Source: https://www.ssb.texas.gov/texas-securities-act-board-rules/board-rules/recent-changes-board-rules/november-17-2014
Timestamp: 2019-04-24 00:56:34+00:00

Document:
The Texas State Securities Board adopts an amendment to §113.5, concerning financial statements, without changes to the proposed text as published in the May 9, 2014, issue of the Texas Register (39 TexReg 3651).
The amendment permits certain "small business issuers" whose previous sales of securities did not exceed $1 million to file reviewed financial statements for a registered offering that does not exceed $5 million. The new crowdfunding exemption contained in §139.25, which is being concurrently adopted, has been added to the list of prior securities offerings that do not disqualify an issuer from being able to file reviewed financial statements in a subsequent registered offering.
The capital raising efforts of more small business issuers will be facilitated by allowing the use of reviewed financial statements in conjunction with a registered securities offering.
The Texas State Securities Board adopts amendments to §115.1, concerning general provisions, and §115.3, concerning examination, without changes to the proposed text as published in the May 9, 2014, issue of the Texas Register (39 TexReg 3652). New §115.19, concerning Texas crowdfunding portal registration and activities, is adopted with changes to the proposed text as published in the May 9, 2014, issue of the Texas Register (39 TexReg 3652).
The following changes were made to §115.19. Subsection (b) was changed to allow prospective investors to self-certify Texas residency to view securities-related offering materials. Also in subsection (b), the "condition of entry" language that a commenter found confusing was removed. A nonsubstantive change to grammar was made in subsection (d). And, in subsection (e)(2)(F), "prospective investors" was changed to "prospective purchasers."
A new restricted dealer registration category for Texas crowdfunding portals is created. The registration process and permitted activities of a Texas crowdfunding portal, including an examination waiver, is specified. A Texas crowdfunding portal would be a Texas-only dealer, able to utilize the exclusion from federal registration available to dealers whose business is exclusively intrastate. A portal's securities-related activities are limited to operating an Internet website for §139.25 exempt offerings. It cannot participate in secondary market transactions or engage in certain prohibited activities. To preserve the intrastate character of the dealer's activities and the offering, the Internet website must contain appropriate disclaimers and Texas residency confirmed before allowing access to the offering materials.
Prior to offering securities on the Internet website, the portal conducts background and regulatory checks on the issuer and its principals. Additionally, the portal must obtain affirmative acknowledgments of certain disclosures common to all crowdfunding offerings from investors before a sale can be made. A portal is required to keep records related to its limited activities rather than the more extensive records required of other securities dealers. A portal is also not required to maintain a supervisory system. But a portal's records are subject to inspection and must be furnished on request of the Securities Commissioner.
A Texas crowdfunding portal applies for registration by filing Form 133.15, which is being concurrently adopted, and by providing its organizational documents to establish its status as a Texas entity. Portals are subject to the same registration fee as other dealers registered in Texas. Portals are also subject to the post-registration reporting requirements in §115.9. Amendments to a portal's registration are filed using Form 133.15. When a portal withdraws its registration, it uses Form 133.16, which is also being concurrently adopted.
The simplified registration process and record-keeping requirements of the new rule will facilitate creation of Texas crowdfunding portals and, by extension, the capital raising efforts of small business issuers who utilize the Texas intrastate crowdfunding exemption.
No comments were received regarding adoption of the amendments to §115.1 and §115.3.
The Board received numerous comments regarding new §115.19 from attorneys and others interested in equity crowdfunding. New York-based Ellenoff Grossman & Schole LLP commented that the proposals took "an intelligent and balanced approach," and New Jersey-based StartupValley described the proposals as "well thought out and put together."
Some commenters questioned how certain aspects of the rule would work, while others recommended specific changes to text or objected to core concepts in the proposal. All comments were considered, and the Board made several changes as a result of feedback received.
The restrictions in subsection (a) of the proposal that were designed to keep portals in compliance with the federal intrastate exemption drew several comments. Staff provided explanation and background in response to the comments. The Board considered the public comments and Staff responses but made no changes to the rule text.
StartupValley asked if out-of-state portals such as itself can register in Texas if the websites are structured to facilitate offerings for Texas residents and issuers only. Staff explained that an out-of-state portal cannot register as a Texas crowdfunding portal under §115.19. An out-of-state entity can register in Texas as a general dealer to operate an Internet website for §139.25 offerings; however, such an entity would probably also have to register as a broker-dealer at the federal level due to the interstate nature of its business operations. A crowdfunding portal registered with the U.S. Securities and Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA") is restricted by the Jumpstart Our Business Startups Act ("JOBS Act") from offering securities other than those offered pursuant to §4(16) of the Securities Act of 1933 (the federal crowdfunding exemption). Securities offered pursuant to §139.25 are offered under the exemption in §4(11) of the 1933 Act, so would not be eligible to be listed on a federal crowdfunding portal. Texas crowdfunding portals handling §139.25 transactions should be physically located in Texas and operate exclusively within Texas. Since §139.25 was crafted to comply with the federal intrastate exemption from securities registration, any transmission of data as part of an offer or sale that occurs in more than one state could potentially subject the issuer to federal registration liability. Similarly, as §115.19 was crafted to comply with the federal intrastate exemption from broker-dealer registration requirements, a firm or its servers located out of state may also create a federal broker-dealer registration issue. Yet even a federally-registered broker-dealer would still face the federal intrastate securities exemption issue. In any case, since the portal is subject to onsite and unannounced inspections in the same way securities dealers and investment advisers are, a portal and its records physically located outside the state would impair the ability of the Agency to ensure compliance with the new regulations.
UrbanEquity recommended that Texas-based platforms making offers and sales of Regulation D, Rule 506(c) securities nationally be allowed to offer and sell securities pursuant to the Texas intrastate crowdfunding exemption if registered as a Texas crowdfunding portal. Similarly, CrowdBoarders asked that Texas crowdfunding portals not be limited to intrastate offers and sales of securities and that a portal not be required to limit its activities to §139.25 securities. Staff responded that what these commenters want to do is possible only if the platform is registered as a general dealer, not as a Texas crowdfunding portal. On February 5, 2013, the SEC Division of Trading and Markets issued Frequently Asked Questions, providing guidance on the exemption from federal broker-dealer registration in Title II of the JOBS Act. The JOBS Act added §4(b) to the 1933 Act. This provision allows a person meeting certain conditions to maintain an online platform that offers and sells securities through general solicitation or advertisements in a 506(c) offering without having to register as a broker or dealer under federal law. The exemption from broker-dealer registration in the federal act, §4(b) only applies when securities are offered and sold under Rule 506 of Regulation D. Other activities by the platform that do not fall within the exemption (such as offering securities under an intrastate exemption) would appear to require such an online platform to register federally. Since the federal exemption in §4(b) does not also provide an exemption from state registration requirements, offering and selling securities pursuant to SEC Rule 506(c) on the platform to Texas residents would require registration in Texas as a general dealer. A general dealer can make intrastate offers and sales of securities pursuant to §139.25 through an Internet website. A registered Texas crowdfunding portal may engage in other non-securities business on its website, including donation- or rewards-based crowdfunding. But the portal would need to be careful not to commingle the records of its securities and non-securities business. In the event that records are commingled, the commingled records would be subject to inspection and review by representatives of the Securities Commissioner. As the exemption functions only with intrastate activities, the Board disagreed with the commenters and declined to change the text to allow offers and sales of other securities, including Rule 506(c) securities.
