Over the next few weeks, CrowdCheck will be posting a series of blog posts regarding issuer compliance with the disclosure requirements of Regulation CF. We believe this series will be important for prospective issuers and platforms, and ultimately investors. Of the ninety-six Form C filings as of September 1, 2016, very few have actually met the disclosure requirements under Rule 201 of Regulation CF.
This is important for a variety of reasons. First, issuers operating under the belief that they qualify for Regulation CF may actually be in violation of Section 5 of the Securities Act. To qualify for Regulation CF, the issuer must provide all of the information required by Rule 201. If the issuer does not do that, and the omitted disclosures do not meet the “insignificant deviation” test under Rule 502, the exemption provided by Regulation CF is not available and the offering of securities will be a violation of Section 5 of the Securities Act – an enumerated Bad Act. Further, the omitted information may make other information provided materially misleading, creating liability to investors for securities fraud.
Second, investment intermediaries may not be able to show that they have a “reasonable basis for belief” that the issuer is in compliance with Regulation CF, as required by Rule 301(a). Under the rule, an intermediary may rely on representations from the issuer unless the intermediary has reason to question the reliability of the representation. When it comes to the presentation of disclosure materials on an intermediary’s own website, any intermediary should be aware when the information provided the issuer is not sufficient under Rule 201. In such cases, the intermediary will not be able to rely on the issuer’s representation that it is in compliance with Regulation CF, and doing so means that the intermediary is in violation of Rule 301(a).
Third, and most importantly, investors are not receiving the information they need to make informed investment decisions. Regulation CF is opening up new investment opportunities to unsophisticated investors. These investors may not have experience reviewing investment opportunities and are lured in by flashy sounding ideas. This is not meant to be a paternalistic sentiment, but merely a statement of facts. You do not have to look much further than the significant number of questionable campaigns that have received funding on donation/rewards crowdfunding sites to see that ideas can receive funding without backers fully vetting the concept. Under Regulation CF, investors may not be made aware of how historical financial results may not predict future performance if the issuer fails to include that disclosure, and yet the investor may still invest based on the belief that those financial results will continue.
Regulation CF is creating new possibilities for online capital raising. However, issuers that do not comply with the disclosure rules may pollute the market, making it more difficult for other issuers and investors to take full advantage of the rules.