Disclaimer: For the back story on this post, you will need to read my previous LinkedIn blog about the JOBS Act. Only by reading this previous post will you understand my comments below. Read them? Good. Let’s begin.
Before the Securities & Exchange Commission (S.E.C.) establishes final rules on crowdfunding through the JOBS Act, it gave the public the opportunity to make comments and provide feedback about its proposed rules. Comments about the details of Title III of the JOBS Act, which deals with the private offering transaction described in my previous blog, were due March 2nd of 2015 but can be found online. I missed the deadline being that I was in the middle of a legislative session and I am a Georgia legislator BUT, I thought I would blog my comments that I would have submitted if…you know…I wasn’t serving the State of Georgia and its 9.5 million residents.
The S.E.C. asked for comments by describing the particular requirements of the JOBS Act legislation, giving proposed rules and then asking specific questions on those rules for comment. You can download the proposed rules here as well as their specific questions for comment and follow along. Here are my thoughts on some of the comments solicited below.
- Should we propose that the $1 million limit be net of fees charged by the intermediary to host the offering on the intermediary’s platform? Why or why not? If so, are there other fees that we should allow issuers to exclude when determining the amount to be raised and whether the issuer has reached the $1 million limit?(pg. 20, Question 1) Comment: The $1 million limit should be net of fees charged by the intermediary to host the offering on the intermediary’s platform. Remember that the underlying purpose of the JOBS Act was to provide entrepreneurs access to as much capital as possible within the $1 million limit Congress was comfortable with providing. Therefore, fees should not be counted towards the $1 million limit if we want to stay in line with the underlying purpose of the JOBS Act. However, I would suggest putting a cap on the percentage of the total offering that could be used towards intermediary fees and not be credited towards the $1 million cap to discourage excessive fees and encourage vigilance by the issuers.
- Under the proposed rules, whether an entity is controlled by or under common control with the issuer would be determined based on whether the issuer possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the entity, whether through the ownership of voting securities, by contract or otherwise. This standard is based on the definition of “control” in Securities Act Rule 405. Is this approach appropriate? Why or why not? Should we define control differently? If so, how?(pg. 21-22, Question 4)Comment: The standard of “control” as defined by Rule 405, I believe, is too broad to accomplish the underlying purpose of the Act which is access to capital. Instead, I would restrict the definition of control to those entities that possess and have actually exercised control in the past for perhaps a certain number of years. Additionally, I would recommend erasing all references to “indirectly” as that may be hard to understand from the issuer’s point of view in order for the issuer to be able to comply with the $1 million cap.
- While we acknowledge that there is ambiguity in the statutory language and there is some comment regarding a contrary reading, we believe that the appropriate approach to the investment limitations in Section 4(a)(6)(B) is to provide for an overall investment limit of $100,000 and, within that limit, to provide for a “greater of” limitation based on an investor’s annual income or net worth. In light of ambiguity in the statutory language, we are specifically asking for comment as to the question of whether we should instead require investors to calculate the investment limitation based on the investor’s annual income or net worth at the five percent threshold of Section 4(a)(6)(B)(i) if either annual income or net worth is less than $100,0000? Similarly, for those investors falling within the Section 4(a)(6)(B)(i) framework, should we require them to calculate the five percent investment based on the lower of annual income or net worth? Should we require the same for the calculation of the 10 percent investment limit within the Section 4(a)(6)(B)(ii) framework? If we were to pursue any of these calculations, would we unnecessarily impede capital formation?(pg. 27-8, Question 6)Comment: No, the rules should not require the investor to calculate their investment at the five percent threshold if either annual income or net worth is less than $100,000; if either the annual income or net worth meets the requirements of Section 4(a)(6)(B)(ii) then the investor should be able to invest the higher tier of ten percent. However, to balance the risk of allowing the higher tier of ten percent, there should be a requirement that the investment be the lower of the annual income or net worth. The same should apply for the ten percent framework. Capital formation would be impeded if the less riskier options were chosen for either of these frameworks, but the framework I describe above keeps the variance between risk and protection lower than otherwise allowed by the statute and allows for sufficient capital formation.
