Title III Do-Over

It is an absolutely glorious, summerlike morning in Seattle.

I'm walking to work, listening to a webcast of a hearing of the House Financial Services Committee, which is considering draft legislation to fix things not working with the JOBS Act (both the text of the original legislation, and the implementation of it).

6a01156e3d83cb970c01a3fcfe88cc970b-580wiIt's very gratifying to hear Representative Patrick McHenry openly admit that Title III was a failure from the get-go, and that the fault lies with Congress, not the SEC's prospective implementation. (Title II and the rulemaking surrounding new Form D filing requirements is a different story.)

Gratifying, but not surprising. Rep. McHenry made similar statements at the ACA Summit in Washington DC in March of this year.

State securities administrators are going to be heard on the non-accredited crowdfunding issue. Bill Beatty, the state securities administrator for Washington State, should be speaking at this hearing shortly.

With respect all sides, I think my Individual Crowdfunding Account concept may be part of a holistic, national solution.

When I get to a desktop, I will add links to relevant prior posts on that topic, just below.

Update; links on McHenry Do-Over / Individual Crowdfunding Accounts:

A Simple Act of Congress to Make Things Better for Startups

My friend Joe Wallin had an idea earlier today, which was, “how can Congress pass a single, simple law, to tell federal agencies to back off the rulemaking?”

His idea is borne of the frustration we all feel when Congress passes a reform intended to make life easier for startups, entrepreneurs, and the angel investors and VCs who support them, only to see that new law languish – or, worse yet, backfire – through rulemaking to implement the Congressional reform.

Here’s a simple bill we’ve come up with. With respect, we believe this bill, by itself, might help curtail the problem we’ve seen with rulemaking under the JOBS Act.

“In implementing any Act of Congress through rulemaking, or in construing the meaning of any Act of Congress through ruling or interpretation, the various administrative bureaus and agencies of the United States shall not make it harder or more difficult for entrepreneurs or emerging companies to raise money privately from accredited investors, and may expand, but shall not diminish, the pool of persons who qualify as accredited investors.”

What do you think? If it were to pass, and you were a clever person in a federal agency bent on drafting rules to frustrate this Act of Congress, how would you undermine it? 

Another Car2Go story

I love this service.

A lot of people in Seattle are talking about the politics of ride sharing services.

But Car2Go is more like a self-service. Or the loan of hardware, I guess you could say. Because you find a car, passkey yourself in, and drive yourself to where you want to go.

Latest episode of ad hoc transportation delight: I left my downtown office midmorning yesterday, running for my car to make a meeting with a client in Fremont. When I got to the garage, I found I didn't have my keys on me. I started to trudge back to the office, thinking of the alternatives: be a half hour late; call instead of meet in person.

Then I thought of checking on whether a Car2Go buggy might be near. Checking the app, I found one a block away.

I was only 10 minutes late!

Got home the same way, via Car2Go parked outside the building I'd just visited.

Midweek Report

Non-accredited crowdfunding: a license to pillage the vulnerable, or democracy in action?

Monday, a friend sent me a link to a weekend New York Times editorial which strongly condemned the SEC's proposed rules under Title III of the JOBS Act.

However, unlike the criticism coming from those in the nascent non-accredited crowdfunding industry, the NYT editorial board faults the SEC's proposed rules, not for being unworkable, but for not being restrictive enough.

BjvXNWuIgAASow1I'll leave aside the Times' misconception that the faults lie in the agency's rulemaking rather than the legislation itself. In this regard, the editorial board makes the same mistake that non-accredited crowdfunding advocates, coming from the other direction, make. (Interestingly enough, at the ACA Summit last week in Washington DC, Rep. Patrick McHenry, the father of the original federal non-accredited crowdfunding bill, stated that Title III needed to be fixed legislatively, by Congress, not by rulemaking at the SEC.)

I'll also leave aside other aspects of the legislation and proposed rules which the NYT editorial board gets wrong.

