"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.


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)

Correction re: Senate CF Bill / Actual Text

Several readers have written to say that I got it wrong about the Senate crowdfunding bill, that the final legislation is more like Merkley's S.1970 than McHenry's H.R.2930, which became part of the JOBS act. Thank you for the correction! Brad McGee of iCrowd pieced together the actual text of the crowdfunding portion of the JOBS Act-- see below, and many thanks to Brad. I can't digest it now but look forward to doing so soon.

Click here to download:
McGee Crowdfunding Act.pdf (99 KB)

Signed Into Law Next Week

Many of you already know this, but a federal crowdfunding exemption is expected to be signed into law next week, probably next Tuesday. My mailing list and blog hasn't kept up with the rollercoaster of news around this over the past two weeks, but the upshot is:

1. The JOBS Act, which included legislation based on the original Patrick McHenry crowdfunding bill, HR2930, passed the Senate 73-26 on Thursday, along with two added amendments: S.1884 from Jeff Merkley (D-OR) and Scott P. Brown (R-MA), and S.1391 from Jack Reed (D-RI). These amendments do things that I like and have advocated for, so I'm pleased with how the legislation turned out.  I don't think Washington ruined the idea.  I think it benefited from collective wisdom and discussion, as crowdfunding legislation should. (The two crowdfunding proposals that emerged in the Senate after HR.2930 passed, S.1791 (Brown) and S.1970 (Merkley), turned out to be detours.)

2. Since the JOBS bill had amendments passed in the Senate (only regarding the crowdfunding component), the amended version needs to go back to the House for a vote. House Majority Leader Eric Cantor (R-VA) expects to schedule a vote early next week, and it's expected to pass as-is, because the GOP leadership doesn't want differences on the crowdfunding bill stop a big victory on the whole JOBS Act. The White House has said that the President will sign the JOBS Act into law without delay. After this, the legislation gives the SEC 270 days to make and enact the new rules.

I can't easily find the specific text of the amendments by themselves, although you can find their language mixed in with other proceedings via these two linksHere's an article from crowdsourcing.org that runs down the changes from the two amendments.  Assuming that this article is accurate, here are the changes:


1. Mandatory financial disclosures and tiered levels of assurance on their accuracy: < $100K offering: CEO must vouch; $100K - $500K: CPA certification; > $500K: CPA audited financials made public.  Sounds smart to me.

2. Companies are responsible and liable for the accuracy of the information they transmit. Of course, sounds great.

3. Intermediaries (platforms) are required, and they need to be registered with the SEC, but need not be registered broker-dealers. They can't give investment advice.  Intermediaries can certainly help with investor protection, oversight, and damage control. But this requirement leaves out businesses that are not tech-savvy or are in low-income neighborhoods on the other side of the digital divide. Those entrepreneurs should not be left out of the party, so I think the requirement for an intermediary should be waived in cases where the business is location-based and all of the investors reside within a 100 mile radius. That way someone could just put out a sign, talk to their customers, and raise investments that way-- and those investors don't need the same protections because everyone's close by and can check the business out in person. 

4. Scaled cap on individual investment: 2% of income for individuals earning up to $40K a year; up to 5% for investors earning up to $100K; and a cap of 10% for those earning above $100,000. This is important and great; my main problem with HR2930 has always been that the individual investment cap is too high, too risky, and tiering makes sense.

5. A minimum 3-week listing to closure period, to let the collective “wisdom of the crowd” identify possible fraudulent activity. This is important, as previously discussed.

6. Anyone promoting an investment needs to disclose if they are earning fees for doing so. Good idea.

Clearly, my thinking has tended to be pretty mainstream on this issue.  Some other people who advocated for this exemption are angry about the two Senate amendments and think they'll ruin it, but I think we wound up with a good balance. Of course, no one really knows yet. Time will tell.

