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SEC proposes rules to allow anyone to invest in startups

SEC proposes rules to allow anyone to invest in startups

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The Securities and Exchange Commission (SEC) has finally proposed new rules for equity-based crowdfunding, a way of raising money that is similar to Kickstarter but allows companies to offer stock instead of T-shirts and backstage passes.

The proposed rules are still months away from being approved. However, the SEC's recommendations were modest and unsurprising, which should settle industry fears that the agency would make regulations too onerous. The SEC's presentation was light on details about enforcement, however, which may concern some state and local regulators that are worried about fraud.

Equity-based crowdfunding is prohibited under laws intended to protect the general population from making risky investments. However, it will soon become legal under Title III of the Jumpstart Our Business Startups (JOBS) Act, which passed in 2012 on the promise that it would help small businesses and create jobs. The SEC has been charged with making specific rules for how this new investment vehicle will work.

The SEC's recommendations were modest and unsurprising

Today the commission proposed rules for investors, companies raising money, and funding portals, the newly created financial intermediaries that will handle transactions. However, there are gaps in the rules. For example, investors are subject to caps based on their income and net worth — but the SEC doesn't say when to use which metric. The SEC also alluded to "safe harbors" that would protect funding portals and fundraising companies from being sued by investors, but did not elaborate on how this would work. The agency also included a list of 295 questions it hopes to have answered by stakeholders during the public comment period.

The specific rules proposed by the SEC today include a requirement that companies offering between $100,000 and $500,000 must have their financial statements reviewed by an independent accountant, while companies offering more than $500,000 will be subject to a full independent audit. Companies would be able to raise up to $1 million through equity-based crowdfunding in any 12-month period, and must provide information about their ownership to investors and funding portals.

However, there are gaps in the rules

Companies that cannot raise money through equity-based crowdfunding include: foreign companies, public companies, investment banks or funds, companies that don't comply with annual reporting requirements, and companies that have no business plan or "that have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies."

The SEC also proposes that funding portals outside the US be allowed to operate as long as they comply with US securities regulations.

Rory Eakin, COO of the California-based equity crowdfunding portal CircleUp, says the SEC's proposed rules are "workable" and demonstrate a commitment to equity-based crowdfunding, but that they raise some concerns.

"The requirements for funding portals to be credible securities professionals with compliance requirements will help lay the foundation for a healthy market," he says in an email statement. "The key area we are waiting to hear more about is the liability protection for the companies and the funding portals." The financial reporting requirements may also discourage too many companies from raising money through equity-based crowdfunding, he says.

The commission unanimously approved releasing the framework, which will now be published for public comment. The schedule for approval will depend on the reaction to the proposed rules and how quickly the agency acts to revise them.

Funding portals will also be subject to additional rules under the Financial Industry Regulatory Authority, a private organization that regulates the finance industry. Those rules will be proposed soon.