10/1/2014

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ModeratorRon OrolSenior EditorThe Deal

Expert Panel:Marianne HudsonExecutive DirectorAngel Capital Association

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Expert Panel:Gregory J. NowakPartnerPepper Hamilton LLP

Expert Panel:Brian S. KornOf CounselPepper Hamilton LLP

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JOBS Act Overview

• Crowdfunding – online fundraising…but there’s a catch

• Regulation A+ - from $5mm to $50 mm

• Private Placement Reforms

− General Solicitation relaxed – effective Sept. 23

− Enhanced verification of Accredited Investors if Soliciting

• “Go Public” Shareholder Thresholds Increased

• IPO On-Ramp and Emerging Growth Companies

• Relaxation on Research Restrictions

• Decimalization – move to $.09 tick increments?

• Prospective Issuer Outreach

• Signed into law April 5, 2012

“To increase American job creation and economic growth by improving access to the public capital markets for

emerging growth companies.”

JOBS Act IPO On-Ramp

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The IPO On-Ramp

• Title I of the JOBS Act – Reopening American Capital Markets to Emerging Growth Companies

• Intended to make capital raising easier

• The lengthy exhaustive IPO process was perceived as impeding capital raising by smaller companies

• Costs and difficulties of going public, listing on an exchange and being a public reporting company are high

Emerging Growth Company

• New category of issuer: “Emerging Growth Company”

− Total annual revenues of less than $1 billion (indexed for CPI every 5 years)

− Has not issued more than $1 billion of non-convertible debt over the previous 3 years

− Issuer is not a “large accelerated filer” under Securities Exchange Act Rule 12b-2; a large accelerated filer meets all of the following:

• $700 million worldwide public float (excludes affiliates)

• Has been subject to reporting requirements for one year

• Has filed at least one 10-K/20-F

− EGC status carries a 5 year maximum – last day of fiscal year containing 5th

anniversary of first public equity offering

− Electing EGC status is optional

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Benefits of EGC Status – IPO Process

• Confidential Submissions of Registration Statement to SEC Staff until 21 days prior to launch of roadshow

− Electronic EDGAR-only submission not visible to the public until S-1 is publicly filed

− Can clear comments, but letters and responses will become public upon public filing of the Registration Statements

• “Testing the Waters” meetings (oral or written communications) are permitted with QIBs and Accredited Investors pre- or post-filing

− Issuers or persons authorized by issuers

− Exempt from Section 5, but still liable for statements

Benefits of EGC Status - Disclosure

• Reduced Disclosure

− Excused from Sarbanes Oxley 404(b)

− Executive Compensation

• No CD&A

• No mean compensation data

• No CEO vs. median employee pay multiple data

• No Say on Pay, Say When on Pay and Say on Golden Parachutes Votes (which are non-binding anyway)

− Audited financials- 2 years permitted instead of 3

• Selected financials – need not show more than audited years presented (2 years instead of 5)

− Need not comply with new financial accounting standards (must declare at outset and cannot cherrypick or switch back and forth)

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New Advertised Private Placement Rules

Private Placements – Former Law

• Former Private Placement Rules (Reg. D) prohibited general solicitation and general advertising

− Rule 504: Up to $1 million

− Rule 505: Up to $5 million, not including “bad boys”

− Rule 506: Unlimited amount, limited to accredited investors or financially sophisticated investors

− Blue Sky Laws

• Preempted only for Rule 506 offerings

• Individual states exempt sales to “institutional buyers”

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New Structure of Rule 506

• Regulation D Rule 506 now has two alternatives: (b) and (c)

− 506(b) is the traditional rule

• no general solicitation or advertising permitted

• offers and sales must be to either accredited or financially sophisticated investors

• up to 35 non-accredited investors permitted

• information requirements for non-accredited investors

• unlimited accredited investors permitted

• unlimited dollar amount of offering

− 506(c) is the new rule

• general solicitation or advertising is permitted

• sales must be to accredited investors only

• unlimited accredited investors permitted

• unlimited dollar amount of offering

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Verification of Accredited Status

