regulation crowdfunding

7/24/2019 Regulation Crowdfunding

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November 9, 2015

Regulation Crowdfunding

On October 30, 2015, more than three years after the passage of the Jumpstart Our

Small Business Startups Act of 2012 (the JOBS Act) the U.S. Securities andExchange Commission (the SEC) adopted rules that implement the

crowdfunding provisions of Title III of the JOBS Act.

Title III of the JOBS Act and the SECs rules promulgated thereunder (referred to

herein as Regulation CF) have been called some of the most sweeping changes to

U.S. securities laws since the passage of the Securities Act of 1933 (the Securities

Act). They permit, for the first time, small business issuers to generally solicit

investments in their securities using public advertising, and permitting investment

by both accredited and non-accredited investors. Intended to spur investment in

small business start-ups, Title III of the JOBS Act was a bi-partisan effort that

attempts to apply the power of crowdsmade possible by the Internetto the market

for startup for capital.

This white paper summarizes Regulation CF in a manner intended to provide assistance to

small business owners and professionals who may consider conducting a fundraising through

Regulation CF.

General Requirements

An issuer may sell securities in reliance on Section 4(a)(6) provided that:

1) The aggregate amount of securities sold to all investors by the issuer in reliance on

Section 4(a)(6) during the 12-month period preceding the date of the 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) during the 12-month period preceding the date of such transaction,including the securities sold to such investor shall not exceed:

a) The greater of $2,000 or five percent of the lesser of the investors annual

income or net worth if either the investors annual income or net worth is less

than $100,000; or

b) 10 percent of the lesser of the investors annual income or net worth, not to

exceed an amount sold of $100,000, if both the investors annual income and

net worth are equal to or more than $100,000.

3) The transaction is conducted through an intermediary that complies with the

intermediary rules of Regulation CF and the transaction is conducted exclusively

through the intermediarys platform; and

4) The issuer complies with the requirements in Section 4A(b) of the Securities Act

(including filing certain information, including results of operations and financial

statements, with the SEC and making such information available to potential investors,

not advertising the deal terms, complying with broker and promoter disclosure

requirements), provided that the failure to comply with Rule 227.202, 227.203(a)(3)

and 227.203(b) shall not prevent an issuer from relying on the exemption in Section

4(a)(6).


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Prohibited Issuers

The exemption provided in Regulation CF cannot be used by any issuer that:

1) Is not organized under the laws of any state or the District of Columbia;

2) Is a reporting company under Section 13 or Section 15(d) of the 1934 Act;

3) Is an investment company as defined in Section 3 of the Investment Company Act of

1940;

4) Is disqualified under the disqualification provisions in Section 227.503(a);

5) Has sold securities in reliance on Section 4(a)(6) and has not filed with the Commission

and provided to investors the ongoing annual reports required by Regulation CF during

the two years immediately preceding the filing of the required offering statement; or

6) Has no specific business plan or has indicated in its business plan is to engage in a

merger or acquisition with an unidentified company or companies.

Disclosure Requirements

An issuer relying on the exemption in Regulation CF must file with the Commission and provide

to investors and the relevant intermediary the following information:

a) The name, legal status, physical address and website of the issuer;

b) The names of the directors and officers 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.

c) A description of beneficial owners of 20% or more of the issuers outstanding voting

securities;

d) A description of the business 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 offering does not meet the minimum offering amountthat no securities will be sold in the offering and any investment commitments will be

cancelled and any 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 the issuer will accept;

i) A description of the purpose and intended use of the offering proceeds;

j) A description of the process to complete the transaction or cancel an investment

commitment, including a statement that investors may cancel an investment

commitment until 48 hours prior to the scheduled closing, that the intermediary will

notify investors when the target offering amount has been met, that the closing may

be accelerated if the issuer reaches its target offering amount sooner than expected,

if an investor does not cancel its investment commitment as required that the funds

will be released to the issuer at the closing;k) A statement that if an investor does not reconfirm his investment commitment after a

material change is made in the offering that the investors 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;

m)A description of the ownership and capital structure of the issuer, including the details

of the securities being offered and the details of each other class of security of the

issuer;


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n) The name, SEC file number and CRD number of the intermediary through which the

offering is being conducted;

o) A description of the intermediarys financial interest in the issuers transaction and in

the issuer, including details regarding the intermediarys compensation, financial

interest (if any) in the issuer, and the intermediarys fees;

p) A description of the material terms of any indebtedness of the issuer;

q)

A description of any exempt offerings conducted by the issuer during the past three

years;

r) A description of any material related party transactions closed since the beginning of

the issuers last fiscal year to which the issuer was a party and the amount involved in

the transaction (which materiality defined by amounts in excess of 5% of the amount

raised by the issuer in reliance on Regulation CF) and with related parties defined as

the directors or officers of the issuer, beneficial owners of 20% or more of the issuers

securities, promoters of the issuer, and family members of any of the foregoing; and

s) A discussion of the issuers financial condition including, to the extent material,

liquidity, capital resources and historical results of operations.

