Untitled Extract PagesThe growing use of social media has created challenges for federal securities regulators and, given the significance of social media as a preferred method of communication for a large percentage of market participants, the need to adapt Federal securities laws and the regulatory framework applicable to broker-dealers and investment advisers to social media channels has become all the more urgent.

To help navigate these issues, Socially Aware contributors and Morrison & Foerster partners Jay Baris and David Lynn have just released their Guide to Social Media and Securities Law, which provides a comprehensive overview of how federal regulation of securities has evolved in the face of the growing use of social media by investors, securities issuers, broker-dealers, investment advisers and investment companies.

The guide is now available here. We think that you will find it to be a terrific resource.

As the use of social media continues to grow, social media is likely to play an increasingly more prominent role in proxy contests. In this context, the recent Compliance and Disclosure Interpretations issued by the SEC’s Division of Corporation Finance provide helpful clarifications on how social media outlets can be used in proxy contests in compliance with SEC regulations.

SOCIAL MEDIA’S IMPACT ON PROXY CONTESTS

Activist investors have used social media and have at times been able to “move the market” through social media statements in support of or against a public company. Carl Icahn first used Twitter to express his concerns against Dell Inc.’s buyout in 2013, referencing his interest in Dell in his first Twitter posting. Icahn also made extensive use of social media in the recent eBay, Inc proxy contest, in which Icahn pressured eBay to add two of Icahn’s nominees to eBay’s board of directors and to spin off eBay’s PayPal division. Icahn made multiple statements related to the eBay proxy contest through his personal Twitter account, including a link to an article about eBay’s corporate governance problems, links to letters on Icahn’s website supporting his position and criticizing eBay, and short jabs at eBay that could stand alone within the 140 character limitation of a Twitter post. Similarly, members of eBay’s board also used Twitter to announce their positions against Icahn in the proxy contest (In April 2014, Icahn and eBay reached an agreement that put one of Icahn’s nominees on the eBay board).

In the general effort to inform and persuade shareholders during a proxy contest, social media can be a powerful tool, and it can grab the attention of a larger audience. As Carl Icahn’s example suggests, social media can be used to make statements with a length and tone tailored to a specific social media platform, and to share links to information and analysis that provide more depth and greater disclosure to an interested reader.

Continue Reading Social Media and Proxy Contests

The latest issue of our Socially Aware newsletter is now available here.

In this issue of Socially Aware, our Burton Award-winning guide to the law and business of social media, we analyze a groundbreaking FTC complaint alleging deceptive practices online that could turn website Terms of Use into federal law; we summarize a U.S. Supreme Court copyright case that could impact existing technologies and future technological innovation; we discuss a ruling from Europe’s highest court that will aid copyright owners in the fight against illegal streaming sites; we report on new SEC guidance on social media use by investment advisers as it relates to testimonials; we take a look at the development of the Internet of Things and the many regulatory, privacy and security issues that go along with it; and we highlight a recent class action decision that potentially impacts any company that hosts videos on its website.

All this—plus a collection of thought-provoking statistics about digital music…

The staff of the Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC) recently provided guidance on applying its rules regarding communications in connection with securities offerings, tender offers, business combinations and proxy contests when statements are made utilizing certain social media channels. The staff’s guidance permits the use of a hyperlink to information required by certain rules when a character- or text-limited social media channel such as Twitter is used for a regulated communication, and also confirms that, at least in the context of a securities offering, a communication that has been re-transmitted by a third party that is not an offering participant or someone acting on behalf of the issuer is not attributable to the issuer for the purposes of the rules that apply to such communication. Continue Reading SEC Staff Guidance on the Use of Social Media in Securities Offerings, Tender Offers, Business Combinations and Proxy Contests

When the Securities and Exchange Commission lifted the ban on general solicitation and general advertising for private offerings of securities, can marketing blitzes on Twitter and other social media sites be far behind?

