By Gene Trowbridge, Esq.
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startup (JOBS Act), which amends the Securities Act of 1933 and is designed to facilitate capital formation for small businesses. This article highlights Titles II, III and IV; three important areas of the JOBS Act, and our opinion as to how these changes will impact real estate syndicators in their private money raising efforts.
Question: How will the elimination of the ban on advertising and solicitation for Regulation D, Rule 506 Offerings impact sponsors’ money raising activity?
Title II of the JOBS Act (entitled “Access to Capital for Job Creators”) allows general solicitation and advertising in a Regulation D, Rule 506 offering, providing that all purchasers are accredited investors. Once implemented, the use of advertising and solicitation, by itself, will not void the private placement exemption (which alleviates the requirement that each securities offering must be registered with the SEC), as it has in the past.
To avail themselves of the ability to advertise and solicit accredited investors, under the new law, sponsors (aka syndicators) will be required to take “reasonable steps” to verify that the purchasers are, in fact, accredited investors.
The JOBS Act directs the SEC to draft regulations, within 90 days, to instruct the sponsors as to what “reasonable steps” must be taken to ensure that only accredited investors are allowed to purchase the securities. In addition, it is expected that the SEC will issue regulations describing what is allowable advertising and solicitation. Based on past SEC actions, we anticipate some type of sanitized, boilerplate approach.
Under the new law, Regulation D, Rule 506 offerings will remain exempt from state securities (blue sky) laws and will remain eligible for sale by the issuer under the current issuer exemption.
Our opinion is that this is the most significant aspect of the JOBS Act for real estate syndicators. Even with the new, stricter net worth requirements (which took effect in February 2012), which eliminate the ability to include the value of the investor’s primary residence, the ability to advertise and solicit for accredited investors will increase a sponsor’s ability to raise private capital for their syndications.
Question: Will “Crowdfunding” become a viable method for real estate syndicators to raise private money?
Title III of the JOBS Act (interestingly entitled the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012” or “CROWDFUND Act”), commonly known as “Crowdfunding”, will allow sponsors to use the internet and social media to sell up to $1 million of securities in a 12-month period. There is no limit on the number of investors allowed, but the amount of money one investor can purchase from all Crowdfunding issuers within a 12-month period is limited to:
- The greater of $2,000 or 5% of the investor’s annual income or net worth, as long such investor’s annual income or net worth is <$100,000; or
- If the investor’s annual income or net worth is ≥$100,000, the limit is 10% of the investor’s annual income or net worth, not to exceed a maximum aggregate investmentof $100,000 of crowdfunding securities purchased.
All crowdfunding transactions must be conducted using a registered broker dealer or a “funding portal”, which is an entity that must complete a limited broker dealer registration with the SEC, effectively precluding the issuer from directly selling their own securities.
It appears that the issuer must be corporation. Additionally, the issuer may not compensate any person to promote its offering other than in accordance with rules to be drafted by the SEC, and must: a) provide investors with “certain disclosures” to ensure that investors understand the risks involved in the offering, b) provide annual results of the operations of the fund to its investors, and c) must file annual reports with the SEC, as prescribed by the SEC.
Under the JOBS Act, investors can bring suit against a crowdfunding company for material misstatements and omissions during fundraising and operations of the company. Liability extends to the company’s directors and principal officers, so individuals running a company funded through crowdfunding will be taking on a significant amount of responsibility when they accept investment capital under these rules.
As in Regulation D offerings, securities purchased through a crowdfunding offer will be restricted, in that they cannot be freely resold during the first year of ownership and they are exempt from state securities (blue sky) laws.
The SEC has been given 270 days from the date of the signing of the JOBS Act to complete its rulemaking regarding crowdfunding, so no crowdfunding offerings will be allowed until the rulemaking process is concluded in early 2013. Since the name of this part of the JOBS Act includes the words “While Deterring Fraud and Unethical Non-Disclosure” it is likely that the rules relating to required disclosure during the sale of the securities, the annual reporting requirements and the oversight of any “funding portal,” will be quite restrictive.
The crowdfunding concept is drawing quite a bit of attention. A group purporting to be the “National Crowdfunding Association” already has its own webpage at www.nlcfa.org.
Becauseof the annual $1 million offering limit and the $100,000 limitation on the amount of crowdfunding securities an issuer can sell to one investor within a 12-month period, and the unknown restrictions that may be placed on such offerings by the SEC, we see little potential for real estate syndicators to use this new fund-raising vehicle. It is possible that legal and organizational costs (and time constraints) associated with getting a crowdfunding offering to the market will be cost- and time-prohibitive for real estate syndicators.
Question: Will the changes to Regulation A, which allows an exemption from full registration for public offerings of up to $50 million, be of use to real estate syndicators?
Title IV of the JOBS Act (entitled “Small Company Capital Formation”) amends the rules governing the offering of securities known as Regulation A securities. Prior to the passage of the JOBS Act, there was a $5 million limit placed on a Regulation A securities offering. The results of the JOBS Act amendment will be that:
- The $5 million limit on offers and sales within a 12-month period has been increased to $50 million;
- The securities may be marketed and sold publicly;
- There are no investor net worth requirements as found in Regulation D or crowdfunding offerings; and
- The issuer is required to file a limited registration statement and file annual audited financial statements with the SEC.
Initially, unless sold through a national securities exchange, offerings under Regulation A will be subject to state securities (blue sky) laws, although the JOBS Act requires the Comptroller General to conduct a study on the impact of State Blue Sky laws on Regulation A securities offerings and submit a report to Congress within 90 days.
For syndicators who wishing to take advantage of the ability to advertise publicly to investors without concern for investor net worth requirements, and with the luxury of being able to wait while the SEC approves their offering, the amended Regulation A offering rules may be attractive. These will likely be blind pool offerings, in that the time required and the cost of bringing a Regulation A offering to the market, combined with the need to comply with state securities laws will make a Regulation A offering impractical for syndication of a specific property.
It is our opinion that the most important aspect of the JOBS Act, for our current and future clients, will be the elimination of the prohibition against advertising and solicitation in Regulation D, Rule 506 offerings and we will be looking for the new rules and regulations to be issued by the SEC covering this important change this summer.
TO VOICE YOUR OPINION
The SEC has opened a website to receive preliminary public comments on the regulations it has been directed to write pursuant to the JOBS Act. If you wish to review the complete text of the JOBS Act or provide comments for SEC consideration, please visit: http://www.sec.gov/spotlight/jobsactcomments.shtml.
For a free 30-minute consultation, call Gene Trowbridge at (949) 855-8399 or email: Gene@SyndicationLawyers.com.
Gene Trowbridge is a California licensed Attorney with practice areas in Real Estate Investment and Securities Law, Private Placement Offerings, Entity Formation, Partnership Agreements; and Public Speaking for Real Estate Investment/Education events. He is a partner in the law firm of Trowbridge & Taylor LLP, which has offices in Lake Forest, California and Saint Augustine, Florida.
© 2012 Trowbridge & Taylor LLP