Is Crowd-Funding on the Horizon?
By Cydney Posner
In his Jobs Act speech last week, President Obama taunted us with this statement: "We're also planning to cut away the red tape that prevents too many rapidly growing startup companies from raising capital and going public." Was there anything in the proposed Act that might provide some insight into precisely what he was contemplating? No, but fortunately there was a fact sheet released by the White House press office that provides some guidance. According to the fact sheet, the Administration plans to help entrepreneurs and small businesses access capital by working with the SEC to "explore ways to address the costs that small and new firms face in complying with Sarbanes-Oxley disclosure and auditing requirements. The administration also supports establishing a ‘crowdfunding' exemption from SEC registration requirements for firms raising less than $1 million (with individual investments limited to $10,000 or 10% of investors' annual income) and raising the cap on ‘mini-offerings' (Regulation A) from $5 million to $50 million. This will make it easier for entrepreneurs to raise capital and create jobs." Some of the proposals regarding capital-raising initiatives are already underway in Congress.
For example, the House of Representatives is joining the push for a crowd-funding exemption. According to this article in the WSJ, "Fizzled Beer Deal Prompts 'Crowd-Funding' Hearing," Rep. Patrick McHenry (R-N.C.) is holding hearings tomorrow on a possible crowd-funding exemption and plans to introduce legislation as early as today (but not yet). All of this action was apparently prompted by a case the SEC brought against two entrepreneurs attempting to buy Pabst Brewing Co. using "crowd-funding" to raise $300M in online pledges to fund the bid on a website called BuyaBeerCompany.com. "Crowd-funding" involves fund raising, usually over the internet, in small amounts from typically thousands of investors. According to this Corporate Counsel podcast, crowd-funding has usually been used to raise funds for charity or activities such as entry into a beauty pageant, where the purchaser or donor receives a token gift (e.g., a t-shirt) in return. Most critically, the purchaser does not receive a profits interest, thereby avoiding characterization of the transaction as the sale of an investment contract that could violate Section 5 in the absence of Securities Act registration. In the beer case, over five million investors pledged as much as $200M, with an average pledge of $40, in exchange for a "certificate of ownership." The SEC became aware of the offering as a result of a social-media campaign to find investors and took the position that this activity violated Section 5. There was no allegation of fraud, nor did the two ultimately receive any funds. While offerings could potentially be made using Rule 504 or Reg A , they may be complex to effect, create issues under blue sky laws and quickly run afoul of the 499-person trigger for Exchange Act registration.
The WSJ reports that, in an interview, Rep. McHenry indicated that he grew interested in the issue after reading about the SEC's case against the two entrepreneurs. According to the WSJ, his draft legislation would provide exemptions from the SEC's general solicitation prohibition and lift restrictions related to accredited investor status, allowing an unlimited number of individuals to contribute a total of $5 million to crowd-funded start-ups, with individual contributions capped at $10,000 or 10% of the investors' annual incomes. It would also provide an exemption from the SEC's 499-shareholder trigger for Exchange Act registration for privately traded companies that raise capital through crowd-funding.
With regard to the Administration's suggestions regarding changes to Reg A, note that, in March, Rep. Schweikert (R-AZ) introduced HR 1070, the ‘‘Small Company Capital Formation Act of 2011,'' which would exempt a class of securities under Section 3(b) that was offered and sold publicly for which the aggregate offering exceeds $5M but is less than $50M. The securities would not be "restricted securities," and the issuer could solicit interest in the offering prior to filing any offering statement, on terms and conditions as prescribed by the SEC, including requirements for audited financials, offering statements and periodic disclosures. In June, that bill was considered in committee and ordered to be reported out. On September 12, Senator Jon Tester (D-MT), with co-sponsor Senator Pat Toomey (R-PA), introduced a similar bill as S 1544; this bill requires audited financials, makes applicable Section 12(a)(2) liability and also addresses the issue of treatment under NSMIA as "covered securities" under specified circumstances, including exchange listing or qualified purchasers. This bill has been referred to committee.
But don't carried away yet. As you might recall, SEC Chair Mary Schapiro emphasized to House Oversight Committee Chairman Darrell Issa (R., Calif.) the necessity to ensure there were adequate investor protections in any easing of its rules. (See my article of 4/10/11.)