Tags: crowdfunding | SEC | proposal | investors

SEC Issues Proposed Crowdfunding Rule

By    |   Monday, 28 Oct 2013 01:23 PM

On Oct. 23, again without giving the customary week's notice, the Securities and Exchange Commission (SEC) voted unanimously to issue eagerly awaited proposed regulations to implement the crowdfunding provisions of the Jumpstart Our Business Startups (JOBS) Act of 2012.

In her opening statement, SEC Chairman Mary Jo White explained that crowdfunding has been used as a method for funding innovative and artistic endeavors, with contributors rewarded by something of value, such as recognition. Under the JOBS Act, they would now be able to receive securities, and this would provide a new avenue for small businesses to raise up to $1 million in capital in order to create jobs.

For some reason, participants in SEC meetings where regulations are adopted are loath to mention the length of the comment period, but by consulting the documents one can learn that the comment period is a generous 90 days.

Staff presenters explained that crowdfunding entails raising capital over the Internet and that this would be done both through traditional broker-dealers and a new vehicle called "funding portals," which would involve an entirely new regulatory program. The justification for requiring that intermediaries be involved is to provide a nexus for investor protection measures, as well as "educational material," given that the securities will be exempt from registration requirements. The portals would be required to register and to join the Financial Industry Regulatory Authority (FINRA).

Financial statements must be filed in accordance with generally accepted accounting principles, as well as information on the issuer, the business, the terms and related party transactions, accompanied by tax returns and certification by the CFO. The extent of required auditing would depend on the size of the company. There would also be regulations to exclude "bad actors" from the activity.

Among the SEC commissioners, Luis Aguilar warned that "Even the strongest supporters acknowledge that [crowdfunding] carries substantial risk." He pointed out that 70 percent of venture capital investors lose money, the investments tend to be "highly illiquid" and, therefore, investors may have to hold their stock indefinitely. Additionally, there are risks of fraud, self-dealing and over-reaching by management.

He invited public comment on the potential for "affinity fraud," which is targeted against ethnic and religious groups, and he called for a "proactive" approach of aggressive monitoring for potential fraud. (Aguilar might have added that even successful startup companies tend to depend on a single product, and once this product reaches its full potential, it is vulnerable to ruinous decline as its market is captured by competitors with newer technologies.)

Commissioner Daniel Gallagher praised FINRA for its work in helping to develop the proposal, and he noted that there are 295 questions for the public to discuss.

Commissioner Michael Piwowar recognized that the proposal this new funding mechanism "presents a number of challenges in developing a completely new framework that must protect investors from fraud." He expressed the hope that the investing public would benefit from early-stage investing based on "the wisdom of crowds."

Commissioner Kara Stein remarked that the SEC knows very little about the dynamics of this new funding method — who would take advantage and what abuses might occur. She invited comments in three specific areas: 1) ambiguity over the standard for determining who is eligible to invest based on income and net worth standards; 2) whether foreign portals should be allowed to participate if they agree to submit to conditions such as on-site examinations; and 3) how shareholder records would be maintained, perhaps with the help of third-party contractors, to ensure that issues can accurately determine who their shareholders are.

Later the same day, in opening remarks on legislation related to capital formation, Rep. Scott Garrett, R-N.J., took note of the Commission's steps toward implementing the JOBS Act, but he also took the opportunity to chide the SEC for changing the disclosure requirements for the lifting of the ban on general solicitation of qualified investors, because he believes the regulations put too much emphasis on protecting sophisticated investors, with the result that excessive compliance burdens are imposed on small businesses.

This proposal is certain to be highly controversial, and the public will have the opportunity both to comment on it and to follow the comment process through the SEC's website.

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Robert-Feinberg
On Oct. 23, again without giving the customary week's notice, the Securities and Exchange Commission (SEC) voted unanimously to issue eagerly awaited proposed regulations to implement the crowdfunding provisions of the Jumpstart Our Business Startups (JOBS) Act of 2012.
crowdfunding,SEC,proposal,investors
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2013-23-28
Monday, 28 Oct 2013 01:23 PM
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