McHenry Amendment to Protect Angel Groups and Incubators

Update to Friday's post: I've located the angel platform amendment offered on the House floor by Represenative McHenry, which passed as part of the JOBS Act. Thanks again are due Jim Hamilton, who reported last week this had occured.

For those organizing and running angel groups or incubators, McHenry's angel platform amendment is a very big deal. It would give them comfort their activities will not run afoul of federal broker-dealer regulations. 

And for startups that promote themselves to, on and through incubators and angel networks, this amendment would give them additional comfort they aren't blowing the general solicitation and general advertising prohibitions of Reg D. (General solicitation is also the topic of the McCarthy bill, discussed Friday).

Open Coffee Club eventMcHenry's amendment is not about crowdfunding - well, not the equity crowdfunding that would permit the 99% to invest (up to certain limits) in startups. The populist crowdfunding concept is best exemplified by the McHenry bill that passed the House last year and is one of the several rolled up in the JOBS Act "package."

This angel platform amendment, newly offered by the very same McHenry, is about crowdfunding for the 1%: it blesses overtly public activitity - online and offline (think pitch events) - in connection with seeking and securing investments from angels.

Were it to become law, the angel platform amendment would protect (from federal broker-dealer purview) the following kinds of activities in which an angel group, angel platform, or incubator might engage:

  • maintaining an online platform on which Reg D Rule 506 deals are offered, sold, or negotiated;
  • conducting meetings (presumably to include pitch events or other publicly advertised events) at which Reg D Rule 506 deals are offered, sold, or negotiated;
  • co-investment in Reg D Rule 506 deals posted online or pitched at meetings;
  • providing due diligence services in connection with Reg D Rule 506 deals (excluding investment advice or recommendations); and
  • providing optional standard documents to entrepreneurs or angels.

Two overriding conditions for this proposed safe harbor are that the group, platform or incubator (1) receive "no compensation in connection with the purchase or sale of such security," and (2) "not have possession of customer funds or securities." It looks like payments received for due diligence services will not blow condition (1). 

Below is an excerpt from the Congressional Record for March 8, 2012. It's worth reading for the mise-en-scène alone. But it's important to see how Rep. McHenry, a Republican, characterized the amendment, and to note that Representative Frank, a Democrat, labeled the amendment non-controversial. The amendment passed the House by voice vote.

   ``The Chair recognizes the gentleman from North Carolina.

   ``Mr. McHENRY. Madam Chair, I yield myself such time as I may consume.

   ``This amendment is very simple. We know, and policymakers in Washington here know, that entrepreneurship is at a 17-year low in the United States. We also know that small businesses are the drivers of our economy. So what this amendment does is it enables investors to connect with start-ups.

  ``It takes away some red tape that is within securities regulations, and it allows incubators, forums, and online platforms which only connect accredited investors to start-ups to be exempt from SEC registration as a broker-dealer if they, number one, do not charge a commission or fee for their service; number two, do not handle the moneys of investors; and, number three, only permit accredited investors to use their platforms.

   ``This is a very narrow amendment, very specifically crafted. In fact, the President's Council on Jobs and Competitiveness in October of last year said in their report that the emergence of angel investors and networks have also played a crucial role in initial funding of companies, and that the council recommends that clarifying that experience and active seed in angel investors and their meeting venues should not be subject to the regulations that were designed to protect inexperienced investors.

   ``This amendment deals with that subject matter within the President's jobs council recommendations. I ask my colleagues to support this amendment.

   ``I reserve the balance of my time.

   ``Mr. FRANK of Massachusetts. Madam Chairman, I rise to claim the time that would go to someone in opposition if there is anybody in opposition, which there does not appear to be.

   ``The Acting CHAIR. Without objection, the gentleman is recognized for 5 minutes.

   ``There was no objection.

   ``Mr. FRANK of Massachusetts. Madam Chair, I support this amendment. I am pleased that we have been able to come together in a process that is providing some improvement. As I've said, I think there have been people in both the executive and legislative branches that have exaggerated the impact of these, but they are helpful.

   ``I do want to make one point, though, that it is true that the President has been one of those who has been a proponent of this--it's been a very bipartisan and very cooperative process--and there is a Statement of Administration Policy in support of the bills.

   ``I do want to make it clear because there will be some subsequent amendments that I think will be controversial. This one is not. . . ."

Pretty remarkable.

Here is the text of the amendment itself, with certain technical cross-references deleted (for the unabridged amendment, click the link provided at the top of this post): 

    ``(1)With respect to securities offered and sold in compliance with Rule 506 of Regulation D under this Act, no person who meets the conditions set forth in paragraph (2) shall be subject to registration as a broker or dealer pursuant to section 15(a)(1) of this title, solely because--

    ``(A) that person maintains a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person, or through any other means;

    ``(B) that person or any person associated with that person co-invests in such securities; or

    ``(C) that person or any person associated with that person provides ancillary services with respect to such securities.

    ``(2) The exemption provided in paragraph (1) shall apply to any person described in such paragraph if--

    ``(A) such person and each person associated with that person receives no compensation in connection with the purchase or sale of such security;

    ``(B) such person and each person associated with that person does not have possession of customer funds or securities in connection with the purchase or sale of such security; and

    ``(C) such person is not subject to a statutory disqualification as defined in section 3(a)(39) of this title and does not have any person associated with that person subject to such a statutory disqualification.

    ``(3) For the purposes of this subsection, the term `ancillary services' means--

    ``(A) the provision of due diligence services, in connection with the offer, sale, purchase, or negotiation of such security, so long as such services do not include, for separate compensation, investment advice or recommendations to issuers or investors; and

    ``(B) the provision of standardized documents to the issuers and investors, so long as such person or entity does not negotiate the terms of the issuance for and on behalf of third parties and issuers are not required to use the standardized documents as a condition of using the service.''

As discussed in prior posts and summarized in this GeekWire guest post from last weekend, the Reg D reforms and the crowdfunding exemptions don't yet play well together. McHenry's angel platform amendment throws another quandry into relief. Assuming it and the crowdfunding exemption both become law, as written, will online angel portals and crowdfunding platforms have to make sure they remain siloed, disconnected from each other?

It's ironic that McHenry has now drafted legislation for the 99% and legislation for the 1%, without getting the two pieces to synch.

But that's looking a gift horse in the mouth. Presumably the inconsistencies can be fixed in the Senate next week. McHenry's angel platform amendment goes a very long way toward redressing the "digital angels, analog rules" problem.

Photo: Open Coffee Club Pittsburgh, by @alphalab/Flickr.

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