Category Archives: Social Media

Introducing Startups to the Crowd: The SEC’s “Regulation Crowdfunding”

As I discussed in a previous post last spring, startups and investors alike have been eagerly awaiting action by the  U.S. Securities and Exchange Commission (“SEC”) to promulgate rules to facilitate equity-based crowdfunding.  Well, alas, the SEC has proposed crowdfunding rules as mandated by the Jumpstart Our Business Startups Act (the “JOBS Act”).  The JOBS Act, enacted back in April of 2012, is intended to enable startups and small businesses to raise capital through crowdfunding. The public comment period is set for 90 days, which means that equity-based crowdfunding could become a reality in early 2014.


The text of the SEC’s notice of proposed rulemaking is an ambitious 585 pages.  Unlike the SEC, I value brevity.  So, after providing a quick refresher on crowdfunding and the Securities Act, the remainder of this post will discuss the key provisions that potential crowdfunding issuers (i.e., the startups) and investors (i.e., the crowd) may find interesting.   Specifically, I will point out a few key aspects of the long-awaited crowdsourcing rule’s requirements for exemption from the registration requirements of the Securities Act.

Background: Crowdfunding and the Securities Act

Currently, the only type of crowdfunding that is authorized in the US are those forms that do not involve the offer of a share in any financial returns or profits that the fundraiser may expect to generate from business activities financed through crowdfunding.  Examples of crowdfunding websites that have become mainstream include the likes of indiegogo and Kickstarter.  These platforms prohibit founders (the project starter) from offering to share profits with contributors (i.e., equity or security transactions) because such models would trigger the application of federal securities laws.  And, under the Securities Act, an offer and sale of securities must be registered unless an exemption is available.

However, newly created Section 4(a)(6) of the Security Act, as promulgated under the JOBS Act, provides an exemption (the “crowdfunding exemption”) from the registration requirements of Securities Act Section 5 for certain crowdfunding transactions.  With the introduction of this exemption, startups and small businesses will be able to raise capital by making relatively low dollar offerings of securities to “the crowd” without invoking the full regulatory burden that comes with issuing registered securities.  Additionally, the crowdfunding provisions create a new entity, referred to as a “funding portal”, to allow Internet-based platforms to facilitate the offer and sale of securities without having to register with the SEC as brokers.  Together these measures were intended to help small businesses raise capital while protecting investors from potential fraud.

Startups:  Limits on Amount Raised

The exemption from registration provided by Section 4(a)(6) is available to a U.S. startup (the issuer) provided that “the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under Section 4(a)(6) during the 12-month period preceding the date of such transaction, is not more than $1,000,000.”

In the proposed rule, the SEC clarifies that only the capital raised in reliance on the crowdfunding exemption should be counted toward the limitation.  In other words, all capital raised through other means will not be counted against the $1M sold in reliance on the crowdfunding exemption.  As the SEC stated in its notice of proposed rule:

“If an issuer sold $800,000 pursuant to the exemption provided in Regulation D during the preceding 12 months, this amount would not be aggregated in an issuer’s calculation to determine whether it had reached the maximum amount for purposes of Section 4(a)(6).”

Startups: Limits on the Method of Crowdfunding

Under Section 4(a)(6)(C), an offering seeking the crowdfunding exemption must be “conducted through a broker or funding portal that complies with the requirements of Section 4A(a).”  This means that crowdfunding can only occur through an intermediary, and that intermediary must meet the requirements of either (1) a broker, or (2) a funding portal. The SEC proposed two related limitations here:

1)      Single intermediary – Prohibits an issuer from using more than one intermediary to conduct an offering or concurrent offerings made in reliance on the crowdfunding exemption.  For example, you couldn’t use both and for the same offering or even for different offerings when conducted concurrently.

2)      Online-only requirement – Requires that an intermediary (i.e., the broker or funding portal) effect crowdfunding transactions exclusively through an intermediary’s platform. The term “platform” means “an Internet website or other similar electronic medium through which a registered broker or a registered funding portal acts as an intermediary in a transaction involving the offer or sale of securities in reliance on Section 4(a)(6).”

According to the SEC’s notice, with respect to the online-only requirement:

“We believe that an online-only requirement enables the public to access offering information and share information publicly in a way that will allow members of the crowd to decide whether or not to participate in the offering and fund the business or idea.  The proposed rules would accommodate other electronic media that currently exist or may develop in the future. For instance, applications for mobile communication devices, such as cell phones or smart phones, could be used to display offerings and to permit investors to make investment commitments.”

A Quick Note about Funding Portals

As mentioned above, to fit within the crowdfunding exemption, the offering must be conducted through a broker or funding portal that complies with the requirements of Securities Act Section 4A(a).