JOBS Act Passes House (Second Time for CF Exemption) / All Eyes on Senate Banking Committee

The JOBS Act, introduced by House majority leader Eric Cantor (R-VA) passed the House with a 390-23 vote last Thursday. The package includes H.R.2930, the original CF exemption bill from Patrick McHenry (R-NC) that sailed through the House last November.  This puts the Senate Banking Committee in an interesting position.  Here's what Woodie Neiss reports:

We have this small window of opportunity to make Crowdfund Investing law over the next several weeks  [...] The Senate has been sitting idly even though a few Senators have tried to push Crowdfunding forward [S.1719 from Scott Brown (R-MA) and S.1970 from Jeff Merkley (D-OR)].  However both Senate Majority Leader Reid (D-NV) and Banking Committee Chairman Johnson (D-SD) refuse to bring it to vote.  Until now. 

2 days ago, the House took 6 of the Capital Formation bills that passed with almost unanimous bipartisan support (including our Crowdfunding bill), packaged them together into one (called the JOBS Act) and passed it again with overwhelming bipartisan support.  The President came out and endorsed this Republican-led initiative and now they are calling the Senate's bluff.  Either sit and do nothing and come election-time Americans will know that the Senate is the cause of the gridlock in DC or bring the bill (or their own version of the bill) to the floor to vote and act on our country's behalf.

When the JOBS Act was introduced, Senate Majority Leader Harry Reid (D-NV) said, "I look forward to moving these measures and our economy forward with the help of my Republican colleagues." Among CF advocates, it is hoped but not necessarily assumed that Reid and Senate Banking Committee Chair Tim Johnson (D-SD) want meaningful and well-designed reform, as opposed to nominal and symbolic pseudo-reform. Some see a message in the fact that Johnson didn't show up to the committee's March 6th hearing on capital formation, which he was scheduled to open-- he reported a prior commitment with the Energy Committee, which he is a member of. Meanwhile, reports are that state regulators and others are spending a lot of time and money trying to scare Congress away from passing a crowdfunding exemption, or at least to have it watered down to ineffectiveness.

Here's a sneaky example: On March 5th, a couple of days before the House vote on JOBS Act, two organizations called the Consumer Federation of America and Americans for Financial Reform sent a letter to all members of the House strongly opposing the act. I'm including the letter below because I think it's worth parsing. At the top of the letter, it says, "We are writing on behalf of the Consumer Federation of America and Americans for Financial Reform (“AFR”) to express our strong opposition to this ill-conceived legislation."  Then, if you skip down to the end of the letter, there's a long list of what appear to be signatories, including Common Cause, Consumers Union, CREDO Mobile, Move On, and many of the big labor unions and PIRGs. It looks like everyone opposes the JOBS Act.

But read the fine print above the "signatures" and you see that they actually aren't signatures at all -- it's just a list of "partners of Americans for Financial Reform," but "Not all of these organizations work on all of the issues covered by the coalition or have signed on to every statement."  Meanwhile, the only two real signatures on the letter are the Consumer Federation of America and Americans for Financial Reform themselves.  These two organizations wrote this letter "on behalf of" themselves (and no one else), which seems like a strange way to word things, and then listed all of their partners, signature style, at the end of the letter.  The only explanation I can think of is that this letter was intentionally crafted to mislead people who might just read the first paragraph, and then skip down to the end to see who signed it.  Is this tactic common in DC?  Do the neutrality-defending lawyers at the Consumers Union (for example) know that their organization's name is being used in this way?

Click here to download:
CFA-AFR-JOBS-Act-Letter-3-5-12.pdf (113 KB)
Contrast this dishonest letter with this February 29th letter from the Small Business & Entrepreneurship Council (whom Woodie has been working with), which supports CF exemption legislation and has the following as actual signatories, no trickery:

Harry Alford, President & CEO, National Black Chamber of Commerce
Kristie Arslan, President & CEO, National Association for the Self-Employed
Roger Campos, President & CEO, Minority Business Roundtable
Allen Gutierrez, National Executive Director, The Latino Coalition
Barbara Kasoff, President & CEO, Women Impacting Public Policy (WIPP)
Karen Kerrigan, President & CEO, Small Business & Entrepreneurship Council
Todd McCracken, President, National Small Business Association

