US companies crowdfunding abroad: you might want to pack a securities lawyer alongside your umbrella!

It’s frustrating. We are all so ready to do crowdfunding. But we have to wait till the SEC and FINRA come up with their rules.

Some US companies can’t wait and they have gone off to seek their fortunes (or at least funding) on foreign crowdfunding portals. Companies thinking of following them should make sure they have all their ducks in a row before they do so.

Warning: this is where things get seriously technical. But it’s important. If you have questions you should talk to a securities lawyer.

Section 5 of the Securities Act of 1933 says that if you sell securities to the public* using the “jurisdictional means” you have to register that offering with the SEC. “Public” would include over the internet and “jurisdictional means” means phones, internet and the like. There’s nothing in Section 5 that says “to the public in the United States” so Section 5 has extraterritorial effect. (That’s extraterritorial, not extraterrestrial, but I think US securities law apply on Mars too, so don’t get any ideas.)

As the international securities markets developed, this began to present problems, and so since the 1960s the SEC has had rules that limit the extraterritorial impact of Section 5. The current version of these rules is Regulation S, adopted in 1990, and then tweaked in the late 90s. (Full disclosure: I led the team that drafted Regulation S.)

Regulation S states the general principle that an offering of securities outside the United States does not need to be registered with the SEC, and then goes on to explain what “outside the United States” means, because these days, with international markets and instant communications, it’s sometimes not clear where a transaction takes place. Regulation S provides “bright line” guidance for various different types of offering, so that you know if you meet the conditions you know the SEC won’t be chasing you for making an unregistered offering of securities.

Here’s what the conditions are for US companies that are not registered with the SEC making offerings of shares on crowdfunding portals:

  • The offering has to be an “offshore transaction”. This means no offer in the United States and the company has to reasonably believe the buyer is outside the United States.
  • There can’t be any “directed selling efforts” (in essence, trying to get people interested in the offering) in the United States.
  • The company has to adopt “offering restrictions”. This means that people involved in distributing the securities (and I would think this would include the foreign portal) have to agree that the shares can’t be sold or resold to US persons for a year. Also, all the company’s offering materials (this would include its profile on a funding portal) have to include statements that the shares can’t be sold or resold to US persons for a year.
  • The shares can’t be resold to US persons for a year.
  • During that year, if the shares are sold, the buyer has to certify that it’s not a US person, and agree to resell only to non-US persons, the shares have to be “legended” with a statement that resales are restricted, and the company has to agree, either by contract or a provision in its bylaws, not to permit transfers of the shares to US persons. There are additional requirements for brokers trading the shares.

That’s a really rough summary, and as you can see, some of these requirements don’t work that well with the crowdfunding model. But only if you comply with all of them do you get any assurance that your offering is OK. There is no “close enough” and if you get it wrong then your shareholders can make you give them their money back. (And to make things worse, there may also be state law implications, especially in states that have adopted the Uniform Securities Act.) And don’t forget that the company has to comply with securities laws in the country where it’s doing the offering too.

So when venturing abroad, pack a lawyer (and as always, this isn’t legal advice!)

* If you aren’t selling to the public (eg, you sell only to accredited investors) then of course these rules don’t apply, whether you are selling inside or outside the United States.

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