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.

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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?

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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.

 

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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.

Posted in Capital Raising, Corporate Governance, Corporate Law, Crowdfunding, General, Regulation A+ Resource Center, SEC Developments | Tagged , , , , , , , , , , , , , | Comments Off on Why I am “High” on the Prospects for SME’s in 2017

SEC Issues Regulation A+ White Paper – What’s Working?

There has been a great deal of hyperbole and misinformation surrounding the use of the new SEC Regulation A+, which allows a private U.S. company to issue freely tradeable shares to the general public.

A new White Paper recently  released by the SEC sheds some important light on how things are going since Regulation A+ went into effect back in June 2015. Most interesting to would be issuers is cost data: attorneys fees averaging $40,000 – $50,000, a far cry from a fully registered IPO. Many attorneys are reluctant to volunteer this information, as these relatively low cost figures to not fit within their business model.

Not so with Guzik & Associates or this writer.

I hope to publish a more detailed article next week in CrowdfundInsider.com.   In the meantime, here is a link to the White Paper.

Happy Holidays and Happy New Year to all of my readers!

Posted in Capital Raising, Corporate Law, Crowdfunding, General, Regulation A+ Resource Center, SEC Developments | Tagged , , , , , , , | Comments Off on SEC Issues Regulation A+ White Paper – What’s Working?

HR 3784 – SEC Office of Small Business Advocate – Is Now the Law of the Land

On December 16, 2016, President Barack Obama Signed into Law HR 3784 – SEC Office of Small Business Advocate, creating an independent Office of Small Business Advocate at the SEC, reporting directly to the full Commission and Congress. This legislation was first introduced into Congress in October 2015, where it was originally co-sponsored by former House Representative John Carney (D-Del) (now Governor-Elect of the State of Delaware) and Congressman Sean Duffy (R-Wisc) and was passed unanimously by the House of Representatives in 2016. It was passed unanimously by the U.S. Senate on December 9, 2016, as part of a flurry of year-end bills passed by the Senate before it recessed for the year.

The bill had broad industry support upon its introduction in October 2015, including the U.S. Chamber of Commerce, the National Venture Capital Association, National Small Business Association, Small Business Investor Alliance, SBEC, and the Crowdfunding Professional Association (CfPA), of which I served as its Chair and President at the time.

Remarkably, this Bill passed Congress unanimously without the support of the SEC. In testimony from SEC Chair Mary Jo White before the Senate Banking Committee in June 2016 she was asked by the Senate bill co-sponsor, Heidi Heitkamp (D-ND), whether she supported this legislation. Her response:

 “We currently have the Office of Small Business Policy within the Division of Corporate Finance. I am an advocate for small business.” 

A roundabout way of saying “no” – it seems to me.

In the past I have referred to this bill as the missing title of the JOBS Act of 2012. Though it parallels to a large extent to the SEC Office of Investor Advocate – part of the Dodd Frank Act of 2010 – the need for this legislation goes back decades.

The successful passage of this law was the result of the participation and support of many individual and groups. However, I am proud to have had a major role in initiating this legislation, among other things:

  • I was the first person to publicly advocate for this legislation, in Feb 2014, in an article published on Crowdfund Insider.
  • I met with former SEC Commissioner Daniel M. Gallagher in June 2014 to advocate for this bill.
  • I was cited by Commissioner Gallagher in a public address (Note 36) by Commissioner Gallagher given at the Heritage Foundation in September 2014 where he advocated for the need for a permanent Office of Small Business Advocate.
  • I worked with the original sponsor, Rep. John Carney (D-Del) (now Governor-elect of Delaware) in drafting this legislation prior to its introduction in Congress.
  • I assisted in procuring the initial Republican co-sponsor – Rep. Sean Duffy (R-Wis).

A special thank you is in order for SEC Commissioner Gallagher. Without his public and vocal support for this legislation it might have taken many more years for this historic legislation to become a reality.

A copy of the Bill can be found here.

For those of you who want to dig deeper on this subject, here is some background material on the Bill and my role in its journey:

http://www.crowdfundinsider.com/2016/12/93592-sec-small-business-advocate-moves-closer-reality-senate-passes-bill/

http://www.crowdfundinsider.com/2016/11/92607-unstacking-deck-smes-washington-call-sec-small-business-advocate/

Posted in Capital Raising, Corporate Governance, Corporate Law, Crowdfunding, General, Regulation A+ Resource Center, SEC Developments | Tagged , , , | Comments Off on HR 3784 – SEC Office of Small Business Advocate – Is Now the Law of the Land

Congress Passes H.R. 3784 SEC Office of Small Business Advocate Bill

Christmas in Washington DC Capitol

[Author’s Note: HR 3784 was signed into law by President Barack Obama on December 16, 2016. For an update on this historic legislation, see my most recent article appearing on this Blog.]

