Wealthy patrons have been a godsend to artists, musicians, writers and other creators for centuries. The commissioning of Michelangelo to paint the Sistine Chapel, the portraits and sculptures done for royalty and others allowed many famous artists to pursue their creativity full time. Individual benefactors have been counted on to provide a living wage to the artistic community, and this model continues to this day, with Broadway “Angels”, big investors underwriting new companies, and business forms for films that allow for “private offerings” of a limited amount of shares in the film. The traditional and most oft-used development process for films is still begging and borrowing funds from friends and family, since federal and state securities laws have prevented any wider solicitation of the general public. The laws and rules are designed to protect so-called “passive” investors, especially the less-sophisticated and less wealthy, from fraud, and provide both civil and criminal punishments under federal and state law. Independent filmmakers in particular, weary of the money crunch, have wished for a way to fund their film other than taking out a mortgage on their home. They need not only wealthy angels, but a way to reach out to not-so-wealthy angels who believe in their project and want to help out monetarily.
There were already exemptions in the Securities Laws to allow for certain types of small offerings to accredited or sophisticated investors, and limit participation by non-accredited, or less sophisticated investors. State and federal laws provide that limited private offerings (less than 35 investors in Ohio) may be transacted without regular registration with the SEC or Ohio Securities Commission. However, any private placement of offerings through the internet has been extremely limited under former law, leading people who wanted to use the internet to construct platforms for funding that did not involve sales of shares in a project, company, film, or musical album. There was no real way to raise capital by publicly selling small amounts of securities to a large number of random people over the internet, due to restrictions in the law on the type of investor solicited.
The convenience and expedience of the internet in reaching a broad swath of people around the world led to ideas for finding new patrons, maybe not so wealthy, to help fund big projects such as musical albums, films, inventions, and artworks. Sites began to pop up in the late nineties that allowed many people to pledge smaller amounts that combined together would bankroll projects in art, music, films and even businesses, usually with new inventions or products. Many of these sites were straight donation sites, some like Kickstarter a for-profit company that takes five percent of the pledges as their fee. Sites that offer straight philanthropy as a nonprofit 501(C)(3) company, supporting a charity or cause are not subject to SEC requirements as such; they are governed by federal tax laws. Some for-profit companies that solicit funds through pledges have procedures that get around the federal and state securities laws, since pledgers are not buying a piece of the project, and the offeror does not own an interest in the project; pledgers are promised various prizes and premiums as tangible mementoes for their donation. A band may offer their new CD that was funded through the site, filmmakers a DVD copy of their movie, or restauranteurs a permanent seat at their restaurant that received funding. This can lead to unforeseen problems with fulfillment of the prize promised, such as when the cost of sending out five thousand CDs or DVDs may not have been calculated into the funding request. Also, Kickstarter’s requirement of giving something of value can get a bit persnickety, with the overseers asking for “cool” rewards for project pledgers, and sometimes seemingly selecting projects based on their entertaining video or the promise of an unusual reward, rather than the viability of the project.
New federal legislation signed last year by President Obama amended the SEC rules for share offerings, and now will allow funding of businesses and projects through solicitation of the general public online. The new securities law, entitled “Jumpstart Our Business Startup Act” is aimed at entrepreneurs and startup businesses that are unable to get traditional financing. Title III of that Act is entitled the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012”, or the “CROWDFUND Act”. Though exempted from the SEC’s strict rules for the sale of securities, the Act has its own requirements intended to prevent fraud on investors. The issuer of shares in a project or company, which are considered “securities” under the law, is limited to an aggregate amount of no more than $1,000,000 in sales to all investors during a twelve month period. The amounts of the transactions are tied to the investor’s annual income, as a further fraud prevention provision, and to make sure they do not sink too much of their income into a venture. The aggregate sold to any investor may not exceed the greater of $2000 or five percent where the annual income or net worth of investors is less than $100,000, and less than 10% of an investor’s net worth of $100,000 or more.
