On Friday, January 10, Practising Law Institute will be hosting a “Free Friday” during which the briefing “Wisdom of Crowds: A Review of the Proposed Crowdfunding Regulatory Framework” will be accessible to everyone for free. The briefing, which was presented in November by David Lynn and Anna Pinedo, focuses on the proposed rules implementing the JOBS Act mandate to create an exemption from registration for certain crowdfunded offerings. To access the briefing, please visit: http://www.pli.edu/Content/OnDemand/Wisdom_of_Crowds_A_Review_of_the_Proposed/_/N-4nZ1z12dns?ID=206768&t=KFJ3_SMBR9&utm_source=SMBR9&utm_medium=EMAIL&utm_campaign=KFJ3.
2013 has proven to be a strong year for IPOs. According to a recent PWC study, total IPO volume for 2013, as of December 17, reached 237 public company debuts, which is an increase over 2012. The overwhelming majority of these IPOs were completed by issuers that qualified as emerging growth companies. (The full details of the study are available here: http://www.pwc.com/us/en/press-releases/2013/pwc-q4-2013-ipo-watch-press-release.jhtml.) Issuers and their counsel have become progressively more comfortable with the IPO on-ramp practices. Issuers continue to rely on the confidential submission process for at least one or two amendments. EGCs are regularly relying on the executive compensation disclosure accommodations.
During 2013, the SEC also made substantial progress with JOBS Act implementation. Here is a brief recap:
Title I: The SEC recently published the report required by Section 108 regarding the disclosure requirements of Regulation S-K. Given the dialogue on disclosure reform generally, it seems safe to say that we should expect continued focus on this in 2014.
Title II: Title II provided additional legal certainty (beyond that which had been provided by pre-JOBS Act no-action letters) for matchmaking sites. Even before the Rule 506 amendments were finalized, it became clear that matchmaking sites that use the internet to reach (at that point) accredited investors would play an important role in the private financing market. During 2013, the SEC Staff provided additional guidance on these models both through the issuance of FAQs and through the issuance of no-action letters to AngelList and Funders Club. On September 23, 2013, the amendments relaxing the prohibition against general solicitation in certain Rule 506 offerings and in Rule 144A offerings became effective, as did the bad actor rules (required by the Dodd-Frank Act, not the JOBS Act). The SEC Staff also released guidance on various questions related to Rule 506 offerings and on bad actor issues. However, many questions have arisen regarding the necessary steps for investor verification in Rule 506(c) offerings, and additional guidance on these would be welcome. Relaxing the prohibition against general solicitation raises fundamental questions regarding the demarcation between “private” offerings and “public” offerings, and the integration of offerings occurring in close proximity to one another. SEC representatives have acknowledged that these integration issues will need to be tackled in the future. The SEC also proposed amendments to Regulation D, Form D and Rule 156. These have proven quite controversial, and it is difficult to predict whether certain of these amendments will be adopted.
Title III: The SEC released proposed rules establishing a framework for crowdfunded offerings.
Title IV: Most recently, the SEC released for comment proposed rules that provide a framework for Regulation A+ offerings. The SEC’s proposed rules would implement the JOBS Act mandate by amending and modernizing existing Regulation A; creating two tiers of offerings, Tier 1 for offerings of up to $5 million ($1.5 million for selling stockholders) and Tier 2 for offerings of up to $50 million ($15 million for selling stockholders); setting issuer eligibility, disclosure and reporting requirements; and imposing additional disclosure and ongoing reporting requirements, as well as an investment limit, for Tier 2 offerings, and, given these investor protection measures, making Tier 2 offerings exempt from blue sky requirements. Regulation A+ offerings may prove to be an important financing alternative for non-reporting companies seeking capital and broader market exposure.
All told, it has been a year of significant changes. Over time, we believe these changes are likelier to have more lasting impact on exempt financings than on the IPO market.
In this alert, we provide a detailed overview of the proposed regulatory framework that will be applicable to crowdfunding offerings conducted pursuant to Title III of the JOBS Act in reliance on Section 4(a)(6) of the Securities Act. As we have noted in our prior initial observations related to the rules proposed by the Securities and Exchange Commission, or SEC, in late October 2013, implementing the Congressional mandate to formulate a framework for crowdfunded offerings, whether or not one intends to avail oneself of this new offering exemption, the tailored approach taken by the SEC and by FINRA in their proposed regulations merits a close look. Both the SEC and FINRA acknowledge that regulation of these offerings requires adapting disclosure-based principles and the existing approach to broker-dealer regulation and oversight to an entirely new public offering rubric. While drawing on these well-established principles, the SEC’s and FINRA’s proposed rules stand out because the proposed rules attempt to provide a scaled or “right-sized” approach. For example, the SEC’s proposed rules would establish limited disclosure requirements for issuers that rely on crowdfunding, as well as limited ongoing reporting requirements for these issuers, although these issuers will not be SEC-reporting companies for the purposes of other SEC requirements. This is novel. Similarly, both the SEC’s and FINRA’s proposed rules relating to funding portals establish a pared-down regulatory framework that acknowledges the limited functions of a funding portal. We hope our discussion below provides a perspective as to whether the SEC and FINRA have struck the right balance in designing regulations that facilitate crowdfunding while promoting investor protection concerns.