So now we're all wondering what's going to happen in the Senate. It no longer looks like the CF exemption and its JOBS Act kin will die there, and hopefully it will find a champion in the Senate-- ideally a Democrat, but Jeff Merkley's bill in its current form is brain-dead and embarrassing.  It doesn't require an open means of communication among investors and offerors, which is essential to crowdfunding, and it does not not preempt state law, so it would basically have no effect.  What it authorizes is already legal, the one exception being that it allows for the creation of web-based intermediaries.  The tables are seemingly turned on this issue, with the Senate Dems starting out by working to preserve the 1%'s monopoly on independent investment opportunities.

Fortunately there's work going on to improve the proposal from the Democratic side in the Senate.  Michael Bennet (D-CO) is now collaborating on a new or significantly revised crowdfunding bill -- see his tweet from yesterday: "Crowdfunding passed the House 390-23 & I’m pushing it in the Senate. RT if you think letting small biz raise start-up $ online is smart."  Woodie has been working with the Merkley and Bennet offices and says that they understand that Merkley's original bill is too restrictive for CF to flourish under.

We have a small window of opportunity now, as Woodie says. Here's how you can help:
  • Call Harry Reid and Tim Johnson's offices to express your support for a meaningful crowdfunding exemption:
    Harry Reid (D-NV), Senate Majority Leader: (202) 224-3542
    Tim Johnson (D-SD), Senate Banking Committee Chair: (202) 224-5842
  • Tell the Senate to Legalize Crowdfunded Securities with a Full-page Ad in Politico - this campaign is even more important now, after last week's news, and there's not much time left to reach the goal.  If you've read this far, you can at least cough up a measly $5.
  • Register yourself on Legalizecrowdfunding.org
  • Retweet Bennet's tweet - hey, it can't hurt, but I'm reluctant to list this here since I think it's only marginally helpful. Please don't consider this by itself as "doing your part."

Politico Ad -- Please Fund! / LegalizeCrowdfunding.org / WH Startup Initiative / NASAA Proposal

Our Loudsauce campaign for an ad in Politico to nudge the Senate on CF is now live! Please donate, and spread the word: http://goo.gl/ZnHTl. The ad still has a few tweaks pending, and we may give it a more directly challenging lede (Dear Senate: The House and White House Agree... Why Don't You?), but you can see a near-final version below. It was written by Michael Shuman, author of The Small-Mart Revolution and Going Local, and designed by Jake Levitas, who created posters and other graphics for Occupy Wall Street.

We want to fund this soon. By all accounts, during this presidential election year, it will be near-impossible to get any new legislation passed if it doesn't happen soon.  This article from Portfolio.com (thanks, Kostas Stoilas!) makes the same point. I set the fundraising deadline to March 12, but sooner is better, and Politico needs about 1 week's notice to place an ad. We're figuring if we don't get some significant movement in the Senate by April 1, then there's no way-- no joke.

The ad will direct people to a new website LegalizeCrowdfunding.org, which Woodie Neiss and the Startup Exemption folks plan to launch tomorrow.  The site will include a form for people to register themselves as entrepreneurs who would benefit from a CF exemption, and then fill in a couple more fields (including their location). This info will be combined into a mouse-over map of the USA, with pop-ups showing all of the supporters, and how many jobs they hope to create through crowdfunding.  Nice!


In older news (catching up here) the White House called for a national crowdfunding framework in its Jan 31 package of pro-startup legislation, as covered here by William Carleton.

Carleton has also been covering the Jan 25th crowdfunding proposal from NASAA (state regulators), citing Jim Hamilton's discussion. The proposal requires intermediaries that would need to be registered broker-dealers (boo), but it has an aggregate individual investment cap and a 30-day escrow (good ideas). It also spells out regular reporting requirements. One major question not fully answered in my reading is that it proposes a new "Form CF" for issuers to file in their home state-- but I don't see any promise that this would be the only state filing required. Bad news if an issuer wants to offer to investors in multiple states and would need to file in every state that any investor resides in-- or, if not, by what date would all 50 state securities offices be able to agree, coordinate, and build the infrastructure for this?

