By Audris G. Hampton, Esq
Posted on 1-17-2014
CATEGORIES: Business Law
I disclosed in Part 1 of this article-series, that the Jumpstart Our Business Startups Act of 2012 (the JOBS Act) eliminated the ban on general solicitation and advertising in the private placement of securities. I also disclosed that Title III of the JOBS Act created a securities-law exemption for the offer and sale of securities through crowdfunding (the CROWDFUND Act).
At the conclusion of Part 1, I referenced the twofold purpose that underlies the CROWDFUND Act: One, Congress intended to facilitate the use of peer-to-peer financing networks, accessible via internet portals; and, two, Congress intended to open up to “non-accredited” investors a financing-market for small, innovative (albeit speculative), business startups.
I advised in Part 1 that I next would focus upon the actual SEC proposals and recommendations. Just prior to publishing Part 1 of this article-series, the SEC issued a press release entitled, “SEC Issues Proposal on Crowdfunding” (2013-227 Washington D.C. Oct. 23, 2013; “SEC Proposal”). That SEC Proposal, and the below-referenced information, are the primary sources from which I derived the informational-content that I reference and disclose in this Part 2 of the article-series.
The JOBS Act established the foundation for crowdfunding. The JOBS Act went into effect on Sept. 23, 2013. On October 23, 2013, the SEC unanimously voted to propose rules that would implement the JOBS Act by providing a regulatory and administrative structure for crowdfunding. The public-comment phase of the proposed Rules closed this past January 2014.
SEC Chair Mary Jo White emphasized that the JOBS Act presents new capital-investment opportunities for small businesses and for a wide range of potential investors. White advised, “There is a great deal of excitement in the marketplace about the crowdfunding exemption, and I’m pleased that we’re in a position to seek public comment on a proposal to permit crowdfunding. …We want this market to thrive in a safe manner for investors.”
The opportunity for public comment upon the rules remained available for 90-days following the October 23, 2013 publication of the rules (in the Federal Register). I derived the following excerpts, explanations, and comments from information that the SEC made available, through the “Open Meeting” process, in developing the FACT SHEET (and Background Information) in support of the October 23, 2013 proposal, publication, meeting, and public-comment process.
Title III of the JOBS Act establishes a foundation for a regulatory structure that permits small businesses to utilize crowdfunding. The exemption requires the SEC to write rules to implement the exemption; and the exemption establishes a new entity, the “funding portal”, through which intermediaries, acting through internet-based platforms, may facilitate the offer and sale of securities, without being registered “brokers”. Congress intends for these combined measures to facilitate capital-raising by small businesses, while providing significant protections to investors.
The proposed rules:
(1) permit individuals to invest (in accordance with certain thresholds);
(2) limit the amount of money companies can raise;
(3) require companies to disclose certain information about their offers; and
(4) create a regulatory framework for the intermediaries (broker-dealers and funding-portals) that facilitate the crowdfunding transactions.
Certain companies would not be eligible to use the crowdfunding exemption.
Ineligible companies include:
(1) non-U.S. companies;
(2) companies that already are SEC-reporting companies;
(3) certain investment companies;
(3) companies that are disqualified specifically under the proposed disqualification rules;
(4) companies that have failed to comply with the annual reporting requirements in the proposed rules; and
(5) companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.
Title III of the JOBS Act prohibits the reselling of securities, purchased in a crowdfunding transaction, for a period of one year from the date of purchase/investment. However, the holders of these crowdfunding-securities are not “counted’ in the (number-of-holders) threshold that requires a company to register with the SEC under Section 12(g) of the Exchange Act.
The proposed rules will impose upon companies conducting a crowdfunding-offering the obligation to file with the SEC, provide to the actual investors, and provide to the intermediary that is facilitating the crowdfunding-offering, certain information which the companies also must make available to potential investors.
One of the key investor protections that Title III of the JOBS Act provides for crowdfunding is the requirement that crowdfunding transactions take place through an SEC-registered intermediary, either a “broker-dealer” or a “funding-portal”. Under the proposed rules, the offerings will be conducted online, exclusively, through a platform operated by a registered broker-dealer or a funding portal, which will be a new type of SEC registrant.
The proposed rules also will impose upon the funding-portal certain restrictions on compensating third-parties for the solicitation of crowdfunded-securities-offers.
Along with the imposed restrictions and limitations, the proposed rules will provide “safe harbor” definitions, descriptions, and guidelines. If funding-portals comply with the safe harbor provisions, then the funding-portals can engage in certain activities that are deemed consistent with the restrictions, even if, arguably, one could reasonably reach a different conclusion about whether the activities are permitted.
Now that the Commission has sought public comment on the proposed rules for 90 days, the Commission will next review the comments and determine whether to adopt the proposed rules.