Instead, I want to identify certain presumptions implicit in the NYT critique, for purposes of comparing and contrasting those presumptions with those underlying the critique of the very same proposed rules by non-accredited crowdfunding advocates:

Here are what I infer to be the NYT editorial board's presumptions:

  • People of modest means or on fixed incomes will be scammed out of money they can ill-afford to lose.
  • Even if a crowdfunded company turns out to be promising, later, more sophisticated investors will cheat the earliest investors out of fair returns.
  • Reliance on participant representations and self-policing is a recipe for fraud.

Non-accredited crowdfunding advocates approach the subject from a variety of different subcultures, you might say: some our tech start up oriented; others are community activists; others have a small business orientation. But these advocates share at least one or more of the following presumptions:

  • Startup and private company funding should be democratized in some meaningful way, and not remain the private preserve of the 1%.
  • Friends and family should not be shut out of legally investing in the business of a nephew, or a child, or an aunt, or a colleague.
  • More local dollars should circulate through local communities. Neighbors should be able to own a piece of the local restaurants, craft breweries, and other brick-and-mortar small businesses they support with their day-to-day commerce.
  • People are motivated to crowdfund for reasons other than Wall Street-like fixation on financial return.

So, which set of presumptions are correct?

Both sets are correct.

And herein lies the problem with non-accredited crowdfunding under Title III of the JOBS Act: it does not pick a consistent worldview, but instead hedges each feature of the exemption as though the fears of each camp are certain to be realized.

I happen to agree with the New York Times editorial board. For purposes of a federal law which preempts state law, crowdfunding should be limited to accredited investors. Accredited crowdfunding is supported by Title II of the JOBS Act, and the changes to Rule 506 that have been implemented by SEC regulation under Title II. There are transition headaches here, to be sure, but so far these accredited crowdfunding reforms are enabling (some would say, ratifying) significant changes in how angel deals are syndicated.

And I happen to agree with the aims of most of the non-accredited crowdfunding adovcates, though I believe Title III to be a lost cause, not worth fighting anyway because the proper place for non-accredited crowdfunding exemptions is at the state level, where rules can be scoped with local conditions in mind.

Photo: Rep. Patrick McHenry addressing the 2014 Angel Capital Association Summit last week.

Cherry blossoms

The Angel Capital Association 2014 Summit took me to Washington DC at the end of last week. I stayed over Saturday, mostly to take the opportunity to see Eddie Johnson play for the DC United football club at RFK Stadium, but also in the hope of seeing cherry blossoms at the Tidle Basin.

The cherry trees in DC were not in bloom.

But they are in full bloom back in my neighborhood in Seattle.

Cherry blossoms

SEC official to angel community: go ahead, develop your own verification methods!

Keith Higgins, the relatively new Director of the Division of Corporation Finance, delivered a speech at the closing session of the 2014 Angel Capital Association Summit - and was it a doozy!

A huge issue for angel investors is the "reasonable steps to verify" accredited status that is part of new Rule 506(c), which permits issuers to engage in "general solicitation." The issue was a focus of at least two breakout sessions at the Summit, including one Thursday moderated by ACA policy chair Mike Eckert that I participated in with the gifted lawyers Peter Rosenblum and Rob Rosenblum (not related), and an excellent breakfast briefing Friday from K&L Gates lawyers Gary Kocher and Kevin Gruben.

1842308438_83cb923365_oThe reason for such attention is the anxiety caused by the non-exclusive verification "safe harbors" set out in Rule 506(c). These verification methods contemplate that, going forward, an issuer is going to have to demand personal financial information from investors, or engage third party verification services to do so. To many readers of the new rule, including a majority of securities lawyers, the safe harbors - in spite of the "non-exclusive" label - feel destined to prove de facto requirement.

But Higgins said that needn't be the case.

In his speech (the full text of which you can access on the SEC's website), Higgins emphasized that if any verification standard might be core under Rule 506(c), it is the flexible, "principles-based" approach laid out in the inital release proposing the new rule:

"These [applications of the principles-based method] are all part of a deliberate effort by the Commission to provide issuers with an alternative to the clear but highly prescriptive list of verification methods included in the rule. In fact, it is ironic that this list of verification methods is being viewed by some as the primary way to verify a purchaser’s accredited investor status when, in fact, the Commission originally proposed the principles-based approach as the way issuers would comply with the rule’s verification requirement and added the list of specific verification methods only in response to address the concerns of commenters who wanted more certainty."