To read our alert, please visit: http://www.mofo.com/files/Uploads/Images/131115-SEC-FINRA-Crowdfunding.pdf.
Even if you have no interest in crowdfunding, there are a number of interesting elements in the SEC’s crowdfunding proposal that may have broader applicability.
Phased disclosure: the crowdfunding proposal incorporates a number of information requirements. An issuer that intends to engage in a crowdfunded offering must prepare certain disclosures, which will be filed on Form C. The Form C would include basic information about the company and its business, information about its officers, directors and principal shareholders, its use of proceeds, a description of capital stock, related party transactions, recent securities offerings, a description of financial results (similar to an MD&A), etc. These disclosure requirements acknowledge that a one-size-fits-all disclosure model may not be appropriate. The SEC seems to have given thought to those disclosures that would be most relevant for an investor, and has tailored the disclosure requirements. Might this signal that the SEC is receptive to a phased disclosure approach that may be more broadly applied? The special forms (SB forms) that once were used for offerings by smaller public companies were abandoned years ago in favor of having all issuers use the same forms, but providing disclosure accommodations for smaller public companies. Now, EGCs also may benefit from certain disclosure accommodations. But, even with these accommodations, the disclosure requirements might still be further scaled back to focus on those items that are most important to investors and not risk having investors be overwhelmed by disclosures of only modest significance. It seems fair to assume that the SEC may use the Form C model to inform its approach to rulemaking for Regulation A+ deals.
Ongoing Reporting Requirements: the crowdfunding proposal contemplates that companies that complete an offering will be subject to certain ongoing reporting requirements. These would be made on a Form C-AR and would include information similar to that required in the initial Form C. This is the first time that the SEC has outlined an approach to public disclosures for a non-reporting company. Certainly these requirements might be made applicable to companies undertaking a Regulation A+ offering and choosing to remain private. It is also possible to anticipate that with many more companies choosing to stay private longer and having a market for their securities, some reporting requirements might be imposed.
Modified Regulatory Framework for Funding Portals: the proposal (especially when read in conjunction with FINRA’s proposal) is also significant in that it outlines a regulatory approach for an intermediary (funding portals) that will be regulated but will be something less than broker-dealers. This may be an approach that could be used for other purposes, such as in connection with regulating entities that engage only in M&A advisory services.
On November 15, 2013 at 1:00 pm, Morrison & Foerster partners David Lynn and Anna Pinedo will participate in a PLI webcast on crowdfunding.
In October, the Securities & Exchange Commission approved proposed rules implementing the JOBS Act mandate to create an exemption from registration for certain crowdfunded offerings. The proposal, which was long-awaited, outlines a very detailed framework for issuers that intend to take advantage of these offerings and includes initial and ongoing reporting requirements. Offerings are required to be made through an intermediary, which is either a registered broker-dealer or a funding portal, and the proposed rules also set out detailed requirements for these entities. Funding portals, the activities of which will be limited, are to be regulated by the SEC and by FINRA. On the same day, FINRA released proposed regulations for funding portals.
Topics of discussion will include:
- The proposed requirements for issuers;
- Disclosure requirements for issuers;
- Bad actor disqualification provisions;
- The role, responsibility and liability of intermediaries; and
- The regulatory structure applicable to funding portals.
To register for the webcast, please visit: http://www.pli.edu/Content/Seminar/Wisdom_of_Crowds_A_Review_of_the_Proposed/_/N-4kZ1z12dns?Ns=sort_date%7c0&ID=204146.
The SEC has provided very short notice of an open meeting to consider proposed rules under Title III of the JOBS Act. Title III of the JOBS Act amended Section 4 of the Securities Act to add paragraph (6), which provides a new crowdfunding exemption from registration under the Securities Act. This exemption is only operative after the SEC adopts implementing rules, which the JOBS Act directed the SEC to do by the end of 2012. Now, more than nine months later, the SEC is first proposing the Title III rules. The proposals will provide for the applicable conditions for the use of the Securities Act exemption, as well as address the non-broker dealer funding portals that are contemplated by the JOBS Act. If the SEC approves the proposed rules, they will be subject to a public comment period. FINRA will also have to engage in rulemaking with regard to the oversight of funding portals. As a result, it is likely that we won’t see completed crowdfunding rules until some time in 2014.
