The New Crowdfunding Law As Applied to Filmmaker Issuers
 
By John W. Cones
 
            The new so-called crowdfunding exemption from the registration requirements of the Securities Act of 1933 (section 302 of H.R. 3606) – the Crowdfund Act) allows issuers of securities to raise up to $1,000,000 during a 12-month period. However, if either the annual income or the net worth of the investor is less than $100,000 the amount sold to such investor cannot exceed the greater of $2,000 or 5 percent of the annual income or net worth of such investor. If either the annual income or net worth of the investor is equal to or more than $100,000, such an investor can invest up to 10 percent of his or her annual income or net worth, as applicable, but such investments cannot exceed $100,000. In addition, the transaction must be conducted through a broker or funding portal that complies with further requirements of this legislation, and the issuer must comply with certain additional requirements. The income and net worth of a natural person are to be calculated in accordance with the rules of the Securities and Exchange Commission (“SEC”) relating to an accredited investor.
 
            Required Disclosures – Clearly, the legislation contemplates the preparation of a securities disclosure document to be provided to each prospective investor before they invest, since the law requires that the issuer file with the SEC and provide to investors and the relevant broker or funding portal, and make available to potential investors, the following information:
 
            (1) the name, legal status, physical address, and website address of the issuer;
 
(2) the names of the directors and officers (and any persons occupying a similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer;
 
(3) a description of the business of the issuer and the anticipated business plan of the issuer; and
 
            (4) a description of the financial condition of the issuer.
 
            For offerings that, together with all other offerings of the issuer under this same law  within the preceding 12-month period, have, in the aggregate, target offering amounts of $100,000 or less, the income tax returns filed by the issuer for the most recently completed year (if any) should be included in the disclosure document, along with the financial statements of the issuer, which must be certified by the principal executive officer of the issuer to be true and complete in all material respects.
 
            If the amount described in the above paragraph is more than $100,000, but not more than $500,000, the financial statements must be reviewed by a public accountant who is independent of the issuer, using professional standards and procedures for such review or standards and procedures established by the Commission, by rule, for such purpose.
 
            If the amount described in the above paragraph is more than $500,000 (or such other amount as the Commission may establish, by rule), audited financial statements are required.
 
            Further Disclosures – The law also requires the issuer to include in its securities disclosure document to be provided to the Commission, brokers, funding portals and prospective investors, a description of the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount.
 
            The issuer must also state the target offering amount, the deadline to reach the target offering amount, and provide regular updates regarding the progress of the issuer in meeting this target offering amount.
 
            The issuer must also disclose the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor must be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities.
 
            The issuer must also provide a description of the ownership and capital structure of the issuer, including:
 
(i) terms of the securities of the issuer being offered and each other class of security of the issuer, including how such terms may be modified, and a summary of the differences between such securities, including how the rights of the securities being offered may be materially limited, diluted, or qualified by the rights of any other class of security of the issuer;
 
(ii) a description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;
 
(iii) the name and ownership level of each existing shareholder who owns more than 20 percent of any class of the securities of the issuer;
 
(iv) how the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions; and the risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions, including additional issuances of shares, a sale of the issuer or of assets of the issuer, or transactions with related parties.
 
            The issuer will also have to disclose such other information as the Commission may, by rule, prescribe, for the protection of investors and in the public interest. In addition, the issuer must disclose the information required to meet the anti-fraud provisions which are set out specifically in the law (see “Issuer Liability” below”).
 
            Advertising – The law prohibits the issuer from advertising the terms of the offering, except for notices which direct investors to a funding portal or broker.
 
            Finder Compensation – The issuer also cannot compensate or commit to compensate, directly or indirectly, any person to promote its offerings through communication channels provided by a broker or funding portal, without taking such steps as the Commission shall, by rule, require to ensure that such person clearly discloses the receipt, past or prospective, of such compensation, upon each instance of such promotional communication.
 
            Filing Obligation – The issuer must, not less than annually, file with the Commission and provide to investors, reports of the results of operations and financial statements of the issuer, as the Commission shall, by rule, determine appropriate, subject to such exceptions and termination dates as the Commission may establish, by rule; and comply with such other requirements as the Commission may, by rule, prescribe, for the protection of investors and in the public interest.
 
            Possible Litigation – The law authorizes purchasers of securities in transactions exempted from registration by its provisions to bring lawsuits against the issuer and to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, or for damages if such person no longer owns the security.
 
            Issuer Liability – The law also provides that an issuer may be liable in such lawsuits for making any untrue statement of a material fact or omitting to state a material fact required to be stated or necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading, provided that the purchaser did not know of such untruth or omission; and the purchaser does not sustain the burden of proof that such issuer did not know, and in the exercise of reasonable care could not have known, of such untruth or omission. This requirement is equivalent to the anti-fraud provisions that apply to all securities offerings.
 
            Definition of Issuer – The law defines “issuer” to include any person who is a director or partner of the issuer, and the principal executive officer or officers, principal financial officer, and controller or principal accounting officer of the issuer (and any person occupying a similar status or performing a similar function) that offers or sells a security in a transaction exempted by the provisions of this law, and any person who offers or sells the security in such offering.
 
            Restricted Securities – The law provides further that securities issued pursuant to its provisions may not be transferred by the purchaser of such securities during the 1-year period beginning on the date of purchase, unless such securities are transferred (a) to the issuer of the securities; (b) to an accredited investor; (c) as part of an offering registered with the Commission; or (d) to a member of the family of the purchaser or the equivalent, or in connection with the death or divorce of the purchaser or other similar circumstance, in the discretion of the Commission. Such sales are also subject to such other limitations as the Commission shall establish.
 
            Combined With Other Funding Methods – The law specifically allows issuers to raise capital through other methods besides the Crowdfund Act.
 
            Certain Persons Are Disqualified – People who have been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of any false filing with the Commission (among others) are disqualified from relying on this new Crowdfund Act.
 
            Commission to Promulgate Rules – The Commission is required to promulgate rules deemed necessary or appropriate for the protection of investors within 270 days (9 months).
 
            Funding Portal Regulations – Other provisions of the law impose numerous requirements on the funding portals.
 
 
Copyright 2011 by John W. Cones
ALL RIGHTS RESERVED
jwc6774@gmail.com