Monday, October 14, 2013
The JOBS Act offers two new opportunities to offer securities on the Internet without Securities Act registration. Both the Rule 506(c) exemption and the new crowdfunding exemption could be used to sell securities on web sites open to the general public. But could a single web site offer securities pursuant to both exemptions at the same time (assuming the SEC eventually proposes and adopts the regulations required to implement the crowdfunding exemption)?
Background: The two exemptions
Rule 506(c) allows an issuer to publicly advertise a securities offering, as long as the securities are only sold to accredited investors. Rule 506(c) is not limited to Internet offerings, but it could be used by an issuer to advertise an offering on an Internet site open to the general public—as long as actual sales are limited to accredited investors.
The new crowdfunding exemption, added as section 4(a)(6) of the Securities Act, allows issuers to sell up to $1 million of securities each year. The offering may be on a public Internet site, as long as that site is operated by a registered securities broker or a “funding portal,” a new category of regulated entity created by the JOBS Act.
Could a single intermediary do both 506(c) and crowdfunded offerings?
Yes, but only if the intermediary is a federally registered securities broker.
Rule 506(c) does not limit who may act as an intermediary, but the crowdfunding exemption says that only registered brokers or funding portals may host crowdfunded offerings. By definition, funding portals appear to be limited to offerings under the crowdfunding exemption. A funding portal is “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to section 4(6).” Exchange Act section 3(a)(80), as amended by the JOBS Act. Thus, funding portals could not act as intermediaries in Rule 506(c) offerings.
The JOBS Act does not impose a similar limitation on brokers, so brokers could act as intermediaries in both Rule 506(c) and crowdfunded offerings.
Could a broker include both types of offerings on the same web site?
The answer to this is probably yes.
Rule 506(c) does not limit the content of the web site, so any limitations are going to come from the crowdfunding exemption. Crowdfunding intermediaries are subject to a number of requirements, but the crowdfunding exemption does not appear to prohibit the inclusion of other offerings on the same web site.
Operating a dual site could be cumbersome. For example, Rule 506(c) offerings could appear on the site's main page, but no investor may see crowdfunded offerings until they satisfy the crowdfunding exemption’s investor education requirements. But unless the SEC rules implementing the crowdfunding exemption prohibit it, dual-exemption sites should be possible.
Could an issuer do a double-door offering, using a single web site to simultaneously sell the same securities in both types of offerings?
I have heard that some ill-advised fledgling intermediaries have plans to do this, but the answer to this question is no. The integration doctrine would not allow it.
Rule 506(c) incorporates the requirements of Rule 502(a) of Regulation D, and Rule 502(a) indicates that “[a]ll sales that are part of the same Regulation D offering must meet all of the terms and conditions of Regulation D.” Section 4(a)(6) of the Securities Act, the crowdfunding exemption, exempts “transactions” that meet the criteria of the exemption.
Under that transactional language, as consistently interpreted by the SEC and the courts over the years, the entire offering must comply with the requirements of the exemption, or none of the sales is exempted. An issuer cannot sell parts of a single offering pursuant to two separate exemptions.
Unless an integration safe harbor is available, and none would apply here, the SEC uses a five-factor test to determine whether ostensibly separate offerings are part of the same transaction. This test considers (1) whether the sales are part of a single plan of financing; (2) whether the sales involve issuance of the same class of securities; (3) whether the sales are made at or about the same time; (4) whether the issuer receives the same type of consideration; and (5) whether the sales are made for the same general purpose.
Under this test, an issuer could not sell a security pursuant to the Rule 506(c) exemption and at the same time sell the same security on the same web site pursuant to the crowdfunding exemption. Those two ostensibly separate offerings would be integrated and would have to fit within a single exemption. (There is vague language in the crowdfunding exemption that might arguably protect against integration, but the argument is a weak one. For a discussion of that argument see pp. 213-214 of my article here.)