The Securities and Exchange Commission passed by a 3-1 vote on Friday long-awaited final equity crowdfunding rules and proposed to update rules on intrastate crowdfunding.
The dissenting vote was cast by the only Republican commissioner, Michael Piwowar, who said on the day before Halloween that he believed “traps hidden” in the final rules would “spook” small companies and investors from participating in crowdfunding.
“While crowdfunding was intended to be a treat for the smallest and least sophisticated companies seeking to raise capital, today’s rules are full of tricks,” Piwowar said. “The rules will spin a complex web of provisions and requirements for compliance,” adding that he fears “many traps for the unwary are hidden in the regulations, creating potential nightmares for small-business owners that fail to place regulatory compliance at the top of their business plans.”
The SEC also issued proposed amendments to existing Securities Act Rule 147 to modernize the rule for intrastate offerings to further facilitate capital formation, including through crowdfunding.
The final equity crowdfunding rules allow the “offer and sale of securities through crowdfunding,” and give small businesses an additional avenue “to raise capital and provide investors with important protections,” SEC Chairwoman Mary Jo White said during the open meeting at SEC headquarters in Washington.
The rules — three years in the making — would complete the Commission’s major rulemaking mandated under the Jumpstart Our Business Startups (JOBS) Act. White said Friday that the final rules were a “full re-evaluation” of the proposed rules the Commission first floated in 2013.
The Financial Industry Regulatory Authority, which is charged with regulating broker-dealers that intend to develop Internet funding portals, filed with the SEC on Oct. 22 its proposed rule changes for funding portals, including the registration rules, and is waiting for Commission action, SEC Commissioner Luis Aguilar stated at the meeting. He urged the Commission and staff to “expedite the review of FINRA’s application.”
Funding portals are required to register with the Commission and to become FINRA members.
While the SEC noted the importance of monitoring the progress of the new rules that allow nonaccredited investors to invest in startups and other private businesses, financial services firms applauded the SEC’s adoption of the crowdfunding rules.
The SEC’s rules allow individuals to purchase securities in crowdfunding offerings subject to certain limits, require companies to disclose certain information about their business and securities offering, and create a regulatory framework for the intermediaries facilitating crowdfunding transactions.
Specifically, the SEC rules would:
Permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period;
Permit individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to:
If either their annual income or net worth is less than $100,000, than the greater of: $2,000 or 5% of the lesser of their annual income or net worth
If both their annual income and net worth are equal to or more than $100,000, 10% 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.
SEC staff is required to monitor and submit a report to the Commission no later than three years following the effective date of the crowdfunding rules assessing the impact of the regulation on capital formation and investor protection. Jim Dowd, CEO of North Capital Private Securities, says that he’s pleased the SEC’s rulemaking process “underscores the seriousness” the SEC places on investor protection, and that as with a lot of SEC rules “the details will get worked out as we live with them.”
Dowd noted two “important” changes to the final rules. First, that the rules require no audits for first time issuers. “This is great news since with most startups an audit adds little or no value,” he says.
Second, investor limits are reduced to lower of income or net-worth limit. “Some intermediaries will complain about this, but it is an additional mandatory risk-reduction mechanism for investors,” Dowd says. “We do not believe that the revised limit will be too restrictive. Over time, if it does appear too restrictive (or too generous), I expect the rules will be revisited.”
Denise Valentine, a senior analyst with Aite Group’s Institutional Securities & Investment team, hailed the SEC’s rules as providing “an additional alternative asset class for the investing public.”
While the rules include limits on what investors can invest, they are “far lower than that of an accredited investor, meaning billions of dollars for small new issuers and businesses for overall economic growth.”
Valentine noted that “investors will need education and validation of their risk appetite,” and that the crowdfunding platforms “must ensure issuer parameters.” She anticipates that independent experts from advisory and investment advice firms will step in to offer up such guidance.
The proposal rule involving intrastate crowdfunding would amend Securities Act Rule 504 to increase the aggregate amount of money that may be offered and sold pursuant to the rule from $1 million to $5 million and apply bad actor disqualifications to Rule 504 offerings to provide additional investor protection.
— Check out 11 Cool Crowdfunded Products on ThinkAdvisor.