It is not likely that we will see hedge funds aggressively touting investments on Twitter, or on bus shelters or milk cartons any time soon, because federal regulations will limit what issuers can say in these media.  Even then, hedge funds and other issuers will want to proceed cautiously, because they must comply with specific rules designed to prevent fraud.

Lifting the ban on general solicitation.  For decades, start-ups, hedge funds and other companies seeking capital could only solicit investors in private offerings.  These issuers could only publicly offer their shares if they registered such shares with the SEC.  Further, commingled funds could only publicly offer their shares by registering with the SEC under the Investment Company Act.  In either case, registration involved significant capital, disclosure, reporting and operational restrictions that start-ups and hedge funds found prohibitive.

The Jumpstart Our Business Startups Act (JOBS Act), which Congress enacted in April 2012,  ordered the SEC to relax the ban on general solicitation and general advertising in certain private offerings.  Among other things, this law required the SEC to adopt rules to allow issuers to make a general solicitation of investors, and to advertise, without registering with the SEC.

On July 10, 2013, the SEC published regulations implementing the JOBS Act’s mandates to ease the ban on general solicitations.  While this development is welcome news to start-ups and small hedge funds that want new investors but can’t afford the costs of registering with the SEC, the rules come with some important catches.  Most notably, issuers relying on the new exemption can only sell shares to “accredited investors,” that is, investors that meet minimum annual income or net worth thresholds.  They must also file with the SEC “Form D,” which contains specific information about the issue and the issuer.  Click here to read our client alert, Goldilocks, Porridge and General Solicitations.

General Advertising. The SEC proposed rules that would require issuers to disclose prominently certain warnings in “any written communication that constitutes a general solicitation or general advertising” of any offering that relies on the new exemption from registering shares with the SEC.  Social media entries and blogs fall squarely within this category, thus creating compliance challenges for issuers that want to find investors in social media.  For example, all issuers must disclose in all written communications and advertising that:

  • the securities may be sold to “accredited investors;”
  • the securities are being offered in reliance on an exemption from the registration requirements of the federal securities laws and thus do not have to comply with those disclosure requirements;
  • the SEC has neither passed upon the merits nor approved the offering;
  • the securities are subject to legal restrictions on transfer and resale and investors should not assume they will be able to resell their securities; and
  • the investment involves risk.

To be sure, it will be difficult to cram these disclosures into a 140 character tweet.

Private funds.  Private funds, such as hedge funds and private equity funds, must also disclose that the offering is not subject to the protections of the Investment Company Act, which regulates investments in mutual funds, ETFs and other registered pooled investment vehicles.  Further, private funds that want to mention performance would also be required to disclose, in any written communication, that, among other things:

  • performance data represents past performance;
  • past performance does not guarantee future results;
  • current performance may be lower or higher than performance data presented;
  • the private fund is not required by law to follow any standard methodology when calculating and representing performance data;
  • the performance of the private fund may not be directly comparable to the performance of other funds; and
  • investors can call a phone number or visit a website for more current performance data.

The SEC believes that private funds should be subject to the same rules for advertising and written communications that apply to mutual funds, whether or not the private funds rely on the exemption from registration.  Click here to read about the SEC’s performance advertising guidelines.

The SEC is watching.  The SEC will monitor general solicitations, general advertising and social media entries posted by issuers, including private funds.  This area is fertile ground for SEC enforcement proceedings.  Accordingly, you should proceed with cautiously when discussing private offerings, especially in social media, where cramming in all required disclaimers may be difficult.

Federal securities regulators have published guidance for issuers, investment advisers, broker-dealers and investment companies that use social media.  Click here to read our Guide to Social Media and the Securities Laws, which contains a comprehensive summary of this regulatory guidance.  Click here to read our post about a recent FINRA compliance examination sweep of broker-dealer use of social media.  You can listen to our presentation about use of social media by investment advisers, broker-dealers and investment companies by clicking here.

Article courtesy of Morrison & Foerster’s MoFo Tech

As financial institutions and investors turn to social media to instantly share snippets of news and potential clues about market trends, the FBI and SEC are monitoring such postings for evidence of insider trading and improper investment information. Companies must comply with pre-Internet federal securities laws covering antifraud, advertising, record keeping, and more, even though the use of Facebook and Twitter is far outpacing the development of federal regulations aimed at social media.

