The SEC’s crowdfunding proposal offers small, startup
businesses a new way to raise capital without triggering the expensive
registration requirements of the Securities Act of 1933. But the capital needs
of small businesses are often uncertain. They may need to raise money again
shortly after an exempted offering. Or they may want to sell securities pursuant
to another exemption at the same time they’re using the crowdfunding exemption.
How do other offerings affect the crowdfunding exemption? The proposed crowdfunding
rules are unexpectedly generous with respect to other offerings, but they still
contain pitfalls.

Other Securities Do Not Count
Against the $1 Million Crowdfunding Limit

The proposed rules make it clear that the crowdfunding
exemption’s $1 million limit is unaffected by securities sold outside the crowdfunding
exemption. As I explained in an earlier post, only securities sold pursuant to
the section 4(a)(6) crowdfunding exemption count against the limit.

Crowdfunding and the Integration Doctrine

But the integration doctrine, the curse of every securities
lawyer, poses problems beyond determining the offering amount.

Briefly, the integration doctrine defines what constitutes a
single offering for purposes of the exemptions from registration. The Securities
Act exemptions are transactional; to avoid registration, the issuer must fit
its entire offering within a single exemption. It cannot separate what is
actually a single offering into two or more parts and fit each part into
different exemptions.

Unfortunately, the application of the integration doctrine
is notoriously uncertain and unpredictable, making it difficult for issuers who
do two offerings of securities at or about the same time to know whether or not
those offerings qualify for an exemption. (For a critical review of the
integration doctrine, see my article here.)

The SEC’s crowdfunding proposal begins with what appears to
be absolute protection from integration. The proposal says (p. 18) that “an
offering made in reliance on Section 4(a)(6) should not be integrated with another
exempt offering made by the issuer, provided that each offering complies with
the requirements of the applicable exemption that is being relied on for the
particular offering.”

However, the SEC giveth and the SEC taketh away. First, this
isn’t really a rule, just a pledge by the SEC. The anti-integration language
does not appear anywhere in the rules themselves; it’s only in the release
discussing the rules. Other integration safe harbors, such as Rule 251(c) of
Regulation A and Rule 502(a) of Regulation D, appear in the rules.
It’s not clear why the SEC was unwilling to write an integration provision into
the crowdfunding rules, but an actual rule would provide much more comfort to
issuers than the SEC’s bare promise.

And, unfortunately, the SEC doesn’t stop with the broad
anti-integration pledge. It adds (pp. 18-19) that

An issuer conducting a concurrent exempt offering for which
general solicitation is not permitted, however, would need to be satisfied that
purchasers in that offering were not solicited by means of the offering made in
reliance on Section 4(a)(6). Similarly, any concurrent exempt offering for
which general solicitation is permitted could not include an advertisement of
the terms of the offering made in reliance on Section 4(a)(6) that would not be
permitted under Section 4(a)(6) and the proposed rules.

These qualifications may prove particularly mischievous.
Assume, for example, that an issuer is offering securities pursuant to section
4(a)(6) and, around the same time, offering securities pursuant to Rule 506(b),
which prohibits general solicitation. The issuer would have to verify that none
of the accredited investors in the Rule 506(b) offering saw the offering on the
crowdfunding platform. Since crowdfunding platforms are open to the general public,
that might be difficult.

As a result of the second sentence quoted above, there’s
also a potential problem in the other direction. Assume that an issuer is
simultaneously offering the same securities pursuant to both section 4(a)(6)
and Rule 506(c). Rule 506(c) allows unlimited general solicitation, but the
crowdfunding rules severely limit what an issuer and others may say about the
offering outside the crowdfunding platform. The SEC seems to be saying that a
public solicitation under Rule 506(c) would bar the issuer from using the
crowdfunding exemption to sell the same securities. Since the same securities
are involved in both offerings, the 506(c) solicitation would arguably “include
an advertisement of the terms of the offering made in reliance on Section
4(a)(6).”

Double-Door Offerings Redux

Before the SEC released the crowdfunding rules, I questioned
whether “double-door” offerings using the crowdfunding exemption and the new
Rule 506(c) exemption were viable. I posited a single web site that sold the
same securities (1) to accredited investors pursuant to Rule 506(c) and (2) to the
general public pursuant to the crowdfunding exemption. I concluded that,
because of the integration doctrine, such offerings were impossible. The SEC
anti-integration promise may change that result, if the SEC really means what
it says.

The anti-integration promise doesn’t exclude simultaneous
offerings, even if those offerings involve the same securities. And I don’t see
anything in the rules governing crowdfunding intermediaries that would prevent
both 506(c) and crowdfunding offerings on a single web platform, with
accredited investors funneled to a separate closing under Rule 506(c).
Funding portals could not host such a double-door platform, because they’re
limited to crowdfunded offerings, but brokers could.

However, both the issuer and the broker would have to be
careful about off-platform communications. Ordinarily, an issuer in a Rule
506(c) offering may engage in any general solicitation or advertising it
wishes, on or off the Internet. But the SEC crowdfunding release, as we saw,
warns that “any concurrent exempt offering for which general solicitation is
permitted could not include an advertisement of the terms of the offering made
in reliance on Section 4(a)(6) that would not be permitted under Section 4(a)(6)
and the proposed rules.” To avoid ruining the crowdfunding exemption, any
off-platform communications would have to be limited to what the crowdfunding
rules allow, and that isn’t much.