Most of us were probably sleeping last night when the U.S. Senate passed by unanimous consent H.R. 3784, a Bill to create an Office of Small Business Advocate at the SEC. Earlier this year H.R. 3784 passed the House, by voice vote.

This legislation is now on its way to the President, and is expected to be signed into law this year.

For those of you who want to dig into this more, you may want to read my most recent article on this topic.

I expect more good things will come for SME’s in 2017!

And to read more on my thoughts as to the need for, and importance of, this legislation, you may find this article in Crowdfund Insider of interest.

Here  is the original Letter of Support  for HR 3784 when it was first introduced into the House of Representatives in October 2015.  The bill was supported by eight major industry trade associations, including the Crowdfunding Professional Association (CfPA), of which I was the Chair and President at the time.

 

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Unstacking the Deck Against SME’s in Washington: A Call for an SEC Small Business Advocate

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[As published inn Crowdfund Insider on November 16, 2016]

With a new administration set to take the reins of power in the White House in January 2017, not to mention a new, Republican appointed Chair of the SEC in the offing, when it comes to the interests of small business’s access to capital, many things are now possible – indeed likely.

Today I would like to focus on a particular piece of legislation, now pending in the Senate, one of a number of important pending or proposed legislative reforms, which I and others consider vital to advancing the interests of SME’s to access capital – both in the deliberative process at the SEC, and in Congress.  The Bill, H.R. 3784, introduced in the Senate as S. 2867, is a piece of “common sense” legislation which would establish a permanent, independent office at the SEC, whose exclusive charge would be to represent, and advocate for, the interests of SME’s, both internally, and as a spokesperson for SME’s on Capitol Hill.  The bill is largely patterned after a similar bill which was part of the Dodd-Frank Act of 2010, creating an independent office of Investor Advocate.

After being voted out of the House Financial Services Committee, and ultimately the full House of Representatives, by voice vote, it now sits in the Senate in the Banking Committee, awaiting action – or inaction – as the case may be.  The bill is likely to see action, sooner or later, in view of the changing of the guard at the White House – not to mention the Commission. In my view, the sooner the better. Hopefully, a majority in the Senate will share that view.

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So who could be opposed to such a bill, and why? It seems to fit in well with Mom and Apple Pie. Right? After all, who could object to having a dedicated, independent voice, and advocate, for small business at the SEC?

Well, it seems there are still some doubters on the Senate side. This article is intended to speak to those fence sitters, on both sides of the aisle – not to mention our President-Elect Donald J. Trump, who is on the hunt for meaningful reforms in Washington which will grow our economy – and fuel the creation of new jobs.

Oddly, it seems that I was the first person to publicly advocate for an independent voice for SME’s at the SEC. I do not take too much credit for this, as this is a common sense proposal – even more so following Dodd-Frank’s creation of an Office of Investor Advocate at the SEC back in 2010. Instead, and very sadly, what this reflects, in my opinion, is the absence of voices in Washington dedicated to interests of small business, and their need to access capital. Yes, there are some – but they are heavily outnumbered – and outspent. History alone tells us that this has not been a fair fight, when it comes to addressing the need of small business to access capital.

Small business needs a legislative fix to even the playing field – both at the SEC and in Congress.

Daniel Gallagher Dont Be Bullied 2Not only my view. Others, with a better vantage point than me at the SEC, have echoed this sentiment in no uncertain terms.  Former SEC Commissioner, Daniel M. Gallagher, who left his post as Commissioner after four years in October 2015, had this to say on the subject, in a major address delivered at The Heritage Foundation in September 2014, aptly titled: “What Ever Happened to Promoting Small Business Capital Formation”:

“But small business has a big collective action problem here in Washington, where it is regularly and systematically underrepresented in the legislative and regulatory process. Small business owners are focused on making ends meet and growing their businesses, not hiring high-priced lobbyists to influence policy. Big businesses and unions, by contrast, can afford to hire lobbyists to develop relationships with politicians and regulators—which is the way business in the U.S. increasingly gets done. As an SEC Commissioner, I believe that this issue warrants the agency’s highest level of priority. And, as the son of two long-time small business owners, I take this issue personally.”

