SELC, ASBC Recommendations on Crowdfunding Legislation / S.1791 Review Soon

After discussions last week, Sen. Scott Brown's office (R-MA) asked the Sustainable Economies Law Center (SELC) and American Sustainable Business Council (ASBC) to submit their recommendations for S.1791, in descriptive form rather than changes to the bill's actual language. It's a great document-- see the whole thing below, and here's a summary:

Changes essential to success of legislation:

  • Individual investment cap at $1000 or 5% of annual income.
  • Exempt CF securities from state notice filings and fees.
  • Don't require an intermediary (crowdfunding platform) for exclusively local or in-state offerings.
  • Exempt intermediaries from both federal and state broker-dealer licensing requirements.
  • Allow individuals and regulated entities besides corporations to use CF exemption (S.1791 currently allows only corporations).
  • Guarantee SEC filing requirement for issuers to be just one page.

Other suggested changes, to improve legislation:

  • Require investors to declare that they aren't investing more than 10% of their income per year in CF-exempt offerings.
  • Add a lower-tier category with even easier compliance requirements for offerings capped at $100 individual investment.
  • Prohibit people who have been previously convicted of securities fraud from making offerings under CF exemption.
  • Limit offerings to one per person or entity year.
  • Require the formation of a non-profit governing body of intermediaries, presumably reporting to the SEC.

S.1791 is expected to be reviewed by the Senate Banking Committee before year's end.  If it passes (I think it will), then it will be need to be reconciled with H.R.2930.

Click here to download:
SELC-ASBC-comments-HR2930-S1791.pdf (64 KB)
(download)

SEC Forum Reports: Carleton, Priore / S.1791 Recommendations TK

William Carleton and Ken Priore both posted great reports on the SEC Small Business Forum last Thursday.  A crowdfunding exemption was definitely on the menu, and a couple of people expressed astonishment that the idea had come so far so quickly.  My favorite line is from Columbia Law professor John Coffee, paraphrased by Carleton: On crowdfunding: "A catchy, fashionable idea, tweeting for investors." As drafted now, should it pass, then we will see, every night in every bar in America, a Danny DeVito-figure hawking securities. "It would add some stigma to the securities marketing process."  (This sounds good to me, on all counts!)

I haven't heard how the rally outside the SEC went, but suspect that in terms of media attention, Occupy Wall Street's declared day of coordinated global demonstrations unfortunately took up all the reporters covering the outside-demonstrations beat.  It's too bad none dared branch out to learn about another grassroots revolution, but there was plenty of attention paid to crowdfunded securities inside the SEC that day.

Meanwhile, staff from the office of Sen. Scott Brown (R-MA) have been consulting on possible revisions to S.1791, hoping to appeal to "the other 99 Senators," as they put it.  They are of course well aware of the overwhelming majority with which H.R.2930 passed the House.  I hope to post some recommendations on S.1791 soon that I have read and am very excited about-- they're very well thought-through and inspiring. (I feel like such a wonk saying that.)

The Wall Street Journal and The Economist have articles; nothing new for readers of this blog, but good to see what's getting out there-- and the WSJ article has some lively discussion in the comments.

Here's a wonderful essay by Michael Shuman that I should have posted earlier (d'oh!): "Don't Occupy Wall Street, Ditch It."

And here's Steve Bradford's slide deck, from his SEC presentation last Thurs-- I linked to it before, but nicer to embed:

Click here to download:
sbforum111711-materials-bradford.pdf (368 KB)
(download)

McHenry at SEC Rally Tomorrow! (Please Support) / Hazen On S.1791, and New Draft / Fraud vs. Failure

Great news if you're going to Woodie Neiss's Rally To Make Crowdfund Investing Legal in front of the SEC tomorrow morning -- Rep. Patrick McHenry (R-NC), who introduced H.R.2930 and heroically shepherded it through to near-unanimous success in the House on Nov 3rd, will be speaking at the event!  If you're in DC, check it out tomorrow morning 8am-10am and then attend the SEC Small Business Forum in the afternoon.  (If the Forum format is the same as last year, the morning is all presentations, and the afternoon is where the discussion with the public happens.)

UPDATE: One of the morning presentations (slide deck) at the SEC will be by Steve Bradford, based on his paper "Crowdfunding and Federal Securities Law," which was posted here earlier.

If you can't attend the rally, please help support it, and talk it up!

Meanwhile, Prof. Thomas Lee Hazen sent a nice response to my recent comments on his article, along with a revised version of it (below), which includes discussion of H.R. 2930 and S.1791.  He writes:

Thanks for your comments.  I believe we are on the same page.  The House Bill as I understand it, like most of the proposals to date have virtually no or too little disclosure requirements.  The Senate Bill on the other hand seems to address the disclosure issues.  I have no problem with an exemption  conditioned on meaningful disclosure on the nature of the business and attendant risks.  The fact that investor risk is limited by setting a cap on the investment justifies a lower level of disclosure than would apply in a registered public offering.  However, it does not justify an exemption without any meaningful disclose requirements.

