A History of the Sustainable Economies Law Center's involvement in the JOBS Act
The Sustainable Economies Law Center played a key role in initiating the campaign for the CROWDFUND ACT (Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act), which became a key part of the JOBS Act that was signed into law by President Obama in April, 2012.
The Securities and Exchange Commission (SEC) finalized rules under the Act, after years of delays, and you can read more about our analysis of some of the rules here.
In 2009, Sustainable Economies Law Center adviser Michael Shuman, authored an article in the Community Development Investment Review, a publication of the Federal Reserve Bank of San Francisco. In the article, Michael pointed out that while locally owned, small businesses constitute about one half of the private economy in terms of output and jobs, they receive almost no investment from the public.
The reason for this, Michael argued, is that securities laws essentially ban public investment in small, locally owned businesses. “The regulations prohibit the average American from investing in any small business, unless the firm is willing to spend $50,000 to $100,000 on lawyers . . . .” Michael pointed out that if you go to a casino, you’re not required to attest that you are an accredited gambler and read a thick disclosure document about the risks of gambling. Yet this is what is required for investing which is arguably less risky than gambling!
So Michael made a modest proposal in the article: “One easy reform would be for the SEC to exempt from its usual expensive disclosure requirements any low-risk public ownership of locally owned microbusinesses. By low-risk, I mean that no person can hold more than $100 worth of any one stock. By local ownership, I mean that only residents within a state can buy, hold, and sell stock shares. And by microbusinesses, I mean any business with a total stock valuation on issuance of less than $250,000.”
In the summer of 2010, law student interns at the Sustainable Economies Law Center, with support from Paul Spinrad of Make Magazine, worked on a petition to the SEC to request a rule change that would implement Michael’s proposal. While the SEC did not respond to the request, news spread of this simple request. It seemed like a no-brainer – exempt $100 investments from the extremely onerous registration requirements. Amazingly, members of Congress and the President eventually expressed support for the idea of an exemption for small investments. This culminated in the passage of the CROWDFUND Act, which became a part of a bundle of securities law reforms called the JOBS Act.
A Summary of the Crowdfunding Title of the JOBS Act
The JOBS Act as it was signed into law is considerably different from our original proposal. The law allows businesses to raise capital from the public using an SEC-registered crowdfunding intermediary (ie a web platform). The maximum amount that can be raised is $1 million per year and each investor will be able to invest up to five percent of his or her annual income or net worth (ten percent if they have more than $100,000 in net worth or annual income).
Each investor is limited to investing as follows in any one enterprise:
(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 of 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.
The intermediaries must meet several requirements including:
- provide disclosures related to risks and other investor education materials;
- ensure that each investor reviews investor-education information;
- positively affirm that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss;
- answer questions demonstrating an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers and an understanding of the risk of illiquidity;
- take measures to reduce the risk of fraud, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of the issuer;
- ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount;
- make efforts to ensure that no investor in a 12-month period has purchased securities offered pursuant to the crowdfunding exemption that, in the aggregate, from all issuers, exceed the investment limits of the exemption.
The intermediary must provide the following information:
- the name, legal status, physical address, and website address of the issuer;
- the names of the directors and officers (and any persons occupying a similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer;
- a description of the business of the issuer and the anticipated business plan of the issuer;
- a description of the financial condition of the issuer, including, for offerings that, together with all other offerings of the issuer under the crowdfunding exemption within the preceding 12-month period, have, in the aggregate, target offering amounts of—$100,000 or less
- (I) the income tax returns filed by the issuer for the most recently completed year (if any);
- (II) financial statements of the issuer, which shall be certified by the principal executive officer of the issuer to be true and complete in all material respects;
- more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures for such review or standards and procedures established by the SEC, by rule, for such purpose; and
- more than $500,000 (or such other amount as the SEC may establish, by rule), audited financial statements;
- a description of the stated purpose and intended use of the proceeds;
- the target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
- the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities;
- a description of the ownership and capital structure of the issuer, including
- terms of the securities of the issuer being offered and each other class of security of the issuer, including how such terms may be modified, and a summary of the differences between such securities, including how the rights of the securities being offered may be materially limited, diluted, or qualified by the rights of any other class of security of the issuer;
- a description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;
- the name and ownership level of each existing shareholder who owns more than 20 percent of any class of the securities of the issuer;
- how the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions; and
- the risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions, including additional issues of shares, a sale of the issuer or of assets of the issuer, or transactions with related parties
The issuer may not advertise the terms of the offering, except for notices which direct investors to the intermediary’s web site. The issuer will also be required to provide regular reports to the SEC and investors.
There are two provisions of the CROWDFUND Act that make it much easier to raise money from a large number of small investors:
1. Offerings under the CROWDFUND Act are exempt from the requirement that a company with more than 500 investors in a single equity class that has $10 million in assets automatically becomes a public reporting company (the SEC may impose conditions on this exemption in its rulemaking process)
2. The states are not allowed to require registration of offerings that are exempt under the CROWDFUND Act (however they can require notice filings and fees in the state that is the issuer’s principal place of business and in any state in which purchasers of 50 percent or greater of the aggregate amount of the issue are residents)
Finally, the legislation requires that dollar amounts under the exemption will be adjusted not less frequently than once every 5 years to reflect any change in the Consumer Price Index.
The JOBS Act is just one legal way to raise money by investment crowdfunding in your community. For more information about securities laws for lawyers and small business owners see our online library on Community Enterprise Law at http://communityenterpriselaw.org/. It's also always best to confer with a lawyer who is very familiar with securities law to discuss your unique situation before starting an investment crowdfunding campaign!