CapitalReady addressed the limitation on portal activities and SEC guidance in the compliance (Regulation FD) context that, in its view, allows offerings exempt under §139.25 to be advertised via social media. Staff noted that SEC Regulation FD (Fair Disclosure) requires companies to distribute material information in a manner reasonably designed to get that information out to the general public broadly and non-exclusively. It is intended to ensure that all investors have the ability to gain access to material information at the same time. The 2013 guidance CapitalReady cited specifically notes that companies can use social media outlets like Facebook and Twitter to announce key information in compliance with Regulation FD so long as investors have been alerted about which social media will be used to disseminate such information. It is unclear how this would work in the context of promoting a crowdfunding offering when a public market in the securities being offered does not otherwise exist. Staff also noted that recently issued (October 2, 2014) SEC guidance on Rule 147 offerings (compliance with Rule 147 is required to claim the §139.25 exemption) and social media indicate that there is some risk involved with using social media in intrastate offerings using the Rule 147 exemption. According to the guidance, issuers generally use their websites and social media presence to advertise their market presence in a broad and open manner. "Although whether a particular communication is an 'offer' of securities will depend on all of the facts and circumstances, using such established Internet presence to convey information about specific investment opportunities would likely involve offers to residents outside the particular state in which the issuer did business." The SEC went on to provide additional guidance on an issuer's use of communications and social media: "We believe, however, that issuers could implement technological measures to limit communications that are offers only to those persons whose Internet Protocol, or IP, address originates from a particular state or territory and prevent any offers to be made to persons whose IP address originates in other states or territories. Offers should include disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law. Issuers must comply with all other conditions of Rule 147, including that sales may only be made to residents of the same state as the issuer." In light of the caution in the SEC guidance specifically addressing Rule 147 offers, older or other SEC pronouncements on use of social media in other contexts are not persuasive and reliance on them may cause a Texas issuer or portal to violate the Rule 147 exemption. The proposal assists issuers and Texas crowdfunding portals from inadvertently violating the restrictions in the federal intrastate exemptions by restricting interstate activities and communications. For these reasons, the Board disagreed with the commenter.
Subsection (b), which covers how a Texas crowdfunding portal operates its website, received many comments. Georgia-based SparkMarket and UrbanEquity suggested that self-certification of Texas residency by prospective purchasers should be enough for portals to allow access to the securities-related offering materials on their websites. SparkMarket pointed to current SEC guidance for support, and warned that requiring proof initially would discourage participation. UrbanEquity echoed the concern that people will not want to provide personal information just to view offerings on a portal. Staff explained that the establishment of Texas residency before receiving access to securities offering materials is a safeguard to keep the issuer, registered dealer, or Texas crowdfunding portal from inadvertently making an interstate (rather than an intrastate) offering and losing both the state and federal exemptions. Although recent SEC guidance has been issued on Rule 147 securities offerings, the SEC's Division of Trading and Markets has not yet issued comparable formal guidance for the intrastate dealer side of the transaction. However, Staff anticipates that the dealer guidance will be similar, so Staff recommended to the Board that a prospective purchaser be allowed to self-certify Texas residency to gain access to the securities-related offering materials. The Board agreed with the commenters and the Staff recommendation and changed the subsection accordingly.
A comment received from CapitalReady led to another change in subsection (b). While clarifying how portals will implement specific requirements such as verifying evidence of Texas residency, CapitalReady said that the "as a condition of entry" language in published subsection (b)(2) creates confusion as to when and how frequently the portal needs to gather proof of residency. CapitalReady asked if the phrase could be removed. Staff responded that the idea behind "as a condition of entry" was that a portal website could have a homepage open to the world but protect offering materials behind a login wall. During the sign-up process, a person would affirm Texas residency to be approved to log in and see offering materials. A separate verification process would occur before a prospective investor could purchase securities, but affirming residency would not be required on every visit to the website. Therefore, Staff recommended to the Board that the "as a condition of entry" language be removed. The Board agreed with the commenter and the Staff recommendation and revised the subsection. Additional clarification on this point will be provided in intrastate crowdfunding guidance materials that will appear on the Agency's website.
CapitalReady also asked how a portal can verify residency with general property tax records. Specifically, would viewing records on county appraisal district websites be sufficient? Staff answered yes, if the records show that the investor owns the property and has claimed a homestead exemption for it, appraisal district website records can be used to verify Texas residency.
Turning to the requirement in subsection (b)(3) of the proposal that a portal give the Securities Commissioner access to its Internet website prior to offering investment opportunities to Texas residents, CapitalReady asked if administrator-level access would be sufficient. Staff agreed that such access would satisfy the requirement but noted that the Commissioner need only be able to view all of the offerings and communications postings as an investor would. Other portal information can be obtained by a records request made pursuant to subsection (e)(5) or through an inspection pursuant to §13-1 of the Texas Securities Act.
A related question came from one individual who asked if videos made by an issuer can be included on the Internet website where the offering is made. Staff responded yes, videos can be included, and they would be part of the information required to be made available to the Commissioner and potential investors for a minimum of 21 days before any securities are sold in the offering. (See §139.25(h)(3)) Since all communications between the issuer, prospective purchasers, or investors must occur through the Internet website of the registered general dealer or Texas crowdfunding portal, the video could not appear elsewhere where prospective purchasers or investors could view it until after the §139.25 offering has concluded. The video would need to be kept by the portal pursuant to the recordkeeping requirements in §115.19(e)(2)(G) (for any information made available through the portal's Internet website).
The prohibited activities in subsection (c) also drew comments. One individual inquired if a Texas crowdfunding portal could give advice to an issuer on such matters as how to structure the issuer's offering or value the securities offered. The commenter also asked the Board to consider allowing a Texas crowdfunding portal to offer investment banking services to the issuer. Staff explained that if a person's securities activities include advising on or facilitating a securities offering, including, but not limited to, origination, underwriting, marketing, structuring, syndication, and pricing of such securities and managing the allocation and stabilization activities of such offering, that person is required to obtain either a restricted dealer registration to act as an investment banker and take the corresponding Series 79 examination-Investment Banking Representative Qualification Examination or register as a general dealer. By contrast, a person registered as a Texas crowdfunding portal (a restricted dealer registration category) is not required to take any qualification examination and the registrant's activities are limited to operating an Internet website utilized to offer and sell securities exempt from registration under §139.25. The examination waiver and limited recordkeeping required by portals were considered appropriate due to the limited nature of the activities a portal and its agents could perform. The Board would have had to reconsider the examination waiver and recordkeeping requirements if additional securities-related activities were permitted to be conducted by a portal. Since a registered Texas crowdfunding portal is required to conduct background and regulatory checks on the issuer and its control persons and must deny access to an issuer if the portal has a reasonable basis for believing the issuer is engaging in fraud or the offering would operate as a fraud or deceit, the portal could discuss its specific findings and assessments with the issuer. A portal could also provide general information and resources to issuers but could not provide issuer- or offering-specific guidance. A registered general dealer that operates an Internet website that offers and sells securities exempt from registration under §139.25 would be able to advise an issuer on structuring and valuation of its offering and, generally, offer a wider range of securities-related services consistent with the capacity in which the general dealer is registered. Given the foregoing, the Board disagreed with the commenter but may revisit this suggestion in the future.
CapitalReady objected to the language in subsection (c)(3) that prohibits a portal from holding, managing, possessing, or otherwise handling investor funds or securities. CapitalReady noted that portals can automate transfers of investor funds, streamlining the process and providing a more comprehensive audit trail. Accordingly, the third-party escrow requirement in §139.25 is unnecessary. Staff noted that, while the escrow requirement may be inconvenient, it is consistent with the JOBS Act requirement for portals and the SEC's crowdfunding portal proposal and appears in several other states' crowdfunding provisions. That the portal would not be handling investor money or securities was a key consideration of Staff in relaxing the dealer registration requirements for portal registration. Unlike other dealers who handle money or securities, Texas crowdfunding portals are not required to provide financial statements in connection with registration. Because of the limited activity of a portal, the waiver of the examination requirements was considered appropriate in the proposal. The Board disagreed with the commenter and adopted the subsection as proposed.