• The proposed new rules require the issuer to take “reasonable steps to verify” that the purchasers of the securities are accredited investors, considering the following factors:

− nature of purchaser / category of accredited investor

− amount and type of information issuer has concerning the purchaser

− nature of offering

• manner in which purchaser was solicited

• term of the offering

• minimum investment amount, if any

• Observations:

− Online activities have burden of demonstrating they are not advertising

− Professional verification firms are cropping up (eg, Accredify)

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Crowdfunding and Regulation A+

Backdrop: Current Crowdfunding Landscape – Five VarietiesType Rewards/

Donation-

Based

Securities to Accredited

Investors (Title II)

Securities to

the Public (Title

III)

Peer-to-Peer Lending Intrastate Crowdfunding

Examples Kickstarter,

Indiegogo,

Rockethub,

Youcaring

Ourcrowd, Realty Mogul,

FundersClub, AngelList,

None so far;

potentially a

rewards or

accred platform

LendingClub, Prosper, Funding

Circle, Zopa (UK), Ratesetter (UK),

Auxmoney (Germany)

Invest Georgia Exemption,

Michigan Invests Locally

Exemption (MILE), Maine,

Kansas, Texas (pending)

Securities Reg

Status

Not sales of

“securities”

Sales of securities to

accredited investors through

deal-specific special purpose

vehicles; Intrastate rules have

been enacted in GA, MI, ME

and KS and are proposed in TX

Sales of

securities to the

general public

Registered borrower-payment

dependent notes to the general public

(25 states only) or private placements

Public offerings to residents of a

single state; exempt from SEC

rules under Securities Act

3(a)(11) exemption/Rule 147

Regulation State-level

antifraud only;

not SEC-

regulated

SEC-regulated, no-action

letters protect website

solicitations from being public

offerings

Extensive SEC

regulation;

currently illegal

until SEC rules

are finalized

SEC-registered securities, not really

crowdfunding; banking regulations,

not legal in several states due to blue

sky restrictions; Private placements

have blue sky preemption

State regulated

Bad Actor

Disqualification

Not applicable Applies for all issuers and for

the crowdfunding sites

themselves

Not applicable

under JOBS Act,

but SEC has

said it will apply

Not applicable Varies by state

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• Comprises Title III of the JOBS Act

• Originated from two perceived needs:

− that smaller retail investors did not have access to early stage investment opportunities

− that start-up companies did not have adequate access to available capital, particularly online capital raising

• Adds exemption from SEC registration for crowdfunding transactions in the form of new Section 4(6) of the Securities Act

Public Crowdfunding Background

• Capital

• Raising

• Online

• While

• Deterring

• Fraud and

• Unethical

• Non-

• Disclosure

Issuers Not Eligible to Crowdfund

• Non-US companies

• Public reporting companies (only required filers are excluded, not “voluntary filers”)

• Investment companies, including companies excluded from the definition of Investment Company by 3(b) or 3(c) of the Investment Company Act of 1940, including:

− Mutual Funds

− Private Equity Funds

− Asset Management Vehicles

− Business Development Companies

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Crowdfunding vs. Other ExemptionsFeature Public Crowdfunding (Title

III)

Regulation A+

(Tier 1)

Regulation A+

(Tier 2)

Private Placements Including Title

II Crowdfunding (Regulation D Rule

506 (b/c))

Maximum Total

Raised

$1 million per 12 month

period

$5 million per 12 month

period; including up to $1.5

million for selling

shareholders

$50 million per 12 month period;

including up to $15 million for selling

shareholders

Unlimited

Number of

Investors

Unlimited but subject to

maximum total raised

Unrestricted

Unrestricted

Unlimited accredited investors; up to

35 non-accredited investors unless

soliciting (if soliciting- 0 non-accreds)

Investment Per

Investor

Restricted by income/net

worth

Unrestricted

Restricted by income/net worth Unrestricted

Investor

Disclosure

Required, must be filed with

SEC

Required, must be filed

with SEC

Required, must be filed with SEC Not required if all accredited investors;