Late last year, two FBI agents told Reuters that they see social media as a breeding ground for insider trading and securities fraud. “If there is any way to exploit it, these individuals will,” one agent said. The FBI also began a public search for an application that would scan social media for national security threats. “In trying to establish whether a trader who made significant gains in advance of market-moving news got nonpublic information from a company insider, the FBI might be interested in a list of the trader’s friends and contacts on social media sites,” says J. Alexander Lawrence, a Morrison & Foerster partner who works in securities law. “Evidence on Facebook, LinkedIn, or other sites could help the FBI connect the dots.”

Government investigators have been pursuing insider traders with growing intensity, according to Morrison & Foerster’s 2012 Insider Trading Annual Review. One reason could be the relative lack of success in bringing cases related to the financial crisis. “While the SEC and DOJ have been criticized, fairly or not, for not bringing more cases arising from the financial crisis—especially against individuals—both agencies have received abundant praise for their crackdown on insider trading,” the report concluded.

When communicating information through social media channels, companies have had to carefully consider whether material nonpublic information is being selectively disclosed in violation of Regulation FD. The SEC recently clarified its views regarding the applicability of Regulation FD to social media in a Report of Investigation which concluded that disclosure of material nonpublic information on the personal social media site of an individual corporate officer, without advance notice to investors that the social media site may be used for this purpose, is unlikely to qualify as an acceptable method of disclosure under the securities laws.

However, the SEC indicated that companies using social media to communicate information could apply existing guidance on the use of corporate websites in determining if that information is adequately being disseminated through social media channels so that a company won’t run afoul of Regulation FD, which would include taking steps to notify the market that material information about the company can be gleaned from those social media channels.

There are legal uncertainties about how far investigators can go in seeking information that is not publicly available on social media. Courts have ruled that certain messages sent on social media are protected under the Stored Communications Act, which limits the government’s power to force Internet service providers to disclose customer information. In addition, “friending” someone for the sole purpose of uncovering evidence may go against Facebook’s terms of service. States differ as to whether investigations led by attorneys can use deception, such as “friending” someone to uncover evidence, says Carl H. Loewenson Jr., a Morrison & Foerster partner and co-chair of the firm’s Securities Litigation, Enforcement, and White-Collar Defense Group. “If a prosecutor directs agents to do that, there is the risk of ethical violations resulting from engaging in misrepresentation under some state bar rules,” he says.

On April 2, 2013, the U.S. Securities and Exchange Commission (SEC) issued guidance in the form of the Report of Investigation under Section 21(a) of the Securities Exchange Act of 1934 which indicates that social media channels—such as Twitter and Facebook—could be used by public companies to disseminate material information, without running afoul of Regulation FD. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Netflix, Inc., and Reed Hastings, Release No. 34-69729 (April 2, 2013) (the “21(a) Report”). The SEC emphasized that companies should apply the guidance from its 2008 interpretive release regarding the disclosure of material information on company websites when analyzing whether a social media channel is in fact a “recognized channel of distribution,” including the guidance that investors must be provided with appropriate notice of the specific channels that a company will use in order to disseminate material nonpublic information.

The SEC confirmed in the 21(a) Report that Regulation FD applies to social media and other emerging means of communication used by public companies in the same way that it applies to company websites as discussed in the 2008 Guidance, which clarified that websites can serve as an effective means for disseminating information if investors have been made aware that they can locate the company information on the website.

The 21(a) Report indicates that, while every situation must be evaluated on its own facts, disclosure of material nonpublic information on the personal social media site of an individual corporate officer, without advance notice to investors that the social media site may be used for this purpose, is unlikely to qualify as an acceptable method of disclosure under securities laws. In this regard, the SEC notes that it would not normally be assumed that the personal social media sites of public company employees would serve as channels through which the company discloses material nonpublic information.