Feel free to post this on your blog.

Thanks Tom, I agree-- we are on the same page.  Lower investment should mean lower level of required disclosure, and higher for higher. His revised article, "Crowdfunding or Fraudfunding? Social Networks, and the Securities Laws – Why any Specially Tailored Exemption Should be Conditioned on Meaningful Disclosure" (below), gives some background on the House Bill and then argues:

The problem with the House Bill is that like the other proposals, the exemption is not conditioned on meaningful disclosure. In contrast, the proposed crowdfunding exemption found in Senate Bill 1791 would be conditioned on disclosure “to investors all rights of investors, including complete information about the risks, obligations, benefits, history, and costs of offering.” The proposed exemption would allow a maximum $ 1,000 investment per investor and further would be conditioned on an offering of no more than $1 million per year. This is clearly a step in the right direction. A viable crowdfunding exemption should include not only disclosure of the “risks, obligations, benefits, [and] history” of the offering but also meaningful disclosure of the nature of the business sufficient to enable investors to evaluate the merits of the securities being offered.

Click here to download:
Hazen crowdfunding draft rev1 ssrn nov 16.pdf (502 KB)
(download)

Another important point is that in typical early stage investing, honest failure is a much greater source of loss than fraud is.  Woodie Neiss and Kevin Lawton make a great argument about this here. So I think the question is, would this continue to hold true under a new crowdfunding exemption, or would such an exemption inspire significantly more people to commit successful fraud, lifting it to a comparable threat level as failure? The answer will of course depend on how the exemption is designed.

A couple of readers noted that the ATM argument in my last post is flawed, because each bank doesn't know about any other bank transactions.  Good point!  Such a scheme would require a global database variable for each individual (maintained by whom-- the SEC?) that updates their total no matter what actor or financial institution it originated from-- so yes, it's certainly doable, but not as simple as the check that ATM systems do on just the banks' own withdrawals.

Hazen Paper / Per Annum Invest Cap?

Thomas Lee Hazen at UNC Chapel Hill recently published a draft paper entitled "Crowdfunding, Social Networks, and the Securities Laws – The Inadvisability of a Specially Tailored Exemption Without Imposing Affirmative Disclosure Requirements."  You can check it out below or at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1954040.

Hazen is critical of recent crowdfunding exemption proposals because they dramatically reduce disclosure requirements. After citing several, he asks, "If the exemption is conditioned on limiting amounts from each investor, who monitor[s] investors’ claims that they meet the exemption’s qualifications?" He repeats the question later:

If, as the proposals suggest, the limited dollar exposure of each investor is a precondition of the exemption, who will monitor this? Will crowdfunding operations have to do their due diligence to assure than investors in fact qualify? If not, what is to prevent an investor from making multiple investments that are not in compliance with the exemption’s limitations?

I can't pretend to be a lawyer, but as an former software engineer, Hazen's question strikes me as akin to asking a retail bank, "If you limit the daily amount that I can withdraw from an ATM, what prevents me from going to an ATM multiple times and withdrawing more than the limit allows?"  The answer, I would assert, is a simple software check designed to prevent disallowed transactions.  Such a check might fail in the instance of an eager investor with multiple identities and SSNs, each having their own bank accounts-- but such an individual would be in violation of federal law already.

Hazen also suggests that "limiting investments to small amounts from each investor does little if anything to provide meaningful investor protection without either sophistication or disclosure requirements." He later elaborates:

Why does a small amount of money from many investors present less of an investor protection threat than more significant amounts of money from fewer investors? While the argument that the limited risk exposure per investor warrants less regulation may have some surface appeal, a deeper analysis does not support this as the primary basis for a specially tailored exemption.

In my reading of Hazen's article, this assertion seems unsupported. Consider an individual investment cap of $10, for example, or $0.01. If Hazen concludes that the possibility of losing $0.01 does not present "less of an investor protection threat" than the possibility of losing $10,000, I would like to see more of his deep analysis.

Having said that, Hazen's heart is clearly in the right place, and he brings up a point that did change my opinion, which I appreciate.  In a footnote citing some of his earlier work on gambling, he points out:

It has been suggested that people who cannot afford the risk are lured to gambling as a chance to hit it big in order to exit from their dire economic circumstances.

