Intrastate Crowdfunding at Risk

NASAA Letter Quote North American Securities Administrators Association

Has Intrastate Crowdfunding in Washington State Been Washed Out by NASAA and the SEC?

On May 5, 2014, I published an article in Crowdfund Insider highlighting recent informal “rulemaking” at the SEC Division of Corporation Finance, which in my opinion quietly dampened the efforts of three states to implement their own brand of intrastate crowdfunding: Kansas, Georgia, and most recently, Washington State.

US Map Crowdfunding ExmemptionsA prominent feature of the Kansas, Georgia and recently enacted Washington State crowdfunding legislation: issuers would be able to crowdfund on their own website through general solicitation of investors – unlike JOBS Act crowdfunding, which mandates use of a licensed intermediary, and severely limits the ability of an issuer to call any attention to its crowdfunded offering outside of a licensed portal.

However, on April 10, 2014, the SEC Division of Corporation Finance, the same division at the SEC charged with implementing Title III (crowdfunding) legislation and Title IV (Regulation A+) under the JOBS Act, cut the heart out of three states’ intrastate crowdfunding initiatives.  The most recent victim – Washington State – whose legislature proudly enacted its own intrastate crowdfunding legislation in March 2014.

Joe WallinAs prominent Washington State corporate lawyer Joe Wallin noted in his May 6 article on Crowdfund Insider, discussing the ability of Washington businesses to solicit Washington State residents under the new Washington statute:

“Companies won’t be able to ‘generally solicit’ their offerings on the Internet for the whole world to see because that would be inconsistent with an intrastate exemption, according to the SEC.”

The SEC ruling at issue, C&DI 141.05.  As Joe Wallin pointed out:

“C&DI No. 141.05 make[s] it clear that the SEC’s position is that use of the Internet through websites and social media ‘in a broad, indiscriminate manner…to convey information about specific investment opportunities would likely’ not be compatible with the intrastate exemption.”

In fact, under the SEC ruling, an issuer utilizing the new Washington State exemption cannot even mention it is conducting fundraising on any part of its website accessible to the general public.

Question MarkThe immediate impact of this informal April 2014 SEC Staff ruling is to nullify one of the more important features of the Washington statute before it even becomes effective – the ability of an issuer to communicate with the public via the Internet to call attention to its intrastate crowdfunded offering. Thus, on April 10, 2014, the SEC stopped the Washington state legislature dead in its tracks – on the eve of the implementation of the Washington state statute.  Essentially, the SEC ruled that federal law prohibits this type of activity under the federal “intrastate” exemption that Washington State and two other states have relied on.  Why?

secIn the view of the SEC staff, the so-called federal intrastate exemption, which prohibits “offers and sales” of securities by an issuer to non-residents, would be violated if an issuer did anything on its website to call attention to the offering. It would seemingly make no difference to the SEC even if the issuer cautioned the public that the offering was only available to state residents – and even if the issuer also implemented procedures to ensure that no non-resident could actually purchase securities in the intrastate offering.

Social MediaSo while the U.S. Department of Justice is officially looking the other way while Washington State mom and pop retail businesses openly dispense marijuana to its residents, no Washington State business operating within the newly enacted Washington State crowdfunding statute can openly offer its securities to the public via the Internet –  at least not without incurring the ire of the SEC Division of Corporation Finance.  Something is wrong with this picture.

At a time when the investment crowdfunding world patiently awaits the SEC’s federal crowdfunding rules, one might ask: Why is it that Washington State residents can puff away on marijuana to their hearts’ content, in violation of federal law, while at the same time the SEC Division of Corporation Finance is putting a muzzle on Washington State’s entrepreneurs who seek to do no more than to use the Internet to reach out their residents for needed working capital?  Seems to me that being “laid back” has a higher priority at some quarters in Washington, D.C. than being “laid off.”  

Time for a Step Forward at the SEC for Crowdfunding in the Internet Age – Not a Step Backwards

Marijuana_joint smoke smoking torben hansenPerhaps the folks at the SEC’s “Corp Fin” ought to step back, take a deep breath, “inhale” and reconsider their April 10 position.

