On July 1, as thoughts everywhere turned to the coming Independence Day holiday, securities regulators from New England’s six states gathered in Boston with a difference set of freedoms on their minds: how to streamline crowdfunding across their states and carve out a sensible approach to capital-raising in the region.
The meeting was part of an ongoing discussion among the six neighboring states—Vermont, New Hampshire, Maine, Massachusetts, Connecticut and Rhode Island—about how to address some of the thorny issues that have held back small business funding in their region and others, even as new avenues have been opened up by changes in state and federal securities laws.
The goal, said Michael Pieciak, Deputy Commissioner of the Vermont Securities Division, is “to make it easier for New England businesses to access capital in the region.”
The six New England states have all adopted or are preparing to adopt some form of intrastate crowdfunding, which allows small companies based in a state to raise money from residents of the state. Most of those laws are based on Rule 147, a federal law that creates a “safe harbor” for intrastate offerings. (Maine is one of the few states that have based their crowdfunding law on Rule 504).
Intrastate crowdfunding is great for community-scale offerings. But for many companies, especially those located near a state border, in a small state like Rhode Island, or an area with a strong regional identity, state borders impose an artificial boundary.
Therefore, the New England talks have centered on Rule 504 offerings, specifically on coordinating the review process across the six states and raising the $1 million capital-raising threshold for that exemption. The New England states have also traded notes on what is working in their states and what is not, and discussed ways they might work together to educate the public and entrepreneurial ecosystem about crowdfunding.
“A big component will be how to get the word out and do collective outreach.”
Other close knit states are holding similar talks, including New Jersey, Pennsylvania and Delaware, as well as Maryland, Virginia and Washington DC.
A separate effort to update Rule 147, the intrastate offering, to make it more useful is taking place at the Securities & Exchange Commission (SEC) and was the subject of a hearing in early June.
While a federal law allowing mainstream crowdfunding (Title III of the JOBS Act) is bogged down at the SEC, more than 20 states across the country have adopted intrastate crowdfunding. Another 20 or so states are working on similar laws.
Most of those intrastate laws build on the federal Rule 147. However, that exemption, created in 1974, comes with serious drawbacks that have limited its use, in particular a prohibition against advertising an offering across state lines. That makes it hard for companies to publicize their offerings on Facebook or other Internet sites. When states are in close proximity, even conventional channels like local radio and newspaper may run afoul of the law.
What’s more, federal securities laws take a broad view of what it means to make an offer, creating even more uncertainty for issuers.
Other drawbacks to Rule 147 include the so-called 80% rule, which specifies that 80% of a company’s revenues and assets must be located in the state where it is making its offering. That can be hard for a company to calculate, especially when they have online sales.
A third impediment is a requirement that companies must be incorporated in the state where the offering is being conducted—that rules out companies that incorporate in Delaware.
Issuers and crowdfunding platforms that are found to violate the law face stiff penalties. As a result, lawyers and crowdfunding platforms have been leery of advising their clients to use the rule.
“Rule 147, particularly in a geographic area like New England, makes it hard to meet the requirement that the offering (is contained) to one state,” said Pieciak, who also heads corporate finance for the North American Securities Administrators Association (NASAA).
Fixing Rule 147 was the topic of a recent hearing by the SEC Advisory Committee on Small and Emerging Companies on June 3rd. The committee recommended that the agency update Rule 147 to address the three major obstacles. A modernized Rule 147 would allow companies to advertise their offering beyond their state borders, as long as they restrict sales to in-state residents. And it would emphasize a company’s physical location, rather than its sales or place of incorporation, to determine jurisdiction.
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 a year or so.
Is Rule 504 the Answer?
In the meantime, the New England states are looking to streamline Rule 504 offerings across their regions. Rule 504, one of three rules that fall under the broad federal Regulation D exemption, allows private companies to raise up to $1 million from the public (both accredited and unaccredited investors) using general solicitation if they register with state regulators and file a public disclosure document.
As such, it is a flexible rule that avoids some of the pitfalls and restrictions of Rule 147-based intrastate crowdfunding. “Any regional approach would have to be under Rule 504,” says Pieciak.
There have been other efforts to make the state-by-state review process less burdensome for companies. The North American Securities Administrators Assoc. (NASAA) last year introduced a coordinated review process for Regulation A meant to make the multi-state review process less burdensome for companies. And there are regional coordinated reviews for Rule 504 on the books, however they are outdated and little used.
“In the last 20 years, I don’t think anyone has done a coordinated 504 review,” says Pieciak, the Vermont regulator who also heads NASAA’s corporate finance department. “So there is a mechanism, but the question is how can we update that, publicize it and what might that look like under this new modernized approach?”
A Regional Approach
The talks among the New England states are still in the early stages. One possible scenario is that a lead state would be designated, and other states in the region would agree to follow its lead in approving or declining an offering.
Or, the states could adopt something similar to the Regulation A coordinated review, where one state is the facilitator, collecting comments from the other states so that issuers need only deal with one consolidated comment letter.
A third possibility is that issuers could simply file a notice with the states, with no review.
In addition, Pieciak would like to see the $1 million aggregate fundraising threshold for Rule 504 raised, which is lower than what many states allow under Rule 147. “That’s a complaint we hear from issuers and their lawyers,” he said.
At the July 1 meeting, the six New England states agreed to go back and solicit input from key stakeholders in their states, including the legal and entrepreneurial communities, before reconvening in the fall. But rule changes and streamlined review are only half the battle, said Pieciak. One reason new capital-raising options have been slow to catch on is a general lack of awareness, he noted, so “a big component will be how to get the word out and do collective outreach.”