No surprise that, in that same speech, Commissioner Gallagher was the first public official to publicly address the need for an independent office at the SEC devoted exclusively to advancing the interest of SME’s, being one of the most outspoken, and effective, advocates for small business at the SEC in my lifetime.

office-of-small-business-advocateAnd so, I believe the SEC needs to create an Office of the Small Business Advocate, reporting to the Commission. This office would be modeled on the Office of the Investor Advocate created by the Dodd-Frank Act. There’s a natural parallel here, in that our staff perennially faces difficulty in receiving views from certain segments of the market that find it difficult and expensive to participate in the normal notice and comment rulemaking process: retail investors and small businesses. Having a single point of contact for outreach to these underrepresented groups, who can then turn around and advocate their views to the staff, is critical. Finally, just as the Investor Advocate now runs the Investor Advisory Committee, the Small Business Advocate could take charge of the SEC’s Advisory Committee on Small and Emerging Companies and the Government-Business Forum, an incredibly important group that does not have the profile it deserves at the Commission.

My sources tell me that there are still some doubters on the Senate side. On this piece of legislation there ought to be no doubt.  Yes, there is the perennial opposition of everything which would empower small business at the SEC and in the capital markets. To name one – that powerful and well funded (and “state sponsored”) North American Securities Administrators Association (NASAA). Also, some inside the SEC are not sanguine, to say the least, about the prospects that this change in the status quo would bring.  Unfortunately, necessary change often disrupts the status quo.

Many industry organizations have already weighed in on the record in support, including the U.S. Chamber of Commerce, National Venture Capital Association, National Small Business Association, Small Business Investor Alliance, SBEC, and BIO, the largest organization representing the biotech industry.  Also in the mix was the Crowdfunding Professional Association (CfPA), under my leadership as Chair and President when the bill was originally introduced into the House of Representatives back in 2015.

So Why are there Still Doubters?

To be fair, there are, and have been, doubters on both sides of the aisle. Some question whether there is a need to “expand” any governmental agency. Others question how effective a Small Business Advocate would be.  The most potent and pointed response to these doubters might be in the form of data – a tactic which some folks (NASAA) recently used as a sword to dismember the most recent legislative effort to resuscitate federal investment crowdfunding, Congressman McHenry’s Fix Crowdfunding Act, H.R. 4855.

Patrick McHenryUnfortunately, it is difficult to quantify, or datify if you will, the need for a dedicated small business advocate. Much of the story is told in what has not happened – and thus cannot be easily quantified. Alas, not all stories must be told with numbers, even in this digital age. 

History alone will not convince all of the doubters, measured by the progress that small business capital formation reforms have made since 1980, when a bi-partisan Congress enacted a host of legislative initiatives intended to empower small business at the SEC.  So I turn this conversation to some concrete, recent qualitative examples of why an independent small business advocate is necessary at the SEC.

Sometimes it Takes Some Red Meat to Change Minds.

Though I was not called upon to testify in support of H.R. 3784, here is some of what I would have put in the record.

Example No. 1 – Intrastate Crowdfunding.

Back in April 2014 the Staff at the SEC’s Division of Corporation Finance issued an informal, non-binding ruling, opining that states could not allow for broad, unrestricted internet solicitation in state legislation relying upon the federal exemption from registration, Section 3(a)(11), which in simple terms leaves it up to the states as to how best regulate securities offerings within their state.

I personally was “inflamed,” not only because this ruling reflected an about face on earlier rulings allowing broad solicitation, in radio, TV and newspapers, even when it crossed state lines,” but because it took away a powerful and inexpensive tool for small businesses to reach outside of their inner circle when seeking much needed capital. So inflamed, I penned two articles on the subject, followed by a meeting with ranking members of the SEC’s CorpFin staff. I was told in no uncertain terms that there were some (unnamed) people inside the SEC’s headquarters who did not share my view that internet solicitation was a good thing, when it came to capital formation. Others, including a former president of the Crowdfunding Professional Association, were also shown the “hand” on this issue by the Staff.  To put a fine point on this, when I left my meeting at SEC headquarters, I was consoled by another Staff member, who aptly remarked in a sympathetic manner that I was “beating my head against the wall.” Yes, there was a wall. And my head was exploding.