UrbanEquity objected to the prohibitions in subsection (c) against a portal taking an interest or investing in the issuers listed on its Internet website. UrbanEquity thinks a portal should be able to have an affiliate put together deals that are offered and sold on the portal's internet website. Issuers under common control should not be prevented from doing concurrent offerings. Staff responded that this provision is similar to that in the SEC's crowdfunding proposal and is based on the potential for conflicts of interest arising from holding such an interest. The prohibition is designed to protect investors from the conflicts of interest that may arise when the portal facilitating a crowdfunding transaction has a financial stake in the outcome. The existence of a financial interest in an issuer may create an incentive to advance that issuer's fund-raising efforts over those of other issuers, which could potentially adversely affect investors. The promise of a financial stake in the outcome could give a portal an incentive to ensure the success of its own investment in the issuer, to the disadvantage of investors and other issuers using the portal's Internet website, particularly if the financial interest is provided to the portal on different terms than to other investors. The Board disagreed with the commenter and adopted the subsection as proposed.
Turning to the background and regulatory history checks required in subsection (d), SparkMarket and one individual commenter asked how Texas crowdfunding portals should conduct such checks. Staff explained that subsection (d) does not establish specific procedures for portals to follow, opting instead for a flexible approach where a portal can use its experience and judgment, as well as its concern for the reputational integrity of its Internet website, to design systems and processes to help reduce the risk of fraud in securities-based crowdfunding. The portal can conduct these checks itself or contract them out to a third-party provider. If a third party is used, the portal should investigate and understand the procedures used by the third party to determine if it is reasonable to rely upon their results. Whether conducting the check itself or relying on a third party, the portal must have a reasonable basis for believing that the check was thorough enough to reveal any of the listed disqualifications or the likelihood of fraud. This requirement is similar to the one in the SEC proposal, which requires an intermediary to conduct a "background and securities enforcement regulatory history check" on issuers and the issuer's control persons. The checks should be conducted to help ensure both investor protection and the health of equity crowdfunding by aiding in fraud deterrence and detection. Suggestions for the content of or procedure for such checks will be provided in future Agency guidance.
A number of comments were made with regard to the recordkeeping requirements in subsection (e). SparkMarket asked why records of portal compensation should include investor names and suggested removing "name of investor" from subsection (e)(2)(A) because it is unlikely that portals will charge users (potential investors) a fee. Staff explained that this requirement reflects its understanding that some matching services (for Rule 506 offerings under §109.15) charge their investor members (who must be accredited investors). This requirement is included in case the registered dealer or registered Texas crowdfunding portal charges a fee to the potential investors for access to the securities offerings or for verification of accredited investor status to exceed the $5,000 investment cap. If the business model does not contemplate charging a fee to investors, there would be no corresponding recordkeeping requirement on the portal to record and document non-existent fees or compensation. The Board disagreed with the commenter and declined to remove the requirement.
SparkMarket also suggested changing "immediate" location of documents required in subsection (e)(7) to the less severe standard of "expedient." Staff responded that "immediate" location of records is the standard required of other registered dealers (See §13-1 of the Texas Securities Act and §115.5(e)(6)), so it is also appropriate for a dealer registered as a Texas crowdfunding portal. The Board agreed with Staff and declined to make the commenter's change.
CapitalReady identified a minor inconsistency in language, specifically that subsection (e)(2) referred to both "prospective purchasers" and "prospective investors." As "prospective purchaser" is the phrase used throughout the section, Staff recommended to the Board that the "prospective investors" language be changed. The Board agreed with the commenter and Staff and revised subsection (e)(2)(F) accordingly.
Texas Entrepreneur Networks asked what sort of verification an accredited investor has to provide to a portal. Staff noted that the intrastate crowdfunding exemption requires that the issuer have a reasonable basis for believing that the purchaser is an accredited investor. Since a Texas crowdfunding portal can only offer and sell securities pursuant to the §139.25 exemption (See §115.19(a)(2)), the portal should also establish that a prospective purchaser is accredited before permitting an individual investment that exceeds the $5,000 cap in §139.25(e). The portal is required to maintain the records it uses to establish that a prospective purchaser or investor is an accredited investor. See §115.19(e)(2)(E). Guidance can be obtained by reviewing the SEC's discussion of the "reasonable belief" standard in the discussion of "Current Practices" in SEC Release No. 33-9415, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, 78 FedReg 44,771, at 44,795-44,796.
Turning to the filing requirements in subsection (f), Texas Entrepreneur Networks asked exactly what investor information must be collected and reported to the Board on a monthly basis, suggesting that a trust company or escrow agent could provide such information. Staff responded that §115.19 does not require monthly reports to the Securities Commissioner. However, there is an application filing requirement for a Texas crowdfunding portal to register with the Texas Securities Board, an annual renewal requirement, and a requirement that the information in the application be updated over time. Form 133.15, being concurrently adopted, is the form Texas crowdfunding portals will use to register and amend their registration.
Texas Entrepreneur Networks also asked if there are Customer Identification Program requirements or other anti-money laundering provisions. Staff explained that the Texas Securities Act and Board rules do not contain any anti-money laundering provisions other than the requirement that a registered securities dealer or registered investment adviser establish, maintain, and enforce written supervisory procedures to supervise the activities of its agents or representatives that are reasonably designed to achieve compliance with the Texas Securities Act, Board rules, and all applicable securities laws and regulations. See §115.10 and §116.10. It appears likely that a Texas crowdfunding portal would be carved out of the federal anti-money laundering requirements since it cannot handle funds, securities, etc. A Texas crowdfunding portal should avoid engaging in activities that would cause it to be required to register with the SEC, but if the portal is careful to conduct only intrastate activities, it should fall within the intrastate exemption from broker-dealer registration at the federal level. Whether the escrow agent is subject to the federal anti-money laundering provisions is a matter outside of the Securities Commissioner's jurisdiction. More information on the federal anti-money laundering laws can be found on the U.S. Department of Treasury's Financial Crimes Enforcement Network website (http://www.fincen.gov/) and on the Federal Financial Institutions Examination Council website (http://www.ffiec.gov/bsa_aml_infobase/default.htm).
Some commenters suggested changes to or raised questions regarding the proposals that went beyond the scope of the published proposal. UrbanEquity suggested that real estate crowdfunding portals be treated differently from other crowdfunding portals. Staff disagreed with the commenter on this point. Creating a special class of crowdfunding portals exempt from various provisions applicable to other Texas portals would have required substantial changes to the published proposals or separate rules altogether. More importantly, real estate investments are not without risk or volatility, so singling out this type of investment for disparate treatment does not appear justified at this time. Equity crowdfunding is a new area that does not have an established track record. The Board disagreed with the commenter and made no change to the rule text to treat real estate crowdfunding portals differently. The Board may revisit this category of offerings after there has been more experience with equity crowdfunding.
CapitalReady expressed concern that the provisions in §139.25 regarding the offering notice may constrain portals from facilitating an SEC-compliant communication. For instance, CapitalReady could obtain an SEC no-action letter covering social media communications but would still be constrained absent a Texas rule change. Staff responded that, depending upon the scope of such letter, individual analysis of each request or a rule change may be appropriate. Like the SEC, Texas has a no action/interpretative letter process. Rule changes can occur fairly quickly. Additionally, the Commissioner has the ability to waive or relax restrictions in Board rules if, in his opinion, the restrictions are unnecessary for the protection of investors in a particular case. This section is consistent with SEC pronouncements to date. Future changes in SEC guidance can be dealt with through the no action or interpretative letter context, through a waiver request to the Commissioner, or by amending the section at a later date. Accordingly, the Board declined to change the section in response to the comment.
