BY Lauren Leibowitz, Principal at 1st BridgeHouse Securities, LLC, Crowdfund Beat Sr. contributing editor,
The Evolving Crowdfunding Regulations: Now Presenting “The Fix Crowdfunding Act”
On April 5, 2012 the JOBS Act was passed. On October 30, 2015 Title III: Equity Crowdfunding final rules were passed which marked all 7 Titles of the JOBS Act were approved. Recently, the ‘‘Fix Crowdfunding Act’’ was introduced to Congress to improve Regulation Crowdfunding. FINRA and SEC has taken an approach of letting the crowdfunding industry cultivate the business model and the regulators will oversee and implement regulations on an as needed basis. The integration of technology within the private capital markets is monumental since in the 21st century the internet is incorporated in every aspect of your daily life and business.
9 Funding Portals have been FINRA approved as of May 16. A handful of previously interested business and FINRA member Broker Dealers announced they would not join the crowdfunding marketplace because the current crowdfunding regulations are not conducive to operate in but hope that the ‘Fix Crowdfundung Act’ will be passed in order for them to reconsider joining the crowdfunding marketplace. Jeff Lynn, CEO and co-founder of Seedrs-a leading UK based investment crowdfunding platform, intended to expand its operations across the pond but believes the current crowdfunding regulations to be “not workable in its current form”, especially burdensome compared to FCA’s crowdfunding regulations that has made the United Kingdom a workable model of successful crowdfunding. His full statement is below:
“Title III of the JOBS Act, which comes into force today, should have been one of the most important pieces of legislation to impact US fintech in recent years. But although Title III nominally makes it possible for non-accredited (regular) investors to invest in startup businesses and private firms in the US, the legislation’s considerable limitations and poor drafting means we believe it is simply not workable in its current form. Among other things, Title III:
- Makes it likely that only lower-quality investment opportunities will use equity crowdfunding in the U.S. Title III places such significant burdens on companies seeking to raise capital—making crowdfunding far more expensive, time-consuming and difficult than raising money through other channels (such as institutional or private angel investors)—that businesses will only to turn to crowdfunding as a last resort after more efficient capital-raising methods have failed. The result will be that ordinary retail investors will have access only to those businesses that cannot raise capital elsewhere, which is an adverse selection phenomenon that has not occurred in Europe.
- Gives insufficient protection given to investors. While Title III and the related regulations place significant focus on limiting the losses that may be experienced by investors, loss of capital is not the only risk in this asset class. Also important is that investors be protected in the case of a business’s success: a successful business can see its valuation increase 100-fold or more, but if the investment has not been properly structured or monitored, investors may receive nothing. Where restrictions interfere with crowdfunding platforms’ ability to provide those protections—which is precisely what Title III does—investors will be significantly worse off in the long run.
- Reduces the likelihood of businesses succeeding raising capital. One of the key lessons from the growth of equity crowdfunding in Europe is that raising capital in this way is a dynamic process that requires the business to build momentum behind its campaign. Successful crowdfunding campaigns tend to require active outreach, ongoing and multi-modal engagement with prospective investors, and the participation of one or more “anchor” angel or institutional investors, all before the crowd investors start to commit capital in a meaningful way. Title III’s significant marketing restrictions mean that companies will be very limited in their ability to create momentum, which in turn will make it exceptionally difficult for their campaigns to succeed.
“What is particularly unfortunate in all this is that Europe, and the UK in particular, has shown how a regulatory system can facilitate a thriving equity crowdfunding environment, allowing the best companies to raise funds successfully and giving investors the protections they need. US lawmakers would have been well advised to look much more closely at the UK system when developing Title III.
“However, I am hopeful about the future of Title III, and under revised legislation (a version of which is already being considered by Congress), I would love for Seedrs to use it to facilitate investments in the US.
“In the interim, Seedrs will launch stateside under Title II of the JOBS Act, which is limited to accredited investors, and which will offer a specific demographic of investor access to many of the European businesses seeking capital on our platform. Whilst it means that entrepreneurs will only have access to a portion of the American crowd, the opportunity for those investors who are accredited is really exciting. We believe Europe has the fastest-growing ecosystem of early-stage businesses in the world, and the combination of reasonable valuations and fast growth that many companies see on this side of the pond should make them highly appealing investment opportunities for accredited American investors.”
