the model privacy form and online model
privacy form builder. Given these considerations, we estimate that each
funding portal will spend, on an ongoing basis, an average of
approximately 12 hours per year complying with the information
collection requirement of Regulation S-P, for a total of approximately
600 annual burden-hours (12 hours/respondent x 50 funding portals).
---------------------------------------------------------------------------
\1694\ Regulation S-P has no recordkeeping requirement, and
records relating to customer communications already must be made and
retained by broker-dealers pursuant to other Commission rules. The
estimates of the burdens relating to recordkeeping requirements for
funding portals are discussed below in Section IV.C.2.l.
\1695\ The model privacy form adopted by the Commission and the
other agencies in 2009, designed to serve as both a privacy notice
and an opt-out notice, is only two pages.
---------------------------------------------------------------------------
Funding portals will be required to comply with Regulation S-AM,
which will require funding portals to provide notice to each affected
individual informing the individual of his or her right to prohibit
such marketing before a receiving affiliate may make marketing
solicitations based on the communication of certain consumer financial
information from the broker. Based on our discussions with industry
participants, we estimate that approximately 20 funding portals will
have affiliations that will subject them to the requirements of
Regulation S-AM under the final rules, and that they will incur an
average one-time burden of one hour to review affiliate marketing
practices, for a total of 20 burden hours (1 hour/respondent x 20
funding portals).
We estimate that these 20 funding portals will be required to
provide notice and opt-out opportunities to consumers pursuant to the
requirements of Regulation S-AM, as imposed by Rule 403(b), and that
they will incur an average initial burden of 18 hours to do so, for a
total estimated initial burden of 360 hours (18 hours/respondent x 20
funding portals). We also estimate that funding portals will incur an
ongoing burden related to Regulation S-AM's requirements for providing
notice and opt-out opportunities of approximately four hours per
respondent per year. This burden will cover the creation and delivery
of notices to new investors and the recording of any opt-outs that are
received on an ongoing basis, for a total of approximately 80 annual
burden-hours (4 hours/respondent x 20 funding portals).
Funding portals will be required to comply with rule S-ID, which
will require funding portals to develop and implement a written
identity theft prevention program that is designed to detect, prevent
and mitigate identity theft in connection with certain existing
accounts or the opening of new accounts. We estimate that the initial
burden for funding portals to comply with the applicable portions of
Regulation S-ID, as imposed by Rule 403(b), will be (1) 25 hours to
develop and obtain board approval of a program; (2) four hours to train
staff; and (3) two hours to conduct an initial assessment of relevant
accounts, for a total of 31 hours per funding portal. We estimate that
all 50 funding portals will incur these initial burdens, resulting in
an aggregate time burden of 1,550 hours ((25 + 4 + 2 hours/respondent)
x 50 funding portals).
With respect to the requirements of Rule 403(b) relating to
Regulation S-ID, we estimate that the ongoing burden per year will
include: (1) Two hours to periodically review and update the program,
review and preserve contracts with service providers and review and
preserve any documentation received from service providers; (2) four
hours to prepare and present an annual report to a compliance director;
and (3) two hours to conduct periodic assessments to determine if the
entity offers or maintains covered accounts, for a total of eight
hours, of which we estimate 7 seven hours will be spent by internal
counsel and 1 one hour will be spent by a compliance director. We
estimate that all 50 funding portals will incur these ongoing burdens,
for a total ongoing burden 400 hours (8 hours/respondent x 50 funding
portals).
l. Records to be Made and Kept by Funding Portals
(1) Time Burden
All funding portals will be required to make and keep records
related to their activities to facilitate transactions in reliance on
Section 4(a)(6) and the related rules.\1696\ These books and records
requirements are based generally on Exchange Act Rules 17a-3 and 17a-4,
which apply to broker-dealers. To estimate the initial burden for
funding portals, we base our analysis upon the current annual burdens
of Rules 17a-3 and 17a-4.
---------------------------------------------------------------------------
\1696\ See Rule 404 of Regulation Crowdfunding.
---------------------------------------------------------------------------
We currently estimate the annual recordkeeping burden for broker-
dealer compliance with Rule 17a-3 to be 394.16 hours per respondent,
and the most recently approved annual recordkeeping burden for broker-
dealer compliance with Rule 17a-4 to be 249 hours per respondent.
Given the more limited scope of a funding portal's business as
compared to that of a broker, the more targeted scope of the books and
records rules, and the fact that funding portals will be required to
make, deliver and store records electronically, we expect the burden of
the final rules will likely be less than that of Rules 17a-3 and 17a-4.
For the purposes of the PRA, we assume that the recordkeeping burden,
on average, for a funding portal to comply with the final rules will be
50% of the burdens of a broker-dealer to comply with Rules 17a-3 and
17a-4. Therefore, we estimate the initial burden to be approximately
325 hours per respondent,\1697\ or 16,250 hours total (325 hours/
respondent x 50 respondents). We expect the ongoing recordkeeping
burden for funding portals will be the same as the initial burden
because the requirements regarding maintaining such records will be
consistent each year.
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\1697\ 394.16 hours (recordkeeping burden for Rule 17a-3) + 249
hours (recordkeeping burden for Rule 17a-4) = 643.16 hours. 638.16
hours/2 = 321.58 hours.
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(2) Cost
We currently estimate the annual recordkeeping cost for broker-
dealer compliance with Rule 17a-3 to be $5,706.67 per respondent. These
ongoing recordkeeping costs reflect the costs of systems and equipment
[[Page 71532]]
development. We currently estimate the annual recordkeeping cost for
broker-dealer compliance with Rule 17a-4 to be $5,000 per respondent.
Given the more limited scope of a funding portal's business as
compared to that of a broker, the more targeted scope of the books and
records rules, and the fact that funding portals will be required to
make, deliver and store records electronically, we expect the annual
recordkeeping cost of the final rule requirements will likely be less
than that of Rules 17a-3 and 17a-4. For purposes of the PRA, we assume
that the annual recordkeeping cost on average for a funding portal to
comply with the requirements that records be made and kept will be
about 50% less than burdens of a broker-dealer to comply with Rules
17a-3 and 17a-4. We expect the initial recordkeeping cost for funding
portals, therefore, to be approximately $5,350 per respondent,\1698\ or
$267,500 total ($5,350 per respondent x 50 respondents). We expect the
ongoing recordkeeping cost burden for funding portals will be the same
as the initial burden because the requirements regarding maintaining
such records will be consistent each year.
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\1698\ $5,706.67 (recordkeeping cost for Rule 17a-3) + $5,000
(recordkeeping cost for Rule 17a-4) = $10,706.67. $10,706.67/2 =
$5,353.34.
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One commenter stated that ``[u]nder the expectation that
crowdfunding portals will be online operations and will almost
certainly retain records through digital methods, the burden of
collection should be minimal.'' \1699\ We agree that digital
recordkeeping can help to minimize costs, and our estimates reflect
this assessment.
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\1699\ Joinvestor Letter.
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D. Collections of Information are Mandatory
The collections of information required under Rules 201 through 203
will be mandatory for all issuers. The collections of information
required under Rules 300 through 304 will be mandatory for all
intermediaries. The collections of information required under Rules 400
through 404 will be mandatory for all funding portals.
E. Confidentiality
Responses on Form C, Form C-A, Form C-U, Form C-AR and Form C-TR
will not be kept confidential. Responses on Form ID will be kept
confidential by the Commission, subject to a request under the Freedom
of Information Act.\1700\ Responses on Forms BD and Forms Funding
Portal will not be kept confidential.
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\1700\ 5 U.S.C. 552. The Commission's regulations that implement
the Freedom of Information Act are at 17 CFR 200.80 et seq.
---------------------------------------------------------------------------
F. Retention Period of Recordkeeping Requirements
Issuers are not subject to recordkeeping requirements under
Regulation Crowdfunding. Intermediaries that are brokers will be
required to retain records and information relating to Regulation
Crowdfunding for the required retention periods specified in Exchange
Act Rule 17a-4. Intermediaries that are funding portals will be
required to retain records and information under Regulation
Crowdfunding for the required retention periods specified in Rule
404.\1701\
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\1701\ See Rule 404 of Regulation Crowdfunding.
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V. Final Regulatory Flexibility Act Analysis
The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA''), in accordance with the provisions of
the Regulatory Flexibility Act,\1702\ regarding Regulation
Crowdfunding. It relates to the rules for securities-based crowdfunding
being adopted today. An Initial Regulatory Flexibility Analysis
(``IRFA'') was prepared in accordance with the Regulatory Flexibility
Act and included in the Proposing Release.
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\1702\ 5 U.S.C. 603.
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A. Need for the Rule
The regulation is designed to implement the requirements of Title
III of the JOBS Act. Title III added Securities Act Section 4(a)(6),
which provides a new exemption from the registration requirements of
Securities Act Section 5 for securities-based crowdfunding
transactions, provided the transactions are conducted in the manner set
forth in new Securities Act Section 4A. Section 4A includes
requirements for issuers that offer or sell securities in reliance on
the crowdfunding exemption, as well as for persons acting as
intermediaries in those transactions. The rules prescribe requirements
governing the offer and sale of securities in reliance on Section
4(a)(6) and provide a framework for the regulation of registered
funding portals and brokers that act as intermediaries in the offer and
sale of securities in reliance on Section 4(a)(6).
As discussed above, the crowdfunding provisions of the JOBS Act,
which we implement through this regulation, are intended to help
alleviate the funding gap and accompanying regulatory concerns faced by
small businesses by making relatively low dollar offerings of
securities less costly and by providing crowdfunding platforms a means
by which to facilitate the offer and sale of securities without
registering as brokers, with a framework for regulatory oversight to
protect investors.
B. Significant Issues Raised by Public Comments
In the Proposing Release, we requested comment on every aspect of
the IRFA, including the number of small entities that would be affected
by the proposed amendments, the existence or nature of the potential
impact of the proposals on small entities discussed in the analysis,
and how to quantify the impact of the proposed rules.
Some commenters expressed concern that the IRFA did not comply with
the Regulatory Flexibility Act because it did not, in their view,
adequately describe the costs of the proposed rule on small entities,
and did not set forth significant alternatives which accomplish the
rule's objectives and which minimize the significant economic impact of
the proposal on small entities.\1703\ These commenters recommended that
the Commission republish for public comment a supplemental IRFA to
address these concerns. One commenter stated that the IRFA did not set
forth significant alternatives which accomplish the Commission's stated
objectives because the IRFA only considered alternatives related to
exempting small business from the proposed rules.\1704\ One commenter
believed that the Commission should exercise its discretion and
eliminate the need for two years of audited financial statements,\1705\
whereas another commenter viewed the audit requirement as a ``heavy-
handed'' regulatory approach.\1706\
---------------------------------------------------------------------------
\1703\ See SBA Office of Advocacy Letter; NAHB Letter; Graves
Letter.
\1704\ See SBA Office of Advocacy Letter.
\1705\ See Guzik Letter.
\1706\ See Rockethub Letter.
---------------------------------------------------------------------------
Commenters suggested several alternatives which in their view could
reduce costs while accomplishing the rule's objectives.\1707\
Commenters suggested that the Commission use its discretion to raise
the threshold amount above which issuers would be required to provide
audited financial statements,\1708\ with one commenter specifically
recommending a threshold of $900,000.\1709\ One commenter also
suggested that the Commission adopt a ``question and answer'' format
for nonfinancial disclosures similar to the
[[Page 71533]]
format used in Regulation A offerings.\1710\ This same commenter also
recommended that the Commission could develop ``standard, boilerplate
disclosures'' for some of the ``more complicated'' nonfinancial
disclosures such as risk factors. This commenter stated that the
nonfinancial disclosures are not required under the JOBS Act and
encouraged the Commission to develop alternatives that would be less
burdensome for small issuers. One commenter recommended that the
Commission revise the ongoing financial reporting requirements for
small issuers to require the disclosure of reviewed rather than audited
financial statements, even if such issuers were previously required to
disclose audited financial statements pursuant to Section
4A(b)(1)(D).\1711\ This commenter also supported a requirement that
issuers submit annually an updated statement of financial condition,
similar in nature to an abbreviated management's discussion and
analysis of financial condition and results of operations.\1712\ This
commenter also suggested that issuers with total revenue below $5
million should be permitted to use either cash-based or accrual-based
methods of accounting, so that businesses using cash accounting will
not be required to create two sets of accounting records in order to
access crowdfunding.\1713\
---------------------------------------------------------------------------
\1707\ See Graves Letter; SBA Office of Advocacy Letter.
\1708\ Id.
\1709\ See Graves Letter.
\1710\ See SBA Office of Advocacy Letter.
\1711\ See Graves Letter.
\1712\ See Id.
\1713\ See Id.
---------------------------------------------------------------------------
One commenter suggested that smaller entities tend to be more
volatile and more illiquid than larger entities.\1714\ This commenter
explained that this illiquidity needs to be considered when crafting
regulations for small entity intermediaries and small entity issuers.
This commenter also stated that, regardless of whether an intermediary
has internal compliance personnel, or uses a third party, these
compliance costs ultimately will have to be borne by the investors and
issuers using the intermediary service. Another commenter expressed
concern that the statutory liability standard of Section 4A(c) will be
particularly burdensome for funding portals and noted that the IRFA
does not account for the large expense statutory liability will impose
on intermediaries.\1715\ Similarly, one commenter thought it was
appropriate to apply the same level of liability that is reserved for
issuers to broker-dealers, but not funding portals.\1716\ This
commenter urged the Commission to either eliminate liability for
funding portals, or create regulatory alternatives for funding portals
such as allowing them to limit the offerings on their platforms.\1717\
One commenter stated that the IRFA did not account for the cost of
prohibiting funding portals from limiting the offerings on their
platforms on the basis of subjective factors and suggested that the
Commission create a safe harbor for funding portals that allows them to
limit such offerings.\1718\
---------------------------------------------------------------------------
\1714\ See RocketHub Letter.
\1715\ See SBA Office of Advocacy Letter (stating that the
liability standard is especially burdensome for funding portals
because broker-dealers already have procedures in place for
conducting due diligence on issuers in order to meet FINRA
requirements, and funding portals will have to establish these
procedures anew).
\1716\ See Graves Letter (stating that the Commission should
recognize the difference in the ability of funding portals and
registered broker-dealers to use discretion in selecting or curating
offerings, and apply liability to each as appropriate).
\1717\ Id. (suggesting that funding portals should be allowed
the discretion to exclude offerings from their platforms if they
deem them to be overly risky, or if they view the offerings as
having shortcomings that could be detrimental to investors).
\1718\ See SBA Office of Advocacy Letter.
---------------------------------------------------------------------------
C. Small Entities Subject to the Rules
For purposes of the Regulatory Flexibility Act, under our rules, an
issuer (other than an investment company) is a ``small business'' or
``small organization'' if it has total assets of $5 million or less as
of the end of its most recently completed fiscal year and is engaged or
proposing to engage in an offering of securities which does not exceed
$5 million.\1719\ We believe that many issuers seeking to offer and
sell securities in reliance on Section 4(a)(6) will be at a very early
stage of their business development and will likely have total assets
of $5 million or less. Also, to qualify for the exemption under Section
4(a)(6), the amount raised by an issuer must not exceed $1 million in a
12-month period. Therefore, we estimate that all issuers who offer or
sell securities in reliance on the exemption will be classified as a
``small business'' or ``small organization.''
---------------------------------------------------------------------------
\1719\ 17 CFR 230.157.
---------------------------------------------------------------------------
For purposes of the Regulatory Flexibility Act when used with
reference to a broker or dealer, the Commission has defined the term
``small entity'' to mean a broker-dealer that: (1) Had total capital
(net worth plus subordinated liabilities) of less than $500,000 on the
date in the prior fiscal year as of which its audited financial
statements were prepared pursuant to Rule 17a-5(d) or, if not required
to file such statements, a broker or dealer that had total capital (net
worth plus subordinated debt) of less than $500,000 on the last
business day of the preceding fiscal year (or in the time that it has
been in business if shorter); and (2) is not affiliated with any person
(other than a natural person) that is not a small business or small
organization as defined in this release.'' \1720\ Currently, based on
FOCUS Report \1721\ data, there are 871 broker-dealers that are
classified as ``small'' entities for purposes of the Regulatory
Flexibility Act.\1722\ Because of some overlap in permitted functions
of funding portals and brokers, we look to the definition of a small
broker-dealer to quantify the estimated numbers of small funding
portals that will likely register under the new regulation. Based on
discussions with industry participants prior to the publication of the
proposed rules, we estimate that, of the anticipated 50 funding portals
we expect to register under the new regulation, 30 will be classified
as ``small'' entities for purposes of the Regulatory Flexibility Act.
---------------------------------------------------------------------------
\1720\ 17 CFR 240.0-10(c).
\1721\ FOCUS Reports, or ``Financial and Operational Combined
Uniform Single'' Reports, are monthly, quarterly, and annual reports
that broker-dealers generally are required to file with the
Commission and/or self-regulatory organizations pursuant to Exchange
Act Rule 17a-5 (17 CFR 240.17a-5).
\1722\ See 17 CFR 240.0-10(a).
---------------------------------------------------------------------------
D. Projected Reporting, Recordkeeping and Other Compliance Requirements
As discussed above, the final rules include reporting,
recordkeeping and other compliance requirements. In particular, the
final rules impose certain disclosure requirements on issuers offering
and selling securities in a transaction relying on the exemption
provided by Section 4(a)(6). The final rules require that issuers
relying on the exemption provided by Section 4(a)(6) file with the
Commission certain specified information about the issuer and the
offering, including information about the issuer's contact information;
directors, officers and certain beneficial owners; business and
business plan; current number of employees; financial condition; target
offering amount and the deadline to reach the target offering amount;
use of proceeds from the offering and price or method for calculating
the price of the securities being offered; ownership and capital
structure; material factors that make an investment in the issuer
speculative or risky; indebtedness; description of other offerings of
securities; and transactions with related parties. Issuers also will be
required to file updates with the Commission to describe the progress
of the issuer in meeting the target offering amount, unless the issuer
relies on the
[[Page 71534]]
intermediary to include this information on its platform, and to
disclose the total amount of securities sold in the offering. In
addition, any issuer that sells securities in reliance on Section
4(a)(6) also will be required to file with the Commission an annual
report to update the previously provided disclosure about the issuer's
contact information; directors, officers and certain beneficial owners;
business and business plan; current number of employees; financial
condition; ownership and capital structure; material factors that make
an investment in the issuer speculative or risky; indebtedness;
description of other offerings of securities; and transactions with
related parties.
Intermediaries will be required to register with the Commission as
either brokers or as funding portals. Intermediaries also will be
required to provide quarterly reports to the Commission. Funding
portals will be required to make and keep certain records in accordance
with the rules. Registered broker-dealers are already required to make
and keep certain records in accordance with existing Exchange Act Rules
17a-3 and 17a-4. In addition, the final rules impose specific
compliance requirements on intermediaries, such as the maintenance of
written policies and procedures.