In analyzing the applicability of Regulation FD to any communications, the SEC notes that while the Regulation FD adopting release highlighted concerns about “selective” disclosure of information to favored analysts or investors, “the identification of the enumerated persons within Regulation FD is inclusive, and the prohibition does not turn on an intent or motive of favoritism.” The SEC also emphasizes that nothing in the Regulation FD would suggest that disclosure of material nonpublic information to a broader group that includes both enumerated and non-enumerated persons, but that still would not constitute a public disclosure, would somehow result in Regulation FD being inapplicable. Rather, the SEC states that “the rule makes clear that public disclosure of material nonpublic information must be made in a manner that conforms with Regulation FD whenever such information is disclosed to any group that includes one or more enumerated persons.” As a result, whenever a company makes a disclosure to an enumerated person, including to a broader group of recipients through a social media channel, the company must consider whether that disclosure implicates Regulation FD, including determining whether the disclosure includes material nonpublic information and whether the information was being disseminated in a manner “reasonably designed to provide broad, non-exclusionary distribution of the information to the public” in the event that the issuer did not choose to file a Form 8-K.

Drawing on the reference to “push” technologies (such as email alerts, RSS feeds and interactive communication tools, such as blogs) in the 2008 Guidance, the SEC acknowledged that social media channels are an extension of these concepts, and therefore the guidance should apply equally in the context of social media channels. Given the “direct and immediate communication” possible through social media channels, such as Facebook and Twitter, the SEC expects companies to examine whether such channels are recognized channels of distribution. In particular, the SEC emphasized the need to take steps to alert the market about which forms of communication a company intends to use for the dissemination of material nonpublic information. The SEC notes that without this sort of notice, the investing public would have to keep pace with a “changing and expanding universe of potential disclosure channels.” The ways in which such notice could be provided would include: (1) references in periodic reports and press releases on the corporate website and disclosures that the company routinely posts important information on that website and (2) disclosures on corporate websites identifying the specific social media channels a company intends to use for the dissemination of material nonpublic information (thereby giving people the opportunity to subscribe to, join, register for, or review that particular channel).

In light of the SEC’s guidance, companies should consider whether to specifically address the use of social media in Regulation FD policies, including whether prohibitions, restrictions or editorial oversight should be implemented to govern the use of social media by those persons authorized to speak for the company. This will remain an evolving area that must be continually monitored, as the methods for interacting with shareholders, analysts and others continue to evolve. As with the 2008 Guidance, companies may not be in a position to implement the 21(a) Report’s guidance in such a way that they could do away with more traditional forms of public dissemination, but the guidance may provide more comfort for companies using social media to supplement other more traditional forms of communication. Companies should carefully evaluate what social media channels may be useful for communicating information, and begin providing notice that information about the company may be found on those social media channels, while using those channels as a regular source of information. At the same time, companies should advise individual officers, directors and employees that posting information about the company on social media channels could potentially implicate Regulation FD, and therefore such persons must exercise caution when communicating through social media.

Following this morning’s meeting, the Commission has published its proposed rules:

http://www.sec.gov/rules/proposed/2012/33-9354.pdf

Summary

The SEC published its guidance today as a proposed rule, with a comment period, and not as an interim final rule.

The SEC proposes to amend Rule 506 to provide that the prohibition against general solicitation contained in Rule 502(c) shall not apply to offers and sales of securities made pursuant to Rule 506 provided that all purchasers are accredited investors and the issuer takes reasonable steps to verify their status.

Form D will be amended so that an issuer will be required to indicate whether it has used general solicitation.

The SEC is not proposing to amend the Section 4(a)(2) exemption.

Rule 506 offerings

Release implements a bifurcated approach—that is an issuer can conduct a Rule 506 offering without general solicitation, or a Rule 506(c) offering using general solicitation

A new Rule 506(c) is introduced, which would permit general solicitation provided:  issuer takes reasonable steps to verify investor status; purchasers are accredited investors; and other conditions of Rule 501 and 502(a) and 502(d) are satisfied.

