Saturday, December 27, 2014

Blue Sky Filings Made Easy?

One of the reasons that explains why Rule 506 offerings have been so popular as a means of conducting a private placement is because they are exempt from state regulation.  In 1996, the National Securities Markets Improvement Act stated that securities offered under Rule 506 of Regulation D qualify as "covered securities" under Section 18(b)(4) of the Securities Act.  Consequently, securities sold under Rule 506 enjoy a exemption from the registration requirements of state-level securities laws (blue sky laws).

But states can still ask the issuers to make notice filings and pay filing fees with respect to Rule 506 private placements if any of the investors are their residents.  Most states make it easy for the issuers: they ask for a copy of Form D and a fee that typically ranges around $100-$300.  Some states take it a lot further.  I think New York State blue sky compliance requirements merit a separate blog post (to come).

On December 15, 2014, the North American Securities Administrators Association (NASAA) launched an Electronic Filing Depository system, EFD, that allows issuers to submit Form D and applicable fees to different states at once.  It also allows the public to view blue sky filings made by any issuer in any state that participates in the EFD.  Here is NASAA's training video.  The system provides an electronic receipt as proof of compliance and allows issuers to monitor the progress of states' review of the filing and respond to any deficiencies that may arise.  

Of course, when it comes to blue sky compliance, things cannot be made that simple that fast.  First, not all states participate.  As of now, 41 states and territories participate (New York is not one of them).  Some state regulators want filings to be made only through the EFD, other states accept only hard copies, and yet the third group accepts either.  To confirm what the state regulators expect, attorneys can contact the relevant state regulator using this contact information.  Second, some states may ask for additional documentation (such as consent to service of process or a copy of the offering memorandum) that would need to be sent to them separately.  Third, there is a $150 system use fee for each offering.  The fee covers the issuer's initial Form D filing and all amendment and renewal filings made through the EFD for that offering.

Still, as a lawyer who diligently spends hours (if not days) figuring out each state's blue sky requirements for each private placement I work on, I am thankful for the EFD. Even if it is not perfect, and even if there is a fee to use it, it will save time and will actually increase blue sky compliance.   

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Friday, December 26, 2014

Real Estate Crowdfunding

More about crowdfunding and portals...

When speaking about equity-based crowdfunding, the U.S. securities laws do not differentiate among different uses of proceeds derived from raising funds through crowdfunding portals.  The same securities laws apply to real estate crowdfunding as to crowndfunding campaigns with a goal of investing into technology startups.  The key terms that participants should be aware of are: the JOBS Act, private placements, accredited investors, Rule 506(b) offerings, Rule 506(c) offerings, general solicitation and advertising, intrastate offerings, and broker-dealer registration, among others.  

This guide on real estate crowdfunding prepared by Goodwin Proctor attorneys provides a useful overall summary of applicable laws and may just as well apply to other types of equity-based crowdfunding.  The most useful, in my opinion, is the chart on pages 6-7 of the guide that summarizes how various online crowdfunding portals enable securities offerings.  Interestingly, most if not all, rely on Rule 506(c) that allows conducting private placements that use general solicitation and advertising.  The choice, in my opinion, depends in large part on the amount of information about possible offerings that is available to users of the websites.  Such information can be viewed as general solicitation and advertising if it is easily accessible on the Internet by anybody.  In such cases, reasonable steps must be taken to ensure that only accredited investors participate in the offerings.  

Another interesting fact that can be learned from the chart is that most portals are not registered as broker-dealers.  These are examples of how portals comply with the exemption from registration found in Section 4(b) of the Securities Act that was made possible by the JOBS Act.  I discussed the broker-dealer exemption in my recent blog post available here.  

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

Thursday, December 25, 2014

Crowdfunding Portals and the Securities Laws

The SEC has recently intensified its enforcement efforts against crowdfunding portals. The SEC's main focus is on these two legal issues: whether the crowdfunding portals offer and sell securities in unregistered transactions to US persons in violation of the Securities Act, and whether the crowdfunding portals act as unregistered broker-dealers to US persons. A recent example of an enforcement action against Eureeca Capital SPC is a good illustration.