In adopting this regulation, we took into account that the
regulation, as mandated by the JOBS Act, aimed to address difficulties
encountered by small entities. Accordingly, we designed the final rules
for intermediaries, to the extent possible in light of investor
protection concerns, with the needs and constraints of small entities
in mind, including small intermediaries. We believe that the reporting,
recordkeeping and other compliance requirements of the final rules
applicable to intermediaries will impact, in particular, small entities
that decide to register as funding portals. We believe that most of
these requirements will be performed by internal compliance personnel
of the broker or funding portal, but we expect that at least some
funding portals may decide to hire outside counsel and third-party
service providers to assist in meeting the compliance requirements.
Given the statutory limitations on crowdfunding, we believe that the
potential impact of the final rules on larger brokers and funding
portals will be proportionally less than on small brokers and small
intermediaries.
E. Agency Action To Minimize Effect on Small Entities
In response to comments, the final rules include a number of
changes from the proposal, many of which were made to minimize the
effect of the rules on small entities. These changes are outlined in
detail above in the discussions of the rules adopted.
1. Issuers
To address commenters' concerns about the cost of the rules to
small issuers, we have considered the alternatives suggested by
commenters and are adopting final rules which implement certain
alternatives we believe will minimize the cost of the final rules to
small issuers while also preserving necessary investor protection
measures.
First, the final rules include an accommodation for issuers
conducting an offering for the first time in reliance on Regulation
Crowdfunding. Under the final rules, issuers conducting an offering of
more than $500,000 but not more than $1,000,000 that have not
previously sold securities in reliance on Section 4(a)(6) will not be
required to provide audited financial statements, unless audited
financial statements are otherwise available. Instead, the final rules
permit these issuers to provide reviewed financial statements. As
discussed above, this is a change from the proposal that is responsive
to concerns raised by many commenters about the expense of obtaining
audited financial statements, especially for start-up issuers without a
track record of successfully raising capital.\1723\ We believe that
requiring reviewed financial statements for issuers using Regulation
Crowdfunding for the first time to raise more than $500,000 but not
more than $1 million, rather than audited financial statements, will
minimize costs for issuers while providing sufficient investor
protection by maintaining the benefit of an independent review.
---------------------------------------------------------------------------
\1723\ See, e.g., SBA Office of Advocacy Letter.
---------------------------------------------------------------------------
As suggested by one commenter,\1724\ and as discussed above, the
final Form C includes an optional question-and-answer format that
issuers may elect to use to provide the disclosures that are not
required to be filed in XML format. Issuers opting to use this format
would prepare their disclosures by answering the questions provided and
filing that disclosure as an exhibit to the Form C. Given our
expectation that issuers engaged in offerings in reliance on Section
4(a)(6) will encompass a wide variety of industries at different stages
of business development, we do not believe it would be practical or
useful to develop standard, predetermined disclosure, as suggested by
one commenter, for such a variety of issuers. Also, as discussed above,
we do not believe that financial statements prepared in accordance with
other comprehensive bases of accounting, such as cash or accrual-based
accounting, as suggested by one commenter, provide investors with a
fair representation of a company's financial position and results of
operations, and it may be difficult for investors to determine whether
the issuer complied with such basis. Although we acknowledge, as some
commenters observed, that other bases of accounting may be less
expensive than U.S. GAAP, we believe the benefit of a single standard
that will facilitate comparison among securities-based crowdfunding
issuers justifies any incremental expenses associated with U.S. GAAP.
We also note that financial statements prepared in accordance with U.S.
GAAP are generally self-scaling to the size and complexity of the
issuer, which we expect to reduce the burden of preparing financial
statements for many early stage issuers, including small issuers.
---------------------------------------------------------------------------
\1724\ Id.
---------------------------------------------------------------------------
The final rules also maintain the progress update requirement, but
with a significant modification from the proposed rule which is
intended to reduce duplicative disclosure and minimize the burden on
small issuers. The final rules will require an issuer to file a Form C-
U at the end of the offering to disclosure the total amount of
securities sold in the offering, but the rules permit issuers to
satisfy the 50% and 100% progress update requirements by relying on the
relevant intermediary to make publicly available on the intermediary's
platform frequent updates about the issuer's progress toward meeting
the target offering amount.
With respect to ongoing reporting requirements, rather than
requiring an issuer to provide financial statements in the annual
report that meet the highest standard previously provided, as proposed,
the final rules require financial statements of the issuer certified by
the principal executive officer of the issuer to be true and complete
in all material respects. We expect that reducing the required level of
public accountant involvement will minimize the costs and burdens for
all issuers, including small issuers, associated with preparing
reviewed and audited financial statements on an ongoing basis.
In addition, the final rules provide for termination of the ongoing
reporting obligation in two additional circumstances: (1) The issuer
has filed at least one annual report and has fewer than 300 holders of
record, or (2) the
[[Page 71535]]
issuer has filed the annual reports for at least the three most recent
years and has total assets not exceeding $10,000,000. We believe the
addition of these termination events should help reduce related costs
for issuers that may not have achieved a level of financial success
that would sustain an ongoing reporting obligation.
Overall, we considered whether to establish different compliance or
reporting requirements or timetables or to clarify, consolidate or
simplify compliance and reporting requirements for small issuers. As
noted above, we have made significant revisions to the final rules to
address commenters' concerns about compliance and reporting burdens
faced by issuers, especially small issuers. With respect to using
performance rather than design standards, we used performance standards
to the extent appropriate under the statute. For example, issuers have
the flexibility to customize the presentation of certain disclosures in
their offering statements.\1725\ We also considered whether there
should be an exemption from coverage of the rule, or any part of the
rule, for small issuers. However, because the rules have been designed
to implement crowdfunding, which focuses on capital formation by
issuers that are small entities, while at the same time provide
appropriate investor protections, we do not believe that small issuers
should be exempt, in whole or in part, from the proposed rules.
---------------------------------------------------------------------------
\1725\ See Section II.B.3.
---------------------------------------------------------------------------
2. Intermediaries
In response to comments, we have made a number of changes from the
proposal with respect to intermediaries that will help to alleviate the
compliance burdens faced by small entities. Most significantly, and in
response to commenters' concerns about the application of Section 4A(c)
liability,\1726\ as discussed above, Rule 402(b)(1) has been modified
from the proposal to include a safe harbor that provides a funding
portal the ability to determine whether and under what terms to allow
an issuer to offer and sell securities in reliance on Section 4(a)(6)
of the Securities Act through its platform; provided that a funding
portal otherwise complies with Regulation Crowdfunding. This change is
expected to allow intermediaries, including small entities, to reduce
their exposure to such liability by denying access to issuers that
present risk of fraud or other investor protection concerns. In
addition, in a change from the proposed rules, we are not requiring a
fidelity bond for intermediaries and also are expanding the definition
of qualified third party. These changes should reduce costs for all
intermediaries, including small entities.
---------------------------------------------------------------------------
\1726\ See, e.g., SBA Office of Advocacy Letter.
---------------------------------------------------------------------------
The final rules have been tailored to the more limited role
intermediaries will play in offerings made pursuant to Securities Act
Section 4(a)(6) (as compared to the wide range of services that a
traditional broker-dealer may provide). Registered brokers and funding
portals will engage in similar activities related to crowdfunding and
must comply with the adopted rules. The effective date for the
registration provisions for funding portals will allow funding portals
to be in a position to engage in crowdfunding at the same time as
registered brokers once the rest of the rules become effective. These
effective dates are designed to accommodate competitiveness concerns
related to funding portals' and registered broker dealers' abilities to
begin crowdfunding concurrently. While registered broker-dealers may
perform services that a funding portal is prohibited from performing,
the Exchange Act and rules thereunder, as well as SRO rules, already
govern those activities. Therefore, we believe that the adopted rules
are appropriate and properly tailored for the permissible activities of
all brokers and funding portals.
We also considered whether, for small brokers or small funding
portals, to establish different compliance, reporting or timing
requirements, or whether to clarify, consolidate or simplify those
requirements in our rules. While the final rules are based in large
part on existing compliance requirements applicable to registered
brokers to the extent they are applicable to activities permitted for
funding portals, we do not believe we should establish different
requirements for small entities (whether registered brokers or funding
portals) that engage in crowdfunding because such activities are
limited in scope and, as such, the adopted rules are tailored to that
more limited activity.
VI. Statutory Authority
We are adopting the rules and forms contained in this document
under the authority set forth in the Securities Act (15 U.S.C. 77a et
seq.), particularly, Sections 4(a)(6), 4A, 19 and 28 thereof; the
Exchange Act (15 U.S.C. 78a et seq.), particularly, Sections 3(b),
3(h), 10(b), 15, 17, 23(a) and 36 thereof; and Pub. L. 112-106, secs.
301-305, 126 Stat. 306 (2012).
List of Subjects
17 CFR Part 200
Administrative practice and procedure, Authority delegations
(Government agencies), Organization and functions (Government
agencies). Reporting and recordkeeping requirements.
17 CFR Part 227
Crowdfunding, Funding Portals, Intermediaries, Reporting and
recordkeeping requirements, Securities.
17 CFR Parts 232 and 239
Reporting and recordkeeping requirements, Securities.
17 CFR Part 240
Brokers, Confidential business information, Fraud, Reporting and
recordkeeping requirements, Securities.
17 CFR Part 249
Brokers, Reporting and recordkeeping requirements, Securities.
17 CFR Part 269
Reporting and recordkeeping requirements, Securities, Trusts and
Trustees.
17 CFR Part 270
Confidential business information, Fraud, Investment companies,
Life insurance, Reporting and recordkeeping requirements, Securities.
In accordance with the foregoing, title 17, chapter II of the Code
of Federal Regulations is amended as follows:
PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND
REQUESTS
Subpart A--Organization and Program Management
0
1. The authority citation for Part 200, Subpart A, continues to read,
in part as follows:
Authority: 15 U.S.C. 77c, 77o, 77s, 77z-3, 77sss, 78d, 78d-1,
78d-2, 78o-4, 78w, 78ll(d), 78mm, 80a-37, 80b-11, 7202, and 7211 et
seq., unless otherwise noted.
* * * * *
0
2. Amend Sec. 200.30-1 by:
0
a. Redesignating paragraphs (d), (e), (f), (g), (h), (i), (j) and (k)
as paragraphs (e), (f), (g), (h), (i), (j), (k) and (l), respectively;
and
0
b. Adding new paragraph (d).
The addition reads as follows:
Sec. 200.30-1 Delegation of authority to Director of Division of
Corporation Finance.
* * * * *
(d) With respect to the Securities Act of 1933 (15 U.S.C. 77a et
seq.) and
[[Page 71536]]
Sec. Sec. 227.100 through 227.503 of this chapter, to authorize the
granting of applications under Sec. 227.503(b)(2) of this chapter upon
the showing of good cause that it is not necessary under the
circumstances that the exemption under Regulation Crowdfunding be
denied.
* * * * *
0
3. Effective January 29, 2016, part 227 is added to read as follows:
PART 227--REGULATION CROWDFUNDING, GENERAL RULES AND REGULATIONS
Authority: 15 U.S.C. 77d, 77d-1, 77s, 78c, 78o, 78q, 78w, 78mm,
and Pub. L. 112-106, secs. 301-305, 126 Stat. 306 (2012).
Sec. 227.400 Registration of funding portals.
(a) Registration. A funding portal must register with the
Commission, by filing a complete Form Funding Portal (Sec. 249.2000 of
this chapter) in accordance with the instructions on the form, and
become a member of a national securities association registered under
section 15A of the Exchange Act (15 U.S.C. 78o-3). The registration
will be effective the later of:
(1) Thirty calendar days after the date that the registration is
received by the Commission; or
(2) The date the funding portal is approved for membership by a
national securities association registered under section 15A of the
Exchange Act (15 U.S.C. 78o-3).
(b) Amendments to registration. A funding portal must file an
amendment to Form Funding Portal (Sec. 249.2000 of this chapter)
within 30 days of any of the information previously submitted on Form
Funding Portal becoming inaccurate for any reason.
(c) Successor registration. (1) If a funding portal succeeds to and
continues the business of a registered funding portal, the registration
of the predecessor will remain effective as the registration of the
successor if the successor, within 30 days after such succession, files
a registration on Form Funding Portal (Sec. 249.2000 of this chapter)
and the predecessor files a withdrawal on Form Funding Portal;
provided, however, that the registration of the predecessor funding
portal will be deemed withdrawn 45 days after registration on Form
Funding Portal is filed by the successor.
(2) Notwithstanding paragraph (c)(1) of this section, if a funding
portal succeeds to and continues the business of a registered funding
portal and the succession is based solely on a change of the
predecessor's date or state of incorporation, form of organization, or
composition of a partnership, the successor may, within 30 days after
the succession, amend the registration of the predecessor on Form
Funding Portal (Sec. 249.2000 of this chapter) to reflect these
changes.
(d) Withdrawal. A funding portal must promptly file a withdrawal of
registration on Form Funding Portal (Sec. 249.2000 of this chapter) in
accordance with the instructions on the form upon ceasing to operate as
a funding portal. Withdrawal will be effective on the later of 30 days
after receipt by the Commission (after the funding portal is no longer
operational), or within such longer period of time as to which the
funding portal consents or which the Commission by order may determine
as necessary or appropriate in the public interest or for the
protection of investors.
(e) Applications and reports. The applications and reports provided
for in this section shall be considered filed when a complete Form
Funding Portal (Sec. 249.2000 of this chapter) is submitted with the
Commission. Duplicate originals of the applications and reports
provided for in this section must be filed with surveillance personnel
designated by any registered national securities association of which
the funding portal is a member.
(f) Nonresident funding portals. Registration pursuant to this
section by a nonresident funding portal shall be conditioned upon there
being an information sharing arrangement in place between the
Commission and the competent regulator in the jurisdiction under the
laws of which the nonresident funding portal is organized or where it
has its principal place of business, that is applicable to the
nonresident funding portal.
(1) Definition. For purposes of this section, the term nonresident
funding portal shall mean a funding portal incorporated in or organized
under the laws of a jurisdiction outside of the United States or its
territories, or having its principal place of business in any place not
in the United States or its territories.
(2) Power of attorney. (i) Each nonresident funding portal
registered or applying for registration pursuant to this section shall
obtain a written consent and power of attorney appointing an agent in
the United States, other than the Commission or a Commission member,
official or employee, upon whom may be served any process, pleadings or
other papers in any action under the federal securities laws. This
consent and power of attorney must be signed by the nonresident funding
portal and the named agent(s) for service of process.
(ii) Each nonresident funding portal registered or applying for
registration pursuant to this section shall, at the time of filing its
application on Form Funding Portal (Sec. 249.2000 of this chapter),
furnish to the Commission the name and address of its United States
agent for service of process on Schedule C to the Form.
(iii) Any change of a nonresident funding portal's agent for
service of process and any change of name or address of a nonresident
funding portal's existing agent for service of process shall be
communicated promptly to the Commission through amendment of the
Schedule C to Form Funding Portal (Sec. 249.2000 of this chapter).
(iv) Each nonresident funding portal must promptly appoint a
successor agent for service of process if the nonresident funding
portal discharges its identified agent for service of process or if its
agent for service of process is unwilling or unable to accept service
on behalf of the nonresident funding portal.
(v) Each nonresident funding portal must maintain, as part of its
books and records, the written consent and power of attorney identified
in paragraph (f)(2)(i) of this section for at least three years after
the agreement is terminated.
(3) Access to books and records; inspections and examinations--(i)
Certification and opinion of counsel. Any nonresident funding portal
applying for registration pursuant to this section shall:
(A) Certify on Schedule C to Form Funding Portal (Sec. 249.2000 of
this chapter) that the nonresident funding portal can, as a matter of
law, and will provide the Commission and any registered national
securities association of which it becomes a member with prompt access
to the books and records of such nonresident funding portal and can, as
a matter of law, and will submit to onsite inspection and examination
by the Commission and any registered national securities association of
which it becomes a member; and
(B) Provide an opinion of counsel that the nonresident funding
portal can, as a matter of law, provide the Commission and any
registered national securities association of which it becomes a member
with prompt access to the books and records of such nonresident funding
portal and can, as a matter of law, submit to onsite inspection and
examination by the Commission and any registered national securities
association of which it becomes a member.
(ii) Amendments. The nonresident funding portal shall re-certify,
on Schedule C to Form Funding Portal
[[Page 71537]]
(Sec. 249.2000 of this chapter), within 90 days after any changes in
the legal or regulatory framework that would impact the nonresident
funding portal's ability to provide, or the manner in which it
provides, the Commission, or any registered national securities
association of which it is a member, with prompt access to its books
and records or that would impact the Commission's or such registered
national securities association's ability to inspect and examine the
nonresident funding portal. The re-certification shall be accompanied
by a revised opinion of counsel describing how, as a matter of law, the
nonresident funding portal can continue to meet its obligations under
paragraphs (f)(3)(i)(A) and (B) of this section.
0
4. Effective May 16, 2016, part 227 is revised to read as follows:
PART 227--REGULATION CROWDFUNDING, GENERAL RULES AND REGULATIONS
Subpart A--General
Sec.
227.100 Crowdfunding exemption and requirements.
Subpart B--Requirements for Issuers
227.201 Disclosure requirements.
227.202 Ongoing reporting requirements.
227.203 Filing requirements and form.
227.204 Advertising.
227.205 Promoter compensation.
Subpart C--Requirements for Intermediaries
227.300 Intermediaries.
227.301 Measures to reduce risk of fraud.
227.302 Account opening.
227.303 Requirements with respect to transactions.
227.304 Completion of offerings, cancellations and reconfirmations.
227.305 Payments to third parties.
Subpart D--Funding Portal Regulation
227.400 Registration of funding portals.
227.401 Exemption.
227.402 Conditional safe harbor.
227.403 Compliance.
227.404 Records to be made and kept by funding portals.
Subpart E--Miscellaneous Provisions
227.501 Restrictions on resales.
227.502 Insignificant deviations from a term, condition or
requirement of this part (Regulation Crowdfunding).
227.503 Disqualification provisions.
Authority: 15 U.S.C. 77d, 77d-1, 77s, 78c, 78o, 78q, 78w, 78mm,
and Pub. L. 112-106, secs. 301-305, 126 Stat. 306 (2012).
Subpart A--General
Sec. 227.100 Crowdfunding exemption and requirements.
