The Impact of the 2012 Jobs Act on Independent Film Financing

The newly enacted federal JOBS Act of 2012 (H.R. 3606; http://bit.ly/JfRRg2) impacts independent film financing by loosening the restrictions on companies (“issuers”) raising capital via securities offerings that are exempt from registration with the Securities Exchange Commission (SEC). One section of the JOBS Act permits “crowd funding,” which is aimed at equity or debt offerings of not more than $1 million through “funding portals,” envisioned as websites that match investors to investments. Another section permits general solicitation and advertising for offerings sold only to “accredited investors.”

The theory behind the crowd funding exemption is laudable, but the Act actually makes crowd funding a chimera because it adds so many hurdles and restrictions that it makes the crowd funding exemption worse than just relying on the current exemptions from registration. Here are just a few reasons why the crowd funding exemption is smoke and mirrors:

1. The SEC recently issued a notice making clear that the exemption cannot be relied on until the SEC issues regulations, and it has until the end of 2012 to do so.
2. Investors are limited to how much they can invest in a 12-month period in all crowd funding investments, based on the amount of their net worth or income. For investors with more than $100,000 of annual income or net worth (and it appears that the new worth test excludes the investor's principal residence), the limit is 10% of the greater of either amount.
3. The funding portal must: a) ensure that the investors review investor education material and confirm that they understand that they can lose their investment; b) run a background check on every officer, director and more than 20% shareholder of each issuer; c) ensure that invested cash is released to the issuer only once the required minimum raise to close is reached; d) register with the SEC; and e) be a member of a self-regulating crowd funding securities association (which has yet to be formed).
4. A funding portal cannot: a) pay anyone to identify potential investors; b) offer investment advice or recommendations; c) solicit investments in listed offerings; d) compensate anyone based on sales of listed offerings; or e) handle investor funds or investments.
5. The issuer must file with the SEC, the funding portal and investors extensive information about the issuer, including a business plan, intended use of the investment, the capital structure of the issuer, the terms of the offering, the basis for valuation of the investment being offered, the risks involved, and the names of its officers, directors, and more than 20% shareholders. But the law also requires financial information in a particular format depending on the amount of the offering, ranging from tax returns for offerings of not more than $100,000, reviewed financials for offerings of not more than $500,000, and fully audited financials if the issuer is seeking to raise more than $500,000. (This last requirement will almost always be cost prohibitive).
6. There is a three-week holding period between the date that the offering material is submitted to the SEC and the date that invested cash can be accepted.
7. No advertising is permitted, except for “notices which direct investors to the funding portal.”
8. The issuer must file annual financials with the SEC and the investors.
9. The issuer and its directors, executive officers, CFO and any person who offers the security is liable to the investors for the full amount of their investment for any inaccurate or omitted material fact in the offering material. The potential liability under this provision is more expansive than under other exemptions from registration.
10. There is a one-year restriction on transfers of the investment by investors, other than narrow exceptions.

So what is the theoretical benefit of meeting this mass of restrictions and qualifications, compared to relying on an existing exemption for offerings up to the same $1 million? Rather meager, but here they are:

1. Crowd funding offerings can use a funding portal to permit investment by widows, orphans and other investors that are not “accredited investors” (discussed below).
2. The crowd funding exemption overrides state securities laws, except the requirement to pay any applicable filing fees in the state of the issuer's principal place of business or where investors making more than 50% of the investment reside.

The alternative to all this lunacy for small offerings is to just rely on good ol' Rule 504 of Federal Regulation D, which exempts offerings of not more than $1 million to whomever you want, as long as you disclose all material facts, don't commit fraud, don't advertise, and file Form D with the SEC. That's it. For Rule 504 offerings, you also have to comply with state securities laws, but for most of them, all you need to do is keep the offering to under 35 investors that either have a pre-existing relationship with the promoter or that are financially sophisticated (or are represented by someone that is).

The JOBS Act also makes a significant change to offerings to “accredited investors” by permitting general solicitation and advertising, as long as the issuer takes reasonable steps to verify that the purchasers are accredited investors, as opposed to accepting a self-serving declaration, which is permitted for offerings that do not have general solicitation or advertising. An “accredited investor” is an investor that is one of the following:

1. A natural person whose net worth (together with their spouse, if any) exceeds $1,000,000 at the time of this purchase (excluding their principal residence); or
2. A natural person who had an individual income in excess of $200,000 (or $300,000 if married) in each of the two most recent years, and who reasonably expects an income in excess of that amount in the current year;
3. An entity that has over $5 million of gross assets that was not formed for the specific purpose of making this investment; and
4. An entity owned solely by one or more of the foregoing.

In addition, the JOBS Act permits offerings to accredited investors through funding portals as long as the following requirements are met:

1. The funding portal must either: a) register as a broker/dealer; or b) not receive or pay any compensation in connection with the sale of listed investments; and
2. The funding portal cannot have possession of customer funds or investments.

If these requirements are met (which are far less stringent than the requirements for funding portals under the crowd funding exemption), the funding portal may provide ancillary services, such as: a) the provision of due diligence services, so long as such services do not include, for separate compensation, investment advice or recommendations to the issuers or investors; and b) the provision of standardized documents to the issuers and investors, so long as the funding portal does not negotiate the terms of the issuance for and on behalf of third parties, and issuers are not required to use the standardized documents as a condition of using the service.

Conclusion

So while the crowd funding exemption is a bust, the permission of advertising to accredited investors is significant. Coming to a theater near you may be trailers of upcoming investment offerings in film deals, rather than of upcoming films.

