SEC Adopts New Crowdfunding Rules

Websites (homepages) of five leading crowdfunding platforms in the world - Kickstarter, IndieGoGo, RocketHub, Crowdfunder and GoFundMe on a computer screen.

Over the past few years, crowdfunding websites have become an increasingly significant source of consumer feedback and funding for fashion companies as fashion-specific sites such as Betabrand and general sites such as Kickstarter have allowed designers to prescreen new designs and raise funding from interested users. In some cases, supporters of a company will be asked to provide contributions for which the contributors will generally receive some form of gift or other recognition. In other cases, supporters will be asked to preorder a particular item, but only if the funding goal is met will the item go into production.

However, until recently restrictions under the federal and state securities laws have prevented fashion and other companies from raising funds in securities offerings on the internet unless the offerings were registered with the securities authorities or were limited to institutional or wealthy individual investors.

In October 2015, the Securities and Exchange Commission (“SEC”) adopted final rules that will permit ordinary investors to participate in internet-based crowdfunded securities offerings.

The final rules, which will be effective commencing in May 2016, will:

  • Permit a non-public U.S. company (other than an investment company or a shell company) to raise a maximum aggregate amount of $1 million through crowdfunding offerings – in a 12-month period;
  • Require that the offering be conducted through a registered broker dealer or funding portal;
  • Permit individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to:
    • The greater of $2,000 or 5% of the lesser of their annual income or net worth – if either their annual income or net worth is less than $100,000; or
    • 10% of the lesser of their annual income or net worth – if both their annual income and net worth are equal to or more than $100,000.
    • During the 12-month period, the aggregate amount of securities sold to a particular investor through all crowdfunding offerings may not exceed $100,000.

Companies that rely on the crowdfunding rules to conduct a crowdfunding offering will be required to file certain information with the SEC and provide this information to investors and the intermediary facilitating the offering, including among other things:

  • A description of the business and the use of proceeds from the offering;
  • The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount;
  • A discussion of the company’s financial condition;
  • Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements, unless financial statements of the company are available that have been audited by an independent auditor;
  • Information about officers and directors as well as owners of 20 percent or more of the company; and
  • Certain related-party transactions.

In addition, companies relying on the crowdfunding exemption will be required to file an annual report with the SEC and provide it to investors that contain information similar to that in the initial disclosure statement.

Each issuer will need to evaluate whether the initial and ongoing costs of a crowdfunding offering make this an attractive capital raising method in light of the amount to be raised and other available funding alternatives. For some issuers a crowdfunding offering will be a useful method to raise funds and to begin to establish a committed shareholder base with the goal of eventually becoming a full public company.

Credit:  R. Brian Brodrick

Brian is a partner in Phillips Nizer’s Corporate Law and Securities & Private Placement Practices.


Is the Country of Origin Labeling Requirement Unconstitutional?

ClothingLabel-MadeChinaThe constitutional rights of businesses are hot topics. Freedom of speech is a fundamental tenet of liberty, protected by the First Amendment to the Constitution, that benefits commercial entities as well as individuals. The right to spend unlimited money to support the election or defeat of particular candidates for office derives from the right to freedom of speech. But does the same First Amendment right protect businesses from being compelled by government regulations to speak on matters as to which they would prefer not to comment, whether or not they are “controversial” or “political”? Is there a freedom to refrain from speaking?

If you think this question has nothing to do with fashion, you would be wrong. Every manufacturer in the fashion and accessory business labels its products with their “country of origin”, guided by detailed regulations promulgated by the Federal Trade Commission. Decisions in two recent cases, which have nothing to do with fashion, but everything to do with government regulations compelling businesses to speak on the source of their products, suggest that the “country of origin” regulatory scheme for the fashion industry may be challenged on First Amendment grounds.

A federal statute requires country of origin labeling for meat to address the country where the animal was born, raised or slaughtered. New rules for implementing the statute were promulgated in 2013 to comply with a World Trade Organization ruling on a complaint from Mexico and Canada, requiring greater specificity in describing separately the country where each of these events in the animal’s life occurred. A group of trade associations, feedlot operators and meat processors filed suit to enjoin the rules, claiming they violated the First Amendment. The argument was rejected by a three judge panel of the Court of Appeals for the D.C. Circuit, holding that the First Amendment did not bar the government from compelling factual speech on a non-controversial matter that might be of interest to consumers. The full court, however, voted to hear the case anew before all eleven judges of the court. The parties were directed to address the scope of First Amendment protection for mandatory disclosure of purely factual and non-controversial commercial information, compelled for reasons other than preventing consumer deception.

The outcome of this review may be foreshadowed by the same court’s decision on April 14, 2014, striking down Securities and Exchange Commission regulations that required public companies to disclose whether they used “conflict minerals” (minerals from the Democratic Republic of the Congo used by warring factions to finance their operations) in products they marketed or manufactured. The three judge panel found that it was unconstitutional to compel speech in the absence of a need to prevent consumer deception.

So one might well ask whether it is unconstitutional to compel apparel manufacturers to say anything about the subject when they are not marketing goods based on the country of origin. What purpose does it serve and do consumers need the information?

Credit: Helene M. Freeman