The Staff is not prescribing a verification approach, but recognizing that the reasonableness of the steps taken to verify status will be based on particular facts and circumstances.  The Staff sets out a number of measures (in the form of a non-exclusive list) that could be used in order to assess investor status.

Rule 144A

Rule 144A will be amended to remove the reference to “offer” and “offeree” from Rule 144A(d)(1), requiring only that securities be sold only to a QIB or person reasonably believed to be a QIB.

Integration

Rule 144A/Rule 506 offerings will not be integrated with contemporaneous Regulation S offerings—however, the language used in the release may not be as clear as market participants would like.

At a meeting this morning, the SEC voted to propose rules relaxing the ban on general solicitation for certain offerings conducted pursuant to Rule 506 and resales under Rule 144A.  In a meeting that lasted approximately 45 minutes, the Staff outlined the principal aspects of the proposed rules.  The Staff indicated that it was proposing rules for comment, and not proposing an interim final rule.  As a result, market participants will have an opportunity to comment on the proposal and the Staff will have an opportunity to consider these comments prior to the adoption of final rules.  As anticipated, close attention will be required in relation to the Staff’s proposals regarding the “reasonable steps” to be taken to verify accredited investor status for offerings in which general solicitation is used.  The Staff discussed generally the verification process.  The Staff also discussed proposed changes to Form D.  The Staff also noted that the proposal would address the “directed selling effort” prong of Regulation S.  We will provide a detailed analysis of the proposal shortly.

The Commissioners provided interesting perspectives on the proposed rules and on the rulemaking process.

Commissioner Walter noted her support for modification of the communications rules in order to make these rules more contemporary.  She noted that allowing general solicitation is “a profound change,” which likely will have “unintended consequences.”  Commissioner Walter noted that comments on the proposal should help to identify these potential unintended consequences.  She also suggested that the Staff consider updating Form D in order to make it a source for more information regarding the types of offerings in which general solicitation is used and that the Staff should study the uses of general solicitation.  Commissioner Walter asked how the Staff intended to monitor the use of Rule 506 offerings involving general solicitation.  Meredith Cross noted that a multi-divisional task force would be formed in order to identify offerings in which general solicitation was used and to understand the verification processes used in these offerings.

Commissioner Aguilar noted he did not support the proposal and he would issue a separate statement which would be forthcoming.  He expressed concerns about investor protection.

Both Commissioners Paredes and Gallagher expressed their support for the proposal, while noting their significant concerns with the rulemaking process itself.  The two Commissioners noted that the original rulemaking course, which had been to release an interim final rule (not a proposal), had been changed in midstream.  This change had been occasioned after significant concerns had been expressed by various groups, including state regulators.  Both Commissioners Paredes and Gallagher noted their concern regarding the change in course and the resulting delays.

For several months, various legislative proposals that would ease regulatory and financing burdens on smaller companies have been discussed by legislators, business leaders and commentators. These proposals were brought together under the Jumpstart Our Business Startups (JOBS) Act (H.R. 3606). The JOBS Act was passed by Congress on March 27, 2012 and signed into law by President Obama on April 5, 2012. For a comprehensive overview of the JOBS Act, see our Client Alert.

The JOBS Act tackles various issues relating to financing businesses, however, within the realm of social media, “crowdfunding” is a key topic which Congress has chosen to regulate. In this article, we take a close look at the crowdfunding component of the new law.