And the salt on the wound – the Commission was still dragging its feet on adopting proposed crowdfunding rules under Title III of the JOBS Act.

Ultimately the Commission Saw the Light

In 2015, in what I believe was a response to state securities administrators outraged by the SEC’s position, the SEC made intrastate crowdfunding, and SEC Rule 147, a priority, ultimately proposing new rules in October 2015.  In what I described in my formal comment letter on the proposed rule, what the Commission had proposed was a Faustian bargain of sorts – it would allow state legislatures to enact provisions allowing broad internet solicitation – but at a price. The Feds sought to cap the amount raised in any year to $5 million.

As history would have it, rule commenters were almost universally opposed to this cap – hence it was removed when the final rules were enacted in October 2016.

So What Difference Would a Small Business Advocate Have Made?

Well, I believe that if small business had a strong, independent voice at the table back in 2014, that Staff ruling would never had seen the light of day, and instead we would have seen much needed rulemaking, ultimately implemented in October 2016.  The ruling went against the grain of prior SEC pronouncements and published views of noted SEC scholars, Rutheford B. Campbell, to be precise – an influential voice in the enactment of regulations implementing Title IV of the JOBS Act, Regulation A.

Given that the new, final rules do not go into effect until April 2017, many startups, and would be startups, lost the opportunity for three years to utilize the internet to reach out to accredited and non-accredited investors in their own community.

Moreover, this ruling directly impacted state legislatures contemplating intrastate crowdfunding legislation. In my home state of California, yet to enact a crowdfunding statute due to intense lobbying efforts of the payday lenders, the Committee text to one of the bills stated that California was essentially forced to craft this legislation under another federal rule, Rule 504, which carried with it at that time an SEC mandated limit of $1 million per year.

And well, those legislatures which had enacted intrastate crowdfunding legislation back in 2014, or earlier – their local entrepreneurs would have to pound sand – when it came to the use of the internet – for three years.

Example No. 2 – Making Sausage out of a Pure Beef “Fix Crowdfunding Act”

I like many others, like sausage. Undoubtedly, I would forever renounce it if I witnessed the process by which it were made.  So too, apparently, 86% of the American electorate, fed up with business as usual in Congress.  Those with “access” can get things done in D.C., be it through high paid lobbyists or well placed political partisans. As former SEC Commissioner Dan Gallagher pointed out, small businesses don’t stand a chance.

where is the beef meatWe saw the result of this (but not the cause) as Congressman McHenry’s pristine Fix Crowdfunding Act fell victim to Washington sausage making before it was voted out of Committee. Though it was ultimately voted out of the House Financial Services Committee, and subsequently the full house, the amended bill fell victim to partisan deal making, losing one of its most vital provisions, what would have allowed would be investment crowdfunders to “test the waters” – in other words to interact with the public, through social media and the internet, to gauge interest in their business and their financing plan – before filling out all of the paperwork necessary to commence the formal offering process.

Though universally supported by the crowdfunding industry and small business advocates alike, it was opposed, on the record, by NASAA. Not enough data for them yet, it seemed. At least that is what their spokesperson, William Beatty, stated on the Congressional record.

OK, no surprise there. NASAA can always be counted upon to oppose any reform which would widen the spigot of capital to early stage businesses – too risky for the investing public they say.

But Here is the Big Surprise!

fix-mechanic-car-repair-auto-tune-up-toolsMuch of the important deliberations in Washington occur behind closed doors, outside the eyesight and hearing of the public.  After all, sausage making is ugly.

Less known, and unsettling to say the least, is that according to a highly credible Capitol Hill source, at least one SEC official weighed in on the testing the waters provision of the Fix Crowdfunding Act, behind the closed doors of a Congressional member of the House Financial Services Committee. In that person’s view, the testing the waters provision did not belong in the Fix Crowdfunding Act.

Wouldn’t it have been nice if there were a designated point person at the SEC who could freely and openly advocate for the interests of small business, both behind closed doors – and openly in Congressional hearings?

That is exactly what the pending Small Business Advocate Bill would allow. A dedicated, independent voice, to weigh in not only in Congress, but with some “bully pulpit” authority, now lacking, in the internal rulemaking deliberations of the SEC.

