Frequently Asked Questions About the Texas Intrastate Crowdfunding Rules
1. Can an officer, director, or control person of an issuer be a non-Texas resident?
Yes. Although the issuer itself must be a Texas entity, residency is not required for the officers, directors, or control persons of the issuer. However, at least 80% of the issuer's gross revenues must be derived from the operation of a business in Texas, at least 80% of the issuer's assets must be located in Texas, at least 80% of the net proceeds of the offering must be used in connection with the operation of a business within Texas, and the issuer must have its principal office in Texas. See Rule 139.25(b)(1). If all or many of the issuer's principals are not located in Texas, it may be difficult for issuer to meet these additional requirements.
2. Can an officer, director, or control person of a Texas crowdfunding portal (TCP) be a non-Texas resident?
Yes. The TCP must be an entity incorporated or organized under the laws of Texas, but there is no residency requirement imposed upon its principals. See Rule 115.19(a)(1).
3. Can a control person of an issuer or TCP be an entity?
Yes. Section 4.B of the Texas Securities Act (TSA) defines the term "person" to include not only natural persons but entities such as a corporation, partnership, limited partnership, association, company, firm, syndicate, or trust, among others.
4. May an issuer offer and sell its securities on multiple TCPs simultaneously if the $1 million cap in Rule 139.25(d) is observed?
No. One of the characteristics of crowdfunding is fostering communications between the issuer, prospective purchasers, and investors to tap into the "wisdom of the crowd." Accordingly, Rule 139.25(g) requires all communications between the issuer, prospective purchasers, and investors to occur thorough the communications channel on the general dealer's or TCP's website. These communications must be visible to all of those with access to the offering materials on the website. If multiple websites or multiple TCPs are used for the offering, all of the communications will not be visible to all of the prospective purchasers and investors so would not meet the requirements of the rule.
5. What potential liability exists for a TCP that lists an offering that is fraudulent or deceptive?
Potentially, a TCP that assists or participates in a fraudulent or deceptive offers and sales of securities is subject to administrative action pursuant to Section 14 of the TSA, civil liability pursuant to Section 33 of the TSA, and/or criminal liability pursuant to Section 29 of the TSA.
Rule 115.19(d) requires a TCP to conduct a reasonable investigation into the background and regulatory history of an issuer whose securities will be offered on its website and all of that issuer's control persons. These checks are conducted to help assure both investor protection and the health of the crowdfunding industry by aiding in fraud deterrence and detection.
A TCP must deny an issuer access to its Internet website if it has a reasonable basis for believing that:
- The issuer or any of its control persons is subject to a disqualification listed in Rule 139.25(m). These disqualifications include certain actions by the SEC or state securities administrators, criminal convictions, certain court orders, and related party transactions.
- The issuer has engaged in, is engaging in, or the offering involves any act, practice, or course of business that will, directly or indirectly, operate as a fraud or deceit upon any person.
- The TCP cannot adequately or effectively assess the risk of fraud by the issuer or its potential offering.
These checks must be performed prior to any offering appearing on the TCP's website and the TCP is given the flexibility to conduct these checks itself or to contract them out to a third party provider. Specific procedures for conducting checks are not prescribed by rule. This approach allows a TCP to use its experience and judgment, as well as its concern for reputational integrity, to design systems and processes to help reduce the risk of fraud in securities based crowdfunding.
Although Section 33.N of the TSA contains a provision that may limit liability for certain persons involved in certain small business offerings. The limitation does not apply if a trier of fact finds the person engaged in intentional wrongdoing in providing the services.
6. May a TCP pay commissions to its unregistered agents or allow its unregistered agents to share commissions with its registered agents?
No. A commission or other remuneration cannot be paid or given, directly or indirectly, for the offer or sale of the securities unless the person receiving such compensation is registered in Texas as a dealer or agent or as a TCP. See Rule 139.25(l). A TCP cannot compensate employees, agents, or other persons not registered in Texas for soliciting offers or sales of securities displayed or referenced on its website. See Rule 115.19(c). A TCP registers its designated officer and its agents using Form U 4. See Rule 115.19(f).