The last time that the Staff of the Division of Corporation Finance visited the issue of the utilization of the Internet in cross-border transactions, and espoused a restrictive view which parallels the view adopted in April 2014, was in 1998. Significantly, however, in 1998 the Staff noted that this restrictive policy on utilization of the Internet to solicit offers and sales would be revisited in the futurewith a view towards expanding the ability of an issuer to broadcast the availability of an offering in an offer with geographical limitations:

In the context of broader Securities Act reform, we have been considering whether the current general solicitation and other offering communications restrictions on issuers and other offering participants should be modified to create greater flexibility. To the extent that we reform those restrictions on offering communications in the future, we also will consider the implications of those changes for .  .  . Internet offerings”

Congress finally spoke in the affirmative on the expanded use of general solicitation in unregistered offerings in 2012, allowing the use of general solicitation in private placements to accredited investors, whether on or off the Internet.  So one would have thought that 16 years after this change in policy was suggested by the Division of Corporation Finance, the Staff at the Division of Corporation Finance would put pen to paper – allowing capital starved small businesses to use the Internet to reach out to prospective investors in intrastate offerings.

Yet at exactly the same time when the hoped for change in policy by the SEC would have allowed the Washington State legislature to have its way – with intrastate crowdfunding – by allowing issuers to solicit investors on the Internet – the SEC publicly stood its ground on an outmoded 16 year old policy.

Why is the SEC Division of Corporation Finance Quietly Stepping on State Crowdfunding Legislation?

So the question is why did this “C & DI” come out when it did, on April 10, 2014, at a time when the SEC is by all accounts overwhelmed with rulemaking tasks and understaffed – witness the 2+ year delay in implementing federal investment crowdfunding? And just in the knick of time to stop the Washington State legislature dead in its tracks?

Thus far, the answer to this question remains unknown – as this informal rulemaking by the Division of Corporation Finance falls outside the normally transparent formal rulemaking SEC rulemaking procedures.  But for me, this gratuitous informal SEC rulemaking raises some red flags that do not bode well for small business, at least at the SEC.

What has Changed at the SEC in 2014?

Barney Frank & Chris DoddWhat has changed since 1998 at the SEC – since it promised to reconsider broadening the use of the internet by an issuer to solicit investors? Well, perhaps not coincidentally, on February 21, 2014, Rick Fleming took office as the first Chief of the Office of Investor Advocacy at the SEC, courtesy of Section 915 of the Dodd-Frank Act of 2010.  Yes, this is the same Rick Fleming who served as the North American Securities Administrators Association’s (NASAA) legal counsel before moving into his new quarters at the SEC.  Yes – the same Rick Fleming who was employed by the State of Kansas when Kansas enacted the very first intrastate crowdfunding statute in 2011 – the same Kansas statute that, but for this 2014 ruling, would allow issuers to solicit offers on their own Internet portals or other social media pursuant to the Kansas intrastate crowdfunding exemption.

Strengthening Reg D Rick Fleming NASAAWell, this is the same Rick Fleming who was listed as the NASAA contact person on a January 17, 2014 letter penned by NASAA on the eve of his appointment at the SEC.  The NASAA letter, addressed to an association of the 50 state legislatures, urged state legislatures to be mindful of a whole host of federal laws which, in their opinion, would constrict the ability of states to craft their own intrastate legislation. Included in the NASAA letter was a citation to the 1998 SEC Release.

And it is not likely that Mr. Fleming was a big fan of the 2011 Kansas crowdfunding exemption – at least not after, according to public reports, he was unceremoniously dismissed by then Kansas Securities Commissioner, Aaron Jack, the architect of the Kansas intrastate exemption.

Washington State Comes to Washington – Courtesy of NASAA

And then, something else to think about. William Beatty, the chief securities administrator for the State of Washington, and President-Elect of NASAA, was a regular visitor to Washington, D.C. in the Spring of 2014. Perhaps his most visible appearance was to testify on behalf of   before the House Financial Services Committee Subcommittee on Capital Markets – against Congressman Patrick McHenry’s draft 2014 crowdfunding bill – on May 1, 2014.

Seems that this was not the only appearance by the Washington State Securities Administrator in Washington, D.C.:

  • On April 7, 2014, Mr. Beatty and five other NASAA representatives met with SEC Commissioner Luis Aguilar to discuss the SEC’s proposed regulations under Title IV of the JOBS Act.
  • And on April 9, 2014, Mr. Beatty and seven other NASAA representatives met with the Chair of the SEC, Mary Jo White, Keith Higgins, Director of the Division of Corporation Finance and other SEC officials to discuss proposed regulations under Title IV of the JOBS Act.
  • And on April 29, 2014, Mr. Beatty and four other NASAA representatives participated in a telephone conference with SEC Commissioner Michael S. Piwowar to discuss proposed regulations under Title IV of the JOBS Act (Regulation A+)
  • And on May 9, 2014, Mr. Beatty and seven other NASAA representatives met with the Staff of the SEC to discuss proposed regulations under Title IV of the JOBS Act (Regulation A+).

