S.E.C. Advances New JOBS Act Rule, but Not Crowdfunding

The Agenda

How small-business issues are shaping politics and policy.

Over the last few months, the messages have piled up in The Agenda’s in-box, heralding a new securities regulation that, our correspondents say, will usher in a new era of crowdfunded financing. That new regulation took effect on Monday, but equity crowdfunding — at least as most people understand it — remains a long way off.

The new rule lifts a longstanding ban on broadly advertising a private stock placement, a restriction that had been in place since the Securities Act of 1933. Companies use private placements to issue stock without registering the offering with the Securities and Exchange Commission. By avoiding registration, a company also avoids having to make the disclosures necessary if it were offering the stock to the general public. However, with a few exceptions, this stock may be sold only to an institutional buyer or a so-called accredited investor — someone with annual income of at least $200,000 or net worth exceeding $1 million who is presumed to be a sophisticated investor.

Typically, early stage companies use the rules for private placements to structure transactions with angel investors or venture capital funds, though larger and more mature companies, including publicly traded businesses, also sell securities privately. Under the change to Rule 506, companies may now advertise stock sales widely, in newspapers or through social networks and e-mail blasts, but they can sell the stock only to accredited investors.

“The distribution capability, the reach, of the entrepreneur is no longer restricted to people with whom you have a pre-existing relationship,” said Douglas Ellenoff, a securities lawyer with the New York firm Ellenoff Grossman & Schole. Mr. Ellenoff said that consumer products companies, especially, would be poised to take advantage of the new rule. “A lot of our public companies are exploring this as well, because they have substantial distribution, and they have loyal customers who if they knew the company was in need of money, would have been the obvious profile people to contact. But you couldn’t have done that until today.”

The change was mandated as part of last year’s Jumpstart Our Business Start-Ups Act, commonly known as the JOBS Act — the same law that also established investment crowdfunding, though in a different section. (Lifting the ban on general solicitation, as it is called, is addressed in Title II of the law; crowdfunding in Title III.)

But the law contemplates crowdfunding — generally, selling stock and other securities over the Internet directly to the public — in a very specific way, taking its cue from Web sites like Kickstarter. “Crowdfunding is a little bit from a lot of people,” Mr. Ellenoff said. “And that’s not what this is,” he added, referring to the new rule allowing general solicitation.

With crowdfunding, the JOBS Act establishes a mechanism for ordinary people to make small investments in small companies. The law limits how much investors can put into these stocks and restricts issuing companies to raising $1 million in a year. The law also requires a certain amount of financial disclosure from issuers — those hoping to raise more than $500,000 may have to supply audited financial statements to prospective investors — and even has an investor education component.

None of that is present in a private placement — companies can raise as much capital as they wish, investors can sink as much they would like, and no financial disclosure is required. And of course, the crowd is much thinner, because only accredited investors can buy stock.

The confusion seems to have been driven in large part by crowdfunding’s boosters, who have grown ever more frustrated waiting for the S.E.C. to set rules for the new market. The JOBS Act set the end of last year as the deadline for final rules on crowdfunding, but the S.E.C. has not yet even proposed those regulations, much less finalized them. As a result, many of the companies formed to crowdfund stock are attempting to turn themselves into platforms to facilitate private placements.

“Because a lot of people spent a lot of money building out technologies that are sitting idle, they need to pivot, since the S.E.C. has not enabled Title III to go forward,” Mr. Ellenoff said. “And the 506 platform business and Title II platform business is a viable way to use the technology.”

Those would-be crowdfunding platforms may have a long wait yet, said Richard Levin, a securities lawyer with the firm Baker & Hostetler. “Looking at Title II and how long it took for those rules to be approved, we could be looking at a year from the date the rules are proposed for crowdfund investing to become approved. It could be longer.”