(a) Exemption. An issuer may offer or sell securities in reliance
on section 4(a)(6) of the Securities Act of 1933 (the ``Securities
Act'') (15 U.S.C. 77d(a)(6)), provided that:
(1) The aggregate amount of securities sold to all investors by the
issuer in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)) during the 12-month period preceding the date of such offer
or sale, including the securities offered in such transaction, shall
not exceed $1,000,000;
(2) The aggregate amount of securities sold to any investor across
all issuers in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)) during the 12-month period preceding the date of such
transaction, including the securities sold to such investor in such
transaction, shall not exceed:
(i) The greater of $2,000 or 5 percent of the lesser of the
investor's annual income or net worth if either the investor's annual
income or net worth is less than $100,000; or
(ii) 10 percent of the lesser of the investor's annual income or
net worth, not to exceed an amount sold of $100,000, if both the
investor's annual income and net worth are equal to or more than
$100,000;
Instruction 1 to paragraph (a)(2). To determine the investment
limit for a natural person, the person's annual income and net worth
shall be calculated as those values are calculated for purposes of
determining accredited investor status in accordance with Sec. 230.501
of this chapter.
Instruction 2 to paragraph (a)(2). A person's annual income and net
worth may be calculated jointly with that person's spouse; however,
when such a joint calculation is used, the aggregate investment of the
investor spouses may not exceed the limit that would apply to an
individual investor at that income or net worth level.
Instruction 3 to paragraph (a)(2). An issuer offering and selling
securities in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)) may rely on the efforts of an intermediary required
by Sec. 227.303(b) to ensure that the aggregate amount of securities
purchased by an investor in offerings pursuant to section 4(a)(6) of
the Securities Act will not cause the investor to exceed the limit set
forth in section 4(a)(6) of the Securities Act and Sec. 227.100(a)(2),
provided that the issuer does not know that the investor has exceeded
the investor limits or would exceed the investor limits as a result of
purchasing securities in the issuer's offering.
(3) The transaction is conducted through an intermediary that
complies with the requirements in section 4A(a) of the Securities Act
(15 U.S.C. 77d-1(a)) and the related requirements in this part, and the
transaction is conducted exclusively through the intermediary's
platform; and
Instruction to paragraph (a)(3). An issuer shall not conduct an
offering or concurrent offerings in reliance on section 4(a)(6) of the
Securities Act of 1933 (15 U.S.C. 77d(a)(6)) using more than one
intermediary.
(4) The issuer complies with the requirements in section 4A(b) of
the Securities Act (15 U.S.C. 77d-1(b)) and the related requirements in
this part; provided, however, that the failure to comply with
Sec. Sec. 227.202, 227.203(a)(3) and 227.203(b) shall not prevent an
issuer from relying on the exemption provided by section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)).
(b) Applicability. The crowdfunding exemption shall not apply to
transactions involving the offer or sale of securities by any issuer
that:
(1) Is not organized under, and subject to, the laws of a State or
territory of the United States or the District of Columbia;
(2) Is subject to the requirement to file reports pursuant to
section 13 or section 15(d) of the Securities Exchange Act of 1934 (the
``Exchange Act'') (15 U.S.C. 78m or 78o(d));
(3) Is an investment company, as defined in section 3 of the
Investment Company Act of 1940 (15 U.S.C. 80a-3), or is excluded from
the definition of investment company by section 3(b) or section 3(c) of
that Act (15 U.S.C. 80a-3(b) or 80a-3(c));
(4) Is not eligible to offer or sell securities in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) as a result
of a disqualification as specified in Sec. 227.503(a);
(5) Has sold securities in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) and has not filed with the
Commission and provided to investors, to the extent required, the
ongoing annual reports required by this part during the two years
immediately preceding the filing of the required offering statement; or
Instruction to paragraph (b)(5). An issuer delinquent in its
ongoing reports can again rely on section 4(a)(6) of the Securities Act
(15 U.S.C. 77d(a)(6)) once it has filed with the Commission and
provided to investors both of the annual reports required during the
two years
[[Page 71538]]
immediately preceding the filing of the required offering statement.
(6) Has no specific business plan or has indicated that its
business plan is to engage in a merger or acquisition with an
unidentified company or companies.
(c) Issuer. For purposes of Sec. 227.201(r), calculating aggregate
amounts offered and sold in Sec. 227.100(a) and Sec. 227.201(t), and
determining whether an issuer has previously sold securities in Sec.
227.201(t)(3), issuer includes all entities controlled by or under
common control with the issuer and any predecessors of the issuer.
Instruction to paragraph (c). The term control means the
possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of the entity, whether through
the ownership of voting securities, by contract or otherwise.
(d) Investor. For purposes of this part, investor means any
investor or any potential investor, as the context requires.
Subpart B--Requirements for Issuers
Sec. 227.201 Disclosure requirements.
An issuer offering or selling securities in reliance on section
4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) and in accordance
with section 4A of the Securities Act (15 U.S.C. 77d-1) and this part
must file with the Commission and provide to investors and the relevant
intermediary the following information:
(a) The name, legal status (including its form of organization,
jurisdiction in which it is organized and date of organization),
physical address and Web site of the issuer;
(b) The names of the directors and officers (and any persons
occupying a similar status or performing a similar function) of the
issuer, all positions and offices with the issuer held by such persons,
the period of time in which such persons served in the position or
office and their business experience during the past three years,
including:
(1) Each person's principal occupation and employment, including
whether any officer is employed by another employer; and
(2) The name and principal business of any corporation or other
organization in which such occupation and employment took place.
Instruction to paragraph (b). For purposes of this paragraph (b),
the term officer means a president, vice president, secretary,
treasurer or principal financial officer, comptroller or principal
accounting officer, and any person routinely performing similar
functions.
(c) The name of each person, as of the most recent practicable date
but no earlier than 120 days prior to the date the offering statement
or report is filed, who is a beneficial owner of 20 percent or more of
the issuer's outstanding voting equity securities, calculated on the
basis of voting power;
(d) A description of the business of the issuer and the anticipated
business plan of the issuer;
(e) The current number of employees of the issuer;
(f) A discussion of the material factors that make an investment in
the issuer speculative or risky;
(g) The target offering amount and the deadline to reach the target
offering amount, including a statement that if the sum of the
investment commitments does not equal or exceed the target offering
amount at the offering deadline, no securities will be sold in the
offering, investment commitments will be cancelled and committed funds
will be returned;
(h) Whether the issuer will accept investments in excess of the
target offering amount and, if so, the maximum amount that the issuer
will accept and how oversubscriptions will be allocated, such as on a
pro-rata, first come-first served, or other basis;
(i) A description of the purpose and intended use of the offering
proceeds;
Instruction to paragraph (i). An issuer must provide a reasonably
detailed description of any intended use of proceeds, such that
investors are provided with enough information to understand how the
offering proceeds will be used. If an issuer has identified a range of
possible uses, the issuer should identify and describe each probable
use and the factors the issuer may consider in allocating proceeds
among the potential uses. If the issuer will accept proceeds in excess
of the target offering amount, the issuer must describe the purpose,
method for allocating oversubscriptions, and intended use of the excess
proceeds with similar specificity.
(j) A description of the process to complete the transaction or
cancel an investment commitment, including a statement that:
(1) Investors may cancel an investment commitment until 48 hours
prior to the deadline identified in the issuer's offering materials;
(2) The intermediary will notify investors when the target offering
amount has been met;
(3) If an issuer reaches the target offering amount prior to the
deadline identified in its offering materials, it may close the
offering early if it provides notice about the new offering deadline at
least five business days prior to such new offering deadline (absent a
material change that would require an extension of the offering and
reconfirmation of the investment commitment); and
(4) If an investor does not cancel an investment commitment before
the 48-hour period prior to the offering deadline, the funds will be
released to the issuer upon closing of the offering and the investor
will receive securities in exchange for his or her investment;
(k) A statement that if an investor does not reconfirm his or her
investment commitment after a material change is made to the offering,
the investor's investment commitment will be cancelled and the
committed funds will be returned;
(l) The price to the public of the securities or the method for
determining the price, provided that, prior to any sale of securities,
each investor shall be provided in writing the final price and all
required disclosures;
(m) A description of the ownership and capital structure of the
issuer, including:
(1) The terms of the securities being offered and each other class
of security of the issuer, including the number of securities being
offered and/or outstanding, whether or not such securities have voting
rights, any limitations on such voting rights, how the terms of the
securities being offered may be modified and a summary of the
differences between such securities and each other class of security of
the issuer, and how the rights of the securities being offered may be
materially limited, diluted or qualified by the rights of any other
class of security of the issuer;
(2) A description of how the exercise of rights held by the
principal shareholders of the issuer could affect the purchasers of the
securities being offered;
(3) The name and ownership level of each person, as of the most
recent practicable date but no earlier than 120 days prior to the date
the offering statement or report is filed, who is the beneficial owner
of 20 percent or more of the issuer's outstanding voting equity
securities, calculated on the basis of voting power;
(4) How the securities being offered are being valued, and examples
of methods for how such securities may be valued by the issuer in the
future, including during subsequent corporate actions;
(5) The risks to purchasers of the securities relating to minority
ownership in the issuer and the risks associated with corporate actions
including additional issuances of
[[Page 71539]]
securities, issuer repurchases of securities, a sale of the issuer or
of assets of the issuer or transactions with related parties; and
(6) A description of the restrictions on transfer of the
securities, as set forth in Sec. 227.501;
(n) The name, SEC file number and Central Registration Depository
(CRD) number (as applicable) of the intermediary through which the
offering is being conducted;
(o) A description of the intermediary's financial interests in the
issuer's transaction and in the issuer, including:
(1) The amount of compensation to be paid to the intermediary,
whether as a dollar amount or a percentage of the offering amount, or a
good faith estimate if the exact amount is not available at the time of
the filing, for conducting the offering, including the amount of
referral and any other fees associated with the offering, and
(2) Any other direct or indirect interest in the issuer held by the
intermediary, or any arrangement for the intermediary to acquire such
an interest;
(p) A description of the material terms of any indebtedness of the
issuer, including the amount, interest rate, maturity date and any
other material terms;
(q) A description of exempt offerings conducted within the past
three years;
Instruction to paragraph (q). In providing a description of any
prior exempt offerings, disclose:
(1) The date of the offering;
(2) The offering exemption relied upon;
(3) The type of securities offered; and
(4) The amount of securities sold and the use of proceeds;
(r) A description of any transaction since the beginning of the
issuer's last fiscal year, or any currently proposed transaction, to
which the issuer was or is to be a party and the amount involved
exceeds five percent of the aggregate amount of capital raised by the
issuer in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)) during the preceding 12-month period, inclusive of the
amount the issuer seeks to raise in the current offering under section
4(a)(6) of the Securities Act, in which any of the following persons
had or is to have a direct or indirect material interest:
(1) Any director or officer of the issuer;
(2) Any person who is, as of the most recent practicable date but
no earlier than 120 days prior to the date the offering statement or
report is filed, the beneficial owner of 20 percent or more of the
issuer's outstanding voting equity securities, calculated on the basis
of voting power;
(3) If the issuer was incorporated or organized within the past
three years, any promoter of the issuer; or
(4) Any member of the family of any of the foregoing persons, which
includes a child, stepchild, grandchild, parent, stepparent,
grandparent, spouse or spousal equivalent, sibling, mother-in-law,
father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-
in-law, and shall include adoptive relationships. The term spousal
equivalent means a cohabitant occupying a relationship generally
equivalent to that of a spouse.
Instruction 1 to paragraph (r). For each transaction identified,
disclose the name of the specified person and state his or her
relationship to the issuer, and the nature and, where practicable, the
approximate amount of his or her interest in the transaction. The
amount of such interest shall be computed without regard to the amount
of the profit or loss involved in the transaction. Where it is not
practicable to state the approximate amount of the interest, the
approximate amount involved in the transaction shall be disclosed.
Instruction 2 to paragraph (r). For purposes of paragraph (r), a
transaction includes, but is not limited to, any financial transaction,
arrangement or relationship (including any indebtedness or guarantee of
indebtedness) or any series of similar transactions, arrangements or
relationships.
(s) A discussion of the issuer's financial condition, including, to
the extent material, liquidity, capital resources and historical
results of operations;
Instruction 1 to paragraph (s). The discussion must cover each
period for which financial statements of the issuer are provided. An
issuer also must include a discussion of any material changes or trends
known to management in the financial condition and results of
operations of the issuer subsequent to the period for which financial
statements are provided.
Instruction 2 to paragraph (s). For issuers with no prior operating
history, the discussion should focus on financial milestones and
operational, liquidity and other challenges. For issuers with an
operating history, the discussion should focus on whether historical
results and cash flows are representative of what investors should
expect in the future. Issuers should take into account the proceeds of
the offering and any other known or pending sources of capital. Issuers
also should discuss how the proceeds from the offering will affect the
issuer's liquidity, whether receiving these funds and any other
additional funds is necessary to the viability of the business, and how
quickly the issuer anticipates using its available cash. In addition,
issuers should describe the other available sources of capital to the
business, such as lines of credit or required contributions by
shareholders.
Instruction 3 to paragraph (s). References to the issuer in this
paragraph and its instructions refer to the issuer and its
predecessors, if any.
(t) For offerings that, together with all other amounts sold under
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) within the
preceding 12-month period, have, in the aggregate, the following target
offering amounts:
(1) $100,000 or less, the amount of total income, taxable income
and total tax, or the equivalent line items, as reported on the federal
income tax returns filed by the issuer for the most recently completed
year (if any), which shall be certified by the principal executive
officer of the issuer to reflect accurately the information reported on
the issuer's federal income tax returns, and financial statements of
the issuer, which shall be certified by the principal executive officer
of the issuer to be true and complete in all material respects. If
financial statements of the issuer are available that have either been
reviewed or audited by a public accountant that is independent of the
issuer, the issuer must provide those financial statements instead and
need not include the information reported on the federal income tax
returns or the certifications of the principal executive officer;
(2) More than $100,000, but not more than $500,000, financial
statements of the issuer reviewed by a public accountant that is
independent of the issuer. If financial statements of the issuer are
available that have been audited by a public accountant that is
independent of the issuer, the issuer must provide those financial
statements instead and need not include the reviewed financial
statements; and
(3) More than $500,000, financial statements of the issuer audited
by a public accountant that is independent of the issuer; provided,
however, that for issuers that have not previously sold securities in
reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)), offerings that have a target offering amount of more than
$500,000, but not more than $1,000,000, financial statements of the
issuer reviewed by a public accountant that is independent of the
issuer. If financial statements of the issuer are available that have
been
[[Page 71540]]
audited by a public accountant that is independent of the issuer, the
issuer must provide those financial statements instead and need not
include the reviewed financial statements.
Instruction 1 to paragraph (t). To determine the financial
statements required under this paragraph (t), an issuer must aggregate
amounts sold in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)) within the preceding 12-month period and the offering
amount in the offering for which disclosure is being provided. If the
issuer will accept proceeds in excess of the target offering amount,
the issuer must include the maximum offering amount that the issuer
will accept in the calculation to determine the financial statements
required under this paragraph (t).
Instruction 2 to paragraph (t). An issuer may voluntarily meet the
requirements of this paragraph (t) for a higher aggregate target
offering amount.
Instruction 3 to paragraph (t). The financial statements must be
prepared in accordance with U.S. generally accepted accounting
principles and include balance sheets, statements of comprehensive
income, statements of cash flows, statements of changes in
stockholders' equity and notes to the financial statements. If the
financial statements are not audited, they must be labeled as
``unaudited.'' The financial statements must cover the two most
recently completed fiscal years or the period(s) since inception, if
shorter.
Instruction 4 to paragraph (t). For an offering conducted in the
first 120 days of a fiscal year, the financial statements provided may
be for the two fiscal years prior to the issuer's most recently
completed fiscal year; however, financial statements for the two most
recently completed fiscal years must be provided if they are otherwise
available. If more than 120 days have passed since the end of the
issuer's most recently completed fiscal year, the financial statements
provided must be for the issuer's two most recently completed fiscal
years. If the 120th day falls on a Saturday, Sunday, or holiday, the
next business day shall be considered the 120th day for purposes of
determining the age of the financial statements.
Instruction 5 to paragraph (t). An issuer may elect to delay
complying with any new or revised financial accounting standard that
applies to companies that are not issuers (as defined under section
2(a) of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201(a)) until the
date that such companies are required to comply with such new or
revised accounting standard. Issuers electing this accommodation must
disclose it at the time the issuer files its offering statement and
apply the election to all standards. Issuers electing not to use this
accommodation must forgo this accommodation for all financial
accounting standards and may not elect to rely on this accommodation in
any future filings.
Instruction 6 to paragraph (t). An issuer required to provide
information from a tax return under paragraph (t)(1) of this section
before filing a tax return with the U.S. Internal Revenue Service for
the most recently completed fiscal year may provide information from
its tax return for the prior year (if any), provided that the issuer
provides information from the tax return for the most recently
completed fiscal year when it is filed with the U.S. Internal Revenue
Service (if the tax return is filed during the offering period). An
issuer that requested an extension from the U.S. Internal Revenue
Service would not be required to provide information from the tax
return until the date the return is filed, if filed during the offering
period. If an issuer has not yet filed a tax return and is not required
to file a tax return before the end of the offering period, then the
tax return information does not need to be provided.
Instruction 7 to paragraph (t). An issuer providing financial
statements that are not audited or reviewed and tax information as
specified under paragraph (t)(1) of this section must have its
principal executive officer provide the following certification:
I, [identify the certifying individual], certify that:
(1) the financial statements of [identify the issuer] included in
this Form are true and complete in all material respects; and
(2) the tax return information of [identify the issuer] included in
this Form reflects accurately the information reported on the tax
return for [identify the issuer] filed for the fiscal year ended [date
of most recent tax return].
[Signature and title].
Instruction 8 to paragraph (t). Financial statement reviews shall
be conducted in accordance with the Statements on Standards for
Accounting and Review Services issued by the Accounting and Review
Services Committee of the American Institute of Certified Public
Accountants. A signed review report must accompany the reviewed
financial statements, and an issuer must notify the public accountant
of the issuer's intended use of the review report in the offering. An
issuer will not be in compliance with the requirement to provide
reviewed financial statements if the review report includes
modifications.
Instruction 9 to paragraph (t). Financial statement audits shall be
conducted in accordance with either auditing standards issued by the
American Institute of Certified Public Accountants (referred to as U.S.
Generally Accepted Auditing Standards) or the standards of the Public
Company Accounting Oversight Board. A signed audit report must
accompany audited financial statements, and an issuer must notify the
public accountant of the issuer's intended use of the audit report in
the offering. An issuer will not be in compliance with the requirement
to provide audited financial statements if the audit report includes a
qualified opinion, an adverse opinion, or a disclaimer of opinion.
Instruction 10 to paragraph (t). To qualify as a public accountant
that is independent of the issuer for purposes of this part, the
accountant must satisfy the independence standards of either:
(i) 17 CFR 210.2-01 of this chapter, or
(ii) The American Institute of Certified Public Accountants. The
public accountant that audits or reviews the financial statements
provided by an issuer must be:
(A) Duly registered and in good standing as a certified public
accountant under the laws of the place of his or her residence or
principal office; or
(B) In good standing and entitled to practice as a public
accountant under the laws of his or her place of residence or principal
office.
Instruction 11 to paragraph (t). Except as set forth in Sec.