CapitalReady also inquired about the effect of offering securities to non-Texas residents under the §139.25 exemption since an offeror wouldn't be entitled to damages under a §33 rescission offer. Staff explained that an offering transmitted to an out-of-state person who can't and doesn't purchase the securities would not confer a §33 rescission right on that out-of-state offeree; there was no purchase, so there are no damages to recover. The danger of offers to out-of-state persons is that they may cause the issuer to lose the exemption for the entire offering if that exemption is based on the offering being conducted within the state since the issuer will have failed to comply with the terms of the exemption. If the issuer's exemption is lost and no other exemption is available, all offers and sales by the issuer would be of unregistered securities. That would confer rights of rescission or damages upon all of the purchasers in the offering, whether or not they still own the securities (although a prior sale of the securities would enter into the recovery calculation). Additionally, by offering and selling unregistered securities, the issuer has created a disclosure item (failure to comply with blue sky laws is a material fact that must be disclosed to investors in future offerings) and created a contingent liability for the amount of the potential rescission offer. The issuer can cut off civil liability if it completes a §33 rescission offer to investors who purchased the unregistered securities. However, a rescission offer doesn't shield the issuer from a state or federal regulatory action. The dealer (including a portal) involved in the offering may also be liable for assisting or offering securities when there is no exemption for the offer and sale of those securities. This includes administrative, civil, and criminal liability. If the out-of-state offers and sales also result in the loss of a federal intrastate exemption from securities or dealer registration, remedies and liability exist under federal law as well.
The amendments to §115.1 and §115.3 and new rule §115.19 are adopted under Texas Civil Statutes, Article 581-28-1. Section 28-1 provides the Board with the authority to adopt rules and regulations necessary to carry out and implement the provisions of the Texas Securities Act, including rules and regulations governing registration statements and applications; defining terms; classifying securities, persons, and matters within its jurisdiction; and prescribing different requirements for different classes.
The adopted amendments to §115.1 and §115.3 and new rule §115.19 affect Texas Civil Statutes, Articles 581-12, 581-13, 581-14, 581-15, and 581-18.
The Texas State Securities Board adopts three new rules, §§133.15 - 133.17, concerning forms adopted by reference, with changes to the proposed text as published in the May 9, 2014, issue of the Texas Register (39 TexReg 3655). The change to the form adopted by reference in §133.17 adds a place for the issuer to identify the bank or depository institution where the investor's funds will be held in escrow and to clarify the time when the notice filing will be made. The latter change corresponds with a change made to §139.25, which is being concurrently adopted. The remaining changes to the forms adopted by reference in §§133.15 - 133.17 are changes to punctuation.
Specifically, the State Securities Board adopts §133.15, which adopts by reference the Texas Crowdfunding Portal Registration form, and §133.16, which adopts by reference the Texas Crowdfunding Portal Withdrawal of Registration form. These forms are tailored to the limited activities performed by a portal and eliminate the need for a portal to use the more comprehensive dealer forms. The Board also adopts §133.17, which adopts by reference the Crowdfunding Exemption Notice form. Form 133.17 would be filed by an issuer claiming the exemption from securities registration afforded by §139.25, which is being concurrently adopted.
Texas crowdfunding portals will be able to use these simplified forms to register and amend their registration (Form 133.15) and to withdraw their registration (Form 133.16). Issuers will be able to claim the intrastate crowdfunding exemption in §139.25 by filing Form 133.17.
The new rules are adopted under Texas Civil Statutes, Article 581-28-1. Section 28-1 provides the Board with the authority to adopt rules and regulations necessary to carry out and implement the provisions of the Texas Securities Act, including rules and regulations governing registration statements and applications; defining terms; classifying securities, persons, and matters within its jurisdiction; and prescribing different requirements for different classes.
New rules §133.15 and §133.16 affect Texas Civil Statutes, Articles 581-12, 581-13, 581-14, 581-15, and 581-18. New rule §133.17 affects Texas Civil Statutes, Articles 581-5 and 581-7.
The State Securities Board adopts by reference Form 133.15, Texas Crowdfunding Portal Registration. This form is available from the State Securities Board, P.O. Box 13167, Austin, Texas 78711-3167 and at www.ssb.state.tx.us. §133.16.Texas Crowdfunding Portal Withdrawal of Registration.
The State Securities Board adopts by reference Form 133.16, Texas Crowdfunding Portal Withdrawal of Registration. This form is available from the State Securities Board, P.O. Box 13167, Austin, Texas 78711-3167 and at www.ssb.state.tx.us. §133.17.Crowdfunding Exemption Notice.
The State Securities Board adopts by reference Form 133.17, Crowdfunding Exemption Notice. This form is available from the State Securities Board, P.O. Box 13167, Austin, Texas 78711-3167 and at www.ssb.state.tx.us.
The Texas State Securities Board adopts new §139.25, concerning intrastate crowdfunding exemption, with changes to the proposed text as published in the May 9, 2014, issue of the Texas Register (39 TexReg 3655).
The following changes were made to §139.25. Subsection (b)(1) was changed to remove the requirement that the issuer be organized under the laws of Texas. This was removed as redundant since the same paragraph also requires the issuer to be an entity that has filed a certificate of formation with the Texas Secretary of State. Because commenters expressed confusion, subsection (b)(1) also reiterates that the issuer must be a Texas entity. Subsection (h)(1) was changed to allow a prospective investor to self-certify Texas residency to view securities-related offering materials. The provision requiring evidence of Texas residency before a sale can be made was retained. A nonsubstantive clarification was also made in the text of subsection (h)(3). Subsection (j) was changed to remove the reference to 21 days before offering securities and instead requires that the issuer make the notice filing with the Commissioner before use is made of any publicly available Internet website to offer securities in reliance on the exemption. Various nonsubstantive grammatical changes were also made throughout the section.
New §139.25 provides a registration exemption for securities offered in an intrastate crowdfunding offering. Offers and sales of the exempt securities are made using an Internet website of a Texas crowdfunding portal or an Internet website of a registered general dealer. The offering must also comply with the federal intrastate offering exemption (§3(a)(11) of the Securities Act of 1933) and U.S. Securities and Exchange Commission ("SEC") Rule 147, so the securities do not have to register at the federal level.
The exemption is designed to assist small issuers conducting offerings that are local in nature where many investors are likely to be part of the company's customer base or from the surrounding community that will benefit from the growth of local businesses and the jobs they provide. Accordingly, certain issuers are excluded from the exemption, including: investment companies, SEC reporting companies, and blind pool and blank check companies. Similarly, the exemption is unavailable if the issuer or its principals are subject to bad actor disqualifications.
The offering amount is capped at $1 million in a 12-month period. The cap is reduced by the amount received for sales of the issuer's securities occurring within six months prior to, during, or six months after the offers and sales made pursuant to this exemption. This period corresponds with the integration period identified in SEC Rule 147. An issuer cannot accept more than $5,000 from a single purchaser unless the purchaser is an accredited investor. Funds raised must be placed in an escrow account until the minimum target offering amount specified in the disclosure statement is reached.
Information about the offering must be posted on the Internet website for a minimum of 21 days before the securities may be sold. During this time, and for the course of the offering, all communications between the issuer, prospective purchasers, or investors must occur on the Internet website. The site must provide channels so potential purchasers and investors can communicate with each other, with the issuer, and have those communications visible to others on the site.
So the issuer can alert interested persons to its offering, the issuer may distribute a limited notice stating the issuer is conducting an offering, giving the name of the general dealer or Texas crowdfunding portal, and a link to the Internet website. Distribution of the notice is restricted to within Texas and it must contain a disclaimer reflecting that the offering is limited to Texas residents and that offers and sales on the Internet website are made only to Texas residents. A similar disclaimer is required on the Internet website. The website must require self-certification of Texas residency before securities offering materials can be viewed and evidence of residency before a sale can be made. A Texas crowdfunding portal is required to obtain an affirmative acknowledgment from the purchaser before investment is permitted.
