President Trump: It’s High Time for a few More Tweets to SEC Chairman Jay Clayton

[Originally published in Crowdfund Insider on August 28, 2018]

President Trump:  It’s High Time for a few More Tweets to SEC Chairman Jay Clayton

Any good litigator can tell you that the difference between success and failure is often the ability to ask the right questions – at the right times – and asking the right follow up questions.  This can be the difference between success and failure – and how long it takes to get there. Delays often have consequences.  And like it or not, when it comes to our government, delays are typically the order of the day.

Case in point: The Donald Trump “SEC Tweet”

Donald Trump shook the halls of the SEC’s headquarters on August 17 when  he so much as mentioned the SEC in one of his infamous Tweets.  Trump tweeted:

“In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. “Stop quarterly reporting & go to a six month system,” said one. That would allow greater flexibility & save money. I have asked the SEC to study!

Donald J. Trump

@realDonaldTrump

In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. “Stop quarterly reporting & go to a six month system,” said one. That would allow greater flexibility & save money. I have asked the SEC to study!

The response from the SEC’s Chair, Jay Clayton, was faster than a speeding blockchain.  Within hours Chairman Clayton issued a five sentence public statement, entitled “Statement on Investing in America for the Long Term.” Following are three of the five sentences of the Release:

“In addition, the SEC’s Division of Corporation Finance continues to study public company reporting requirements, including the frequency of reporting. As always, the SEC welcomes input from companies, investors, and other market participants as our staff considers these important matters.”

Yes, Mr. President, we at the SEC are already on top of this. We thank you for your input.

Others more steeped in the public markets dominated by institutional investors were less polite in reacting: no way they were going to invest large sums of other peoples’ money (not to mention their own) in public companies absent the full transparency that quarterly reporting ensures.

Unfortunately, our President asked the wrong question.

If you don’t ask the right question, you won’t get the right answer.  And if you are not adequately informed you are unlikely to ask the right question – at least not the first time.

In all fairness, our President is a creature of private markets and real estate. Undoubtedly, the regulatory structure of capital markets is not his strong suit.  To be blunt: he is no Joe Kennedy! (the first Chair of the SEC and the father of Jack Kennedy).  But what he surely understands is that most bureaucrats are neither risk takers nor innovators – especially if they value job security or their commercial value after leaving public service. Our SEC historically has proven to be no exception to this rule.

Bureaucrats need to do more than “study” an issue – especially when there is no deadline for that final exam. Sometimes bureaucrats need to be told what to do – by a higher authority.

The Right Question

To have asked the right question would have required some basic knowledge of SEC Regulation A+ and its modern origin, the Jumpstart Our Business Startups Act of 2012 (the JOBS Act).  Since 2015 we have had in place a regulatory structure which permits companies to raise capital from the public, and to take advantage of a reduced onramp to public reporting which includes semi-annual reporting!

One of the questions our President should have asked / Tweeted is whatever happened to raising the offering limits on Regulation A+ from $50 million per year, and how can we make this Regulation less burdensome to issuers and more attractive to investors? . In fact, when Congress passed the JOBS Act in 2012, it expressly directed the SEC to periodically study the question of whether the original $50 Million ceiling should be raised – and under what conditions.

Unfortunately, to the dismay of many, including two SEC Commissioners, the Commission is unwilling to even study this question through its rulemaking process.  In the words of Commissioners’ Hester Peirce and Michael Piwowar in April 2018:

“That said, the undersigned are persuaded that the time to commence that careful study is now, not when the kicked can comes to rest a couple of years down the road.”

A Suggested Answer to the Right Question

One possible answer to the question I posed might have been:  Raise the Annual Regulation A+ limit to $100 Million, but require that larger offerings be shepherded by a licensed broker-dealer to ensure greater protection for Main Street investors. But do not expect the SEC to study this issue any time soon.

And then there is Regulation CF

Many industry participants have long argued vociferously for raising the federal investing crowdfunding limit in Regulation CF to a level much above the current $1.070 Million limit – pegged at $5 million in the original draft legislation championed by Congressman Patrick McHenry in 2011.  Though there is disagreement as to how high is too high, there are many benchmarks to look to – including the $5 million crowdfunding limit in the State of Georgia, thanks to the efforts of a former businessman and current Georgia Secretary of State and gubernatorial hopeful,  Brian Kemp – not to mention our counterparts in the UK and the EU.

As Jim Morrison of the Doors reminded us: “You cannot petition the Lord with prayer.”

We cannot count on federal administrative agencies to innovate. Likewise, these innovations are likely to be slow in coming, if at all, if the public is dependent solely upon these governmental agencies.  And waiting on Congress to act is not usually a very sanguine option, given the seemingly perpetual state of Congressional gridlock.

Nor do I hold out much hope for public petitions calling on the SEC for change.  The SEC already has an institutionalized framework allowing for any member of the public to submit a rulemaking petition on its website. Unfortunately, in the past it has largely served as a graveyard for good ideas.

A recent case in point is the rulemaking petition submitted by Vincent Molinari back in March 2017, calling for the SEC to “study” the regulation of digital assets and blockchain technology – by way of a public concept release comment process.  So far, only one Release in July 2017, the so called DAO Release, addressing a very cut and dry issue for most securities lawyers (which is why I refer to it as the “Duh Release”), leaving the difficult questions unanswered.  Otherwise, no movement by the SEC to even “study” this issue with the participation of industry participants – through a “concept” proposal.  Only a steady barrage of informal admonitions by Chairman Clayton from the Bully Pulpit.

A Path Forward

Well, when things seem hopeless, as they sometimes do in life, humor may provide the only short-term solution.  Seems that the Bully Pulpit has proven to be the most effective means of change at the SEC – without the time, expense and formalities of rulemaking and legislation. Witness the barrage of public statements emanating from the SEC Chair since July 2017 – all but killing the ICO (Initial Coin Offering) market in the US.  So perhaps our President can fire a few more Tweets at the SEC – but this time better focused – and better informed.  After all, didn’t he run on a platform of reducing government regulations in order to create Jobs Jobs and more Jobs – till the country is sick of creating Jobs.  And after all, aren’t government regulations which unduly limit capital formation sorta like tariffs – with the same impact – sending economic growth (and jobs) off shore.

So how about taking to the Twitterverse (or otherwise) to encourage our President to send out a few short, well crafted, Tweets from his Bully Pulpit – with your idea for changing one unnecessary government regulation?

One thing is certain: When the President Tweets – the SEC Chairman Clayton is listening. If only our President could get his Tweets right the first time.


Samuel S. Guzika Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation.

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A PRIMER FOR DUMMIES – BLOCKCHAIN, ICOs and STOs


Beyond the Hype of ICOs and STOs

One can hardly read anything these days without at least a passing reference to “blockchain” and how it has the potential to change the world.  As  a securities lawyer my interest has been focused on how blockchain and cryptocurrency can assist my clients in raising money – the oxygen for entrepreneurs (and that dirty word, capitalism).

As of today the jury is still out. And frankly, most of us, including securities lawyers, remain confused as to how, if at all, blockchain technology will assist clients in raising capital for their businesses.

The bottom line: most emerging businesses will benefit, if at all, only indirectly, from the blockchain/token boom. Using one of the many traditional paths of raising capital, as expanded in 2012 by the enactment of federal legislation, the Jumpstart Our Business Startups Act of 2012 (the JOBS Act), remains the best path.

So called Initial Coin Offerings (ICOs) grabbed worldwide headlines in 2016 and 2017 as a way for blockchain-based businesses to raise capital – in large sums and with no dilution. In hindsight, what fueled these new offerings was simple: circumventing  regulatory protections to investors – in the US, developed over the past 80 years – administered by the US Securities and Exchange Commission.

The SEC began to weigh in very publicly on ICOs in the second half of 2017 – cautioning would be issuers of “tokens” or “coins” that these were likely securities. As such they needed to be registered with the SEC or sold under an exemption from registration.  So too  US exchanges which traded these new instruments.

Trends Emerge in 2018

With the SEC weighing in early and often in 2017, coupled with a host of headlines regarding failed and fraudulent ICOs alike, ICOs quickly became a dirty word – shunned by US financial markets.

What has emerged in 2018, on the coattails of ICOs are “STOs” – securities token offerings. Other than the fact that securities “tokens” are crypto, or digital securities, they bear no resemblance to the ICOs of the past.

Unfortunately, the hyperbole which has surrounded ICOs has carried over to STOs – and with it a great deal of misinformation and confusion.

To be sure, securities issued in digital form will have many potential benefits, as they can be more easily tracked, and controlled – through programming any number of features into the security token, including when the security token can be transferred, and to whom.  This is an important feature for regulatory minded issuers who have issued securities under an exemption from registration – and thus with restrictions on transferability.

However, securities token offerings are neither a new type of securities offering nor, in substance, even a new type of security. Rather, they might be best described as old wine in a new bottle.  The impact for most developing or mature businesses in the foreseeable future will be no more impactful than converting paper stock certificates to “book entry” ledger entries.

So if  you are a computer programmer looking for work, securities tokens will open up a whole new world in fintech.  But if you are looking to a Security Token Offering as a new and improved way to raise capital for your business, you are in my opinion, looking in the wrong place.

Posted in Capital Raising, Corporate Law, Crowdfunding, General, Regulation A+ Resource Center, SEC Developments, Security Tokens/ICOs | Tagged , , , , , , , | Comments Off on A PRIMER FOR DUMMIES – BLOCKCHAIN, ICOs and STOs

Fixing the JOBS Act Beyond JOBS Act 3.0: Follow the Money

[Originally Published in Crowdfund Insider on July 25, 2018]

Often repeated, but not always followed, is the advice: follow the money. Sometimes basic problems – and their solutions – are more readily understood (and solved) with this simple mantra.

Effective capital markets are no exception. They demand faithful adherence to this principle. Lose sight of this, and you will lose your way in the forest.

I was reminded of this lesson recently by a gentlemen who has earned the well deserved title “Father of the JOBS Act,” David Weild, whose credits include former Vice Chair of Nasdaq.  For those active in the capital markets and regulatory reform, his name is a household word.

Way back in 2011, on the eve of the genesis of the Congressional legislation that became known as the Jumpstart Our Business Startups Act of 2012 (the JOBS Act), Mr. Weild penned an article in the Wall Street Journal on a subject that has captured widespread attention in recent years: the need for capital markets with rules tailored to facilitate trading in small cap securities – often referred to as venture markets. The title:  How to Revive Small Cap IPOs.” 

