Lawmaker Urges “Light Touch” to Crowdfunding Regulation

CFIRA Crowdfunding Symposium. Courtesy Candace Klein.

Washington, DC – July 13, 2012. (Updated 6:17 pm EDT). At a Washington symposium on crowdfunding under the JOBS Act, Rep. Patrick McHenry (R-NC) urged a “light touch” to crowdfunding rules, while Securities and Exchange Commission (SEC) staff members shed some light on the SEC’s thinking as it develops equity crowdfunding rules that are due by December 31, 2012.  The insights were made during  ”The Crowdfund Act – Framing the new regulatory landscape Symposium” sponsored today in Washington by the Crowdfund Intermediary Regulatory Advocates (CFIRA).

The Jumpstart Our Business Startups Act (JOBS Act) became law on April 5, 2012, and, among other things, enables small businesses to seek up to $ 1 million per year from small investors through online crowdfunding portals. The Act requires the SEC to implement rules to regulate crowdfunding by December 31, 2012.

Rep. McHenry told participants that they should realize the impact that crowdfund  investing can have on “small business folks,” claiming the JOBS Act “can have a major impact on small business and a small community.”

Rep. Patrick McHenry (R-NC)

While rooting out fraud is a major goal in implementing rules to regulate crowdfunding, Rep. McHenry believes there is power in the crowd.  He pointed out reviews that people post about vendors on eBay as an example. “If you get a bad review, they are done,” he noted.  ”The worst thing is fraud,” he said. “We’re going to have people try to do bad things no matter what. This stuff will happen, but we want to minimize it.”

He said the basic construct of the crowdfund provisions of the JOBS Act was a “light touch to regulation.” He suggested that the amendments made by the U.S. Senate to the crowdfunding provisions of the Act are “deeply flawed” and the Act will need technical changes. However, “the good news is that we now have a crowdfunding law in the United States,” Rep. McHenry told participants. Rep. McHenry suggested that the Act should be amended to allow investors with a net worth of under $100,000 to invest up to $5,000 per year and that the crowdfund investing ceiling be raised from $1 million to $5 million. He indicated that the SEC had “broad purview” to clarify the Act by regulation and urged participants to work with the SEC in formulating rules, including a provision that would provide a safe harbor to immaterial omissions made of facts in an offering.

CFIRA Co-Chair Vince Molinari moderates panel of SEC and FINRA staff.

SEC staff members informed participants that the SEC is “working very hard” to implement crowdfunding rules, according to SEC’s David Blass.  Mr. Blass is Chief Counsel in the SEC’s Division of Trading and Markets and leads the SEC’s team working on rules for funding portals and other crowdfund investment intermediaries.  He acknowledged that “there is a fair amount of rule-making necessary,” but said that the SEC’s staff is “mindful of the deadlines” established in the JOBS Act by Congress.  “The SEC staff wants crowdfunding to be a success and we want to implement the rules consistent with the Act while protecting investors,” he said.  Mr. Blass encouraged the public to submit comments to the SEC through its website.

SEC staff told participants it was analyzing, among other things, how broker-dealers should be regulated if they offer crowdfunding portals and what limits may be imposed on intermediaries regarding questions of investment advice, which is regulated under the Investment Adviser Act of 1940. Lona Nallengara, Deputy Director in SEC Division of Corporation Finance, told participants his view is that the crowdfunding provisions under the JOBS Act likely would apply to any type of securities governed by securities law, including common stock, subordinated offerings or loans. “I don’t think there is anything inherent in the type of securities that can be offered,” he said. But there is a need for disclosing the terms of the securities, “including the risk of securities.” Mr. Nallengara reminded participants that his comments did not state an official position of the SEC.

Mr. Nallengara repeatedly emphasized the need to provide investors with adequate disclosures. “They should know what they’re investing in,” he said. While offering common stock may be easier to disclose, Mr. Nallengara stressed that crowdfund investors need to know the implications if they are investing in subordinated classes of securities.

SEC staff at the symposium also hinted that the SEC will take a different view on how crowdfunding intermediaries can interact with businesses seeking crowdfunding compared to dealing with investors. Mr. Nallengara  was less troubled by intermediaries — crowdfunding portals licensed under the JOBS Act to handle crowdfunding transactions — assisting businesses in submitting their investment offers on the portals, compared to making suggestions on what offers investors should buy.  Staff reminded participants that crowdfunding portals cannot serve as investment advisers regulated under the Investment Advisers Act. For example, portals using standardized forms to help startups submit their offerings may not be problematic. “Part of the reason of the intermediary is to guide issuers through the process,” said Mr. Nallengara. On the other hand, the SEC will take a harder look if a portal desires to suggest what an investor should buy.

The SEC staff also suggested that broker-dealer rules are more likely to apply to broker-dealers who meld their crowdfunding portal business into their broker-dealer business.

Andy Green

“This is a real testimony to the democratic process,” Andy Green, Legislative Counsel to U.S. Senator Jeff Merkley (D-Oregon), told the symposium. Green said Congress will scrutinize crowdfunding over the “long term.” Such review will include the success based on new companies that grow from crowdfund investing and whether investors will return to make new crowdfunding investments. Green likewise observed that the Act does not limit crowdfunding to any specific type of securities.

Other issues covered during the symposium included:

• What role social media will play in crowdfunding? Representatives from the SEC and Financial Industry Regulatory Authority (FINRA) both urged the public to provide comments on the role social media may play in crowdfunding. FINRA likely will serve as the self-regulatory organization for intermediaries.
• How to regulate broker-dealers if they operate crowdfunding portals. Should broker-deals abide by stricter regulations imposed under current SEC rules?
• Where will intermediaries — or crowdfuding portals — be deemed investment advisers regulated by the Investment Adviser Act when they post offerings on their portals.
• Will the SEC rely on a simpler online registration process for portals that seek to register as crowdfunding intermediaries under the crowdfunding provisions of the JOBS Act?

Robert Colby, FINRA’s Chief Legal Officer, urged prospective portals to “take the high road.”

“Play it straight,” Colby warned participants. He said intermediaries should not crowdfund under the perception of what “they can get away with” under the regulations. “If you call it wrong, you can blow it for the exemption,” he warned.

Summary prepared by A. Brian Dengler, a Leadership Team Member of CFIRA and an attorney with Vorys, Sater, Seymour and Please LLP.