May 2012 Bar Bulletin
Crowdfunding: Internet Investment Requires Caution
By Mike Liles, Jr.
(First of two parts)
For several years entrepreneurs have looked forward to the day when they could freely raise capital for emerging businesses over the Internet without having to register the securities with federal or state securities regulators. The recently adopted Jumpstart Our Business Startups Act (JOBS Act) provides a statutory structure for how this may be done, but it cannot be used until the Securities and Exchange Commission (SEC) adopts enabling rules, the scope and nature of which cannot now be predicted with any degree of confidence.
Enabling Rules Pending
Congress has passed, and President Obama has signed, the JOBS Act,1 which will allow emerging businesses to raise capital over the Internet. The Act directs the SEC to revise its rules relating to offerings made in reliance upon the private offering safe harbor afforded by Rule 506 of Regulation D under the Securities Act of 1933 to provide that the prohibition against general solicitation or general advertising not apply to offers and sales of securities made pursuant to Rule 506, provided that all purchasers of the securities are accredited investors.2
This rule revision would allow such offerings of any size to be made over the Internet by emerging businesses directly to accredited investors. The Act also amends the Securities Act of 1933 to allow small businesses to raise capital from the general public ("crowdfunding")3 in small amounts through an Internet intermediary registered with the SEC and an applicable self-regulatory agency.4 The intermediary may be either a broker or an Internet "funding portal."5
The Act directs the SEC to revise its rules relating to Rule 506 offerings within 90 days of the date of enactment of the Act and to adopt enabling rules for crowdfunding within 270 days of that date. Thus, small businesses cannot legally raise capital over the Internet under this new legislation until the SEC rulemaking process has been completed, and the SEC's work backlog is currently such that it may not meet the rulemaking deadlines Congress established under the statute.6
Raising capital over the Internet before the SEC rules have been promulgated could lead to sanctions by state or federal securities regulators, which might disqualify the violator for up to 10 years from being associated with a business that seeks to raise capital through either Rule 5067 or crowdfunding.8
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