The Ontario Securities Commission has published Multilateral Instrument 45 – 108, which introduces a crowdfunding prospectus exemption for issuers in conjunction with a registration framework for funding portals.
The attraction of crowdfunding is that it allows businesses (primarily small to medium-sized enterprises) to gain increased access to capital from a large pool of investors via a funding portal that will be operated by a registered dealer. The rules established under MI 45-108 create an exemption for the prospectus requirements imposed under the Ontario Securities Act. Nevertheless, the crowdfunding regime imposes requirements aimed at protecting the investing public, including limits on how much can be raised from individual investors, and how much can be raised in total, as well as requirements in respect of disclosure at the time the funds are raised and ongoing disclosure thereafter.
The U.S Securities and Exchange Commission also recently adopted rules to permit companies to offer and sell securities through crowdfunding. Title III of the Jumpstart Our Business Startups Act (JOBS Act) created a federal exemption to the securities law so that this type of capital formation could be used to buy and sell securities through online portals. As a result, many crowdfunding services have developed to fill this need and the industry is evolving quickly.
Required Documentation
Pursuant to the exemption, issuers are required to provide disclosure documentation to investors. Under the regime, issuers are subject to a standard of liability on the offering document and other permitted materials and investors are afforded a related right of action.
Some of the key documentation required is:
a) an offering document prepared by the issuer that contains all the information about the issuer and its business that an investor should know prior to investing;
b) a Risk Acknowledgement Form completed by the investor that requires the investor to confirm that they have read and understood the risk warnings and information in the offering document;
c) non-reporting issuers must provide investors with ongoing disclosure in the form of (i) annual financial statements; (ii) a notice of use of proceeds and (ii) a notice of discontinuation of the issuer’s business, a change in the issuer’s industry, or a change of control of the issuer. Reporting issuers must continue to comply with all of their disclosure requirements.
Risks and Rewards in a Changing World
The crowdfunding regime and other recent initiatives reflect the reality that the ways businesses communicate with, and raise money from, the public are changing rapidly. Regulators such as the OSC and the SEC have attempted to adapt to this changing world in carrying out their investor protection mandates. Businesses in turn have to adapt to both a rapidly changing business environment and a regulatory environment that may or may not have moved with the times. Crowdfunding over the internet is a relatively new and rapidly evolving phenomenon but from a risk management perspective, it presents risks and opportunities that are very familiar.
Understand the Requirements: The crowdfunding regime is a streamlined process, but it is still a process. There are detailed and prescriptive documents that must be filled out, detailed requirements that must be followed and ongoing disclosure responsibilities for issuers. Businesses raising capital through crowdfunding, and particularly registered dealers operating crowdfunding portals, will have to have a clear understanding of these requirements. Failing to adhere to the crowdfunding requirements will give rise to exactly the same kind of regulatory exposure than failing to adhere to any of the other requirements of securities legislation.
Understand the Risks: As with any offering to the public, complying with the regulatory requirements is a necessary condition, but not a sufficient condition, for protecting against claims by unhappy investors. Under the crowdfunding regime those raising capital are required to provide a contractual right of action for claims of misrepresentation. In addition, unhappy investors will have their rights and remedies under the common law. It may be that because the amount raised under the crowdfunding regime will be relatively small, the risk of class proceedings may be somewhat mitigated in respect of individual issues. However, dealers operating crowdfunding portals will be expected to act as gatekeepers by “attempting to ensure that issuers comply with the requirements of the crowdfunding prospectus exemption and to maintain the integrity of the capital markets.” This due diligence requirement is potentially significant, and largely unexplored. The one thing that is certain is that a portal that fails to carry out its gatekeeping function can expect to be exposed to both regulatory and civil peril.
Understand the Audience: Crowdfunding has the appeal of drawing large numbers of people, who might not otherwise invest through more familiar means, as potential investors. That carries with it both risks and opportunities. Disclosure forms are required to be in plain language, and experience will likely show the plainer the better. Whatever assumptions issuers might otherwise have about the investing public may need to be revisited. It will also be important to remember that crowdfunding is an internet-based phenomenon, and the internet can be fickle: it has a short attention span, a long memory and it is impossible to predict. Crowdfunding is an example of the power of new ways of doing business. As with anything else, an important part of adapting effectively to this new opportunity will be to understand and manage the associated risks.