NASAA LogoAnd for those of you whose imaginations run wild with conspiracy theories (like mine occasionally does), you will never guess who reached out to me on May 6, one day after I published by May 5 article on Crowdfund Insider questioning who was behind the April 10, 2014 SEC ruling? A gentleman by the name of Rex Staples.  According to his LinkedIn bio, he served for 10 years at the Washington State Securities Division before joining – you guessed it – NASAA – serving for seven years as their General Counsel.

And what do you think Mr. Staples did when we met for lunch two weeks later at a midtown Manhattan restaurant?  He pressed his smart phone into action midway through our lunch, to confirm a face-to-face meeting with one of his former subordinates, Rick Fleming, at his new digs at 100 F Street in Washington, D.C.

And what was the outcome of the meeting between Staples and Fleming two weeks later? I contacted Mr. Staples via email the day after his meeting with Chief Investor Advocate, Rick Fleming to ask him that very question.

Staples’ response: Fleming was too busy setting up his new office at the SEC to focus on anything of substance.

My response: “not too busy to squeeze out a CDI.”  Staples’ response:  “Touche”

The Wizard of OzSo who was the Wizard of Oz behind the curtain at the SEC on the April 2014 Staff ruling.  As I indicated in my May 5 article, I requested a meeting with SEC Commissioner Daniel M. Gallagher, in part to raise my concerns about this 2014 ruling.   And so we met on June 23. On this issue Commissioner Gallagher politely referred me to the Head of the Division of Corporation Finance, Keith Higgins – who officially presided over the April 2014 ruling.

I will withhold judgment on this matter, at least until I get an official answer to my question from the Division of Corporation Finance:  When is the Division of Corporation Finance going to revisit this issue as it promised to do in 1998? – of great importance to over 40 state legislatures around the country considering the contours of state crowdfunding legislation – and undoubtedly of great importance to NASAA as well.

Justic by CarptrashDraw your own conclusions – I’ve drawn mine. It appears that NASAA has landed in force at the headquarters of the SEC – replete with “boots on the ground” in the persona of Rick Fleming and a cadre of loyal constituents.  If true, this does not bode well for small business – most immediately, in terms of implementation of the JOBS Act – as many of us anxiously await implementation of JOBS Act crowdfunding and Regulation A+ by the SEC – on the heels of a massive lobbying effort by NASAA in Congress and at the SEC.

More on this in the coming days and weeks, as the search for truth and justice for small business in Washington, D.C. continues.

 

 

____________________________

 Samuel S. GuzikSamuel 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 Counselorfor 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.

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  • Bill G Wilminton NC

    Good Afternoon Gentlemen,
    I am grateful for this opportunity to speak….

    CROWDFUNDING is ‘PRIVATE FORMATION OF CAPITAL’ a pure jet engine to startups. The banks and large law firms are against crowdfunding and lobby congress and senate extensively, they know If crowdfunding Title 111 was passed the banks and law firms would not be needed and billions and billions in small investments would go into startups. Randy said it right “protection of investors” is the OZ curtain. Outside the curtain these investors are purchasing lottery tickets by the fistful haha whats the return on that. Or to purchase an automobile do you bring a lawyer and thats typically over 20 K. The joke is ” KICKSTARTER ” put them all to shame they are raising millions and millions through calling it ” DONATIONS ” haha. A new donation offering lol named ” Coolest Cooler ” is up to 7 million haha what a joke. Thanks for listening guys.

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  • Randy Shipley

    Bravo – wish I could have articulated this as well as you, which is how I have felt about NASAA and SEC over the past year. The delays in crowdfunding are serving special interests – the “protection of investors” is a curtain that our regulators are hiding behind. If they were truly interested in protecting investors, they would be much more focused on real estate equity deals, insider trading and pump and dump penny stocks where investor fraud dwarfs the entire spectrum of crowdfunding.

