October 24, 2013
By Caroline Lee, SELC Community Enterprises Law Fellow
The Securities and Exchange Commission (SEC) released the long-awaited Crowdfunding proposed regulations on October 23, 2013, over nine months after its deadline. The 585 pages of rules are open for public notice and comment for 90 days, and were supposed to come 270 days after the April 5, 2012 enactment of Title III of the Jumpstart Our Business Startups Act (JOBS Act). Title III mandated the SEC to draft an exemption to the registration requirements of Section 5 of the Securities Act of 1933 for certain crowdfunding transactions. The new Securities Act Section 4(a)(6), commonly referred to as the crowdfunding exemption, allows for the offer and sale of securities without formal registration provided that certain specific requirements are satisfied. The goal of the exemption is to provide additional financing mechanisms for small businesses, to stimulate job growth, and to open up the opportunity for middle- and lower-income individuals to invest and to participate directly in our capital markets.
And let’s not forget one impetus for these regulations–on July 1, 2010 the Sustainable Economies Law Center petitioned the SEC for a crowdfunding exemption to allow individuals to raise up to $100,000, subject to a maximum $100 per investor investment limit, via the sale of securities. The letter was received with much public enthusiasm, sparking numerous public comment letters in favor of such an exemption. However, over time the limitations on investors and the allowable investments have changed from the Sustainable Economies Law Center’s initial petition, likely due to the sometimes competing aims of the SEC to both protect investors and to facilitate capital formation while maintaining efficient markets.
Commentators were skeptical that the JOBS Act would actually achieve its primary objectives. Focusing on investor and market protection, many were concerned that the Congressional mandates embedded in the JOBS Act would make it difficult for small businesses to actually benefit from the exemption, as the compliance requirements may be too onerous and expensive for these emerging start-ups. In particular, the requirements that businesses hoping to raise over $500,000 must submit audited financials, if hoping to raise over $100,000 must submit reviewed financials and all must transact solely through an intermediary, which includes a registered broker or one of the newly created “funding portals,” impose significant hurdles for small businesses. Additionally, the JOBS Act requires: (1) the offering not exceed $1 million in a 12-month period; (2) limitations on individual investments based on income–the greater of $2,000 or 5 percent of annual income or net worth, if annual income or net worth is less than $100,000; and 10 percent of the annual income or net worth if the annual income or net worth is more than $100,000, and cannot exceed an aggregate of $100,000; and (3) the transactions must be conducted through a registered broker or the newly minted intermediaries called funding portals.
However, speculation on how the SEC will interpret this Congressional mandate is over—approximately 300 pages of the proposed regulations are devoted to a discussion of the SEC’s proposal including a detailed analysis of the crowdfunding exemption, the limitation on capital that can be raised, the investment limitations, the requirements for intermediaries, the requirements imposed on the new funding portals, issuers that are excluded from the exemption, and a liability scheme. The remaining 286 pages are devoted to additional analysis required under several statutes implicated when drafting new regulations including the Paperwork Reduction Act, the Small Business Regulatory Enforcement Fairness Act and the Initial Regulatory Flexibility Act Analysis. Much of this discussion focuses on the costs and benefits of the draft rules, determination of whether the exemption is necessary or appropriate for the public interest, whether the exemption adequately protects investors, and whether the exemption promotes efficiency, competition, and capital formation in our markets.
Stay tuned for further analysis of the SEC proposed regulations and how you can be involved in the notice and comment proceeding.