Authored by Senator
Jeff Merkley (D-OR), Title III of the JOBS Act adds a new crowdfunding
exemption from the Securities Act allowing companies to accept and pool
donations of up to $1 million over the Internet. Generally, the term
crowdfunding describes a new form of raising capital whereby groups of people
pool money, typically comprised of small individual contributions, to support
an entrepreneurial effort.
Title III imposes disclosure
obligations on both crowdfunding intermediaries and
crowdfunding issuers. For their
part, issuers are required to provide to investors a number of typical offering disclosures
including, among others, the business's name and legal status, the names of
directors and officers, a description of the business of the issuer, and
a report of financial condition. The Ohio Securities Division encourages the
Commission to mandate a single-offering-circular standard, incorporating
disclosures prepared by
both the intermediary
and the issuer.
One disclosure document is
simpler, reasoned the Division, and
may encourage investors
to more fully
review and consider
the document. Moreover, a
single offering document
would be consistent
with other types
of offerings where two
parties are responsible
for preparing disclosure, for example,
in an underwritten public
offering, underwriters and issuers
generally work together to craft
a single disclosure document.
Each offering should
clearly disclose that the issuer is
seeking an exemption from both state and
federal securities registration
and therefore no
regulatory agency has
reviewed the offering. The offering should clearly state that an investor
must make his or her own investment decision.
The offering should also clearly state that regulatory agencies
do not recommend or endorse the
investment for any offeree and that any
representation to the contrary is a
violation of state and federal securities laws.
This disclosure is similar to that required by Rule 253(d) under
the Securities Act.
The Division also asked
the SEC to consider restricting if not
prohibiting outright, the use of
any forecasts or projections of the issuer's future financial performance,
whether by the issuer, the
intermediary, or any
officer, director, employee
or agent of either.
In the Division's experience,
forecasts and projections
are often rife with fraud,
bear no reasonable basis in reality, and fail to
identify the assumptions made and
the sources of information relied upon.
The Division
explained that it is widely accepted that Title III was intended to be used by
very young issuers, and even true
start-ups. An issuer with little or
no operating history has no historical
basis on which
to reasonably predict
future operating results.
The factual or historical
basis on which
to reasonably predict
future financial returns
becomes even more tenuous
where a business
is led by
inexperienced management, employs
new or unproven processes, offers
new or untested
products or services, or
enters new markets
with unknown levels of demand and
competition. In the Division’s view, it
is difficult to see how any young entity or start-up can, in good faith
and with a sound
factual or historical
basis, predict its future
financial performance..
Title III requires
that each crowdfunding issuer provide a description of the business
of the issuer and the
anticipated business plan of
the issuer. Traditionally, a business
plan was a planning document prepared by management for internal use only, and
not intended to be
disseminated outside the
company. Among start-up companies, however, the word
business plan has taken on the meaning of a marketing document used to pitch
investors, not to
disclose the materials
terms and risks
of a securities offering. They
are neither tailored for prospective investors nor drafted with the securities
laws in mind. Thus, the Division said the Commission should
clarify the meaning of the term
"business plan," as used in Title
III so that issuers do not inadvertently
provide to investors a document that opens the issuer to potential civil and
criminal liability.
Title III conditions
the exemption on at least an annual SEC filing of reports of the
results of operations and
financial statements. In the Division’s view, the most appropriate
interpretation of this provision is to require the annual filing of updated
financial statements for the fiscal year
end in the form as
referenced in Section
4A(b)(l) which were provided to investors. Smaller issuers should not be required to
obtain an audit. However, the Commission
should require audited financial
statements for the larger size
offerings over $500,000 and for smaller issuers if during the course
of their business they obtain an audit for other purposes.
Under Title
III, the crowdfunding exemption is only available
to offerings transacted through
a broker or
funding portal. Because
crowd funding offerings are
exempt from registration and review by the Commission, and
preempted from review by state securities regulators, Congress placed
upon intermediaries the
responsibility of serving as
the primary gatekeepers to
the crowdfunding marketplace. As such, the intermediaries must play a critical role in ensuring the integrity of the
market and maintaining meaningful investor protections. It is crucial that the Commission's
rulemaking recognizes the significance of this role, and requires crowdfunding intermediaries to
uphold their obligation.
Unlike
broker-dealers, the activities of funding
portals are significantly restricted under Title III of
the JOBS
Act. Funding portals
may not offer
investment advice or make recommendations. The Division hinted
that strong guidance from the Commission may be needed to inform this new
breed of industry professional about the
broad scope of both
recommendation and investment advice activities. This guidance may prevent them from creeping
into practices prohibited by the statute down the road and would also inform
the public of the extent of the lawful capabilities of funding portals.
Crowdfunding intermediaries will
have extensive due
diligence obligations under existing
securities law and
under the Title III, noted the
Division. As an
initial matter, new
Section 4A(a)(5) of the Securities Act provides, in part,
that crowdfunding intermediaries
are to take such measures to
reduce the risk of fraud with respect to such transactions, as
established by the Commission, by rule. According to the Division, this
section establishes a due diligence requirement by noting that the measures to
reduce the risk of fraud include conducting a criminal and securities
enforcement background check of officers, directors, and 20 percent shareholders of an issuer.
Moreover, given the balance of power in these
transactions, the Division believes that crowdfunding intermediaries may be the
only securities professionals with the bargaining power necessary to
require access to the issuer's information, given that the
issuers cannot conduct a crowdfunding offering without the intermediary. Investors will view crowdfunding
intermediaries not merely
as passive "bulletin boards,"
noted the Division, but as active gatekeepers that
make representations regarding
licensing and their
affiliation with a
self-regulatory agency,
and offer various securities with different pricing.