    • Samuel S. Guzik

      Randy, Thanks for your input. I believe the simple reality is that the Internet and the JOBS Act have been “disruptive” to NASAA. Ultimately their resistance will yield to the reality that investors have unprecedented access to information, and the price for having a “nanny state” in the form of Blue Sky regulation, is to continue to choke off capital to small business – something this country cannot afford. Sam

  • Anthony Zeoli

    Great Article Samuel! I agree with you that CDI 141.05 may have been implemented to make intrastate crowdfunding more difficult but I respectfully disagree that an issuer “cannot even mention it is conducting fundraising on any part of its website accessible to the general public.” I do not read CDI 141.05 as specifically prohibiting an Issuer from making ANY mention of its securities offerings through its website/social media. I would instead argue that under CDIs 141.03 (which permits limited general advertising) and 141.04 (which permits the limited use of internet portals) if an Issuer implemented the same “adequate measures” as permitted for third-party portals (e.g. legends, disclaimers, etc.) an Issuer could use its own website/social media to give limited general information regarding its offering (e.g. to solicit general interest and provide direction to another person/site link for more information whereupon the interested investor would be vetted for residency before further disclosure).

    • Samuel S. Guzik

      Anthony. I wish I could share your confidence in your conclusions. What the SEC needs to do is what it did in 1998 – present a detailed, reasoned release – and to expand the use of general solicitation under a Section 3(a)(11) offering, which it promised to reconsider in the 1998 Release after the SEC expanded the use of general solicitation in other contexts.

      As of now the SEC has done neither. So one is left to speculate, at best, as to what an issuer can say about an offering under Section 3(a)(11).

      Joe Wallin seems to share my view of the SEC’s recent interpretation.

      Of course, if Washington State (or any other state) based its Intrastate Exemption on Regulation D Rule 504, none of this would be an issue. But unfortunately that is not what Washington State did. Also, if a state wants to allow offerings above $1 million, Rule 504 is not an option for the states.

      This ball has bounced back to Corp Fin. Let’s see what they have to say.

      Bottom line – clear, forward looking guidance is needed. The SEC has yet to do this.

      • Anthony Zeoli

        I certainly see your view, and it is a valid one. I am also in agreement that clear guidance is necessary. Unfortunately clarity has never been a strength of the SEC, or any governmental agency for that matter. I guess it will take someone pushing the issue to force their hand and until then you are correct we are left here speculating as to their meaning.

  • Elan Amram

    The SEC will not react favorably by providing simple rules in implementing Tittle III or Intrastate Crowdfunding unless they are forced by the public. This means thousands of emails and phone calls to each of the commissioners demanding they change their tune.

    YOU CAN MAKE A DIFFERENCE #ReleaseTheRules Now

    Commissioners

    Mary Jo White, Chair (202) 551-2100

    Luis A. Aguilar (202) 551-2500

    Daniel M. Gallagher (202) 551-2600

    Kara M. Stein (202) 551-2800

    Michael S. Piwowar (202) 551-2700

    You can also contact:

    Sebastian Gomez Abero

    Division of Corporation Finance

    Phone 202 551-3500

    Email:

    100 F Street NE,Washington DC 20549

    Leila Bham

    Division of Trading and Markets

    Phone 202 551-5532

    Email:

    100 F Street NE.,Washington DC 20549

    • This is very helpful information Elan, Thank You!
      How would one go about acquiring the email addresses on these contacts?

      Regards,
      L.W. Dusty Brogdon
      CFO / Founder
      http://iNCUBANKER.com
      An ATS For Title III – Equity Based Crowdfunding

  • Elan Amram

    The SEC will continue to do everything they can to assert their power and control over the States in preventing crowdfunding for unacreddited investors from taking root. This incules Reg A+ and Tittle III

    • Samuel S. Guzik

      Elan, See my response to Scott McIntyre below. Hopefully with attention now on this issue, which it is, the SEC will reconsider both its substantive position and the way it formulates policies impacting small business. Time will tell. Sam

  • Scott E. McIntyre

    thoughtful commentary on Sam’s research into what I can only see as collusion to the benefit of anyone other than the recipients of the benefits the JOBS Act intended.

    • Samuel S. Guzik

      Scott, As I am sure you realize, my article touches on a number of critical policy issues affecting small business capital formation. The issue goes beyond the substance of the ruling, which is not insignificant, but also the process by which the ruling was issued.

      At the least, if I were the Governor of Washington State or a member of its legislature, I would question why they were not given a heads up on this ruling. Presumably they were not – lest they would not have enacted this legislation in its current form. So I think the SEC has to reconsider the process from this point of view.

      Secondly, given the importance of this issue to the many state legislatures considering intrastate crowdfunding legislation, it seems to me that the Division of Corporation Finance should have addressed these issues in a manner similar to the 1998 interpretive release – a detailed and well reasoned discussion. Two C&DI’s comprising a few sentences falls short of the mark on the important issues raised at the state level.