To me, this suggestion evokes the scenario of a big-hearted soul with little money but ample trust and optimism, who might come to ruin by repeatedly investing in ill-conceived (or fraudulent) schemes presented by various members of his or her community.  That's bad.  To mitigate this, I think there should be a cap not just on individual investment in a crowdfunded offering, but also a cap on an individual investor's total annual investment in exempted crowdfunded securities, perhaps three or four times the individual investment cap.  What do you think?

I do agree with Hazen that transparency and disclosure are important for any investment offering, no matter how limited. I just believe that the specific requirements for such can be lighter (as they are in H.R.2930 and S.1791) if only small-dollar investments are allowed, and that open communication will foster transparency and disclosure where it is most needed.

Click here to download:
SSRN-id1954040.pdf (520 KB)
(download)

S.1791 vs. H.R.2930 Legal Analysis; Nice McHenry Video

The text of S.1791 has been published, and William Carleton has a good analysis of how it differs from H.R.2930, along with some nice discussion in the comments.

Ken Priore also writes a fun report on S.1791 and H.R.2930, and anticipates that it should be fairly easy to reconcile the two bills.

Meanwhile, Patrick McHenry (R-NC), H.R.2930's original sponsor, has a sweet video promoting H.R.2930:

It's been out for a while, but I hadn't seen it.  I especially like the sound of the birds tweeting after he talks about letting everyday Americans invest in their communities.

UPDATE (Aug 2012)

I'm updating old blog entries to include linked screenshots to relevant external documents from around the same time. Here's one:

8 Nov 2011
Back to Work
by Bill Clinton 

On page 177 of this book about jobs and the economy, Clinton advocates a crowdfunding exemption, citing the White House OSTP proposal and McHenry's H.R.2930. He adds: "In 2010, the Sustainable Economies Law Center petitioned the SEC to allow investors to raise up to one hundred thousand dollars in contributions of no more than one hundred dollars per person. Even that would make a real difference. This is a reform that should get bipartisan support."

S.1791 (Brown, R-MA) in Senate Banking Committee

According to http://thomas.loc.gov/cgi-bin/bdquery/z?d112:s1791: S.1791 is a new crowdfunding exemption bill in the Senate; I'm not sure how it relates to HR2930 under Rule XIV in the Senate, if my report from yesterday was indeed accurate.  S.1791 is listed as "A bill to amend the securities laws to provide for registration exemptions for certain crowdfunded securities, and for other purposes."  It's sponsored by Scott Brown (R-MA) and it has been referred to Senate Committee on Banking, Housing, and Urban Affairs.  I haven't seen any text for it yet.

Some readers took the time to comment on my editorializing yesterday about lowering the individual cap-- I appreciate the input, which included the great point that it might be prohibitively difficult and draining for a small enterprise to maintain hundreds of investors.  Where the individual investment cap should be set is a tough question, and FWIW my opinions on this are not fixed.

SEC Forum and Rally Nov 17; HR 2930 Direct to Senate Floor (Unfortunately)

On November 17th, the SEC will hold its annual Government-Business Forum on Small Business Capital Formation, which is open to the public and is a great place to advocate for a crowdfunding exemption-- I went last year and it was definitely worthwhile.

On the same day, Woodie Neiss is organizing a Rally to Make Crowdfund Investing Legal in front of the SEC, to raise awareness of the issue and work it both inside and outside the SEC that day.  I think this will be a very constructive (and fun) demonstration, so please attend or contribute-- Woodie needs money to get the permit, rent a PA, etc.  I wish I could go, but I'm glad I can at least help crowdfund it!

Meanwhile, I hear that the Senate has begun the "Rule XIV" process for placing HR2930 on their calendar-- this is a 3-day process that's used for speed bills up, by which the Majority Leader can call them up for consideration by the Senate without their going into committee. This greatly reduces the opportunity for revision.

Honestly, I think this is unfortunate.  As thrilled as I am to see how far the idea of a crowdfunding exemption has come so quickly, I believe the $10K / 10% of income limit for individual investment is too high, and I was hoping that a Senate version would bring this cap down, perhaps influenced by state regulators.  Yes, I believe that the transparent and uncontrollable nature of crowdfunding makes it naturally resistant to scam-ification, but this exemption is still unknown territory.  It would be heartbreaking to see people's lives ruined because of some unanticipated result of this exemption.  I think it would be prudent to start with a lower individual limit, like $100, $500, or $1000. Then, if problems don't arise, raise the cap later.

In addition to fraud concerns, I would also want an individual investment cap that's low enough to be automatically uninteresting to detached investor types who only care about the return.  A lower limit would filter those people out while inviting smaller and more connected investors-- people who do want some stake in the venture, sure, but who are also interested in the idea itself or person pursuing it, and who want to participate in the community that forms around both.  Again, I'd say let's start small and then revisit.