This is a continuation of my previous article on crowdfunding rules. In light of its thrust to help raise capital for small and local business startups, and the power of the Securities and Exchange Commission (SEC) under the Securities and Regulation Code, the crowdfunding rules exempt crowdfunding securities from the requirement of registration that is normally imposed on the issuer of securities. By exempting crowdfunding securities from registration, small and local business startups and SME are spared from the potentially tedious and costly process of securities registration. However, there are qualifications to the exemption.
For instance, the issuer must be incorporated in the Philippines or is a Filipino natural person, and accredited and/or accepted by a crowdfunding intermediary (CFI) to utilize its platform. Also, the aggregate amount of securities that can be offered and sold by the issuer on one hand, and bought by an investor on the other hand, must comply with certain limits.
The aggregate amount of securities that can be offered and sold by the issuer within a 12-month period shall be limited to: P10 million when offered and sold to any investor; and more than P10 million but not exceeding P50 million when offered and sold to qualified investors.
The amount of securities that retail investors may purchase through a CFI during the 12-month period is also limited. The aggregate amount of securities sold to any investor across all issuers in securities crowdfunding during the 12-month period shall not exceed: a maximum value of 5 percent of their total income per year for retail investors with annual income of up to P2 million,; and a maximum value of 10 percent of their total income per year, for retail investors with annual income of more than P2 million.
The issuer must likewise not fall under the disqualifications from availing of the exception.
Apart from the exemption of crowdfunding securities from registration, there are three main actors involved in this newly regulated activity of crowdfunding. First is the issuer of the security who is required to register with the CFI, and on whom disclosure requirements are also imposed. The crowdfunding rules also limit to one CFI per issuer’s offering of securities under the crowdfunding rules.
Second is the CFI, which refers to a registered broker, an investment house or funding portal. A CFI mediates offer and sale of crowdfunding securities through its online electronic platform. While “registered brokers” and “investment houses” are familiar terms because they have long been regulated actors, the concept of a “funding portal” is new.
The funding portal is defined as an “intermediary organized and registered as a corporation to facilitate transactions involving the offer or sale of crowdfunding securities through online electronic platform” but “does NOT: offer investment advice or recommendation; solicit purchases, sales or offers to buy securities displayed on its platform; compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its platform; or handle investor funds or securities.
Unlike a registered broker or entity registered as an investment house, which can immediately apply as CFI, a funding portal needs to apply for registration as such apart from the application as a CFI. While a funding portal need not be a Philippine resident, a non-resident funding portal is required to establish that there is an information sharing agreement between the SEC and the competent regulator that has jurisdiction (place of incorporation or principal place of business) over the said funding portal and subject to reciprocity.
An entity applying as a CFI is required to satisfy the criteria under the crowdfunding rules, including the ability of the applicant’s Board to “ensure the [CFI] complies with all the requirements under the SRC and its Rules.” Numerous “ongoing obligations” are expected from the CFI, including the “review, due diligence exercise and/or risk assessment activities carried out on prospective issuers” and the disclosure of relevant information relating to its crowd-funding activities on its platform.
The CFI is also required to provide information under the crowdfunding rules through electronic means, including delivery of educational materials to investors establishing an account with it; and, disclosure of the manner by which it is compensated. It also required to establish communication channels on its platform where investors/potential investors can communicate with each other, and with the issuer. As a “mere” platform, the crowdfunding rules allow the CFI to rely on the issuer’s representations in seeking to offer and sell securities through the CFI’s platform unless there is/are reason/s to question the “reliability of those representations.”
Third is the investor, who could either be a retail investor or a Qualified Investor. This actor is required to open an account with the CFI, who in turn should obtain the investor’s consent to electronic delivery of materials, before the CFI may accept an investment commitment from it.
The crowdfunding rules were published in 10 July 2019 and is expected to take effect on 26 July 2019, or 15 days after its publication. To give time for these actors and those involved in crowdfunding to comply with the crowdfunding rules, the SEC gave them three months from effectivity of the rules as transition period. After the lapse of this three-month period, those who have applied in accordance with the crowdfunding rules shall be allowed to continue with their operations until their application is approved.
With the growth of tech incubators and accelerators in the Philippine startup ecosystem, the creation of rules that provide legal framework to protect a new breed of tech-savvy and potential investors, on one hand, and the regulation of new ways of doing old activities appear to be very promising. But whether the crowdfunding rules will have significant positive impact on startups and SME, the same remains to be seen. Continuous collaboration between and among the regulators, the crowdfunding actors, especially the CFI and their legal team, and the investing public is therefore key to make the crowdfunding rules’ objective a reality.
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