The new CROWDFUND Act has important limitations and places significant obligations on participants in this new, alternative-investment market. Under the statute, as mentioned above, issuers (companies) may only raise up to $1,000,000, annually, through securities-crowdfunding. However, in addition to the monetary limitation, issuers also must state a minimum amount for the offering and can collect the proceeds of the offering only if they reach or exceed that target.
The financial disclosures that the issuers must provide will depend on the size of the offering: For offerings of $100,000 or less, issuers will be required to produce income tax returns for the last fiscal year and unaudited financial statements that are certified as accurate by the principal executive officer; for offerings of between $100,000 and $500,000, issuers will be required to produce financial statements that are reviewed by an independent, certified public accountant; and for offerings of between $500,000 and the $1 million maximum, the issuer will be required to produce fully-audited financial statements. Finally, all issuers must follow-up each crowdfunding offering by filing with the SEC, and making available to investors, annually, a report on the results of crowdfunding-transactions.
As for investors, the maximum, annual aggregate-amount of crowdfunded-securities that any one investor may purchase depends on her wealth and income: If an investor’s net worth or annual income is under $100,000, she can invest the greater of $2,000, or five percent of her annual income, in crowdfunded-securities each year; if her net worth or annual income equals or exceeds $100,000, she can invest 10% of her annual income each year (as above-referenced).
The Act provides that crowdfunding-transactions may not be consummated directly between an issuer and an investor. Rather, the transactions must be executed through a financial intermediary registered with the SEC as either a broker-dealer or a funding portal (as referenced above, the Act specifically “creates” these new types of intermediaries). Also alluded-to, above, the Act imposes a number of serious obligations on these financial intermediaries, such as the requirement to take approved measures to reduce the risk of fraud – expressly including a background check on officers, directors and substantial investors in the crowdfunding-issuers.
With respect to a secondary market, for crowdfunded-securities that are not part of an SEC-registered offering, the Act provides that the original investors/purchasers may not sell, or otherwise transfer, any crowdfunded-securities, for a period of one year after the date of the investment/purchase, unless the original investor is transferring-back to the issuer (the company), an accredited investor, or a family member of the original purchaser, the crowdfunded-securities.
The CROWDFUND Act expressly pre-empts state law regarding the registration or qualification of securities. However, the companies/issuers must provide states with notice of crowdfunded-offerings; and each state retains the right to bring an enforcement action for fraud or other violations of state securities-law (i.e., laws that are not related to registration).
To police fraudulent behavior, the Act expressly authorizes civil actions against an issuer – and, specifically, its officers and directors – if an officer or director makes an untrue statement of a fact that is material to the offering. In addition, the SEC is granted examination, enforcement and other rulemaking authority over dealer-brokers/funding-portals, and presumably retains authority to enforce the various statutory and regulatory mandates for both issuers and intermediaries.
How securities-crowdfunding will play out, in actual practice, remains to be seen and depends greatly upon the rules that the SEC just proposed on October 23, 2013. Those proposed rules, called “Regulation Crowdfunding,” are available online.
The CROWDFUND Act represents an opportunity for enterprising and entrepreneurial individuals and businesses to shape a new alternative-financing/creative-investment market for securities. There will be original and exciting opportunities to facilitate a process that literally could “open many doors”. Crowdfunding has the potential to accommodate, for the first time, the capital/cash needs of impassioned-visionaries who love what they do and live to “be different” and “make a difference”. The possibilities, alone, are amazing and inspiring!
By Audris G. Hampton, Esq.
Posted on 1-7-2014
CATEGORIES: Business Law
This initial article is the first in a multi-part series of articles on alternative financing. In this “Part One”, I’ll provide a preliminary review of recent developments in the law relevant to crowdfunding. This first article will be rather limited and introductory in nature. Still, I hope to provide a basic familiarization with the business concepts and legal aspects of crowdfunding.
Every business requires operating capital. Also, every business needs a source of available cash. Accordingly, every business faces the challenges of raising capital, and acquiring cash, as a normal-course function of initial formation, ongoing development, and operational functionality.
There are various means by which businesses traditionally raise capital and acquire cash. In our current economic climate, though, traditional methods for funding, financing, and investing in smaller businesses often are not available or are not feasible. Thankfully, there are alternatives.
Certain alternatives to mainstream financing/investment activities have become well established. Innovative approaches to venture-capital funding, private-equity investment, and special-facility financing all are alternatives that have become relatively mainstreamed.
The latest alternative-financing models are related to innovations that arose very early in history, as opposed to mainstreamed alternatives that arose in the recent past. The commonality between certain ancient approaches, and their modern counterparts, is intriguing but not surprising.
