Crowdfunding and General Solicitation Bills Move Forward

The Committee on Financial Services of the House of Representatives has approved two bills which could have a major impact on private securities offerings (we discussed each of these bills in a previous post).  The first bill, HR 2930, would establish an exemption under the federal securities laws for “crowdfunded securities.”  The second bill, HR 2940, would eliminate the ban on “general solicitation” for private securities offerings conducted under Rule 506 of Regulation D.  Now that the Financial Services Committee has approved these bills, the bills will be considered by the full House of Representatives.  Each of the bills is described in more detail below.

Elimination of General Solicitation Ban

Under current SEC rules, companies seeking to raise capital are generally prohibited from seeking investors by means of a “general solicitation.”  This means that the company cannot approach potential investors unless a principal of the company or an agent of the company has a substantive, pre-existing relationship with that investor.  Accordingly, even if the company knows that the investor is, for example, listed on the Forbes 400 list of the world’s wealthiest individuals, the company cannot approach the investor about investing in the offering unless there is a pre-existing relationship.

HR 2940 directs the SEC to eliminate the ban on general solicitation and advertising with respect to offerings conducted under Rule 506 of Regulation D.  This is the exemption that is most typically used by companies conducting private offerings.  The only limitation in the bill is that all investors in such an offering must be “accredited investors.”  (Information on recent changes to the “accredited investor” definition can be found here)

We believe that this bill could be a game changer with respect to private offerings and could significantly boost the ability of early stage companies to obtain needed capital.

Crowdfunding Exemption

HR 2930 would establish an exemption under the federal securities laws for sales of certain “crowdfunded” securities.  The term “crowdfund” typically refers to the raising of funds in small amounts from a large group of contributors.  In its original incarnation, the bill would have allowed up to $5 million to be raised under this exemption.  Unfortunately, the bill has been watered down substantially.  Below are the basic requirements to satisfy the exemption under the current version of the bill:

• The aggregate annual amount raised cannot exceed $1 million ($2 million if the issuer provides investors with audited financial statements).
• The total amount invested by each investor cannot exceed $10,ooo per year (or 10% of the investors income, if less).
• The securities cannot be resold within the first year after issuance (except to the issuer or an accredited investor).
• Certain “bad actors” will be disqualified from utilizing the exemption.  The SEC is directed to issue rules implementing the disqualification standards.
• Importantly, the bill pre-empts state law.  This means that issuers would not be required to obtain an exemption under state blue sky laws for an offering conducted under this exemption.  This is critical since each state has different blue sky laws and most state laws do not contain an exemption similar to this bill.  It is unlikely that any issuer would utilize the crowdfunding exemption if the issuer was required to comply with 50 different state laws.

In addition to the general requirements listed above, the bill contains two separate sets of similar requirements that must be satisfied.  One set of requirements applies if the issuer is using an “intermediary.”  The second set of requirements applies if the issuer is not using an intermediary.  The requirements applicable to an issuer who is not using an intermediary are summarized below:

• The issuer must provide certain warnings to the investor.  It appears that these warnings are similar to the language we already include in subscription agreements.
• The issuer must provide the SEC with certain basic information and must also provide the SEC with ”investor level access” to the issuer’s web site.
• The issuer must obtain answers to certain questions from each investor.
• The issuer must disclose a target offering amount and withhold offering proceeds until the aggregate capital raised from investors other than the issuer is no less than 60 percent of the target offering amount.  This appears to be similar to escrow accounts commonly used in private offerings.
• The issuer must provide the SEC with a basic notice of the offering.  Curiously, the bill does not mention Form D - a previously established method for providing electronic notice of an offering to the SEC.
• The issuer must outsource cash management functions to a broker-dealer or an insured bank.  Again, it would appear that the typical bank escrow would satisfy this requirement.
• The issuer must maintain such books and records as the SEC deems appropriate (hopefully this won’t result in a requirement to obtain audited financials).
• The issuer must provide a method on the issuer’s web site to enable investors and the issuer to communicate.

As with the bill eliminating the ban on general solicitation, this bill would significantly increase the ability of small companies to access capital in an efficient and inexpensive manner.  We will continue to update you on developments in this area.

-Wythe Michael