By Rebekah Mintzer, From Corporate Counsel

Title III of the Jumpstart Our Business Startups Act, signed by President Barack Obama in April 2012, asked the U.S. Securities and Exchange Commission to create rules that would allow businesses to issue securities through internet-based crowdfunding. After much deliberation and hundreds of comments from the public, the commissioners at the SEC recently voted 3-1 to finalize these rules, which will make it easier for companies and startups to access capital from investors who might not have otherwise been included.

The final rules will hopefully open up doors for both businesses and investors. But companies that want to raise money this way shouldn’t let the “crowdfunding” label fool them into thinking that taking advantage of the new framework is as simple as setting up a Kickstarter page or sending out an email asking for investments.  Issuing securities under this new system will involve some work on the part of both the issuer and the broker-dealer or funding portal that is facilitating transactions.

The newly finalized crowdfunding rules change a system that previously allowed companies and entrepreneurs to only issue securities to individual investors with relatively high annual incomes or net worth. Now, smaller-time investors will be permitted by the SEC to participate as well. If the investor has a net worth or income of $100,000 or less a year, he or she will be able to invest $2,000 per year or 5 percent of his or her income or net worth, whichever is lower. If the investor’s income or net worth are over $100,000 per year, that threshold changes to 10 percent. The issuers will be allowed to collect up to $1 million per year in crowdfunded investments before they lose Title III coverage.

As would be expected from any securities issuer, those doing crowdfunding under the new SEC rules need to give investors enough information to make educated decisions. “Every issuer has to provide robust disclosures, such as documenting what the risk is, who the people are behind the company, as well as financials,” says Kiran Lingam, a partner at Nelson Mullins Riley & Scarborough

Then there are requirements around auditing, which have changed somewhat in response to comments on the SEC’s original proposed rules. “One of the most controversial aspects of the proposed rules,” explains Eliza Fromberg, counsel at Day Pitney “was requiring issuers seeking to raise over $500,000 to get audited financial statements, and there was lot of concern that this would simply price people out of making crowdfunded offerings.”

The SEC softened up the requirement a bit, says Fromberg, by giving issuers something of a pass the first time around. If they are offering between $500,000 and $1 million of securities they can rely on reviewed rather than fully audited (and therefore more expensive) financial statements during their first stab at raising capital through crowdfunding.

In addition to the issuers, the broker-dealers and funding portals that connect issuers with investors will have rules to follow as well. Among many requirements, they will need to register with the Financial Industry Regulatory Authority, explain the rules and processes of the platform to investors and ensure that investors are compliant with crowdfunding standards set out by the SEC.

One of the main concerns about the new rules is that they might attract companies looking at crowdfunding as a way to defraud investors. Lingam says that while he understands the concern, he sees the fact that investments have to go through well-regulated registered broker dealers or funding portals as a solid safeguard against fraud. Also, since crowdfunding is done online, there will be plenty of people around to spread the word about bad actors. “The wisdom of the crowd is the buzzword to describe that effect, when you’re doing something so publically, it’s hard to hide if you’re’ not on the up and up,” says Lingam.

There have also been questions about how the new rules and the growth in crowdfunding that’s expected to follow will impact the venture capital world. But it looks like the two may not overlap much in their investment interests, as VC tends to come in further down the road in a company’s development.

Jonathan Wilson, a partner at Taylor English Duma believes that a growth in crowdfunding could even be beneficial for venture capital as a kind of bellwether. “Crowdfunding and venture capital investing should not be butting heads,” he says. “If a company is successful at raising money through crowdfunding, it’s actually a target for venture capital.” Once a company has proven that it can attract interest from the crowd, the hope is, more funding in larger amounts could soon follow.

For more on this story go to: http://www.corpcounsel.com/id=1202741662172/New-SEC-Rules-Work-the-Crowd-for-Funds#ixzz3qfw9nSIw