A dealer, including a TCP, who is selling or has sold securities in Texas through an agent other than a registered agent is subject to administrative action under Section 14.A(5) of the TSA. No agent may sell or offer any securities in Texas on behalf of a dealer unless registered as an agent for that particular registered dealer. See Section 12.A of the TSA.
A person who offers or sells a security without registration is civilly liable to the person buying the security from him. See Section 33.A(1) of the TSA. Selling, offering for sale, soliciting subscription or orders for, inviting offers for, or dealing in any other manner in any security without being a registered dealer or agent can be prosecuted criminally as a third degree felony. See Section 29.A of the TSA.
7. Are there limits on the type and amount of the fees paid by an issuer to a TCP or a third-party service provider?
The Texas crowdfunding rules do not set limits on fees, except to prohibit certain types of compensation arrangements. These prohibitions include:
- A TCP or general dealer cannot be affiliated with or under common control with an issuer whose securities appear on the TCP's Internet website. See Rule 115.19(c)(4) and Rule 139.25(l).
- A TCP cannot hold a financial interest in any issuer offering securities on the TCP's Internet website. See Rule 115.19(c)(5). Likewise, an issuer may not list its securities on the Internet website of a general dealer or TCP that holds an interest in the issuer. See Rule 139.25(l).
- A TCP cannot receive a financial interest in an issuer as compensation for services provided to or on behalf of an issuer. See Rule 115.19(c)(6). Similarly, an issuer may not compensate a general dealer or a TCP by providing a financial interest in the issuer as compensation for services provided to or on behalf of the issuer. See Rule 139.25(l).
- A commission or other remuneration cannot be paid or given, directly or indirectly, for the offer or sale of the securities unless the person receiving such compensation is registered in Texas as a dealer or agent or as a TCP. See Rule 139.25(l) and Rule 115.19(c).
If proceeds from the issuer's offering are used to pay the TCP, dealer, or third-party service providers, the issuer's disclosure statement filed with the Agency and posted on the Internet website of the TCP or dealer should set out those arrangements to prospective investors. Material information in the disclosure statement includes how the proceeds of the offering will be used. See Rule 139.25(l)(1).
A dealer, including a TCP, who engages in an inequitable practice in the sale of securities is subject to administrative action under Section 14.A(3) of the TSA. Charging an excessive or unconscionable fee could constitute an inequitable practice.
8. We operate a website to offer SEC Regulation D, Rule 506(c) securities to accredited investors in multiple jurisdictions. Can we offer Rule 139.25 securities on the same website or do we need a different website for the Rule 139.25 offerings?
Rule 115.19(a)(2) requires that a Texas crowdfunding portal limit its activities to operating an Internet website utilized to offer and sell securities exempt from registration pursuant to Rule 139.25. Similarly, a website that offers securities in multiple states could not offer Rule 139.25 securities since Rule 139.25(h)(1)(A) requires the Internet website offering the Rule 139.25 securities to contain a disclaimer that reflects that access to securities offerings on the website is limited to Texas residents and offers and sales of the securities appearing on the website are limited to persons that are Texas residents. This means that a registered Texas crowdfunding portal could list no other types of securities offerings (including those under SEC Rule 506(c)) on its website.
If an applicant/registrant is operating a website for offering securities outside of Texas (e.g., in another state or states), and then sets up another website to offer securities within Texas, the applicant/registrant would be engaged in interstate (rather than intrastate) commerce and would need to register as a dealer with the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) (since it would no longer fall within the federal intrastate exemption from broker/dealer registration), and may need to register as a dealer in the states in which it is offering securities. Since the applicant/registrant would not be engaged exclusively in intrastate offers and sales of securities in Texas as required by Rule 115.19(a)(1), it would not be eligible for registration as a Texas crowdfunding portal. Such an applicant/registrant must take examinations, qualify as a general dealer, and be subject to the more comprehensive general dealer requirements in Chapter 115 to offer Rule 139.25 securities on its website.
A party offering 506(c) securities on its website is likely relying on the Section 4(b) exemption in the federal Securities Act of 1933, applicable to platforms offering 506(c) securities. Section 4(b) does not permit a platform to offer and sell securities other than 506(c) securities. (See Question 3 of the FAQs on the SEC website.) If an applicant is offering and selling both 506(c) and Rule 139.25 securities, it could no longer claim the Section 4(b) exemption from SEC and FINRA registration at the federal level since it is engaging in activities beyond the scope of the Section 4(b) exemption.
