The much heralded JOBS Act was signed into law in 2012 during a brief moment of bi-partisan cooperation. The objective was to drive economic growth, and job creation, via a series of regulatory updates including the legalization of investment crowdfunding. But has the JOBS Act worked as intended?
That question is very much open to debate. For some companies, it has been very helpful, and for others not so much. There is a broad belief that the Securities and Exchange Commission (SEC), as well as Congress, should do much more to improve opportunity for both issuers and investors. Supporting small businesses is a desirable policy goal.
In a presentation last week, sponsored by the Heritage Foundation, Rutherford Campbell Jr., the William T. Lafferty Professor of Law, University of Kentucky College of Law, criticized areas of the JOBS Act that he believes fell far short of the goal. More specifically, Reg A+ and Reg CF; the two smaller exemptions that are ostensibly targeted to smaller firms.
Under the JOBS Act three crowdfunding exemptions were created: Title II, Title III, and Title IV.
Title II created Reg D 506c. This portion of the law enabled general solicitation (advertising & promotion) by issuers to accept investments from accredited investors. Issuers are allowed to raise an unlimited amount of funds from these investors while benefiting from state securities registration pre-emption.
Title III, the awkwardly titled Regulation Crowdfunding (Reg CF), was the smallest exemption allowing issuers to raise up to $1.07 million from both accredited and non-accredited investors.
Title IV, or Reg A+, was an improvement to old Reg A, a securities exemption that almost no one in their right mind used. Reg A+ created two Tiers (1 and 2); with Tier 1 issuers allowed to raise up to $20 million and Tier 2 issuers able to raise up to $50 million.
So what does Professor Rutherford believe?
When it comes to Reg D 506c he believes it was a “very good move by the Commission.” Rutherford is a “very big fan” and he sees that small businesses are using the exemption.
“We have a modest success here.”
Reg D (both 506c and 506b) is the most popular securities exemption raising over a trillion dollars each year.
But after that, in his opinion, things get a “little bleak.”
Regarding Title III, or Reg CF, the ability to pre-empt state registration is huge. But some of the compliance mandates of the law have undermined Reg CF’s effectiveness.
“It is just not working,” said Rutherford. “We were all really hoping it would really take off … it is not an over-statement to say that people have been disappointed in this … I thought the problems with [Reg CF] were apparent on the front end.”
Apparently, these problems were not obvious to all.
Rutherford believes Reg CF has foundered mainly due to several reasons.
The first has to do with promotional restrictions. Issuers are limited to certain avenues of off – site promotion.
Another limitation, in his opinion, is the inability to easily integrate Reg D and Reg CF.
Rutherford said the Commission could have provided an integration safe harbor but they decided not to do it. While this may be true, it is also a fact that many platforms will do a side-by-side Reg D/Reg CF offering effectively listing two investments for the same company concurrently.
Perhaps the biggest challenge for Reg CF is reporting requirements which create both an initial and ongoing cost – especially at the level where an audit is mandated ($500,000 & up).
“I do not have much hope for [Reg CF] for it helping the 5 million small businesses out there.”
Rutherford believes that the Commission and Congress should work together and fix these rules. He points to the relatively small amount raised under the exemption – a total of a bit over $100 million since rules came into effect in mid 2016.
When reviewing Title IV and the two separate tiers, Rutherford notes that issuers are avoiding Tire 1 due to the lack of state pre-emption. In fact, smaller businesses who are raising less than $20 million are dodging the pain inflicted by the states under Tier 1 as state registration is a duplicative process and one that is not needed.
“These small businesses will migrate from Tier 1 to Tier 2 to get rid of the states.”
Having to deal with all the states, territories and District of Columbia, “just swamps the transaction cost.”
Citing his data, Rutherford said there were 97 offerings which were less than $20 million that went into Tier 2.
“It sounds crazy. It’s just not working.”
Rutherford believes the failure of the Commission was not to pre-empt state authority over Tier 1 offerings (not to mention pre-emption for secondary trading).
The state securities regulators lobbied aggressively against state pre-emption in a huge turf battle. These state officials went so far as to sue the SEC in a case that was eventually tossed from the courts.
“I was never convinced [the states] had any chance of winning this. It was a shot across the bow … It was just showing you we are in your face.”
The states know that their process drives up overall cost for issuers, but in the end it is a question of parochial politics and ongoing relevance.
Beyond this, the other problem is the level of disclosure. Rutherford sees potential in Reg A+ IF the SEC decides to act. He notes that Congress gave the Commission extensive leeway.
“Their delegation [by Congress] was very broad.”
There is a need to scale disclosure with the size of the offering.
While critical of the JOBS Act, Rutherford remains a “big fan.”
“I think it offers three good paths … [but] I think [Reg CF] will never be what we hoped for.”
What is crystal clear is the need to remove state registration requirements for all securities exemptions. In fact, state involvement in most financial service regulation – must me removed. It is an ongoing, and extensive tax, upon the population. A shared burden that must be eliminated by Congress.
Perhaps one area where Rutherford falls a bit short is in the definition of an accredited investor.
The current definition is based off of economic standards that attempt to qualify individuals to invest in private offerings contingent upon the size of their bank account (salary or net worth). The current definition of an accredited investor makes no exception for sophistication.
While there are many individuals who may be wealthy, but lack poor investment acumen, there are millions, upon millions, of people who have the knowledge and education to make their own investment decisions but are blocked by the federal government.
Most thoughtful observers and policy makers have finally come to the realization that the current definition is simply wrong and profoundly flawed. It allows the rich to get richer while disenfranchising the majority of the population. Fortunately, there is a bill in Congress that may right this wrong.