Crowdfunding

  • In April of 2012 the US enacted The JOBS Act, which contained provisions intended to expand private capital formation in the US, both in terms of issuer access to capital as well as the individual investor participation in private offerings.   The new law enables the use of public advertising through the internet and other media channels tocommunicate information relate to a private placement offerings.

 

  • “Crowdfunding” offerings fall into one of two offering approaches: 1)  Rule 506(c), in which investment may only be made by third-party verified Accredited Investors, as defined in Rule 501 of SEC Regulation D, and where an unlimited amount of funds can be raised in the offering, and 2) via a FINRA-approved “Crowdfunding Portal”  to individual investorswhose financial resources are not as great as is required to be an Accredited Investor, but where the offering amount is limited to $1,000,000. 

 

  • The JOBS Act tasked the SEC, and by extension, FINRA, the self-regulatory authority for securities broker-dealers, to develop regulations to guide participants in thes new forms of private placements.  

 

  • Under Rule 506(c), the SEC must receive the offering documents as least 15 days before the solicitation is to occur (an “Advanced Form D” Filing) and also notification within 15 days of the first purchase by an investor (a “Form D” Filing).  Not making each filing within the prescribed deadlines could result in a prohibition of the Issuers access to the Regulation D market for 1 year.

 

  • Crowdfunding private offerings can include any form of security, such as promissory notes or equity interests (eg. common stock, preferred stock or membership interest in a Limited Liability Company).

 

  • Private placements are subject to all federal and state regulations regarding misrepresentation or fraud.

Accredited Investor Verification Guidelines

As of September 23, 2013, all investors participating as Accredited investors in Regulation D, Rule 506c (and the legacy Rule 506b) private placement offered by CFG must verify, through presentation of third-party validated information, that their financial status qualifies them as an Accredited Investor.  In the past, self-verification by the Investor was sufficient.  After September 23, 2013, self-verification is no longer sufficient to qualify as an Accredited Investor, third party verification is required under newly the adopted SEC Rule 506c.  

The non-exclusive and non-mandatory verification methods (i.e. the SEC authorizes that CFG can determine the best manner for each investor on a case by case basis) may be broken out into three categories:

1) Reasonable steps to directly verify income. An issuer may verify income by reviewing any Internal Revenue Service form that reports the purchaser's income for the two most recent years and obtaining a written representation from the purchaser that the purchaser has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year. Examples of acceptable Internal Revenue Service forms include Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040.

2) Reasonable steps to directly verify net worth. An issuer may rely on the following types of documentation dated within the prior three months of the purchase of the security to establish net worth, plus a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed.

  • With respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and
  • With respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies.

3) Third party verification. As an alternative to the foregoing approaches to collecting direct information from a purchaser as to income or net worth, the issuer may accept a written confirmation from one of the following persons or entities that the person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that the purchaser is an accredited investor.

  • A registered broker dealer;
  • An investment advisor registered with the Securities and Exchange Commission;
  • A certified public accountant.
  • A licensed attorney; or

If qualification of an accredited investor is based on joint income or net worth with a spouse, any certification will have to be provided both by the investor and by the spouse.

As the verification requirement is recently effective, presents potential criminal liability by investors who misrepresent their status and is a very important part of compliance by issuers of private securities, investors are encouraged to treat such verification very seriously.

Regulation D, Rule 506(c)

  • Regulation D was established by the SEC in the 1980’s to more specifically define a manner of privately offering securities.    Most companies issuing private securities do so by following one of the Rules within Regulation D.   
  • Rule 506(c) of Regulation D enables issuers to issue an unlimited amount of securities so long as only accredited investors participate in the offering.
  • Rule 506(c)  of Regulation D was approved by the SEC on July 10, 2013 enabled “general solicitation” (i.e. advertising) for Regulation D offering where only Accredited Investors may purchase the securities offered under 506(c).  Under this Rule, the SEC must receive the offering documents as least 15 days before the solicitation is to occur (an “Advanced Form D” Filing) and also notification within 15 days of the first purchase by an investor (a “Form D” Filing).  Not making each filing within the prescribed deadlines could result in a prohibition of the Issuers access to the Regulation D market for 1 year.
  • Virtually any type of security can be offered to investors through a 506(c) private placement including promissory notes or equity interests (eg. common stock, preferred stock or membership interest in a Limited Liability Company).
  • Investors participating in a 506(c) private placement must complete an Accredited Investor Questionnaire.
  • IMPORTANTLY – All accredited investors participating in a 506(c) private placement must also provide third party verification that they qualify as an Accredited Investor.  The means of verification standards is communicated to Investors by the Issuer, but often involves tax return submission and/or an accountant’s statement.

