Monday, April 21, 2014

State Crowdfunding Exemptions and Federal Law

The SEC has proposed, but not yet adopted, an exemption that would allow securities to be sold to the general public through crowdfunding. But a number of states have beat the SEC to the punch, adopting exemptions allowing securities to be sold in crowdfunding offerings within those states. See here for a list of the state exemptions.

Those state exemptions do not (and cannot) provide an exemption from federal law. Even if a state exemption is available, the issuer of the securities must still register with the SEC unless a federal exemption is available. The obvious exemption is the intrastate offering exemption in section 3(a)(11) of the Securities Act, and its safe harbor, Rule 147.

The intrastate offering exemption imposes a number of restrictions on the issuer and the issuer's use of the offering proceeds. But there's a potential problem with crowdfunded intrastate offerings even if the issuer complies with all of those other restrictions.

Both section 3(a)(11) and Rule 147 require that the securities be offered and sold only to residents of that one state. It’s not enough to limit sales to residents. An offer to nonresidents would violate the intrastate offering exemption, even if those nonresidents were successfully filtered out before any sales were made.

So how can securities sold on an Internet web site open to the general public not be offered to non-residents? Given the global nature of the Internet, aren’t offers to non-residents inevitable?Luckily, the SEC staff has stepped in and provided advice that will allow intrastate offerings on public Internet sites.

Here is a recent staff interpretation:

Question 141.04

Question: An issuer plans to use a third-party Internet portal to promote an offering to residents of a single state in accordance with a state statute or regulation intended to enable securities crowdfunding within that state. Assuming the issuer met the other conditions of Rule 147, could it rely on Rule 147 for an exemption from Securities Act registration for the offering, or would use of an Internet portal necessarily entail making offers to persons outside the relevant state or territory?

Answer: Use of the Internet would not be incompatible with a claim of exemption under Rule 147 if the portal implements adequate measures so that offers of securities are made only to persons resident in the relevant state or territory. In the context of an offering conducted in accordance with state crowdfunding requirements, such measures would include, at a minimum, disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law, and limiting access to information about specific investment opportunities to persons who confirm they are residents of the relevant state (for example, by providing a representation as to residence or in-state residence information, such as a zip code or residence address). Of course, any issuer seeking to rely on Rule 147 for the offering also would have to meet all the other conditions of Rule 147.

Thus, as long as the web site makes it clear that offers are being made only to residents of the relevant state and potential purchasers are screened for residence before they see the details of the particular offering, the intrastate offering exemption would still be available.

However, the staff went on to warn about the use of social media or the issuer’s own web site:

Question 141.05

Question: Can an issuer use its own website or social media presence to offer securities in a manner consistent with Rule 147?

Answer: Issuers generally use their websites and social media presence to advertise their market presence in a broad, indiscriminate manner. Although whether a particular communication is an "offer" of securities will depend on all of the facts and circumstances, using such established Internet presence to convey information about specific investment opportunities would likely involve offers to residents outside the particular state in which the issuer did business.

Social media and an issuer’s general web site would reach non-residents and violate the intrastate offering exemption. However, there’s nothing in section 3(a)(11) or Rule 147 that requires an intermediary to be used for the offering, so I don’t think issuers would be excluded from direct, unmediated offerings—as long as they complied with the requirements of Question 141.04—using a separate web page with appropriate disclaimers and only allowing residents to see the actual offering. However, staff interpretations and no-action letters often attempt to impose restrictions that have little relationship to the statutory or regulatory requirements, so perhaps the staff did mean to exclude unmediated offerings.

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