Exchange Act Section 3(a)(80) (added by Section 304 of the JOBS Act), defines the term “funding portal” as any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to Securities Act Section 4(a)(6), that does not: (1) offer investment advice or recommendations; (2) solicit purchases, sales or offers to buy the securities offered or displayed on its platform or portal; (3) compensate employees, agents or other person for such solicitation or based on the sale of securities displayed or referenced on its platform or portal; (4) hold, manage, possess or otherwise handle investor funds or securities; or (5) engage in such other activities as the Commission, by rule, determines appropriate.”

Under the SEC’s proposed rules, the definition of “funding portal” is exactly the same as the statutory definition, except the word “broker” is substituted for the word “person”.  The SEC is making clear that funding portals are brokers (albeit a subset of brokers) under the federal securities laws.

Investors: Limits on Amount Invested

Under Section 4(a)(6)(B), the aggregate amount sold to any investor by an issuer, including any amount sold in reliance on the exemption during the 12-month period preceding the date of such transaction, cannot exceed: “(i) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and (ii) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.”

Because the statutory definition above creates some potential ambiguity, the SEC’s rule seeks to clarify the relationship between annual income and net worth for purposes of determining the applicable investor limitation.  Essentially, the proposed rules take a “whichever is greater” method for measuring whether limitation (i) or (ii) applies.  As the rule proposes,

  • Where both annual income and net worth are less than $100,000, then the limitation will be set at the greater of (a) $2,000 or (b) the greater of (x) $5% of annual income or (y) 5% of net worth.
  • Where either annual income or net worth exceeds $100,000, then the limitation will be set at the greater of (a) 10% of annual income or (b) net worth; provided, however, in either case (a) or (b) may not exceed $100,000.

Related to investor limits, but more important for startups to understand, the proposed rules alleviate burdens associated with vetting investor suitability.  Specifically, the rule allows startups to reasonably rely on the efforts that the intermediary takes in order to determine that the amount purchased by an investor will not cause the investor to exceed investor limits.

#InsidersBeware: Social Media and Regulation FD

Many CEOs have now obtained celebrity-like status.  And like their Hollywood counterparts, they have made themselves more digitally connectable through social media.  Last July, Reed Hastings (CEO of Netflix) announced to 200,000+ of his dearest “friends” that his company had streamed 1 billion hours of its online library during the single month of June.  His forum was not a quarterly earnings call or an official press release, but instead his Facebook wall.  Here’s the actual post (no, I’m not Facebook friends with Reed…my friend request was blocked due to an excessive number of pending friend requests in Reed’s queue):


The SEC’s Division of Enforcement, concerned that Hastings may have violated Regulation FD, began a formal investigation that led to a report issued on April 2, 2013 (the “Report”).

Reg FD Refresher

In a nutshell, Regulation FD says that when a company shares material, non-public information to securities professionals (think investment advisers) or shareholders where such information would be a basis for making an investment decision, then the company must contemporaneously share that same information to the public at large.  As the SEC stated in its report, “Regulation FD was adopted out of concern that issuers were selectively disclosing important nonpublic information, such as advance warning of earnings results, to securities analysts or selected institutional investors before making full disclosure of the same information to the general public.”  The Commission went on to say,

In our previous statements on Regulation FD, we have recognized that the regulation does not require use of a particular method, or establish a “one size fits all” standard for disclosure. We did, however, caution issuers that a deviation from their usual practices for making public disclosure may affect our judgment as to whether the method they have chosen in a particular case was reasonable.


The SEC’s 2008 Guidance

In 2008, the SEC issued a report entitled Commission Guidance on the Use of Company Web Sites (the “Guidance”).  In the 2008 Guidance, the SEC addressed the growing use by public companies of the internet as a means for disseminating (either intentionally or inadvertently) material, non-public information.  At the time, the Commission was primarily concerned with companies’ websites, although the Guidance certainly acknowledged that internet technology and media may change in the future, so cautioned against a rigid interpretation of the Guidance.

As explained in the 2008 Guidance,

Whether a company’s web site is a recognized channel of distribution will depend on the steps that the company has taken to alert the market to its web site and its disclosure practices, as well as the use by investors and the market of the company’s web site.

And then restated slightly in the Netflix Report,

The central focus of this [recognized channel] inquiry is whether the company has made investors, the market, and the media aware of the channels of distribution it expects to use, so these parties know where to look for disclosures of material information about the company or what they need to do to be in a position to receive this information.


Social Media as a Channel

In issuing the Report, the SEC took the opportunity to expound on Regulation FD in an effort to clarify its application to disclosures made through social media channels.  Using the facts of the Netflix CEO’s Facebook posting as its backdrop (although they stressed every cases will be determined on its own facts), the SEC made two key points:

  1. A company’s communications through social media require careful Regulation FD analysis; and,
  2. The 2008 Guidance applies by extension to disclosures made via social media.