Background on Crowdfunding

“Crowdfunding” or “crowdsourced funding” is a new outgrowth of social media that provides an emerging source of funding for ventures. Crowdfunding works based on the ability to pool money from individuals who have a common interest and are willing to provide small contributions toward the venture. Crowdfunding can be used to accomplish a variety of goals (e.g., raising money for a charity or other causes of interest to the participants), but when the goal is commercial in nature and there is an opportunity for crowdfunding participants to share in the venture’s profits, federal and state securities laws will likely apply. Absent an exemption from SEC registration (or actually registering the offering with the SEC), crowdfunding efforts that involve sales of securities are in all likelihood illegal. In addition to SEC requirements, those seeking capital through crowdfunding have had to be cognizant of state securities laws, which include varying requirements and exemptions. By crowdfunding through the Internet, a person or venture can be exposed to potential liability at the federal level, in all 50 states, and potentially in foreign jurisdictions. Existing exemptions present some problems for persons seeking to raise capital through crowdfunding. For example, Regulation A requires a filing with the SEC and disclosure in the form of an offering circular, which would make conducting a crowdfunding offering difficult. The Regulation D exemptions generally would prove too cumbersome, and a private offering approach or the intrastate offering exemption is inconsistent with widespread use of the Internet. Section 25102(n) of the California Corporations Code might provide a possible exemption for some California issuers, given that it permits general announcement of an offering without qualification in California (with a corresponding exemption from registration at the federal level provided by SEC Rule 1001, the California limited general solicitation exemption). Crowdfunding advocates have called on the SEC to consider implementing a new exemption from registration under the federal securities laws for crowdfunding. For more on crowdfunding, see also our prior Client Alert here.

When H.R. 3606 was adopted in the House of Representatives, the bill included Title III, titled “Entrepreneur Access to Capital.” This Title provided an exemption from registration under the Securities Act for offerings of up to $1 million, or $2 million in certain cases when investors were provided with audited financial statements, provided that individual investments were limited to $10,000 or 10 percent of the investor’s annual income. The exemption was conditioned on issuers and intermediaries meeting a number of specific requirements, including notice to the SEC about the offering and the parties involved with the offering, which would be shared with state regulatory authorities. The measure would have permitted an unlimited number of investors in the crowdfunding offering, and would have preempted state securities regulation of these types of offerings (except that states would be permitted to address fraudulent offerings through their existing enforcement mechanisms).

The House measure also contemplated that the issuer must state a target offering amount and a third-party custodian would withhold the proceeds of the offering until the issuer has raised 60 percent of the target offering amount. The provision also contemplated certain disclosures and questions for investors, and provided for an exemption from broker-dealer registration for intermediaries involved in an exempt crowdfunding offering.

After it was adopted, the House crowdfunding measure drew a significant amount of criticism, with much of that criticism focused on a perceived lack of investor protections. In a letter to the Senate leadership, SEC Chairman Mary Schapiro noted that “an important safeguard that could be considered to better protect investors in crowdfunding offerings would be to provide for oversight of industry professionals that intermediate and facilitate these offerings,” and also noted that additional information about companies seeking to raise capital through crowdfunding offerings would benefit investors.

In the Senate, an amendment to H.R. 3606 submitted by Senator Merkley and incorporated in the final JOBS Act provides additional investor protections in crowdfunding offerings. Title III, titled “Crowdfunding,” amends Section 4 of the Securities Act to add a new paragraph (6) that provides a crowdfunding exemption from registration under the Securities Act. The conditions of the exemption are that:

  • The aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the crowdfunding exemption during the 12-month period preceding the date of the transaction, is not more than $1,000,000;
  • The aggregate amount sold to any investor by the issuer, including any amount sold in reliance on the crowdfunding exemption during the 12-month period preceding the date of the transaction, does not exceed:
    • the greater of $2,000 or 5 percent of the annual income or net worth of the investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; or
    • 10 percent of the annual income or net worth of an 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;
  • The transaction is conducted through a broker or funding portal that complies with the requirements of the exemption; and
  • The issuer complies with the requirements of the exemption.

Among the requirements for exempt crowdfunding offerings would be that an intermediary:

  • Registers with the SEC as a broker or a “funding portal,” as such term is defined in the amendment;
  • Registers with any applicable self-regulatory authority;
  • Provides disclosures to investors, as well as questionnaires, regarding the level of risk involved with the offerings;
  • Takes measures, including obtaining background checks and other actions that the SEC can specify, of officers, directors, and significant shareholders;
  • Ensures that all offering proceeds are only provided to issuers when the amount equals or exceeds the target offering amount, and allows for cancellation of commitments to purchase in the offering;
  • Ensures that no investor in a 12-month period has invested in excess of the limit described above in all issuers conducting exempt crowdfunding offerings;
  • Takes steps to protect privacy of information;
  • Does not compensate promoters, finders, or lead generators for providing personal identifying information of personal investors;
  • Prohibits insiders from having any financial interest in an issuer using that intermediary’s services; and
  • Meets any other requirements that the SEC may prescribe.

