JOBS Act: Comments to the SEC on Crowdfunding
Daniel Gorfine and Staci Warden
The Milken Institute Center for Financial Markets (CFM) provided written comments to the Securities and Exchange Commission on proposed crowdfunding rules under Title III of the Jumpstart Our Business Startups (JOBS) Act. Generally speaking, crowdfunding is a funding method used to generate financial support for projects from a large number of individual contributors.
Up until the release of the proposed rules on October 23, 2013, crowdfunding was not viewed as a viable way to offer and sell securities in a company due to the application of federal securities laws. Under the proposal however, the SEC would allow a company to raise $1 million through crowd-investing offerings in a twelve-month period. During that period investors would be allowed to invest:
• $2,000 or five percent of their annual income or net worth, whichever is greater, if their annual net income and net worth are less than $100,000;
• Ten percent of their annual income or net worth, whichever is greater, if their annual income or net worth is $100,000 or more. During this period, investors would not be allowed to purchase more than $100,000 of securities through crowdfunding.
Importantly, investors who purchase securities through crowd-investing would not be allowed to resell those securities for one year. At the same time, holders of the securities would not trigger 12(g) Exchange Act reporting requirements with the SEC as they would not be counted towards the relevant threshold. To ensure investor protection under this new crowd-investing model, the proposal requires offerings to be conducted through a platform operated by a registered broker or through a funding portal—a new type of SEC registrant.
In written comments submitted to the SEC on February 3, 2014, CFM provided a list of guiding principles for the SEC to consider as the Commission finalizes rules in this area. First, investors involved in crowd-investing may be motivated for a number of reasons, whether financial or nonfinancial, or both. While there is still a question as to whether this mix of motivating factors leads to a successful investment, consideration of what will likely motivate investors does help to inform investor expectations and preferences when making a crowd-investment.
Second, for crowd-investing to be successful it will require that the crowd effectively deploy new vetting methodologies and criteria with the help of technology-driven tools and platform-based communication channels. The hope is that the 'wisdom of the crowd' will promote innovative forms of transparency and investor protection.
Third, because of the relatively small size of crowd-investing offerings it will be extremely important for the SEC to properly calibrate the disclosure and compliance requirements in order to make crowd-investing economical for issuers and intermediary platforms. Under the current proposed rules, these requirements may, in aggregate, impose too great a burden on the crowd-investing ecosystem.
Lastly, given the inherent riskiness of startups or small-business investing, the most efficient way to limit downside risk to investors is through an emphasis on investor caps—at least until the crowd-investing innovation has a chance to develop and prove the ability to effectively vet investment opportunities.
Download the letter for details.