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News November 9, 2015 Issue

Crowdfunding: Get Ready for Client Interest and Potential Investments

The SEC this week adopted final crowdfunding rules that will allow small businesses to raise capital from investors – including possibly your clients – through web portals. Many of your clients will likely not be interested in making these investments, but smart advisers will be ready with at least some answers for those who are.

The final rules, collectively, Regulation Crowdfunding, were adopted by the Commission on October 30. They permit individuals to invest in securities-based crowdfunding transactions subject to certain investment limits. They also limit the amount of money a small company can raise per year through crowdfunding, impose disclosure requirements on those companies and, according to the SEC, "create a regulatory framework for the broker-dealers and funding portals that facilitate crowdfunding transactions."

The new rules and forms will be effective 180 days after they are published in the Federal Register. The forms enabling portals to register with the Commission will be effective on January 29, 2016.

"There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need," said SEC chair Mary Jo White. She noted that, with the adoption of the crowdfunding rules, the SEC has completed the major rulemaking required of the agency under the JOBS Act.

Crowdfunding and advisers

What advisers can expect, according to Leech Tishman partner Steven Irwin, is that their clients "will inevitably be approached to invest in ventures through crowdfunding," and, as a result, it may be difficult to keep track of the number of crowdfunded startups investors may be placing their money in.

"Advisers should look out for the best interest of their clients by monitoring whether they are funding any such projects," he said. "Are their clients investing amounts above the statutory maximum?"

There are dangers. "The equity received often will be in the form of restricted stock, and even when shares can be sold, it’s doubtful there will be a vibrant market for shares," Irwin said. "Although the SEC’s regulations attempt to limit investor losses, small business startups are among the riskiest investments one can make. Advisers will need to develop an approach to help their clients evaluate crowdfunding investments, or their clients may seek that advice elsewhere, or not at all."

Of course, there is no requirement that advisers must work with their clients on crowdfunding investments, said Mayer Brown partner Michael Hermsen, just as there is no requirement that each adviser must handle derivative investments or purchases of fine art. Advisers could simply limit their portfolio management to what they are familiar with.

But advisers choosing that course may run into competition from other advisers that will provide crowdfunding services, and risk losing clients, he said.

For those advisers that intend to work with clients planning to invest in small businesses through crowdfunding, "nothing is changed in terms of the adviser’s fiduciary obligations," Hermsen said. That will, by definition, require due diligence of the companies the clients might invest in and the returns they would receive and the risks that are acceptable to their clients. "Until we get some experience with crowdfunding, people are going to think of these things as fairly risky and not suitable to every client."

The limits

The final rules set limits on the amounts that individuals could purchase in securities via crowdfunding, as well as limits as to how much companies could raise each year via crowdfunding.

  • A company could raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
  • Individuals with annual income or net worth of less than $100,000 could invest the greater of either $2,000 or 5 percent of the lesser of their annual income or their net worth. That limit would apply in the aggregate to all crowdfunding offerings over a 12-month period.
  • Individuals whose annual income and net worth are equal to or more than $100,000 could invest 10 percent of the lesser of their annual income or net worth
  • During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.

Securities that are purchased through a crowdfunding transaction "generally could not be resold for one year," the SEC said.

The platforms

Businesses seeking to raise money through crowdfunding must register with the SEC using a new form for a funding portal, and they would also be required to become a member of FINRA. Such businesses could raise capital only through one portal at a time.

The intermediaries running the portals would be obligated to comply with a number of requirements, including providing investors with educational materials that explain the process for investing on the platform, the types of securities offered, resale restrictions and investment limits. They would also need to take certain measures to reduce the risk of fraud, provide communication channels to permit discussions about offerings on the platform, and more.

Intermediaries would be prohibited from, among other things, providing access to their platforms to any companies they have a reasonable basis for believing might be engaged in fraud. They would also be prohibited from having a financial interest in a company offering securities on the platform, unless that financial interest is compensation for its services.


Companies relying on crowdfunding would also be required to disclose information to the SEC and investors, including:

  • The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach that amount, and whether the company will accept investments in excess of the offering amount;
  • A discussion of the company’s financial condition;
  • Financial statements, possibly with tax information, that would need to be reviewed by an independent financial accountant or audited by an independent auditor;
  • A description of the business and the use of proceeds from the offering; and
  • Information about officers and directors, as well as owners of 20 percent or more of the company.

"These requirements may be seen as onerous by small companies," said Hermsen, and since the final rules won’t take effect for six months, companies may choose to explore other ways than crowdfunding to raise capital.