Third #crowdfunding bill is no charm

There's now a third crowdfunding bill in Congress, and it's poorly conceived.

Using the acronym "CROWDFUND," for "the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act," it was introduced last week by Senator Jeff Merkley.

I'll just call it S. 1970. The bill has no core. Its drafters don't really believe in democratizing seed financing.

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Superficially, S. 1970 tracks the bill that passed the House (H.R. 2930) and Senator Scott Brown's bill (S. 1791) on key points and thresholds. Like the other bills, S. 1970 has a $1,000,000 limit on what issuers can raise in any 12-month period. Disclosure of investment risks is required, and Dodd-Frank "bad actor" disqualification rules are contemplated.

But compare S. 1970 with the House and other Senate bill on other points, and you chalk up telling differences:

  • The individual investment limit is capped at the greater of $500, or 1% or 2% of an investor's annual income (depending on the investor's income);
  • S. 1970 also introduces the complexity of capping what an individual may invest in crowdfunding deals on an aggregate, annual basis, the baseline cap set at $2,000 - suggesting that the average person, fully maxing out each deal at $500, can invest in no more than four (4) exempt crowdfunded deals each year;
  • the paternalism of the annual, aggregate cap on individuals gets worse - if your income is higher, your cap is higher; up to four percent of your annual income if you make more than $50,000; eight percent of your income if you make more than $100,000;
  • an intermediary, called a "funding portal" in this bill, is required to screen issuers, take affirmative steps to educate investors, keep track of investors' income levels, and follow SEC rules created especially for funding portals . . .  but isn't permitted to recommend deals or solicit sales for the deals it vets;
  • proceeds can be released only when the offering is 100% subscribed, not at the 60% threshold set in the other bills (meaning Merkley's bill will encourage entrepreneurs to set lower funding targets); 
  • issuers must file quarterly reports and financial statements with the SEC (which is supposed to do, what, tell all the crowdfunders the financials are fine?); and
  • a new securities fraud violation is created, seemingly giving every $500 investor a direct, private right of action against the personal assets of any director or officer of a crowdfunding issuer.

Let me be clear on my own feeling about paternalism in securities regulation: I'm all for it. I love Rule 506 under Reg D and like the fact that the exemption is pretty much useless if you allow any non-accredited investor to participate. I also think the accredited investor thresholds are pretty much right where they should be (though it's also fine if they creep lower over time, i.e., they needn't be adjusted for inflation).

But you can't take a Reg D or paternalistic mindset in crafting a crowdfunding exemption. If you're going to scope one, you have to have the courage of a conviction that the experiment is worth trying, that there are entrepreneurs out there who will put crowdfunded funds to good use, and to the economic benefit of all of us.

Being skeptical, or suspicious, or outright hostile to a federal crowdfunding exemption are all reasonable positions in my view. But this bill is not reasonable, because it takes paternalism to new (and wholly impractical) magnifications of micro-management.

If the sponsors of S. 1970 have such fundamental misgivings about crowdfunded securities offerings, they should be opposing the bill that passed the House and the bill Senator Brown introduced, and instead line up behind the NASAA proposal. State regulators would be far more suited to the regulatory burdens this bill misguidedly places with the SEC.

Chart is an update of my prior comparative table, adding a new column for S. 1970. Let me know if you see errors and I'll try to correct them in a subsequent iteration. Or if you'd like to build on it, please do, under a creative commons license that permits others to freely build on your version.

Update 10:30 AM Pacific: The Senate Banking Committee held a hearing this morning that touched on crowdfunding. I wasn't able to follow it in real time, but I've peaked at the written testimony submitted by one of the witnesses, Mark Hiraide, a California lawyer. Below is an excerpt from that written testimony, expressing an opinion that Merkley's crowdfunding bill is better than Brown's.

“I fully support the intent behind the crowdfunding bills. However, I share Professor Coffee’s concerns that unregistered salespersons may abuse the broker-dealer registration exemption set forth in Section 7 of the {Brown] bill. Unregistered salepersons of the sort that I described will, with little effort, satisfy the requirements for the exemption in Section 7 of S.1791.

“On the other hand, S.1970, adopts a regulatory regime for intermediaries that requires them either to elect to register with the Commission as a broker-dealer or as a newly defined 'funding portal,' subject to several definitional proscriptions.

“S.1970 appropriately limits the scope of permissible activity of a funding portal by prohibiting it from:

  • offering investment advice or recommendations;
  • soliciting purchases, sales, or offers to buy the securities offered or displayed on its website or portal; and
  • compensating employees, agents, or other third parties for such solicitation or based on the sale of securities displayed or references on its website or portal.

“S.1970 also provides reasonable limits on maximum individual investment limits.  By including an aggregate limit applicable to all crowdfunded investments, in addition to dollar investment limits per company, S.1970 addresses a concern known as 'stacking,' whereby an individual investor invests in successive offerings but manages to satisfy the requirements of each individual offering.”

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