The Jumpstart Our Business Startups Act (the “JOBS Act”) was signed into law on April 12, 2012, by President Obama. The JOBS Act is intended to encourage the creation of more startup companies, historically a significant driver of job growth in the U.S., by easing various securities regulations around fundraising from small investors. The JOBS Act creates an exemption which permits U.S. issuers to sell up to $1 million of their securities each year without requiring registration under the Securities Act of 1933.
The “model” for the JOBS Act is online platforms like Kickstarter and Indiegogo, which have been raising money in small amounts for years to promote artistic ventures, fund video game startups and other small business ventures. Putting aside legitimate concerns about the potential for fraud and abuse of the crowdfunding rules, it is worth asking whether it makes sense for individual entities engaged in promoting the sales of insurance-linked securities, such as life settlements, to attempt to use these new rules to raise funds.
As an initial matter, there are significant restrictions imposed on issuers who desire to raise funds under these new rules, including but not limited to: a) caps on the amount an investor can invest in all crowdfundings over a 12-month period tied to the investor’s income and net worth; b) a requirement that crowdfunding be done through a registered broker-dealer or a registered “funding portal”; c) required disclosure documents to be filed with the SEC at least 21 days prior to first sale, and scaled financial disclosure is required, including audited financial statements for raises of over $500,000; and d) reports must be filed thereafter with the SEC at least annually.
As a practical matter, crowdfunding is unlikely to be attractive to anyone attempting to structure a fund for the purposes of purchasing insurance-linked securities. Due to the costs associated with the purchase of life insurance policies in the secondary market, $1 million per year is unlikely to be sufficient to purchase more than one or two life insurance policies, and that assumes the costs of structuring the investment program do not consume more than a quarter of the funds raised. As a result, crowdfunding is unlikely to be a useful or viable option.
However, at least in theory, crowdfunding may be more useful to entities that engage in the fractionalization of life insurance policies. In these investment structures, one or more life insurance policies are purchased, and small interests in the death benefits in those policies are sold to multiple small investors. While it is possible to conceive of a properly structured program for the sale of fractionalized interests in life insurance policies, there are many who argue that the chances of the investment being successful are as likely as winning the lottery. Because individual mortality is extremely difficult to predict (by contrast, life insurance companies base their underwriting on pools of tens of thousands of lives), purchasing interests in individual policies entails significant risks. Coupling the risks inherent in these investments with the restrictions and requirements of crowdfunding is a potentially volatile combination that could result in investors being severely disappointed in the results and potential liability for the promoters of these programs.
The SEC only recently released its 568 pages of proposed crowdfunding regulations. Even when the comments period expires and the rules become final, anyone considering the use of the new crowdfunding rules to raise funds to purchase insurance-linked securities should first consult an expert to guide them through the process.