The premise was simple. Absent federal legislation and SEC rulemaking which was “friendly” to the trading of small cap stocks in the secondary market, initial public offerings for these securities would be artificially limited. Friendly, of course, meant at the least, providing a market environment which would incentivize those in the business of buying and selling securities – licensed broker-dealers. Money naturally seeks “higher ground” – meaning higher returns.  According to Weild:

“What’s needed now is a new, parallel market for public companies under $2 billion in value. Trading rules in this new market would allow for higher commissions, which would provide adequate incentives for small investment firms to get back into the business of underwriting and supporting small-cap companies. The SEC could use its authority under securities laws to exempt this market from rules standing in the way, or Congress can step in.” [Emphasis added]

The concept of venture exchanges was nowhere to be found in the 2012 JOBS Act – more than six years later we are still awaiting updated legislation and SEC rulemaking to implement Weild’s vision of vibrant small cap markets.  But recognizing the need to adequately compensate licensed broker-dealers remains a lynchpin of unlocking the full potential of two JOBS Act reforms: Crowdfunding (Title III of the JOBS Act)) and Title IV (aka Regulation A+).

Regulation A+

I recently wrote an article in Crowdfund Insider discussing the subject of increasing the offering limit of Regulation A+ from the current limit of $50 million.  Moving up the limit to $100 million would likely attract greater attention from the broker-dealer community – and higher quality offerings. Thus far, the SEC has turned a blind eye and a deaf ear to increasing this limit, though the JOBS Act directs the SEC to periodically review and adjust this limit.

Less spoken to publicly are the current FINRA / SEC rules governing compensation in Regulation A+ offerings.

Though these offerings are akin to IPOs, permissible compensation to broker-dealers under FINRA rules is far less attractive than FINRA-allowable compensation for fully registered IPOs.  The problem is exacerbated by the inability of broker-dealers to utilize what is known as the “Green Shoe,” a commonly negotiated right in traditional IPOS – allowing the underwriter to purchase up to 15% of the offering amount, at the offering price – for a period of up to 45 days from the offering date.

Recently, at a Deal Flow Media Regulation A+ conference in Manhattan, Mark Elenowitz, CEO of TriPoint Global Equities, the most active broker in the Reg A+ space, confirmed that he has had discussions with the SEC to allow the use of the Green Shoe in best efforts Reg A offerings, so far without success.

And the inability of broker-dealers to utilize the Green Shoe in Regulation A+ offerings may explain the relatively poor aftermarket performance of the few Regulation A+ broker-assisted offerings to date.  With a Green Shoe in place, brokers are incentivized to price the offering on the low end of the offering range – hoping to profit from an active (hot) aftermarket above the offering price.  With the Green Shoe off the table, brokers are incentivized to price the offering on the high end of the range –increasing their aggregate dollar compensation as a percentage of the offering’s proceeds.

My take: unless and until Regulation A+ offering limits are increased, and broker-dealer compensation rules tailored to address the market risk of participants – both offering quality and deal flow will continue to suffer.

Regulation CF Crowdfunding – How Much Does Size Really Matter?

While permissible offering size matters, this is only part of the equation in facilitating active capital markets.  It seems that this message was completely lost on the 10 highly visible and distinguished signatories to a recently publicized letter to the Chairman of the SEC, requesting that the current $1,070,000 Regulation CF offering limit be increased to a lofty $20 million.

While larger deals could in theory benefit this market, there are equally compelling roadblocks to an expanded use of this exemption from SEC registration – which could easily be remedied by the SEC – and must accompany any increase in the Regulation CF offering limit if this is to be a meaningful exercise of SEC rulemaking power.

Courtesy not of the JOBS Act legislation, but in my opinion, short sighted and overly cautious SEC regulations, the SEC’s broker-dealer and funding portal compensation rules restrict the ability of market participants to receive equity-based compensation.  So called “warrant coverage,” a staple of most brokered private placements, are taboo under the SEC Regulation CF regulations.  So this is one more reason for a broker to avoid a Regulation CF offering, and instead opting for the more lucrative Regulation D private placements.

Certainly, modifying permissible broker/funding portal compensation is not the only fix necessary to improve Regulation CF, but it is a critical one. Simply raising the offering limits will not, ipso facto, attract capital.  The history of Regulation A+ is one recent example– where offerings of up to $50 million are allowed – but few if any companies have even come close to this mark. Nor is the issue of permissible crowdfunding compensation a new one for the SEC – it was raised repeatedly in SEC comment letters during proposed rulemaking, and was labeled by me in an article in Crowdfund Insider as one of the “six deadly sins” of Regulation CF rulemaking back in 2014 – something I referred to then as a “potential ‘industry killer’” for the fledgling investment crowdfunding market.  (So too, burdensome SEC rules requiring overly detailed annual ongoing reporting). And a self-inflicted wound by the SEC at that – limitations on broker/funding portal compensation was nowhere to be found in the original JOBS Act legislation.

And even enhanced broker / funding portal compensation may not adequately incentivize brokers to steer retail non-accredited investors to the most risky of investments – who are saddled  under FINRA rules with KYC (know your customer) responsibilities and the attendant liability to investors if the investment goes south.

So with all due respect to the signatories to the July 19 letter to Chairman Clayton, by taking a shotgun approach to Regulation CF fixes – simply focusing on increasing the permissible limits of a Regulation CF offering – rather than putting their best foot forward they may have shot themselves and the industry in the foot –- giving some credence to the somewhat Freudian typo in the first sentence of their July 19 letter:

“ We compromise the largest online crowdfunding platforms and industry influencers in the United States.” [Emphasis added].

I rest my case. Time for the SEC and FINRA to pick up the slack.


 

Samuel S. Guzik, a Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation.

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SEC Regulation A+, ICOs and Small Business Capital Formation: For Whom the Bells Toll?

[Originally Published in Crowdfund Insider on May 30, 2018]

If the Wall Street Journal is any indicator, so called Regulation A+ offerings, which sprung to life in June 2015, courtesy of Title IV of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act) and SEC rulemaking,  are (or should be) all but dead.

A series of articles penned by the WSJ in 2018 noted that only  a handful of offerings under Regulation A+ have garnered the interest of the broker-dealer community (as opposed to self-underwritten offerings), and it seems that all of these are trading lower than their initial offering price. So far, the WSJ concludes, not a good bet for investors.

Over the past few years many have touted the benefits of the new Regulation A+ as a “mini-ipo”, allowing private (non-SEC reporting) companies to raise up to $50 million annually from both accredited and non-accredited investors, receiving freely tradable securities under federal law, unlike Regulation D, which has a six or 12 month holding period.

The catch: the issuer would need to have the offering “qualified” by the SEC, which meant filing a short form registration statement with the SEC and undergoing an SEC review process.  And if the offering was successful, unlike Regulation D, an issuer would then have to file annual, semi-annual, and interim reports with the SEC, but with much lighter disclosure obligations than a “fully reporting” company.

A Growing Consensus – The Regulation A+ Glass is Only Half Full

But if the opinions of small business stakeholders on Main Street are any indicator, the Regulation A+ glass is only half full, at least according to the overwhelming consensus of participants in the SEC’s 2017 Annual Government-Small Business Forum.

Also in accord, the opinions of Congress and the U.S. Treasury Department. And most recently, as discussed below, a newly formed trade association, Institute for Blockchain Innovation has weighed in on the benefit of utilizing Regulation A+ for offering freely tradable blockchain-based securities to both accredited and non-accredited investors.

So if the proverbial bells are tolling, they are tolling not for Regulation A+, but rather for the seeming complacency of the Commission – dragging its feet when it comes to any expansion of the use of Regulation A – and with less than the expected transparency.

You see, at the SEC’s 2017 SEC Annual Government-Business Forum on Small Business Capital Formation the participants ranked, in order of importance, 20 issues regarding small business capital formation, for further consideration by the SEC.

Number two in the ranking comprised six subparts, each addressing suggested future rulemaking by the SEC intended to enhance the operation of Regulation A+.  One of these recommendations: increasing the $50 million offering limit to $75 million; and a second proposal – to expand the use of Regulation A+ to all companies, reporting and non-reporting, not only private, non-reporting companies.

Six months later, there are no signs that the SEC is preparing to act on any of these recommendations. Indeed, one of these recommendations, that the $50 million offering ceiling be raised to $75 million, was expressly rejected by three of the five members of the Commission in April 2018 in a thus far unpublished letter to the Senate Banking Committee.

Under Title IV of the 2012 JOBS Act, the initial $50 million offering limit was set by Congress, but Congress also directed the SEC to review this ceiling every two years – with no upper limit set in the original law. Six years later the Commission has declined to increase this limit.

This latest failure of the Commission to act did not go unnoticed by two of the five Commissioners. In an unusual public communication, two of the five Commissioners, Hester Peirce and Michael Piwowar, in a letter penned to the Senate Banking Committee, called for their fellow Commissioners to give further consideration to increasing the $50 million annual limit:

“We share the views that animated the Treasury Report’s recommendation that the Tier 2 offering limit be increased to $75 million. Indeed, we also share this perspective with the bipartisan group of 246 members of the House of Representatives that recently passed the Regulation A+ Improvement Act of 2017 (H.R. 4263), which similarly called for an increase of the limit to $75 million.”

They further stated:

“As Commissioners of an independent regulatory agency, calibrating an appropriate Tier 2 limit is a matter for rigorous analysis via the standard notice and comment rulemaking process, conducted in full compliance with the Administrative Procedure Act. That said, the undersigned are persuaded that the time to commence that careful study is now, not when the kicked can comes to rest a couple of years down the road.”

Regulation A+ – Congress Lights a Fire Under the SEC

And in a little noticed piece of legislation signed into law in May 2018, Congress directed the SEC to amend its rules to allow both reporting and non-reporting companies to utilize Regulation A+, something allowed under the JOBS Act, but foreclosed by the SEC in subsequent rulemaking.

This small legislative change could prove to be significant to reporting companies whose shares trade on the over-the-counter markets, such as The OTC Market, versus a national exchange such as Nasdaq or the NYSE.

Once the SEC implements this new law, a reporting company which trades on the OTC market will be able to utilize Regulation A+ to reach an unlimited number of non-accredited investors outside of a fully registered offering – and without being subject to state Blue Sky laws.

Prior to this change, OTC companies would not only be barred from using Regulation A+, but if they wanted to reach more than 35 non-accredited investors in an offering, they would have to register the offering with the SEC. And unlike their peers who are trading on a national exchange, even in a fully SEC registered offering a non-exchange listed company would still need to navigate the labyrinth of state Blue Sky laws – as current law only exempts exchange listed companies from complying with state Blue Sky laws.