A disclosure statement must be provided to each prospective purchaser on the Internet website. Material information and risk factors must be disclosed and topics to be addressed in the disclosure statement are noted in the rule. Financial statements provided may be certified by the issuer's principal executive officer. However, if recent audited or reviewed financial statements have been prepared, they must be provided as well.
A notice on Form 133.17, which is being concurrently adopted, is filed with the Securities Commissioner to claim the exemption, along with a copy of the issuer's disclosure statement and the summary of the offering that appears on the Internet website. The notice filing is made before any publicly available Internet website can be used to offer securities in reliance on the exemption.
Payments to unregistered persons are prohibited as are certain compensation arrangements and affiliations between an issuer and the general dealer or Texas crowdfunding portal.
The exemption will spur small business development in the state by allowing entrepreneurs and start-ups to raise capital through crowdfunding using the Internet.
The Board received numerous comments regarding new §139.25 from attorneys and others interested in equity crowdfunding. New York-based Ellenoff Grossman & Schole LLP commented that the proposals took "an intelligent and balanced approach," and New Jersey-based StartupValley described the proposals as "well thought out and put together." Georgia-based SparkMarket noted the very robust recordkeeping and retention requirements of §139.25. Chris Crow & Associates commented that Texas investors and businesses would benefit greatly from the crowdfunding proposals. Arizona-based TRAKLIGHT approved of the way the proposals spell out the risks involved.
Some commenters questioned how certain aspects of the rule would work, while others recommended specific changes to text or objected to core concepts in the proposal. All comments were considered and the Board made several changes as a result of feedback received.
Several commenters asked questions about the issuer requirements in subsection (b). Staff provided clarification and explanation in response to the comments. The Board considered the public comments and staff responses but made no changes to the rule text.
SparkMarket asked which entities would be able to use the exemption, i.e. which entities file a "certificate of formation" as called for in subsection (b)(1), and recommended that nonprofits be prevented from using the exemption. Staff explained that, in Texas, a "certificate of formation" is filed by a corporation (for-profit or nonprofit), limited liability company, professional corporation, or a limited partnership. This terminology was chosen to exclude general partnerships and joint ventures, types of entities that expose investors to potential legal liabilities exceeding their initial investment and that, historically, have been used in fraudulent offerings. Nonprofits are not excluded from using crowdfunding. But, if it appears in the future that the exemption is being misused by nonprofits, an exclusion can be adopted to address the problem. The Board disagreed with the commenter and declined to change the text to exclude nonprofits.
One individual asked why an issuer formed under the law of another state but with business operations in Texas is excluded from using the exemption. Staff explained that to avoid an issuer having to register its securities with the SEC at the federal level, the Texas exemption was drafted to coordinate with the federal intrastate offering exemption (§3(a)(11) of the Securities Act of 1933) and SEC Rule 147. Section 3(a)(11) and SEC Rule 147 require that the securities be offered and sold only to persons resident within a single state where the issuer of such security is also a resident and doing business within the state. SEC Rule 147 provides that, if an issuer is a corporation or other form of business organization that is organized under state law, the issuer is deemed to be a resident of the state in which it is incorporated or organized. Rule 147 also contains a number of tests to determine when an issuer is doing business in a state. An issuer formed under the laws of another state could not use the federal intrastate exemption to offer securities in Texas. An offering by an out-of-state issuer would be an interstate offering and may subject both the issuer and the portal to federal registration.
TRAKLIGHT asked how the 80% in Texas revenue requirement in subsection (b)(1)(A) would be measured for online companies. The staff explained that the 80% in gross revenues requirement in the Texas exemption comes from SEC Rule 147(c)(2)(i). Rule 147 provides that this requirement is met from the issuer's operation of a business within the state; from real property located in the state; or from the rendering of services within the state. However, the provision does not apply to any issuer which has not had gross revenues in excess of $5,000 from the sale of products or services or other conduct of its business for its most recent twelve-month fiscal period. Although no SEC guidance addressing online companies was located, the guidance in SEC Release 33-5450, 39 FedReg 2353 (01/07/1974) concerning mail order companies is helpful. The release includes an example of the applicability of Rule 147. The facts presented were: X corporation is incorporated in State A and has its only warehouse and only office in that state. X's only business is selling products throughout the United States and Canada through mail order catalogs. All orders are filled at and products shipped from X's warehouse to customers throughout the United States and Canada. X purchases the products it sells from corporations located in other states. These activities are X's sole source of revenue. The SEC's interpretative response was that X derives more than 80% of its gross revenues from the operation of a business or rendering services within State A.
Coordination of the exemption with federal securities laws is addressed specifically in subsection (c). CapitalReady suggested that a portal could host 506(c) and crowdfunding offerings concurrently for the same issuer. Staff noted that this suggestion is problematic for several reasons. First, proposed §115.19 limits portals to operating a website for §139.25 exempt offerings; a portal registered under §115.19 cannot list other types of offerings. Second, according to SEC guidance, the exemption from federal broker-dealer registration available to platforms that offer and sell securities under Rule 506 only applies if no other type of securities are offered and sold on the platform; a 506 platform could not list other types of offerings, including intrastate or §139.25 ones. A platform listing 506 securities would be required to register as a general dealer in Texas. A registered general dealer could make offers and sales of both Rule 506 and §139.25 securities through an Internet website. Third, the proposed rules were drafted to be consistent with the integration safe harbor in Rule 147 (sales that take place before the 6 months immediately preceding or after the 6 months immediately following an offer or sale). The Staff is concerned that issuers not inadvertently violate federal registration requirements. If a concurrent Rule 506(c) public offering takes place, the SEC may determine (by applying their five integration factors to the facts of the case) that the offers and sales are part of the same issue and should be integrated. This would cause the loss of the Rule 147 exemption. The Board disagreed with the commenter's suggestion and made no change to subsection (c).
CapitalReady also questioned whether there was a conflict between the 12-month period and the 6-month look back/look forward periods in subsection (d). The Staff explained that there is no conflict because the time periods relate to different things. The 12-month period relates to the $1 million cap on the amount that can be raised in a crowdfunding offering by an issuer using the §139.25 exemption. The 6-month look back and 6-month look forward come from the integration safe harbor in SEC Rule 147 and relate to other sales of securities by the issuer in any type of securities offering, not just other offerings under the §139.25 exemption. Subsection (c) of §139.25 makes compliance with SEC Rule 147 necessary to claim the exemption.
The $1 million cap on the amount that can be raised in a 12-month period found in subsection (d) of the exemption was faulted for being too low by several commenters. CapitalReady suggested that the cap be set somewhere between $3-1/2 to $6 million. UrbanEquity proposed a $3 million cap in real estate offerings. And Chris Crow & Associates supported a $5 million cap. The Staff responded that the $1 million dollar cap is consistent with the SEC's crowdfunding proposal and with what most other states have done, no state having a cap greater than $2 million. Companies that need to raise more than $1 million are likely larger and/or more established than the type of small business or startup meant to be the focus of the §139.25 exemption and have other options for funding both elsewhere and under other existing securities exemptions. There are a variety of other options for larger offerings, including public offerings under SEC Rule 506(c) and Regulation A and A+. Given the foregoing, and that equity crowdfunding is a new area without an established track record, the Board disagreed with the commenters and retained the $1 million cap from the proposal. Once there is some experience with equity crowdfunding, the Board may revisit the issue and adjust the cap, if appropriate.
SparkMarket asked if sales to officers/directors of the issuer are exempt from the $1 million cap if they invest through the crowdfunded offering. The Staff responded that it considered excluding investments by the issuer's officers and directors from the $1 million dollar cap but rejected this approach. An issuer using crowdfunding has likely already raised the maximum possible from the people with whom it has a preexisting relationship (friends, family, officers, directors, employees, etc.) and is using crowdfunding to obtain additional money from potential customers and others. The Board made no change to the rule text in response to the question.
