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.

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.

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.

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.

The use of social media by public companies and their employees raises many legal issues, such as the application of the federal securities laws to communications made through company websites, blogs, Twitter and Facebook. Those communications implicate laws regulating selective disclosure and prohibited disclosures during public and private securities offerings. In this program we will provide best practices and practical advice on addressing these issues. Topics will include:

• The latest trends in the use of social media for communicating corporate and investor information
• The use of social media in the public and private securities offering process, including crowdfunding
  • Social media considerations under Regulations FD and G and proxy solicitation
  • Social media guidelines vs. policies
  • Antifraud considerations with social media communications

Speakers

• John F. Delaney, Partner, Morrison & Foerster
• Jordan Eth, Partner, Morrison & Foerster
• Jackie Liu, Partner, Morrison & Foerster
• David M. Lynn, Partner, Morrison & Foerster
• Brandon C. Parris, Partner, Morrison & Foerster

To register for one of these sessions, please click here.

NY and CA CLE credit are pending.