Joe BorgAnd well, those NASAA folks, they seem to be cutting off their nose to spite their face on the battle against testing the waters provisions.  After all, public internet-based solicitation before an offering formally commences would provide an early warning system for state regulators, on the hunt for the next securities fraud du jour. As one of my favorite State Securities Administrators and former NASAA President has remarked, Joe Borg, at the helm in the State of Alabama, the challenge of state regulators is to catch bad actors before the forest is burned to the ground – leaving victims who may have lost their life savings to fraudsters with no effective recourse.

Also argued by opponents to testing the waters in investment crowdfunding: it will have the impact of conditioning investors’ minds before they are afforded full disclosure. Well, it seems that the Fix Crowdfunding Act squarely addressed this concern, by expressly providing that material departures from testing the waters material would need to be highlighted as such in the mandatory SEC disclosure accompanying the formal offer and sale process.

perry-mason-1And for those investor protectionists concerned for perhaps the largest vulnerable population, the elderly, more than half of that population suffers from some form of dementia by time they reach their 80’s.  Surely they need protection from bad actors. But let’s get real.  It is unlikely, indeed impossible, that anyone with an impaired short term memory will be mentally conditioned by anything for very long.

So for those who question whether an independent small business advocate is necessary. I say: it is both essential – and long overdue.  And for those concerned about cutting government spending: plenty left, unutilized, in the current SEC budget, according to this week’s Congressional record. And I would expect that with a dedicated focus at the SEC on the interests of SME’s, this would reap oversized financial dividends for years to come – in terms of more focused SEC rulemaking and federal legislation – and more capital in the hands of this Nation’s largest engine of job creation – small business.

I rest my case.


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.

Posted in Capital Raising, Crowdfunding, General, Regulation A+ Resource Center, SEC Developments | Comments Off on Unstacking the Deck Against SME’s in Washington: A Call for an SEC Small Business Advocate

On the SEC’s New Intrastate Crowdfunding Rules and the Nanny State

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On October 26, 2016, the SEC’s three Commissioners convened at their headquarters to adopt new rules intended to modernize what had historically been a little used path of raising capital for startups, early stage businesses and community-based enterprises: the so called intrastate exemption. It had its origins in our federal securities regulation legislation adopted back in 1933, which required the federal registration of the sale of securities in the U.S.  absent an exemption from registration.

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In 1933 Congress, in its wisdom, carved out from the registration requirement those offerings that were purely local in character, where offers and sales were made by local businesses within their state borders.  This area it left to regulation by the states – on a state by state basis – with each state left to decide for itself how best to balance the need to protect its investing public with the ability of local businesses to access capital.

And to facilitate the utilization of this exemption from registration the Commission enacted Rule 147, intended to be a non-exclusive safe harbor to facilitate compliance with the federal exemption.

Over the years it became more and more apparent that both the exemption itself and the Rule were flawed – hence its use languished – in favor of other more manageable exemptions from federal registration.   Its use was generally shunned by securities lawyers, as it was too easy to fall out of compliance with its requirements.

And time was not kind to the intrastate exemption. If your business was a corporation, the statutory exemption was limited to corporations incorporated in the state where the offering occurred, thus excluding local businesses who might elect to incorporate in out of state jurisdictions.   And with the onset of the Internet in the 1990’s the Commission struggled with how to address offers by a local business on the internet which by their very nature would cross state borders.  This struggle came to a head in 2014, when the SEC Staff issued an informal interpretation, a “CDI” (compliance and disclosure interpretation), opining that unrestricted Internet solicitation and advertising of an offering was taboo for an offering relying on the intrastate exemption.  This effectively put a damper on local investment crowdfunded offerings in the dozens of states that had adopted, or were to adopt, intrastate crowdfunding statutes relying on the intrastate exemption.

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The 2014 CDI was greeted with a growing chorus of mystified securities lawyers, state securities regulators and small business advocates.  At a time when the SEC was dragging its feet to adopt regulations to implement interstate (nationwide) investment crowdfunding,  it had in effect shut off many states from enacting local crowdfunding statutes which would enable SME’s to leverage the Internet in local investment crowdfunding campaigns.

Invest Today Billboard AdvertisementIn 2015 the Staff at the SEC’s Division of Corporation Finance took the bull by the horns, recommending that the Commission adopt new rules to modernize and expand the federal intrastate crowdfunding exemption. On October 30, 2015, the same day that the Commission adopted the long-awaited final rules implementing JOBS Act Title III crowdfunding, it came with its own October surprise: proposed rules to update and expand the intrastate exemption – notably, allowing unrestricted Internet advertising of an offering.

