SEC Takes Baby Steps Towards Equity Crowdfunding
The SEC recently issued some updated guidance on crowdfunding. I asked my partner and securities lawyer Richard Schmalzl to weigh in:
You may have read that the SEC recently made it easier for small businesses to use their own company Web site and social media outlets to raise capital for intrastate equity crowdfunding. Like most developments affecting equity crowdfunding, there are different views about whether the SEC has loosened its standards in a meaningful way. But what really matters to most entrepreneurs looking to raise capital is that the new era of equity crowdfunding is still to come.
The key word here is intrastate. For those of you waiting for the SEC to adopt final regulations that would allow equity crowdfunding nationwide, the wait continues with no end in sight. To quickly recap where we stand on that score, the Jobs Act was signed into law on April 5, 2012. It directed the SEC to adopt regulations to legalize equity crowdfunding. A year and a half later on October 13, 2013, the SEC issued proposed regulations to exempt certain crowdfundings from the registration requirements of the federal securities laws. Those proposed regulations drew much criticism for being too limited, containing too many requirements, and requiring small companies to spend too much money to comply.
Increasingly frustrated with SEC delays and impediments, equity crowdfunding advocates came up with an innovative solution to facilitate local crowdfunding and effectively bypass federal oversight. The opening arises from the existing, but seldom used, intrastate exemption created by Section 3(a)(11) of the federal securities laws, and related SEC Rule 147. Under that exemption, an issuer is exempt from the federal registration requirements if the issuer offers and sells its securities only to investors who reside in the same state as the issuer. But there’s a major drawback to the Rule 147 exemption, particularly in tri-state areas like Greater Cincinnati. The offer of securities must be limited solely to residents of a single state. Because there is a high risk that an issuer could inadvertently make an offer to a non-resident, the Rule 147 exemption can easily disappear. If so, then all the sales are unlawful, even to those investors who do reside in the intended state.
Nonetheless, working within the parameters of Rule 147, twelve states, including Indiana, have now adopted their own new laws, rules or regulations to allow equity crowdfunding solely within the confines of their own state, and another fifteen states or so are actively considering similar proposals. Neither the Ohio nor Kentucky legislatures are currently considering similar exemptions, although Representative Steve Riggs of Louisville has publicly supported the notion of introducing a Kentucky equity crowdfunding bill. In states where this concept has caught traction, it’s fueled in large part by state legislators who believe that intrastate equity crowdfunding can help grow small businesses, which produce jobs, in their own state. This is because the business has to be located in and doing substantial business in their state to be eligible to use the exemption.
So, you may be asking, what’s the SEC got to do with intrastate equity crowdfunding? It’s because those intrastate exemptions still have to comply with Rule 147. Depending on your point of view, the SEC was either trying to help or throw a monkey wrench at these exemptions when the SEC staff published three Q&As in April 2014.
On the helpful side, the staff affirmed that Rule 147 permits general advertising or general solicitation in a purely intrastate offering. Since successful equity crowdfunding relies on reaching potential investors who the issuer doesn’t know directly, the ability to publicize the securities offerings is essential.
On the non-helpful side, the staff said that if an issuer used its own Web site or social media presence to offer securities, that use would likely involve offers to residents outside the particular state in which the issuer does business. That position pretty much undermined the effective use of intrastate exemptions as a practical matter.
The good news is that on October 2, 2014 the SEC staff revised its stance on the use of issuer Web sites and social media. The Q&A now goes on to say that issuers could implement technological measures to limit communications to persons whose IP address originates in other states or territories and that offers should include disclaimers and restrictive legends expressly stating that the offer is limited solely to residents of the relevant state. Ultimately, it’s a facts and circumstances test, but at least the door is open for those small businesses fortunate enough to be located in a state that has enacted its own intrastate equity crowdfunding exemption.