So by Congress passing this law, for the first time smaller reporting companies will not only have access to the Regulation A+ exempt offering process, allowing them to reach an unlimited number of non-accredited investors – without conducting a fully registered offering – they will also be able to do so and without complying with state Blue Sky laws – something they are still required to do in a fully registered offering.

And How About the SEC Raising that $50 Million Offering Limit?

So what’s behind the Commission’s refusal to even consider acting on an increase to the $50 million ceiling – six years after the passage of the JOBS Act? It’s not for a lack of credible support: apart from the very recent views of Commissioners Peirce and Piwowar, former SEC Commissioner Dan Gallagher called for an increase of the $50 million limit to $75 million or $100 million when he was a Commissioner back in September 2014, before Regulation A+ was enacted by the SEC, in an address delivered at The Heritage Foundation, entitled “What Ever Happened to Promoting Small Business Capital Formation?

Perhaps part or all of the answer for the continuing delay in even considering an increase to the Regulation A+ offering limit lies in a three letter acronym: ICO – initial coin offering – the letters that have struck fear in the hearts of many government regulators worldwide over the past two years.

You see, since July 2017 the SEC has, understandably, done a full court press (aka “fire and fury”) to force would be ICO issuers to either register their coins, or tokens, as securities, or to sell them under one of the available exemptions from registration.

Thus far, some token issuers have taken their offering off shore to friendlier (or less hostile) jurisdictions. Those in the US have continued to rely on an exemption from registration, Regulation D, which does not require SEC review, has no limitation on offering amount, but restricts the pool of US purchasers to “accredited investors.” 

The open question, however, for would be ICO issuers is how to expand the circle of token purchasers outside the circle of an estimated 8 million US accredited investors – to include the tens of millions of non-accredited US investors – and provide immediately free trading digital securities.

Enter the JCO – The Hybrid Regulation A+ “JOBS Crypto Offering”

The answer proposed by a recently formed trade association, Institute for Blockchain Innovation, boasting 60 industry members including Indiegogo, Finova, and 500 Startups, is the “JCO” – “JOBS Crypto Offering.”

The so called JCO is essentially a two-step process, whereby an issuer first conducts an offering to accredited investors under Regulation D, and then follows this with either a Regulation A+ offering or a fully registered offering.  This second step allows an issuer to include non-accredited investors in the offering. More importantly, by utilizing Regulation A+, or a fully registered offering, the investors will receive securities (e.g. tokens) available for immediate resale under federal law, compared to the 12 month holding period under Regulation D for private company offerings.  And it is widely anticipated that a secondary marketplace, dedicated to blockchain based securities, aka digital securities, will be operational later this year under the auspices of tZero, a subsidiary of Overstock.com.  Others are expected to follow tZero’s lead.

Perhaps there were some at the Commission who not only saw the same path for compliant token offerings – utilizing Regulation A+ – but also cringed at the thought of expanding the potential offering size from the current $50 million to $75 million or $100 million, as many have suggested – especially in the wake of extremely high risk, and in some cases fraudulent offerings that have characterized the ICO marketplace.  Perhaps there were some at the Commission who also perceived that their plate was already overflowing with an onslaught of SEC enforcement actions directed at non-compliant and fraudulent “coin” offerings.

This is, of course, speculation, but there is other foot dragging at the Commission level which lends credence to a real concern that the voice of small business is being ignored by the Commission, even in the face of Congressional mandates.

And What Ever Happened to the SEC Office of Small Business Advocate?

In December 2016 then President Obama signed into law a bill, entitled the SEC Small Business Advocate Act of 2016, approved unanimously by both houses of Congress, with the support of the U.S. Chamber of Commerce and the National Venture Capital Association, among others.  The bill directed the SEC to establish an independent Office of Small Business Advocate, reporting directly to Congress, a proposal that was first publicly advocated in February 2014 in my article on Crowdfund Insider, and later publicly championed by former SEC Commissioner Dan Gallagher.

Also placed under the umbrella of this new Office would be the SEC’s Small Business Capital Formation Advisory Committee, something that had operated on an ad hoc basis in the past, now codified into law.

Largely patterned after a similar law, part of the Dodd-Frank Act of 2010, which established an Office of Investor Advocate at the SEC to protect the interest of investors, the SEC Small Business Advocate Act of 2016 was intended to provide small business with a dedicated, independent voice to advocate for issues involving small business capital formation.

So where is the SEC’s Small Business Advocate today?

Though the SEC publicly cast a broad net for potential applicants back in the fall of 2017, with the application window closing in October 2017, to date there have been no formal pronouncements by the Commission on the status of this new office.  Adding to the mix, the SEC’s Small Business Capital Formation Advisory Committee was dissolved in September 2017, awaiting its reconstitution under the auspices of the new Office of Small Business Advocate.

And what does the SEC’s Chairman, Jay Clayton publicly have to say about all this? Not much – at least since his remarks on November 30, 2017 at the SEC’s Annual Government Small Business Forum:

“Additionally, we are taking steps to fill the position of the Advocate to head the Commission’s new Office of the Advocate for Small Business Capital Formation. The Advocate will be a powerful voice for small businesses across the country, providing assistance, conducting outreach to better understand their concerns and recommending improvements to the regulatory environment. The Advocate also will be responsible for organizing this annual Forum and will become a member of our Small Business Capital Formation Advisory Committee. I anticipate that the Commission will select the Advocate in the near future.”

Six months later – only crickets – not even bells tolling. No Office of the Advocate for Small Business Capital Formation – no Small Business Capital Formation Advisory Committee.

Meanwhile, many issues that could benefit from an independent advocate, not to mention an independent advisory committee, such as expanding Regulation A+ or focusing on an appropriate regulatory framework for blockchain-based securities – are seemingly being “kicked” down the road.

So, most respectfully, perhaps it is high time for the Commission to reconsider its priorities – and address the question posed by then SEC Commissioner Dan Gallagher back in September 2014: “What Ever Happened to Small Business Capital Formation?”


 

Samuel S. Guzik, a Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation

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The SEC and Regulated ICOs: Be Careful What You Wish For

[Originally Published in Crowdfund Insider on November 12, 2017]

 Man Proposes and God Disposes

On November 8, at an Annual  New York City gathering of securities professionals, SEC Chair Jay Clayton went off script – and in doing so provided what is likely to be the clearest guidance we can expect to receive from the SEC in the very near future on the much debated question: when are “coins” or “tokens” securities – or not?

The consequences of guessing wrong on this one are serious and unforgiving – to both coin “issuers” and investors.  There is no margin for error – and the price for those who choose to go it alone – without seasoned securities counsel – will not be insignificant.

Only two days before Jay Clayton’s remarks, in an article I penned on Crowdfund Insider calling for the SEC to provide greater regulatory clarity on the scope of its jurisdiction over ICOs, I mused:

“I obviously cannot speak for the SEC’s new Chair, Jay Clayton. But I can hope to influence thought – and perhaps successfully make the case that, as far as the jurisdiction of the SEC is concerned, we are in the midst of a crisis.  And the answer is not simply general pronouncements or stepped up enforcement.  What the ICO marketplace needs, at the very least, is detailed, authoritative guidance on some very basic securities issues.” 

Two days later, though his remarks were lacking in detail – they were not lacking in substance or impact.

The ICO industry is now doing “damage” assessment – expect to see a great deal of industry head spinning – and pivoting.

Well, the Chair of the SEC just cut right to the chase on Wednesday, bypassing committees and formal rulemaking.  His official, scripted remarks provided no new insight. But the repetition of earlier, similar SEC caveats to the ICO markets was in and of itself significant:

The Official Remarks:

Initial Coin Offerings.There is also a distinct lack of information about many online platforms that list and trade virtual coins or tokens offered and sold in Initial Coin Offerings, or ICOs. Through these platforms, individual investors can buy and sell tokens in the secondary market using virtual or fiat currencies. But investors often do not appreciate that ICO insiders and management have access to immediate liquidity, as do larger investors, who may purchase tokens at favorable prices. Trading of tokens on these platforms is susceptible to price manipulation and other fraudulent trading practices.

The Commission recently warned that instruments, such as “tokens,” offered and sold in ICOs may be securities, and those who offer and sell securities in the United States must comply with the federal securities laws. The Commission also cautioned that any person or entity engaging in the activities of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration. In addition to requiring platforms that are engaging in the activities of an exchange to either register as national securities exchanges or seek an exemption from registration, the Commission will continue to seek clarity for investors on how tokens are listed on these exchanges and the standards for listing; how tokens are valued; and what protections are in place for market integrity and investor protection.

His unscripted remarks were more impactful, as reported by Dave Michaels at the Wall Street Journal.  In an article entitled “SEC Chief Fires Warning Shot Against Coin Offerings,” it reported:

’I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security,’ Mr. Clayton said in an unscripted remark delivered in the middle of a speech at the Institute on Securities Regulation in New York Wednesday .

And the conclusion drawn by the Wall Street Journal:

“Mr. Clayton’s remarks suggest firms using the coin offerings, also known as ICOs, to raise cash in the U.S. may need to register the deals with the SEC and provide investors with extensive disclosure documents, depending on how broadly they market them. Startups that once conducted virtually unregulated token sales will likely have to consult lawyers and other gatekeepers to advise them on how to navigate laws and rules overseen by the SEC.”

An article published on CoinList had a different take:

Implications of SEC registry means teams of attorneys for future ICOs.”

Taking a Page from the SEC’s Israeli Counterpart

Earlier that day we heard from Chair Clayton’s Israeli counterpart, Professor Shmuel Hauser, Chair of the Israel Securities Authority (ISA), from a Fintech conference in Tel Aviv, with his measured assessment of the ICO market:

“We’re going to look at the ICO industry on a case by case basis, not ban it altogether.

 

But first, we have to decide whether it’s a financial tool that falls under our jurisdiction. If it’s a coin and not a security, it doesn’t fall under our jurisdiction. Maybe we can regulate it through corporate laws, but not necessarily by securities laws.

 

I’m bothered by the lack of transparency in the ICO industry. I say to the investors – beware! It might be a bubble. And as for us, I say that what is legal now, might be illegal tomorrow.

 

ICOs are a part of a welcomed evolution in the funding industry. But it needs to be properly managed and regulated.”

Unlike the SEC, however, the Israeli ICA has already formed a special committee to study this area, and its findings and recommendations are expected to be reported by the end of the year – this year. 

Though it is too soon to expect any formal rulemaking or interpretive releases in the US,  the Commission ought to engage with industry stakeholders on a formal basis – attorneys, computer geeks, game theorists, state regulators and economists, to name a few – whether it be by way of an ad hoc advisory committee or industry roundtable.  This area is complex – and practical solutions require multi-disciplinary input.

