This post is the fifth in a series examining
the impact of the Jumpstart Our Business Startups Act (or JOBS Act) one year
after its passage and focuses on the provisions related to crowdfunding.
Previously in this series, I discussed the progress of
implementing the JOBS Act, specifically Titles
I and II.
In this fifth post, I will continue that discussion by focusing on
Title III, which creates a new exemption from the federal securities
registration requirement for certain small offerings conducted over the
internet, a practice commonly known as "crowdfunding."
Title III creates a new Section 4(a)(6) to the Securities
Act of 1933 exempting offerings up to $1,000,000 on the condition that:
Intermediaries will be required to:
Issuers and their officers, directors, partners and other
similar controlling persons would have heightened liability for material
misstatements or omissions in connection with the offering. Securities
sold under the crowdfunding exemption would not be transferable by
the purchaser for a one-year period beginning on the date of purchase,
except in certain limited circumstances. The provision would preempt state
securities laws by deeming securities issued pursuant the crowdfunding
exemption "covered securities" (similar to Rule 506 offerings).
In contrast with some of the other provisions of the JOBS
Act, there has been next to no activity from the SEC on crowdfunding.
Title III itself required the SEC to issue implementing regulations by
December 31, 2012. As of May 2013, there are no signs that the rules will be
issued any time soon. The SEC has not even proposed preliminary rules
(which must go through a comment period prior to the adoption of final rules)
as it has with Title II. In addition, after the SEC issues its rules, FINRA
will also need to act to create its own rules governing intermediaries.
Therefore, it is unlikely that we will have a working crowdfunding
exemption prior to 2014 at the earliest.
In addition to timing issues, as I
discussed in a previous post, I have concerns that the crowdfunding
exemption, as passed by Congress, will turn out to be unusable. As can be
seen from my description above, the exemption is very complicated, with
significant compliance burdens and liability risks imposed on the issuer and
its management. Small issuers will likely find that the cost of
professional services necessary to manage this compliance risk may be too high
to make conducting a crowdfunding offering worthwhile. It may be possible
that funding portals will be able to manage some of this compliance burden for
issuers, but by taking on those burdens, it may be that the portals themselves
become financially unviable in the long run. In addition, even without
all of these compliance burdens, issuers may still find that crowdfunding may
be more trouble than it's worth (see this
post for some of the reasons why).
So has my opinion on Title III changed at all in the last
year since the passage of the JOBS Act? It has only slightly. I
still believe the exemption is significantly more complicated than it needs to
be. I also still believe that there are enormous practical problems with
any crowdfunding exemption. However, one thing that has struck me over
the last year is how much of a hopeful and enthusiastic response the
crowdfunding exemption has received from some parts of the startup community.
A significant crowdfunding industry has sprung up since the passage of
the JOBS Act, consisting of hundreds of startup funding portals dedicated to
crowdfunding and numerous associations and conferences. The sheer size of
the industry increases the chances that somebody will find a way to make the
exemption workable and cost-effective. Of course, with the SEC's delays
in implementing the exemption, this industry remains one without a legal
business model. With these continued delays, many startup funding portals
may fold due to a lack in revenue, or pivot to other business models,
suffocating the enthusiasm that offers a glimmer of hope that we may, one day,
see a functioning crowdfunding model in the United States.
 In addition, it is strongly implied by the new
Section 4A(a)(8) that the investor limits apply across all issuers. For
instance, if an investor's annual limit is $2,000 per year, that investor could
not invest more than $2,000 in crowdfunding in total. Under the JOBS Act,
it is the intermediaries who are required to enforce this. It is unclear
(though it will likely be clarified in the regulations) what the consequences
to the issuer will be for an inadvertent violation of this provision.
 Just about all of the funding portals that currently
claim to be up and running are doing one of three things: (1) operating a site
that offers kickstarter-type donation-based crowdfunding, (2) operating an
online angel investment platform (restricted to accredited investors), or (3)
© 2013 Alexander
J. Davie - This article is for general information only. The
information presented should not be construed to be formal legal advice nor the
formation of a lawyer/client relationship.
Read more articles by Alexander Davie at Strictly
Business, a business law blog for entrepreneurs, emerging companies, and
the investment management industry.
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