Thursday, October 24, 2013

SEC Issues Proposal on Crowdfunding

By Tim Dulaney, PhD, FRM and Tim Husson, PhD

Yesterday, the Securities and Exchange Commission (SEC) issued proposed rules (PDF) on crowdfunding to regulate the offer and sale of crowdfunding securities.  The press release for the proposed rules can be found here.  These proposed regulations are meant to fulfill the SEC's requirements under Title III of the JOBS Act (PDF). We have previously discussed the JOBS Act crowdfunding provisions in the context of real estate investments, but the proposed rules cover all types of crowdfunded investments.

Under the new rules, investors with annual income less than $100,000 could invest at most $5,000 with a particular issuer while investors with more than $100,000 in net worth or annual income could invest up to $100,000 (up to 10% of their annual income or net worth).  Investors who do purchase crowdfunded securities would not be able to sell those securities for one year. 

The proposed rules limit the aggregate amount of capital raised through the sale of crowdfunding securities to $1 million per twelve month period.  Importantly, holders of these exempted securities would not count toward the total used to determine the registration requirement under the Exchange Act (PDF) -- requires registration for as few as 500 non-accredited investors.  In addition, the proposed rules require companies to disclose information to the SEC and investors including: officer and director information, use of proceeds, description of financial condition, company's tax returns, etc.  The SEC will collect comments on the proposed rules over the next three months.

Crowdfunding certainly presents an opportunity for abuse of unsophisticated investors.  Many in the mainstream media are concerned that it will lead to a proliferation of highly speculative investments, but another concern is that the relatively small amount sold to each investor could limit potential redress in the event of fraud.  It is unclear whether the SEC's disclosure requirements will be sufficient to detect crowdfunded fraud or what form enforcement would take in this context.

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