It could be possible for an entity to create multiple subsidiaries. In such a case, each subsidiary would be the applicant/registrant so only the individual subsidiary's activities would be considered when determining if registration on the state and/or federal level is required.
- Subsidiary #1 could limit its activities as required by Rule 115.19 and register as a Texas crowdfunding portal to offer only Rule 139.25 securities. Since Subsidiary #1 is engaging only in intrastate (within a single state) activity, the federal intrastate exemption from dealer registration should be available.
- Subsidiary #2 could operate within the confines of the intrastate crowdfunding laws and regulations of another state if those activities do not touch Texas, the TSA would not apply to that subsidiary and would not trigger registration here. Subsidiary #2 would need to review the portal/dealer registration requirements in that other state to determine if it must register and in what capacity. Again, since Subsidiary #2 would engage in only intrastate activity, the federal intrastate exemption from dealer registration with the SEC and FINRA should be available.
- Subsidiary #3 could limit it activities to those of a 506(c) platform under Section 4(b) of the federal law to avoid having to register with the SEC and FINRA. However, it would need to look to state laws and regulations to see if state registration is required by the jurisdictions in which it is offering and selling the Rule 506(c) securities.
Affiliated entities that offer 506(c) securities (subsidiary #3) and Rule 139.25 securities (subsidiary #1) would need to, at minimum, use different domain names to avoid investor confusion over the types of offerings on each website and which dealer/entity is responsible for the website. A subdomain within another website would likely not accomplish this purpose. Each domain would need to contain the appropriate notices and disclaimers that apply to the type of offering on that particular website. A registered TCP would also need to maintain a physical office in Texas where all the records of the portal would be available for inspection by Securities Board staff.
9. Is the bank or other depository institution holding the escrow account required to make any filings with the Securities Commissioner regarding the intrastate crowdfunding offering?
No. The Texas intrastate crowdfunding rules do not require the bank or depository institution holding the escrow account to make any filings with the Securities Commissioner.
10. May a non-accredited investor invest up to $5,000 in more than one issuer?
Yes. A non-accredited investor may invest up to $5,000 in multiple securities offerings conducted by different issuers relying upon the Rule 139.25 exemption. However, a non-accredited investor is limited to a lifetime cap of $5,000 investment with any one particular issuer using the Rule 139.25 exemption for the offering(s). See Rule 139.25(e). It should be noted that an existing shareholder may be able to purchase additional securities (exceeding the $5,000 cap) from an issuer in an offering conducted under a different exemption from securities registration or in a registered offering.
11. Can an issuer close an offering prior to the expiration of the 21-day posting requirement?
No. An issuer’s disclosure statement and offering summary must be made available on the TCP or general dealer’s Internet website for 21 days before any securities can be sold in the offering. See Rule 139.25(h)(3). A sale is considered to have occurred if the prospective purchaser enters into a binding agreement to purchase the securities. However, an issuer could, through the website, accept nonbinding solicitations of interest prior to the expiration of the 21-day posting requirement and grant those interested persons priority when the securities can legally be sold.
The 21-day waiting period was designed to foster communications between the issuer and prospective purchasers. See answer 4 for further discussion on this point.
12. What happens if a non-Texas resident is permitted to invest in a Rule 139.25 offering?
Out-of-state sales will cause the issuer to lose the federal exemption for intrastate offers (SEC Rule 147) because it has engaged in interstate commerce. This means that the issuer will be subject to federal action for violating federal securities laws.
Furthermore, as compliance with SEC Rule 147 is a condition to claiming the Rule 139.25 exemption, the issuer will also lose the Texas crowdfunding exemption. The issuer can, however, make a rescission offer per Section 33 of the TSA to limit its civil liability. Such a rescission offer must be made to all investors in the non-exempt offering, not just the out-of-state ones.
13. Can an issuer use its own website or social media presence to offer securities in a manner consistent with Rule 139.25 and SEC Rule 147?
