Navigating the New Crowdfunding Frontier: Rule 3a-9 and Regulation Crowdfunding SPVs

Part 3 of a 5 Part Series

In our previous installments in this blogpost series, we discussed how Regulation Crowdfunding in its first iteration gave rise to several issues for both companies and investors. The crowded cap table problem presented administrative struggles and was focused on by the venture community as the focal, unsurmountable objection to the Regulation Crowdfunding exempt offering framework. These companies, until 2021, couldn’t pool investors into a special purpose vehicle, because Section 4A(f)(3) of the Securities Act of 1933, as amended (the “Securities Act”), expressly prohibited an investment company from utilizing the Reg CF exemption. Rule 3a-9 of the Investment Company Act of 1940, as amended (the “ICA”), was designed to address the challenges posed by Section 4A(f)(3) of the Securities Act. In this third installment in our blogpost series, we clarify the requirements of Rule 3a-9 and explore how it works to strike a balance between the startups’ needs and investor protections.

Under 17 CFR § 270.3a-9 (Rule 3a-9):

• “[A] crowdfunding vehicle will be deemed not to be an investment company if the vehicle:
• (1) Is organized and operated for the sole purpose of directly acquiring, holding, and disposing of securities issued by a single crowdfunding issuer and raising capital in one or more offerings made in compliance with §§ 227.100 through 227.504 (Regulation Crowdfunding);
• (2) Does not borrow money and uses the proceeds from the sale of its securities solely to purchase a single class of securities of a single crowdfunding issuer;
• (3) Issues only one class of securities in one or more offerings under Regulation Crowdfunding in which the crowdfunding vehicle and the crowdfunding issuer are deemed to be co-issuers under the Securities Act (15 U.S.C. 77a et seq.);
• (4) Receives a written undertaking from the crowdfunding issuer to fund or reimburse the expenses associated with its formation, operation, or winding up, receives no other compensation, and any compensation paid to any person operating the vehicle is paid solely by the crowdfunding issuer;
• (5) Maintains the same fiscal year-end as the crowdfunding issuer;
• (6) Maintains a one-to-one relationship between the number, denomination, type and rights of crowdfunding issuer securities it owns and the number, denomination, type and rights of its securities outstanding;(7) Seeks instructions from the holders of its securities with regard to:
  • (i) The voting of the crowdfunding issuer securities it holds and votes the crowdfunding issuer securities only in accordance with such instructions; and
  • (ii) Participating in tender or exchange offers or similar transactions conducted by the crowdfunding issuer and participates in such transactions only in accordance with such instructions;
• (8) Receives, from the crowdfunding issuer, all disclosures and other information required under Regulation Crowdfunding and the crowdfunding vehicle promptly provides such disclosures and other information to the investors and potential investors in the crowdfunding vehicle’s securities and to the relevant intermediary; and
• (9) Provides to each investor the right to direct the crowdfunding vehicle to assert the rights under State and Federal law that the investor would have if he or she had invested directly in the crowdfunding issuer and provides to each investor any information that it receives from the crowdfunding issuer as a shareholder of record of the crowdfunding issuer.”

For the purposes of Rule 3a-9, a “crowdfunding issuer” is a company raising capital under Regulation Crowdfunding as a co-issuer with a crowdfunding vehicle. A crowdfunding vehicle is an issuer formed by or on behalf of a crowdfunding issuer to conduct a Reg. CF offering (which is controlled by the crowdfunding issuer) as a co-issuer with the crowdfunding issuer. In this context, the “crowdfunding vehicle” is the SPV. The crowdfunding vehicle raises capital on behalf of the crowdfunding issuer in a crowdfunding campaign and then the crowdfunding issuer sells the securities it sought to sell to the crowd to the crowdfunding vehicle. The crowdfunding vehicle pays for its acquisition of the crowdfunding issuer’s securities with the capital it raised in the crowdfunding campaign. The result is that the crowdfunding vehicle is owned by the crowd investors and the crowdfunding vehicle owns the securities it acquired from the crowdfunding issuer, thereby making crowd investors indirect owners of the securities of the crowdfunding issuer.

The language of Rule 3a-9 aims to ensure that the crowdfunding issuer and the crowdfunding vehicle are organized according to a “conduit” structure, whereby the crowdfunding vehicle serves as a direct pipeline for investors to fund the crowdfunding issuer while enjoying the same treatment and exposure as if they had invested directly. Therefore, Rule 3a-9 imposes nine requirements, which are, in accordance with their respective subsections of the Rule, as follows:

1. Sole Purpose: The sole purpose of the crowdfunding vehicle must be dealing in the securities of the crowdfunding issuer for its offering(s).
2. Proceeds: The crowdfunding vehicle can use only the proceeds from selling its securities to purchase securities of the crowdfunding issuer.
3. Class Singularity: The crowdfunding vehicle may issue only one class of securities in one or more offerings under Regulation Crowdfunding in which it serves as the co-issuer.
4. Financial Responsibility: The crowdfunding issuer, and only the crowdfunding issuer, must cover all expenses of the crowdfunding vehicle, including operating expenses such as transfer agent expenses, and the crowdfunding vehicle’s tax and reporting obligations.
5. Fiscal Mirroring: The crowdfunding vehicle must mirror the fiscal year of the crowdfunding issuer.
6. One-to-One Relationship: There must be a one-to-one relationship between the securities of the crowdfunding issuer and the crowdfunding vehicle such that each entity’s securities share the same number, denomination, type, and rights. This requirement tends to introduce a variety of complexities depending on the type of security sought to be sold by the crowdfunding issuer, such as when the crowdfunding issuer seeks to offer convertible securities. In such circumstances, care should be taken by counsel to ensure the crowdfunding issuer’s securities and the crowdfunding vehicle’s securities are as closely mirrored to each other as possible.
7. Seeks Investor Instructions: The crowdfunding vehicle is required to seek instructions from investors in voting the securities of the crowdfunding issuer and participating in crowdfunding issuer transactions.
8. Disclosure and Information Flow: The crowdfunding vehicle must receive from the crowdfunding issuer, and provide to its investors, all appropriate Reg. CF disclosures.
9. Investor Direction: Investors must be able to direct the crowdfunding vehicle to assert their rights under state and federal law.

In our latest blogpost, we’ve explored the nuances of Rule 3a-9, a critical tool for crowdfunding issuers. This Rule allows for the use of special purpose vehicles to navigate around the constraints of Section 4A(f)(3) of the Securities Act. By meeting nine specific requirements, companies can harness SPVs to streamline their fundraising efforts while upholding investor protections.

Looking ahead to our next installment, we’ll dive into a discussion on Section 12(g) of the Securities Exchange Act. We’ll focus on the conditional exemption it offers for crowdfunding issuers from the holder of record threshold. This exemption serves as a crucial mechanism SPVs to mitigate the risk of inadvertently triggering registration obligations.

Together with this blogpost, our upcoming fourth installment will underscore the significance of understanding both Section 12(g) and Rule 3a-9 of the ICA for crowdfunding issuers utilizing SPVs in their offerings. Stay tuned as we continue to unravel the complexities of crowdfunding regulations and their impacts on both fundraising companies and investors.