There is of course the obvious question – when should a token offering be under SEC jurisdiction?

Notwithstanding recent remarks by Chair Clayton, it is not sufficient for issuers to simply “play it safe” and find an available SEC exemption under which to conduct their “crowdsale.”  US issuers will require liquid, SEC compliant secondary markets if this market is to grow and thrive under SEC regulation.

On this, tZero, a subsidiary of Overstock.com, may be the first out of the gate – recently approved by the SEC – as a registered Alternative Trading System (ATS), expected to be up and running by mid to late 2018.  But to be listed for trading on tZero, your token will have to be a “security” under SEC rules. If it is not, tZero risks being shut down by the SEC as a non-compliant ATS.  So unless your token is “clearly” a security, determined in the first instance by tZero, your token may wind up trading in a gray cloud somewhere.

So it is not enough for coin issuers to play it safe and find an available SEC exemption, such as a Regulation A+ offering to the public or Regulation D offering limited to accredited investors. Nor can issuers simply (safely) take the position that their tokens are not securities if they have “utility” – once the issuer launches its network – as many have done thus far. 

Absent clear guidance from the SEC, rightly or wrongly, your token may find itself shut out of secondary securities markets.

In the meantime, the only safe route for any US based company seeking to conduct an ICO is to consult seasoned securities attorneys and investment professionals, and plot your best course forward in these uncharted waters.


 

Samuel S. Guzik, a Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. In 2014, some of his speaking engagements have included leading a Crowdfunding Roundtable in Washington, DC sponsored by the U.S. Small Business Administration Office of Advocacy, a panelist at the MIT Sloan School of Business 2014 Crowdfunding Roundtable, and a panelist at a national bar association event which included private practitioners, investor advocates and officials of NASAA. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation. Mr. Guzik was also instrumental in the passage of legislation in 2016 calling for the creation of an independent office of small business advocate at the SEC, and was the first person to advocate publicly for this legislation – on the pages of Crowdfund Insider.

Posted in Capital Raising, Corporate Governance, Corporate Law, General, SEC Developments, Security Tokens/ICOs | Comments Off on The SEC and Regulated ICOs: Be Careful What You Wish For

The SEC, the ICO and Avoiding the ICU: A Call for Leadership and Action

 

[Originally Published in Crowdfund Insider on November 6, 2017]

As a securities lawyer and a sometimes advocate for smart regulation of capital formation, I must confess: When it comes to addressing the current state of the Initial Coin Offering (ICO) marketplace, I believe that market participants face a crisis of growing proportions. No Hype needed here – headlines of all sorts populate the Internet on a daily – if not hourly – basis.

The crisis I see is not necessarily the dearth of government regulation. Rather it is the degree of uncertainty in our existing regulatory structure.  When it comes to the role of the SEC, there is too much uncertainty – and a vacuum of public pronouncements of any use to market participants who wish this ship to float – and not sink.  More on this below.

Thus far, it seems that only the crooks are attracting much regulatory attention. Yes, enforcement is important – and there is a natural tendency towards going after the low hanging fruit – the obvious (and perhaps the not so obvious) frauds.  But as far as providing regulatory guidance to market participants, the SEC has thus far fallen flat – at least based upon their public pronouncements to date.

This inaction is understandable.  We are dealing with extremely difficult “facts and circumstances” legal issues, in an area that is both fast moving and complex – so much so that this burgeoning world of “crypto” currency might more aptly be named “cryptic” currency.  But the price of inaction I believe is a costly one.

Vast sums of money are flowing into the ICO marketplace – real dollars into the billions –which can be put to good use to create measurable value added in the US economy – accelerate the development and utilization of groundbreaking technology – and jobs.  But legitimate market participants abhor regulatory uncertainty. 

A gating issue, such as whether an ICO involves a “security” – subjecting it to SEC regulation – is not a simple one.  And taking the wrong path carries with it serious consequences – starting with a free investor “put” under the Securities Act of 1933 if security ICOs are sold to the public without first registering the offering or conducting it under an exemption from registration – a “put” which could bring an ICO issuer (and offering participants) down before it has the opportunity to get up and running. Simply put, after your ICO “party” you could find yourself in triage in the ICU (intensive care unit).

And there is a second, often overlooked gating issue. If your ICO involves an “equity security” (not the same as mere “security”), and you are lucky enough to raise over $10 million and attract thousands of token owners, the issuer will be required to register under another US securities law, the Securities Exchange Act of 1934, after the ICO closes, and forever be required to file 10-Ks and 10-Qs with the SEC (or face potentially draconian penalties for failing to do so).

So How are Marketplace Participants Handling the Regulatory Uncertainty?

Well, as best they can, given the current uncertainty in US securities laws and the, thus far, muted pronouncements of the Commission on this subject.  And let me say at the outset, my hat is off to the brave pioneers in this area.  But I am also reminded of the Biblical Moses – who wandered in the desert for 40 years in search of the Promised Land – but never lived to see it.

Two of the early pioneers in this area are FileCoin, counseled by the Cooley law firm, and Cappasity, counseled by DLA Piper – legal powerhouses to be sure. Both followed a similar approach in structuring their ICO “pre-sales.” And both appeared to share the same opinion as to whether the underlying “tokens” were securities.  Let’s take a closer look.

Each of these offerings involved the sale of a security referred to as a SAFT – Simple Agreement for Future Tokens.  The SAFT represents the right to purchase, at a discount, tokens to be issued in the future upon the launch of the issuer’s network.  Each of these issuers treated the SAFT as a security, and sold the SAFTs under one of the new JOBS Act exemptions, Rule 506(c), which allows companies to escape registration, but solicit publicly, by limiting the purchasers to verified high net worth (accredited) investors.  But each of these issuers opined that the tokens themselves, when later issued and sold to the public, would not be offered and sold as “securities.”  Hence, no need to register the token’s offer or saleto the (non-accredited) general pubic when the network launches. And no need to become a fully reporting issuer under the Securities Exchange Act of 1934.

The FileCoin offering was interesting in that not only did it create the obligatory “White Paper” immediately preceding its offering, but its counsel, the Cooley firm, launched a now widely circulated White Paper of its own on the heels of the completion of the FileCoin ICO.  The ostensible purpose of the Cooley White Paper was to propose a path forward toward regulatorily compliant ICOs. In simple terms, Cooley posited that the SAFT itself is a security (not very controversial, in my opinion), but the tokens are not securities.  In their words:

“The SAFT is a security. It demands compliance with the securities laws. The resulting tokens, however, are already functional, and need not be securities under the Howey test.”

So what is the “Howey” test, you ask?  That is the name of the first US Supreme Court case, decades ago, to address the issue of what is a “security” for purposes of determining the applicability of federal securities laws.  In simple terms, in order for an instrument to be a security, it must satisfy four criteria:

The Howey test:

  1. an investment of money
  2. in a common enterprise
  3. with the expectation of profit
  4. that comes significantly from the efforts of others

So what was the basis of the Cooley opinion that utility tokens are not “securities”:

“To be sure, public purchasers may still be profit-motivated when they buy a post-SAFT utility token. Unlike a pre-functional token, though, whose market value is determined predominantly by the efforts of the sellers in imbuing the tokens with functionality, a genuinely functional token’s value is determined by a variety of market factors, the aggregate impact of which likely predominates the “efforts of others.” Sellers of already functional tokens have likely already expended the “essential” managerial efforts that might otherwise satisfy the Howey test.”

Hence, Cooley concludes that “genuinely functional tokens” do not satisfy the fourth prong of the Howey test and, therefore, are not securities. As discussed below, there is a growing chorus of opinions in recent weeks which do not buy off on this analysis.

The Cappasity SAFT ICO

The Cappasity ICO followed shortly after the FileCoin offering, reportedly counseled by legal powerhouse DLA Piper.  As with the FileCoin offering, the Cappasity ICO offering, of SAFTs, was accompanied by a Private Placement Memorandum, replete with the usual “Risk Factors” disclosures – 26 to be precise.  And guess what was the first risk presented in the PPM:

“ARTokens may be considered securities in various jurisdictions.”

There is a substantial risk that in numerous jurisdictions, including the United States, ARTokens may be deemed to be a security. ARTokens issued on conversion of SAFT will have current use and functionality on an existing Platform. However, it is possible that securities regulatory authorities or plaintiffs lawyers may assert that the ARTokens inherently involve investment features that should be regulated by the securities, investment or similar laws. Such regulation may result in restrictions or other limitations applicable to the holder.”

And whose responsibility is it to make this determination? According to the Cappasity PPM, YOU, the investor:

“Every user, purchaser, and holder of ARToken is required to make diligent inquiry into determine if the acquisition, possession and transfer of ARTokens is legal in its jurisdiction and to comply with all applicable laws.”

OK, so now I am sitting in the shoes of a prospective investor, reading this? What am I supposed to think?  Regulatory compliance is my responsibility? Not so fast.

But Wait, there is More!

A prospective investor who bothers to carefully read the second risk factor may conclude, as I did, that Cappasity is now not only (understandably) unsure of the applicability of US securities laws to the sale of its tokens, but now seems to be talking out of both sides of its mouth (as lawyers often are accused of doing) on yet another gray area in US securities laws: whether an issuer of these tokens is subject to becoming a fully reporting issuer following the completion of a successful ICO.

Here is Cappasity Risk Factor Number 2:

“The Offering may result in a requirement that Cappasity register its SAFTs or ARTokens as securities under the Securities Exchange Act of 1934, as amended, depending on its level of assets, its number of holders, and whether the SAFTs and ARTokens are considered equity securities.

 Cappasity believes that ARTokens, when issued on conversion of the SAFTs, will be utility tokens and not securities (equity or otherwise), but there is no clear guidance from the SEC on this point.” [emphasis added]

Notice the schizophrenic disclosure on this one.  The bold heading says that the tokens “may” be subject to registration under the 1934 Act.  Yet in the first sentence of the narrative which follows, Cappasity now tells us that they “believe” that the tokens will not be securities. The reason for this ambiguity perhaps explained by Cappasity in the same sentence: “there is no clear guidance from the SEC on this point.”

So Why Does Any of This Matter?

So perhaps some of you readers are thinking that, well, maybe there is “safety in numbers.” If we simply move in lockstep behind first movers, with outsized law firms, we can weather this regulatory storm.  Well, think again.