The issuer must also provide financial statements for the issuer. The requirements for those

financial statements vary depending on the target offering amount for the issue (in

combination with all offerings made by the issuer under Section 4(a)(6) during the preceding

12-month period).

For issuers with offerings of $100,000 or less, the financial statements must be for the most

recently completed year and must be certified by the issuers chief executive officer. For

issuers with offerings of more than $100,000 but not more than $500,000, the financial

statements must be reviewed by a public accountant that is independent of the issuer. (If the

issuer has audited financial statements the issuer must provide the audited financial

statements.) For issuers offering more than $500,000 the issuers financial statements must

be audited by a public accountant that is independent of the issuer.

The issuer must also disclose any matters that would have triggered disqualification under

Section 227.503(a) but occurred before the effective date of Regulation CF. But, an issuer

that fails to make such disclosure will not be prevented from relying on the exemption in

Section 4(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.

The issuer must also provide:

a) Updates regarding the progress of the issuer in meeting the target offering amount

(which updates must be provided through the intermediary as required by Rule

227.203);

b) Where on the issuers website investors will be able to find the issuers annual report

and the date by which such report will be available on the issuers website;c) Whether the issuer or any of its predecessors previously failed to comply with the

ongoing reporting requirements of Rule 227.202; and

d) Any material information necessary in order to make the statements made, in light of

the circumstances under which they were made, not misleading.

(Rule 227.201)


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Ongoing Reporting Requirements

After the consummation of an offering exempt under Regulation CF, the issuer must file with

the Commission an annual report along with financial statements certified by the issuers chief

executive officer and various statements regarding the business of the issuer. (Rule 227.202)

Filing Requirements

An issuer intending to rely on Regulation CF for an exempt offering must:

1) File a Form C offering statement with specified information;

2) File amendments to its Form C offering statement when required; and

3) File progress updates when required by Regulation CF.

(Rule 227.203)

Advertising

Regulation CF contains specific restrictions on how issuers may advertise the existence and

terms of their crowdfund offerings.

An issuer may not, directly or indirectly, advertise the terms of an offering under Regulation

CF except for a notice that advertises the terms of the offering and that directors investors to

the intermediarys platform and includes no more than the following items of information:

1) A statement that the issuer is conducting an offering under Regulation CF, the name

of the intermediary through which the offering is being conducted and a link directing

the potential investor to the intermediarys platform;

2) The terms of the offering; and

3) Factual information about the legal identify and business location of the issuer, limited

to the name of the issuer, the address, phone number and website of the issuer, the

email address of a representative of the issuer and a brief description of the business

of the issuer.

This requirement limits written advertising to factual statements that meet the requirements

of the rule.

Notwithstanding this general limitation, however, 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 intermediarys

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 intermediarys platform. Presumably, this additional pathway for

advertising is intended to permit direct communications and non-written presentations (such

as webinars) that are provided on the intermediarys platform and that comply with theremaining provisions of the rule. (Rule 227.204)

Promoter Compensation

Regulation CF contains specific requirements pertaining to compensation paid by an issuer to

promoters of the issuer.

In general, an issuer may compensate or commit to compensate, any person to promote the

issuers offerings made in reliance on Regulation CF but only if the issuer takes reasonable


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steps to ensure that the person promoting the offering clearly discloses the receipt, past or

prospective, of such compensation with any communication it makes. The promoter must

make all of its communications to prospective investors through communication channels

provided by the intermediary on the intermediarys platform.

One of the rationales for this rule is that, by requiring promoters to communicate to

prospective investors solely through communication channels on the intermediarys platform,the rule ensures that all such communications will be channeled through the intermediary. By

doing this the rule is trying to ensure that a record is established of all investor

communications so that parties will be able to prove the existence of those communications

at a later time in the event of a dispute. (Rule 227.205)

Requirements for Intermediaries

Regulation CF requires all transactions involving the offer or sale of securities in reliance on

Section 4(a)(6) to be conducted through an intermediary and exclusively through the

intermediarys platform.

