JOBS Act Update
By Jonathan Friedland*
The hearing included testimony from: (a) Benjamin Miller, Co-Founder of Fundrise; (b) Annemarie Tierney, Executive Vice President and General Counsel of SecondMarket; (c) William Beatty, Director of Securities in the Securities Division of the Washington State Department of Financial Institutions, who testified on behalf of the North American Securities Administrators Association, Inc.; and (d) Jeff Lynn, Chief Executive Officer of Seedrs Limited. You can listen to the hearing here.
The hearing examined the discussion drafts for (a) the Equity Crowdfunding Improvement Act of 2014 (click here to read the bill); (b) the Startup Capital Modernization Act of 2014 (click here to read the bill); and (c) the Bill to direct the Securities and Exchange Commission to revise the proposed amendments to Regulation D, Form D, and Rule 156 (click here to read the bill).
Background/JOBS Act Refresher
By way of partial background (the JOBS Act did more than “lift the ban” and create a framework for non-accredited investors to invest in private offerings via “crowdfunding,” to be sure, but these are the two attributes of the JOBS Act which deservedly get the most attention and the two with which this newspaper is most concerned):
- This past Fall, the SEC removed the prohibition against general solicitation and general advertising for securities offerings relying on Rule 506, provided that (a) sales are limited to accredited investors; and (b) an issuer takes reasonable steps to verify that all purchasers of the securities are accredited investors. The SEC was required to do this pursuant to the JOBS Act, which was enacted into law for the purpose of making it easier for a company to raise capital.
- Thus, an issuer can now generally solicit and advertise a securities offering without having to register it with the SEC as a public offering, so long as that issuer complies with certain regulations, and so long as actual sales are limited to accredited investors. You can see more information about this here.
- The SEC has also released proposed draft regulations that would, if approved, implement Title III of the JOBS Act. The proposed rules, consistent with Title III, would (among other things) permit many non-accredited investors to invest in offerings not registered with the SEC as public offerings, subject to various requirements and limitations. These limitations include maximum amounts limiting how much an investor can invest and how much a company can raise in a 12-month period. For example, under the proposed rules:
- Investors, over the course of a 12-month period, would be permitted to invest up to:
- $2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
- 10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000.
- A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
- Investors, over the course of a 12-month period, would be permitted to invest up to:
From the beginning, many entrepreneurs, other issuers, and participants in the nascent crowdfunding industry have criticized the JOBS Act for creating too many hoops through which they, and potential investors, would have to jump in order to actually conduct business under the JOBS Act. At the same time, others believe that fewer hoops will threaten potential investors because those hoops were built into the JOBS Act for the very purpose of investor protection.
All of the proposed amendments discussed at the May 1st hearings would, if approved, serve to remove hoops.
Proposed Changes to the JOBS Act
In their excellent May 1st Wall Street Journal article, “Frustration Rises Over Crowdfunding Rules,” Ruth Simon and Angus Loten wrote that while “President Barack Obama hailed the JOBS Act as a potential ‘game-changer’ for small, private businesses eager to raise money . . . The JOBS Act’s benefits so far have been ho-hum, in the eyes of some of its critics.” Simon and Loten call the various ideas for revising the JOBS Act, “JOBS Act 2″ proposals.
As Simon and Loten noted, the various JOBS Act 2 proposals “are a long shot, with little likelihood of being enacted into law this year, in part because there is little appetite to further roll back the securities laws in the Democratic-controlled Senate. But the discussion underscores a sense of disappointment and frustration with how the JOBS Act is playing out.”
‘JOBS Act 2′ proposals include changes to both Titles II and III of the JOBS Act.
Proposed changes to Title II would:
- remove requirements that issuers file solicitations materials in advance (read more on this here); and
- remove requirements that issuers take reasonable steps to verify accredited investor status (that is, it would allow investors to simply “check a box” to represent they are, indeed accredited investors).