WHAT IS PROPOSED IN THE “FIX CROWDFUNDING ACT”?
QUALIFICATION FOR CROWDFUNDING EXEMPTION
- Increase the Issuer offering limit to $5,000,000 from $1,000,000.
- Take the “Greater of Approach” rather than the “Lesser of Approach” regarding the Crowd’s annual investing limitations.
An investor will be limited to investing: (1) the greater of: $2,000 or 5 percent of the lesser GREATER of the investor’s annual income or net worth if either annual income or net worth is less than $100,000; or (2) 10 percent of the lesser GREATER of the investor’s annual income or net worth, not to exceed an amount sold of $100,000, if both annual income and net worth are $100,000 or more.
CLARIFICATION OF CERTAIN FUNDING PORTAL REQUIREMENTS AND EXCLUSIONS FOR REGULATION CROWDFUNDING.
EXCLUSION OF ISSUERS FROM FUNDING PORTALS
- CLARIFICATION OF CERTAIN EXCLUSION REQUIREMENTS FOR FUNDING PORTALS—Section 302 of the Jumpstart Our Business Startups Act
ADD (e) to “Under the rules issued pursuant to subsection (d), a funding portal shall have a reasonable basis for disqualifying an issuer from offering securities through such funding portal pursuant to section 4(a)(6) of the Securities Act of 1933 if the funding portal, through a background check of the issuer or other means, has found that such issuer, in connection with the offer, purchase, or sale of securities, has knowingly—
‘‘(1) made any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or
‘‘(2) engaged in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.’’.
- CLARIFICATION OF OTHER OBLIGATIONS TO REDUCE THE RISK OF FRAUD.
Securities Act Section 4A(a)(5) requires an intermediary to “take such measures to reduce the risk of fraud with respect to [transactions made in reliance on Section 4(a)(6)], as established by the Commission, by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person.”
Amend language to read as follows:
“(5) as a minimum to reduce the risk of fraud with respect to such transactions obtain a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person;’’.
- CLARIFICATION OF LIABILITY OF FUNDING PORTALS FOR MATERIAL MISSTATEMENTS AND OMISSIONS
Securities Act Section 4A(c) provides that an issuer will be liable to a purchaser of its securities in a transaction exempted by Section 4(a)(6) if the issuer, in the offer or sale of the securities, makes an untrue statement of a material fact or omits to state a material fact required to be stated or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading, provided that the purchaser did not know of the untruth or omission, and the issuer does not sustain the burden of proof that such issuer did not know, and in the exercise of reasonable care could not have known, of the untruth or omission. Section 4A(c)(3) defines, for purposes of the liability provisions of Section 4A, an issuer as including “any person who offers or sells the security in such offering.”
In describing the statutory liability provision in the Proposing Release, the Commission noted that it appears likely that intermediarieswould be considered issuers for purposes of the provision. Several commenters agreed that Section 4A(c) liability should apply to intermediaries noting that it “may serve as a meaningful backstop against fraud” and would create a “true financial incentive” for intermediaries to conduct checks on issuers and their key personnel.
However, a large number of other commenters disagreed that Section 4A(c) liability should apply to intermediaries. Some of these commenters stated their views that applying statutory liability to intermediaries would have a chilling effect on intermediaries’ willingness to facilitate crowdfunding offerings. Others cited the cost of being subject to this liability as overly burdensome on funding portals, to the extent that they may not be able to conduct business. Several commenters also explained that the nature of funding portals, as intended by Congress, is distinct from that of registered broker-dealers. According to these commenters, a funding portal’s role is not to offer and sell securities, but rather to provide a platform through which issuers may offer and sell securities. As such, these commenters asserted that it would not be appropriate to hold them liable for statements made by issuers.