In two programs focusing on the JOBS Act, Anna Pinedo and David Lynn of Morrison & Foerster share their expertise to help course attendees gain a greater understanding of the JOBS Act and its implications for different types of companies.
JOBS Act Program 1 – Title I
- IPO on-ramp
- IPO process for an emerging growth company (“EGC”)
- Application of Title I concepts to other transactions, including exchange offers, tenders, acquisitions and spin-offs
- Research for an EGC
- Other capital formation discussions
JOBS Act Program 2 – Private Placements & Other Exempt Offerings
- Title II and the elimination of the ban on general solicitation
- Regulation A+
- Titles V and VI
- Other discussions relating to the JOBS Act
In its upcoming July 11th meeting, FINRA will consider a proposal to solicit comment via Regulatory Notice on proposed rules and related forms governing funding portals pursuant to Title III of the JOBS Act. See the FINRA release: http://www.finra.org/Industry/Regulation/Guidance/CommunicationstoFirms/P292644.
Any milestone, such as an anniversary, provides an opportunity for reflection and evaluation. At the one-year anniversary of the JOBS Act, preliminary experience gives reason for some optimism. The centerpiece of the JOBS Act, the “IPO on-ramp” provisions contained in Title I, have proven quite useful. The SEC Staff’s guidance in the form of Frequently Asked Questions (or FAQs) promptly filled the gaps in the legislation and helped facilitate prompt reliance on these new provisions. It would be too soon to draw conclusions regarding the impact of the on ramp on IPOs in general, and smaller IPOs in particular. The provisions relating to the Exchange Act threshold, which also were immediately effective, have already been relied upon by many smaller banks to suspend their ongoing reporting. Most of the other provisions of the JOBS Act await further SEC rulemaking. Below we provide a very brief “cheat sheet” of the status of the various provisions. We believe that it is fair to say though that the JOBS Act has already had a profound effect on capital formation by restarting an important dialogue on SEC disclosure requirements and permissible communications that seemed to come to an end just after the Securities Offering Reform in 2005, when attention turned to executive compensation disclosures, corporate governance concerns, and ultimately the financial crisis. The JOBS Act also has served to bring greater general awareness of the important changes that have taken place in the last decade in the way that promising companies choose to finance their growth. Finally, even for the non-securities lawyers among us, the JOBS Act has focused attention on the divide between public and private offerings—challenging all of us to think more closely about the appropriateness of certain existing regulations that seem more and more “artificial” in the face of social media and other developments.
Title I (the IPO on-ramp)
- This Title was immediately effective, so no SEC rules were required for this title to take effect.
- The “IPO on-ramp” provisions generally have proven helpful for companies undertaking IPOs:
- The SEC Staff immediately put out guidance in the form of FAQs.
- Market participants have been cautious in relying on some of the accommodations available to EGCs; however, over time, market practice may shift.
- Most EGCs are still presenting three years of financial information (instead of the permissible two years).
- Most EGCs are taking advantage of the ability to present abbreviated executive compensation disclosures.
- Most EGCs are taking advantage of the ability to submit their IPO registration statements for confidential review by the SEC, and relying on the confidential process for at least one or two rounds of SEC comments, before the first public filing.
- EGCs also are benefiting from the delayed phase-in of other costly compliance requirements, like the Sarbanes 404 attestation requirement.
- Now, at the one-year anniversary, a fair number (just over 100) of EGC IPOs have been completed.
- Statistics indicate an increase in smaller IPOs, which, in part, was one of the desired outcomes of the JOBS Act.
- In addition to providing a new approach for EGC IPOs, Title I also addresses analyst research issues, and requires that the SEC undertake several studies.
- Even after the JOBS Act, the unlevel playing field remains as to research, as a result of the Attorney General Settlement, the terms of which have not been modified.
- FINRA modified its rules in accordance with the JOBS Act.
- Most investment banks now have settled (informally) on a 25-day post IPO quiet period before publishing research following completion of an IPO.
- There is no evidence that investment banks are interested in releasing pre-deal research reports for EGCs.
- Additional regulatory changes would be needed in order to promote additional research coverage for EGCs.
- The SEC published the required decimalization study and held a decimalization roundtable; a consensus has formed that a pilot program should be initiated for larger tick sizes.