Regulation D, Rule 506(b)

  • Regulation D was established by the SEC in the 1980’s to more specifically define a manner of privately offering securities.    Most companies issuing private securities do so by following one of the Rules within Regulation D.   
  • Rule 501 creates the “Accredited Investor” definition for investor eligibility for Rule 505 and Rule 506 Regulation D private placements.  Accredited Investors includes high net worth individual investors having incomes exceeding either $200,000/year (for single persons) or $300,000/year (married couples) or a net worth exceeding $1,000,000 (excluding the value of their principal residence).  There are other definitions under Rule 501 which designate qualifying institutions or investment companies.
  • According to the SEC: “It (Rule 506) is by far the most widely used Regulation D exemption, accounting for an estimated 90 to 95% of all Regulation D offerings and the overwhelming majority of capital raised in transactions under Regulation D.”
  • Rule 506(b) of Regulation D enables issuers to issue an unlimited amount of securities so long as no more than 35 non-accredited investors participate in the offering.
  • Investors participating in a 506(c) private placement must complete an Accredited Investor Questionnaire.
  • IMPORTANTLY – All accredited investors participating in a 506(c) private placement self-verify that they qualify as an Accredited Investor.  
  • Virtually any type of security can be offered to investors through a Regulation D private placement including promissory notes or equity interests (eg. common stock, preferred stock or membership interest in a Limited Liability Company).
  • Regulation D private placements are subject to all other federal and state regulations regarding misrepresentation or fraud.
  • Form D must be filed with the SEC and in each state the securities are sold under Regulation D within 15 days of the commencement of the offering.

What is a Private Placement

  • Private placements are offerings of securities which do not involve registration of the underlying security with the Securities Exchange Commission (SEC).  They are traditionally offered discreetly and sold to investors, historically, in a non-public manner (i.e. without public advertising).  (see Regulation D, Rule 506(b))
  • However, a recent SEC Rule authorizes general solicitations for some privately placed securities which are only purchased by Accredited Investors and Accredited Investors Questionnaire .  (see Regulation D, Rule 506(c)).
  • Regulation D is a regulation of the SEC, and it contains specific rules for the proper conduct of a private placement in the United States (“safe harbor” guidelines).  Following the Rules within Regulation D is strongly recommended.  All CFG private offerings follow Regulation D guidelines.
  • Registered securities broker-dealers may act as a “Placement Agent” to conduct an offering on behalf of the issuer or the issuer can offer securities directly to investors.  If a Placement Agent is used, the firm must be a registered broker-dealer with the Financial Industry Regulatory Authority (FINRA).
  • Private offerings can include any form of security, such as promissory notes or equity interests (eg. common stock, preferred stock or membership interest in a Limited Liability Company).
  • Investors in private placements include individuals, wealth managers, managed funds, insurance companies, etc.
  • Private placements are subject to all federal and state regulations regarding securities issuance, including those relating to misrepresentation and fraud.

Private Placement Investment Considerations

  • Private offerings can be purchased directly from the issuer of the security during the offering period or through an agented, “best efforts” process managed by a FINRA-registered broker dealer acting as a “placement agent”.  Under US law, other than the issuer, only registered broker-dealers can conduct private placements as third-parties and receive compensation for such services. 
  • Any type of company can raise capital in the amounts they need through a private placement of securities.
  • Virtually any type of security can be offered to investors through a private placement including debt (such as promissory notes) or equity interests (eg. common stock, preferred stock or membership interest in a Limited Liability Company).
  • Investment in privately placed securities offers investors a significantly expanded universe of investment alternatives, but investors must also be aware of the greater increase risks associated with these securities.   Additional risks include:
    1. Illiquidity – Private placements are “buy and hold” investments.  Secondary trading (i.e. selling the security before its maturity) is not allowed and so broker dealers do not make secondary markets in private placements.
    2. Unaudited financial statements – There is no requirement that issuers of private securities have their financial statements audited by an accounting firm, though some do.
    3. Inconsistent pricing of similar securities – Since there are no trading markets, the pricing of private placements carrying similar risk can vary significantly.
    4. Difficult to determine the ongoing value of the investment – The lack of secondary markets makes it more difficult to independently determine the ongoingvalue of the investment, which is necessary for valuing personal financial statements and for estate-related transfers.
  • Private placements are subject to all federal and state securities regulations, including those related to misrepresentation or fraud.