In the run-up to the enactment of the JOBS Act, passed by Congress in April 2012, officials are scrambling to meet their January 2013 deadline for nailing down regulations for equity-based crowdfunding portals, which will be legalized by the bill. Proponents of the new fundraising method predict that it will make as much as $300 billion in investment capital available to entrepreneurs to start new businesses.
More than 70 crowdfunding industry stakeholders participated in a discussion on rulemaking with Securities Exchange Commission and White House officials in Washington yesterday.
But the conversation made clear that many details remain to be sorted out before the legislation goes into effect. Joining the conference by phone or in person were industry pioneers including SoMoLend founder Candace Klein, International Crowd Funding Association board chairman Mark Jones, Jason Burmer of EarlyShares, A KickIn Crowd founder Tony Reynolds, RocketHub COO Jed Cohen, and Crowdnetic founder Luan Cox.
Participants expressed some strong differences of opinion about how several aspects of equity crowdfunding should be regulated. Many are concerned about protecting investors without overburdening crowdfunding portals with compliance or limiting the creativity of startups that want to raise money through the method. Too many or confusing rules, they say, would interfere with the innovative nature of crowdfunding. Several participants agreed that if platforms "have to worry about legal liability with every move they make" it won't work.
Unresolved questions included:
What level of fiduciary responsibility do crowdfunding platforms have to investors?
EarlyShares' Burmer voiced the opinion that the Act already contains enough fiduciary duty protection that "there's enough for the SEC to delineate and iron out for us to move forward without adding responsibilities to portals. … The more you do the less likely … the intent of congress comes to fruition."
Steven Cohen, a broker-dealers' attorney who participated in the discussion, noted that "broker-dealers don't have a fiduciary duty to their clients," so crowdfunding platforms shouldn't either. He also noted that because Congress made clear that portals aren't able to charge transaction-based compensation "they don't get paid enough to be giving investment advice."
Platforms are prohibited by the act from offering investment advice, but what constitutes investment advice?
One participant asked, "How do portals decide who's going to be listed on their portal? Does the act of choosing to list a company constitute endorsement of that company, and thereby investment advice?"
Reynolds from A KickIn Crowd, said, "Portals don't have time or resources to offer investment advice … if they follow the recommendations that are set out, then they're well within the self-regulatory guidelines."
How will crowdfunding platforms be differentiated from broker-dealers?
Many participants agreed that a safe harbor statement would be useful way to clarify crowdfunders' liability under the law and ensure that they act in compliance with JOBS Act standards.
SoMoLend founder Klein said that crowdfunding portals need safe harbors for investment advice, and that she wouldn't advise copying existing safe harbor language from other industries: "We need something that fits the new circumstances. It must be specific to crowdfunding."
One participant said it's important to distinguish between the roles of a portal and a broker-dealer. "A broker-dealer is trained to give investment advice. People running portals are not." He agreed that a safe harbor could clarify that difference.
Attorney Cohen also encouraged crowdfunding platform managers to submit to review by the self-regulating organization FINRA (the Financial Industry Regulatory Association). "Allow FINRA to come in and make sure you're keeping good books and records," he recommended. "As long as your beginners' mistakes aren't fraudulent, they won't shut you down."
Should the terms of a rescission period be mandated by SEC?
While many agreed that the period of time a crowdfunding investor has to rescind an offer of investment should be short, others argued that investors should have the right to withdraw from an offering at the last minute if adverse information is disclosed.
"Crowdfunding is a unique new kind of offering and one of the earmarks is a time limit. These offerings are going to be live online for a specified time," said one caller. "Keeping the rescission period as short as possible makes sense."
Crowdnetic's founder Cox disagreed. She objected to the notion that issuers should be able to deny investors the right to pull out of an investment. Say, for instance, she said, "On the last day of the campaign a big news article comes out that the issuer is a crook." Rescission rules would mean that a crowdfunding portal would have to tell the investors, "Sorry, we put a law in place that you can't pull out." She argued that it should be up to portals to decide how they manage these questions.
Cohen from RocketHub noted that the last-minute revelation of harmful details about a company would likely qualify as a failure to disclose material information, which would give the investor the right to rescind, and perhaps voids the entire issuance, without any additional rulemaking.
"Most private placements have a 48-hour cooling-off period. It could be made a lot simpler than we're discussing," said an attorney participating in the discussion.
How should overallotment of shares be prevented?
One participant argued that FINRA should set subscription limit rules. Over-allotment has already proven to be an issue in donation-based crowdfunding, he said: "It's possible to say, 'I want to raise $100,000 to make a bobblehead and you get 6,000 donors wanting a bobblehead and you can't fulfill all the orders. We've seen these disasters."
But Reynolds argued that the person issuing the stock, not the SEC or FINRA, should be allowed to regulate those limits.
Ultimately, the discussion made clear that the industry isn't ready to start equity based crowdfunding tomorrow. And even if they do, the rules will evolve as this new web-enabled domain shakes out. As one participant said, "It's only a matter of time before someone comes up with a new and better way of doing crowdfunding."
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