- The required study on Regulation S-K has not been delivered.
Title II (Private placements)
- The SEC proposed rules in August 2012 to carry out the JOBS Act mandate to relax the ban on general solicitation
- The comment period closed in October 2012; however, the rules have not been finalized.
- There was vigorous comment on the SEC’s proposed rules, with some commenters advocating the adoption of a safe harbor relating to the measures that would be deemed “reasonable” to verify the status of investors; the adoption of content restrictions or guidelines for materials used in general solicitation; and a reexamination of the “accredited investor” threshold.
- We anticipate that the SEC will seek to finalize the rules in the spring, and seek to finalize the “bad actor” provisions (required to be adopted for Rule 506 offerings by the Dodd-Frank Act) contemporaneously
- Matchmaking sites
- There were no rules needed in respect of the broker-dealer registration exemption for matchmaking sites
- The SEC Staff put out guidance in the form of FAQs addressing various matters relating to the types of entities that might engage in these activities without subjecting themselves to broker-dealer registration.
- The SEC Staff issued two no-action letters addressing the applicability of the exemption in the context of VC platforms.
Title III (crowdfunding)
- No SEC rule proposal as yet (SEC missed deadline)
- The SEC Staff published FAQs regarding the crowdfunding exemption.
- FINRA has provided a form for collecting information about funding portals.
- Concerns remain about the extent to which the crowdfunding exemption as contemplated by the JOBS Act could be used by ventures to raise small amounts of capital in a cost-efficient manner.
Title IV (Regulation A+ or Section 3(b)(2))
- No SEC rule proposal as yet.
- Now, pending legislation would mandate that the SEC take action by a date certain.
Titles V & VI (Exchange Act threshold)
- These provisions relating to the Exchange Act threshold were immediately effective; SEC rulemaking was not required.
- Many banks (over 100, according to published reports) have taken advantage of these provisions to suspend their SEC filings.
- The SEC is expected to provide guidance regarding various “holder of record” issues.
What should you expect in the coming months? We anticipate that the SEC will move ahead with finalizing the rules required under Title II to address general solicitation in certain Rule 506 and Rule 144A offerings. We expect that this will be accompanied by the final “bad actor” rules required under the Dodd-Frank Act. The discussion about general solicitation is likely to cause the SEC to revisit the “accredited investor” definition—perhaps resurrecting parts of the SEC’s 2007 “larger accredited investor” standard. Given the complexities to be addressed by the SEC and FINRA in connection with creating a framework for crowdfunded offerings and funding portals, we anticipate that a proposal relating to crowdfunding may not be released until the second half of 2013. As we have already seen from meetings of various advisory committees, more attention likely will continue to be focused on rationalizing the disclosure requirements and the communications rules applicable to smaller public companies and companies that might have qualified for EGC status (but for the date of their initial offering of equity securities). Given the higher registration thresholds under the Exchange Act, we may continue to see the development of a trend toward staying private longer, and the growth of markets designed to provide liquidity to investors in those companies. Given the press of other business under both the JOBS Act and the Dodd-Frank Act, we may not see a proposal for exempt public offerings under Title IV in 2013. Lastly, we would hope that the momentum toward encouraging capital formation that was created by the JOBS Act will not be lost in its second year of existence, and we will instead see continued dialogue—coupled with regulatory and market action—that is oriented toward creating opportunities to put capital to work companies of all sizes.
As we noted, last month FINRA’s Board of Governors authorized FINRA to issue an interim form to seek essential information from prospective funding portals intending to apply for membership with FINRA pursuant to the JOBS Act. FINRA has now announced the availability of the Interim Form for Funding Portals (“IFFP”), which is an online form for prospective intermediaries that intend to apply for membership with FINRA as funding portals. FINRA is inviting prospective funding portals to complete the IFFP voluntarily until FINRA and the SEC adopt final rules implementing Title III of the JOBS Act and establishing the registration procedures for funding portals.
Until the SEC and FINRA rules are adopted, FINRA will use the information collected with the IFFP to become more familiar with the proposed business models, activities and operations of funding portals. Once the final crowdfunding rules are adopted, additional information will be required of funding portals seeking to actually register with FINRA and the SEC. The information now requested in the IFFP includes:
- contact and general information about the funding portal;
- ownership and funding information about the prospective funding portal;
- information about the prospective funding portal’s management; and
- information about the funding portal’s business relationships, business model and compensation.
FINRA will treat information submitted using the IFFP as confidential.
The IFFP is available at: http://www.finra.org/Industry/Issues/Crowdfunding/