In the fourth century AD, the Christian church formalized earlier, canon-law edicts that prohibited usury (“selling time” by charging for the “use” of money). During the Middle Ages merchants responded with the “Contractum Trinius”: a set of contracts that separately established three distinct agreements. The church previously approved each, individual arrangement (an investment agreement; an insurance agreement; and a limited-licensing agreement).
The combined agreements of the Contractum Trinius, interoperating as a whole, implemented a compensated-funding transaction by which the investor received payment of an insurance premium, as compensation for potential losses; along with payment of a licensing fee, as compensation for potential gain (from the productive use of the investment); as well as future payments of the investor’s (retained) profits-entitlement, as compensation for the actual gain.
The results obtained were similar to what could be achieved by making an interest-bearing loan, without accommodating the susceptibilities to abuse that were so inherent with interest-bearing loans. As a result, the Contractum Trinius circumvented the Christian anti-usury directives.
Analogous to the Christian proscriptions, Jewish money-lenders could not charge interest on loans between Jewish citizens. However, developments in Jewish law permitted a royalty approach that was distinguishable from usury. A royalty-issuer paid to a royalty-holder (the funding party) a percentage of future revenues generated by the productive use of the funding.
The royalty was not an interest charge. This was true in part because the parties could not know the amount of any future revenue (the royalty basis). Also, the royalty “fixed” the allocation of future revenue (if any), but did not impose a fixed-debt obligation. Further, the royalty expired upon maturity without any residual obligation, benefit, or value.
Islamic law also condemned the payment of interest. Further, Islamic law prohibited the fixed-return of profits, even in joint venture arrangements, if there existed, in essence, a debtor/creditor relationship in which only a non-funding partner was liable exclusively for any losses.
The approved, alternative method provided for a direct-investment approach by which the capital-funding contributed to a recognized, charitable purpose. The investor purchased an “equitable position” in the enterprise (analogous to “stock ownership”). Through this arrangement, the investor participated in both the financial gains and losses of the venture and, most importantly, invested in the social value of the benevolent purpose to be achieved.
These three financing alternatives originated from business arrangements that arose as early as the 8th century BC. These alternatives – along with certain investment/funding approaches derived from these alternatives – were utilized within an expanded scope of commercial applications, as a result of revived implementations that occurred as late as the 14th century AD.
These alternatives discouraged the use of morally-questionable practices; encouraged the achievement of important community goals; provided for an equitable participation in gains and losses; and implemented non-traditional resources. Currently, these beneficial attributes are shaping financing alternatives that are among the most innovative of contemporary approaches.
This limited, historical background provides a context in which to consider the financial alternatives that are impacting significantly the emerging landscape of new business practices and creative capitalization approaches: crowdfunding; micro-financing; peer-to-peer lending; and alternative-investment strategies. As I mentioned above, this article will focus on crowdfunding.
Crowdfunding is the term utilized to describe an evolving method of raising money via the Internet. For several years, this alternative-funding approach has been effectively implemented to generate financial support for creative endeavors in the arts (e.g., theater, film, and music), typically through relatively small, individual contributions from a very large pool of people.
During the last several years, crowdfunding generally has not been employed as a means for offering and selling securities. This limited implementation of crowdfunding was based primarily upon the fact that offering a share of profits, as a financial return from business activities, easily could trigger the application of federal securities laws, especially in light of the fact that an offer or sale of securities must be registered with the SEC (unless an exemption is available).
In 2012, crowdfunded-financing raised $2.7 billion. That amount is up 81% from 2011. According to 2013 projections, the total amount raised from crowdfunding will be approximately $5 billion (nearly twice the 2012 total). This staggering expansion has occurred without a rules-based, regulated market (which should be developing in 2014, for the below-stated reasons).
The application of the existing form of crowdfunding – “reward-crowdfunding” – has engendered a significant increase in resources available for private financing, especially micro-financing, along with a correlated increase in viable investment strategies and effective funding contributions. As a result, reward-crowdfunding has satisfied the capitalization requirements of individuals, collectives, and entities for which the broader investment markets and traditional sources of financing have not been a particularly good fit.
Accordingly, “securities-crowdfunding” has the potential to revolutionize financing by creating a phenomenon that is “of the people, by the people, [and] for the people”. Among the potential beneficiaries of this (congressionally-intended) democratization are entrepreneurial startups, small businesses, and boutique/niche undertakings; along with an indefinite variety of socially-aware, policy-focused, and special-agenda enterprises.
Federal law previously prohibited Securities-crowdfunding. In 2012, Congress legislatively overturned the prohibition of securities-crowdfunding. Upon the SEC’s finalization of governing regulations, a new crowdfunded-securities market will be actively engaged and commercially functional. The SEC did not meet the initial 2012 rules deadline. However, the SEC did propose new rules on October 23, 2013. The new rules probably will be effective, officially, in 2014.
