Crowdfunding – Not General Solicitation

Crowdfunding

Crowdfunding—Not General Solicitation
People tend to assume a synonymous relationship between crowdfunding and general solicitation. At a perfunctory glance, the two appear to display no difference. Misleading information may partly account for the confusion. Websites casually reference crowdfunding interchangeably with general solicitation.[i] But the SEC distinguishes these easily conflated terms.

Crowdfunding—Defined

“Crowdfunding” denotes the cumulative process of generating funds through capital investment, recruiting small money from many people over time [ii], Unlike General solicitation which exploits advertisements, crowdfunding simply directs investors to a funding portal or broker. [iii] Crowdfunding typically fundraises via the internet.

While crowdfunding accepts contributions from “crowds” of investors, the Jumpstart Our Business Startups Act (JOBS ACT) prohibits advertisements for crowdfunding, unless to notify about a prospective investment opportunity. [iv]

General Solicitation—Defined

Under SEC 506(b) of Regulation D, General solicitation includes, inter alia, advertisements/promotions displayed in the following:

• Newspapers;
• Magazines;
• Published websites;
• Broadcast radio/television communications; and/or
• Social media outlets as Facebook, LinkedIn, Twitter, personal blogs, etc. [v]

Difference Between Crowdfunding & General Solicitation

The differences between crowdfunding and general solicitation display as follows:

• The SEC recognizes a difference between crowdfunding and general solicitation. Title II, AKA § 506(b), governs general solicitation. Crowdfunding falls under Title III of the SEC which prohibits advertisements beyond attracting investors to a crowdfunding platform. [vi]
• Under Title II, issuers—legal entities that finance operations by selling securities—must take reasonable steps to verify the accredited investors they recruit. [vii] An accredited investor generally refers to any individual whose (a) net worth including assets surpasses $1 million, or (b) individual income supersedes $200,000 annually for at least two years; $300,000 combined income if married. [viii] If issuers fail to verify before solicitation as a condition precedent, liability results. In other words, Title II entrusts issuers with knowledge or reason to infer such reasonable steps as an extension of their fiduciary responsibility. Hence, any such omission despite reasonably foreseeable knowledge of the foregoing precondition subjects the issuer to liability. However, Crowdfunding encourages eligible participation from accredited and non-accredited investors alike.
• Additionally, unlike crowdfunding, Title II requires no agent intermediary for general solicitation. Furthermore, Title II as promulgated recognizes a legal exemption under the aforementioned 506 (b) prerequisite for general solicitation; not so with crowdfunding, which appears questionably illegal. [ix] Title III, nonetheless, authorizes crowdfunding for the sole limited legal purpose of selling securities in small amounts to many investors. [x] Therefore, 506(b)—an exemption to the original rule—permits general solicitation, providing issuer(s) take all reasonable steps in procuring accredited investor(s). In 2013, Congress subdivided the original 506 rule into 506(b) and (c). Thus, the bifurcated rule provides a safe harbor under 506(b), while still retaining its original flavor pursuant to 506(c). [xi] Title III provides no such exemption for crowdfunding.

Crowdfunding At The Technological Forefront

Nevertheless, increasing technological trends appear to plausibly support the probative inference of crowdfunding possibly receiving a similar exemption. Though speculation drives this tentative consideration. For more information, consider the following references and resources:

References:

[i] Joe Wallen, Crowdfunding v. Rule 506(c) Offerings, StartUpLaw Blog (Oct. 1, 2013), http://www.startuplawblog.com/2013/10/01/crowdfunding-v-rule-506c-offerings/

[ii] Kim L. Taylor, REG D, RULE 506. REG A+ & CROWDFUNDING—Powerful Tools to Raise Big Money, SyndicationLawyers.com, Trowbridge, Taylor, Sidoti (May 26, 2015), http://www.syndicationlawyers.com/reg-d-rule-506c-reg-crowdfunding-powerful-tools-raise-big-money/
[iii] C. Steven Bradford, Crowdfunding and the Federal Securities Laws, 2012 COLUM. BUS. L. REV. 1, 10 (2012) (“Bradford”)
[iv] https://www.sec.gov/info/smallbus/secg/general-solicitation-small-entity-compliance-guide.htm
[v] See Id. at 1
[vi] 15 U.S.C. 77b(15)(ii)
[vii] 17 CFR, §230.215
[viii] General Rules and Regulations, Securities Act of 1933 §230.215 (1933).
[ix] Is Crowdfunding Legal, Startup Company Lawyer (May 26, 2012), http://www.startupcompanylawyer.com/category/general/
[x] See Bill Carlton, Patch of Land, SEC Regulation D Rule 506(c) & General Solicitation Explained in Video, (Feb. 26, 2014), https://patchofland.com/blog/qa-from-the-patch/2014/02/26/rule-506c-general-solicitation-explained-in-a-video/?utm_source=Hubspot&utm_medium=email&utm_term=&utm_content=investorWF_leftcta_060115&utm_campaign=general&hsCtaTracking=bbce6976-1a3e-4bd7-9489-574c6fb87795%7Cdb630ae2-ef47-4a38-996d-ec67a9657f8a&utm_medium=email&_hsenc=p2ANqtz-_0YRxP523vqk6e5RGufvbYovbMGZAxOj1RK-sqQiDwWSPTMEEF4-27Bq7mrvSW8uRJRGM0pVDomjKxvMtPLvLQqpCjvsSWIlrbg4_YlOuWT_2xLys&_hsmi=18086281&utm_source=hs_automation&utm_content=18069489;
[xi] SEC Rule 506 of Regulation D, Securities Act of 1933, § 4(a)(2), http://www.sec.gov/answers/rule506.htm.

Resources:

1. https://www.sec.gov/about/laws/sa33.pdf
2. SEC Rule 506 of Regulation D, Securities Act of 1933, § 4(a)(2), http://www.sec.gov/answers/rule506.htm
3. The Electronic Code of Fed. Regs., US Gov’t Publishing Office, (Aug. 20, 2015), http://www.ecfr.gov/cgi-bin/text-idx?SID=3bfd62667cca0a16625adf3dc1136de0&node=se17.3.230_1215&rgn=div8
4. http://www.sec.gov/rules/proposed/2013/33-9470.pdf
5. http://www.legalandcompliance.com/wp-content/uploads/2012/06/LC_White_Paper_10-8-12.pdf
6. http://www.joneskeller.com/news/2014/sec-proposes-crowdfunding-rules-issuers-and-funding-portals
7. Alixe B. Cormick, Definition of Accredited Investor in the United States, Venture Law Corporation, http://www.venturelawcorp.com/definition_accredited_investor_usa.pdf
8. http://www.alleywatch.com/2013/09/what-are-reasonable-steps-to-verify-accredited-investors/