Carleton also performed the public service of re-publishing the NASAA crowdfunding proposal draft, since it was removed from NASAA'a own site soon after it was published there.

Finally, this post from Carleton's blog discusses whether a CF exemption should (per S.1791) or should not (per H.R.2930) require an intermediary, aka a platform.  I think that non web-savvy businesses should be able to crowdfund small investments locally by putting a sign up and connecting personally rather than having to do it online, but I understand the argument both ways and see the benefits of registered intermediaries for control and monitoring. I'd say the ideal solution would be something like requiring an intermediary if investors reside over 100 miles away from the offeror's main business location, but not if they're all local.


CF Stuck in Senate / Upcoming Politico Ad / Heminway and Shelden

This Investment News article from Jan 1 (registration required) reports that the three crowdfunding exemption bills (H.R.2930, S.1791, and S.1970) are stalled in the Senate. On Jan 24th, it's still true.

To remedy this, a bunch of us will be launching a CF campaign soon to raise money to buy a full back-page advertisement in Politico, which is distributed in printed tabloid format in DC, and is reportedly read by congresscritters. According to Politico's rate card (PDF), a black-and-white full-page ad on the back cover will cost $13,680K.

Here's a draft (PDF below), still in need of a designer's touch.  Comments welcome, and please watch this space for when the campaign goes live.  Of course I hope you will contribute!  People in the Senate need to see that there is public interest and support for these proposals before venturing to consider them. That's not just our assumption-- DC sources have told us this.

Click here to download:
politico-ad-v4.pdf (94 KB)

Meanwhile, Joan MacLeod Heminway and Shelden Ryan Hoffman have published their final version of Proceed at Your Peril: Crowdfunding and the Securities Act of 1933 in the University of Tennessee Law Review.  It's comprehensive and current, and new tables in the back list and compare crowdfunding platforms worldwide-- a wonderful contribution.

Click here to download:
SSRN-id1986187.pdf (1.69 MB)

Two semi-random excerpt from Heminway and Hoffman's paper:

[...] it seems prudent to engage those involved in crowdfunding in the regulatory discussions in a meaningful way before Congress passes legislation that legalizes crowdfunded offerings of securities or the SEC publishes a rule proposal as part of the notice-and-comment process

Our approach encourages a balancing of issuer, investor, and regulatory interests in a manner similar to that involved in federal consumer protection regulation. The overall analogy to consumer protection is too complex to explore in any depth here. Suffice it to say, however, that there are both commonalities and differences in selling securities and other products at similar price points over the Internet.

On the latter point, I wonder if the newly-created Consumer Financial Protection Bureau
will have primary jurisdiction over CF, rather than the SEC.



Plug: MAKE Ultimate Kit Guide / More Grassroots Innovation and Economic Development

If you're interested in innovation (or just like to have fun) check out the MAKE Ultimate Kit Guide, which is available online (see below) or at newsstands nationwide. I may be biased since I worked on it, but it is an amazing document, like nothing you've seen before, and all of us at MAKE are so proud of it.

Many people aren't aware of this, but over the past couple of years there has been an explosion of artisan kit-makers creating wonderful, surprising, and innovative kits, particularly in electronics. The new kits scene has been drawing lots of young, enthusiastic electrical and mechanical engineering talent, and many successful grassroots startups have been growing out of it.  This special issue of MAKE (which is not included in a regular subscription) opens up this world by pulling the best of these kits together for the first time, and introducing you to some of the people behind them. You'll see 175 hands-on reviews and personal recommendations for electronics kits, crafts, robots, music, vehicles, food and beverage, science, sports, siege weapons, and more-- almost none of which you will find at the mall or in any other catalog.