Securities-crowdfunding utilizes the internet to accommodate (unregistered) securities sales to a large pool of retail investors. Each retail investor contributes a relatively small funding-amount. Securities-crowdfunding, therefore, is based upon the main attributes of reward-crowdfunding.
Websites such as Kickstarter, GoFundMe, and IndieGoGo are, at this point, well established internet portals for reward-crowdfunding. The prior securities law, which practically imposed an effective ban upon securities-crowdfunding, prevented the investing “crowd” from receiving securities (e.g., stocks, bonds, etc.) from their funding activities on these websites.
The “rewards” received by funding-contributors, for their investment activities on Kickstarter and similar websites, usually are CDs, books, tickets, and similar items from the musicians, writers, producers, and other artists who typically solicit funding on these internet portals. Business ventures, intending to produce tangible products in commerce, are the newest form of entrepreneurs attempting to raise capital on websites such as Kickstarter.
When Congress legislatively overturned the prohibition of securities-crowdfunding, it did so by amending existing federal securities laws. In Title III of the Jumpstart Our Business Startups (JOBS) Act—the “CROWDFUND Act”—Congress established a new exemption from the registration requirement for crowdfunded-securities. In April 2012, President Obama signed into law the JOBS Act. As referenced above, the law will go into effect after the SEC completes its rulemaking process, which (also as referenced above) probably will occur in 2014.
The primary purpose of the CROWDFUND Act is twofold. First of all, the law is intended to facilitate the use of peer-to-peer financing networks, accessible via internet portals. This interactive utilization of technological resources should prove to be a very effective means by which entrepreneurial startups, small businesses, and similar enterprises can obtain modest amounts of business capital, with low costs and high efficiency.
Second of all, as alluded to, above, the law is intended to implement Congress’s intention to democratize the market for financing speculative startups, and other business undertakings with similar risk/benefit profiles, by accommodating financing by investors of modest means. Previously, these types of investments could be offered only to “accredited” (relatively wealthy) investors. Now, retail investors of modest means have the opportunity to finance innovative product/service ideas, by participating in personally-meaningful funding ventures.
When Congress amended Title III of the JOBS Act, and thereby created a securities-law exemption for securities-crowdfunding, the resulting statutory scheme established a legislative foundation for a regulatory structure (via SEC rules-promulgation) for implementing securities-crowdfunding. In my next article, I’ll explore certain details of the proposed Rules and I’ll address the Rules’ anticipated impact upon alternative financing-opportunities; creative investment-participation; and innovative business-development. Stay tuned and join the crowd!
By Sheryl A. Fernandez, Paralegal
Posted on 1-7-2014
CATEGORIES: Family Law
The 2013 Colorado Legislative Session brought some big changes through Criminal and Family Law legislation. From the re-introduction of Jessica’s Law—asking for a 25 year, mandatory incarceration sentence for those convicted of sexual abuse on a child younger than 15—to the slow (and sometimes painful) implementation process surrounding Amendment 64 (legalization of marijuana), the Colorado General Assembly had their work cut out for them.
Many legislators focused on clarifying existing statutes in order to fine tune the law. This approach was reflected in House Bill 13-1204 (abbreviated as “HB13-1204”) by Representative Bob Gardner (R- Colorado Springs) and Senator Jessie Ulibarri (D- Thornton). House Bill 13-1204 makes changes to the law surrounding Premarital and Marital agreements.
The Colorado Commission on Uniform State Laws recommended the adoption of HB 13-1204 because it aligns Colorado law with the Uniform Premarital and Marital Agreements Act, which has been adopted in 26 other states to date according to the Uniform Law Commission.
Basically, this piece of legislation establishes new statutory guidelines (and standardizes existing ones) governing premarital and marital agreements; it also identifies what might require judicial review. This continues to clarify some key points by inserting new language:
Formation requirements: A premarital or marital agreement must be in a record signed by both parties; and, it is enforceable without consideration.
When agreement effective: A premarital agreement is effective upon marriage. A marital agreement is effective upon execution (signing by both parties).
Void marriage: If a marriage is determined to be void, a premarital or marital agreement is enforceable only to the extent necessary to avoid an inequitable result.
Enforcement: A premarital or marital agreement is unenforceable if a party was not a voluntary participant (or entered into the agreement under duress); if one party did not have access to legal representation; if the agreement did not include a notice of waiver of rights or a plain language explanation of the marital rights were modified by the waiver; or, if a party did not receive proper financial disclosures.
This law does not take effect until July 1, 2014 and does not affect any right, obligation, or liability arising under a premarital or marital agreement signed before July 1, 2014. This law easily passed out of the Colorado House with no opposition; however, it was opposed in the Colorado Senate by most of the Republican Senators.