Title III proposed changes include:
- raising the limit on the amount of capital an issuer can raise in 12 month period from $1 million to $5 million;
- not requiring audited financial statements when the amount an issuer raises is less than $3 million (rather than the current $500,000 threshold); and
- allowing the aggregation of investors into special purpose vehicles, which would enable issuers to deal with far fewer shareholders, thus making corporate governance and communication far easier to deal with than under the currently proposed rules.
Summary of Testimony
- Benjamin Miller shared Fundrise’s experience using Regulation A to crowdfund the development of local real estate in the District of Columbia. Miller explained that since the JOBS Act of 2012 did not exist when Fundrise started its endeavor, it had to work within the existing regulatory framework, which it did using Regulation A. In response to a question by Vice Chairman Hurt as to why issuers have avoided Regulation A, Miller responded that the process has limited appeal and that there is a perception that good companies do not use Regulation A.
- Annemarie Tierney testified generally in support of the JOBS Act 2 proposals. Among other things, Tierney discussed the challenges presented under the current legal framework for private company shareholder liquidity and that, while she supports the underlying goals of minimizing investor fraud and enabling the SEC to evaluate market practices in Rule 506 offerings, she strongly believes that many of the SEC’s proposed changes are unworkable for startups raising capital in today’s electronic world.
Tierney testified about the SEC’s proposed rules which would require that an “Advance Form D” be filed by the issuer with the SEC no later than 15 days before the commencement of general solicitation. In Tierney’s view, this would effectively impose a 15-day cooling off period for offerings by startups seeking capital on a continuous basis and is “quite simply” inconsistent with the intent of the original JOBS Act.
Tierney argued that the proposed amendment to Rule 507, which would disqualify an issuer from being able to rely on Rule 506 for any new offering for a one-year period if that issuer failed to comply with the Form D filing requirements within the past five years, is clearly contrary to the intent of the JOBS Act and punitively disproportionate to the impact that such failure would have on investors and the market.
- William Beatty argued that states are leaders in modernizing capital formation, but that the enactment of the JOBS Act unfortunately precluded the states from playing a leading role in crowdfunding. Beatty stated that the overall impact of the Startup Capital Modernization Act of 2014 would substantially and further weaken investor protections in several important ways. Beatty continued that NASAA continues to oppose Congress’s regulation of small investments in small companies because the federal government has neither the inclination nor the resources to regulate effectively in this area. In addition, he referred to the revisions specified by the draft legislation seeking to revise the SEC’s existing and proposed amendments to Regulation D and Rule 156 as an “assault on the authority” of the SEC to provide “basic, reasonable investor protection.”
- Jeff Lynn expressed frustration that the SEC has not yet adopted rules to implement Title III. In addition, he contended that the principle of caps on the amount an investor can invest has an unnecessarily paternalistic element to it, especially when other safeguards are in place. Lynn also testified that he believes curation is an essential part of running an equity crowdfunding platform.
Accredited Investor Markets’ View
The idea that no investors falsely claim to be accredited, as suggested by one of the witnesses, is hard to believe. Self-certification may be an unwelcome burden from the perspective of some, but AIMkts believes it is a prudent and reasonable measure designed to make sure the law is enforced. Most of the other JOBS Act 2 proposals, however, simply pose little or no risk to investors. Moreover, many are necessary if the JOBS Act is to succeed.
Keep in mind that when AIMkts refers to the JOBS Act “succeeding,” we do not refer to the funding of start-ups and the creation of jobs. While those are laudable goals and were, indeed, the goals of its drafters, AIMkts looks at the JOBS Act through a different lense.
This publication’s concern is solely for the financial well being of accredited investors. AIMkts does not exist to serve the needs, or promote the interests, of entrepreneurs, founders, or other issuers. Thus, the ability for start-ups to raise money is not an end to itself. Rather, it is a means to the different end of creating a marketplace that works, where people can invest money with confidence. Without some, perhaps many, of the changes sought by the various JOBS Act 2 proposals, this simply will not happen.
* Jonathan Friedland is a partner with Sugar Felsenthal Grais & Hammer LLP and is the publisher of Accredited Investor Markets.
Updated May 14, 2014