UrbanEquity's proposed $3 million cap for real estate offerings is based on its larger suggestion that real estate investments be treated differently from other investments in the crowdfunding context. Staff disagreed with the commenter on this point. Real estate investments are not without risk or volatility, so singling out this type of investment for disparate treatment - with regard to the issuer cap, or otherwise - does not appear justified at this time. The Board disagreed with the commenter and made no change to the rule text to treat real estate offerings differently from other securities offerings in this context.
Chris Crow & Associates, which suggested a $5 million cap, asked that it be waived for entities that act as a general partner or manager of an LLC, and own no more than 25% of the partnership or LLC, to facilitate each of the companies under common control raising $5 million under the exemption. Such a change, it was argued, would encourage small oil and gas companies to use portals. Staff noted that a general partnership or joint venture is not eligible to use §139.25 since those types of entities do not file a certificate of formation with the Texas Secretary of State. An LLC or limited partnership is able to use the exemption since that type of entity does file a certificate of formation. The disqualifications in subsection (m) applicable to related entities and entities under common control are based upon Staff's experience with such vehicles being used by promoters in fraudulent securities offerings. Oil and gas offerings can be offered under a number of other specific exemptions for the industry (§5.Q, and Board Rules §109.14 and §139.12), as well as Regulation D, which do not contain a cap on the amount that can be raised. The Board disagreed with the commenter and declined to raise the cap.
A few commenters also thought the individual investment cap of $5,000 unless accredited in subsection (e) was too low. The Board disagreed with the commenters and retained the $5,000 cap. Once there is additional experience with equity crowdfunding in Texas, the Board may revisit the issue and adjust the cap, if appropriate.
Chris Crow & Associates asked that the investment amount for individual unaccredited investors be capped at not more than 10% of their income. Staff explained that tying the investment cap to an individual investor's income would make the exemption more complex. Such a change would require the Texas crowdfunding portal or general dealer to verify the income for unaccredited investors and to calculate the amount of the permitted investment on an individual basis for each investor. Accredited investors are not subject to the $5,000 investment cap. The Board disagreed with the commenter and declined to adjust the investment cap.
UrbanEquity asked that the individual investment cap be raised to $10,000 for conservatively leveraged real estate, with less than or equal to 65% loan-to-value ("LTV") at origination. Staff noted that real estate and REIT offerings that register are subject to analysis under the North American Securities Administrators Association ("NASAA") statements of policy adopted by reference in §113.14(b)(13) and (17). Before singling out real estate offerings sold to unaccredited investors for an exemption, other investor safeguards provided in those NASAA guidelines may also be appropriate, rather than limiting the analysis solely to the LTV. The matter may be appropriate for future study, but there is inadequate information at this time to make such a substantive change. Unlike most other restricted registrations, registration as a Texas crowdfunding portal does not include any type of competency examination by the registrant. The examination waiver and limited recordkeeping required by portals were considered appropriate given the limited nature of the activities a portal and its agents can perform and would need to be reassessed in the real estate crowdfunding context proposed by the commenter, which contemplates additional services. The Board disagreed with the commenter and declined to raise the investment cap or single out real estate investments for different treatment that other securities offerings.
Texas Entrepreneur Networks asked how accredited investor status is verified. The Staff noted that subsection (e) of the intrastate crowdfunding exemption requires that the issuer have a reasonable basis for believing that the purchaser is an accredited investor. Guidance can be obtained by reviewing the SEC's discussion of the "reasonable belief" standard currently applicable to all Rule 506 offerings. See the discussion of "Current Practices" in SEC Release No. 33-9415, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, 78 FedReg 44,771, at 44,795-44,796.
The escrow requirement in subsection (f) of §139.25 drew comments and questions.
Representatives of a Texas bank and affiliated trust company expressed interest in serving as an escrow agent in Texas intrastate crowdfunding offerings and asked the following questions: (1) What is a depository institution, and are trust companies included?; (2) Could the rule specify that payments be made to the escrow agent via the Automated Clearing House ("ACH") network?; (3) Are the escrow accounts required to be interest bearing?; (4) Could the escrow agent deduct a fee for returning funds to the investor by check?; (5) Would the Financial Industry Regulatory Authority ("FINRA") regulate these transactions?; and (6) Is there a prohibition against a financial institution serving as an escrow agent if one or more investors in the offering have an account with the escrow agent? Staff responded to (1) by explaining that a depository institution is an entity with the power to accept deposits under applicable law and so can hold funds deposited into an escrow account. A trust company with the power to accept deposits under Texas law could be among the Texas-chartered entities permitted to hold funds in an escrow account. Staff responded to question (2) by noting that, to give parties flexibility, the exemption does not specify the method for an investor's payment into the escrow account. The parties to the escrow agreement or contract could impose requirements or restrictions, such as requiring that all payments be made via ACH. Some portals may choose to permit purchasers to buy securities by using a credit card to make payments, rather than through money or funds transfer between financial institutions. It does not appear appropriate to limit the method of payment in the rule. However, the parties are not precluded from limiting payment methods if they so choose. Staff responded to (3) by noting that there is no requirement in the rule that the escrow account be interest bearing. In response to (4), the staff noted that §139.25 requires that, if the offering is terminated without being funded or closed, each investor receives back the full amount of his or her investment from the escrow account. There can be no deduction made from the investors' funds. Any fees collected by the escrow agent for issuing checks to investors must be paid by a party other than the investor. It is anticipated that the other party to the escrow agreement (be it the portal or the issuer) would pay any such fees charged by the escrow agent. Staff explained in response to question (5) that, since a Texas crowdfunding portal is a Texas-registered intrastate dealer, the portal would not be required to register with FINRA. The same is true of a Texas-only registered intrastate general dealer who offers §139.25 securities on an Internet website. However, a general dealer who does not limit its activities to Texas and who engages in interstate commerce would likely be an interstate dealer, and required to register with FINRA under the federal securities laws. As for question (6) posed by the bankers, the rule does not prohibit a financial institution from acting as an escrow agent for funds in a §139.25 crowdfunding securities offering when some of the funds in the escrow account come from an investor who is also a customer of the financial institution.
SparkMarket, the Georgia crowdfunding website, said it has been unable to find a Georgia depository institution willing to act as escrow agent for crowdfunding transactions. SparkMarket asked if the requirement in subsection (f) that the escrow depository institution be "located in Texas" means that it has to have a branch in Texas, even if it is not a "Texas depository institution." Staff remarked that, in addition to the Texas bank and affiliated trust company already mentioned, the Staff has been in contact with an attorney representing small Texas banks as well as representatives of the Texas Department of Banking and industry trade groups (the Independent Bankers Association of Texas and the Texas Bankers Association) concerning the escrow requirement. It appears that these financial institutions are interested in acting as escrow agents for Texas intrastate crowdfunding offerings. The escrow account would need to be in a federal or Texas-chartered bank or depository institution located in Texas. An account at a Texas branch of a federal-charted bank or depository institution would be sufficient under the rule. Staff recommended not limiting account depositories to Texas-chartered banks since doing so would give fewer options to Texas crowdfunding portals, securities dealers, or issuers.
Kennedy Sutherland LLP asked that language be added to subsection (f) to clarify that in accepting the escrow, a bank is not making a recommendation regarding the securities offered and is not liable to any subscriber who participates in the offering. Staff explained that obligations of parties to an escrow agreement, and liability that attaches for failing to meet any of those obligations, are most likely governed by the terms of the escrow agreement and general contract law. The exemption gives the parties the ability to set the terms of the escrow contract, including any indemnification agreement that they deem appropriate. Accordingly, any liability arrangement is more appropriately addressed in the contract between the parties and in disclosures that may be made in connection with the limitation on liability for small business issuances that is provided for in §33.N of the Act. The Board does not have rulemaking authority, pursuant to §5.T and §28-1 of the Texas Securities Act, to alter the statutory provisions addressing civil liability. The Board declined to make the change requested by the commenter.