227.100(c), references to the issuer in this paragraph (t) and its
instructions (2) through (10) refer to the issuer and its predecessors,
if any.
(u) Any matters that would have triggered disqualification under
Sec. 227.503(a) but occurred before May 16, 2016. The failure to
provide such disclosure shall not prevent an issuer from continuing to
rely on the exemption provided by section 4(a)(6) of the Securities Act
(15 U.S.C. 77d(a)(6)) if the issuer establishes that it did not know
and, in the exercise of reasonable care, could not have known of the
existence of the undisclosed matter or matters;
Instruction to paragraph (u). An issuer will not be able to
establish that it could not have known of a disqualification unless it
has made factual inquiry into whether any disqualifications exist. The
nature and scope of the factual inquiry will vary based on the facts
and circumstances concerning, among other things, the issuer and the
other offering participants.
[[Page 71541]]
(v) Updates regarding the progress of the issuer in meeting the
target offering amount, to be provided in accordance with Sec.
227.203;
(w) Where on the issuer's Web site investors will be able to find
the issuer's annual report, and the date by which such report will be
available on the issuer's Web site;
(x) Whether the issuer or any of its predecessors previously failed
to comply with the ongoing reporting requirements of Sec. 227.202; and
(y) Any material information necessary in order to make the
statements made, in light of the circumstances under which they were
made, not misleading.
Instruction to Sec. 227.201. If disclosure provided pursuant to
any paragraph of this section also satisfies the requirements of one or
more other paragraphs of this section, it is not necessary to repeat
the disclosure. Instead of repeating information, an issuer may include
a cross-reference to disclosure contained elsewhere in the offering
statement or report, including to information in the financial
statements.
Sec. 227.202 Ongoing reporting requirements.
(a) An issuer that has offered and sold securities in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) and in
accordance with section 4A of the Securities Act (15 U.S.C. 77d-1) and
this part must file with the Commission and post on the issuer's Web
site an annual report along with the financial statements of the issuer
certified by the principal executive officer of the issuer to be true
and complete in all material respects and a description of the
financial condition of the issuer as described in Sec. 227.201(s). If,
however, an issuer has available financial statements that have either
been reviewed or audited by a public accountant that is independent of
the issuer, those financial statements must be provided and the
certification by the principal executive officer will not be required.
The annual report also must include the disclosure required by
paragraphs (a), (b), (c), (d), (e), (f), (m), (p), (q), (r), and (x) of
Sec. 227.201. The report must be filed in accordance with the
requirements of Sec. 227.203 and Form C (Sec. 239.900 of this
chapter) and no later than 120 days after the end of the fiscal year
covered by the report.
Instruction 1 to paragraph (a). Instructions (3), (8), (9), (10),
and (11) to paragraph (t) of Sec. 227.201 shall apply for purposes of
this section.
Instruction 2 to paragraph (a). An issuer providing financial
statements that are not audited or reviewed must have its principal
executive officer provide the following certification:
I, [identify the certifying individual], certify that the financial
statements of [identify the issuer] included in this Form are true and
complete in all material respects.
[Signature and title].
(b) An issuer must continue to comply with the ongoing reporting
requirements until one of the following occurs:
(1) The issuer is required to file reports under section 13(a) or
section 15(d) of the Exchange Act (15 U.S.C. 78m(a) or 78o(d));
(2) The issuer has filed, since its most recent sale of securities
pursuant to this part, at least one annual report pursuant to this
section and has fewer than 300 holders of record;
(3) The issuer has filed, since its most recent sale of securities
pursuant to this part, the annual reports required pursuant to this
section for at least the three most recent years and has total assets
that do not exceed $10,000,000;
(4) The issuer or another party repurchases all of the securities
issued in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)), including any payment in full of debt securities or any
complete redemption of redeemable securities; or
(5) The issuer liquidates or dissolves its business in accordance
with state law.
Sec. 227.203 Filing requirements and form.
(a) Form C--Offering statement and amendments (Sec. 239.900 of
this chapter).
(1) Offering statement. An issuer offering or selling securities in
reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6))
and in accordance with section 4A of the Securities Act (15 U.S.C. 77d-
1) and this part must file with the Commission and provide to investors
and the relevant intermediary a Form C: Offering Statement (Form C)
(Sec. 239.900 of this chapter) prior to the commencement of the
offering of securities. The Form C must include the information
required by Sec. 227.201.
(2) Amendments to offering statement. An issuer must file with the
Commission and provide to investors and the relevant intermediary an
amendment to the offering statement filed on Form C (Sec. 239.900 of
this chapter) to disclose any material changes, additions or updates to
information that it provides to investors through the intermediary's
platform, for any offering that has not yet been completed or
terminated. The amendment must be filed on Form C: Amendment (Form C/A)
(Sec. 239.900 of this chapter), and if the amendment reflects material
changes, additions or updates, the issuer shall check the box
indicating that investors must reconfirm an investment commitment
within five business days or the investor's commitment will be
considered cancelled.
(3) Progress updates. (i) An issuer must file with the Commission
and provide to investors and the relevant intermediary a Form C:
Progress Update (Form C-U) (Sec. 239.900 of this chapter) to disclose
its progress in meeting the target offering amount no later than five
business days after each of the dates when the issuer reaches 50
percent and 100 percent of the target offering amount.
(ii) If the issuer will accept proceeds in excess of the target
offering amount, the issuer must file with the Commission and provide
to investors and the relevant intermediary, no later than five business
days after the offering deadline, a final Form C-U (Sec. 239.900 of
this chapter) to disclose the total amount of securities sold in the
offering.
(iii) The requirements of paragraphs (a)(3)(i) and (ii) of this
section shall not apply to an issuer if the relevant intermediary makes
publicly available on the intermediary's platform frequent updates
regarding the progress of the issuer in meeting the target offering
amount; however, the issuer must still file a Form C-U (Sec. 239.900
of this chapter) to disclose the total amount of securities sold in the
offering no later than five business days after the offering deadline.
Instruction to paragraph (a)(3). If multiple Forms C-U (Sec.
239.900 of this chapter) are triggered within the same five business
day period, the issuer may consolidate such progress updates into one
Form C-U, so long as the Form C-U discloses the most recent threshold
that was met and the Form C-U is filed with the Commission and provided
to investors and the relevant intermediary by the day on which the
first progress update is due.
Instruction 1 to paragraph (a). An issuer would satisfy the
requirement to provide to the relevant intermediary the information
required by this paragraph (a) if it provides to the relevant
intermediary a copy of the disclosures filed with the Commission.
Instruction 2 to paragraph (a). An issuer would satisfy the
requirement to provide to investors the information required by this
paragraph (a) if the issuer refers investors to the information on the
intermediary's platform by means of a posting on the issuer's Web site
or by email.
(b) Form C: Annual report and termination of reporting (Sec.
239.900 of this chapter). (1) Annual reports. An
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issuer that has sold securities in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) and in accordance with section 4A
of the Securities Act (15 U.S.C. 77d-1) and this part must file an
annual report on Form C: Annual Report (Form C-AR) (Sec. 239.900 of
this chapter) with the Commission no later than 120 days after the end
of the fiscal year covered by the report. The annual report shall
include the information required by Sec. 227.202(a).
(2) Amendments to annual report. An issuer must file with the
Commission an amendment to the annual report filed on Form C: Annual
Report (Form C-AR) (Sec. 239.900 of this chapter) to make a material
change to the previously filed annual report as soon as practicable
after discovery of the need for the material change. The amendment must
be filed on Form C: Amendment to Annual Report (Form C-AR/A) (Sec.
239.900 of this chapter).
(3) Termination of reporting. An issuer eligible to terminate its
obligation to file annual reports with the Commission pursuant to Sec.
227.202(b) must file with the Commission, within five business days
from the date on which the issuer becomes eligible to terminate its
reporting obligation, Form C: Termination of Reporting (Form C-TR)
(Sec. 239.900 of this chapter) to advise investors that the issuer
will cease reporting pursuant to this part.
Sec. 227.204 Advertising.
(a) An issuer may not, directly or indirectly, advertise the terms
of an offering made in reliance on section 4(a)(6) of the Securities
Act (15 U.S.C. 77d(a)(6)), except for notices that meet the
requirements of paragraph (b) of this section.
Instruction to paragraph (a). For purposes of this paragraph (a),
issuer includes persons acting on behalf of the issuer.
(b) A notice may advertise any of the terms of an issuer's offering
made in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)) if it directs investors to the intermediary's platform and
includes no more than the following information:
(1) A statement that the issuer is conducting an offering pursuant
to section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)), the
name of the intermediary through which the offering is being conducted
and a link directing the potential investor to the intermediary's
platform;
(2) The terms of the offering; and
(3) Factual information about the legal identity and business
location of the issuer, limited to the name of the issuer of the
security, the address, phone number and Web site of the issuer, the
email address of a representative of the issuer and a brief description
of the business of the issuer.
(c) Notwithstanding the prohibition on advertising any of the terms
of the offering, an issuer, and persons acting on behalf of the issuer,
may communicate with investors and potential investors about the terms
of the offering through communication channels provided by the
intermediary on the intermediary's platform, provided that an issuer
identifies itself as the issuer in all communications. Persons acting
on behalf of the issuer must identify their affiliation with the issuer
in all communications on the intermediary's platform.
Instruction to Sec. 227.204. For purposes of this section, terms
of the offering means the amount of securities offered, the nature of
the securities, the price of the securities and the closing date of the
offering period.
Sec. 227.205 Promoter compensation.
(a) An issuer, or person acting on behalf of the issuer, shall be
permitted to compensate or commit to compensate, directly or
indirectly, any person to promote the issuer's offerings made in
reliance on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6))
through communication channels provided by an intermediary on the
intermediary's platform, but only if the issuer or person acting on
behalf of the issuer, takes reasonable steps to ensure that the person
promoting the offering clearly discloses the receipt, past or
prospective, of such compensation with any such communication.
Instruction to paragraph (a). The disclosure required by this
paragraph is required, with each communication, for persons engaging in
promotional activities on behalf of the issuer through the
communication channels provided by the intermediary, regardless of
whether or not the compensation they receive is specifically for the
promotional activities. This includes persons hired specifically to
promote the offering as well as to persons who are otherwise employed
by the issuer or who undertake promotional activities on behalf of the
issuer.
(b) Other than as set forth in paragraph (a) of this section, an
issuer or person acting on behalf of the issuer shall not compensate or
commit to compensate, directly or indirectly, any person to promote the
issuer's offerings made in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)), unless such promotion is limited
to notices permitted by, and in compliance with, Sec. 227.204.
Subpart C--Requirements for Intermediaries
Sec. 227.300 Intermediaries.
(a) Requirements. A person acting as an intermediary in a
transaction involving the offer or sale of securities in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) must:
(1) Be registered with the Commission as a broker under section
15(b) of the Exchange Act (15 U.S.C. 78o(b)) or as a funding portal in
accordance with the requirements of Sec. 227.400; and
(2) Be a member a national securities association registered under
section 15A of the Exchange Act (15 U.S.C. 78o-3).
(b) Financial interests. Any director, officer or partner of an
intermediary, or any person occupying a similar status or performing a
similar function, may not have a financial interest in an issuer that
is offering or selling securities in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) through the intermediary's
platform, or receive a financial interest in an issuer as compensation
for the services provided to or for the benefit of the issuer in
connection with the offer or sale of such securities. An intermediary
may not have a financial interest in an issuer that is offering or
selling securities in reliance on section 4(a)(6) of the Securities Act
(15 U.S.C. 77d(a)(6)) through the intermediary's platform unless:
(1) The intermediary receives the financial interest from the
issuer as compensation for the services provided to, or for the benefit
of, the issuer in connection with the offer or sale of the securities
being offered or sold in reliance on section 4(a)(6) of the Securities
Act (15 U.S.C. 77d(a)(6)) through the intermediary's platform; and
(2) the financial interest consists of securities of the same class
and having the same terms, conditions and rights as the securities
being offered or sold in reliance on section 4(a)(6) of the Securities
Act (15 U.S.C. 77d(a)(6)) through the intermediary's platform. For
purposes of this paragraph, a financial interest in an issuer means a
direct or indirect ownership of, or economic interest in, any class of
the issuer's securities.
(c) Definitions. For purposes of this part:
(1) Associated person of a funding portal or person associated with
a funding portal means any partner, officer, director or manager of a
funding portal (or any person occupying a similar status or performing
similar functions), any person directly or
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indirectly controlling or controlled by such funding portal, or any
employee of a funding portal, except that any person associated with a
funding portal whose functions are solely clerical or ministerial shall
not be included in the meaning of such term for purposes of section
15(b) of the Exchange Act (15 U.S.C. 78o(b)) (other than paragraphs (4)
and (6) of section 15(b) of the Exchange Act).
(2) Funding portal means a broker acting as an intermediary in a
transaction involving the offer or sale of securities in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)), that does
not:
(i) Offer investment advice or recommendations;
(ii) Solicit purchases, sales or offers to buy the securities
displayed on its platform;
(iii) Compensate employees, agents, or other persons for such
solicitation or based on the sale of securities displayed or referenced
on its platform; or
(iv) Hold, manage, possess, or otherwise handle investor funds or
securities.
(3) Intermediary means a broker registered under section 15(b) of
the Exchange Act (15 U.S.C. 78o(b)) or a funding portal registered
under Sec. 227.400 and includes, where relevant, an associated person
of the registered broker or registered funding portal.
(4) Platform means a program or application accessible via the
Internet or other similar electronic communication medium through which
a registered broker or a registered funding portal acts as an
intermediary in a transaction involving the offer or sale of securities
in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)).
Instruction to paragraph (c)(4). An intermediary through which a
crowdfunding transaction is conducted may engage in back office or
other administrative functions other than on the intermediary's
platform.
Sec. 227.301 Measures to reduce risk of fraud.
An intermediary in a transaction involving the offer or sale of
securities in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)) must:
(a) Have a reasonable basis for believing that an issuer seeking to
offer and sell securities in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) through the intermediary's
platform complies with the requirements in section 4A(b) of the Act (15
U.S.C. 77d-1(b)) and the related requirements in this part. In
satisfying this requirement, an intermediary may rely on the
representations of the issuer concerning compliance with these
requirements unless the intermediary has reason to question the
reliability of those representations;
(b) Have a reasonable basis for believing that the issuer has
established means to keep accurate records of the holders of the
securities it would offer and sell through the intermediary's platform,
provided that an intermediary may rely on the representations of the
issuer concerning its means of recordkeeping unless the intermediary
has reason to question the reliability of those representations. An
intermediary will be deemed to have satisfied this requirement if the
issuer has engaged the services of a transfer agent that is registered
under Section 17A of the Exchange Act (15 U.S.C. 78q-1(c)).
(c) Deny access to its platform to an issuer if the intermediary:
(1) Has a reasonable basis for believing that the issuer or any of
its officers, directors (or any person occupying a similar status or
performing a similar function) or beneficial owners of 20 percent or
more of the issuer's outstanding voting equity securities, calculated
on the basis of voting power, is subject to a disqualification under
Sec. 227.503. In satisfying this requirement, an intermediary must, at
a minimum, conduct a background and securities enforcement regulatory
history check on each issuer whose securities are to be offered by the
intermediary and on each officer, director or beneficial owner of 20
percent or more of the issuer's outstanding voting equity securities,
calculated on the basis of voting power.
(2) Has a reasonable basis for believing that the issuer or the
offering presents the potential for fraud or otherwise raises concerns
about investor protection. In satisfying this requirement, an
intermediary must deny access if it reasonably believes that it is
unable to adequately or effectively assess the risk of fraud of the
issuer or its potential offering. In addition, if an intermediary
becomes aware of information after it has granted access that causes it
to reasonably believe that the issuer or the offering presents the
potential for fraud or otherwise raises concerns about investor
protection, the intermediary must promptly remove the offering from its
platform, cancel the offering, and return (or, for funding portals,
direct the return of) any funds that have been committed by investors
in the offering.
Sec. 227.302 Account opening.
(a) Accounts and electronic delivery.
(1) No intermediary or associated person of an intermediary may
accept an investment commitment in a transaction involving the offer or
sale of securities in reliance on section 4(a)(6) of the Securities Act
(15 U.S.C. 77d(a)(6)) until the investor has opened an account with the
intermediary and the intermediary has obtained from the investor
consent to electronic delivery of materials.
(2) An intermediary must provide all information that is required
to be provided by the intermediary under subpart C of this part
(Sec. Sec. 227.300 through 227.305), including, but not limited to,
educational materials, notices and confirmations, through electronic
means. Unless otherwise indicated in the relevant rule of subpart C of
this part, in satisfying this requirement, an intermediary must provide
the information through an electronic message that contains the
information, through an electronic message that includes a specific
link to the information as posted on intermediary's platform, or
through an electronic message that provides notice of what the
information is and that it is located on the intermediary's platform or
on the issuer's Web site. Electronic messages include, but are not
limited to, email, social media messages, instant messages or other
electronic media messages.
(b) Educational materials. (1) In connection with establishing an
account for an investor, an intermediary must deliver educational
materials to such investor that explain in plain language and are
otherwise designed to communicate effectively and accurately:
(i) The process for the offer, purchase and issuance of securities
through the intermediary and the risks associated with purchasing
securities offered and sold in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6));
(ii) The types of securities offered and sold in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) available
for purchase on the intermediary's platform and the risks associated
with each type of security, including the risk of having limited voting
power as a result of dilution;
(iii) The restrictions on the resale of a security offered and sold
in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6));
(iv) The types of information that an issuer is required to provide
under Sec. 227.202, the frequency of the delivery of that information
and the possibility that those obligations may terminate in the future;
(v) The limitations on the amounts an investor may invest pursuant
to Sec. 227.100(a)(2);
[[Page 71544]]
(vi) The limitations on an investor's right to cancel an investment
commitment and the circumstances in which an investment commitment may
be cancelled by the issuer;
(vii) The need for the investor to consider whether investing in a
security offered and sold in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) is appropriate for that investor;
(viii) That following completion of an offering conducted through
the intermediary, there may or may not be any ongoing relationship
between the issuer and intermediary; and
(ix) That under certain circumstances an issuer may cease to
publish annual reports and, therefore, an investor may not continually
have current financial information about the issuer.
(2) An intermediary must make the most current version of its
educational material available on its platform at all times and, if at
any time, the intermediary makes a material revision to its educational
materials, it must make the revised educational materials available to
all investors before accepting any additional investment commitments or
effecting any further transactions in securities offered and sold in
reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)).
(c) Promoters. In connection with establishing an account for an
investor, an intermediary must inform the investor that any person who
promotes an issuer's offering for compensation, whether past or
prospective, or who is a founder or an employee of an issuer that
engages in promotional activities on behalf of the issuer on the
intermediary's platform, must clearly disclose in all communications on
the intermediary's platform, respectively, the receipt of the
compensation and that he or she is engaging in promotional activities
on behalf of the issuer.
