The crowdfunding world has been abuzz with rumors that the rules for the crowdfunding provision of the JOBS Act—which would open up investment crowdfunding to all investors—will be finalized this fall. That timing was seemingly confirmed on Wednesday when S.E.C. Chair Mary Jo White told an advisory committee that final rules were coming “in the very near term.”
At the same meeting, the Advisory Committee on Small and Emerging Companies formally recommended changes to another rule, Rule 147, that could dramatically bolster intrastate crowdfunding.
A Watershed Moment
After enduring three years of promises by the S.E.C. that it would finalize the crowdfunding provision, also known as Title III, some industry participants are taking a “we’ll believe it when we see it” attitude. But if the final rules are indeed issued, and if they address troublesome aspects of the original rules, as seems the case, it will be a true watershed moment for investment crowdfunding.
“I am encouraged that the delay gave the S.E.C. time to fix the problematic issues that would hinder a healthy and viable marketplace,” said Kim Wales, an executive board member of the Crowdfund Intermediary Regulatory Advocates (CFIRA), and the founder of Wales Capital and CrowdBureau.
When the JOBS Act was signed into law in Aril 2012, Title III was widely hailed as the most revolutionary piece of the landmark legislation—which itself was the first major update to the nation’s securities laws in eight decades and attempted to fix a broken system of small business capital-raising. Yet three-and-a-half years later, Title III is the one JOBS Act provision that is still in limbo. The SEC issued draft rules in October 2013, but has been reluctant to finalize them.
With the exception of Title IV, better known as Regulation A+, Title III was the one piece of the JOBS Act that would impact ordinary investors, who, for the most part, are cut off from investing in all but publicly traded companies. And unlike Regulation A+, which is suited for growth companies with substantial capital needs of up to $50 million, Title III was aimed at helping small companies raise modest amounts of capital, up to $1 million.
The S.E.C. is expected to release the final rules, which would make Title III effective at last, in October or November, most likely at one of the agency’s scheduled small business events.
The question still to be answered is whether the agency will address some of the sticking points contained in its draft rules that industry participants contend impose unnecessary costs on issuers and crowdfunding platforms, and render Title III unworkable. Those issues include:
– A requirement that companies raising more than $500,000 provide audited financials. That was controversial because a professional audit by an accounting firm can be very costly for small firms, and audits are not required for most private placements.
– A $1 million cap on the amount that companies can raise. Critics say that is too low.
– Language that heaps liability on crowdfunding portals and hampers their ability to decide what companies can list on their sites.
Investors protections, such as caps on how much unaccredited investors can raise and company disclosure requirements, are likely to remain unchanged.
There are other elements of Title III that critics have taken issue with, but they are written into the law and therefore must be fixed by Congress, not S.E.C. rulemaking. A Title III re-do has been floating around the House of Representatives, but with the SEC poised to finalize the original rules, its prospects seem dim.
Fixing the Intrastate Exemption
While the S.E.C has stalled on Title III, an intrastate crowdfunding movement has flourished. More than 20 states to date have passed laws allowing any local business to raise money from any resident of the state.
The S.E.C. Advisory Committee on Small and Emerging Companies, a group of financial and industry professionals, also approved recommendations that would address some of the issues that have bedeviled the adoption of intrastate crowdfunding.
In particular, the committee recommended that offers made under Rule 147, the intrastate exemption, should be able to be viewed by out-of-state residents (although only in-state residents would be able to buy the securities). The current law prohibits out-of-state solicitation, which in practical terms prevents any Internet, social media or even newspaper or radio advertising, since it might possibly reach an out-of-state audience.
The committee also suggested removing the requirement that 80% of a company’s revenues and assets, as well as its use of proceeds, must take place within the state in order for them to use Rule 147.
The final recommendation relating to intrastate crowdfunding called for eliminating the requirement that eligible companies be incorporated in the state where they are offering securities. Many companies are incorporated in Delaware, for example, because of that state’s favorable business laws.
The S.E.C. must formally accept the recommendation and then put the proposed rule change out for public comment before finalizing it. That process could take several months.
The moves are encouraging an industry that has grown weary of waiting. “It looks like the market may get the boost it needs for more job creation and capital formation when the true vision of securities crowdfunding finally come together,” said Wales, the CFIRA executive, who is also an adjunct professor at City College of New York.