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7/27/2019 Legal Aspects of Crowdfunding by Natalia Thurston, Social Venture Law
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CROWDFUNDING: LEGAL ASPECTSOF ALTERNATIVE FINANCE
Presented by Natalia Thurston, Social VentureLaw
55 Francisco St., Suite 403San Francisco, CA 94133Tel: [email protected]
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Background
Economic Climate
Focus on Small Business
Growth of Micro-Lending
Social Impact Investing
Federal Law: JOBS Act
SEC Regs (Title II)
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Alternative Investment Vehicles
Reward-Based
Entity offers gifts/rewards in exchange for funding
Kickstarter, Indiegogo
Peer-to-Peer Lending Loans from unrelated individuals to individual
borrowers with verifiable credit history
Lending Club, Prosper
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Alternative Investment Vehicles
Direct Public Offerings Entity raises capital without intermediary offering stock directly to
public
Requires state-level registration and exemption from SEC
regulations; compliance with state Blue Sky laws
Self-Directed IRAs Individual retirement funds are invested in assets such as real
estate, restaurants, promissory notes, tax lien certificates, and
private placement securities LLC Structured IRA
IRS regulations govern to prohibit self-dealing
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Securities Act of 1933
Section 5 prohibits use of mails or interstatecommerce for the direct or indirect sale of securitieswithout SEC registration.
Additional provisions in the Securities Act regulate
registration process, impose audited financialreporting, public disclosure requirements, and waitingperiods on marketing efforts.
Section 4(2) exempts from Securities Actrequirements transactions by an issuer not involving
any public offering. SECs Rule 146 prohibits general solicitation and
general advertising; issuers were required to pre-screen offerees and evaluate their financial conditionand sophistication. (1974)
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Securities Act of 1933
Reg D was promulgated in early 1980s to addressuncertain patchwork of exemptions
Reg D superseded Rule 146 and authorized the
SEC to exempt from registration offerings up to $5million
Private placements under Reg D avoid the fullburden ofthe Acts registration, disclosure &
reporting requirements
General solicitation and general advertising
continued to be prohibited without a least anunderlying state registration
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Regulation D
Rule 504 Rule 505 Rule 506Eligible
Transaction
s $1 Million maximum offering
Not available to reporting
(Public) companies or
investment companies
$5 Million maximum
offering No maximum offering
size
Eligible
Participants No limitation on the number of
purchasers No accreditation or
sophistication requirements
Limited to 35 purchasers
Certain purchasersincluding accredited
investors do not count
toward the purchaser limit
Limited to 35
purchasers Certain purchasers
including accredited
investors do not count
toward the purchaser
limit
Non-accredited
investors or their
representatives must
meet sophistication
standardsRequiremen
ts No affirmative disclosure
obligations (state securities
offering laws are thought to
provide the necessary
protections) Resale of securities is
Affirmative disclosure
obligations apply when
non-accredited investors
participate in the
transaction Resale of securities is
Affirmative disclosure
obligations apply when
non-accredited
investors participate in
the transaction Resale of securities is
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Reg D Limitations
Securities may not be resold except underlimited circumstances highlighting lack of liquid
secondary market for resale. General Solicitation is not allowed, a pre-
existing substantive relationship must exist.
Generally advisors pre-qualify would beinvestors before providing information on thesecurities and frequently use a waiting periodbefore investment.
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Reg D Applied
Online investment platform: Mosaic(https://joinmosiac.com) utilizes Reg Dexemption to provide loans to solar projects
Investors must either be residents of California orNew York; or they must be accredited investors orin some cases sophisticated non-accreditedinvestors
When a projects Note has reached its fundingcommitment, investors commitment amounts aretransferred to the project
Investors receive return on their notes frompayments made by the projects to Mosaic
https://joinmosiac.com/https://joinmosiac.com/7/27/2019 Legal Aspects of Crowdfunding by Natalia Thurston, Social Venture Law
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Future Legal Landscape
SECs forthcoming regulations
JOBS Act directed SEC to produce regulationsallowing crowdfunding up to $1million per yearthrough broker dealer or newly created intermediaries
funding portals
Reporting/disclosure requirements for crowdfundingrules undetermined
JOBS Act instructs SEC to remove ban on generalsolicitation
SECs non-accredited investor solicitation investorrules due Dec 31, 2012; both accredited and non-accredited rules expected end of 2013
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SEC Title II Regulations
SECs adopts new rules lifting ban on general solicitation (July10, 2013) New SEC rules address Title II of the JOBS Act, creating a walled
garden for accredited investors.
New SEC rules address Dodd-FrankActs investor risk concerns andrestrictsfelons and other bad actors from participating in Reg D offerings
Allows equity-based crowdfunding intermediaries to promoteinvestment offerings to accredited investors using the Internet andsocial media (Ex: CircleUp, Mosaic, Crowdfunder.com)
Promotion must lead back to a platform that verifies accreditedinvestors before giving them access to the investment offering
Requires additional registrations with SEC
New rules regarding Title III unaccredited investors expected byend of 2013
Estimated U.S. market for Title II crowdfunding(accredited investors): $20 Billion (Source: CrowdFundBeat)
Estimated U.S. market for Title III crowdfunding (non-accredited investors): $2 Trillion (Source: CrowdFundBeat)
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Fiduciary Duties
Fiduciary duties of broker-dealers vs. investment advisors toinvestors.
Investment advisors (regulated by FINRA) owe a fiduciary obligationto their clients.
Broker dealers must recommend suitable investments but are not
generally assumed to owe a fiduciary standard. Distinction between advice/planning and merely facilitating the
transaction is lost on many investors.
A number of investors in failed Reg D offerings have filed suit againstbrokerages based on failure to conduct adequate due diligence.
Under the JOBS Act crowdfunding provisions, it is unclear whether
a fiduciary duty will be owed by broker-dealers or funding portals toinvestors.
Dodd Frank legislation gives authority to SEC to adopt a uniformfiduciary standard applicable to all giving investment advice.
Funding portals mayfall under the Uniform Fiduciary Standardalong with investment advisors and broker-dealers.
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Risks to Investors
Use of Internet and social media to marketofferings increases risk to investors of improperoffers to sell securities
Hack, Pump & Dump Schemes (spreading falseinformation on the Internet to inflate stock price)
Risks to investors of fraud will weaken capitalmarkets
No current marketplace for secondary exchangeof securities
Public scrutiny and transparency in reward-basedcrowdfunding
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Public Policy Issues
Regulatory burden too great?
Regulations defeat purpose of efficiency?
Case Study: Pabst BrewingCompany/BuyaBeerCompany.com
Two advertising executives created BuyaBeerCompany.com to raise
$300 million to purchase Pabst Brewing Company by collecting pledgesthrough their site, Facebook, and Twitter. Contributors would receive:
A crowdsourced certificate of ownership and Beer worth the value of their pledge
Collected pledges totaling $14.5 million in the first 3 weeks and morethan $200 million in the first four months.
SEC took the position that the arrangement constituted an offer to sellsecurities, triggering Section 5s registration requirement.
Ultimately the two agreed to a cease and desist order from the SEC. Pabst was later sold for an undisclosed amount, reportedly about $250
million.
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Questions/Discussion
Natalia Thurston
Social Venture Law
55 Francisco Street, Suite 403
San Francisco, CA 94133
Tel: (415) 240-9024
Email: [email protected]