      Third, to the extent that NASAA may have had a “disproportionate” back door influence on the April 2014 rulings, this ought to be of concern, as NASAA has vocally opposed every provision of the JOBS Act – an act that was not about investor protection, but rather about removing barriers to capital formation by small businesses in order to jumpstart a stagnating economy.

      And to the extent that there are investor protection issues at the state level, the SEC ought to give more deference to the voice of the state legislatures, who have broader goals and policy objectives than NASAA – who singlemindedly seem to be opposed to all that allows increased access to capital by small business.

      Finally, it is my understanding that both the ruling and the process by which it was obtained is now being scrutinized by the Commission. So regardless of the substantive outcome, hopefully this episode will make the SEC more sensitive to the need for transparency.

      Only if these issues are put under the public spotlight will both the process and the substantive outcome be defensible by the SEC as a matter of both law and public policy. Sam

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  • Crowdfund Jayhawk

    Mr. Guzik, what are you implying about Rick Fleming’s dismissal from his role as General Counsel for the Kansas Securities Commission?

    You are aware that is dismissal was more the result of corrupt behavior by Aaron Jack than anything that was done by Fleming in connection with the Invest Kansas Exemption, right? Jack fired upwards of 70 percent of the investigators, lawyers, and advisers with the Kansas Securities Commission and replaced them with friends and campaign contributors. Jack then used Kansas Securities Commission funds to launch his statewide campaign for Insurance Commissioner. Not exactly the guy you want as standard-bearer for intrastate crowdfunding.

    • Samuel S. Guzik

      My article is not about personalities – it is about policies – good and bad – and how they are made and implemented – and changed.

      As a “Jayhawk” you recognize that Kansas was a thought leader in 1911 when it enacted the first comprehensive state Blue Sky legislation. Kansas was also the thought leader in 2011 when it enacted the first intrastate crowdfunding legislation.

      So this is not about the trials and tribulations of Aaron Jack, or a diss on Rick Fleming.

      As to Rick Fleming, yes he was dismissed by Mr. Jack along with dozens of others – and Mr. Fleming otherwise has had, before and after, a distinguished career.

      So lets keep our eye on the ball – this is about regulatory policies which impose unnecessary barriers on capital formation and job creation – most of which fall disproportionately on small business. Sam

  • LogicLarry

    If this piece were about changing current law–that any offer or sale of a security by the use of interstate commerce is inconsistent with the use of the intrastate exemption from SEC registration–to one that only restricts the sale of a security, I would be on board with what Mr. Guzik wrote. Instead, he goes on this weird diatribe–crafting conspiracy theories and displaying a general misunderstanding of federal administrative process.

    For the record, a CD&I is not a rule, it is an understanding of the law by the SEC as the law currently exists. It has no binding legal authority like a statute or a rule. It is not the standard a court would apply when determining whether an issuer has violated the terms of the intrastate exemption. Calling a CD&I a “ruling” is inaccurate and misleading.

    That said, the SEC CD&I is perfectly reasonable in light of the law as it exists. An intrastate offering, where the issuer has offered securities to citizens of other states, is no longer eligible for the intrastate exemption from registration. The issuer has made an offer or sale of securities using the means of interstate commerce to investors out of state. That does not sound like and intrastate offering to me. The Section 3(a)(11) exemption has never allowed for that type of behavior. Again, Mr. Guzik does a disservice to readers when he suggests that the the law applied a different standard in the past.

    • Samuel S. Guzik

      Larry, This interpretive ruling was perfectly reasonable when originally issued in 1998. However, as the SEC recognized then, there would be a need to revisit this issue when rules regarding general solicitation were expanded – which they have been.

      The time for the SEC to have revisited this issue came and went on April 10, 2014, in what at the very least was a slap in the face of the Washington State legislature and the Governor of Washington State.

      Your comment also misses the boat on the real impact of this “C &DI”. Yes, it does not have the force of law. However, one would be a fool to disregard an SEC Staff Interpretation. And bear in mind that this C&DI now becomes a talking point for NASAA when it lobbies the 40 or so state legislatures yet to adopt intrastate crowdfunding legislation.

      And if you have any doubt as to whether NASAA is actively lobbying state legislatures, please refer to the six page January 17, 2014, penned by NASAA and addressed to the 50 state legislatures.

      So wake up and smell the coffee. This is a part of the political reality of securities legislation and rule making. It is also a drag on small business capital formation at the state and local level. Sam