(d) Compensation disclosure. When establishing an account for an
investor, an intermediary must clearly disclose the manner in which the
intermediary is compensated in connection with offerings and sales of
securities in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)).
Sec. 227.303 Requirements with respect to transactions.
(a) Issuer information. An intermediary in a transaction involving
the offer or sale of securities in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) must make available to the
Commission and to investors any information required to be provided by
the issuer of the securities under Sec. Sec. 227.201 and 227.203(a).
(1) This information must be made publicly available on the
intermediary's platform, in a manner that reasonably permits a person
accessing the platform to save, download, or otherwise store the
information;
(2) This information must be made publicly available on the
intermediary's platform for a minimum of 21 days before any securities
are sold in the offering, during which time the intermediary may accept
investment commitments;
(3) This information, including any additional information provided
by the issuer, must remain publicly available on the intermediary's
platform until the offer and sale of securities in reliance on section
4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) is completed or
cancelled; and
(4) An intermediary may not require any person to establish an
account with the intermediary to access this information.
(b) Investor qualification. Each time before accepting any
investment commitment (including any additional investment commitment
from the same person), an intermediary must:
(1) Have a reasonable basis for believing that the investor
satisfies the investment limitations established by section 4(a)(6)(B)
of the Act (15 U.S.C. 77d(a)(6)(B)) and this part. An intermediary may
rely on an investor's representations concerning compliance with the
investment limitation requirements concerning the investor's annual
income, net worth, and the amount of the investor's other investments
made pursuant to section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)) unless the intermediary has reason to question the
reliability of the representation.
(2) Obtain from the investor:
(i) A representation that the investor has reviewed the
intermediary's educational materials delivered pursuant to Sec.
227.302(b), understands that the entire amount of his or her investment
may be lost, and is in a financial condition to bear the loss of the
investment; and
(ii) A questionnaire completed by the investor demonstrating the
investor's understanding that:
(A) There are restrictions on the investor's ability to cancel an
investment commitment and obtain a return of his or her investment;
(B) It may be difficult for the investor to resell securities
acquired in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)); and
(C) Investing in securities offered and sold in reliance on section
4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) involves risk, and
the investor should not invest any funds in an offering made in
reliance on section 4(a)(6) of the Securities Act unless he or she can
afford to lose the entire amount of his or her investment.
(c) Communication channels. An intermediary must provide on its
platform communication channels by which persons can communicate with
one another and with representatives of the issuer about offerings made
available on the intermediary's platform, provided:
(1) If the intermediary is a funding portal, it does not
participate in these communications other than to establish guidelines
for communication and remove abusive or potentially fraudulent
communications;
(2) The intermediary permits public access to view the discussions
made in the communication channels;
(3) The intermediary restricts posting of comments in the
communication channels to those persons who have opened an account with
the intermediary on its platform; and
(4) The intermediary requires that any person posting a comment in
the communication channels clearly and prominently disclose with each
posting whether he or she is a founder or an employee of an issuer
engaging in promotional activities on behalf of the issuer, or is
otherwise compensated, whether in the past or prospectively, to promote
the issuer's offering.
(d) Notice of investment commitment. An intermediary must promptly,
upon receipt of an investment commitment from an investor, give or send
to the investor a notification disclosing:
(1) The dollar amount of the investment commitment;
(2) The price of the securities, if known;
(3) The name of the issuer; and
(4) The date and time by which the investor may cancel the
investment commitment.
(e) Maintenance and transmission of funds. (1) An intermediary that
is a registered broker must comply with the requirements of 17 CFR
240.15c2-4.
(2) An intermediary that is a funding portal must direct investors
to transmit the money or other consideration directly to a qualified
third party that has agreed in writing to hold the funds for the
benefit of, and to promptly transmit or return the funds to, the
persons entitled thereto in accordance with paragraph (e)(3) of this
section. For purposes of this subpart C (Sec. Sec. 227.300 through
227.305), a qualified third party means a:
(i) Registered broker or dealer that carries customer or broker or
dealer
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accounts and holds funds or securities for those persons; or
(ii) Bank or credit union (where such credit union is insured by
National Credit Union Administration) that has agreed in writing either
to hold the funds in escrow for the persons who have the beneficial
interests therein and to transmit or return such funds directly to the
persons entitled thereto when so directed by the funding portal as
described in paragraph (e)(3) of this section, or to maintain a bank or
credit union account (or accounts) for the exclusive benefit of
investors and the issuer.
(3) A funding portal that is an intermediary in a transaction
involving the offer or sale of securities in reliance on section
4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) shall promptly
direct the qualified third party to:
(i) Transmit funds from the qualified third party to the issuer
when the aggregate amount of investment commitments from all investors
is equal to or greater than the target amount of the offering and the
cancellation period as set forth in Sec. 227.304 has elapsed, provided
that in no event may the funding portal direct this transmission of
funds earlier than 21 days after the date on which the intermediary
makes publicly available on its platform the information required to be
provided by the issuer under Sec. Sec. 227.201 and 227.203(a);
(ii) Return funds to an investor when an investment commitment has
been cancelled in accordance with Sec. 227.304 (including for failure
to obtain effective reconfirmation as required under Sec. 227.304(c));
and
(iii) Return funds to investors when an issuer does not complete
the offering.
(f) Confirmation of transaction. (1) An intermediary must, at or
before the completion of a transaction in a security in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)), give or
send to each investor a notification disclosing:
(i) The date of the transaction;
(ii) The type of security that the investor is purchasing;
(iii) The identity, price, and number of securities purchased by
the investor, as well as the number of securities sold by the issuer in
the transaction and the price(s) at which the securities were sold;
(iv) If a debt security, the interest rate and the yield to
maturity calculated from the price paid and the maturity date;
(v) If a callable security, the first date that the security can be
called by the issuer; and
(vi) The source, form and amount of any remuneration received or to
be received by the intermediary in connection with the transaction,
including any remuneration received or to be received by the
intermediary from persons other than the issuer.
(2) An intermediary satisfying the requirements of paragraph (f)(1)
of this section is exempt from the requirements of Sec. 240.10b-10 of
this chapter with respect to a transaction in a security offered and
sold in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)).
Sec. 227.304 Completion of offerings, cancellations and
reconfirmations.
(a) Generally. An investor may cancel an investment commitment for
any reason until 48 hours prior to the deadline identified in the
issuer's offering materials. During the 48 hours prior to such
deadline, an investment commitment may not be cancelled except as
provided in paragraph (c) of this section.
(b) Early completion of offering. If an issuer reaches the target
offering amount prior to the deadline identified in its offering
materials pursuant to Sec. 227.201(g), the issuer may close the
offering on a date earlier than the deadline identified in its offering
materials pursuant to Sec. 227.201(g), provided that:
(1) The offering remains open for a minimum of 21 days pursuant to
Sec. 227.303(a);
(2) The intermediary provides notice to any potential investors,
and gives or sends notice to investors that have made investment
commitments in the offering, of:
(i) The new, anticipated deadline of the offering;
(ii) The right of investors to cancel investment commitments for
any reason until 48 hours prior to the new offering deadline; and
(iii) Whether the issuer will continue to accept investment
commitments during the 48-hour period prior to the new offering
deadline.
(3) The new offering deadline is scheduled for and occurs at least
five business days after the notice required in paragraph (b)(2) of
this section is provided; and
(4) At the time of the new offering deadline, the issuer continues
to meet or exceed the target offering amount.
(c) Cancellations and reconfirmations based on material changes.
(1) If there is a material change to the terms of an offering or to the
information provided by the issuer, the intermediary must give or send
to any investor who has made an investment commitment notice of the
material change and that the investor's investment commitment will be
cancelled unless the investor reconfirms his or her investment
commitment within five business days of receipt of the notice. If the
investor fails to reconfirm his or her investment within those five
business days, the intermediary within five business days thereafter
must:
(i) Give or send the investor a notification disclosing that the
commitment was cancelled, the reason for the cancellation and the
refund amount that the investor is expected to receive; and
(ii) Direct the refund of investor funds.
(2) If material changes to the offering or to the information
provided by the issuer regarding the offering occur within five
business days of the maximum number of days that an offering is to
remain open, the offering must be extended to allow for a period of
five business days for the investor to reconfirm his or her investment.
(d) Return of funds if offering is not completed. If an issuer does
not complete an offering, an intermediary must within five business
days:
(1) Give or send each investor a notification of the cancellation,
disclosing the reason for the cancellation, and the refund amount that
the investor is expected to receive;
(2) Direct the refund of investor funds; and
(3) Prevent investors from making investment commitments with
respect to that offering on its platform.
Sec. 227.305 Payments to third parties.
(a) Prohibition on payments for personally identifiable
information. An intermediary may not compensate any person for
providing the intermediary with the personally identifiable information
of any investor or potential investor in securities offered and sold in
reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)).
(b) For purposes of this rule, personally identifiable information
means information that can be used to distinguish or trace an
individual's identity, either alone or when combined with other
personal or identifying information that is linked or linkable to a
specific individual.
Subpart D--Funding Portal Regulation
Sec. 227.400 Registration of funding portals.
(a) Registration. A funding portal must register with the
Commission, by filing a complete Form Funding Portal (Sec. 249.2000 of
this chapter) in accordance with the instructions on the
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form, and become a member of a national securities association
registered under section 15A of the Exchange Act (15 U.S.C. 78o-3). The
registration will be effective the later of:
(1) Thirty calendar days after the date that the registration is
received by the Commission; or
(2) The date the funding portal is approved for membership by a
national securities association registered under section 15A of the
Exchange Act (15 U.S.C. 78o-3).
(b) Amendments to registration. A funding portal must file an
amendment to Form Funding Portal (Sec. 249.2000 of this chapter)
within 30 days of any of the information previously submitted on Form
Funding Portal becoming inaccurate for any reason.
(c) Successor registration. (1) If a funding portal succeeds to and
continues the business of a registered funding portal, the registration
of the predecessor will remain effective as the registration of the
successor if the successor, within 30 days after such succession, files
a registration on Form Funding Portal (Sec. 249.2000 of this chapter)
and the predecessor files a withdrawal on Form Funding Portal;
provided, however, that the registration of the predecessor funding
portal will be deemed withdrawn 45 days after registration on Form
Funding Portal is filed by the successor.
(2) Notwithstanding paragraph (c)(1) of this section, if a funding
portal succeeds to and continues the business of a registered funding
portal and the succession is based solely on a change of the
predecessor's date or state of incorporation, form of organization, or
composition of a partnership, the successor may, within 30 days after
the succession, amend the registration of the predecessor on Form
Funding Portal (Sec. 249.2000 of this chapter) to reflect these
changes.
(d) Withdrawal. A funding portal must promptly file a withdrawal of
registration on Form Funding Portal (Sec. 249.2000 of this chapter) in
accordance with the instructions on the form upon ceasing to operate as
a funding portal. Withdrawal will be effective on the later of 30 days
after receipt by the Commission (after the funding portal is no longer
operational), or within such longer period of time as to which the
funding portal consents or which the Commission by order may determine
as necessary or appropriate in the public interest or for the
protection of investors.
(e) Applications and reports. The applications and reports provided
for in this section shall be considered filed when a complete Form
Funding Portal (Sec. 249.2000 of this chapter) is submitted with the
Commission. Duplicate originals of the applications and reports
provided for in this section must be filed with surveillance personnel
designated by any registered national securities association of which
the funding portal is a member.
(f) Nonresident funding portals. Registration pursuant to this
section by a nonresident funding portal shall be conditioned upon there
being an information sharing arrangement in place between the
Commission and the competent regulator in the jurisdiction under the
laws of which the nonresident funding portal is organized or where it
has its principal place of business, that is applicable to the
nonresident funding portal.
(1) Definition. For purposes of this section, the term nonresident
funding portal shall mean a funding portal incorporated in or organized
under the laws of a jurisdiction outside of the United States or its
territories, or having its principal place of business in any place not
in the United States or its territories.
(2) Power of attorney. (i) Each nonresident funding portal
registered or applying for registration pursuant to this section shall
obtain a written consent and power of attorney appointing an agent in
the United States, other than the Commission or a Commission member,
official or employee, upon whom may be served any process, pleadings or
other papers in any action under the federal securities laws. This
consent and power of attorney must be signed by the nonresident funding
portal and the named agent(s) for service of process.
(ii) Each nonresident funding portal registered or applying for
registration pursuant to this section shall, at the time of filing its
application on Form Funding Portal (Sec. 249.2000 of this chapter),
furnish to the Commission the name and address of its United States
agent for service of process on Schedule C to the Form.
(iii) Any change of a nonresident funding portal's agent for
service of process and any change of name or address of a nonresident
funding portal's existing agent for service of process shall be
communicated promptly to the Commission through amendment of the
Schedule C to Form Funding Portal (Sec. 249.2000 of this chapter).
(iv) Each nonresident funding portal must promptly appoint a
successor agent for service of process if the nonresident funding
portal discharges its identified agent for service of process or if its
agent for service of process is unwilling or unable to accept service
on behalf of the nonresident funding portal.
(v) Each nonresident funding portal must maintain, as part of its
books and records, the written consent and power of attorney identified
in paragraph (f)(2)(i) of this section for at least three years after
the agreement is terminated.
(3) Access to books and records; inspections and examinations--(i)
Certification and opinion of counsel. Any nonresident funding portal
applying for registration pursuant to this section shall:
(A) Certify on Schedule C to Form Funding Portal (Sec. 249.2000 of
this chapter) that the nonresident funding portal can, as a matter of
law, and will provide the Commission and any registered national
securities association of which it becomes a member with prompt access
to the books and records of such nonresident funding portal and can, as
a matter of law, and will submit to onsite inspection and examination
by the Commission and any registered national securities association of
which it becomes a member; and
(B) Provide an opinion of counsel that the nonresident funding
portal can, as a matter of law, provide the Commission and any
registered national securities association of which it becomes a member
with prompt access to the books and records of such nonresident funding
portal and can, as a matter of law, submit to onsite inspection and
examination by the Commission and any registered national securities
association of which it becomes a member.
(ii) Amendments. The nonresident funding portal shall re-certify,
on Schedule C to Form Funding Portal (Sec. 249.2000 of this chapter),
within 90 days after any changes in the legal or regulatory framework
that would impact the nonresident funding portal's ability to provide,
or the manner in which it provides, the Commission, or any registered
national securities association of which it is a member, with prompt
access to its books and records or that would impact the Commission's
or such registered national securities association's ability to inspect
and examine the nonresident funding portal. The re-certification shall
be accompanied by a revised opinion of counsel describing how, as a
matter of law, the nonresident funding portal can continue to meet its
obligations under paragraphs (f)(3)(i)(A) and (B) of this section.
Sec. 227.401 Exemption.
A funding portal that is registered with the Commission pursuant to
Sec. 227.400 is exempt from the broker
[[Page 71547]]
registration requirements of section 15(a)(1) of the Exchange Act (15
U.S.C. 78o(a)(1)) in connection with its activities as a funding
portal.
Sec. 227.402 Conditional safe harbor.
(a) General. Under section 3(a)(80) of the Exchange Act (15 U.S.C.
78c(a)(80)), a funding portal acting as an intermediary in a
transaction involving the offer or sale of securities in reliance on
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) may not:
offer investment advice or recommendations; solicit purchases, sales,
or offers to buy the securities offered or displayed on its platform or
portal; compensate employees, agents, or other persons for such
solicitation or based on the sale of securities displayed or referenced
on its platform or portal; hold, manage, possess, or otherwise handle
investor funds or securities; or engage in such other activities as the
Commission, by rule, determines appropriate. This section is intended
to provide clarity with respect to the ability of a funding portal to
engage in certain activities, consistent with the prohibitions under
section 3(a)(80) of the Exchange Act. No presumption shall arise that a
funding portal has violated the prohibitions under section 3(a)(80) of
the Exchange Act or this part by reason of the funding portal or its
associated persons engaging in activities in connection with the offer
or sale of securities in reliance on section 4(a)(6) of the Securities
Act that do not meet the conditions specified in paragraph (b) of this
section. The antifraud provisions and all other applicable provisions
of the federal securities laws continue to apply to the activities
described in paragraph (b) of this section.
(b) Permitted activities. A funding portal may, consistent with the
prohibitions under section 3(a)(80) of the Exchange Act (15 U.S.C.
78c(a)(80)) and this part:
(1) Determine whether and under what terms to allow an issuer to
offer and sell securities in reliance on section 4(a)(6) of the
Securities Act (15 U.S.C. 77d(a)(6)) through its platform; provided
that a funding portal otherwise complies with this part;
(2) Apply objective criteria to highlight offerings on the funding
portal's platform where:
(i) The criteria are reasonably designed to highlight a broad
selection of issuers offering securities through the funding portal's
platform, are applied consistently to all issuers and offerings and are
clearly displayed on the funding portal's platform;
(ii) The criteria may include, among other things, the type of
securities being offered (for example, common stock, preferred stock or
debt securities); the geographic location of the issuer; the industry
or business segment of the issuer; the number or amount of investment
commitments made, progress in meeting the issuer's target offering
amount or, if applicable, the maximum offering amount; and the minimum
or maximum investment amount; provided that the funding portal may not
highlight an issuer or offering based on the advisability of investing
in the issuer or its offering; and
(iii) The funding portal does not receive special or additional
compensations for highlighting one or more issuers or offerings on its
platform;
(3) Provide search functions or other tools that investors can use
to search, sort, or categorize the offerings available through the
funding portal's platform according to objective criteria where;
(i) The criteria may include, among other things, the type of
securities being offered (for example, common stock, preferred stock or
debt securities); the geographic location of the issuer; the industry
or business segment of the issuer; the number or amount of investment
commitments made, progress in meeting the issuer's target offering
amount or, if applicable, the maximum offering amount; and the minimum
or maximum investment amount; and
(ii) The criteria may not include, among other things, the
advisability of investing in the issuer or its offering, or an
assessment of any characteristic of the issuer, its business plan, its
key management or risks associated with an investment.
(4) Provide communication channels by which investors can
communicate with one another and with representatives of the issuer
through the funding portal's platform about offerings through the
platform, so long as the funding portal (and its associated persons):
(i) Does not participate in these communications, other than to
establish guidelines for communication and remove abusive or
potentially fraudulent communications;
(ii) Permits public access to view the discussions made in the
communication channels;
(iii) Restricts posting of comments in the communication channels
to those persons who have opened an account on its platform; and
(iv) Requires that any person posting a comment in the
communication channels clearly disclose with each posting whether he or
she is a founder or an employee of an issuer engaging in promotional
activities on behalf of the issuer, or is otherwise compensated,
whether in the past or prospectively, to promote an issuer's offering;
(5) Advise an issuer about the structure or content of the issuer's
offering, including assisting the issuer in preparing offering
documentation;
(6) Compensate a third party for referring a person to the funding
portal, so long as the third party does not provide the funding portal
with personally identifiable information of any potential investor, and
the compensation, other than that paid to a registered broker or
dealer, is not based, directly or indirectly, on the purchase or sale
of a security in reliance on section 4(a)(6) of the Securities Act (15
U.S.C. 77d(a)(6)) offered on or through the funding portal's platform;
(7) Pay or offer to pay any compensation to a registered broker or
dealer for services, including referrals pursuant to paragraph (b)(6)
of this section, in connection with the offer or sale of securities by
the funding portal in reliance on section 4(a)(6) of the Act(15 U.S.C.