All us mortal securities lawyers can do in this area is make our best judgments, often based upon unique facts and circumstances, and after a careful study of the law.  But what if we are wrong – and who will make that determination?  Unless your offering is a screaming fraud, this determination will likely only be made if the token plummets in value.  An ICO issuer and its offering participants may then be met with what Cappasity, in their Risk Factor No. 1, euphemistically refers to as “plaintiffs lawyers,” stating that they “may assert that the ARTokens inherently involve investment features that should be regulated by the securities, investment or similar laws. Such regulation may result in restrictions or other limitations applicable to the holder.”

Well, if that were the only risk that investors faced, restrictions applicable to the “holder,” I wouldn’t be writing this article.

A bigger risk is that these “plaintiffs lawyers” could bring the entire house (network) down, before (or after) the actual “launch” – leaving the investor holding the proverbial bag.  That is because the penalty for failure of an issuer to comply with federal securities registration provisions is a court enforced “put” by the investor to get his money back (in US dollars) – which means money flowing out of the hands of entrepreneurs – though perhaps not as quickly as it flowed in.  And off course, none of this news would bode well for the token’s secondary market.

So How Real is this Risk?

Go ask the folks at Tezos, who recently completed an ICO raising hundreds of millions of dollars.  When token valuations plummeted, the plaintiffs lawyers came knocking at (as in “ran to”) the courthouse door, in the form of a purported class action complaint against the company, its management and market participants.  Plaintiffs showing up in court often tend to be seen as sympathetic creatures, having lost money in an often failed enterprise.  Under these circumstances judges are unlikely to look solely to legal White Papers as they carve a path to justice.

Case in Point: The Recent Prometheum SEC No Action Ruling Request

When it comes to the applicability of US securities laws, there is no dearth of expert opinions.  Not all of these opinions come down on the side of FileCoin and Cappasity, or the Cooley White Paper, when it comes to the issue of whether a token, utility or otherwise, is a security (or an equity security).  A recent example is a ruling request submitted by an issuer, Prometheum, to the SEC in October 2017. It did not expressly request a ruling on the issue of whether a “token” is, more often than not, a “security,” Nonetheless, the Prometheum No Action ruling request is noteworthy in that it appears to express a point of view diametrically opposed to the one taken in the Cooley White Paper – as to the fourth factor in the Howey test – the significance of the contributions of the efforts of management once an ICO issuer’s network is up and running.

Opining that “the overwhelming majority of ICO tokens are securities under the Howey test”, Prometheum’s counsel cuts to the chase and appears to part company with the Cooley White Paper – addressing the most controversial (and ambiguous) element of the Howey test – the significance of managerial efforts:

“The ICO issuer uses the funds raised in the ICO to build out the network, with the goal of increasing the underlying network’s usage. Increased network usage increases the demand for the token thereby increasing the ICO Token’s value.  Thereafter, the ICO network’s supporting software engineers and operators continuously engage in managerial efforts by continually developing and watching the network and making changes as needed for the ICO network to function.”

They may have a point. After all, even blockchain driven networks do not necessarily, in practice, run themselves. I leave that one to the computer science geeks – at least for now.

Others in the securities bar appear to have reached a conclusion similar to Prometheum’s counsel, albeit perhaps for different or additional reasons.  Of note, my good friend and highly respected colleague, Doug Ellenoff, of Ellenoff, Grossman & Schole, has recently weighed in on the pages of Crowdfund Insider:

“We have reviewed the applicable case law and published memos by law firms, spoken with numerous regulators, industry participants and professionals, attended a variety of crypto/blockchain and engineering conferences, lectures, read source materials, including books and white papers on the subject, and in the end [we] believe that there seems to be very little light to make a convincing argument that a token isn’t subject to existing regulatory oversight by the SEC, other Foreign regulatory authorities, State Securities Agencies or CFTC.”

Mr. Ellenoff also notes the inherent uncertainty with respect to utility tokens generally, remarking “even utility tokens, arguably have many equity-like characteristics (or are investment contracts),”

And where do I stand? I lean towards the Ellenoff view of the world.  In a close case, or gray area, I expect that regulators and courts will come down more often than not on the side of tokens being regulated securities, driven by big picture policy concerns and sympathetic plaintiffs. And in my view the gray area is pretty large compared to the black and white.

And who exactly is Prometheum you might ask? Well, I suggest you check out their recent SEC filing, seeking to qualify their ICO (for Warrants – not SAFTS) under Regulation A to find some answers.

Washington: We Have a Problem!

As I stated at the beginning of this article, as far as providing meaningful regulatory guidance to ICO market participants, the SEC has thus far fallen flat – at least based upon their public pronouncements to date.  Apart from the periodic warnings of SEC enforcement actions and questionable marketing practices, there has been no real guidance as to how compliance-minded issuers can minimize the risk of lawsuits or enforcement actions.  Compliance-minded, responsible market participants, such as investment banker Tim Draper and StartEngine CEO and founder Howard Marks, have also called upon the SEC to come up with further guidance to the ICO marketplace following the SEC’s July 2017 pronouncements. I too join my concerns and voice with them and other like minded market participants.

The Commission’s July 2017 DAO Release was a good start, as a wakeup call to the ICO marketplace, but it did little or nothing to shed light on important and complex securities law compliance issues.  The solution proposed by the SEC’s Divisions of Enforcement and Corporation Finance in a companion Release had this to say:

Consultation with Securities Counsel and the Staff

“Although some of the detailed aspects of the federal securities laws and regulations embody more traditional forms of offerings or corporate organizations, these laws have a principles-based framework that can readily adapt to new types of technologies for creating and distributing securities. We encourage market participants who are employing new technologies to form investment vehicles or distribute investment opportunities to consult with securities counsel to aid in their analysis of these issues and to contact our staff, as needed, for assistance in analyzing the application of the federal securities laws. In particular, staff providing assistance on these matters can be reached at FinTech@sec.gov.”

So how has that been working out, to calm the unsettled regulatory waters? Judging by anecdotal evidence, not very well. One inquiring ICO issuer was, essentially, referred by the SEC Staff to the Howey test and told to consult further with his securities counsel.

My own recent experience, as a seasoned securities lawyer on behalf of an ICO issuer of utility tokens, did not fare much better. Yes, I prepared a detailed written analysis of my client’s “facts and circumstances,” and dutifully directed it to the SEC Staff at FinTech@sec.gov.  The Staffer who eventually responded to my inquiry was thoroughly knowledgeable. Yet in the end, he was unwilling to get into “facts and circumstances,” instead directing me to the same case law which I had already reviewed.

A Much Needed Path Forward for the SEC

I obviously cannot speak for the SEC’s new Chair, Jay Clayton. But I can hope to influence thought – and perhaps successfully make the case that, as far as the jurisdiction of the SEC is concerned, we are in the midst of a crisis.  And the answer is not simply general pronouncements or stepped up enforcement.  What the ICO marketplace needs, at the very least, is detailed, authoritative guidance on some very basic securities issues.  Failure to timely address these issues is certain to have significant economic consequences on the ICO market and its participants. These consequences include less availability of capital in these markets to fund further development and commercialization of blockchain based businesses and technology – and the movement of capital – and jobs – offshore.

Yes, perhaps the Commission could continue to punt on this one – under the guise of these issues calling for refined case by case legal analyses, by private lawyers – based upon individual “facts and circumstances.”  But that, in my opinion, would be – for lack of a better word – a cop out.  In the past the Commission has issued fairly detailed interpretive releases in other areas heavily dependent on multiple facts and circumstances, providing useful guidance to the public and the securities bar in the process. 

Or perhaps, if one New York lawyer is correct, we are in the midst of an exuberant bubble, so the  regulatory issues will soon fade away when the market collapses – leaving the Enforcement Division to pick up the pieces (as presented on November 4, 2017 in The New York Post):

“It’s the Wild West,” Joseph A. Hall, partner at Davis Polk, told The Post.

“It totally reminds me of the dot-com boom,” he added. “It’s exactly the same mentality as 20 years ago, and it will probably end the same way.”

Frankly, I prefer to let properly regulated markets decide how the ICO boom will end.  There is a growing body of authority that this marketplace is not a passing fad – one that if properly regulated can be instrumental in capital formation and rapid economic growth. If this is indeed is a “party,” the regulatory “A Listers” have shown up in force.   One highly respected former SEC Commissioner, Paul Atkins, has recently joined forces with an industry trade association.  And his two time subordinate, former Commissioner Daniel M. Gallagher, has loaned his name and expertise to a privately held blockchain company, joining their Board of Directors. 

And from a regulatory perspective, the 2000 dot-com bubble was quite the opposite of the ICO market. Back then issuers were lining up at the SEC filing window to register their IPOs. Not so with ICOs. Many ICO issuers are looking for creative ways to (hopefully) skirt regulations and avoid compliance with SEC rules and registration. Others, looking for a regulatory compliant path – do not see a clear path forward.

It is no solution for issuers and other market participants to simply seek cover behind securities lawyers, no matter how well qualified.  Unlike H & R Block, if an issuer is hit by a lawsuit or regulatory action, its securities counsel will not accompany them “at no additional charge.” Nor can the most unassailable legal White Paper protect an issuer and others from a massive rescission suit by investors who turned out to be on the wrong side of the market. I would much prefer to have some authoritative views emanating from the SEC’s website to lean on. And by the way, that is exactly what the Plaintiff did in the Tezos class action – it attached the Commission’s July 2017 DAO release as Exhibit “A” to the Complaint.

I respectfully submit to you, Chair Clayton, that the voices of Tim Draper, Howard Marks and others are your “2:00 am” crisis call.  We look to the leadership – and definitive action of the Commission – with the support and participation of ICO marketplace stakeholders. With billions of dollars pouring into these markets in a matter of months, the ICO “crowdsale” marketplace is clearly not your predecessors’ crowdfunding.

*********

Samuel S. Guzik, a Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. In 2014, some of his speaking engagements have included leading a Crowdfunding Roundtable in Washington, DC sponsored by the U.S. Small Business Administration Office of Advocacy, a panelist at the MIT Sloan School of Business 2014 Crowdfunding Roundtable, and a panelist at a national bar association event which included private practitioners, investor advocates and officials of NASAA. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation. Mr. Guzik was also instrumental in the passage of legislation in 2016 calling for the creation of an independent office of small business advocate at the SEC, and was the first person to advocate publicly for this legislation – on the pages of Crowdfund Insider.

Posted in Capital Raising, Corporate Governance, Crowdfunding, General, SEC Developments, Security Tokens/ICOs | Tagged , , , , , , , , , | Comments Off on The SEC, the ICO and Avoiding the ICU: A Call for Leadership and Action

Securities Attorney Samuel Guzik in the News – CFO.com

What’s Wrong with Crowdfunding?

