For a variety of reasons, alternative fundraising vehicles are currently gaining in popularity. In the following guest post, Sarah Abrams, Head of Claims Baleen Specialty, a division of Bowhead Specialty, takes a closer look at Equity Crowdfunding and RegA offerings and related potential liability issues. I would like to thank Sarah for allowing me to publish her article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Sarah’s guest post.
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As Equity Crowdfunding (CF) and Regulation A (RegA) offerings gain traction as capital fundraising vehicles and the Atkins SEC signals support for regulatory changes, will business that lever CF or RegA face increased risk of D&O exposure? The following provides a brief history of the creation of CF and RegA before examining the potential impact of restriction-easing by the SEC on raising capital under CF and RegA and follow-on potential for increased liability to private or public company issuers.
CF and RegA were created and modified, respectively, by the The Jumpstart Our Business Startups Act (JOBS Act). The JOBS Act was passed with bipartisan support and was signed into law on April 5, 2012, with the intent to increase funding for small businesses by easing securities regulations. The JOBS Act amended the Securities Act of 1933 (1933 ACT), which governs private securities offerings, and created new exemptions to capital raising from certain securities offerings.
Before the JOBS Act, RegA restricted issuers (companies issuing private securities for fundraising) to raising $5 million from the public, and issuers had to register offered securities with each state. RegA’s amendment (RegA+) increased the amount that could be raised from the public and introduced fundraising in two tiers; up to $20 million in a 12-month period for Tier 1 and up to $75 million for Tier 2. For Tier 1, there are no investor requirements, but issuers must register or qualify in each state where securities are sold (“Blue Sky” laws). For Tier 2, the amount of money a non-accredited investor may invest is limited, issuers are exempt from state registration and audited financials, and ongoing SEC reporting is required.
In addition, U.S. securities laws before the JOBS Act generally prohibited equity crowdfunding, which, by definition, involves a public offering to the crowd (public). CF allows companies to raise up to $5 million over a 12-month period, typically through a FINRA-registered online funding portal, with fewer disclosures than public offerings or RegA Tier 2. There is a limit on the amount individual non-accredited investors can invest across all crowdfunding offerings in a 12-month period. Accredited investors, largely defined as those with a net worth of at least $1 million excluding home value or an annual salary of $200,000 for an individual, $300,000 for a couple, can invest as much as they wish in private offerings.
With a general understanding of what RegA and CF are as well as the current regulatory guardrails, the following discusses the SEC reporting of offerings raised by CF and RegA securities offered. From May 2016 to December 2024, the SEC reported that 3,869 CF offerings raised $1.3 billion in proceeds. The agency cautioned that such numbers are likely a low estimate given variations in filing practices. From June 2015 to December 2024, the SEC reported that 817 Reg A issuers have raised $9.4 billion through such offerings. That is way short of the RegA 1,400 qualified offerings seeking to raise about $28 billion.
The SEC has signaled that it will focus on the impetus for fundraising shortfalls under CF and RegA. Below discusses various proposals to ease restrictions on RegA and CF security issuance and potential D&O exposure for company issuers.
The SEC’s Small Business Capital Formation Advisory Committee has recommended that the SEC address liquidity problems with RegA by, among other things, providing federal relief from existing state regulations over secondary trading of RegA-issued securities. The committee also recommended that the SEC increase the current thresholds required for crowdfunding issuers to obtain an independent review of their financial statements, to lower costs for smaller businesses.
In February, interim SEC Commissioner Mark Uyeda signaled that the commission should explore ways to make CF more appealing. Uyeda noted that “[n]otwithstanding the availability of Regulation CF, along with other rules available to entrepreneurs to raise capital without registration, 77% of small business owners reported being concerned about their ability to access capital.” In that same speech, he stated that easing limits on the definition of an accredited investor would deepen the pool of capital available to crowdfunding and Reg A issuers.
Whether easing restrictions or altering the definition of accredited investor will be accomplished by the Atkins SEC remains to be seen. However, if restrictions ease, risks may increase with an increase in unaccredited investor purchases of private securities. Decreasing state regulation, “blue sky laws”, may have unintended consequences, including the potential for complaints alleging fraud against company issuers.
In particular, an increase in the promotion of company securities sold under CF or RegA on social media platforms may increase allegations of misrepresentations against issuers. Notably, the Ninth Circuit found that a company can solicit a securities purchase, within the meaning of the provision of the Securities Act of 1933 forbidding the sale or offer of securities by promoting the sale of a security in a mass communication, such as through social media.
In the case Pino v. Cardone Capital, et. al, the Appellate Court found a plaintiff investor could bring a putative securities fraud class action against a promoter of real-estate-investment funds (Cardone), Cardone’s “funds,” and Cardone’s limited-liability company (LLC), for Securities Act violations stemming from untrue statements of material fact or concealment made on social media. In one YouTube video, Cardone stated, “it doesn’t matter whether [the investor] [is] accredited [or] non-accredited … you’re gonna walk away with a 15% annualized return. If I’m in that deal for 10 years, you’re gonna earn 150%.
While egregious, most companies have a social media footprint that may be leveraged to raise capital. Depending on the number of followers, there may be a deep bench of unaccredited investors in a company that may be considering a private security offering under RegA or CF. Understanding the current Rules’ limitations, potential for easing of restrictions and the potential for increased litigation, may inform D&O underwriters of companies looking to raise capital under RegA or CF.
The views expressed in this article are exclusively those of the author, and all of the content in this article has been created solely in the author’s individual capacity. This article is not affiliated with her company, colleagues, or clients. The information contained in this article is provided for informational purposes only, and should not be construed as legal advice on any subject matter.