Issuers also must meet specific conditions in order to rely on the exemption, including that an issuer file with the SEC and provide to investors and intermediaries information about the issuer (including financial statements, which would be reviewed or audited depending on the size of the target offering amount), its officers, directors, and greater than 20 percent shareholders, and risks relating to the issuer and the offering, as well specific offering information such as the use of proceeds for the offering, the target amount for the offering, the deadline to reach the target offering amount, and regular updates regarding progress in reaching the target.

The provision would prohibit issuers from advertising the terms of the exempt offering, other than to provide notices directing investors to the funding portal or broker, and would require disclosure of amounts paid to compensate solicitors promoting the offering through the channels of the broker or funding portal.

Issuers relying on the exemption would need to file with the SEC and provide to investors, no less than annually, reports of the results of operations and financial statements of the issuers as the SEC may determine is appropriate. The SEC may also impose any other requirements that it determines appropriate.

A purchaser in a crowdfunding offering could bring an action against an issuer for rescission in accordance with Section 12(b) and Section 13 of the Securities Act, as if liability were created under Section 12(a)(2) of the Securities Act, in the event that there are material misstatements or omissions in connection with the offering.

Securities sold on an exempt basis under this provision would not be transferrable by the purchaser for a one-year period beginning on the date of purchase, except in certain limited circumstances. The crowdfunding exemption would only be available for domestic issuers that are not reporting companies under the Exchange Act and that are not investment companies, or as the SEC otherwise determines is appropriate. Bad actor disqualification provisions similar to those required under Regulation A would also be required for exempt crowdfunding offerings.

Funding portals would not be subject to registration as a broker-dealer, but would be subject to an alternative regulatory regime, subject to SEC and SRO authority, to be determined by rulemaking. A funding portal is defined as an intermediary for exempt crowdfunding offerings that does not: (1) offer investment advice or recommendations; (2) solicit purchases, sales, or offers to buy securities offered or displayed on its website or portal; (3) compensate employees, agents, or other persons for such solicitation or based on the sale securities displayed or referenced on its website or portal; (4) hold, manage, possess, or otherwise handle investor funds or securities; or (5) engage in other activities as the SEC may determine by rulemaking.

The provision would preempt state securities laws by making exempt crowdfunding securities “covered securities,” however, some state enforcement authority and notice filing requirements would be retained. State regulation of funding portals would also be preempted, subject to limited enforcement and examination authority.

The SEC must issue rules to carry out these measures not later than 270 days following enactment. The dollar thresholds applicable under the exemption are subject to adjustment by the SEC at least once every five years.

The provisions of this title of the JOBS Act are not self-effectuating, as indicated above.

Practical Considerations

Issuers: For those issuers who are seeking to raise small amounts of capital from a broad group of investors, the crowdfunding exemption may ultimately provide a viable alternative to current offering exemptions, given the potential that raising capital through crowdfunding over the Internet may be less costly and may provide more sources of funding. At the same time, issuers will need to weigh the ongoing costs that will arise with crowdfunding offerings, in particular the annual reporting requirement that is contemplated by the legislation. Moreover, it is not yet known how much intermediaries such as brokers and funding portals will charge issuers once SEC and SRO regulations apply to their ongoing crowdfunding operations.

Intermediaries: Brokers and potential funding portals will need to consider how their processes can be revamped to comply with regulations applicable to exempt crowdfunding offerings, in particular given the level of information that will need to be provided in connection with crowdfunding offerings and the critical role that intermediaries will play in terms of “self-regulating” these offerings.