Section 4A(c) of such Act (15 U.S.C. 77d–1(c)) is amended by adding the end the following:
‘‘(4) LIABILITY OF FUNDING PORTALS.—For purposes of this subsection, an intermediary shall not be considered an issuer unless, in connection with the offer or sale of a security, it knowingly— ‘‘(A) made any untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or ‘‘(B) engaged in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.’’.
EXEMPTION FROM REGISTRATION
- Amend Section 12(g)(6) of the Securities Exchange Act
Reader note- (The words in bold are new text)
(6 )Exclusion for persons holding certain securities.— The Commission shall, by rule, exempt, conditionally or unconditionally, securitiesSecurities acquired pursuant to an offering made under section 4(6) of the Securities Act of 1933 [15 U.S.C. 77d(a)(6)] shall be exempt from the provisions of this subsection.
ALLOWING SINGLE-PURPOSE FUNDS.
- Amendment to Section 4A(f) of the Securities Act of 1933:
(f) APPLICABILITY.—Section 4(6)  shall not apply to transactions involving the offer or sale of securities by any issuer that—
(1) is not organized under and subject to the laws of a State or territory of the United States or the District of Columbia;
(2) is subject to the requirement to file reports pursuant to section 13 or section 15(d) of the Securities Exchange Act of 1934;
(3 2 ) is an investment company, as defined in section 3 of the Investment Company Act of 1940, or is excluded from the definition of investment company by section 3(b) or paragraphs (1) to (14) of section 3(c) of that Act; or
(4) the Commission, by rule or regulation, determines appropriate.
- AMENDMENT TO THE INVESTMENT COMPANY ACT OF 1940 :
Add to Definition of Investment Company (Investment Company Act of 1940 Section 3(c))
(c) Notwithstanding subsection (a), none of the following persons is an investment company within the meaning of this title:
ADD ‘‘(15) any issuer that holds, for the purpose of making an offering pursuant to section 4(a)(6) of the Securities Act of 1933 and the rules issued pursuant to such section, the securities of not more than one issuer eligible to offer securities pursuant to such section and such rules.’’.
- APPLICATION OF RULES.—Single-purpose funds that are excluded from the definition of investment company under paragraph (15) of section 3(c) of the Investment Company Act (15 U.S.C. 80a– 3(c))— (A) shall be allowed to sell and offer for sale securities under section 4(a)(6) of the Securities Act of 1933 (15 U.S.C. 77d(a)(6)) under the rules adopted on October 30, 2015, pursuant to title III of the JOBS Act (Public Law 112–106); and (B) shall be considered venture capital funds for purposes of section 275.203(l)–1 of title 17, Code of Federal Regulations.
SOLICITATION OF INTEREST
Section 4A of the Securities Act of 1933
- Add “(f) SOLICITATION OF INTEREST.—
(1) IN GENERAL.—At any time prior to the filing of information with the Commission and the commencement of an offering made in reliance on section 4(a)(6), an issuer may solicit non-binding indications of interest from potential investors in a prospective offering using the same means and pursuant to the same regulations (other than the filing of information with the Commission) as if conducting an offering pursuant to such section if—
(A) no investor funds are accepted by such issuer; and
(B) any material change in the information provided to potential investors during the actual offering pursuant to such section from the information provided to potential investors during such solicitation of interest are highlighted to potential investors in the information filed with the Commission.
(2) STATUS.—Such solicitation of interest shall not be considered an offer or sale of securities under this Act or the Securities Exchange Act of 1934, regardless of whether or not the issuer actually conducts an offering pursuant to such section 4(a)(6).
Consistent with the effective date of the final rules on regulation crowdfunding adopted by the Securities and Exchange Commission on October 30, 2015, pursuant to title III of the JOBS Act (Public Law 112–106), funding portals established under such Act shall make a good faith effort to comply with all such rules. Notwithstanding such effective date, no enforcement action may be brought against a funding portal before May 16, 2021.
Regulation Crowdfunding is in its infancy stages. The crowdfunding industry, the SEC and FINRA will hopefully be able to work together to cultivate the crowdfunding marketplace to empower entrepreneurs while protecting the crowd. Crowdfunding today will continue to evolve as different funding models and Issuers use regulation Crowdfunding.