- Should institutional and accredited investors be subject to the investment limits, as proposed? Why or why not? Should we adopt rules providing for another crowdfunding exemption with a higher investment limit for institutional and accredited investors? If so, how high should the limit be? Are there categories of persons that should not be subject to the investment limits? If yes, please identify those categories of persons. If the offering amount for an offering made in reliance on Section 4(a)(6) is not aggregated with the offering amount for a concurrent offering made pursuant to another exemption, as proposed, is it necessary to exclude institutional and accredited investors from the investment limits since they would be able to invest pursuant to another exemption in excess of the investment limits of Section 4(a)(6)?(pg. 28-9, Question 9)Comment: No, institutional and accredited investors should not have a higher investment limit because then they would have the ability to invest the whole $1 million limit and block any unaccredited investors from investing. While the purpose of the Act is to open up capital, a nice consequence of the Act is to allow more unaccredited investors to invest with hopes of making a return when they otherwise would not qualify to invest. Making a higher investment limit or not putting a limit could shut out these opportunities for normal investors. There is no category of persons that should not be subject to the limit. Therefore, I believe it is a great idea for institutional and accredited investors to not be counted towards the $1 million limit so there is a pool of opportunity for unaccredited investors but issuers will have access to the same amount of capital as before.
- The proposed rules would prohibit an issuer from conducting an offering or concurrent offerings in reliance on Section 4(a)(6) using more than one intermediary. Is this proposed approach appropriate?Why or why not? If issuers were permitted to use more than one intermediary, what requirements and other safeguards should or could be employed?(pg. 34, Question 12)Comment: This is an appropriate approach. It keeps down confusion on liability responsibilities (who is responsible for due diligence, accounting, etc.) and makes the responsibility easier to identify and the accounting, so as not to bust the $1 million limit, easier on the issuer, intermediary and S.E.C.
- Should we define the term “platform” in a way that limits crowdfunding in reliance on Section 4(a)(6) to transactions conducted through an Internet website or other similar electronic medium? Why or why not?(pg. 34, Question 13)Comment: Yes, “platform” should be through an Intern website or other similar electronic form. It’s easier and makes for more accountability for Question No. 12 (above) reasons. However, I would allow offline solicitations and investments but the end result for the investment to be official and binding is for it to be registered through the “platform” online.
Exclusion of Certain Issuers From Eligibility under Section 4(a)(6)
- Section 4A(b)(4) requires that “not less than annually, [the issuer] file with the Commission and provide to investors reports of the results of operations and financial statements of the issuer….” Should an issuer be excluded from engaging in crowdfunding transaction in reliance on Section 4(a)(6), as proposed, if it has not filed with the Commission and provided to investors, to the extent required, the ongoing annual reports required by proposed Regulation Crowdfunding during the two years immediately preceding the filing of the required offering statement? Why or why not? Should an issuer by eligible to engage in a crowdfunding transaction in reliance on Section 4(a)(6) if it is delinquent in other reporting requirements…? Why or why not? Should the exclusion be limited to a different time frame….? (pg. 39, Question 17)Comment: An issuer should be excluded from engaging in a crowdfunding transaction in reliance on Section 4(a)(6) for the reasons above for three (3) years starting after all reports have been filed and fines have been paid for violations made in the previous 2 years before the 4(a)(6) offering. If delinquent in other reporting requirements, issuer should be allowed to participate after a certain time period before the offering (see previous comment) and fines have been paid. The reason is that the issuer should have to comply with what is required but should not be punished for all eternity for something that could have been innocuous and a negligent action. Perhaps there should be a sliding scale, such as the number or scope of violations, whereby the “waiting period” is extended. Additionally, I do think that the time period should be five (5) years to look at reporting requirements.
- What specific risks do investors face with “idea-only” companies and ventures? Please explain. Do the proposed rules provide sufficient protection against the inherent risks of such ventures? Why or why not?(pg. 40, Question 19)Comment: Investors face the risk of no “proof of concept” (i.e. no market for the idea) however this happens all the time and has created tremendous companies from it. The proposed rules provide minimal protection against this and requiring a business plan, in addition to financials, would not be a bad idea so long as the business plan is not legally binding and is not required to be onerous for the issuer. It would then be up to the investor to read through the material, ask follow up questions and decide to invest or not.
I have many, many more comments but I wanted to keep this blog short. There you have some of what I think are the MOST important questions and comments from me as the S.E.C. considers the JOBS Act crowdfunding rules. I hope you learned a lot and enjoyed.
NOTE: I will be discussing this subject in detail during my “Power Raisers” weekly conference call this Monday (Aug. 17th) at 11 am. Visit the News & Events section of my website for more information and see the flyer below.