An intermediary may be either a broker registered under Section 15(b) of the Exchange Act

or a funding portal registered under Section 227.400. A platform means a program orapplication accessible via the Internet or other similar electronic communication medium

through which a registered broker or funding portal acts as an intermediary.

No director, officer or partner of an intermediary may have a financial interest in an issuer

that is conducting a Section 4(a)(6) offering through its intermediarys platform, or receive a

financial interest in an issuer as compensation for the services provided to the issuer in

connection with Section 4(a)(6) offering.

An intermediary may not have a financial interest in an issuer that is offering or selling

securities in reliance on Section 4(a)(6) through the intermediarys platform unless:

1) The intermediary receives the financial interest from the issuer as compensation for

the services provided to the issuer in connection with the Section 4(a)(6) offering; and2) 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 the Section

4(a)(6) offering through the intermediarys platform. (Rule 227.300)

Measures to Reduce Risk of Fraud

Regulation CF contains specific requirements pertaining to an intermediarys role in reducing

the risk of fraud.

In general, an intermediary must have a reason for believing that an issuer seeking to offer

and sell securities in reliance on Section 4(a)(6): (a) complies with the requirements in

Section 4A(b) of the Securities Act and Regulation CF; and (b) has established means to keep

accurate records of the holders of the securities being offered and sold through theintermediarys platform.

If an intermediary has reason to believe that the issuer (or any of its representatives or

security holders owning more than 20 percent) is subject to a disqualification under Section

227.503 or presents the potential for fraud or otherwise raises concerns about investor

protection, then such intermediary must deny access to its platform. (Rule 227.301)


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Account Opening

Regulation CF contains specific disclosure requirements that intermediaries and issuers must

comply with prior to opening any accounts and accepting any investment commitments from

investors.

No intermediary may accept an investment commitment until the investor has opened an

account with the intermediary and the intermediary has obtained from the investor consent

to electronic delivery of materials. All information required to be delivered by the intermediary

under Sections 227.300 through 305 (including educational materials, notices, confirmations,

etc.) must be delivered through electronic means.

The educational materials required to be delivered to investors must effectively and accurately

explain in plain language:

(i) The process for the offer, purchase and issuance of securities and the risks associated

with a Section 4(a)(6) offering;

(ii) The types of securities offered and sold in a Section 4(a)(6) offering and the risks

associated with each type of security;(iii) The restrictions on the resale of a security offered and sold in a Section 4(a)(6)

offering;

(iv) The types of information that an issuer is required to provide, 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 Section

227.100(a)(2);

(vi) The limitations on an investors 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) is appropriate for that investor;

(viii) That following completion of an offering conducted through the intermediary, theremay 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.

In connection with establishing an investors account, an intermediary must inform theinvestor that any person who promotes an issuers offering for compensation must clearlydisclose, in all communications on the platform, (a) the receipt of the compensation and (b)that such person is engaging in promotional activities on behalf of the issuer.

Additionally, an intermediary must clearly disclose the manner in which the intermediary is

compensated in connection with the Section 4(a)(6) offering. (Rule 227.302)Intermediary Requirements Transactions

An intermediary must make available to the Commission and to investors any information

required to be provided under Section 227.201 (Disclosure Requirements) and 203(a) (Form

C-Offering Statement and Amendments). This information must (1) be made publicly

available on the intermediarys platform, (2) be in a manner that reasonably permits a person

accessing the platform to save, download, or otherwise store the information, (3) be available


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for a minimum of 21 days before any securities are sold in the offering, and (4) remain publicly

available on the intermediarys platform until the offering is completed or cancelled.

Prior to accepting any investment commitment, an intermediary must:

1) Have a reasonable basis for believing that the investor satisfies the investment

limitations established by Section 4(a)(6)(B) and this Regulation CF; and

2) Obtain from the investor: (i) a representation that the investor has reviewed the

educational materials and understands the risks involved in the offering, and is in a

financial condition to bear the loss of the investment; and (ii) a questionnaire

completed by the investor demonstrating the investors understanding of the Section

4(a)(6) offering.

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 intermediarys 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 issuers offering.