Form D filing proposed

Intermediary

Required

Yes – broker/dealer or

funding portal

No

No

No

Subject to

ongoing SEC

reporting

following raise

Yes, at least annually,

possibly more frequently

No; as long as exit report

is filed not later than 30

calendar days after

termination or completion

Yes; audited financials filed annually;

annual, semi-annual, current reporting

required

May file exit report, so long as issuer

meets certain qualifications

No

Crowdfunding vs. Other ExemptionsFeature Public Crowdfunding Regulation A+

(Tier 1)

Regulation A+

(Tier 2)

Private Placements

(Regulation D Rule 506 (b/c))

Disclosure Liability Yes, full disclosure

liability with a

knowledge exception

Yes, full disclosure liability

with a knowledge exception

Yes, full disclosure liability with a

knowledge exception

Only anti-fraud liability

Shares restricted Yes, for one year No

No

Yes, for public companies most

can sell under Rule 144 after six

months

State Filing Possibly, depends on

future rules by state

Not exempt from state

securities law registration

and qualification

Exempt from state securities law

registration and qualification if sold

to “qualified purchasers,” defined

to include all offerees in a

Regulation A offering and all

purchasers in a Tier 2 offering

Usually no if only offering to

accredited investors

Advertising and

general solicitation

Not allowed "Testing the waters"

permitted before filing;

general solicitation permitted

after qualification

"Testing the waters" permitted

before filing; general solicitation

permitted after qualification

Allowed if sales are made only

to accredited investors and

issuer takes reasonable steps to

verify accredited status

Can public cos.,

foreign issuers,

investment

companies and

exempt inv.

companies issue

No Yes, but limited Yes, but limited Yes

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Crowdfunding Requirements

• Investment limitations (per trailing 12 month period)

− Company: Can receive up to $1 million

− Investor:

• Less than $100K: greater of $2,000 or 5% of annual income or net worth

• $100K or more: 10% of annual income or net worth

• Must be conducted through broker or “funding portal”

• Must file with the SEC and provide to broker/funding portal and investors extensive disclosure, including tax returns ($100K or less), reviewed financial statements ($100K-$500K) or audited financial statement (>$500K)

Crowdfunding Requirements

• Must not advertise except to direct investors to broker/portal

• Must not pay promoters except as SEC allows

• Must file annual or more frequent reports with the SEC

• Prospectus liability for disclosures with knowledge out

• 1 year holding period on shares sold except to issuer, accredited investor, family member or through registered offering

• Crowdfunded shares do not count towards the 2,000 shareholder rule to force a company public, but see above re SEC reporting

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Debt Crowdfunding - Peer-to-Peer Lending

• What is Peer-to-Peer Lending?

• Is it legal?

• What are the risks for borrowers, lenders?

• What is the legal status of the loans?

• Can the loans be resold?

• Is this a form of crowdfunding?

• Why aren’t big banks intervening?

• Institutional vs. Retail Investors

Peer-to-Peer Lending

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What’s Going On Here?

• Neither LendingClub nor Prosper are banks

− Peer-to-peer lending sites facilitate loans to consumers from WebBank, a Utah-chartered state industrial bank

− WebBank allows interest rate to be “portable”

− WebBank sets credit terms, extends credit and holds loan for 1 day

− Both LC and Prosper have been in business over 5 years

• Battles have been waged in each state to arrive at this point

− Platforms retain servicing rights and service loan

− $$ is not FDIC or SIPC insured

• Bank regulatory “lite” applies – Platforms must comply with consumer finance credit, privacy and auto-deduction laws, but……

− Exempt from 23A and 23B affiliate rules*

− Exempt from regulatory capital rules*

− Exempt from too big to fail, living wills, Volcker

− Will big banks start to care at some point, and then what happens?

• Borrower may not pay and Lender cannot sue Borrower

− Lender has limited ability compared to traditional lending

− Limited recourse to enforce loan

− Collection fees will exceed recovery

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Top Legal issues in Peer-to-Peer

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AUDIENCE Q&A

Thank you for joining the webcast.

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