UrbanEquity asked that "well-established national title companies" be allowed to escrow funds. Staff responded that it considered the request and noted that there is no governmental agency that licenses title companies on a nationwide basis. In Texas, title companies are registered with the Texas Department of Insurance ("TDI") to issue title insurance policies. A title company's escrow officers are also required to be licensed by TDI. Although posting a surety bond is required, there does not appear to be anything equivalent to FDIC insurance over escrow accounts as there is with financial institutions. The commenter offered to but did not supply information on the fiduciary nature of title companies over escrow accounts. The Board disagreed with the commenter and declined to make the suggested change.
Turning to subsection (g) and communications, SparkMarket had questions regarding the subsection (g)(1) requirement that all communications between the issuer and potential purchasers be made through the Internet website. SparkMarket asked how the requirement would work in practice. Specifically, could a user "opt-out" of communications with other users? And, if communications are obscene, illegal, or inappropriate, what editorial control would the portal have? Staff responded that the subsection (g)(1) requirement is similar to the communications channel requirement in the SEC's crowdfunding proposal. While developing the proposal, Staff talked to various individuals with expertise or interest in the area who did not think this would be a problem. A prospective purchaser or investor would not be able to "opt out" but could choose not to read posts made by others on the site. An integral element of crowdfunding is communication with others to tap into the "wisdom of the crowd." Staff did not include specifics on how to structure the communications channels, other than to have the communications preserved and available to those with access to the offering materials. This was to give the registered dealer or registered portal flexibility in setting up this mechanism. Staff did not address what to do about obscene, illegal, or irrelevant communications in the rule but will be issuing guidance to explain that a portal or dealer could establish guidelines pertaining to the length or size of individual postings in the communications channels and, in the event that communications are made that are obscene, illegal, or irrelevant, the portal or dealer would be permitted to remove the postings that include offensive or incendiary language. Any communications that are removed would need to be retained by the portal or dealer under their respective recordkeeping responsibilities. The registered dealer or registered Texas crowdfunding portal also has the option of removing or barring a user that posts obscene, illegal, or irrelevant comments.
SparkMarket and one individual asked about limitations on the issuer distributing the notice or "tombstone" permitted in subsection (g)(2). The individual commenter and CapitalReady asked what types of social media posts might be allowed under the exemption. Staff explained that the exemption requires that the issuer's notice be distributed only in Texas and contain a disclaimer that reflects that the offering is limited to Texas residents, and offers and sales are limited to persons that are Texas residents. Such notices are extremely limited and little more than a link to the issuer or portal's website with the above disclaimer. Again, Staff chose not to limit the options available to the issuer. However, an issuer can only use flyers, internet, e-mail, or social media if the notice is distributed solely in Texas, so some of these options may be, by their nature, unavailable.
Staff's concern with social media posts in particular is that they can be construed as offers and violate the intrastate exemption because they are not limited to residents of Texas (the way offers made through the portals are required to be). Recently issued (October 2, 2014) SEC guidance on Rule 147 offerings (compliance with Rule 147 is required to claim the §139.25 exemption) and social media indicate that there is some risk involved with using social media in intrastate offerings using the Rule 147 exemption. According to the guidance, issuers generally use their websites and social media presence to advertise their market presence in a broad and open manner. "Although whether a particular communication is an 'offer' of securities will depend on all of the facts and circumstances, using such established Internet presence to convey information about specific investment opportunities would likely involve offers to residents outside the particular state in which the issuer did business." The SEC went on to provide additional guidance on an issuer's use of communications and social media: "We believe, however, that issuers could implement technological measures to limit communications that are offers only to those persons whose Internet Protocol, or IP, address originates from a particular state or territory and prevent any offers to be made to persons whose IP address originates in other states or territories. Offers should include disclaimers and restrictive legends making it clear that the offering is limited to residents of the relevant state under applicable law. Issuers must comply with all other conditions of Rule 147, including that sales may only be made to residents of the same state as the issuer." In light of this SEC interpretation, there is significant risk involved in using social media in intrastate offerings in connection with Rule 147 offerings and, by extension, for an issuer using the Texas crowdfunding exemption that coordinates with SEC Rule 147.
The particular requirements regarding Internet websites operated by either Texas crowdfunding portals or registered general dealers are in subsection (h). SparkMarket noted that the restriction in subsection (h)(1)(A) (limiting access to securities offerings on a website to Texas residents) means that any platform operating outside of Texas including JOBS Act platforms would not be able to list these deals. Staff responded that an out-of-state entity could register in Texas as a general dealer and offer and sell §139.25 offerings solely in Texas; however, such an entity would probably have to register as a broker-dealer at the federal level due to the interstate nature of its business operations. An out-of-state portal cannot register under §115.19 to be a Texas crowdfunding portal. Because §139.25 was crafted to comply with the federal intrastate exemption from securities registration, any transmission of data as part of an offer or sale that occurs in more than one state could subject the issuer to federal registration requirements and liability. Similarly, since §115.19 was crafted to comply with the federal intrastate exemption from broker-dealer registration requirements, a firm or its servers located out of state may also create a federal broker-dealer registration issue. Yet even a federally-registered broker-dealer would still face the federal intrastate securities exemption issue. In any case, since the portal would be subject to onsite and unannounced inspections in the same way securities dealers and investment advisers are now, a portal and its records physically located outside the state would impair the ability of the Agency to ensure compliance with the new rules. The Board declined to make any change to the rule in response to the comment.
SparkMarket and UrbanEquity suggested that self-certification, rather than evidence of residency as was proposed in subsection (h)(1)(B) of the exemption, should be enough to "gain entry" to the securities offerings section of these websites. SparkMarket expressed concern that requiring proof of residency beyond self-certification at the offer phase would likely have a chilling effect on users. Staff explained that the establishment of Texas residency before receiving access to securities offering materials is a safeguard to keep the issuer, registered dealer, or Texas crowdfunding portal from inadvertently making an interstate (rather than an intrastate) offering and losing both the state and federal registration exemptions. Although recent SEC guidance has been issued on Rule 147 securities offerings, the SEC's Division of Trading and Markets has not yet issued comparable formal guidance for the intrastate dealer side of the transaction. However, Staff anticipates that the dealer guidance will be similar. Accordingly, Staff recommended to the Board that a prospective purchaser be allowed to self-certify Texas residency to gain access to the securities-related offering materials. The Board agreed with the commenters and the Staff recommendation and revised the subsection accordingly.
One individual asked if an issuer can include videos on the Internet website where its offering is made. The Staff responded yes, an issuer can supplement the issuer information required by subsection (h)(2) with a video also appearing on the same Internet website on which the issuer's offering appears. To the extent that the video includes information required in the disclosure statement or the offering summary it should be treated as part of those documents and included as part of the notice filing made by the issuer with the Securities Commissioner pursuant to subsection (j). The video would be included in the information required to be made available to the Commissioner and potential investors for a minimum of 21 days before any securities are sold in the offering per subsection (h)(3). Since all communications between the issuer, prospective purchasers, or investors must occur through the Internet website of the registered general dealer or Texas crowdfunding portal, the video could not appear somewhere else where prospective purchasers or investors could view it until after the §139.25 offering has concluded.
Commenting on the 21-day before sales are made filing requirement in subsection (h)(3), SparkMarket observed that, although it has not seen such a filing requirement before, it is a very good idea as it will allow the State (and the crowd) to evaluate unworthy offerings. It would also allow issuers to generate buzz. The Board agreed with the commenter and left the provision unchanged.
