Title III Equity Crowdfunding: The Final Rules

The final Title III Equity Crowdfunding rules contain a number of changes from the proposed rules. Some of the changes are good, and some are arguably not so good.

On the good side:

• First time issuers raising more than $500,000 and up to $1 million will not have to have their financial statements audited. Instead, they can rely on reviewed financial statements.
• The annual report will not have to include reviewed or audited financial statements.

On the bad side:

• The final rules adopt stricter limits on the amounts that individuals can invest.
• The Section 12(g) rules may force some companies on to the path of becoming full-blown public reporting companies.

Financial Statements

All issuers have to provide in their offering materials financial statements prepared in accordance with U.S. GAAP.

But, depending on the amount to be raised in the offerings, issuers either have to provide “financial statements of the issuer that are certified by the principal executive officer of the issuer to be true and complete in all material respects,” provide financial statements that have been reviewed by an audit firm, or provide audited financial statement.

The proposed rules would have required issuers raising up to $100,000 to disclose their tax returns. The final rules changed this requirement.

Instead of mandating that issuers offering $100,000 or less provide copies of their federal income tax returns as proposed, the final rules require an issuer to disclose the amount of total income, taxable income and total tax, or the equivalent line items from the applicable form, exactly as reflected in its filed federal income tax returns, and to have the principal executive officer certify that those amounts reflect accurately the information in the issuer’s federal income tax returns.

Ongoing Reporting

The proposed rules would have required issuers to “disclose information similar to that required in the offering statement, including disclosure about its financial condition that meets the highest financial statement requirements that were applicable to its offering statement.”

But the SEC backed off this requirement:

After considering the comments, we are persuaded by the commenters that opposed requiring that an audit or review of the financial statements be included in the annual report that meet the highest standard previously provided, the final rules require financial statements of the issuer certified by the principal executive officer of the issuer to be true and complete in all material respects. However, issuers that have available financial statements that have been reviewed or audited by an independent certified public accountant because they prepare them for other purposes must provide them and will not be required to have the principal executive officer certification.

Investment Limitations

The final rules resolve an ambiguity in the statutory limitation on amounts that can be invested. Here is how the statute described the investment limitations.

the aggregate amount sold to any investor by an issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, does not exceed—(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and (ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000;

But what if your income is greater than $100,000, but your net worth is less than $100,000? What is your limit then?

The final rules opt for the lesser amount. So, if your income or net worth is less than $100,000, you are subject to the $2,000 or if greater 5% test.

Here is how the SEC described this change from the proposed rules, which would have opted for the “greater of” approach.

After considering the comments received, we have decided to adopt a “lesser of” approach. Thus, under the final rules, an investor will be limited to investing: (1) the greater of: $2,000 or 5 percent of the lesser of the investor’s annual income or net worth if either annual income or net worth is less than $100,000; or (2) 10 percent of the lesser of the investor’s annual income or net worth, not to exceed an amount sold of $100,000, if both annual income and net worth are $100,000 or more.

Under this approach, an investor with annual income of $50,000 a year and $105,000 in net worth would be subject to an investment limit of $2,500, in contrast to the proposed rules in which that same investor would have been eligible for an investment limit of $10,500. 

12(g) Reporting

The final rules set up a situation where crowdfunding companies may be essentially putting themselves on a forced path to becoming a public reporting company. I wrote a blog post about this that you can find at this link.

Integration

Crowdfunding offerings under Title III will not be integrated with other offerings, provided all of the offerings comply with their applicable exemptions. Here is how the SEC described their final say on this point:

[W]e note that the final rules do not provide a blanket exemption from integration with other private offerings that are conducted simultaneously with, or around the same time as, a Section 4(a)(6) offering. Rather, we provide guidance that an offering made in reliance on Section 4(a)(6) is not required to be integrated with another exempt offering made by the issuer to the extent that each offering complies with the requirements of the applicable exemption that is being relied upon for that particular offering. As mentioned earlier, an issuer conducting a concurrent exempt offering for which general solicitation is not permitted will need to be satisfied that purchasers in that offering were not solicited by means of the offering made in reliance on Section 4(a)(6). Alternatively, an issuer conducting a concurrent exempt offering for which general solicitation is permitted, for example, under Rule 506(c), cannot include in any such general solicitation an advertisement of the terms of an offering made in reliance on Section 4(a)(6), unless that advertisement otherwise complies with Section 4(a)(6) and the final rules.

Summary

I still think the crowdfunding rules are too complex. I think issuers are going to be spending a lot of money trying to comply. And my hunch is that many issuers are going to take a pass on equity crowdfunding under Title III altogether because of the complexity.