Title III of the JOBS Act created an exemption from registration for the offer and sale of so-called “crowdfunded” securities under the Securities Act of 1933, allowing the offer and sale of securities to an unlimited number of unaccredited investors without registration with the SEC, on an Internet-based platform, through intermediaries (portals) which are either registered broker-dealers or SEC licensed “funding portals.” Title III also provided for a number of built-in investor protections, including limitations on the amount invested, a limitation on the amount an issuer may raise in a 12 month period ($1 million), detailed financial and non-financial disclosure in connection with the offering, and ongoing annual issuer disclosure. Congress left much of the details of Title III in the hands of the SEC, to be fleshed out in the rulemaking process.
SEC Chair Mary Jo White recently spoke to the disruptive power of the Internet—and the challenges and opportunities it has created for regulating capital formation—requiring companies, investors, Congress and the SEC “to reconsider how companies can seek capital and communicate with potential investors.” Chair White further remarked:
In 2012 Congress set the table for addressing the task of melding securities regulation with the Internet’s capabilities head on, through the passage of the JOBS Act of 2012. And it did so with perhaps the most challenging and controversial investment paradigm—investment crowdfunding. At the center of this intersection of technology and investor protection: Title III, entitled “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012.” Its alternate Congressional moniker, the “CROWDFUND ACT,” masked the complexities of this delicate balancing act. And Congress’ delegation to the SEC of significant rulemaking functions necessary to make investment crowdfunding a reality simply deferred addressing important issues necessary to make investment crowdfunding a reality.
The impetus for this law came not from any expansive study to reform federal securities laws, but rather from crowdfunding advocates, who sought to extend the recent crowdfunding phenomenon—social, civic and “rewards-based” crowdfunding—to a realm where small, largely unsophisticated investors could invest relatively modest sums of money in the most risky of ventures—startups and early stage companies. In exchange, crowdfunders expected to receive a valuable economic interest in a commercial venture—triggering the registration requirements of the Securities Act of 1933—and the need to craft an appropriate exemption. Further complicating matters was the relative indifference—if not disdain—of the SEC towards investment crowdfunding—and the Commission’s conspicuous absence from the Title III legislative process.
Thus, it ought to have come as no surprise that despite the 270 day deadline that Congress set for the SEC to promulgate Title III rules, it took both a changing of the guard at the Commission Chair level and 18 months to issue proposed rules. Nor ought it to have come as a surprise that when Congress handed the rulemaking task to the SEC, it would have fumbled the ball—with some observers crying “delay of game”—and others suggesting that “the fix was in” by the SEC to lose the game.
So when the SEC on October 23, 2013, issued proposed Title III rules in a 585 page release, some early bettors on the final outcome of the rules and the fate of Title III seemed heartened, comforted by the simple fact that the SEC was closer to the goal line of final rules. However, a more reflective analysis of the 585 pages reveals choices made by the SEC which add unnecessary, potentially fatal cost and complexity to investment crowdfunding.
No doubt, a major villain in Title III is the cost and complexity which Congress embedded in a financing vehicle for fledgling companies raising relatively modest sums of money—capped at $1 million in a 12 month period. Notwithstanding the challenging statutory framework which Congress constructed for investment crowdfunding, this article argues that many of the choices that the SEC has made in addressing key, discretionary provisions in Title III rulemaking exacerbate, rather than ameliorate the inherent cost and complexity, taking investment crowdfunding in the wrong direction—and perhaps for the wrong reasons.
In many important respects the SEC’s proposed rules represent a toxic brew which appears to be a by-product of institutional complacency and an overly cautious posture of protecting investors through “over-disclosure”. Thus, unless the SEC alters its course in final rulemaking, a potentially useful tool for capital formation by small business will simply not be cost-effective, and will wither on the vine.
This article undertakes an analysis of key provisions of the proposed rules—identifying challenges presented by the proposed rules—and choices which the SEC has made, purportedly within the boundaries permitted by Congress. The article also proposes alternative approaches for the SEC to consider and adopt as it undertakes to finalize Title III rules.
(Editors Note: This article was previously published in the Harvard Law School Forum. This is the second article that Sam Guzik has published in the Harvard Law School Forum addressing the JOBS Act and crowdfunding)
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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.