“As the Commission may prescribe” – CROWDFUND Act Read-Through

I had low expectations for the CROWDFUND Act, but finally actually reading it, I think it’s OK, depending on how the SEC implements it.  Yes, an issuer needs to fill out a lot of information and get a review done for offerings over $100K and an audit for over $500K [corrected from original email/post; thanks readers!].  But many companies are now starting up specifically to facilitate this, in the newly-mandated role of “Funding Portal” (that’s the term that the legislation uses for crowdfunding platform or intermediary; get used to it). I expect and hope that these companies will streamline the process the way opening an internet storefront or filing taxes online has been streamlined.

I am not a lawyer, but it seems that Section 4A(f)(2) grants the SEC broad leeway regarding who’s eligible for the exemption and what the ongoing compliance burden will need to be after the security has been issued. I think it’s these things that will determine how useful and popular the new exemption is, and whether it works. I welcome corrections from anyone who knows more.  [UPDATE: Sara Hanks of CrowdCheck Inc., a securities lawyer who worked at the SEC, says: “The interplay between sections 13 and 15 of the Exchange Act, which determine whether a company has to register with the SEC, are complex and I could spend a long time giving you way more detail than you need. But in essence what the provision that you are looking at says is this: ‘if you are already registered with the SEC you cannot do crowdfunding.'” Thank you Sara!]

With a heavy burden, you risk the brain drain that Kevin Lawton describes (which might be a state brain drain towards states that quickly pass their own crowdfunded investing legislation under the federal intra-state exemption). But hopefully the SEC will see that openly-questioned and discussed offerings operate very differently from one-on-one boiler-room scams, and will give more weight to the actual evidence that crowdfunding fraud has been negligible so far (as Kevin also cites) over people’s speculations that it might be otherwise. If so, the SEC should give their rulemaking a lighter touch.

Crowdsourcing.org’s report on the final Senate CROWDFUND Act gives a good point-by-point description, comparing it with the original House bill that was based on H.R. 2930. Here are some additional notes from my read-through.  Here’s the text itself, and see below for links to sources it refers to, including the Securities Act of 1933.

4A(b)(1)(D)(i)(I) – The issuer of any CF-Exempt security must file their prior year’s income tax returns with the SEC and also make them available to potential investors (i.e. make them public).  This seems unnecessary, and will definitely make the exemption less attractive to trust-funders.

4A(b)(1)(G) – Issuer must file and make available “the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price.” I would rather see an explicit requirement that prices must be all listed and static until offering closes.  The wording here looks like it would allow dynamic pricing, so long as the method for determining the price was explained. The problem with this is, you could program dynamic pricing to create pressure: “Shares available are now for $5, but will go up 50 cents for every hour you wait– act now!”

4A(f)(2) – The exemption “shall not apply to […] any issuer who is subject to the requirement to file reports pursuant to section 13 or section 15(d) of the Securities Exchange Act.” These are the “Periodicals and other reports” and “Duty to file periodic reports” sections. These sections are long, and as far as I can tell from a quick look (tl;dr), they give the SEC authority to require whatever amount and frequency of periodic reports it thinks is necessary. “As the Commission may prescribe” is the phrase.  Section 15(d) suspends duty to file periodic reports when there are fewer than 300 shareholders of record, where “of record” is defined as deemed necessary. A limit of 300 doesn’t make sense with crowdfunding-sized numbers of shareholders.  I’d love to get some more informed opinions on this provision. [See UPDATE above, second paragraph of post.]

Section 3(a)(80) – definition of “Funding Portal
I don’t understand why this section of the legislation didn’t include the requirement of hosting an open discussion forum, since that’s essential to the crowd’s ability to root out questionable claims. Here’s the wording on this from H.R.2930:

“(10) makes available on the issuer’s website a method of communication that permits the issuer and investors to communicate with one another;”

The SEC can certainly require this in their rulemaking (it would be moronic if they didn’t), but it would have been nice if this were actually written into the legislation. 

SEC. 305. [of bill, not Securities Act) RELATIONSHIP WITH STATE LAW. Exemption preempts state registration requirements (yay), but state has jurisdiction and enforcement authority over fraud conducted in state.  State cannot collect registration fees for CF-exempt offerings unless issuer and owners of over 50% of stock are state residents.

Sources

CROWDFUND Act of 2012 (compiled by Brad McGee)

Securities Act of 1933 
Section 4 – p. 19 – location of new crowdfunding exemption as Section 4(6)
Section 3(a)(80) – definition of “funding portal” – defined in bill itself, not currently in Act
Section 12(a)(2) – p. 40 – liability

Securities Exchange Act of 1934
Section 3(a)(26) – p. 16 – Self-Regulatory Organization
Section 13 – p. 120 – Periodicals and other reports
Section 15(d) – p. 167 – Duty to file periodic reports

Code of Federal Regulations (CFR) Title 17, 230.262 – Regulation A – Conditional Small Issues Exemption (Part 230)