To Join Forces with Merkley, Brown Gives Too Much Ground on Crowdfunding Exemption

The HUGE #crowdfunding development yesterday was that Senators Brown and Merkley were subsuming their respective bills into a jointly sponsored S. 2190.

No shortage of instant euphoria over the news, because it signals that a crowdfunding exemption may be viable in the Senate.

A funny thing happenedBut in the cold light of morning, it looks like Brown gave more than he got to stay involved; crowdfunding proponents will have to keep pressing, because the Brown/Merkley bill is too much like the prior Merkley bill. It may even be worse.

True, even were the Senate to pass S. 2190 in the overwrought, 28-page form released yesterday, it should still be possible, in the process of reconciling Senate and House bills, to move a final crowdfunding exemption closer to McHenry's than Merkley/Brown's.

But there is so much in the Merkley/Brown bill that seems to begrudge an honest experiment with equity crowdfunding. The bill just won't let go of the existing securities law mindset, that startup investing is just for the rich.

The sales pitch you get from Merkley's office and the state securities regulators is that little mom and pop investors need to be protected. I think many who say that actually believe it; but if you really remain committed to a paternalistic approach (full disclosure; for Reg D Rule 506 offerings, include me in the paternalistic camp), the soundest way to protect unsophisticated investors in crowdfunding offerings is to limit how much they can invest (or gamble, or throw away - choose the verb that best suits your pessimism).

Put it this way: there must be some threshold, below which you simply don't care whether the investor loses everything. Is that figure $10? $100? $1,000 annually?

In his prior bill, Merkley lowered the table stakes to $500. Brown seems to have gotten him up to $2,000 (lower if the investor's income or net worth is less than $40,000), doubling, I think, Brown's own prior $1,000. That's good, except it isn't. The higher threshold comes at too high a regulatory price: overbearing process and the threat of lawsuits that could very well suffocate the crowdfunding exemption before it can draw a breath.

The Brown/Merkley bill is using tools of the old paradigm when a new paradigm should be ventured. Why try wisdom of the crowds where regulation and regulators are available?

Here are just a few problems with the bill:

Isolating Crowdfunding From Other Kinds of Offerings

Although it retains language that the crowdfunding exemption is not in derogation of other available exemptions ("Nothing in this section . . . shall be construed as preventing an issuer from raising capital through methods not described under Section 4(6)"), amounts raised from accredited investors under a Reg D Rule 506 offering within the same 12 month period would appear to count against the annual $1,000,000 dollar per-issuer cap: "the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on [this crowdfunding] exemption during the 12-month period preceding the date of such transaction, is not more than $1,000,000."

By way of contrast, McHenry's House bill on this point is worded as follows: "the aggregate amount sold within the previous 12-month period in reliance upon this exemption is . . . $1,000,000 . . . ."

In effect, instead of allowing for the possibility of crowdfunding coordinated with angel investing, the Brown/Merkley bill says the 1% should stay in their enclave and the 99% should not try to storm the gates. (See also the reference below to my recent editorial at on crowdfunding for the 1%.)

New Right to Sue Founders, Promoters

The bill goes out of its way to set up a new right to sue startup companies, using a 10b-5-like standard, and possibly a shift of the burden of proof over to the issuer. What's more, "issuer" includes any director, partner, executive officer, controller and select others involved with the startup. This is terrible. A bold crowdfunding exemption would go the opposite direction and make it harder to impose normal private offering disclosure standards on crowdfunded deals. At least McHenry (and Brown, in his prior bill) talked about coordinating with existing fraud standards, and did not invent new ways to sue.

21 Day Waiting Period

Under Brown/Merkley, there will be a 21 day ("or such other period as the Commission may establish") waiting period for each crowdfunded deal, before the first shares can be sold.

Rules, Rules and More Rules, and State Rules

Brown/Merkley charges the SEC with drafting a ton of rules and filling in a lot of blanks on substantive points. The bill says the SEC has 270 days to write rules, and tells the Commission to work closely with the states. There is also a novel (to me) concept of federal preemption over state regulation of a funding portal, in which federal preemption does not apply to a state which happens to impose the same funding portal regulations as the SEC uses.

Closing Thoughts for This Morning

Joe Wallin has written on this topic recently, identifying three principles he thinks any viable crowdfunding exemption should observe. I'll bet Joe finds the Brown/Merkley bill wanting against his standards.

The above discussion does not list out all the different moving pieces of the Brown/Merkley crowdfunding exemption. It is probably four to five times as complicated as the McHenry bill - perhaps more.

Crowdfunding for the 1%

Be sure to check out an editorial I wrote for that was published yesterday: "Crowdfunding for the 1%." It looks at how a new module of McHenry legislation - an exemption from broker-dealer requirements for angel platforms and incubators - doesn't synch with his marquee crowdfunding exemption.

Photo by Scott Sandars/Flickr.

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