The JOBS Act was designed to help online capital formation. So far, the results have been disappointing.

Posted in Capital Raising, Crowdfunding, General, Regulation A+ Resource Center | Tagged , , , , , , , | Comments Off on Securities Attorney Samuel Guzik in the News – CFO.com

The JOBS Act Turns Five, Regulation A+ Turns Two, Regulation Crowdfunding Turns One: What Should Be Next on the SEC Chair Jay Clayton’s Agenda

With the Jumpstart Our Business Startups (JOBS) Act having just reached its five year milestone, Regulation Crowdfunding hitting its one year milestone, and the two year anniversary of Regulation A(+) fast approaching, I thought this would be a good time to (briefly) reflect on the past, and to focus on the future – of our capital markets for startups and smaller emerging business.

Some Things Never Change, Some Things Have Changed – and Some Things Need to Change

Some Things Never Change

In the “some things never change” department:  the “on again – off again” marriage of two prominent equity crowdfunding advocacy groups, CfIRA and the CfPA, still graces the headlines.  As one who has both called for a unified trade association and served a brief stint as President of the Crowdfunding Professional Association (CfPA) in 2015, a single unified voice for stakeholders in this post-JOBS Act world would be more than welcome.  So I am still hoping for a “wedding invitation.”

Some Things Have Changed

In the “some things have changed” department, most notable for me has been the enactment of what I have referred to as the missing Title of the JOBS Act – the creation of an independent office at the SEC tasked with the single mission of advocating for the interests of small business capital formation – reporting to all five SEC Commissioners – and to Congress.  This quietly became law in December 2016.

To my knowledge I was the first person to publicly advocate for the need for such an independent office at the SEC, back in February 2014, on the pages of Crowdfund Insider.  The rest is history.

In September 2014, former SEC Commissioner Daniel Gallagher, and staunch small business advocate, in presenting his wish list for small business regulatory reforms at The Heritage Foundation, put this issue front and center on the national stage.  Shortly thereafter, the Small Business-Investor Alliance, under the guidance of its then General Counsel, Chris Hayes, took the bull by the horns, and was instrumental in initiating draft legislation, which ultimately became HR 3784 in 2015, and was passed into law in December 2016, entitled “The SEC Small Business Advocate Act of 2016.”

Though characterized (and opposed) by NASAA in legislative hearings as creating an unnecessary government funded internal lobby group at the SEC, remarkably it passed the House Financial Services Committee, the House of Representatives and the Senate unanimously, as a stand alone bill. It was the last order of business of a lame duck Senate in the wee hours on a Friday night in December 2016, and was promptly signed into law by President Obama, sans the Rose Garden signing ceremony.  And the ink had hardly dried when in February 2017 then acting SEC Chair Michael Piwowar publicly signaled that setting up this new office would be an SEC priority in 2017 – a tad faster than its sibling, the SEC Office of Investor Advocate, a Dodd-Frank footnote, which took nearly three years for the SEC to implement.

Some Things Need to Change

In the “some things need to change” department there is, to be sure, a lengthy list.  This article, however, focuses on two issues: one addressing a fix to one of the unintended consequences of SEC rulemaking; the other a simple fix to help jumpstart what I perceive to be a rather lackluster Regulation A+ market thus far.

Regulation Crowdfunding (CF) and the Proliferation of “SAFE” Securities – An Unintended Consequence of SEC Rulemaking

One of the more striking and unexpected statistics measuring the Regulation Crowdfunding marketplace surfaced in February 2017, courtesy of DERA, the analytical arm of the SEC. A  DERA Report compiling data on the types of securities offered by Regulation CF, DERA reported that 26% of the securities offered were “SAFES,” an acronym for Simple Agreement for Future Equity.  If the truth be known, most securities lawyers, let alone investors, have never heard of a SAFE – and few lawyers could easily get their heads around it.

The use of SAFES has exploded in Regulation CF offerings, both as a means for an early stage company to avoid having to deal with large numbers of shareholders, and to avoid the risk of inadvertently, or prematurely, becoming a fully reporting public company under current SEC rules.

Recently, SEC Commissioner Piwowar succinctly described the SAFE:

“The SAFE was first invented by Y Combinator, for use by early investors in a startup hoping to get a piece of the next “gazelle” – or even a unicorn. It was essentially, an option to acquire equity in the future, at a price, yet undetermined, pegged to a discount to a future institutional financing round, and usually with a cap on the company’s valuation.  A SAFE investor typically has no ability to realize any return on its investment until a future liquidity or financing event, such as a follow on institutional round, an IPO or an exit through a sale of the business.”

This has served its purpose for investment by a small group of sophisticated investors in startup enterprises, eliminating the need for time consuming negotiations over financing terms. However, as many have observed, it is not necessarily well suited for consumption by a large group of unsophisticated investors, particularly when issued by “slow growth” companies, often with no reasonable prospects for institutional financing, an IPO or a buy out – typical of the vast majority of Regulation CF issuers thus far. 

Adding to this potentially toxic investor brew – unlike the Y Combinator SAFE model, the SAFES touted by Regulation CF intermediaries vary significantly in their terms, from one platform to the next.  Although issuers can modify the templates, they rarely do – as this would require the assistance of a well trained securities lawyer – normally not in a startup’s budget.  The ones I have reviewed, proffered by three major Regulation CF platforms, though issuer friendly, are not a security where, as an investor, I would place my money without significant modifications.

As SEC Commissioner Piwowar recently remarked:

“Intermediaries face a real challenge in educating potential investors about this high-risk, complex, and non-standard security when the security itself is entitled ‘SAFE.’”

And as to issuer disclosure, a la the mandatory Form C, well let’s just say that more often than not issuers make no disclosure whatsoever about the unique risks of the SAFE security (Kudos, however, to issuers guided by iDisclose, a notable and welcome exception to the rule) – something DERA ought to take a closer look at in its next report.

Regulators Perceive a Problem With SAFEs, But Have Yet to Articulate Solutions

The proliferation of SAFEs under Regulation Crowdfunding has not gone unnoticed by the SEC. At an SEC-sponsored crowdfunding forum on February 28, 2017, Commissioner Kara Stein observed:

“These so-called SAFE securities are contractual derivatives. The issuer promises to give the investor stock upon the occurrence of a contingent future event. The event is typically linked to a subsequent valuation event, such as securing an additional round of financing, a company sale, or an initial public offering. However, many small and emerging businesses will never attain the subsequent valuation event. As a result, a retail investor is left with little more than the paper on which the contract is written.”

These same concerns were voiced by Commissioner Piwowar in a public address only two months later, describing the widespread use of SAFES under Regulation Crowdfunding a “concerning development.”

In this same address, Commissioner Piwowar appeared to suggest that the solution to the widespread proliferation of SAFES may lie with the Commission itself.

“As regulators, we also have a responsibility to ensure that our rules are functioning as intended and in an effective and efficient manner. We must engage in a constant process to obtain feedback as to how our rules are operating in practice. When we learn that there are widespread compliance challenges with a rule, we have a duty to fix the situation, particularly where investors may be adversely affected.”

With this I heartily concur. And, well – here is some “feedback,” and some proposed solutions for the Commission to take up at one of its next meetings, on the Agenda of the newly appointed SEC Chair Jay Clayton.

Looking to Solutions for a Safer Regulation Crowdfunding Marketplace

In a well written and insightful analysis of SAFES and Regulation Crowdfunding contained in a University of Virginia Law Review Article

The authors stated:

“.   .   . we believe that early market participants may be unintentionally sabotaging the crowdfunding experiment. Specifically, we believe that the forms of a relatively new startup-financing instrument, the simple agreement for future equity (“SAFE”), currently offered by crowdfunding portals such as WeFunder and Republic, contain terms that are likely to frustrate the ability of investors to share in the upside of successful crowdfunding companies. In other words, crowdfunding investors who purchase SAFEs may discover that these instruments are anything but.”

One of the possible solutions posed in the article, banning the use of SAFES altogether, is not one that I would embrace, and has been roundly criticized by my colleague, Amy Wan, in a piece she penned on Crowdfund Insider back in September 2016.

Ms. Wan, also being the forward thinker she is known to be, presented a solution, in the form of legislation introduced, but not yet law, known as the Fix Crowdfunding Act. The FCA addresses one of the root causes of the proliferation of SAFES in crowdfunding, the nightmare an issuer faces when having to deal with hundreds, even thousands, of shareholders – particularly when shareholder consent is needed, often the case with early stage companies. Or in Silicon Valley speak, the “cap table problem.”

The Fix Crowdfunding Act allows for the formation of “special purpose vehicles” (SPV’s), where the crowdfunding investors would invest through a single entity – whose sole mission was to invest in one crowdfunding issuer – and where shareholder decisions would be made by a single representative – who must also be a registered investment advisor.  And with the SPV, a multitude of crowdfunders on the issuer’s cap table would be replaced by a single shareholder-entity, the SPV.  Absent this legislation, this structure is unlawful under another federal securities law, the Investment Company Act of 1940.

Part of the Problem – and the Solution – is Within the Ambit of SEC Rulemaking

A “messy cap table” with hundreds or thousands of non-accredited investors presents other serious challenges – and risks – for some would be crowdfunding companies.

When a Regulation CF company completes its offering, it is tasked under the JOBS Act and SEC rules with making annual financial and non-financial disclosures, intended to be right-sized for the smallest of companies.

However, for the company expecting explosive growth following a Regulation CF offering, current SEC rules place a major, unnecessary obstacle in the way – one that the Commission can and should remove.

You see, when a crowdfunded company exceeds 500 non-accredited shareholders of record, and then goes on to have more than $25 million in total assets, under current SEC rules this triggers a requirement that this young, emerging company, become a fully reporting SEC company, subject to the same types of public filings made by mature, well capitalized public companies.

This SEC imposed trigger has undoubtedly scared off would be Regulation CF companies, many of a type which would likely be the most worthy of investment – high growth potential companies able to attract future institutional/venture capital, and who wish to avoid or delay becoming a publicly reporting company.  Why would an issuer take this risk of involuntarily becoming a fully reporting company when other less risky options are available – such as private placements which have no reporting obligations, initial or ongoing, no cap on the amount raised, etcetera, etcetera, etcetera.

And who does this disadvantage?  The non-accredited investor, generally excluded from private placements due to long standing SEC rules governing private placements.  The little investor currently gets the “leftovers,” so to speak, to sift through in Regulation CF offerings.