Outside of the communications channel on the general dealer or TCP’s Internet website, Rule 139.25 allows the issuer to distribute a limited notice. Dissemination of the notice must be restricted to Texas. The content of the notice is limited to a statement that the issuer is conducting an offering, the name of the registered general dealer or TCP through which the offering is being conducted, and a link directing potential investors to the dealer or TCP’s Internet website. The notice must contain a disclaimer that the offering is limited to Texas residents and offers and sales of the securities appearing on the Internet website are limited to persons who are Texas residents. See Rule 139.25(g)(2). Some options for the issuer’s distribution of the notice may be unavailable due to the requirement that distribution be limited to Texas if the distribution channel cannot, by its nature, be restricted to Texas.
As for SEC Rule 147, compliance with which is required to claim the Rule 139.25 exemption, the SEC issued the following guidance on October 2, 2014:
Issuers generally use their websites and social media presence to advertise their market presence in a broad and open manner so that information is widely disseminated to any member of the general public. 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.
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.
Given this guidance, we recommend that issuers consult with an attorney to ensure compliance with SEC Rule 147 when using a website or social media in connection with their securities offerings.
14. The Texas Intrastate Crowdfunding Exemption, Rule 139.25(2)(A), precludes an issuer from using the exemption if the issuer is a company “that engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities.” Because the definition of “security” in Section 4.A of the Texas Securities Act is broad and includes a “certificate or any instrument representing any interest in or under an oil, gas or mining lease, fee or title,” entities that hold oil or gas securities have asked for guidance on when the exclusion in Rule 139.25(2)(A) would apply to their business models.
The exclusion would not apply to an entity that devotes substantial efforts to actively acquiring, developing, operating, and maintaining oil or gas properties, even though those properties may also be securities. For example, an entity that engages a petroleum geologist to evaluate a property and make production projections based on the production histories of nearby wells, purchases an oil or gas lease (security), then drills, completes, and maintains a well, or manages others who drill, complete, and maintain a well on the property is engaging in substantial business activities beyond that of investing, owning, holding, or trading in oil or gas securities and could use the Rule 139.25 exemption.
Alternatively, an entity that purchases, holds, and trades oil or gas interests (or other types of securities) with the intent to derive profits from income generated by the securities and/or the appreciation in value of the securities (investment activities), would be disqualified from using Rule 139.25.
15. May an issuer offering debt securities (e.g., notes, bonds, debentures, etc.) pursuant to Rule 139.25 include credit enhancements, such as third-party guarantees by its officers or directors?
Yes. However, material information about the credit enhancements must be included in the issuer’s disclosure document. In the case of third-party guarantees, such information may include financial information about the guarantors or other information pertaining to the ability of the third parties to repay the debt, terms and conditions of repayment by the guarantors, legal remedies available to investors to enforce the guarantee, etc. To avoid a credit enhancement being considered as a security, it cannot be separated from or traded separately from the debt security to which it applies.
Issuers should seek legal advice to ensure that the disclosure document adequately discusses all material information about any credit enhancement provided in connection with the securities offering.
16. If the issuer makes changes to the disclosure statement during the 21-day pre-sale period (required by Rule 139.25(h)(3)), must the issuer wait 21-days from the change before any securities are sold in the offering?
Possibly. If a material change is made to the disclosure statement, the 21-day period would restart on the date of the change to permit the issuer, prospective purchasers, and investors the period required by the rule to discuss and review the offering prior to sales of the securities.
The portal’s Internet website is required to provide a communications channel for the issuer, prospective purchasers, and investors to communicate. All of these communications must occur on the Internet website and the communications must be visible to all persons with access to the securities offering materials on the website. See Rule 139.25(g)(1). One of the integral elements of crowdfunding is to have access to communications with others to tap into the “wisdom of the crowd.” For such communications to operate effectively among all parties, the disclosure document appearing on the website must provide full and fair disclosure of all material information. See the Disclosure Guide. The legal standard for “material” is whether there is a substantial likelihood that the information would be viewed by a reasonable investor as significantly altering the total mix of available information used in deciding whether to invest.
Please note that material changes to the disclosure statement may also require the issuer to supplement its notice filing or make a new notice filing with the Securities Commissioner. The filing consists of Form 133.17, Crowdfunding Exemption Notice, the issuer's disclosure statement, and summary of the issuer's offering that will appear on the Internet website. See Rule 139.25(j). The filing with the Securities Commissioner must reflect the offering that is being offered and sold to investors in Texas.