Monday, October 28, 2013
Title III of the JOBS Act, which contains the new crowdfunding exemption, is not a particularly well-drafted statute. It was put together rather quickly in the Senate as a substitute for the crowdfunding exemption that passed the House and never went through a formal committee markup. The resulting exemption contains a number of ambiguities and loopholes. I am happy to report that the SEC’s proposed rules to implement the crowdfunding exemption clear up the major statutory problems.
1. $1 Million Offering Limit Includes Only Crowdfunded Offerings
Section 4(a)(6)(A) of the Securities Act provides that the exemption is available only if
the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, is not more than $1,000,000.
The “including” clause makes it unclear if only securities sold pursuant to the crowdfunding exemption are included, or if securities sold pursuant to other exemptions during the 12-month period must also be subtracted from the $1 million limit. I argued (here, at p. 200) that only crowdfunded securities should count against the limit, but conceded that this statutory language is “a little unclear.” (I vacillated on this; I argued in an earlier draft that other sales should count against the limit, but changed my mind before my article went to press.)
The SEC has accepted my final interpretation. Proposed Rule 100(a)(1) of the new crowdfunding rules only includes securities sold “in reliance on Section 4(a)(6) of the Securities Act.” Securities sold pursuant to other exemptions would not have to be subtracted from the $1 million limit.
2. Ambiguities in the Individual Investment Limits Cleared Up
The statute limits the amount each investor may invest annually in crowdfunded offerings. The maximum amount an investor may invest is based on that investor’s net worth and annual income. Unfortunately, the section of the statute that sets those limits contains a couple of ambiguities.
Ambiguity No. 1: Two Different Limits Applicable to Some Investors
The statute provides for two sets of limits; which limits apply depends on the investor’s annual income and net worth. The lower set of limits, in section 4(a)(6)(B)(i), applies “if either the annual income or the net worth of the investor is less than $100,000.” The higher set of limits, in section 4(a)(6)(B)(ii), applies “if either the annual income or the net worth of the investor is equal to or more than $100,000.”
I and others have pointed out ( here, at 201) that if one of those two figures (annual income and net worth) is less than $100,000 and the other is equal to or greater than $100,000, then the statute says both limits apply.
The SEC has resolved this ambiguity. Under proposed Rule 100(a)(2), if either net worth or annual income are equal to or greater than $100,000, then the higher limit applies. The lower limit applies only if both annual income and net worth are less than $100,000.
Ambiguity No. 2: What Exactly is the Higher Limit?
The higher limit, if applicable, is “10 percent of the annual income or net worth of such investor, as applicable.” Section 4(a)(6)(B(ii). Unfortunately, the statute doesn’t say whether the limit is the greater or the lesser of those two figures. If, for example, 10% of annual income is $15,000 and 10% of net worth is $12,000, is the limit $15,000 or $12,000?
Proposed Rule 100(a)(2)(ii) clarifies this. The limit is the greater of the two numbers.
3. Financial Disclosure Loophole Blocked
The statutory exemption includes a possible loophole in the issuer’s financial disclosure requirements. The financial information to be provided by the issuer depends on the target amount of the crowdfunded offering. The statute sets up three target amount categories ($100,000 or less; $100,000-$500,000; more than $500,000), and imposes a greater burden as the target amount gets larger.
Since nothing in the exemption prevents an issuer from raising more than its stated target amount, this opens a loophole (which I discuss here, at p. 204). An issuer could specify a target amount of $100,000, to minimize its financial disclosure, then raise up to the full $1 million.
The SEC has closed this loophole. Proposed Rule 201(h) requires the issuer to disclose whether it will accept investments in excess of the target amount, and, if so, the maximum amount it will accept. An instruction to proposed Rule 201(t) indicates that, if the issuer is willing to accept more than its target amount, the required financial disclosure is based on “the maximum offering amount that the issuer will accept.” As a result of these rules, the issuer will not be able to specify an artificially low target amount to avoid the more burdensome financial disclosure.