One year later, on October 26, 2016, the Commission adopted final intrastate crowdfunding rules, much improved from the proposed rules. Gone in the final rules, among other things, was a provision which would have prohibited state legislatures and state securities regulators from authorizing local investment crowdfunded offerings in excess of $5 million per year.  Though no state has yet to authorize crowdfunded offerings above this amount, virtually all of those who commented on the propose rules were unanimous: this was a matter best left to the discretion of each state – not the federal government.  And in the UK, where investment crowdfunding has flourished, the $5 million dollar ceiling has been broken and is expected to go higher.

Though the vote by the Commissioners on the final rules was unanimous, not so with the sentiment of the Commissioners.  In Commissioner Kara M. Stein’s public remarks on the final rules, she was not shy about expressing reservations about the ability of the individual states to protect their local residents from questionable offerings and bad actors, cautioning of the need for continuing federal oversight:kara-stein-sec-intrastate

“Today’s rules amend Rule 147, and create a new federal offering exemption known as Rule 147A.  Hopefully, the updated safe harbor and new exemption before us today will foster opportunities and create new paths forward for such smaller firms, while still safeguarding investors.”

 

“At least, this is the theory.  Like other experimental capital-raising rules, such as Regulation A+ and Regulation Crowdfunding, only time will tell how well the theory works in practice. Only time will tell whether we can relax capital-raising regulations, while also maintaining appropriate investor protections.  So, while today’s rules may provide smaller companies with additional funding opportunities, today’s rules also raise some investor protection concerns.”

And in closing her remarks, Commissioner Stein  again emphasized what she viewed as the “experimental” nature of these new rules:

“Today’s amendments to Rules 147 and 504 and the new exemption under Rule 147A are part of a suite of rules focused on providing options for smaller businesses seeking to raise capital.  On balance, I think they are worth the experiment.  However, by collecting, sharing, and examining data on how these new options are working in practice, we should be able to recalibrate these rules if the experiment is not working out as planned.”

Most respectfully, I must take exception to Commissioner Stein’s characterization of these rules. It is not a question of whether the glass is half full, or half empty. In my opinion, the glass, from Commissioner Stein’s perspective, is simply upside down.

Science Chemistry TechnologyThe real “experiment,” historically, dates back not only to 1933, when Congress first carved out this statutory reservation of power to the states. The “experiment” also dates back to 1776, when our Founders adopted a Constitution which gave specified powers to the federal government, with all other powers being reserved to the states.  The “experiments” our Founders had in mind were those which would take place under laws enacted by each of the states – as they, and not the federal government, saw fit.  States were to set up their own laboratories of experiment for matters uniquely concerning their residents, and occurring within their borders – free from interference by a federal bureaucracy.

Seems that Commissioner Stein never got that memo. In her view, it would be up to the SEC to “recalibrate” the new rules if the states get it wrong – in the judgment of the Commission, of course.

So Why Does Any of This Matter?

It would be easy to be dismissive of the recently adopted intrastate rules.  After all, historically the intrastate exemption has not been in favor –there have been much better options – with far fewer pitfalls. Even more so now, with new pathways of capital formation opened up by the JOBS Act of 2012.  And with the advent of federal investment crowdfunding, most would yawn when examining the seemingly unimpressive statistics for the use of intrastate crowdfunding during brief period in which intrastate crowdfunding has been allowed.

I submit that current statistics are not very meaningful – as they do not tell the whole story. There is a lag between the time that new capital raising paths are created and when they become “mainstream.”  And let us not forget – until these new rules go into effect (April 2017), as a general matter broad internet solicitation is not permitted in intrastate crowdfunded offerings relying on the current Rule 147 – covering most of the 35 states which have adopted their own intrastate crowdfunding statutes.  And crowdfunding without the Internet is more akin to a day without sunshine. Not much can grow in that environment.

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Size Does Not Always Matter

Statistics, however, do not tell the whole story. Most businesses start out as local businesses.  But when it comes to allocating investor capital in SME’s, most of it winds up in California, New York, and Massachusetts, leaving the vast majority of this country as “capital deserts.”

