Today's post is the text of prepared remarks I plan to give later today as part of a public policy and national ACA update panel at the 2013 Angel Capital Association Northwest Regional Meeting. The panel will cover several other current policy issues important to angel investing, but part of my role is to take the lead on a crowdfunding update.
Here's an update on crowdfunding.
Accredited
Crowdfunding
There is one kind of crowdfunding law already in effect today, not
waiting on SEC rulemaking.
That's an exemption from federal broker-dealer registration
requirements, designed for angel investing platforms, including AngelList,
CircleUp, Gust, and the like.
This exemption for angel platforms became law in April 2012, when
President Obama signed the JOBS Act. Unlike other recent Congressional reforms to
securities regulations that impact angel investing, this reform did not ask the
SEC to do anything; instead, Congress changed a statute and we do not need to
wait on rulemaking in order to rely on this exemption.[1]
The exemption[2] in pertinent part says
this:
“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 [this law] shall be subject to
registration as a broker or dealer pursuant to [the Securities Exchange Act of
1934], solely because . . . 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[.]”
Now, you might pick up on the term "general solicitation"
in the legislative language. It's
probably fair to say Congress anticipated the exemption would work hand-in-hand
with the lifting of the ban on general solicitation in Rule 506 offerings that
are limited to accredited investors. That’s
because the lifting of the ban on general solicitation is written up in the
same Title of the JOBS Act, Title II.[3]
However, the lifting of the ban on general solicitation doesn’t go
into effect until the SEC amends Regulation D.[4] Why would Congress make
one piece effective right away, and outsource a companion piece to the SEC for
rulemaking? Hard to say, although Congress may have supposed there wouldn’t be
a gap for too long, as it mandated that the SEC complete the implementing rules
within 90 days of enactment of the law. That
works out to have been July 2012. The
SEC has missed and continues to miss that deadline.
Fortunately, there are existing legal doctrines to support the position
that, when a site is walled off and protected by a password so only accredited
investors are participating, and maybe also when there is some kind of cooling
off period between registering on the site and investing, that in such cases,
there is no “general solicitation,” or there is indicia of a pre-existing
business relationship that negates the generality of any solicitation. At this point in the evolution of our
securities laws, words have lost their plain meanings and become terms of art. But this convoluted jurisprudence is the
basis on which the most prominent angel platforms are addressing the question
of general solicitation, at least for now.
The interim position is best reflected in a legal opinion that
sports the candid title, “K&L Gates Opinion as to Why AngelList Does Not
Need To Register as a Broker and Why Companies Posting Information to
Accredited Investors on the AngelList Website are Not Engaged in a General
Solicitation.”[5]
All the same, we will breathe more easily when the exemption
for angel platforms can be married with a lifted ban on general solicitation. Assuming the angel verification requirements
are not too onerous![6]
Facilitating accredited investor crowdfunding is arguably the most
important feature of the JOBS Act.
Title III Crowdfunding
for Everyone
While there is one type of investment crowdfunding[7]
already in effect – crowdfunding where the crowd is limited to those who are accredited
investors – most people who refer to crowdfunding under the JOBS Act are
talking about Title III, crowdfunding for everyone. Title III crowdfunding is
not yet legal. Here again, Congress chose to require the SEC to first implement
rules.
A nascent investment crowdfunding industry is eagerly awaiting these
rules. Promoters of would-be
non-accredited crowdfunding sites are meeting with the SEC, and with FINRA. Some are reconciling themselves to becoming
registered broker-dealers, as the sense emerges that the constraints Title III
imposes on funding portals are too restrictive.
The JOBS Act gave the SEC 9 months to come up with rules to implement
Title III. That deadline was missed, and I’ve heard secondhand that SEC staff is
signaling it may take all of 2013 to come up with final rules.
Now, if you are one of those angels who thinks investment
crowdfunding for non-accredited investors is a bad idea, take comfort: it won’t
prove workable. It won’t be the SEC’s
fault, either; it will be because Title III is too much of a grab bag of
conflicting imperatives.
Contrary to what is popularly supposed, Title III isn’t the
original, standalone McHenry crowdfunding bill that the White House supported
and got huge bipartisan support when it first passed the House. As, months
later, the the JOBS Act was being cobbled together from disparate bills, Senators
threw into Title III almost every investor protection from the past 80
years that any regulator could think of. Lost was the core idea that
crowdfunding was supposed to be a simple, limited exemption for very small
offerings.
The Senate’s essential problem with crowdfunding, as it turned
out, was that it might involve a crowd.
Below are listed just some of the prohibitions, conditions and
mandates in Title III of the JOBS Act.
For companies raising money:
- No advertising, other than to direct people to
the funding portal or broker-dealer
- Financial statement requirements, including a requirement
for audited financials if raising more than $500,000
- Requirement for a business plan, to be filed
with the SEC, with liability for omissions extending to officers, directors,
and any seller
- Annual SEC reporting requirements
For funding portals:
- No solicitation of purchases, sales, or offers
to buy securities displayed or offered on the portal
- Ensure that no investor has exceeded her
annual crowdfunding limit, across all platforms, with reference to how the
sliding scale applies to her, all while ensuring her privacy
- Requirement to educate and test investors
- Obtain background checks and securities
enforcement regulatory history checks on each officer, director and person
holding more than 20% ownership
- Ensure proceeds are not distributed before the
offering target is hit
- Have no interest in any company raising money
through the portal
NONE of the requirements referenced above apply to crowdfunding on
angel investing platforms.[8]
Photo: Problemkind / Flickr.
ENDNOTES
[1] SEC staff recently concurred with this view in an FAQ dated
February 5, 2013, “Frequently Asked Questions About the Exemption from
Broker-Dealer Registration in Title II of the JOBS Act.” Here is the pertinent
question and answer:
Question 1.
Can I
rely on the exemption from broker-dealer registration in Securities Act Section
4(b) before the SEC adopts rules to eliminate the ban in Rule 506 on general
solicitation?
Answer.
Yes.
The exemption from broker-dealer registration in Section 4(b) does not require
the SEC to issue or adopt any rules. You cannot permit an issuer to conduct a
general solicitation of a Rule 506 offering on your platform, however, until
the SEC’s rules permitting those activities for a Rule 506 offering are
adopted.
[2] Here’s the exemption in fuller context from Section 201(c) of the
JOBS Act:
(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.
[3] To be quite precise, both the lifting of the ban on general
solicitation and the broker-dealer registration exemption for angel platforms
are contained within Section 201 of the JOBS Act. Even so, the statute is quite
clear that the lifting of the ban on general solicitation will require
rulemaking before being effective, but the broker-dealer registration exemption
will not. SEC staff have concurred in this view. See Endnote 1, above.
[4] Congress didn't have to do it this way. When Congress changed the
accredited investor definition, even though that definition was itself an
innovation of administrative regulation and not statute, Congress itself changed
the definition, to state that, in calculating the net worth threshold, one
should exclude the value of the principal residence. Although the SEC followed up with rulemaking
on how to deduct the value of the principal residence from net worth, that
gloss did not delay implementation of the Congressionally reformed accredited
investor definition.
[6] A Congressional quid pro quo for lifting the ban was that the
SEC’s implementing rules “require the issuer to take reasonable steps to verify
that purchasers of the securities are accredited investors, using such methods
as determined by the Commission.” JOBS Act, Section 201(a)(1).
[7] For
purposes of our discussion I am not addressing rewards- or donation-based
crowdfunding, the poster child for which is Kickstarter.