77d(a)(6)), provided that:
(i) Such services are provided pursuant to a written agreement
between the funding portal and the registered broker or dealer;
(ii) Such services and compensation are permitted under this part;
and
(iii) Such services and compensation comply with the rules of any
registered national securities association of which the funding portal
is a member;
(8) Receive any compensation from a registered broker or dealer for
services provided by the funding portal in connection with the offer or
sale of securities by the funding portal in reliance on section 4(a)(6)
of the Securities Act (15 U.S.C. 77d(a)(6)), provided that:
(i) Such services are provided pursuant to a written agreement
between the funding portal and the registered broker or dealer;
(ii) Such compensation is permitted under this part; and
(iii) Such compensation complies with the rules of any registered
national securities association of which the funding portal is a
member;
(9) Advertise the existence of the funding portal and identify one
or more issuers or offerings available on the portal on the basis of
objective criteria, as long as:
(i) The criteria are reasonably designed to identify a broad
selection of issuers offering securities through the funding portal's
platform, and are applied consistently to all potential issuers and
offerings;
[[Page 71548]]
(ii) The criteria may include, among other things, the type of
securities being offered (for example, common stock, preferred stock or
debt securities); the geographic location of the issuer; the industry
or business segment of the issuer; the expressed interest by investors,
as measured by number or amount of investment commitments made,
progress in meeting the issuer's target offering amount or, if
applicable, the maximum offering amount; and the minimum or maximum
investment amount; and
(iii) The funding portal does not receive special or additional
compensation for identifying the issuer or offering in this manner;
(10) Deny access to its platform to, or cancel an offering of an
issuer, pursuant to Sec. 227.301(c)(2), if the funding portal has a
reasonable basis for believing that the issuer or the offering presents
the potential for fraud or otherwise raises concerns about investor
protection;
(11) Accept, on behalf of an issuer, an investment commitment for
securities offered in reliance on section 4(a)(6) of the Securities Act
(15 U.S.C. 77d(a)(6)) by that issuer on the funding portal's platform;
(12) Direct investors where to transmit funds or remit payment in
connection with the purchase of securities offered and sold in reliance
on section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)); and
(13) Direct a qualified third party, as required by Sec.
227.303(e), to release proceeds to an issuer upon completion of a
crowdfunding offering or to return proceeds to investors in the event
an investment commitment or an offering is cancelled.
Sec. 227.403 Compliance.
(a) Policies and procedures. A funding portal must implement
written policies and procedures reasonably designed to achieve
compliance with the federal securities laws and the rules and
regulations thereunder relating to its business as a funding portal.
(b) Privacy. A funding portal must comply with the requirements of
part 248 of this chapter as they apply to brokers.
(c) Inspections and examinations. A funding portal shall permit the
examination and inspection of all of its business and business
operations that relate to its activities as a funding portal, such as
its premises, systems, platforms, and records by representatives of the
Commission and of the registered national securities association of
which it is a member.
Sec. 227.404 Records to be made and kept by funding portals.
(a) Generally. A funding portal shall make and preserve the
following records for five years, the first two years in an easily
accessible place:
(1) All records related to an investor who purchases or attempts to
purchase securities through the funding portal;
(2) All records related to issuers who offer and sell or attempt to
offer and sell securities through the funding portal and the control
persons of such issuers;
(3) Records of all communications that occur on or through its
platform;
(4) All records related to persons that use communication channels
provided by a funding portal to promote an issuer's securities or
communicate with potential investors;
(5) All records required to demonstrate compliance with the
requirements of subparts C (Sec. Sec. 227.300 through 227.305) and D
(Sec. Sec. 227.400 through 227.404) of this part;
(6) All notices provided by such funding portal to issuers and
investors generally through the funding portal's platform or otherwise,
including, but not limited to, notices addressing hours of funding
portal operations (if any), funding portal malfunctions, changes to
funding portal procedures, maintenance of hardware and software,
instructions pertaining to access to the funding portal and denials of,
or limitations on, access to the funding portal;
(7) All written agreements (or copies thereof) entered into by such
funding portal relating to its business as such;
(8) All daily, monthly and quarterly summaries of transactions
effected through the funding portal, including:
(i) Issuers for which the target offering amount has been reached
and funds distributed; and
(ii) Transaction volume, expressed in:
(A) Number of transactions;
(B) Number of securities involved in a transaction;
(C) Total amounts raised by, and distributed to, issuers; and
(D) Total dollar amounts raised across all issuers, expressed in
U.S. dollars; and
(9) A log reflecting the progress of each issuer who offers or
sells securities through the funding portal toward meeting the target
offering amount.
(b) Organizational documents. A funding portal shall make and
preserve during the operation of the funding portal and of any
successor funding portal, all organizational documents relating to the
funding portal, including but not limited to, partnership agreements,
articles of incorporation or charter, minute books and stock
certificate books (or other similar type documents).
(c) Format. The records required to be maintained and preserved
pursuant to paragraph (a) of this section must be produced, reproduced,
and maintained in the original, non-alterable format in which they were
created or as permitted under Sec. 240.17a-4(f) of this chapter.
(d) Third parties. The records required to be made and preserved
pursuant to this section may be prepared or maintained by a third party
on behalf of a funding portal. An agreement with a third party shall
not relieve a funding portal from the responsibility to prepare and
maintain records as specified in this rule. A funding portal must file
with the registered national securities association of which it is a
member, a written undertaking in a form acceptable to the registered
national securities association, signed by a duly authorized person of
the third party, stating in effect that such records are the property
of the funding portal and will be surrendered promptly on request of
the funding portal. The undertaking shall include the following
provision:
With respect to any books and records maintained or preserved on
behalf of [name of funding portal], the undersigned hereby
acknowledges that the books and records are the property of [name of
funding portal], and hereby undertakes to permit examination of such
books and records at any time, or from time to time, during business
hours by representatives of the Securities and Exchange Commission
and the registered national securities association of which the
funding portal is a member, and to promptly furnish to the
Commission, its representatives, and the registered national
securities association of which the funding portal is a member, a
true, correct, complete and current hard copy of any, all, or any
part of, such books and records.
(e) Review of records. All records of a funding portal are subject
at any time, or from time to time, to reasonable periodic, special, or
other examination by the representatives of the Commission and the
registered national securities association of which a funding portal is
a member. Every funding portal shall furnish promptly to the
Commission, its representatives, and the registered national securities
association of which the funding portal is a member true, correct,
complete and current copies of such records of the funding portal that
are requested by the representatives of the Commission and the
registered national securities association.
(f) Financial recordkeeping and reporting of currency and foreign
transactions. A funding portal that is subject to the requirements of
the Currency and Foreign Transactions Reporting Act of 1970 (15 U.S.C.
5311
[[Page 71549]]
et seq.) shall comply with the reporting, recordkeeping and record
retention requirements of 31 CFR chapter X. Where 31 CFR chapter X and
Sec. 227.404(a) and (b) require the same records or reports to be
preserved for different periods of time, such records or reports shall
be preserved for the longer period of time.
Subpart E--Miscellaneous Provisions
Sec. 227.501 Restrictions on resales.
(a) Securities issued in a transaction exempt from registration
pursuant to section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6))
and in accordance with section 4A of the Securities Act (15 U.S.C. 77d-
1) and this part may not be transferred by any purchaser of such
securities during the one-year period beginning when the securities
were issued in a transaction exempt from registration pursuant to
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)), unless
such securities are transferred:
(1) To the issuer of the securities;
(2) To an accredited investor;
(3) As part of an offering registered with the Commission; or
(4) To a member of the family of the purchaser or the equivalent,
to a trust controlled by the purchaser, to a trust created for the
benefit of a member of the family of the purchaser or the equivalent,
or in connection with the death or divorce of the purchaser or other
similar circumstance.
(b) For purposes of this Sec. 227.501, the term accredited
investor shall mean any person who comes within any of the categories
set forth in Sec. 230.501(a) of this chapter, or who the seller
reasonably believes comes within any of such categories, at the time of
the sale of the securities to that person.
(c) For purposes of this section, the term member of the family of
the purchaser or the equivalent includes a child, stepchild,
grandchild, parent, stepparent, grandparent, spouse or spousal
equivalent, sibling, mother-in-law, father-in-law, son-in-law,
daughter-in-law, brother-in-law, or sister-in-law of the purchaser, and
shall include adoptive relationships. For purposes of this paragraph
(c), the term spousal equivalent means a cohabitant occupying a
relationship generally equivalent to that of a spouse.
Sec. 227.502 Insignificant deviations from a term, condition or
requirement of this part (Regulation Crowdfunding).
(a) A failure to comply with a term, condition, or requirement of
this part will not result in the loss of the exemption from the
requirements of Section 5 of the Securities Act (15 U.S.C. 77e) for any
offer or sale to a particular individual or entity, if the issuer
relying on the exemption shows:
(1) The failure to comply was insignificant with respect to the
offering as a whole;
(2) The issuer made a good faith and reasonable attempt to comply
with all applicable terms, conditions and requirements of this part;
and
(3) The issuer did not know of such failure where the failure to
comply with a term, condition or requirement of this part was the
result of the failure of the intermediary to comply with the
requirements of section 4A(a) of the Securities Act (15 U.S.C. 77d-
1(a)) and the related rules, or such failure by the intermediary
occurred solely in offerings other than the issuer's offering.
(b) Paragraph (a) of this section shall not preclude the Commission
from bringing an enforcement action seeking any appropriate relief for
an issuer's failure to comply with all applicable terms, conditions and
requirements of this part.
Sec. 227.503 Disqualification provisions.
(a) Disqualification events. No exemption under this section
4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) shall be available
for a sale of securities if the issuer; any predecessor of the issuer;
any affiliated issuer; any director, officer, general partner or
managing member of the issuer; any beneficial owner of 20 percent or
more of the issuer's outstanding voting equity securities, calculated
on the basis of voting power; any promoter connected with the issuer in
any capacity at the time of such sale; any person that has been or will
be paid (directly or indirectly) remuneration for solicitation of
purchasers in connection with such sale of securities; or any general
partner, director, officer or managing member of any such solicitor:
(1) Has been convicted, within 10 years before the filing of the
offering statement (or five years, in the case of issuers, their
predecessors and affiliated issuers), of any felony or misdemeanor:
(i) In connection with the purchase or sale of any security;
(ii) Involving the making of any false filing with the Commission;
or
(iii) Arising out of the conduct of the business of an underwriter,
broker, dealer, municipal securities dealer, investment adviser,
funding portal or paid solicitor of purchasers of securities;
(2) Is subject to any order, judgment or decree of any court of
competent jurisdiction, entered within five years before the filing of
the information required by section 4A(b) of the Securities Act (15
U.S.C. 77d-1(b)) that, at the time of such filing, restrains or enjoins
such person from engaging or continuing to engage in any conduct or
practice:
(i) In connection with the purchase or sale of any security;
(ii) Involving the making of any false filing with the Commission;
or
(iii) Arising out of the conduct of the business of an underwriter,
broker, dealer, municipal securities dealer, investment adviser,
funding portal or paid solicitor of purchasers of securities;
(3) Is subject to a final order of a state securities commission
(or an agency or officer of a state performing like functions); a state
authority that supervises or examines banks, savings associations or
credit unions; a state insurance commission (or an agency or officer of
a state performing like functions); an appropriate federal banking
agency; the U.S. Commodity Futures Trading Commission; or the National
Credit Union Administration that:
(i) At the time of the filing of the information required by
section 4A(b) of the Securities Act (15 U.S.C. 77d-1(b)), bars the
person from:
(A) Association with an entity regulated by such commission,
authority, agency or officer;
(B) Engaging in the business of securities, insurance or banking;
or
(C) Engaging in savings association or credit union activities; or
(ii) Constitutes a final order based on a violation of any law or
regulation that prohibits fraudulent, manipulative or deceptive conduct
entered within ten years before such filing of the offering statement;
Instruction to paragraph (a)(3). Final order shall mean a written
directive or declaratory statement issued by a federal or state agency,
described in Sec. 227.503(a)(3), under applicable statutory authority
that provides for notice and an opportunity for hearing, which
constitutes a final disposition or action by that federal or state
agency.
(4) Is subject to an order of the Commission entered pursuant to
section 15(b) or 15B(c) of the Exchange Act (15 U.S.C. 78o(b) or 78o-
4(c)) or Section 203(e) or (f) of the Investment Advisers Act of 1940
(15 U.S.C. 80b-3(e) or (f)) that, at the time of the filing of the
information required by section 4A(b) of the Securities Act (15 U.S.C.
77d-1(b)):
(i) Suspends or revokes such person's registration as a broker,
dealer, municipal securities dealer, investment adviser or funding
portal;
(ii) Places limitations on the activities, functions or operations
of such person; or
[[Page 71550]]
(iii) Bars such person from being associated with any entity or
from participating in the offering of any penny stock;
(5) Is subject to any order of the Commission entered within five
years before the filing of the information required by section 4A(b) of
the Securities Act (15 U.S.C. 77d-1(b)) that, at the time of such
filing, orders the person to cease and desist from committing or
causing a violation or future violation of:
(i) Any scienter-based anti-fraud provision of the federal
securities laws, including without limitation Section 17(a)(1) of the
Securities Act (15 U.S.C. 77q(a)(1)), Section 10(b) of the Exchange Act
(15 U.S.C. 78j(b)) and 17 CFR 240.10b-5, section 15(c)(1) of the
Exchange Act (15 U.S.C. 78o(c)(1)) and Section 206(1) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-6(1)) or any other rule or
regulation thereunder; or
(ii) Section 5 of the Securities Act (15 U.S.C. 77e);
(6) Is suspended or expelled from membership in, or suspended or
barred from association with a member of, a registered national
securities exchange or a registered national or affiliated securities
association for any act or omission to act constituting conduct
inconsistent with just and equitable principles of trade;
(7) Has filed (as a registrant or issuer), or was or was named as
an underwriter in, any registration statement or Regulation A (17 CFR
230.251 through 230.263) offering statement filed with the Commission
that, within five years before the filing of the information required
by section 4A(b) of the Securities Act (15 U.S.C. 77d-1(b)), was the
subject of a refusal order, stop order, or order suspending the
Regulation A exemption, or is, at the time of such filing, the subject
of an investigation or proceeding to determine whether a stop order or
suspension order should be issued; or
(8) Is subject to a United States Postal Service false
representation order entered within five years before the filing of the
information required by section 4A(b) of the Securities Act (15 U.S.C.
77d-1(b)), or is, at the time of such filing, subject to a temporary
restraining order or preliminary injunction with respect to conduct
alleged by the United States Postal Service to constitute a scheme or
device for obtaining money or property through the mail by means of
false representations.
(b) Transition, waivers, reasonable care exception. Paragraph (a)
of this section shall not apply:
(1) With respect to any conviction, order, judgment, decree,
suspension, expulsion or bar that occurred or was issued before May 16,
2016;
(2) Upon a showing of good cause and without prejudice to any other
action by the Commission, if the Commission determines that it is not
necessary under the circumstances that an exemption be denied;
(3) If, before the filing of the information required by section
4A(b) of the Securities Act (15 U.S.C. 77d-1(b)), the court or
regulatory authority that entered the relevant order, judgment or
decree advises in writing (whether contained in the relevant judgment,
order or decree or separately to the Commission or its staff) that
disqualification under paragraph (a) of this section should not arise
as a consequence of such order, judgment or decree; or
(4) If the issuer establishes that it did not know and, in the
exercise of reasonable care, could not have known that a
disqualification existed under paragraph (a) of this section.
Instruction to paragraph (b)(4). An issuer will not be able to
establish that it has exercised reasonable care unless it has made, in
light of the circumstances, factual inquiry into whether any
disqualifications exist. The nature and scope of the factual inquiry
will vary based on the facts and circumstances concerning, among other
things, the issuer and the other offering participants.
(c) Affiliated issuers. For purposes of paragraph (a) of this
section, events relating to any affiliated issuer that occurred before
the affiliation arose will be not considered disqualifying if the
affiliated entity is not:
(1) In control of the issuer; or
(2) Under common control with the issuer by a third party that was
in control of the affiliated entity at the time of such events.
(d) Intermediaries. A person that is subject to a statutory
disqualification as defined in section 3(a)(39) of the Exchange Act (15
U.S.C. 78c(a)(39)) may not act as, or be an associated person of, an
intermediary in a transaction involving the offer or sale of securities
in reliance on section 4(a)(6) of the Securities Act (15 U.S.C.
77d(a)(6)) unless so permitted pursuant to Commission rule or order.
Instruction to paragraph (d). Sec. 240.17f-2 of this chapter
generally requires the fingerprinting of every person who is a partner,
director, officer or employee of a broker, subject to certain
exceptions.
PART 232--REGULATION S-T--GENERAL RULES AND REGULATIONS FOR
ELECTRONIC FILINGS
0
5. The authority citation for part 232 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s(a), 77z-3,
77sss(a), 78c(b), 781, 78m, 78n, 78o(d), 78w(a), 78ll, 80a-6(c),
80a-8, 80a-29, 80a-30, 80a-37, 7201 et seq.; and 18 U.S.C. 1350,
unless otherwise noted.
* * * * *
0
6. Amend Sec. 232.101 by:
0
a. In paragraph (a)(1)(xvii) removing ``and'' at the end of the
paragraph; and
0
b. In paragraph (a)(1)(xviii) removing the period at the end of the
paragraph and adding in its place a semicolon; and
0
c. Adding paragraphs (a)(1)(xix) and (a)(1)(xx).
The addition reads as follows:
Sec. 232.101 Mandated electronic submissions and exceptions.
(a) * * *
(1) * * *
(xix) Form C (Sec. 239.900 of this chapter). Exhibits to Form C
(Sec. 239.900 of this chapter) may be filed on EDGAR as PDF documents
in the format required by the EDGAR Filer Manual, as defined in Rule 11
of Regulation S-T (Sec. 232.11 of this chapter). Notwithstanding Rule
104 of Regulation S-T (Sec. 232.104 of this chapter), the PDF
documents filed under this paragraph will be considered as officially
filed with the Commission; and
(xx) Form Funding Portal (Sec. 249.2000 of this chapter). Exhibits
and attachments to Form Funding Portal (Sec. 249.2000 of this chapter)
may be filed on EDGAR as PDF documents in the format required by the
EDGAR Filer Manual, as defined in Rule 11 of Regulation S-T (Sec.