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 investmentcommitment; (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.

An intermediary that is a registered broker must comply with the requirements of 17 CFR

240.15c2-4 (Transmission or maintenance of payments received in connection with

underwritings). An intermediary that is a funding portal must direct investors to transmit the

money directly to a qualified third party that has agreed in writing to hold the funds in escrow.

A qualified third party includes certain registered brokers or dealers, banks or credit unions.

An intermediary must, at or before the completion of a Section 4(a)(6) offering, send notice

to each investor 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, and sold by the issuer in the transaction; (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. (Rule 227.303)


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Completion of Offerings, Cancellations and Reconfirmations

Regulation CF contains specific requirements pertaining to an investors ability to cancel its

investment commitments.

Generally, an investor may cancel an investment commitment for any reason until 48 hours

prior to the deadline identified in the issuers offering materials. During the 48 hours prior to

such deadline, an investment commitment may not be cancelled except as provided in Section

227.304(c).

If an issuer reaches the target offering amount prior to the deadline identified in its offering

materials, the issuer may close the offering on a date earlier than such identified deadline,

provided that:

1) The offering remains open for at least 21 days pursuant to Section 227.303(a);

2) The intermediary provides notice to any potential investors and investors that have

made investment commitments, of: (i) the new deadline; (ii) the right of investors to

cancel investment commitments for any reason until 48 hours prior to the new

deadline; and (iii) whether the issuer will continue to accept investment commitments

during the 48-hour period prior to the new deadline;3) The new offering deadline occurs at least five business days after the required notice

is provided; and

4) At the time of the new offering deadline, the issuer continues to meet or exceed the

target offering amount.

Section 227.304(c). During the 48-hour period prior to such deadline, an investment

commitment may only be cancelled if there is a material change to the terms of an offering

or to the information provided by the issuer. If there is a material change, the intermediary

must give notice to any investor who has made an investment commitment and cancel such

investment commitment unless the investor reconfirms his or her investment commitment

within five business days of receipt of the notice. If the investor fails to reconfirm within the

five days, the intermediary must, within the next five business days, (i) send notification thatthe 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. If material

changes 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.

If an issuer does not complete an offering, an intermediary must within five business days:

1) 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 offeringon its platform.

(Rule 227.304)


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Payments to Third Parties

Regulation CF prohibits an intermediary from compensating any third party for providing the

intermediary with information of any investor or potential investor that can be used to

distinguish or trace such individuals identity. (Rule 227.305)

Funding Portal Regulation

Regulation CF contains detailed requirements in Section 227.400 for the registration of

funding portals with the SEC. Those requirements include a requirement that funding portals

be licensed through FINRA. FINRA has recently finalized its own rules for the licensure of

funding portals. See Release No. 34-76239; File No. SR-FINRA-2015-040, Self-Regulatory

Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of a Proposed

Rule Change to Adopt the Funding Portal Rules and Related Forms and FNRA Rule 4518, 80

Fed. Reg. 66348 (Oct. 28, 2015), available at

http://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-040-federal-register-

notice.pdf.


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About Taylor English Duma LLP

Taylor English Duma LLP is a full-service law firm built from the ground up to provide highest-

quality legal services for optimal value. The firm was founded in 2005 and its attorneys work

each day to provide timely, creative and cost-effective counsel to help clients solve problems

and achieve goals. Taylor English represents all types of clientsfrom Fortune500 companies

to start-ups to individuals. More information can be found on the firms website atwww.taylorenglish.com.

Authors

Jonathan B. [email protected]

Jonathan B. Wilson is a member of the firms Corporate andBusiness practice group and his practice includes corporatesecurities, corporate finance and governance, mergers andacquisitions, and intellectual property.

Eric A. [email protected]

Eric A. Tanenbaum focuses his practice on advising clients ofall sizes on a variety of corporate matters, including mergers,acquisitions and dispositions, joint ventures, start-ups,franchising and general corporate representation.

Morris O. Little, [email protected]

Morris O. Little, Jr. is a corporate lawyer focusing in the areasof aviation, commercial lending, commercial and governmentcontracting, health care, and hospitality, including alcohollicensing matters.

Kean J. [email protected]

Kean J. DeCarlo is a leader in both the mechanical andmedical technology sectors and actively counsels clients onpatent, trademark, trade dress, licensing, unfair competition,

copyright, trade secret, and Internet matters.

regulation crowdfunding

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