And even if the Fix Crowdfunding Act were to become law, not all companies will have or necessarily want SPV investors, simply as a way to circumvent this risk or otherwise.  SEC rulemaking to modify its rules triggering full reporting status – excluding crowdfunded securities from the 500 shareholder of record count – would be a simple fix – and undoubtedly end the proliferation of SAFES in the Regulation CF market place. With this simple fix, issuers could also find workarounds for going to hundreds of shareholders for consent – such as private contractual agreements for proxies on certain matters.

The Solution is an Easy Fix for the New SEC Commission

Under the Securities Exchange Act of 1934 the Commission retains virtually unfettered discretion to exempt issuers and securities from otherwise applicable rules governing when a company must become a fully reporting company.

The Commission ought to simply amend its rules to exclude from the current 500 non-accredited shareholder of record trigger securities issued in a Regulation CF offering.  This is not a novel concept. A similar route was followed by the Commission when it promulgated rules for Regulation A+ for larger, SEC-reviewed offerings.

And One Other Fix Needed – to Invigorate Regulation A+ Marketplace and Increase Quality Dealflow

I would urge our newly constituted SEC Commission, with Chair Clayton at the helm, to invite the folks at FINRA to one of its upcoming meetings.

You see, as both a stakeholder and an observer in the Regulation A+ marketplace, one of my biggest disappointments has been the relatively few number of deals which are sponsored by broker-dealers.

Apart from bringing investors to an offering, licensed broker-dealers serve an important function, especially with smaller, high-risk issuers.  They are required to perform an extensive due diligence review of the company and the offering terms before the deal sees the light of day – an important gatekeeping function which provides some quality filter on Regulation A offerings. In the current environment there is no legal requirement for a Reg A issuer to utilize a licensed broker-dealer, and often Reg A issuers will utilize an unlicensed third party Internet intermediary – or no intermediary at all.

FINRA also regulates the content of public advertising of its members’ offerings – requiring its broker-dealers to refrain from any public statements which are not “fair and balanced.”  The dangers presented to the public when an issuer goes it alone are most recently illustrated by a current Regulation A+ offering,  Yayyo, whose CNBC promotion, was the subject of recent and very skeptical national press. The ad was promptly pulled after receiving a flurry of unwanted, and unflattering press.  The promo, with its celebrity spokesperson, was perhaps, a good way to market a consumer product on late night TV at the ubiquitous price of $19.99, with order takers standing by. But this type of hyperbolic, unbalanced pitch has no place in the offer and sale of any kind of investment.

So why the low level of broker-dealer participation in Regulation A+ “mini-IPO’s?”

Yes, of course there is a learning curve with any new type of securities offering. But I believe a big part of the reason for low broker-dealer interest is the way FINRA has applied its broker compensation rules to these new offerings. Instead of allowing the heftier commissions for brokered private placements, FINRA is limiting broker compensation to the less generous rates for full blown IPO’s.  The industry chatter I have been hearing is that these FINRA limits on Regulation A+ offerings have discouraged many would be broker participants from entering the Reg A market place.  The reasons are not hard to fathom.

Reg A deals tend to be riskier for a broker, less likely to fund – and certainly not at the higher dollar levels typical of a traditional IPO. And Reg A offerings are not the “hot” offerings seen with some traditional IPO’s, where the offering is oversubscribed and the security trades sharply higher in the immediate after-market. For those who know this industry, they understand that in an IPO the big broker payday is from the “green shoe,” where the broker has the option of acquiring securities for its own account, at the offering price, exercisable in the weeks after the offering hits the market.

So please, Chair Clayton, if not a full Commission meeting, at least have a chat with your counterparts over at FINRA.  Yes, FINRA has done a wonderful job in the past year of seeking public comment on its rules. Maybe I missed this, but I have not seen this one on the public comment list.

Yes, NASAA may complain, as it has publicly done with abandoning the “tick size” rule.  They may argue that bigger broker commissions mean higher prices for investors.  But how’s it working out for that favorite restaurant down the street of yours that’s no longer in business – because it couldn’t raise its menu prices to keep up with rising costs?

Posted in Capital Raising, Crowdfunding, General, Regulation A+ Resource Center, SEC Developments | Tagged , , , , , , , , , , , | Comments Off on The JOBS Act Turns Five, Regulation A+ Turns Two, Regulation Crowdfunding Turns One: What Should Be Next on the SEC Chair Jay Clayton’s Agenda

SEC Office of Small Business Advocate – One of Top 10 Fintech News Events in 2016

I am proud to be a part of one of the Top 10 Fintech News Events of 2016 – HR 3784 – SEC Office of Small Business Advocate:

Top Fintech Stories from Crowdfund Insider during 2016

By

 

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As one year comes to end it is a good opportunity to reflect on past events. The preceding 12 months have been a momentous period for internet finance including capital formation online. Fintech started as a curiosity that engendered much excitement – and fear for some. Disruptive finance is now quickly becoming mainstream as all finance migrates online to be managed, monitored and leveraged for all types of services.  We expect more of the same with some twists for 2017 but today we are reviewing some of the larger stories that occurred during the last year. Below is a small selection of some of the top stories published on Crowdfund Insider during 2016.

Boxing FightGust Wins Crowdfunding Patent Infringement Case Against AlphaCap Ventures

This is a big win for the entire US crowdfunding industry.

Gust founder David Rose took the gloves off and went to war against a patent troll and won.  AlphaCap Ventures, a company created to defend a spurious patent on crowdfunding, not only lost the case but was assessed attorneys fees and court costs. Ouch. Kudos to Gust. The entire crowdfunding industry owes you a debt of gratitude (drinks on us in 2017).

FINRA Expels Crowdfunding Portal UFP (uFundingPortal)

This was actually a series of articles as uFundingPortal filed numerous, questionable Reg CF offers only to disappear from the ranks of approved platforms in November.

FINRA later clarified why uFundingPortal got the proverbial ax. The expulsion came as no surprise to many industry participants and now stands as a point of caution for other regulated crowdfunding portals.

office-of-small-business-advocateSEC Small Business Advocate Signed into Law

First proposed on the pages of Crowdfund Insider, the Small Business Advocate will now play a role in advocating on behalf of all small businesses within the halls of the SEC.

Signed into law by President Obama as part of a flurry of last-minute acts of legislation that had broad bi-partisan support, contingent upon the person who holds the office – this could be a turning point in defending the needs of SMEs. Too frequently the SEC has addressed the issues surrounding the largest companies to the detriment of smaller firms. The Small Business Advocate will now be in a position to assist the true engines of the US economy – SMEs (and that is good for us all).

FCA Publishes Interim Report on Crowdfunding Regulatory Update

The UK has been lauded as the gold-standard in crafting a forward-thinking regulatory approach when it comes to internet finance. The interim report indicates that additional rules are on the way. Depending on how it all shakes out, the UK may continue its reign as the Fintech capitol. More in the coming months.

sorry-we-are-closed-small-towns-merchantsOnline Lender DealStruck Shuts Down

Big news in a not so positive way.

As the online lending industry struggled to regain its footing after a tumultuous year, DealStruck saw its funding channel dry up and thus was compelled to close its doors. A shudder went through the entire online lending sector.

Indiegogo Enters Equity Crowdfunding

Anticipated for quite some time, the second largest rewards-based platform pushed into equity crowdfunding in a partnership with MicroVentures. Indiegogo’s move was viewed as further validation of the new form of online capital formation. The first four deals listed on the platform quickly hit their funding targets as Indiegogo predicted rapid growth in 2017.

donald-trump-20-dollars-moneyDonald Trump Elected President

The election of Donald Trump as President will have a profound impact across all manners of policy.  Fintech may benefit from his opinion that excessive regulation has stifled economic growth harming business (both large and small) and consumers alike. With the change in government 2017 is poised to be an interesting year.

France Arc du Triomphe ParisFrance Enlarges the Scope of Crowdfunding by Boosting Cap to €2.5 Million

France displayed a very encouraging ability to work with the emerging investment crowdfunding industry by listening to the advice of industry participants.  The increase in the funding cap came 2 years after the first French regulations were revealed. US policy makers could learn something by this relatively quick action in improving access to capital and thus helping boost the nascent industry.

FIntech Proptech Regtech Insurtech LawtechInsurtech will be the Next Big Thing

The insurance industry is an old lumbering giant that is in dire need of an update and a tech refresh. It is finally happening with entrants like Lemonade and Metromile. More to follow.

The UK Financial Conduct Authority and Cambridge Centre for Alternative Finance (CCAF) Collaborate on Regulatory Review

CCAF has been a leader in global Fintech research with its regional reports on the rise of intenet finance. The fact they are working with a government agency in a regulatory review is not only a “first” but should help provide some balance in the final outcome of forthcoming rule changes.

Canada Sign Post Provinces Cottage LifeNational Crowdfunding Association of Canada Hammers Regulatory Approach

The National Crowdfunding Association of Canada (NCFA) hammered the country’s regulatory approach to internet finance in a strongly worded letter to the Alberta Securities Commission. Earlier in the year, one prominent industry participant labeled the Canadian regulatory environment a “mess.” It appears the constructive criticism is having an effect as Ontario has acknowledged that Fintech demands a new approach.

European Union Stops Harmonization Process for Crowdfunding Rules

At least they are being honest. The EU admitted that harmonized investment crowdfunding rules just weren’t going to happen.

Jeff LynnSeedrs Delivers an Estimated IRR of 14.4%

Transparency is paramount in the emerging investment crowdfunding sector. Publishing honest and understandable return estimates are something every platform should eventually provide for investors. Seedrs published a report that was created with the assistance of Ernst & Young thus increasing the credibility of the numbers. Hopefully, other platforms will eventually follow suit.

China (Finally) Issues Online Lending Rules

China is the largest online lending market in the world. The industry rose to prominence as borrowers needed access to capital and the state-based banks were ill-equipped to provide it. The rapid growth was matched by rampant fraud as too many investors were fleeced and platforms failed. The new rules may bring a semblance of order to the huge Chinese internet finance sector.

First Three Months of Crowdfunding Under Reg CF Deliver Promising Results

CCA and several other platforms like NextGen have published reports on a rolling basis of the emerging Reg CF securities crowdfunding industry. The first CCA report showed a “healthy start” allaying fears that Reg CF wouldn’t generate significant momentum out of the gate.

Fundrise Pivoted and Became a Real Estate Platform for eREITS Instead of Single Properties.

Fundrise, the first real estate crowdfunding platform to launch in the US, revamped their model as an issuer of eREITs using the updated securities exemption Reg A+. And it is working too. Fundrise now has 5 different eREITs seeking $50 Million from investors. The first two have sold out.