So, if a company finds itself in a position like Netflix, the key question seems to be whether the social media channel, in a given case, provides an avenue for the information to be disseminated in a manner reasonably designed to provide “broad, non-exclusionary distribution of the information to the public.”  And, more specifically, whether the particular forum is a “recognized channel” of distribution for communicating with the company’s investors.  The SEC does not provide a bright-line rule, but instead points to factors that may support a finding that a given social media channel is a “recognized channel,” for example,

Disclosures on corporate web sites identifying the specific social media channels a company intends to use for the dissemination of material non-public information would give investors and the markets the opportunity to take the steps necessary to be in a position to receive important disclosures —e.g., subscribing, joining, registering, or reviewing that particular channel.


So, did Hastings’ Facebook Post Violate Regulation FD?

Interestingly, the Report makes clear that Hastings’ post would generally run afoul of Regulation FD, when evaluated in light of the established channels that Netflix made use of prior to the post.  The Commission states,

Although every case must be evaluated on its own facts, disclosure of material, nonpublic information on the personal social media site of an individual corporate officer, without advance notice to investors that the site may be used for this purpose, is unlikely to qualify as a method “reasonably designed to provide broad, non-exclusionary distribution of the information to the public” within the meaning of Regulation FD. (emphasis added)

Moreover, the Report highlights a series of facts that would seem to cut against Netflix’s position:

  • The information Hastings disclosed was “material”

During Netflix’s 2011 year-end and fourth quarter earnings conference call on January 25, 2012, Hastings was asked why this streaming metric was relevant (since Netflix’s revenues are derived through fixed subscriber fees, not based on the number of hours of programming viewed). Hastings explained that streaming was “a measure of an engagement and scale in terms of the adoption of our service and use of our service. . . . . It [two billion hours streaming in a quarter] is a great milestone for us to have hit. And like I said, shows widespread adoption and usage of the service.”


Netflix’s stock continued a rise that began when the market opened on July 3, increasing from $70.45 at the time of Hastings’s Facebook post to $81.72 at the close of the following trading day.


  • The information Hastings disclosed was “nonpublic” 

Prior to his post, Netflix did not file with or furnish to the Commission a Current Report on Form 8-K, issue a press release through its standard distribution channels, or otherwise announce the streaming milestone.


  • Hastings’ Facebook page implicates Regulation FD since the material, nonpublic information was shared with at least some shareholders and securities professionals

Facebook members can subscribe to Hastings’s Facebook page, which had over 200,000 subscribers at the time of the post, including equity research analysts associated with registered broker-dealers, shareholders, reporters, and bloggers.


  • Hastings’ Facebook page is probably not a “recognized channel of distribution”, such that disclosure of this material, nonpublic information was not made to the general public

Neither Hastings nor Netflix had previously used Hastings’s Facebook page to announce company metrics. Nor had they taken any steps to make the investing public aware that Hastings’s personal Facebook page might be used as a medium for communicating information about Netflix. Instead, Netflix has consistently directed the public to its own Facebook page, Twitter feed, and blog and to its own web site for information about Netflix. In early December 2012, Hastings stated for the public record that “we [Netflix] don’t currently use Facebook and other social media to get material information to investors; we usually get that information out in our extensive investor letters, press releases and SEC filings.”

Yikes, this sounds like Netflix is going to get pummeled by the Commission, right?  Wrong. The SEC surprisingly declined to file an enforcement action against Netflix based on Hasting’s Facebook post.  The Commission stressed their policy position that communication with investors is a good thing, stating in relevant part,

We do not wish to inhibit the content, form, or forum of any such disclosure, and we are mindful of placing additional compliance burdens on issuers. In fact, we encourage companies to seek out new forms of communication to better connect with shareholders.

So, it remains somewhat unclear what facts would trigger an enforcement action on a Regulation FD theory in the social media disclosure context.  But, what is clear, is that the SEC has taken notice of social media communications made by, or on behalf of, publicly traded companies.  Whether, and to what extent, the Commission is prepared to exercise their enforcement authority in this arena remains to be seen.

Takeaways, if any

Ultimately, what should be gleaned from the Commission’s Report is that although there may be corporate marketing or branding benefits that are gained with an accessible CEO, there are also legal constraints that must be considered when this CEO takes to the social network scene to share company-related information.  Companies should immediately self-audit and determine what social media or networks are in use by its officers and directors, and with that information determine whether such outlets should (or could) become a distribution channel of information.  Armed with a listing of “potential” distribution channels (i.e., those not traditionally used for distributing information), the company should then publish (on their website, Form 8-K, and/or press releases) the identity (whether corporate or personal, as with Reed Hasting’s) associated with these social media channels, their web/app location, and the method for registering or subscribing to receive updates.  And, as always, corporate counsel and compliance officers should provide proactive training to their officers and directors on the proper use of social media, thereby maximizing the commercial benefits to the company while mitigating the inherent risks of such conduct.