Proceeding to subsection (i) and the required disclosure statement, TRAKLIGHT and SparkMarket approved of the requirement in subsection (i)(3) that financial statements be "certified by the principal executive officer." But SparkMarket suggested a form be provided for this, and that "financial statements" be defined. It also suggested that the disclosure statement be delivered to investors rather than just made "readily available and accessible," noting that there are easy technology solutions for ensuring that potential investors are provided with copies of the offering documents. But SparkMarket also noted the very robust recordkeeping and retention requirements in the proposed rule. Staff explained that the rule requires someone at the issuer take responsibility for the issuer's financial statements, but the additional cost of having a CPA review or audit the company is avoided. Comments received by the SEC in response to their proposal indicated that the cost for a CPA review/audit would undercut the usefulness of crowdfunding as a way for small businesses to raise money. The commenters' remarks seem to agree with this analysis. Staff recommended including a description of financial statements in its website guidance rather than in the crowdfunding rule itself noting that financial statement is a defined term in §107.2. As for SparkMarket's suggestion that the disclosure statement be delivered to investors rather than just made readily available and accessible, Staff responded that it seems unnecessary for all prospective investors to receive delivery of the disclosure statements for all offerings on the Internet website. Staff believes it is sufficient that the full disclosure statement and offering summary are available to prospective investors. The Board disagreed with the commenters and made no changes to subsection (i).
Subsection (j) and the notice filing requirement drew several comments. One individual asked about the interrelation between the notice periods contained in this subsection and subsection (h)(3) and asked if they were meant to run consecutively or concurrently. Staff responded that the intent was to require an issuer to make a notice filing with the Commissioner before the offering could appear on the portal's or general dealer's Internet website. Once an issuer's disclosure statement and offering summary appeared on the Internet website, this information was to be made available online for 21 days before the issuer's securities could be sold. Staff recommended to the Board that this be clarified by adjusting the language in subsection (j), removing the reference to 21 days before offering securities, and requiring instead that the issuer make the notice filing with the Commissioner before use is made of any publicly available Internet website to offer securities in reliance on the exemption. Since the exemption requires all communications between the issuer and potential purchasers be made through the Internet website, there can be no offers made except through the website operated by the portal or general dealer. The Board agreed with Staff's proposed clarification, and the language of the subsection was changed as recommended.
Texas Entrepreneur Networks asked exactly what investor information must be collected and reported to the Board on a monthly basis, suggesting that a trust company or escrow agent could provide such information. Staff responded that the Texas intrastate crowdfunding rule proposals do not contain any requirement for monthly reports to the Securities Commissioner. As previously discussed, issuers claiming the intrastate crowdfunding exemption are required to make a filing before any offer of securities can be made pursuant to the exemption.
Subsection (l) regarding commissions and remuneration, specifically the prohibitions therein against portals taking an interest or investing in the issuers listed on its Internet website, was objected to by UrbanEquity. It commented that a portal should be able to have an affiliate put together deals that are offered and sold on the portal's internet website. The Staff responded that this provision is similar to that in the SEC's crowdfunding proposal and is based on the potential for conflicts of interest arising from holding such an interest. The prohibition is designed to protect investors from the conflicts of interest that may arise when the portal facilitating a crowdfunding transaction has a financial stake in the outcome. The existence of a financial interest in an issuer may create an incentive to advance that issuer's fund-raising efforts over those of other issuers, which could potentially adversely affect investors. The promise of a financial stake in the outcome could give a portal an incentive to ensure the success of its own investment in the issuer, to the disadvantage of investors and other issuers using the portal's Internet website, particularly if the financial interest is provided to the portal on different terms than to other investors. The Board disagreed with the commenter and adopted the subsection as proposed.
Subsection (m), which disqualifies issuers with common control persons from using the exemption to raise more than $1 million, received a comment from CapitalReady which expressed concern about including security holders of 20% or more of the issuer in the definition of "control person." CapitalReady posed the example of a restauranteur who operates restaurants in two cities and wishes to use crowdfunding to finance the opening of two more restaurants in two new cities. Each restaurant is set up as a separate corporation but the restauranteur owns or will own 20% or more in each of the corporations. By including security holders in the definition of control person, the restauranteur is unable to raise $1 million for each of the new restaurant ventures under the crowdfunding proposals. Staff explained that the inclusion of 20% security holders as control persons (subject to background and regulatory checks and disclosures to investors) is consistent with other crowdfunding initiatives at the federal and state levels. The disqualifications applicable to related entities and entities under common control are based upon Staff's experience with such vehicles being used by promoters in fraudulent securities offerings. Related ventures that need to raise more than $1 million are likely more established than the type of small business or startup meant to be the focus of the §139.25 exemption and have other options for funding both elsewhere and under other existing securities exemptions. Equity crowdfunding is a new area that does not have an established track record so Staff recommended, and the Board agreed, that the cap remain at $1 million. Once there is some experience with equity crowdfunding, the Board may revisit the issue and adjust the cap, if appropriate. Alternatively, appropriate safeguards or attributes may be identified in the future that would help distinguish legitimate businesses from those who may seek to merely circumvent the $1 million cap.
Other comments regarding the proposed rules were more general in nature. TRAKLIGHT stressed the importance of education for entrepreneurs and portals and supported inclusion of it in the rules. Staff responded that the rule does not mandate that the portal or issuer provide educational materials to investors. Providing educational materials to investors is not required in connection with other Texas exemptions or registrations. It is hoped that registered Texas crowdfunding portals and general dealers offering securities exempt under the crowdfunding exemption would include investor educational information or links for their customers as part of the services they provide, but it is not required. The Agency makes investor education materials available on the Internet through its website at www.TexasInvestorEd.org and plans to make information specific to crowdfunding offerings available on the main agency website at www.ssb.state.tx.us. The Board disagreed with the commenter and did not add in a requirement to provide educational materials.
SparkMarket suggested a variety of nonsubstantive changes in wording and phrasing. Staff recommended making some of the changes but not others. The Board declined to make changes recommended by the commenter that were not also recommended by Staff.
CapitalReady expressed its preference that portals start with a lot of listings and concern that a slow roll out will reduce the volume of listings. CapitalReady would prefer issuers be able to do more in the beginning rather than wait until the Board expands the exemption later. Staff, again, noted that equity crowdfunding is fairly new and only very recently available to unaccredited investors. There is minimal experience with these types of offerings, so Staff is reluctant to open the flood gates. There is securities fraud in Texas and in most cases, the money is gone before the fraud can be stopped. Incidents of fraud in the new crowdfunding offerings would negatively impact the success of crowdfunding in Texas and the availability of capital to the small and startup businesses that intrastate crowdfunding is being established to help. There is a delicate balance between investor protection and access to capital. After gathering experience in how intrastate crowdfunding is operating under the new rules and identifying and studying safeguards to distinguish between legitimate and fraudulent crowdfunded offerings, the Board can revisit the rules. The Board declined to make further changes to the rule in response to this comment.
(c) Coordination with federal securities laws. Securities offered in reliance on the exemption provided by this section must also meet the requirements of the federal exemption for intrastate offerings in the Securities Act of 1933, §3(a)(11), 15 U.S.C. §77c(a)(11), and Securities and Exchange Commission Rule 147, 17 CFR §230.147.
(f) Escrow. All payments for purchases of securities offered under this section are directed to and deposited in an escrow account with a bank or other depository institution located in Texas and organized and subject to regulation under the laws of the United States or under the laws of Texas, and will be held in escrow until the aggregate capital raised from all purchasers is equal to or greater than the minimum target offering amount specified in the disclosure statement as necessary to implement the business plan. Investors will receive a return of all their subscription funds if the target offering amount is not raised by the time stated in the disclosure statement.
(D) prior to offering an investment opportunity to residents of Texas and throughout the term of the offering, the registered general dealer or registered portal shall give the Securities Commissioner access to the Internet website.

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