The last requirement is that the transaction must be conducted through a broker or funding portal that complies with the requirements of the Act. The Funding Portal Regulation in Sec. 304 of the Act states that the SEC shall by rule exempt funding portals from the requirement to register as a broker or dealer, as long as the portal remains subject to the rulemaking, examination, and enforcement authority of the SEC. A funding portal, as defined by the SEC, is “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, … that does not (A) offer investment advice or recommendations; (B) solicit purchases, sales or offers to buy the securities offered or displayed on its website or portal; (C) compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; (D) hold, manage, possess or otherwise handle investor funds or securities; or (E) engage in such other activities as the Commission, by rule, determines appropriate.”
The law itself already has a great amount of detail about what will be required of “intermediaries” or “funding portals”, including a streamlined registration with the SEC, disclosures regarding risks and other investor education material to make sure the investor understands “the level of risk generally applicable to startups emerging businesses, and small issuers; … the risk of illiquidity; and other matters as the Commission determines appropriate by rule (.)”The funding portals are given an exemption from registering as a broker, though they still have some registration requirements, and remain subject to the examination, enforcement, and other rulemaking authority of the Commission.
Although the law is to be implemented with reference to levels of income of investors and other personal information, the new law requires brokers or intermediaries to protect the privacy of information collected from investors, and there is a prohibition against the intermediaries compensating “promoters, finders or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor”. The portals also are prohibited from having a financial interest in an issuer using its services, and like the existing funding websites like Kickstarter which are based on donations to fund the project, they are only to release the offering proceeds to the issuer when the capital raised from all investors equals or exceeds the target offering amount, and must allow all investors a chance to cancel their commitments to invest.
The Crowdfunding Act also has requirements for issuers of the securities, the startups or other companies offering equity in their projects or companies. Rules are to be promulgated relating to background and securities enforcement regulatory history checks on officers and the larger equity owners of every issuer whose securities are offered to the public. It requires issuers to file numerous financial documents such as tax returns, business plans, and independent review by an accountant for higher target offering amounts. Of course, the Commission wants to know about the project, the target amount to be offered in securities, the deadline to reach the amount, the price to the public, or the method for determining the price. There are restrictions on advertising the terms of the offering, limiting it to notices which direct investors to the funding portal or broker. This could be more difficult than it seems for projects such as filmmaking, since it would require the producers to have all their tax and financial information already before the offering. Forming an LLC for filmmaking generally, instead of for individual films, may suit this type of fundraising best; since the company of the issuer would already be in place when the SEC rules are adopted, the producer would not have to generate all the documents required for the SEC while trying to make a movie. The formation of an all-inclusive organization for filmmaking may also serve another goal in making a series of films, which could then be protected by a trademark registered for the series.
Such involved requirements hardly seem like much of a loosening of the SEC’s securities issuing rules, and some of them seem like they would wind up being almost as complex and expensive as a regular stock offering. But the purpose of the Securities and Exchange Commission is to help investors avoid fraudulent schemes and ensure the stability and reliability of American commerce, and they are not giving up that mission for crowdfunding. There is concern that there will be a lot of unsophisticated investors and unsophisticated issuers in selling stock and other securities over the internet directly to the public. The JOBS Act which contains the Crowdfunding legislation is meant to encourage economic growth and remove some roadblocks to accessible funding for innovators and creators. The combination of these two concepts with some give and take by the regulators can help get inventions produced, businesses started, and can be the “angel” that filmmakers have yearned for to help them get the word out about their project to the masses online, and to help defray some of the massive costs of making a movie.
Unfortunately, the celebrations and capital-raising can’t begin just yet. Although the law itself is very specific in its provisions, no one can legally create funding portals or issue securities until the Commission promulgates its crowdfunding rules, and they are adopted by Congress. Every part of the law has a proviso giving the Commission the last word on how the law will work, “as the Commission, by rule, may determine appropriate”, so the exact provisions and how they will work is now known yet. The new law states that the Commission shall issue rules to carry out the new laws within 270 days after the date of enactment, which would have been by the first week of January, 2013. As of this writing on January 31st, 2013, the SEC has run into a few snags in issuing the new regulations, and as a result, startup businesses, entrepreneurs and filmmakers will not be able to go to funding portals with their projects until possibly the last quarter of 2013 or the first of 2014.
