On November 3, 2011, the U.S. House of Representatives voted overwhelmingly to pass the Entrepreneur Access to Capital Act (H.R. 2930). The bill creates an exemption from the registration requirements of the Securities Act of 1933, adding a new Section 4(6).[1] This section provides that an offering of securities is exempt if it meets the following criteria:
- The aggregate amount sold within the previous 12-month period is $1,000,000 or less. This limit is increased to $2,000,000 if the issuer provides potential investors with audited financial statements. Both limits are indexed to inflation.
- The aggregate amount sold to any investor in reliance on the exemption in any 12-month period is the lesser of (a) $10,000 (indexed to inflation) or (b) 10% of the investor’s annual income. No definition is given for annual income, so presumably fleshing this out will be handled by SEC interpretive regulations.
- The offering must also meet the requirements of the new Section 4A, which I’ll discuss shortly.
The bill also creates a new category of participant in the capital markets called an “intermediary.” There is not much detail provided as to what role an intermediary can play in an offering, but the bill explicitly exempts them from the broker-dealer registration requirements of the Securities Exchange Act of 1934. So presumably, an intermediary could act as a compensated finder and be paid a fee to find investors, though none of this is spelled out, and much will turn on the SEC’s interpretive regulations.
The new Section 4A sets out an additional set of criteria that must be met in order for an offering to qualify under the new Section 4(6) exemption. Such criteria include: warning investors of the risks involved in an investment in a start-up, reporting certain information to the SEC, ensuring that potential investors demonstrate an understanding of the risks involved, stating a target offering amount and a deadline to reach such amount, carrying out background checks on the issuer’s principals, and refraining from offering investment advice. If the offering is carried out by an intermediary, then the burden of complying with Section 4A lies with the intermediary.
The bill also provides that:
- Much of the information collected by the SEC will be shared with the States’ securities divisions.
- The securities sold will be subject to a holding period of one year, unless the securities are sold back to the issuer or to an accredited investor.
- Use of Section 4(6) does not preclude an issuer from raising capital through other means, though in practice, the integration provisions of Regulation D would probably prevent a simultaneous Reg. D offering from taking place, unless the SEC provides otherwise in its regulations.
The bill instructs the SEC to issue interpretive regulations for Section 4A and to issue regulations precluding the use of the Section 4(6) exemption by issuers, intermediaries, or affiliated persons with a poor disciplinary history. Presumably these rules will mirror the new “bad actor” exclusions for Rule 506.
Investors who purchase securities under the crowdfunding exemption would not count towards the 499 investor limit under the Securities Exchange Act.[2] In addition, securities issued under Section 4(6) will qualify as federally covered securities, which means they will be exempt from state registration requirements.[3]
The new exemption is complex and will no doubt keep securities lawyers busy. In a future post, I’ll discuss some of the implications and unanswered questions revolving around the new crowdfunding exemption.
Footnotes
[1] For those of you who might ask “what happened to the old Section 4(6),” the Dodd Fank Act had already moved the old Section 4(6) to Section 4(5), and the old Section 4(5) was eliminated.
[2] Under the Securities Exchange Act of 1934, a company with more than 499 investors held of record and more than $10 million in assets must register their securities with the SEC and become a publicly reporting company.
[3] Via federal preemption of state law.
© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
