In 2012, in an effort to revive the job market, President Obama signed into law a bill known as the “JOBS Act” (Jumpstart Our Business Startups). He called it a “potential game changer” for entrepreneurs seeking financing to start or expand a business. Most notably, it allowed entrepreneurs to solicit investment online and allowed the average investor (not just the wealthy “accredited investor”) to make an investment, a concept known as “crowdfunding.” On the federal level, the Securities and Exchange Commission (“SEC”) was slow in drafting the necessary rule amendments that would allow crowdfunding to occur across state lines (interstate crowdfunding). But state agencies and lawmakers were eager to open up capital for their local businesses. They began passing crowdfunding laws and regulations which let local businesses raise money from local residents on an intrastate basis, some taking action even before the JOBS Act was signed into law.
Kansas and Georgia were the first states to move forward with intrastate crowdfunding regulations, with their “Invest Kansas Exemption” and “Invest Georgia Exemption,” respectively, both adopted in 2011. They did this by writing their new crowdfunding exemptions so that they worked within the parameters of an existing federal intrastate exemption. Although state crowdfunding exemptions cannot supersede the actions of the SEC, there is a longstanding federal exemption from registration for intrastate offerings under Section 3(a)(11) of the Securities Act of 1933, as amended, and SEC Rule 147, which is a “safe harbor” means of compliance with Section 3(a)(11).
Other states followed suit. In fact, by the end of 2015, only a handful of states had yet to propose or enact regulation. Tennessee’s crowdfunding exemption, Invest Tennessee Exemption, or “ITE,” went into effect on January 1, 2015 while specific rules relating to ITE took effect December 16, 2015. I was so pleased with Tennessee's leadership in crowdfunding that I wrote a letter of support for the proposed regulations. While the rules create an opportunity for issuers to raise equity capital, there are unique anti-fraud risks.
State rules, regulations and/or exemptions are not without limitations, however, and there has been much written about whether they will have the desired effect. There are restrictions on the offerings that can be conducted intrastate. Most obviously, issuers can only raise money from investors in their own state. But other restrictions, which vary state to state, can also be burdensome. These include: limits on funds to be raised, limits on the amounts an investor can invest, limits on those that can be issuers, limits on transferability, increased disclosure and reporting requirements, required use of broker-dealers or crowdfunding portals, required use of internet site operators, and required use of escrow agents. In addition, in order to qualify under the state rules, regulations and/or exemptions, the offering must fall under the federal exemption from registration under Section 3(a)(11) and SEC Rule 147.
In October 2015, the SEC finally issued 568 pages of final rules to implement the JOBS Act, which become effective May 16, 2016. These are the parameters of the crowdfunding rules:
- Issuers can raise a maximum of $1 million in a 12-month period
- Investors whose income or net worth are less than $100,000 are limited to $2,000 or 5% of their income, whichever is greater, in aggregate crowdfunding investments over a 12-month period
- Investors whose income or net worth is greater than $100,000 may invest up to 10% of their income or net worth, not to exceed $100,000 in a 12-month period
- All crowdfunding transactions must take place on an SEC-registered intermediary (either a broker-dealer or a crowdfunding portal)
- Intermediaries must take measures to educate investors and mitigate fraud
- Issuers must provide basic financial information (the proposed rules require audited financials for offerings greater than $500,000)