The newly enacted federal JOBS Act of 2012 (H.R. 3606; http://bit.ly/JfRRg2) impacts independent film financing by loosening the restrictions on companies (“issuers”) raising capital via securities offerings that are exempt from registration with the Securities Exchange Commission (SEC). One section of the JOBS Act permits “crowd funding,” which is aimed at equity or debt offerings of not more than $1 million through “funding portals,” envisioned as websites that match investors to investments. Another section permits general solicitation and advertising for offerings sold only to “accredited investors.”

The theory behind the crowd funding exemption is laudable, but the Act actually makes crowd funding a chimera because it adds so many hurdles and restrictions that it makes the crowd funding exemption worse than just relying on the current exemptions from registration. Here are just a few reasons why the crowd funding exemption is smoke and mirrors:

1. The SEC recently issued a notice making clear that the exemption cannot be relied on until the SEC issues regulations, and it has until the end of 2012 to do so.
2. Investors are limited to how much they can invest in a 12-month period in all crowd funding investments, based on the amount of their net worth or income. For investors with more than $100,000 of annual income or net worth (and it appears that the new worth test excludes the investor's principal residence), the limit is 10% of the greater of either amount.
3. The funding portal must: a) ensure that the investors review investor education material and confirm that they understand that they can lose their investment; b) run a background check on every officer, director and more than 20% shareholder of each issuer; c) ensure that invested cash is released to the issuer only once the required minimum raise to close is reached; d) register with the SEC; and e) be a member of a self-regulating crowd funding securities association (which has yet to be formed).
4. A funding portal cannot: a) pay anyone to identify potential investors; b) offer investment advice or recommendations; c) solicit investments in listed offerings; d) compensate anyone based on sales of listed offerings; or e) handle investor funds or investments.
5. The issuer must file with the SEC, the funding portal and investors extensive information about the issuer, including a business plan, intended use of the investment, the capital structure of the issuer, the terms of the offering, the basis for valuation of the investment being offered, the risks involved, and the names of its officers, directors, and more than 20% shareholders. But the law also requires financial information in a particular format depending on the amount of the offering, ranging from tax returns for offerings of not more than $100,000, reviewed financials for offerings of not more than $500,000, and fully audited financials if the issuer is seeking to raise more than $500,000. (This last requirement will almost always be cost prohibitive).
6. There is a three-week holding period between the date that the offering material is submitted to the SEC and the date that invested cash can be accepted.
7. No advertising is permitted, except for “notices which direct investors to the funding portal.”
8. The issuer must file annual financials with the SEC and the investors.
9. The issuer and its directors, executive officers, CFO and any person who offers the security is liable to the investors for the full amount of their investment for any inaccurate or omitted material fact in the offering material. The potential liability under this provision is more expansive than under other exemptions from registration.
10. There is a one-year restriction on transfers of the investment by investors, other than narrow exceptions.

So what is the theoretical benefit of meeting this mass of restrictions and qualifications, compared to relying on an existing exemption for offerings up to the same $1 million? Rather meager, but here they are:

1. Crowd funding offerings can use a funding portal to permit investment by widows, orphans and other investors that are not “accredited investors” (discussed below).
2. The crowd funding exemption overrides state securities laws, except the requirement to pay any applicable filing fees in the state of the issuer's principal place of business or where investors making more than 50% of the investment reside.

The alternative to all this lunacy for small offerings is to just rely on good ol' Rule 504 of Federal Regulation D, which exempts offerings of not more than $1 million to whomever you want, as long as you disclose all material facts, don't commit fraud, don't advertise, and file Form D with the SEC. That's it. For Rule 504 offerings, you also have to comply with state securities laws, but for most of them, all you need to do is keep the offering to under 35 investors that either have a pre-existing relationship with the promoter or that are financially sophisticated (or are represented by someone that is).

The JOBS Act also makes a significant change to offerings to “accredited investors” by permitting general solicitation and advertising, as long as the issuer takes reasonable steps to verify that the purchasers are accredited investors, as opposed to accepting a self-serving declaration, which is permitted for offerings that do not have general solicitation or advertising. An “accredited investor” is an investor that is one of the following:

1. A natural person whose net worth (together with their spouse, if any) exceeds $1,000,000 at the time of this purchase (excluding their principal residence); or
2. A natural person who had an individual income in excess of $200,000 (or $300,000 if married) in each of the two most recent years, and who reasonably expects an income in excess of that amount in the current year;
3. An entity that has over $5 million of gross assets that was not formed for the specific purpose of making this investment; and
4. An entity owned solely by one or more of the foregoing.

In addition, the JOBS Act permits offerings to accredited investors through funding portals as long as the following requirements are met:

1. The funding portal must either: a) register as a broker/dealer; or b) not receive or pay any compensation in connection with the sale of listed investments; and
2. The funding portal cannot have possession of customer funds or investments.

If these requirements are met (which are far less stringent than the requirements for funding portals under the crowd funding exemption), the funding portal may provide ancillary services, such as: a) the provision of due diligence services, so long as such services do not include, for separate compensation, investment advice or recommendations to the issuers or investors; and b) the provision of standardized documents to the issuers and investors, so long as the funding portal does not negotiate the terms of the issuance for and on behalf of third parties, and issuers are not required to use the standardized documents as a condition of using the service.

Conclusion

So while the crowd funding exemption is a bust, the permission of advertising to accredited investors is significant. Coming to a theater near you may be trailers of upcoming investment offerings in film deals, rather than of upcoming films.