232.11 of this chapter). Notwithstanding Rule 104 of Regulation S-T
(Sec. 232.104 of this chapter), the PDF documents filed under this
paragraph will be considered as officially filed with the Commission.
* * * * *
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
0
7. The authority citation for part 239 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-
3, 77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a),
78ll, 78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24,
80a-26, 80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *
0
8. Add Sec. 239.900 to read as follows:
[[Page 71551]]
Sec. 239.900 Form C.
This form shall be used for filings under Regulation Crowdfunding
(part 227 of this chapter).
Note: The text of Form C will not appear in the Code of Federal
Regulations.
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BILLING CODE 8011-01-C
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
9. The authority citation for part 240 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1,78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et. seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Public Law 111-203, 939A, 124 Stat. 1376, (2010), unless otherwise
noted.
0
10. Add Sec. 240.12g-6 to read as follows:
Sec. 240.12g-6 Exemption for securities issued pursuant to section
4(a)(6) of the Securities Act of 1933.
(a) For purposes of determining whether an issuer is required to
register a security with the Commission pursuant to Section 12(g)(1) of
the Act (15 U.S.C. 78l(g)(1)), the definition of held of record shall
not include securities issued pursuant to the offering exemption under
section 4(a)(6) of the Securities Act (15 U.S.C. 77d(a)(6)) by an
issuer that:
(1) Is current in filing its ongoing annual reports required
pursuant to Sec. 227.202 of this chapter;
(2) Has total assets not in excess of $25 million as of the end of
its most recently completed fiscal year; and
(3) Has engaged a transfer agent registered pursuant to Section
17A(c) of the Act to perform the function of a transfer agent with
respect to such securities.
(b) An issuer that would be required to register a class of
securities under Section 12(g) of the Act as a result of exceeding the
asset threshold in paragraph (a)(2) of this section may continue to
exclude the relevant securities from the definition of ``held of
record'' for a transition period ending on the penultimate day of the
fiscal year two years after the date it became ineligible. The
transition period terminates immediately upon the failure of an issuer
to timely file any periodic report due pursuant to Sec. 227.202 at
which time the issuer must file a registration statement that registers
that class of securities under the Act within 120 days.
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
11. The authority citation for part 249 continues to read, in part, as
follows:
Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; and 18 U.S.C. 1350, unless otherwise noted.
* * * * *
0
12. Add subpart U, consisting of Sec. 249.2000 to read as follows:
Subpart U--Forms for Registration of Funding Portals
Sec. 249.2000 Form Funding Portal.
This form shall be used for filings by funding portals under
Regulation Crowdfunding (part 227 of this chapter).
Note: The text of Form Funding Portal will not appear in the
Code of Federal Regulations.
BILLING CODE 8011-01-P
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BILLING CODE 8011-01-C
PART 269--FORMS PRESCRIBED UNDER THE TRUST INDENTURE ACT OF 1939
0
13. The authority citation for part 269 continues to read as follows:
Authority: 15 U.S.C. 77ddd(c), 77eee, 77ggg, 77hhh, 77iii,
77jjj, 77sss, and 78ll(d), unless otherwise noted.
PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940
0
14. The authority citation for part 274 continues to read, in part, as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m,
78n, 78o(d), 80a-8, 80a-24, 80a-26, and 80a-29, unless otherwise
noted.
* * * * *
0
15. Form ID (referenced in Sec. Sec. 239.63, 249.446, 269.7 and
274.402) is amended by adding a check box that reads ``Funding Portal''
in alphabetical order in the list of applicants in Part I; and the
Instructions to Form ID are amended to include the definition of
``Funding Portal'' in alphabetical order under Part I and reads
``Funding Portal: A broker acting as an intermediary in a transaction
involving the offer or sale of securities offered and sold in reliance
on Section 4(a)(6) of the Securities Act, that does not: (1) Offer
investment advice or recommendations; (2) solicit purchases, sales or
offers to buy the securities displayed on its platform; (3) compensate
employees, agents, or other persons for such solicitation or based on
the sale of securities displayed or referenced on its platform; or (4)
hold, manage, possess, or otherwise handle investor funds or
securities.''
Note: The amendments to Form ID will not appear in the Code of
Federal Regulations.
Dated: October 30, 2015.
By the Commission.
Jill M. Peterson,
Assistant Secretary.
Note: The following Exhibit A will not appear in the Code of
Federal Regulations.
Exhibit A
Comment Letters Received Regarding Proposing Release To Implement
Regulation Crowdfunding (File No. S7-09-13)
AABOC: Letter from Doby Gavn, President and CEO, African American
Business Opportunities Communities, Oct. 26, 2013
ABA: Letter from Catherine T. Dixon, Chair, Federal Regulation of
Securities Committee, Business Law Section, American Bar Association
Accredify: Letter from Herwig G. Konings, CEO, Accredify LLC, Nov.
30, 2013
Active Agenda: Letter from Daniel F. Zahlis, Founder, Product
Architect, Active Agenda LLC, Jan. 29, 2014
Advanced Hydro: Letter from Dileep Agnihotri, Ph.D., CEO, Advanced
Hydro Inc., Oct. 23, 2013
AEO: Letter from Connie E. Evans, President & CEO, Association for
Enterprise Opportunity, Feb. 3, 2014
AFL-CIO: Letter from Brandon J. Rees, Acting Director, Office of
Investment, AFL-CIO, Feb. 3, 2014
AFR: Letter from Americans for Financial Reform, March 5, 2014
Ahmad: Letter from Mohamed Ahmad, Aug. 21, 2014
AICPA: Letter from The American Institute of Certified Public
Accountants, Feb. 3, 2014
Amram 1: Letter from Elan Amram, Feb. 3, 2014
Amram 2: Letter from Elan Amram, Feb. 3, 2014
Angel 1: Letter from James J. Angel, Ph.D., CFA, Visiting Associate
Professor, Georgetown University, Feb. 5, 2014
Angel 2: Letter from James J. Angel, Ph.D., CFA, Visiting Associate
Professor, Georgetown University, Jul. 1, 2014
AngelList: Letter from Naval Ravikant, CEO, AngelList, Jan. 24, 3014
Anonymous 1: Letter from an anonymous person, Nov. 9, 2013
Anonymous 2: Letter from an anonymous person, Nov. 13, 2013
Anonymous 3: Letter from an anonymous person, Nov. 25, 2013
Anonymous 4: Letter from an anonymous person, Dec. 5, 2013
Anonymous 5: Letter from an anonymous person, Jan. 25, 2014
Anonymous 6: Letter from an anonymous person, Feb. 7, 2014
Arctic Island 1: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Nov. 4, 2013
Arctic Island 2: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 4, 2013
Arctic Island 3: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 4, 2013
Arctic Island 4: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 4, 2013
Arctic Island 5: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 6, 2013
Arctic Island 6: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 6, 2013
Arctic Island 7: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 6, 2013
Arctic Island 8: Letter from Scott Purcell, Founder and CEO, Arctic
Island LLC, Dec. 31, 2013
ASSOB: Letter from Paul M. Niederer, CEO, ASSOB Equity Funding
Platform Australia, Oct. 25, 2013
ASTTC: Letter from Mark C. Healy, President and Chief Executive
Officer, American Stock Transfer & Trust Company, Brooklyn, New
York, Feb. 3, 2014
AWBC: Letter from Marsha Bailey, Chair, Association of Women's
Business Centers, Feb. 3, 2014
[[Page 71612]]
BackTrack: Letter from Randy Shain, Founder and EVP, BackTrack
Reports, Nov. 12, 2013
Ball: Letter from Robert Ball, Feb. 1, 2014
BCFCU: Letter from Margot Brandenburg, Chair, Brooklyn Cooperative
Federal Credit Union, New York, New York, Feb. 3, 2014
Benavente: Letter from Javier E. Benavente, Jan. 16, 2014
Benjamin: Letter from Jordan Benjamin, Nov. 30, 2013
BetterInvesting: Letter from Kamie Zaracki, Chief Executive Officer,
et. al., Jul. 29, 2014
Borrell: Letter from Monica L. Borell, Jan. 27, 2014
Brown D.: Letter from Douglas Brown, Start-up business owner, Jan.
29, 2014
Brown J.: Letter from J. Robert Brown, Jr., Professor of Law,
University of Denver, Sturm College of Law, Jan. 27, 2014
Bullock: Letter from Leo M. Bullock, IV, Nov. 10, 2013
Bushroe: Letter from Fred Bushroe, Oct. 29, 2013
CalTech Entrepreneurs: Letter from Russell M. Frandsen, Esquire, The
Business Legal Group Executive Committee of the Caltech
Entrepreneurs Forum, Jan. 29, 2014
Campbell R.: Letter from Rutheford B. Campbell, Jr., Spears-Gilbert
Professor of Law, University of Kentucky, Feb. 14, 2014
CAMEO: Letter from Claudia Viek, CEO, California Association for
Micro Enterprise Opportunity, Feb. 3, 2014
CapSchedule: Letter from Scott Purcell, CapSchedule.com, LLC, Oct.
23, 2013
CarbonTech: Letter from Robert Shatz, CEO, CarbonTech Global LLC,
Oct. 24, 2013
CCI: Letter from Carrie Devorah, The Center For Copyright Integrity,
Feb. 3, 2014
CEI: Letter from John Berlau, Senior Fellow, Finance and Access to
Capital, Competitive Enterprise Institute, Feb. 3, 2014
CFA Institute: Letter from Kurt N. Schacht, CFA, Managing Director,
Standards and Financial Market Integrity, and Linda L. Rittenhouse,
Director, Capital Markets, CFA Institute, Feb. 3, 2014
CFIRA 1: Letter from Freeman White, Board Member, et al., CFIRA,
Jan. 19, 2014
CFIRA 2: Letter from Kim Wales, Executive Board Member, and Chris
Tyrrell, Chairman, CFIRA, Jan. 20, 2014
CFIRA 3: Letter from Kim Wales, Executive Board Member, and Chris
Tyrrell, Chairman, CFIRA, Jan. 26, 2014
CFIRA 4: Letter from Kim Wales, Executive Board Member, et al.,
CFIRA, Jan. 26, 2014
CFIRA 5: Letter from Kim Wales, Founder and CEO, Wales Capital, and
Executive Board Member, CFIRA, Jan. 26, 2014
CFIRA 6: Letter from Joy Schoffler, Board Member, et al., CFIRA,
Jan. 27, 2014
CFIRA 7: Letter from Mary Juetten, Board Member, et al., CFIRA, Jan.
31, 2014
CFIRA 8: Letter from Jonathan Miller, Board Member, et al., CFIRA
CFIRA 9: Letter from Daryl Bryant, Board Member, et al., CFIRA, Feb.
4, 2014
CFIRA 10: Letter from Robert Carbone, CFIRA Board Member,
CrowdBouncer, CEO, New York, New York, Feb. 6, 2014
CFIRA 11: Letter from Chris Tyrell, Chairman, and Kim Wales,
Executive Board Member, CFIRA, New York, New York, Feb. 6, 2014
CFIRA 12: Letter from Kim Wales, CEO, Wales Capital, and CFIRA
Executive Board Member, and Scott Purcell, CEO, Artic Island, and
CFIRA Board Member, Apr. 24, 2014
City First: Letter from John Hamilton, President, City First
Enterprises, Washington, District of Columbia, Feb. 3, 2014
Clapman: Letter from Mordechai Clapman, Oct. 25, 2013
ClearTrust: Letter from Kara Kennedy, Executive Director,
ClearTrust, LLC, Jan. 20, 2014
Cole A.: Letter from Adam Cole, Nov. 24, 2013
Cole D.: Letter from Don Cole, Oct. 25, 2013
Commonwealth of Massachusetts: Letter from William F. Galvin,
Secretary of the Commonwealth of Massachusetts, Feb. 3, 2014
Computershare: Letter from Martin (Jay) J. McHale, Jr., President,
US Equity Services, Computershare, Canton, Massachusetts, Feb. 3,
2014
Concerned Capital: Letter from Bruce Dobb, Concerned Capital--A
Social Benefit Corp., Feb. 2, 2014
Consumer Federation: Letter from Barbara Roper, Director of Investor
Protection, Consumer Federation of America, Feb. 2, 2014
Craw: Letter from Kristopher R. Craw, J.D., Denver, Colorado, Jun.
14, 2014
CSTTC: Letter from Steven G. Nelson, President and Chairman of
Continental Stock Transfer Trust Company, Jan. 31, 2014
CST: Letter from Carylyn K. Bell, President, Corporate Stock
Transfer, Inc., Jan. 15, 2014
Coombs: Letter from Jason Coombs, Feb. 7, 2014
CfPA: Letter from Charles Sidman, MBA, Ph.D., President and Chair,
for the Board of, the Crowdfunding Professional Association, Feb. 3,
2014
CRF: Letter from Frank Altman, President and CEO, Community
Reinvestment Fund, USA, Feb. 3, 2014
Cromwell: Letter from David M. Cromwell, Yale School of Management,
Adjunct Professor of Entrepreneurship, Oct. 27, 2013
CrowdBouncer: Letter from Robert C. Carbone, Founder & CEO,
CrowdBouncer, Inc., Buffalo, New York, Feb. 3, 2014
CrowdCheck 1: Letter from Sara Hanks, CEO, CrowdCheck, Inc., Jan. 9,
2014
CrowdCheck 2: Letter from Andrew D. Stephenson, Research Manager,
CrowdCheck, Inc., Jan. 23, 2014
CrowdCheck 3: Letter from Sara Hanks, CEO, CrowdCheck, Inc., Feb. 2,
2014
CrowdCheck 4: Letter from Brian R. Knight, VP, CrowdCheck, Inc.,
Feb. 2, 2014
CrowdFundConnect: Letter from Randy A. Shipley, CrowdFundConnect
Incorporated, Dec. 14, 2013
Crowdpassage 1: Letter from Matthew R. Nutting, Esq., Executive
Director, National Legal Director, Crowdpassage.com, Jan. 31, 2014
Crowdpassage 2: Letter from Matthew R. Nutting, Esq., Executive
Director, National Legal Director, Crowdpassage.com, Jan. 31, 2014
Crowdpassage 3: Letter from Matthew R. Nutting, Esq., Executive
Director, National Legal Director, Crowdpassage.com, Jan. 31, 2014
CrowdStockz: Letter from Frederic C. Schultz, Esq. and Alastair
Onglingswan, Esq., Owners of CrowdStockz.com., CrowdStockETFs.com.,
and CrowdStockFunds.com, Feb. 3, 2014
Crowley: Letter from Vincent Crowley, Nov. 11, 2013
CrwdCorp: Letter from Sean Shepherd, Founder & Chief Executive
Officer, CrwdCorp, LLC, Jan. 16, 2014
Cunningham 1: Letter from William Michael Cunningham, Social
Investing Advisor, Washington, District of Columbia, Feb. 3, 2014
Cunningham 2: Letter from William Michael Cunningham, M.B.A., M.A.,
Social Investing Advisor, Washington, District of Columbia, Feb. 3,
2014
dbbmckennon: Letter from dbbmckennon, Certified Public Accountants,
Oct. 1, 2014
DeMarco: Letter from Peter J. DeMarco, Student, Stanford Law School,
Nov. 12, 2013
Denlinger 1: Letter from Craig Denlinger, CPA, Denver, Colorado,
Feb. 3, 2014
Denlinger 2: Letter from Craig Denlinger, CPA, CrowdfundCPA, Aug.
21, 2014
Doctor: Letter from Roger Doctor, Dec. 10, 2013
Donohue: Letter from Patrick E. Donohue, Minneapolis, Minnesota,
Feb. 24, 2014
DreamFunded: Letter from Manny Fernandez, Co-Founder and CEO,
www.DreamFunded.com, Jan. 8, 2014
Duke: Letter from Heather Duke, Dec. 3, 2013
EarlyShares: Letter from Joanna Schwartz, CEO, EarlyShares.com,
Inc., Feb. 3, 2014
Echterling: Letter from Ian Echterling, Entrepreneur Feb. 21, 2014
Ellenbogen: Letter from David M. Ellenbogen, Jan. 27, 2014
EMKF: Letter from Alicia Robb, Ph.D., Senior Fellow, and Dane
Stangler, Vice President, Research & Policy, Ewing Marion Kauffman
Foundation, Feb. 3, 2014
Empire Stock: Letter from Matthew J. Blevins, Vice President, Empire
Stock Transfer Inc., Jan. 15, 2014
EquityNet: Letter from Judd E. Hollas, Founder and CEO, EquityNet,
LLC
Equity Stock: Letter from Mohit Bhansali, Chief Operating Officer,
Equity Stock Transfer LLC, New York, New York, Feb. 3, 2014
Ex24: Letter from James. P. Lennane, ex24, Inc., Jan. 29, 2014
EY: Letter from Ernst & Young LLP, Feb. 3, 2014
Farnkoff: Letter from Brian Farnkoff, Editor-in-Chief, Journal of
Contemporary Health Law and Policy, Feb. 3, 2014
Farese: Letter from Robert L. Farese, Jr., Oct. 30, 2014
FAST: Letter from Salli A. Marinov, President and CEO, First
American Stock Transfer, Inc., January 23, 2014
Feinstein: Letter from Todd Feinstein, Feinstein Law, P.A., Feb. 3,
2014
Finkelstein: Letter from Elizabeth R. Makris, Finkelstein Thompson
LLP, Jan. 31, 2014
FOLIOfn: Letter from Michael J. Hogan, President & Chief Executive
Officer,
[[Page 71613]]
FOLIOfn Investments, Inc., McLean, Virginia, Feb. 3, 2014
Frutkin: Letter from Jonathan Frutkin, The Frutkin Law Firm, Jan.
