Title III Crowdfunding Goes Live Today with Much Potential, but Different Reality
May 16, 2016
Ever since the Federal securities laws were enacted in 1933, all offers and sales of securities in the United States had to either be registered with the SEC or satisfy an exemption from registration. The commonly used private offering exemption, however, prohibited any act of general solicitation. The JOBS Act of 2012 created a new variation to the private offering exemption under Rule 506 of Regulation D that permits online offers and other acts of general solicitation, but issuers selling under this new Rule 506(c) may sell only to accredited investors and must use reasonable methods to verify investor status.
Starting today, companies will be permitted to offer and sell securities online to anyone, not just accredited investors, without SEC registration. This is pursuant to Title III of the JOBS Act and the final crowdfunding rules promulgated by the SEC called Regulation Crowdfunding. The potential for equity crowdfunding is enormous and potentially disruptive. It is believed that approximately 93% of the U.S. population consists of non-accredited investors who have an estimated $30 trillion stashed away in investment accounts. If only one percent of that amount got redirected to equity crowdfunding, the resulting $300 billion dollars invested would be ten times larger than the VC industry. Hence the potential.
The reality, however, is not as encouraging. In the interest of investor protection, Congress in JOBS Act Title III and the SEC in Regulation Crowdfunding created a heavily regulated and expensive regime that many fear will severely limit the prospects of equity crowdfunding. The rules include a $1 million issuer cap, strict dollar limits on investors, disclosure requirements and funding portal liability, registration and gatekeeper obligations.
SEC registration for funding portals began on January 29. But as of last week, only five portals had completed the registration process: Wefunder Portal LLC, SI Portal LLC dba Seedinvest.com, CFS LLC dba CrowdFundingSTAR.com, NextSeed US LLC and StartEngine Capital LLC. Over 30 others are apparently awaiting approval. Of the two best known and most successful non-equity crowdfunding portals, only Indiegogo has declared an intention to get in the Title III funding portal business; Kickstarter has so far declined.
The likely reason for the apparent lackluster funding portal activity so far is the restrictive regulatory regime referred to above, the burden of which falls disproportionately on funding portals. None of this should be a surprise. Several key aspects of the crowdfunding rules were contentiously debated at the Congressional level and later during SEC rulemaking. Opponents asserted that retail equity crowdfunding is an invitation for massive fraud against those who can least afford it and so believe Title III is a mistake. Proponents advocated against several of the more restrictive rules but conceded on these points in order to get Title III passed. And because the legislation itself was so prescriptive and granular, there was only room for marginal improvement in the final SEC rules relative to those proposed in the initial release.
Regrettably, there’s painful precedent for securities exemptions so restrictive that no one used them. Regulation A allowed for a mini-public offering through a streamlined filing with the SEC. But issuers were capped at $5 million and were forced to go through merit review in each state where they offered the securities. The result: hardly anyone used Reg A. In recognition of this, Title IV of the JOBS Act reformed Reg A by increasing the cap to $50 million and, more importantly, preempting state blue sky review for so-called Tier II offerings which must satisfy investor protection requirements.
In an effort to prevent Title III from a fate similar to pre-reform Reg A, legislation has been introduced in Congress to increase the issuer cap, allow for special purpose vehicles, remove the $25 million asset cap on the exemption from the 500 shareholder SEC registration trigger and allow issuers to test the waters. See my previous blog post here on the proposed Fix Crowdfunding Act.
It may seem somewhat premature to advocate for reform when the rules have barely gone live. But given the time necessary for the legislative process to run its course, and inasmuch as the indications are already fairly clear that both issuers and funding portals remain skeptical about Title III crowdfunding, it makes sense to begin the process now of introducing necessary common sense reform of Title III.