June 2012 Bar Bulletin
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June 2012 Bar Bulletin

Crowdfunding: Raising Capital over the Internet Requires Caution

By Mike Liles, Jr.


(Second of two parts)

Last month, we looked at potential federal and state regulation that will guide implementation of the recently adopted Jumpstart Our Business Startups Act (JOBS Act). This month, we examine various disclosure requirements affecting businesses that wish to take advantage of the Act's investment provisions.

The crowdfunding provisions of the JOBS Act refer briefly to certain disclosures that a small business must make in a crowdfunding offering. These include: a description of the company's business and business plan; certified, reviewed or audited financial statements (depending upon the amount of funds to be raised); use of proceeds; the past or prospective compensation received by persons to promote the offering through the intermediary's channels;1 the method for determining the offering price of the securities; ownership and capital structure; and risks to investors relating thereto.2

But these references in the JOBS Act only indicate the subject matter of certain disclosures and are neither comprehensive nor detailed. Securities offering disclosures have been developed and refined by securities laws professionals and regulators over the almost 80 years during which the Securities Act of 1933 has been in effect, and it is unlikely that inexperienced small-business owners will be able to prepare a balanced and complete set of disclosures without more detailed guidance. The JOBS Act does not by its terms establish a mechanism for preparation of the disclosures by securities professionals or others, and it remains to be seen whether the SEC will try to do so by rule if the statute does not contemplate it.

While the bills that became the JOBS Act were pending in Congress, a committee on small business capital formation of the North American Securities Administrators Association (NASAA), the trade association for state securities regulators, developed a proposed Model Crowdfunding Exemption for state securities regulators to use in crowdfunding offerings if the federal crowdfunding legislation did not preempt state regulation. The Washington securities administrator is a member of that committee.

Attached to that proposed Model Crowdfunding Exemption was a fill-in-the-blanks disclosure document modeled after NASAA's Form U-7 - a question-and-answer disclosure document for state registration of small offerings that are exempt from federal regulation under Rule 504 of Regulation D. Form U-7 was initially developed by the Washington Securities Division.3 The assumption is that filling in a detailed questionnaire has a better chance of evoking adequate disclosure by a small business than does free-writing.

Because the states have been preempted by the JOBS Act, NASAA's proposed Model Crowdfunding Exemption and its fill-in-the-blanks disclosure document will presumably never be adopted. However, the SEC's Offering Circular Model A to its Form 1-A Offering Statement under Regulation A is a question-and-answer disclosure document that is modeled upon and virtually identical to NASAA's Form U-7. Thus, it is possible that in implementing the crowdfunding provisions of the JOBS Act the SEC may reference its Offering Circular Model A as a suggested disclosure aid to crowdfunding issuers.

In any event, under the general antifraud provisions of federal and state securities laws,4 disclosures in connection with the offer and sale of securities must be accurate and complete in all material respects. Any guideposts by the SEC to assist in this should reduce later problems when business failures become manifest.

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