JOBS Act Analysis: How Start-ups Can Attract Small Investors Online Without Being Unfriended by the SEC (4th in a Series)

President Obama signs the Jumpstart Our Jumpstart Our Business Startups Act

President Obama signs the Jumpstart Our Jumpstart Our Business Startups (JOBS) Act April 5, 2012

A primary goal of the JOBS Act (the “Jumpstart Our Business Startups Act“)[i] was to facilitate raising capital by reducing regulatory burdens for organizations. One avenue through which it attempts to do this is by easing the rules relating to crowdfunding.

Crowdfunding itself has been around for some time and is used for a wide variety of purposes: from disaster relief to political campaigns, to funding a movie or a startup business. In fact, last year, crowdfunding raised nearly US$1.5 billion.

What’s Crowdfunding?

crowdfunding (crowd|fund|ing) noun

the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet: musicians, filmmakers, and artists have successfully raised funds and fostered awareness through crowdfunding (Oxford Dictionaries)

The JOBS Act will now permit funds to be raised from a wider pool of smaller investors with fewer restrictions. The Act accomplishes this by modifying the Securities Act of 1933 for initial public offerings. It adds an exemption for transactions that don’t exceed $1 million over a 12-month period and are conducted through a broker or funding portal that complies with the certain requirements (discussed below). Depending on each investor’s financial wherewithal, these transactions cannot exceed:

  • Investors with < $100,000 annual income or net worth: the greater of $2,000 or 5% of the investor’s annual income or net worth.
  • Investors with ≥ $100,000 annual income or net worth: 10% of the investor’s annual income or net worth, not to exceed a maximum aggregate amount sold of $100,000.

Not Just Any Portal in a Storm

Crowdfunding has to be done through a broker or funding portal complying with the requirements of Section 4A(a). These require portals to:

  • Register with the SEC and an applicable self-regulating organization (which may be FINRA)
  • Provide any disclosure required by the SEC (to be determined)
  • Ensure that each investor reviews education information, confirm that the investor understands the risk of loss of its investment and can bear such loss, and answer questions demonstrating that the investor understands the risks inherent in investing in startup companies (as well as other matters that the SEC may require)
  • Take measures to reduce the risk of fraud
  • Make certain that the issuer may only receive the offering proceeds after the aggregate capital raised exceeds the targeted offering amount, as well as permit all investors to cancel their commitment to invest
  • Make sure that no investor exceeds the per-investor limits in any 12-month period
  • Prohibit its directors, officers or partners from having any financial interest in any company that uses the broker or funding portal
  • Not compensate promoters, finders or lead generators
  • No later than 21 days before the first sale to investors, make available to the SEC and potential investors any disclosure information provided by the issuer to meet the requirements of Section 4A(b).

Questions of Disclosure and Control

Clearly there are a lot of unknowns about how the new crowdfunding rules will work. The SEC, for example, could potentially make crowdfunding very costly through the portals. And while a JOBS Act goal is to facilitate the raising of capital, crowdfunding actually requires more disclosure than private offerings conducted under Regulation D’s safe harbors. Until we see the SEC’s rules, the future of crowdfunding will remain uncertain.

With crowdfunding, a company’s shareholders could potentially go from just friends and family to a few thousand overnight. This raises the issue of corporate control as well as how venture capitalists and other major investment firms might view an already crowded organization when it comes time to raising additional capital.

State Laws Haven’t Changed

While state securities law is preempted by the JOBS Act, state law is not. Companies will still need to comply with state corporation law. Each state’s code is different, with some imposing greater costs than others.

Directors and Officers Beware

Big and bad: the JOBS Act defines “issuer” unusually broadly to include the issuing company’s directors and officers. This means that if material misstatements were made during an offering, disgruntled investors could go after the directors and officers—personally. This provision could mean that very few directors or officers may be willing to come on board and incur personal liability. Most D&O Liability insurers are taking a wait-and-see attitude, but some are expressing concern about pump-and-dump schemes.

This new freedom rings in once the Securities and Exchange Commission (SEC) issues its new rules on crowdfunding. The Commission has 270 days from the enactment date (April 5th, 2012) to lay down these rules.

Richard Magrann-Wells and I are examining each of these revisions in individual articles and discussing their potential impact and insurance ramifications.


[i] The JOBS Act provisions have the exhaustive but potentially illuminating title of: ‘Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012’ or the ‘CROWDFUND Act’.

[ii] The specific provision amended is Section 4 of the Securities Act of 1933 (15 U.S.C. 77d).

[iii] Within Regulation D, most issuers use the Rule 504 exemption for private offerings of up to $1 million, and the Rule 506 exemption for all other offerings.  However, Reg D private offerings can’t use any general solicitation or advertisement.  And all securities sold under Reg D are “restricted” securities, so the investor is restricted in its resale.

[iv] And you thought that only employees were “disgruntled”!


The observations, comments and suggestions we have made in this publication are advisory and are not intended nor should they be taken as legal or financial advice. Please contact your own legal or financial adviser for an analysis of your specific facts and circumstances.

About Ann Longmore

Ann is Executive Vice President of Willis' Executive Risks practice. Based in New York, she has been with the compa…
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