In addition, the Ultimate Kit Guide has feature articles on the world’s worst and most dangerous kits, how you can build your own street-legal sports car, and how DIY medical kits are changing health care in the developing world. For Change Crowdfunding Law readers, I especially recommend the essay "Kits and Innovation" by MIT research fellow Michael Schrage on how kits drive technological innovation — and have since the dawn of the Industrial Revolution. Here’s Michael reading an excerpt from this revolution-minded essay, for your podcast-listening enjoyment.

I see kits as akin to crowdfunding as a medium for grassroots innovation and economic development-- but instead of aggregating human energy (money) around specific ideas, they aggregate human attention around specific sets of interconnecting and reconfigurable physical objects, and how they can be developed. More big companies are now beginning to see the value of "kit-ifying" their products by opening them up to user development, and as Michael Schrage's essay points out, the global DIY R&D brainpower that engages collaboratively with open standards and kits is far greater than the brainpower inside any secretive company department, no matter how many hot-shot engineers and designers they have hired.

Anyway, I apologize if you find this post too off-topic, but I'm excited about this magazine, think it would be interesting to most people who are drawn to crowdfunding, and I wanted to let you know!

MAKE Ultimate Kit Guide 2012
At newsstands nationwide - $9.99
Buy at Maker Shed - print: $9.99 / PDF: $699

S.1970 Text and Analysis / The "Tech-Sync" Attempted CF Fraud Story

The text of S.1970 has been published, and William Carleton has a great critical analysis.  S.1970 caps total offerings at $1M with audited financials / $500K without, and it sets a lower individual investment cap than its competing bills: $500 or 1-2% of individual income, depending on income, plus a $2000 cap on people's total annual investment in CF-exempt securities.  It also requires that intermediaries register with SEC, include warnings and investor education, and do background checks, as determined by SEC.

I haven't fully digested how it treats reporting and preemption/integration with state requirements, both of which are important, and it seems too needlessly heavy on reporting requirements.  But the major, killing flaw I see in S.1970 is that it has no provision for an open discussion forum or other means of communication among potential investors.  This is essential for tapping the "wisdom of the crowd" for vetting, anti-fraud, etc. -- which is the whole point of crowdfunding, and is more adaptable and smarter than fixed, detailed reporting requirements. 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;"

And here's S.1791, in its definition of "crowdfunding intermediary":

"(II) provides public communication portals for investors and potential investors;"

For a great specific example of how this works, here is an account by Andy Gelme of a fraudulent offer made on Kickstarter, for the "Tech-Sync Power System."  Long story short, someone claimed to have developed a replacement wall outlet that could communicate via wi-fi to iPhone and Android phones, plus Mac, Windows, and Linux PCs, for home automation use.  This seemed plausible and exciting, and 419 people ponied up $27,637 in pre-orders for the devices (even including installation, at higher "donation" levels).  But then some backers started reading the pitch more closely and saw red flags in both the technical claims made and the way the offering was structured. The discussed their concerns in the comments, and the collective intelligence changed its mind.  In the end, the offering was canceled, the offeror went AWOL, and no one lost any money.

For CF legislation, the Tech-Sync Power System episode underscores the need for a discussion forum (which should be open to everyone who registers interest, not just people who have already invested), and the value of a waiting period between investment and transfer to offeror during which open discusion can continue.

S.1970: Dem CF Bill in Senate / 14 Dec Hearing

I haven't seen the text yet, but last week Sen. Jeff Merkley (D-OR) introduced S.1970, the ambitiously-acronymed CROWDFUND Act (Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure) of 2011. Here is Merkley's press release; it sounds like it has a 1M cap on total offering, just like H.R.2930 and S.1719, and it was likewise referred to the Senate Banking Committee.  Co-sponsors are Michael Bennet (D-CO) and Mary Landrieu (D-LA).  Finally!  This is great news.

On Wednesday, the Senate Banking Committee will hold a hearing on "Examining Investor Risks in Capital Raising" and on Tuesday morning, the Small Business and Entrepreneurship Council is hosting a briefing "Crowdfund Investing: A Modern and Transparent Platform to Help Entrepreneurs Access Capital" at the law offices of Jones Day, featuring Woodie Neiss, Freeman White, and Karen Kerrigan.