A lot of work has gone into the enacting of the regulations, with representatives of current funding sites such as RocketHub and IndieGoGo, two donation-based crowdfunding services, being asked to provide information on their operating practices because of the dearth of data for analyzing equity crowdfunding. However, there are several circumstances that are holding up the work. First, SEC Chairman Mary Schapiro has resigned and several of her top deputies who managed the writing of regulations went with her, leaving a staffing void. In addition, the Congress has not been diligent in confirming a fifth SEC commissioner to break the party split on the current four member Commission. In addition, there must be a 90 day comment period on proposed rules before the regulations can be finalized and put to a vote.
The delays are frustrating to the intermediaries, the funding portals that must be used to sell stock, as their capital may run out before the market structure is in place, and they can start offering crowdfunding services for issuers. Entrepreneurs who have tired of waiting for the new regulations have turned to alternatives like peer-to-peer lending and royalty-based financing deals. The intermediaries want to make sure they face less scrutiny from regulators than broker-dealers do, if their ventures are to be worthwhile for them to operate. Requirements for background checks and verification of investor limits in the law seem severe, but the subjects of the regulations are small businesses, startups, films, and other notoriously risky investments, so the SEC wants to be careful in such dangerous waters.
Crowdfunding industry associations, experts and lobbyists are now working with the SEC in their task of developing rules to implement the new capital raising process. In the last week of January 2013, Financial Industry Regulatory Authority (FINRA) invited prospective crowdfunding portals to voluntarily file an interim funding portal form. Another group, The Crowdfunding Intermediary Regulatory Advocates (CFIRA) and its sister organization the Crowdfunding Professional Association (CfPA) have reviewed FINRA’s form and are optimistic about the progress that has been made, and both organizations fully support the voluntary request for information. The SEC’s approval of FINRA’s form would help move the rulemaking process forward, and cooperation among the industry leaders and the government should facilitate a responsible economic model. Watch for an announcement of the new crowdfunding regulations to come in late summer or early fall 2013.
© 2013 Mary Ellen Tomazic
 “Private offerings” under federal and state securities law are generally limited to thirty-five “sophisticated investors”, have a cap on investment amount at $5 million and are exempt from the strictest SEC disclosure and registration. (See, e.g., SEC Rules 50, 5051 and 506; Ohio Revised Code 1707.03(X), (W); Ohio Administrative Code 1301:6-3-02.
 United States v. Leonard, 529 F.3d 83 (2d Cir. 2008), involved a Limited Liability Company that was formed to produce and distribute motion pictures, and the sellers of shares in the company were convicted under federal criminal fraud laws for misrepresentations of fact to their investors, who did not know they spent most of their money on their own commissions and not in the film.
 Securities Act of 1933, 15 U.S.C. §§77a -77aa; SEC Rules 501 – 506.; O.R.C. 1707.03; Ohio Administrative Code 1301:6-3-01-03.
 RocketHub, IndieGoGo, and CrowdRise are other sites that which help small businesses, entrepreneurs and artists advertise their needs and find money to support new ventures.
 Securities Act of 1933, Sec. 4 (15 U.S.C. 77d-r); one has to wonder how much legislative time was spent by members of Congress to come up with that acronym to conform to the existing crowdfunding term.
 CROWDFUND Act, Sec. 302 (15 U.S.C. 77d).
Securities Exchange Act of 1934, Sec. 3(a) (80) (15 U.S.C. 78c(a)).
 Securities Act of 1933, Sec. 4A (1) – (4) (15 U.S.C. 77d).
 CROWDFUND Act, Sec. 304 (15 U.S.C. 78c).
 Securities Act of 1933, Sec. 4A (a) (5) – (12) (15 U.S.C. 77d).
 Securities Act of 1933, Sec. 4A (b) (1) – (5) (15 U.S.C. 77d).
 See Trademark and Other Modes of Protection for Titles of Movies and Shows, Mary Ellen Tomazic (2012), available at met-iplaw.com.
 IndieGoGo did not provide information; Kickstarter was asked for help as well by SEC officials, who met with an executive in July 2012, but neither the agency
nor Kickstarter would comment on the meeting. Crowdfunding Rules Are Unlikely to Meet Deadline, Robb Mandelbaum, NYTimes.com (December 26, 2012).
 Equity Crowdfunding Stalled at SEC, Kyle Stock, Entrepreneur.com (January 15, 2013).
FINRA and the SEC Move One Step Closer to JOBS Act Implementation, Joy Schoffler, PRWeb/Yahoo.com (January 31, 2013).