30, 2014
Fryer: Letter from Gregory S. Fryer, Esq., Partner, Verrill Dana,
LLP, Portland, Maine, Feb. 5, 2014
FSI: Letter from David T. Bellaire, Esq., Executive Vice President &
General Counsel, Financial Services Institute, Feb. 3, 2014
Fund Democracy: Letter from Mercer Bullard, President and Founder,
Fund Democracy, Associate Professor, University of Mississippi
School of Law, Oxford, Mississippi, Feb. 3, 2014
Funderbuddies: Letter from John Mark Wendler, CPA, Funderbuddies,
Nov. 26, 2013
FundHub 1: Letter from Kendall Almerico, Crowdfunding Expert,
Attorney and CEO, Fund Hub and ClickStartMe, Jan. 29, 2014
FundHub 2: Letter from Kendall Almerico, Crowdfunding Attorney and
CEO of FundHub.Biz, Tampa, Florida, Oct. 8, 2014
Generation Enterprise: Letter from Ubon Isang, Executive, Generation
Enterprise Corporation, Oct. 24, 2013
Gibb: Letter from Jeremy Gibb, Nov. 13, 2013
Gill: Letter from Michael D. Gill, III, Esq., Jan. 22, 2014
Gimpelson 1: Letter from Alexander Gimpelson, Chest Nut Hill,
Massachusetts, Feb. 3, 2014
Gimpelson 2: Letter from Alexander Gimpelson, Chest Nut Hill,
Massachusetts, Feb. 3, 2014
Grassi: Letter from Louis C. Grassi, CPA, CFE, Managing Partner,
Grassi and Co., Jan. 20, 2014
Graves: Letter from Sam Graves, Chairman, U.S. House of
Representatives, Committee on Small Business, Washington, District
of Columbia, Feb. 3, 2014
Greenfield: Letter from Richard D. Greenfield, Esq., Greenfield
Goodman LLC, Nov. 10, 2013
Greer: Letter from Diana Greer, Jan. 27, 2014
Growthfountain: Letter from Growthfountain LLC, Jan. 7, 2014
GSJ Advisors: Letter from George Surgeon, President and CEO, GSJ
Advisors, Ltd., Feb. 3, 2014
Guzik 1: Letter from Samuel S. Guzik, Guzik and Associates, Los
Angeles, California, Feb. 11, 2014
Guzik 2: Letter from Samuel S. Guzik, Guzik and Associates, Los
Angeles, Feb. 20, 2014
Guzik 3: Letter from Samuel S. Guzik, Guzik and Associates, Los
Angeles, California, Feb. 28, 2014
Hackers/Founders: Letter from Charles Belle, Ken Priore, and Timothy
Yim, Hackers/Founders, Feb. 3, 2014
Hakanson: Letter from Sten E. Hakanson, Stillwater, Minnesota, Feb.
28, 2014
Hamilton: Letter from Brenda L. Hamilton, Hamilton & Associates Law
Group, P.A., Nov. 8, 2013
Hamman: Letter from Charles J. Hamman, Oct. 24, 2013
Harrison: Letter from Mark Harrison, Ph.D., Jan. 6, 2014
Holland: Letter from Alexandra D. Holland, Ph.D., Founder and CEO,
PIARCS, PBC, June 3, 2014
Martin: Letter from Andrew Martin, OFS, CB, Rockville, Maryland,
Oct. 18, 2014
MCS: Letter from Andrew M. Hartnett, Missouri Commissioner of
Securities, Feb. 3, 2014
Merkley: Letter from Jeffrey A. Merkley, United States Senator, Apr.
29, 2014
Haylock: Letter from Todd Haylock, Dec. 10, 2013
Heritage: Letter from David R. Burton, Senior Fellow in Economic
Policy, The Heritage Foundation, Feb. 3, 2014
Hyatt: Letter from Todd R. Hyatt, Nov. 6, 2013
IAC Recommendation: Recommendation of the SEC's Investor Advisory
Committee: Crowdfunding Regulations, Apr. 10, 2014
iCrowd: Letter from J. Bradford McGee and John P. Callaghan,
Founders, iCrwod, LLC, Jan. 31, 2014
Inkshares: Letter from Adam J. Gomolin, General Counsel, Inkshares,
Inc., Feb. 3, 2014
Jacobson: Letter from William A. Jacobson, Clinical Professor of
Law, Cornell Law School, and Director, Cornell Securities Law
Clinic, Ithaca, New York, Feb. 3, 2014
Jazz: Letter from Jim C. Shaw, Jazz Gas, Jan. 12, 2014
Johnston: Letter from Phil Johnston, Feb. 3, 2014
Joinvestor: Letter from Bryan Healey, CEO, Joinvestor, Jan. 2, 2014
Kelso: Letter from Carl Kelso, Jan. 7, 2014
Kickstarter Coaching: Letter from Jay Wittner, President Kickstarter
Coaching, Bradenton, Florida, Feb. 3, 2014
Kingonomics: Letter from Rodney S. Sampson, CEO, Kingonomics, Feb.
3, 2014
Kishon: Letter from Mannis Kishon, Dec. 22, 2013
Knudsen: Letter from Michael Knudsen, Jan. 6, 2014
Konecek: Letter from Kathleen Konecek, Nov. 30, 2013
Langrell: Letter from Alex M. Langrell, Camp Pendelton, California,
Jan. 21, 2014
Leverage PR: Letter from Joy Schoffler, Principal, Leverage PR,
Austin, Texas, Sep. 2, 2014
Lopossa: Letter from Gabriel M. Lopossa, Oct. 30, 2013
Luster: Letter from Louise Luster, Oct. 31, 2013
Mahoney: Letter from Steve Mahoney, Managing Director, Highlands
Ranch, Colorado, Jan. 20, 2014
Mantel: Letter from Russ Mantel, Oct. 23, 2013
M.A.V.: Letter from M.A.V., Nov. 3, 2013
Marsala: Letter from Charles E. Marsala -Profitibale Dining LLC,
Feb. 15, 2014
McCulley: Letter from Matthew McCulley, Jan. 10, 2014
McGladrey: Letter from McGladrey LLP, Feb. 3, 2014
Meling: Letter from Rosemary Meling, Oct. 30, 2013
Menlo Park: Letter from James O. Mason, Founder/CEO, Menlo Park
Social Media Crowdfunding Incubator, Feb. 28, 2014
Miami Nation: Letter from Ben Barnes, Director of Tribal Gaming,
Miami Nation Enterprises, Oct. 25, 2013
Milken Institute: Letter from Daniel S. Gorfine, Director, Financial
Markets Policy, and Staci Warden, Executive Director, Center for
Financial Markets, Milken Institute, Washington, District of
Columbia, Feb. 3, 2014
Mlinarich: Letter from Brett A. Mlinarich, Jan. 2, 2014
Mollick: Letter from Ethan R. Mollick, Edward B. and Shirley R.
Shils Assistant Professor of Management, Wharton School, University
of Pennsylvania, Phildelphia, Pennsylvania, Feb. 5, 2014
Morse: Letter from Matt R. Morse, Sr., Dec. 3, 2013
Moskowitz: Letter from Yonatan Moskowitz, Nov. 13, 2013
Moyer: Letter from Mike Moyer, Adjunct Associate Professor of
Entrepreneurship at the University of Chicago Booth School of
Business, Adjunct Lecturer of Entrepreneurship at Northwestern
University, Jan. 25, 2014
Mountain Hardwear: Letter from Alan A. Tabor, Co-founder, Mountain
Hardwear, Jan. 27, 2014
Multistate Tax: Letter from Frank L. Dantonio, Managing Principal,
Multistate Tax Service, LLC, Oct. 29, 2013
NAAC: Letter from Faith Bautista, President and CEO, National Asian
American Coalition, Oct. 31, 2013
NACVA: Letter from David M. Freedman, Editorial Advisor, The Value
Examiner magazine (NACVA), Jan. 16, 2014
NAHB: Letter from David L. Ledford, Senior Vice President, Housing
Finance & Regulatory Affairs, National Association of Home Builders,
Jan. 31, 2014
NASAA: Letter from Andrea Seidt, President, North American
Securities Administrators Association, Inc. (NASAA)
NASE: Letter from Katie Vlietstra, Vice President of Government
Relations Public Affairs, The National Association for the Self-
Employed, Washington, District of Columbia, Feb. 3, 2014
NaviGantt: Letter from Christopher R. York, CEO, NaviGantt, Jan. 27,
2014
NYSSCPA: Letter from J. Michael Kirkland, President, New York State
Society of Certified Public Accountants, Jan. 20, 2014
Nether: Letter from Darrell W. Nether, Nov. 1, 2013
NFIB: Letter from Dan Danner, President and CEO, National Federation
of Independent Business, Feb. 3, 2014
NPCM: Letter from Robert C. Guinto, Jr., President, Non Profit
Capital management, LLC, Oct. 24, 2013
NSBA: Letter from Todd O. McCracken, President, National Small
Business Association, Feb. 3, 2014
Odhner: Letter from Chad E. Odhner, Nov. 25, 2013
ODS: Letter from Faye Morton, General Counsel, Oklahoma Department
of Securities, Feb. 3, 2014
Omara: Letter from Sherouk Omara, Nov. 14, 2013
Otherworld: Letter from Mark Henry, Founder, Otherworld Pictures,
Apr. 11, 2014
Parsont: Letter from Jason W. Parsont, Feb. 18, 2014
Partners: Letter from Jeannine Jacokes, CEO, Partners for the Common
Good, Washington DC, District of Columbia, Feb. 3, 2014
[[Page 71614]]
Patel: Letter from Raj Patel, Jan. 17, 2014
PBA: Letter from Graham R. Laub, Chair, and Katayun I. Jaffari, Vice
Chair, Securities Regulation Committee of the Business Law Section,
Philadelphia Bar Association, Philadelphia, Pennsylvania, Feb. 3,
2014
Peers: Letter from Kit Hayes, Campaign Director, Peers.org, Feb. 7,
2014
Perfect Circle: Letter from Frederick C. Young, Perfect Circle
Solutions, Oct. 30, 2013
PeoplePowerFund: Letter from Steve Mayer, PeoplePowerFund.com, Jan.
31, 2014
Phillips: Letter from Everette Phillips, Entrepreneur, Jan. 15, 2014
Pioneer Realty: Letter from Charles E. Williams, MBA, EA, Founder
and Managing Director, Pioneer Realty Capital, Jan 15, 2014
Platkin: Letter from Matthew Platkin, Nov. 13, 2013
Powers: Letter from Jordan Berg Powers, Nov. 4, 2013
PPA: Letter from Douglas R. Slain, Managing Partner, Private
Placement Advisors LLC
Projectheureka: Letter from Anthony and Erika Endres, Projectheureka
LLC, Nov. 17, 2013
Propellr 1: Letter from Todd M. Lippiatt, CEO, Propellr, LLC, Jan.
27, 2014
Propellr 2: Letter from Todd M. Lippiatt, CEO, Propellr, LLC, Jan.
27, 2014
Public Startup 1: Letter from Jason Coombs, Co-Founder and CEO,
Public Startup Company, Inc., Dec. 15, 2013
Public Startup 2: Letter from Jason Coombs, Co-Founder and CEO,
Public Startup Company, Inc., Feb. 3, 2014
Public Startup 3: Letter from Jason Coombs, Co-Founder and CEO,
Public Startup Company, Inc., Feb. 11, 2014
Public Startup 4: Letter from Jason Coombs, Co-Founder and CEO,
Public Startup Company, Inc., Feb. 22, 2014
Qizilbash: Letter from Muhammad A. Qizilbash, Dec. 18. 2013
Raindance: Letter from Jeffrey L. Tucker, CEO, The Raindance Group,
Dec. 17, 2013
Ramsey: Letter from Rebecca Ramsey, Oct. 24, 2013
Reed: Letter from Terry Reed, J.D., Jan. 21, 2014
Reichman: Letter from Vic Reichman, Esq., Dec. 2, 2013
RFPIA: Letter from T. W. Kennedy, BE, CEO, Regulated Funding Portal
Industry Association, Jan. 26, 2014
Ritter: Letter from Justin A. Ritter, Esquire, Associate Attorney,
Spinella, Owings & Shaia, P.C., Nov. 18, 2013
RoC: Letter from Sang H. Lee, CEO, Return on Change, Jan. 30, 2014
RocketHub: Letter from Alon Hillel-Tuch and Jed Cohen, RocketHub,
New York, New York, Feb. 3, 2014
Rosenthal O.: Letter from Oren Rosenthal, Attorney, Nov. 4, 2013
Sam H.: Letter from Sam H., Oct. 27, 2013
Sander: Letter from Steven M. Sander, CEO, Oct. 27, 2013
Sarles: Letter from Jeff Sarles, Oct. 25, 2013
Saunders: Letter from R. Kevin Saunders, Staff Editor, Vanderbilt
Journal of Entertainment Technology Law, Nashville, Tennessee, Feb.
3, 2014
Sawhney: Letter from Sanjay Sawhney, Jan. 27, 2014
SBA Office of Advocacy: Letter from Winslow Sargeant, Ph.D., Chief
Counsel for Advocacy, and Dillon Taylor, Assistant Chief Counsel for
Advocacy, SBA Office of Advocacy, Jan. 16, 2014
SBEC: Letter from Karen Kerrigan, President & CEO, Small Business &
Entrepreneurship Council, Feb. 3, 2014
SBM: Letter from Cassie Mills, Communications Associate, Small
Business Majority, Feb. 4, 2014
Schatz: Letter from Jonathan Schatz, Nov. 13, 2013
Schwartz: Letter from Andrew A. Schwartz, Associate Professor of
Law, University of Colorado, Boulder, Colorado, Feb. 3, 2014
Scruggs: Letter from Frank Scruggs, Jan. 17, 2014
SeedInvest 1: Letter from Kiran Lingam, Esq., General Counsel,
SeedInvest, Jan. 21, 2014
SeedInvest 2: Letter from Kiran Lingam, General Counsel, SeenInvest,
Jan. 22, 2014
SeedInvest 3: Letter from Kiran Lingam, Esq., General Counsel,
SeedInvest, Feb. 3, 2014
Seed&Spark: Letter from Max Silverman, COO, Seed & Spark
Sewell: Letter from Michael J. Sewell, Esq., Jan 17, 2014
Seyfarth: Letter from Seyfarth Shaw LLP, New York, New York, Feb.
10, 2014
SFAA: Letter from Robert. J. Duke, Corporate Counsel, The Surety &
Fidelity Association of America, Nov. 19, 2013
Sfinarolakis Letter from Manolis E. Sfinarolakis, CFIRA, CFPA,
NLCFA, New Britain, Connecticut, Aug. 6, 2014
Sharewave: Letter from Joshua S. Levine, Co-Founder and CEO,
Sharewave, LLC, Dec. 18, 2013
Smith D.: Letter from Darrell Smith, Jan. 19, 2014
Smith K.: Letter from Kevin G. Smith, Electrical Engineer, Oct. 31,
2013
Song: Letter from Ntxhi Song, Student, Johnson and Wales University
Charlotte, Charlotte, North Carolina, Feb. 3, 2014
STA: Letter from Charles V. Rossi, Chairman, STA Board Advisory
Committee, The Securities Transfer Association, Inc., Dec. 18, 2013
Stalt: Letter from Bill Senner, Stalt, Inc., Jan. 27, 2014
StartEngine 1: Letter from Ron Miller, CEO, StartEngine, Los
Angeles, California, Jul. 25, 2014
StartEngine 2: Letter from Ron Miller, CEO, StartEngine
Crowdfunding, Inc., Oct. 7, 2014
StartupValley: Letter from Daryl H. Bryant, CEO, StartupValley,
Inc., Jan. 15, 2014
Stephenson: Letter from Andrew D. Stephenson, Brian Knight, and
Matthew Bahleda, Feb. 3, 2014
Stieglitz: Letter from Edward B. Stieglitz, Oct. 28, 2013
Syed: Letter from Idrus R. Syed, MBA, Oct. 24, 2013
Tafara: Letter from Peter Tafara, Nov. 8, 2013
Hillside: Letter from Anthony M. Tate, Hillside Technological
Innovation LLC, Cedar Rapids, Iowa, Feb. 11, 2014
TAN: Letter from Olawale Ayeni, MBA, and Bolaji Olutade, Ph.D., The
African Network, Dec. 12, 2013
Taylor M.: Letter from Mack Taylor, Nov. 8, 2013
Taylor R.: Letter from Ryan S. Taylor, Crowdfunder, Oct. 24, 2013
Taylor T.: Letter from Terry L. Taylor, Oct. 24, 2013
Thomas 1: Letter from Jeff Thomas, JD, CPA, Chair of Business and
Associate Professor, Johnson & Wales University, Charlotte, North
Carolina, Feb. 3, 2014
Thomas 2: Letter from Jeff Thomas, JD, CPA, Chair of Business and
Associate Professor, Charlotte, North Carolina, Feb. 3, 2014
Thompson: Letter from Lyle Thompson, Entrepreneur, Dec.10, 2013
Tiny Cat: Letter from L. David Varvel and Ellenor Varvel, Founders,
Tiny Cat Loans, Feb. 3, 2014
TraceFind: Letter from Wendi C. Hawley, MA, ATR-BC, CEO, TraceFind
Technologies, Inc., Oct. 24, 2013
Traklight: Letter from Mary E. Juetten, Founder & CEO,
Traklight.com, Feb. 2, 2014
Tucker: Letter from Gary Tucker, Feb. 17, 2014
US Black Chambers: Letter from Ron Busby, President, US Black
Chambers, Inc., Washington, District of Columbia, Feb. 3, 2014
U.S. Chamber of Commerce: Letter from Tom Quaadman, Vice President,
Center for Capital Markets Competitiveness, U.S. Chamber of
Commerce, Feb. 3, 2014
Verinvest: Letter from David Benway, Chief Executive Officer,
Verinvest Corporation, Jan. 17, 2014
Vann: Letter from James Vann, Greenfield, Missouri, Apr. 11, 2014
Vest: Letter from Sean Osterday & Peter Wild, Vest Inc., San
Francisco, California, Feb. 3, 2014
Vidal: Letter from Eduardo Vidal, Jan. 27, 2014
Vossberg: Letter from Trevor Vossberg, Oct. 23, 2013
Wales Capital 1: Letter from Kim Wales, Founder and CEO, Wales
Capital, Feb. 3, 2014
Wales Capital 2: Letter from Kim Wales, Founder and CEO, Wales
Capital, Mar. 2, 2014
Wales Capital 3: Letter from Kim Wales, Founder and CEO, Wales
Capital, Mar. 12, 2014
WealthForge: Letter from Mathew Dellorso, CEO, WealthForge Holdings,
Inc., Richmond, Virginia, Feb. 3, 2014
Wear: Letter from Zak Wear, Dec. 10, 2013
Wefunder: Letter from Nicholas Tommarello, CEO, Wefunder, January
31, 2014
Whitaker Chalk: Letter from John R. Fahy and Wayne M. Whitaker,
Whitaker Chalk Swindle & Schwartz PLLC, Jan. 7, 2014
Wilhelm: Letter from Jonathan R. Wilhelm, Jan. 27, 2014
Wilson: Letter from Margaret A. Wilson, Professor of Technology
Commercialization, Austin, Texas, Feb. 3, 2014
Winters: Letter from Dennis Winters, Esq., Jan. 9, 2014
WIPP: Letter from Barbara Kasoff, President, Women Impacting Public
Policy, Feb. 3, 2014
Woods: Letter from Thell M. Woods, Jan. 13, 2014
Yudek: Letter from David B. Kopp, CEO, Yudek, Inc. Oct. 29, 2013
[[Page 71615]]
Zeman: Letter from Jason Zeman, Nov. 30, 2013
Zhang: Letter from Runan Zhang, Esq., Law Offices of Runan Zhang,
Washington, District of Columbia, Feb. 3, 2014
7thenterprise: Letter from Jarone V. Price, CEO, 7thenterprise
International Inc., Jan. 22, 2014
11 Wells: Letter from Robert McManus, The 11 Wells Spirits Company,
Jan. 28, 2014
[FR Doc. 2015-28220 Filed 11-13-15; 8:45 am]
BILLING CODE 8011-01-P