On November 10, 2014, the SEC issued an order instituting administrative and cease-and-desist proceedings against Eureeca Capital SPC (“Eureeca”).  Eureeca was formed in the Cayman Islands in May 2013.  It operated an online equity crowdfunding platform connecting foreign issuers with investors. The offerings posted on the Eureeca website were general solicitation of US persons because they were accessible to the US residents and included information about the offerings, such as amounts and informational videos, that was not restricted or protected by password.  Potential investors were then asked to register to get more information by providing their names, dates of birth, email, country of residence and phone number.  They were not asked to certify that they were accredited investors.  Although Eureeca did have a disclaimer of its website that its services were not being offered to US persons, it did not implement procedures to prevent US investors from using the platform.  As of May 2014, Eureeca permitted over 50 persons who chose “United States” as their country of residence, to register on the platform.  Three of them ended up investing approximately $20,000 in total in four offerings advertised on the platform.  Eureeca sent emails to the registered users with detailed investment status and overview of the offerings and encouraged investment into these offerings.  To invest, registered users had to wire the money into Eureeca’s escrow account.  Then, users could allocate the money among different offerings.  If the offerings were fully funded, Eureeca then completed “the final legal requirements and managed the swap of funds for the equity agreed.”  Eureca received a percentage of the funds of the fully funded offerings of securities as compensation for its services upon closing of a deal. 

First, the SEC concluded that Eureeca violated Section 5(c) of the Securities Act by offering the sale of securities to three US investors because, after generally soliciting them, it did not take reasonable steps to verify that the purchasers of the securities were accredited investors. Two of the three investors self-certified by email that they were accredited investors, although such term was not explained to them. The third investor did not do even that.

Rule 506(c) allows issuers to use general solicitation and advertising in conducting private placements so long as their actual investors are accredited. Companies that conduct 506(c) offerings must take “reasonable steps” to verify that all investors in their offerings are accredited and have a reasonable belief that such investors are accredited at the time of the sale of securities. Before the JOBS Act, and still while conducting Rule 506(b) offerings, companies could rely on investors’ self-certification (for example, questionnaires where investors self-report their income and net worth). This is no longer enough for a successful Rule 506(c) offering. Instead, the companies or someone on their behalf must request and review evidence of investors’ income or net worth. I wrote a detailed blog about how the “reasonable steps” here.

Next, the SEC concluded that Eureeca violated Section 15(a) of the Exchange Act by acting as an unregistered broker-dealer to US persons since it solicited investors and participated in key parts of the transactions.

Although much clarification is still needed, the SEC position with respect to whether crowdfunding portals are expected to register as broker-dealers has been based on the following. First, there is Section 201(c) of the JOBS Act that introduced paragraph (b) to Section 4 of the Securities Act. This exemption states that a person who conducts a Rule 506 offering will not be required to register as a broker-dealer solely because they maintain an online investment portal or engage in general solicitations of securities. Such person may not receive “compensation in connection with the purchase or sale of the security,” have possession of customer funds or securities, or be subject to a statutory disqualification. It is permitted for such person to co-invest in the securities and provide “ancillary services”. I discussed this in more detail here.

Second, the SEC issued FAQs in February 2013, clarifying the broker-dealer exemption described above. Here, the Staff clarified that the prohibition of transaction-based compensation extends to “any direct or indirect economic benefits to the person or any of its associated persons” but that any profits derived from co-investing would be permissible.

Third, there is a series of no-action letters on the topic: IPOnet (July 26, 1996), Lamp Technologies, Inc. (May 29, 1997), Angel Capital Electronic Network (October 25, 1996), FundersClub Inc. and FundersClub Management LLC (March 26, 2013) and AngelList LLC and AngelList Advisors LLC (March 28, 2013). I discussed the latter two no-action letters here.

Overall, the SEC position with respect to the need for a crowdfunding portal to register as a broker-dealer appears to be as follows. There may not be a need for registration so long as the following restrictions are observed:

1. There is no transaction-based compensation (i.e., fees are not contingent upon the outcome or success of the offerings).

2. The portals do not participate in any negotiations between the companies and the investors or structuring of the deals.

3. The portals do not handle funds or securities involved in the transactions.

4. The portals do not hold themselves out as providing any securities-related service other than a listing or a matching service.

5. The portals do not provide advice about the merits of a particular opportunity or investment.

Clearly, Eureeca violated a number of these provisions. Eureeca’s compensation was based on the success of the offerings. It handled investors’ money and the securities. Finally, it encouraged investors to invest in the offerings.

In conclusion, it seems advisable for entrepreneurs who are interested in setting up a crowndfunding portal to engage the services of an experienced attorney who specializes in securities laws.  If Eureeca had done it, its legal troubles would have been avoided.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.