Patrick McHenry 2Those are not my words. They are the words of US Congressman and Deputy Whip Patrick McHenry, who hails from the Great State of North Carolina – the same gentlemen who has been unrelenting in his efforts to implement smart federal legislation intended to remove unnecessary federal regulatory barriers to SME capital formation: starting with the JOBS Act of 2012, and continuing to this day with a host of bills to further improve the access of SME’s to much needed capital – especially in capital-starved “flyover” states.

Make no mistake about it.  This is not a political issue, notwithstanding the heated rhetoric in 2016 which has saturated our media.  To put a fine point on this, I offer the views of our Democratic Vice President, Joe Biden, spoken in 2014 at the U.S. sponsored Global Economic Summit, on the other side of the world in Morocco to an assembly of thousands of entrepreneurs and government officials, including the head of the U.S. Small Business Administration, Maria Contreras – Sweet.

“The single most valuable resource on this planet I think we could all agree on in this room is not what’s in the ground, but what’s in the mind.  It’s the single least explored part of the world, the mind.  The things that are going to happen in the next two, five, 10, 15 years are breathtaking.  Investors, they have to be willing to expand the horizon and invest in early stage entrepreneurs — not only in Silicon Valley — but . . . everywhere, everywhere where there’s talent.”

maria-contreras“Governments have to unlock the marketplace of ideas by allowing people to express their views openly about what they’re thinking and what they’re trying.”

“They must unlock the commercial marketplace by eliminating barriers to access to capital; ensuring that rules are fair and predictable, removing excessive cumbersome regulations.”

“The government can’t grow the economy by itself.  As a matter of fact, it’s not the major reason.  It’s a catalyst for growth — no matter how big the megaproject.  To prosper in the 21st century, you also need to grow from the bottom up, allowing your people to unlock their talents through private enterprise and political and economic freedom and action.”

And there was some irony – not apparent from the remarks themselves.  They were spoken at a U.S. sponsored world conference intended to promote entrepreneurial activity in Muslim-majority countries – one of former Secretary of State Clinton’s initiatives started by her back in 2009.

Washington Monument DCSo let’s not be too “provincial” when pronouncing judgment on who knows best, when it comes deciding how investors should best be protected – or what is needed to enhance capital formation for SME’s –  or where those funds are needed most – especially when the boundaries of that “province” are marked by the Washington Beltway – and the matters at hand reside within the borders of a single state.

So let’s wake up – and give some deference to our local communities, big and small, U.S. entrepreneurs everywhere, including in the flyover states, and the state legislatures which regulate them.  Sometimes big ideas start in small, seemingly unlikely places.

“Bite-size” businesses, in the aggregate, are important to our economy and job creation. And in Finfair Panel with Amy Cortesethis day and age of readily accessible technology “Uber” sized businesses often have their genesis with relatively modest amounts of capital.

After all, it’s why one notable leader championing the importance of local investing, and New York Times contributor,Amy Cortese, calls it “Locavesting,” – not “Loco” – vesting.

Posted in Business Formation, Capital Raising, Corporate Law, Crowdfunding, General, SEC Developments | Comments Off on On the SEC’s New Intrastate Crowdfunding Rules and the Nanny State

SEC Adopts Final Expanded Intrastate Crowdfunding Rules

Today the SEC unanimously adopted amendments to Rule 147 and Rule 504, and adopted a new Rule 147A, intended to modernize and facilitate local offerings by companies in their home state.  The final rules are much improved from the proposed rules issued in October 2015, in response to virtually unanimous views of rule commentors.

The only fly in the ointment is that most states will need to update their legislation in order to be able to take advantage on the new, relaxed rules allowing broad internet solicitation. However, sales are still limited to investors in the company’s state.

The new rules will generally take effect in April 2017.

Here is a link to the SEC’s Final Rules Release: https://www.sec.gov/rules/final/2016/33-10238.pdf

Following is the SEC Press Release announcing the adoption of the final rules and a brief summary of the key provisions:

 

SEC Adopts Final Rules to Facilitate Intrastate and Regional Securities Offerings

Rules Provide More Options for Companies to Raise Money While Maintaining Investor Protections

FOR IMMEDIATE RELEASE
2016-226

Washington D.C., Oct. 26, 2016 —The Securities and Exchange Commission today adopted final rules that modernize how companies can raise money to fund their businesses through intrastate and small offerings while maintaining investor protections.

“These final rules, while continuing to provide investor protections, update and expand the capital raising avenues for smaller companies, allowing them to more fully take advantage of changes in technology and business practices,” said SEC Chair Mary Jo White.

