Corp Fin Director's Testimony on Crowd-Funding and Other Issues Regarding Capital Formation

By Cydney Posner

Following is a link to the testimony of Meredith Cross, Corp Fin Director, in connection with today's House subcommittee hearing on crowd-funding. She reminded the subcommittee that the SEC staff is currently reviewing a number of areas related to capital formation, including the regulatory questions posed by crowd-funding. She noted that the staff has been discussing crowd-funding, among other capital raising strategies, with business owners, representatives of small business industry organizations and state regulators. She recognized that the ease of electronic communications presents an opportunity for smaller companies to access needed funds, as well as an opportunity for the unscrupulous. For instance, she raised the example of prior Rule 504, which allowed public offerings to investors (including non-accredited investors) for securities offerings of up to $1 million, with no prescribed disclosures and no limitations on resale, subject only to blue sky regulation and anti-fraud laws. In 1999, however, fraud concerns caused the SEC to significantly revise the exemption.

She suggested the following as issues that should be considered in connection with crowd-funding:

• what information – for example, about the business, the planned use of funds raised, and the principals, agents, and finders involved with the business – should be required to be available to investors;
• what restrictions should there be on participation by individuals or firms that have been convicted or sanctioned in connection with prior securities fraud;
• should a Commission filing or notice be required so that activities in these offerings could be observed;
• should securities purchased be freely tradable; and
• should websites that facilitate crowdfunding investing be subject to regulatory oversight?

She observed that potential investors need information about the business plan or the entrepreneur behind the business. While sophisticated investors can negotiate protections, crowd-funding investors "may have limited investment experience, limited information upon which to make investment decisions, and almost no ability to negotiate for protections." Even though the amount invested may be small, these issues should be considered as part of the cost-benefit analysis.

She also provided an update on the staff's review of SEC regulations relating to the triggers for public reporting, the restrictions on general solicitation and communications in connection with public offerings.

Exchange Act Trigger:  The staff recognizes that numerous changes in the securities markets and the way securities are held militate in favor of revisiting the registration triggers. A number of rule-making proposals -- with opposing goals -- have been received, ranging from, on the one hand, raising the shareholder threshold for registration by excluding employees, or by excluding accredited investors, QIBs or other sophisticated investors from the calculation to, on the other hand, revising the definition of "held of record" to look through record holders to the underlying beneficial owners of securities so that fewer issuers are able to cease reporting. The staff is currently conducting a study to determine the efficacy of the Exchange Act registration and reporting requirements: What does it mean to be a "public" company? What characteristics should be necessary to require registration? The study also will seek to obtain and consider private company information to assess current reporting thresholds.

Restriction on General Solicitation:  The staff acknowledges that there are strong views, both pro and con, regarding the continued necessity, usefulness or viability of this restriction. In analyzing whether to recommend changes to the restriction, the staff is considering whether to issue a concept release seeking public comment on the advisability and the costs and benefits of retaining or relaxing the restrictions on general solicitation, "including specific protections that could be considered if the restriction is relaxed and the types of investors who would be most vulnerable if it is relaxed."

Communications in Public Offerings: Historically, there have been a number of changes adopted to liberalize communications, particularly the changes adopted in 2005 that significantly liberalized the rules governing communications during public offerings by the largest issuers. The staff is reviewing those rules to consider whether any of the liberalizations should be adapted for smaller public companies, including whether more companies should be able to use free writing prospectuses before a substantially complete prospectus is filed. The staff may recommend proposed changes or the issuance of a concept release.

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