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JOBS Act Crowdfunding Rules Approved

The SEC on October 30, 2015, approved its crowdfunding rules under the JOBS Act, opening the doors for start-ups to raise equity financing online through groups of investors.

In a 3-1 vote, with Republican commissioner Michael Piwowar dissenting, the commission capped off its last significant regulatory mandate from the JOBS Act, and perhaps its most divisive. The decision comes two years after the rules were proposed in Release No. 33-9470, Crowdfunding . Sec. 1 of pl112-106

The rules are scheduled to become effective six months after they are published in the Federal Register, which usually happens a few weeks after the SEC posts a rule to its website. Funding portals, which will be used to sell securities to investors, have until January 29, 2016, to register with the SEC.

Also on a 3-1 vote, the commission agreed to issue a proposal relaxing rules around so-called “intrastate” crowdfunding.

The JOBS Act rule establishes a registration exemption for companies raising as much as $1 million a year through online funding portals, and creates a registration process for the intermediaries. Investors do not need to be accredited to participate in the offerings.

The final rules contain several major changes to the proposed rule, based on what SEC Chair Mary Jo White called in her remarks “a full reevaluation of the investor protections provided in the proposal.”

The changes to the rule’s investor protections follow a two-year debate over how to shield unsophisticated investors from fraud while keeping the rule viable for early-stage companies with limited resources. The measure also offers added a new incentive for intermediaries by allowing them to take ownership stakes in the issuers as compensation.

In his dissent, Piwowar doubted the “usefulness and the workability” of the rules, warning that issuers would be caught unaware by a series of complex requirements.

Under both the proposal and final rule, companies must comply with disclosure and accounting requirements that scale upward with the size of the offering.

In the 2013 proposal, a company raising less than $100,000 would be required to provide investors with prior-year tax returns and a financial statement certified by the CEO. Raising between $100,000 and $500,000 would require an independent public accountant to review the financial statements. A company raising more than $500,000 through JOBS Act crowdfunding would be required to provide investors with audited financial statements, a requirement that critics said was unworkable for early-stage companies.

In the final rules, a start-up using the crowdfunding exemption for the first time, and seeking to raise more than $500,000, would only need to have an accountant review financial statements. Subsequent offerings above $500,000 would require audited financials.

The final rules also place tighter limits on how much investors can purchase in a crowdfunded offering.

Investors earning less than $100,000 can invest the higher amount of either $2,000 per year or 5 percent of the lesser of their net worth or income. An investor with both income and net worth above $100,000 could invest 10 percent of his income or net worth, whichever is lesser.

No one would be allowed to put more than $100,000 into crowdfunding deals in any one year.

Securities purchased through a crowdfunding deal would have a holding period of one year before they could be resold.

Intermediaries, who can be either broker-dealers or newly registered funding portals, would be required to join FINRA.

The SEC staff is slated to study the effect of the rules on the market once they are in use and report back to the commission within three years. Democratic Commissioner Kara Stein, in her remarks, said she is comfortable with the rules, and that the study will allow the SEC to respond to changes “if we have gone too far in one direction or the other.”

Also at the meeting, the SEC proposed changes to Rule 147 and Rule 504 of the Securities Act of 1933 to facilitate intrastate crowdfunding, a similar type of offering in which both a start-up and its investors are based within the same state.

Rule 147 provides a safe harbor for companies relying on the exemption in Section 3(a)(11) of the Securities Act. The majority of states and the District of Columbia have enacted some form of crowdfunding law. Most have relied on the Section 3(a)(11) exemption. The SEC’s proposal would lift the in-state restrictions on marketing those deals and relax some eligibility requirements.

Some states have based crowdfunding laws on Rule 504 in Regulation D of the Securities Act, which lets issuers raise up to $1 million without regard to investors’ accreditation status. The SEC is proposing to raise the limit to $5 million.