The final rules amend Securities Act Rule 147 to modernize the safe harbor under Section 3(a)(11) of the Securities Act, so issuers may continue to use state law exemptions that are conditioned upon compliance with both Section 3(a)(11) and Rule 147.  The final rules also establish a new intrastate offering exemption, Securities Act Rule 147A, that further accommodates offers accessible to out-of-state residents and companies that are incorporated or organized out-of-state.

To facilitate capital formation through regional offerings, the final rules amend Rule 504 of Regulation D under the Securities Act to increase the aggregate amount of securities that may be offered and sold from $1 million to $5 million.  The rules also apply bad actor disqualifications to Rule 504 offerings to provide additional investor protection, consistent with other rules in Regulation D.  In light of the changes to Rule 504, the final rules repeal Rule 505 of Regulation D.

Amended Rule 147 and new Rule 147A will be effective 150 days after publication in the Federal Register.  Amended Rule 504 will be effective 60 days after publication in the Federal Register.  The repeal of Rule 505 will be effective 180 days after publication in the Federal Register.

*   *   *

FACT SHEET

Exemptions to Facilitate Intrastate and Regional Securities Offerings

SEC Open Meeting
Oct. 26, 2016

Action

The Securities and Exchange Commission is considering whether to adopt new and amended rules that would update and modernize how companies can raise money from investors through intrastate and small offerings.  The rules are part of the Commission’s efforts to assist smaller companies with capital formation while maintaining investor protections.

Highlights of the Final Rules

New Rule 147A and Amendments to Rule 147

The adoption of new Rule 147A and the amendments to Securities Act Rule 147 would update and modernize the existing intrastate offering framework that permits companies to raise money from investors within their state without concurrently registering the offers and sales at the federal level.

Amended Rule 147 would remain a safe harbor under Section 3(a)(11) of the Securities Act, so that issuers may continue to use the rule for securities offerings relying on current state law exemptions.  New Rule 147A would be substantially identical to Rule 147 except that it would allow offers to be accessible to out-of-state residents and for companies to be incorporated or organized out-of-state.

Both new Rule 147A and amended Rule 147 would include the following provisions:

  • A requirement that the issuer has its “principal place of business” in-state and satisfies at least one “doing business” requirement that would demonstrate the in-state nature of the issuer’s business
  • A new “reasonable belief” standard for issuers to rely on in determining the residence of the purchaser at the time of the sale of securities
  • A requirement that issuers obtain a written representation from each purchaser as to residency
  • A limit on resales to persons residing within the state or territory of the offering for a period of six months from the date of the sale by the issuer to the purchaser
  • An integration safe harbor that would include any prior offers or sales of securities by the issuer made under another provision, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of the offering
  • Legend requirements to offerees and purchasers about the limits on resales

Amendments to Rule 504 and Repeal of Rule 505

Rule 504 of Regulation D is an exemption from registration under the Securities Act for offers and sales of up to $1 million of securities in a 12-month period, provided that the issuer is not an Exchange Act reporting company, investment company, or blank check company.  The rule also imposes certain conditions on the offers and sales, with limited exceptions made for offers and sales made in accordance with specified types of state registration provisions and exemptions.  The amendments to Rule 504 would retain the existing framework, while increasing the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million and disqualifying certain bad actors from participation in Rule 504 offerings.  The final rules also would repeal Rule 505, which permits offerings of up to $5 million annually that must be sold solely to accredited investors or no more than 35 non-accredited investors.

Background

The Commission adopted Rule 147 in 1974 as a safe harbor to a statutory intrastate exemption, Section 3(a)(11), which was included in the Securities Act upon its adoption in 1933.  Commenters, market participants and state regulators have indicated that the combined effect of the statutory limitation on offers to persons residing in the same state or territory as the issuer and the prescriptive eligibility requirements of Rule 147 limit the availability of the exemption for companies that would otherwise conduct intrastate offerings.

The $1 million aggregate offering limit in Rule 504 has been in place since 1988.

Effective Date

Amended Rule 147 and new Rule 147A would become effective 150 days after publication in the Federal Register.  Amended Rule 504 would become effective 60 days after publication in the Federal Register.  The repeal of Rule 505 would become effective 180 days after publication in the Federal Register.

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Posted in Corporate Law, Crowdfunding, General, SEC Developments | Comments Off on SEC Adopts Final Expanded Intrastate Crowdfunding Rules