For those of you who were too busy to notice, U.S. Congressman Patrick McHenry introduced three draft bills into the House Financial Services Committee last week. One of them, if it were to become law, would open up the U.S. equity crowdfunding world in ways which only a true visionary could imagine. Though its passage into law in the 2014 election year is far from certain, according to fellow Congressman David Schweikert, in an interview with him the day following the introduction of the far reaching draft crowdfunding bill, there is not a better “pilot” to navigate the choppy Congressional waters than Congressman McHenry.
Hitting the Crowdfunding Reset Button
One of the bills, entitled “Startup Capital Modernization Act of 2014”, is primarily directed towards fixing some of the potentially fatal defects and ambiguities embedded in the original JOBS Act bill – largely a result of last minute drafting changes in the 2012 legislative process – and compounded by proposed SEC rules - which together threaten to kill equity crowdfunding before it even gets off the ground.
For those of you who read my earlier article, “SEC’s Proposed Crowdfunding Regulations: Six Deadly Sins,” outlining what I considered to be the major impediments in the JOBS Act rulemaking to a successful crowdfunding regimen, the McHenry bill grants absolution for these past crowdfunding regulatory and legislative sins – and then some. As the U.S. and the rest of the world look impatiently to Washington, D.C. for leadership in the emerging crowdfunding capital markets,. Congressman McHenry has once again stepped up to provide the type of leadership that our small businesses (and would-be small businesses) crave.
Specifically, Congressman McHenry’s proposed Title III redo accomplishes a great deal. Here are some of the highlights:
- Raises crowdfunding limits from $1 million to up to $5 million.
- Allows self –certified financials for raises under $500,000 – and independently reviewed financials statements for raises between $500,000 and $3 million – leaving the more onerous audited financials for raises above $3 million.
- Eliminates the requirement that the SEC promulgate rules requiring detailed, registration statement-like non-financial disclosure resembling a public company report.
- Eliminates the need for ongoing annual reporting in perpetuity.
- Allows non-broker-dealer intermediaries (funding portals) to register only with the SEC, avoiding registration with FINRA and compliance with its rules.
- Allows intermediaries which are not licensed broker-dealers to “curate” crowdfunded transactions, screening out those not deemed suitable for their portal.
- Removes the more onerous liability provisions for intermediaries and issuers.
Though some may debate the wisdom of raising the current $1 million crowdfunding dollar limit before this nascent ecosystem is even open for business, it certainly underscores headline grabbing successes with heftier raises in the rewards based crowdfunding domain – Oculus being the crowdfunding success du jour. (Kudos to the brave and lucky Oculus lawyer who took his fees in Oculus stock!)
Perhaps less apparent, however, is the impact the proposed bill could have on intrastate crowdfunding. If the McHenry JOBS Act 2.0 were to become law, it would dwarf, and in many instances make largely superfluous, the developing intrastate crowdfunding ecosystem. Though states would remain free to create their own crowdfunding ecosystems within their borders, the McHenry bill would generally provide a more attractive alternative – its reach extending well beyond state borders.
A Quiet Assault on Small Business by the SEC – The Seventh Deadly Sin
The proposed McHenry crowdfunding bill, though far reaching, would leave untouched a recent informal pronouncement by the SEC Staff, issued below the radar of Congress and crowdfunding supporters (and perhaps even the SEC Commissioners) -which, from my point of view, is questionable on its merits and goes against the grain of the of the entrepreneurial spirit which crowdfunding exemplifies. Even more troubling, the ruling suggests a “backdoor” approach to SEC rulemaking – at least where the interests of small business are concerned.
Specifically, until April 10, 2014, it would appear by all accounts that a state legislature would be free to fashion a crowdfunding regime within its borders which would allow an issuer to throw up a crowdfunding campaign on its own internet site – without the need to utilize an intermediary – be it a licensed broker-dealer or otherwise.
However, on April 10, 2014, the SEC Staff put a chill on any thoughts a state legislature might have to craft an intrastate crowdfunding structure which would permit an issuer to conduct its own crowdfunding campaign – on its own website.
On April 10, 2014, the Staff of the SEC’s Division of Corporation Finance quietly issued a tersely worded interpretive ruling, which sent a chilling message to the 50 states and their legislatures: in the opinion of the Staff of the SEC Division of Corporation Finance, an issuer would be violating the Securities Act of 1933, which regulates the sale of securities by an issuer of securities, if it conducted an otherwise lawful intrastate crowdfunded offering on its own website, bypassing a licensed intermediary. However, the Staff ruled, the same activity by a licensed broker-dealer would not invalidate an otherwise lawful intrastate sale of securities. This SEC ruling, if valid, would trump any state crowdfunding legislation to the contrary.
It seems that the Staff at the SEC Division of Corporation Finance is not (yet) willing to allow small business crowdfunders to disintermediate a licensed broker-dealer intermediary – a Staff goal undoubtedly shared by organizations such as the North American Securities Administrators Association, Inc. (NASAA), a powerful national lobbying organization of state securities administrators which derives a portion of its financial support from FINRA administered state broker licensing exams. Yes, that’s right – an international lobbying organization inclusive of Canada and Mexico which derives direct financial support from these state exams.
However, what is most perplexing, indeed disturbing, is that this informal ruling by the SEC Staff represents a 180 degree about face from a lengthy, well reasoned interpretive release issued by the SEC in 1998 in a parallel situation involving cross-border international offerings on the internet by U.S. companies – to the effect that any limitations on internet solicitations by an issuer would be less restrictive than those faced under federal law for a licensed broker-dealer. So it seems the Staff quietly took a major step backwards on April 10, 2014, when faced with an analogous situation involving U.S. intrastate crowdfunded offerings.
So while the crowdfunding world is keenly focused on a much delayed 585 page SEC release, and the SEC publicly bemoans a more than five year rulemaking backlog, the Staff at the SEC’s Division of Corporation Finance has found the time to gratuitously issue a ruling which interferes with a state’s ability to fashion its own crowdfunding regime. And perhaps even more perplexing – no one outside the SEC had even asked for this ruling – at least not through formal, transparent channels.
So what prompted this Staff ruling – and what can and should be done to avoid further informal, intrusions which threaten to hijack state legislative measures such as intrastate crowdfunding, at the expense of small business, by circumventing more transparent rulemaking processes?
This is precisely the question I intend to ask Commissioner Daniel Gallagher in a meeting I have formally requested with him – to discuss the procedures which led up to this ruling under the noses of five SEC Commissioners– and what can and should be done to prevent future missteps. I have my theory as to what prompted this ruling– which, if accurate, does not bode well for small business capital formation in matters going beyond the scope of the April 10 ruling.
Stay tuned. The fat lady is just getting warmed up. Hopefully Washington will be listening.
Samuel S. Guzik, a recognized authority on the JOBS Act including Regulation D private placements, investment crowdfunding and Regulation A+, writes a regular column, The Crowdfunding Counselor, for Crowdfund Insider. A consultant on matters relating to the JOBS Act, he recently led a Crowdfunding Roundtable in Washington, DC sponsored by the U.S. Small Business Administration Office of Advocacy. He is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience. He is admitted to practice before the SEC and in New York and California. Guzik has represented a number of public and privately held businesses, from startup to exit, concentrating in financing startups and emerging growth companies. He also frequent blogger on securities and corporate law issues at The Corporate Securities Lawyer Blog.