Brewdog-Vladamir-James WattBrewDog Launches US Equity Crowdfunding Offer Under Reg A+

Perennial crowdfunding company BrewDog is setting up shop in the US. The craft brewer has selected Columbus, Ohio as the location for their first international brewery. As part of the expansion, BrewDog is offering US investors the chance to own shares, along with some perks, in the iconoclastic company.  While the EquityforPunks offer is not doing as well as the UK version, thousands of US investors have indicated their interest in owning shares in BrewDog USA.

The craft brewer has selected Columbus, Ohio as the location for their first international brewery. As part of the expansion, BrewDog is offering US investors the chance to own shares, along with some perks, in the iconoclastic company.  While the EquityforPunks offer is not doing as well as the UK version, thousands of US investors have indicated their interest in owning shares in BrewDog USA.

Singapore Wants to Own Fintech

The Asian economic powerhouse of Singapore has decided the Fintech is of strategic importance to their economy. Once they figured that out the country launched multiple initiatives to power their resolve to become the Asian capital of Fintech. And perhaps the world.

Dollar Shave Club Investors Love UsDollar Shave Club Sells for One Billion Dollars

If investment crowdfunding is to be successful investors need to generate solid returns. AngelList, ostensibly the largest investment crowdfunding platform in the world, helped to accomplish just that. Dollar Shave Club, a company that raised capital via an AngelList syndicate, sold to Unilever for $1 billion. Early investors in Dollar Shave Club rejoiced.

Additionally, AngelList disclosed that from 2013 to 2015 the platform generated an estimated IRR of 45% after fees and carry.  That’s pretty awesome.

Goldman Sachs Launches Bespoke Online Lending Platform Marcus

As many online lenders retrenched, the most prominent investment bank in the world shunned partnerships and launched their own online lending platform.

Crowdcube Launches Self-Crowdfunding Round that Jumps the €5 Million Hurdle

Dog fooding equity crowdfunding platform Crowdcube launched an offer for a stake in their company that hurdled the €5 million mark.  Part funding round and part proof of concept, the UK-based Crowdcube proved that issuers could raise more than the mandated limit by filing a prospectus. Expect other companies to follow.

Broken EuropeBrexit

The UK’s decision to depart the European Union shook the world.  While most UK Fintech participants adamantly supported Bremain – others believed it was a good thing. The country is now doing its best to remain the entrepreneurial capital of Europe. The Jury remains out on the final economic impact.

Title III, Reg CF Crowdfunding Launches in May

After years bureaucratic delay, the SEC finally allows investment crowdfunding to take place under Title III of the JOBS Act of 2012, now referred to as Reg CF. While deemed viable, most industry participants pointed to profound shortcomings in the final rules.

Lendit Problem Renaud LaplancheLending Club CEO and Founder Renaud Laplanche Resigns. Online Lending Industry Falls into Disarray.

Former Lending Club CEO and founder Renaud Laplanche departed the largest marketplace lending club under a cloud of controversy.  Viewed as an iconic leader of a sector of finance that he helped to create, the entire online lending industry suffered as investors ran for the door.

Jack Lew Game of ThronesUS Regulators Decide it is Time to Better Understand Online Lending Causing Fear of More Regulations

The US has created the most convoluted and confusing financial regulatory system in the world. It is not just the cornucopia of federal agencies that have a stake in the game. Each and every state needs to justify their import as well. Every time a bureaucracy says we are from the government and we are here to help private industry shudders with fear – even more so when it comes to financial services. Unfortunately, the cost of regulatory overreach is ultimately born by the consumer.

NextSeed Becomes First Approved Reg CF Platform Ushering in a New Era of  Finance

NextSeed was the first funding portal to receive FINRA regulatory approval. Previously active in the intrastate crowdfunding arena (Texas), NextSeed helped to usher in a new era of investment crowdfunding with its debt focused platform.

The Fix Crowdfunding Act Seeks to Improve Reg CF but Falls Short of Expectations

The Fix Crowdfunding Act, created by Congressman Patrick McHenry, sought to address many of the incumbent issues of Reg CF. Unfortunately, by the time the bill hit the House floor, it was largely gutted as timid House Representatives fumbled an opportunity to improve on the exemption.

Jon MedvedOurCrowd Continues to Deliver Exits for Early Stage Investors

Global investment crowdfunding platform OurCrowd registered its 5th exit in the spring of 2016 as Replay Technologies was scooped up by Intel. Mark Cuban was an investor in the company. Since that date, it has tallied five more.  While not disclosing exact returns to investors, OurCrowd is very happy with the results generated by their platform.

While not disclosing exact returns to investors, OurCrowd is very happy with the results generated by their platform.

Mondo Bank Raises £1 Million in Blistering 96 Seconds

Mondo schooled the crowdfunding world in how to raise money online super fast. The digital challenger bank raised £1 million in 96 seconds on Crowdcube. If you blinked, you missed out.

Unhappy Balloon SadThe Second Largest Rewards-Based Crowdfunding Campaign of All Time, Coolest Cooler, is No Longer Cool

Coolest Cooler raised an astounding $13 million on Kickstarter several years back. The money ended up not being enough to fully fund the project and deliver on promised rewards to backers. Besides leaving thousands of supporters disgruntled, the project delivered a painful black eye to the rewards sector of crowdfunding.

Report Says Fintech Growth is Slowing. Other Reports Disagree

Fintech, or financial services innovation, has grown rapidly in the past several years.  One recent report published by consulting groups KPMG and CBInsights stated this growth is slowing. Other reports have countered this sentiment. A report by Innovate Finance released in the fall said Fintech growth continues to boom. So which is it? Regardless of quarterly variations, Fintech growth will continue unabated (Just our $0.02).

Orchard Says 2016 Will Be Different for Marketplace Lending

Orchard Platform, the fulcrum of online lending, nailed it in early 2016 when they stated things were going to be different for the sector of finance as opposed to previous years. They probably had no idea at the time, how right they were.


PS – if you think we have missed something, please email us at info@crowdfundinsider.com.

 

Posted in Capital Raising, Corporate Governance, Corporate Law, Crowdfunding, General, SEC Developments | Tagged , , , , , , | Comments Off on SEC Office of Small Business Advocate – One of Top 10 Fintech News Events in 2016

Why I am “High” on the Prospects for SME’s in 2017

kite-fying-clouds-high


The beginning of a new year is typically accompanied by renewed hope and positive expectations. 2017 is no exception.  As a staunch advocate of promoting the interests of small business generally, and smart regulation of capital formation, in particular, 2017 stands out to me as one of high hopes and great expectations:

  • We will very shortly have a new President move into the White House, one who has promised to be the greatest “jobs” President of all time, and has promised to cut out overly burdensome government regulation.
  • We will have a Commission at the SEC comprised of five Commissioners, three of whom will be Republican appointees.
  • Paul AtkinsWe may have a Chair of the SEC by the name of Paul Atkins, currently head of the Finance branch of the Trump transition team and former SEC Commissioner, widely rumored to be the next Chair of the SEC – a vocal proponent of deregulation of financial markets.
  • And the icing on the cake – with the passage of HR 3784 unanimously by Congress in December 2016, the SEC will have a new, permanent office in 2017 – Office of Small Business Advocate – an independent office reporting directly to Congress, with the singular mission of protecting the interests of small business and small business investors at the SEC.

On the legislative front, 2017 could be the year that investment crowdfunding has its hands untied through further legislation – largely to undo restrictions imposed under Title III of the JOBS Act that were the result of political horse-trading back in 2012.

Of most significance, raising the annual investment crowdfunding limit from $1 million to $5 million would have the immediate effect of generating a great deal of interest and visibility in this nascent market – and with it more, and larger deal flow.  And allowing “special purpose vehicles” to invest in Regulation CF transactions would provide a number of benefits, including (1) channeling accredited investors from other accredited investor platforms, such as AngelList, and (2) providing some bargaining power to investors over the terms of the investment, who now are faced with a “take it or leave it” investment proposition.

Med-X Could be a Potential Dark Cloud for Regulation A+ in 2017?

cheech-and-chong-hippies-highOn the SEC regulatory front, do not be surprised if the failed Med-X Regulation A+ offering of 2016 becomes an “Ascenergy-like” poster child in 2017 for what not to do in a Regulation A+ offering.  Back in September 2016, Med-X had its Regulation A+ exemption temporarily suspended by the SEC, with an administrative hearing set in January 2017 in which the SEC seeks to make the suspension permanent. Med-X failed to timely file its annual and semi-annual reports on time, triggering this administrative action.  Though ultimately these reports were filed by Med-X, this apparently has not slowed the SEC’s quest for a permanent suspension.

There has been a great deal of public speculation as to why Med-X is the subject of this apparently relentless pursuit by the SEC. Some have speculated that this is due to the nature of the business of Med-X – serving the cannabis industry. However, Med-X did manage to clear its SEC Reg A+ review with but a single initial comment from the Staff. And other cannabis companies have already cleared a full SEC review.

Clearly, there is more than meets the eye here.

SEC Securities and Exchange CommissionAt the very least, I believe that the SEC has a general concern with failed Regulation A+ issuers running out of money, becoming dormant, and then being brought back to life as a shell company with another private company – through a reverse merger or otherwise.  This is an area that has plagued the SEC in the past with fully reporting companies.  Undoubtedly, the SEC does not wish to create an easy path for unscrupulous promoters to generate shell companies for “resale,” as a byproduct of failed Regulation A+ issuers, as has been done with reverse mergers prior to Regulation A+.  Barring delinquent filers from permanently utilizing Regulation A+ would put a halt to this potential abuse before it begins.

Investigation Search Money InquiryBut do not be surprised if there is more than currently meets the eye with Med-X – with another shoe (or two) to drop in 2017.  The hearing was originally scheduled for a single day, in December 2016. For reasons not yet clear, the hearing has been continued to January 2017, and the hearing time expanded from one day to three. Many factors could account for this. For now, those of us closely tied to the success of Regulation A+ offerings will simply have to wait and see.

Time will be the ultimate arbiter of 2017. But from where I sit, 2017 is shaping up to be one of the best years ever for small business, our country’s greatest job creator.”


Sam Guzik National Press Club BSamuel S. Guzik, a Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and currently CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. In 2014, some of his speaking engagements have included leading a Crowdfunding Roundtable in Washington, DC sponsored by the U.S. Small Business Administration Office of Advocacy, a panelist at the MIT Sloan School of Business 2014 Crowdfunding Roundtable, and a panelist at a national bar association event which included private practitioners, investor advocates and officials of NASAA. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation.

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