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In December 2015, the Federal Government tabled a bill which proposed a legislative regime to regulate crowd-sourced equity funding in Australia. This bill lapsed upon the dissolution of the Senate in May 2016.
Crowd-sourced equity funding (CSEF) is a form of corporate finance that allows businesses to obtain capital from a variety of investors who contribute money in return for equity in the business.
CSEF is championed as a way to encourage broad-based small scale retail investment in innovative and new business ideas. In Australia and other jurisdictions that as a policy objective want to encourage start-ups and innovation, the current securities and financial laws can operate as a barrier to wide-scale CSEF. As such, in Australia and other jurisdictions, Governments have implemented, or are considering implementing, changes to their legal and regulatory regimes to facilitate CSEF while maintaining appropriate retail investor protections.
The CSEF legislative regime proposed by the Coalition Government in December 2015 was based on recommendations made by the Corporations and Markets Advisory Committee (which has since been abolished) in a report in 2014. It aimed to reduce the securities and financial regulatory barriers to invest in small and start-up businesses. The regime was criticised as it imposed, by comparison to some other countries that have adopted CSEF regimes, restrictive rules on the type of company that could raise funds, the amount that could be raised and the amount investors could contribute.
The proposed legislation was not passed by both houses of parliament and lapsed upon the dissolution of the Senate on 9 May 2016.
The proposed CSEF legislative regime was tabled in the Corporations Amendment (Crowd-sourced Funding) Bill 2015 (Cth) (the Bill). The Bill intended to introduce a CSEF regime with the following key features:
The US, New Zealand and the UK have been the pioneers in the area of CSEF. Each jurisdiction has taken a slightly different approach to each other and Australia. Singapore has also recently signalled a quite radical and different approach. The recent developments for each jurisdiction are outlined below.
United States of America
The USA legislated a CSEF model in 2016 through the Jumpstart Our Business Startups Act 2016 (USA) (JOBS Act). The new provisions allow early-stage businesses to offer and sell securities to retail investors through CSEF portals. The regulations mainly relate to regulating these portals. The Financial Industry Regulatory Authority (FINRA) oversees the registration of CSEF portals and ensures that they comply with securities laws and FINRA rules.
The JOBS Act imposed the following limitations on an investor:
United Kingdom
The United Kingdom’s Financial Conduct Authority (FCA) introduced CSEF rules in April 2014, supplementing existing regulations which covered CSEF as a 'regulated activity'. These rules will be reviewed in 2016.
Under the UK CSEF rules, crowd-funding platforms are required to be authorised by the FCA, a process which can take around six months. As at 2015, 14 were crowd-funding platforms authorised in the UK.
Rather than implementing new legislation, as in the US, to effect the 2014 changes the FCA amended its rules for businesses, which are contained in the Conduct of Business Sourcebook section in the ‘FCA Handbook of rules and guidance’.
Those rules provide that a platform offering CSEF investments must consider the investment to be appropriate for its client(s), based on factors including the investor's knowledge of and involvement in, investments, their investing experience and their education or professional background. The appropriateness test can be managed by the platforms as part of their registration or sign-up process on websites offering CSEF products.
In practice, this means that a platform offering equities to an investor must consider the product suitable for an investor based on their answers to scripted questions and/or other facts or circumstances, and must reasonably believe the investors understand the platform's advice, unless a specific exemption applies. Key exemptions include:
While the above requirements appear restrictive, in reality it is likely that an investor will satisfy one of the above – most commonly as a restricted investor – with certification at the point of investment. Companies raising less than £5m are also exempt from the requirement to produce a prospectus.
New Zealand
New Zealand was an early adopter of CSEF with regulation in place for almost 2 years. New Zealand’s system is relatively similar to the USA’s regulatory regime for CSEF portals. Unlike Australia, New Zealand allows private companies to legally advertise its share offerings not only to wholesale investors but also retail investors. CSEF portal providers have a licence from the Financial Markets Authority (FMA). The FMA checks the provider and the provider must follow rules around helping investors obtain information before investing. These providers have ongoing obligations to continue to comply with the standards they met when first licensed. Start-ups can raise through CSEF up to $2 million in any 12 month period.
Singapore
The Singaporean Government have recently announced a 'regulatory sandbox' for Fintech companies. It appears that what is proposed is that entrepreneurs can start and run fintech companies in an unregulated environment until the companies reach a certain size and scale. It is anticipated that more detailed information will be provided by the Singaporean Government but this is a significant potential development for CSEF and the regulation of business.
The approach to CSEF taken in the USA, UK, NZ and Singapore highlight opportunities and choices available to Australia in formulating its CSEF rules.
Key amongst these opportunities and choices are:
If the new Federal Government pursues a policy objective of seeking to encourage participation and investment in start-up and innovative business, it will have the opportunity to consider what regulatory framework best supports this objective while maintaining appropriate investor protections. While CSEF is a relatively new area of corporate finance, the approaches to CSEF taken in overseas jurisdictions should provide valuable guidance and lessons in formulating Australia’s CSEF regime.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2024
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