Thursday, February 4, 2016

Time for the States to Step up on Crowdfunding or Become Irrelevant



By: Jim Verdonik


Jim Verdonik is an attorney with Ward and Smith, P.A. in Raleigh and is the author of Crowdfunding Opportunities and Challenges .

 He can be reached at


(This article incorporates an article originally published in Triangle Business Journal in November 2015)


On October 30, 2015, the Securities and Exchange Commission issued final rules for Federal Crowdfunding offerings under Section 4 (a) (6) of the 1933 Act, which will become effective in May 2016 ("Section 4(a)(6) Federal Crowdfunding Rules").


Although the Section 4(a)(6) Federal Crowdfunding Rules were long awaited, the changes to SEC Rules 147 and 504 that the SEC proposed the same day to make it easier for more businesses to rely on Rules 147 or 504 to do State crowdfunding offerings may have a bigger positive impact on capital-raising than the Section 4(a)(6) Federal Crowdfunding Rules.


The proposed changes to Rule 147 and Rule 504 are important, because the Section 4(a)(6) Federal Crowdfunding Rules combine a low $1 million maximum offering amount with many expenses and restrictions on both issuers raising capital and platform operators.  The combination of restrictions with a low annual maximum offering amount make it likely that the Section 4(a)(6) Federal Crowdfunding Rules will not be a cost inefficient alternative for most businesses or platform operators.  The history of old SEC Regulation A over several decades proved that few people use an exemption when the exemption is not cost efficient.  Regulation A became something of a joke.  The Section 4(a) (6) Federal Crowdfunding Rules create many inefficiencies by:

  • Only allowing offerings to be made on a platform operated by a registered funding portal or a registered broker.
  • Restricting how funding portals operate their offering platforms, including the types of search tools funding portals can provide investors.
  • Restricting what issuers can say to promote the offering on their own outside the offering platform.
  • Discouraging platform operators that are not registered brokers from disclosing their due diligence investigations to investors.
  • Having a $1 million maximum offering amount.  This will discourage platform operators from spending money on marketing and diligence, because operators will earn relatively low fees for small offerings.   
    Because of these and other limitations in the Section 4 (a) (6) Federal Crowdfunding Rules, no single Federal exemption from registration authorized by the JOBS Act (Rule 506 (c), Regulation A+ and the Section 4 (a) (6) Federal Crowdfunding Rules) gives businesses all of the following attributes of an ideal exemption:

  • The ability to raise large amounts of money.
  • Disclosure flexibility, subject to general rules about material facts.
  • Cost efficiency.
  • The ability to advertise.
  • The ability to sell to both accredited and non-accredited investors.
  • Minimum post-offering duties.

Each Federal exemption lacks one or more of these attributes: 

  • Rule 506(c) does not allow sales to non-accredited investors.
  • Regulation A+ offerings are expensive and Tier 2 of Regulation A+ imposes ongoing reporting requirements on issuers.
  • Section 4(a)(6) Federal Crowdfunding Rules allow you to raise only $1 million, impose fairly inflexible disclosure requirements (including in some cases, excessive financial statements requirements) beyond the normal securities rules about disclosing material facts that increase costs and impose some ongoing disclosure requirements on private companies that may harm their ability to compete.
    The SEC's proposed changes to Rule 147 and Rule 504, however, will clear the way for the states to create offering exemptions that allow businesses to achieve all their goals by: 

  • Allowing businesses to raise up to $5 million.
  • Clarifying that using the Internet and other advertising does not cause issuers to be deemed to be violating rules about making offers in more than one state.
  • Allowing many more types of businesses to use state crowdfunding laws in conjunction with Rule 147 by creating greater flexibility in the current requirements that the business operate in only one state.
  • Permitting multi-state offerings by registering in only one state, if states enact reciprocity laws.
    Facing substantial criticism that the Section 4 (a) (6) Federal Crowdfunding Rules and other JOBS Act exemptions are too restrictive, the SEC is telling the States: "If You Think You Can Do It Better, Go Ahead and Try!"
    So, it's time for the states to finally get their act together.  Both the Federal government and the critics of Federal crowdfunding are encouraging the states to create a better solution.  But will the states really try to solve the problem?  Or will the states enact laws that just pretend to solve problems?