As Gary Kocher explained plainly in his breakfast briefing earlier in the day, lawyers are a conservative bunch, and naturally are going to navigate to the safe harbors. But, Gary stated he believed that the staff meant what they said in the rule and in the release, that the principles-based approach was viable. I think Higgins' speech completely validates Gary's view.

All of this portends well for verification methods based on the Angel Capital Association's Established Angel Group guidance, which would not require the turning over of sensitive financial information to issuers or their vendors.

As for seeking express SEC staff blessing of particular applications of the principles-based method of verification? Higgins seemed to say that was both not likely to be forthcoming anytime soon, and also beside the point:

"On that note, we have had recent inquiries asking whether the staff would provide guidance – presumably on a case-by-case basis – confirming that a specified principles-based verification method constitutes 'reasonable steps' for purposes of the rule’s requirement.  The notion of the staff reviewing and approving specific verification methods seems somewhat contrary to the very purpose of a principles-based rule and I am not yet convinced of the need for this type of staff involvement. Rather, this is an area where issuers and other market participants have the flexibility to think about innovative approaches for complying with the verification requirement of the rule and use the methods that best suit their needs. While the staff may not be in a position at this point to provide guidance on what constitutes 'reasonable steps' under particular circumstances, I also believe the staff will not be quick to second guess decisions that issuers and their advisers make in good faith that appear to be reasonable under the circumstances."

I should note that the angels I spoke to at the Summit, and the questions they posed in the breakout sessions, were more precisely focused on the definition of general solicitation and the activities at pitch events and the like that might push a company from 506(b) territory into 506(c) territory. But let's step back a second and look at the problem from just a story or two higher: to the extent that verification under 506(c) becomes more manageable, then the general solicitation issue becomes somewhat less of an existential distinction. (There may yet be reasons to avoid publicly soliciting investors - but that is another topic.)

Success for principles-based verification approaches will not be self-executing. Angels and their entrepreneurs will have to insist on them, and will have to make sure they have enough rigor to acquire respect. In the right circumstances, lawyers for a given deal might, just might, go along.

Drawing: "Principles Mound" by Paul Downey / Flickr.

Again, which kind of crowdfunding?

Over breakfast, I flipped the pages of a newsprint version of The New York Times and came across an article by Michael J. de la Merced, about a startup crowdfunding portal, called Junction Investments, that is focusing on Hollywood film financing.

Text at the bottom of the first column of the piece startled me into diverting more of my attention from my French toast to the paper:

"Perhaps [the] most notable change [brought by the JOBS Act] was that it blessed crowdfunding. Groups of so-called accredited investors – people who either make $200,000 a year or . . ."

Unexpectedly, I have been handed a coda to the discussion yesterday opening the 2014 Thompson Reuters Online Financial Symposium. At that event, we panelists had debated the right use of the "crowdfunding" term, with some of us eschewing it altogether as risqué; others of us applying it precisely to one subset of crowdsourced financing or another; and still others allowing the term to embrace almost everything, using adjectives to narrow its scope as necessary.

Here was a news article using the term "crowdfunding" to denote Title II crowdfunding limited to accredited investors. A sign, I thought, that an insurgent message (which I approve) is getting traction.

But what the first column inflated, the top of the second column deflated:

" . . . have a net worth of more than $1 million, excluding their home – can band together to buy up to $1 million of a company's equity."

Sigh. That confusion again, conflating JOBS Act Title II accredited crowdfunding with JOBS Act Title III non-accredited crowdfunding.

There is no $1 million limit under Title II, of course, anymore then there is any limit at all on what can be raised under a Rule 506 deal. The $1 million cap is a feature of Title III, still not implemented.


Again, which kind of crowdfunding?