In a White House fact sheet set forth with the introduction of the draft legislation, the American Jobs Act, the Administration expressed support for a number of measures designed to reduce the regulatory burdens on small business capital formation: As part of the President’s Startup America initiative, the Administration will pursue efforts to reduce the regulatory burdens on small business capital formation in ways that are consistent with investor protection.
This effort will include working with the SEC to explore ways to address the costs that small and new firms face in complying with Sarbanes-Oxley disclosure and auditing requirements. The Administration also supports establishing a “crowdfunding” exemption from SEC registration requirements for firms raising less than $1 million (with individual investments limited to $10,000 or 10% of investors’ annual income). The Administration also supports raising the cap on “mini-offerings” (Regulation A) from $5 million to $50 million. This will make it easier for entrepreneurs to raise capital and create jobs.
In testimony before the McHenry House Subcommittee, SEC Corporation Finance Director Meredith Cross said that crowdfunding is a form of capital raising whereby groups of people pool money, typically comprised of very small individual contributions, to support an effort by others to accomplish a specific goal. This funding strategy was initially developed to fund such things as films, books, music recordings, and charitable endeavors. At that time, the individuals providing the funding were more akin to contributors than “investors” and were either simply donating funds or were offered a “perk,” such as a copy of the related book. As these capital raising strategies did not provide an opportunity for profit participation, initial crowdfunding efforts did not raise issues under the federal securities laws.
Interest in crowdfunding as a capital raising strategy that could offer investors an ownership interest in a developing business is growing. Proponents of crowdfunding are advocating for exemptions from the Securities Act registration requirements for this type of capital raising activity in an effort to assist early stage companies and small businesses. For example, the Commission received a rulemaking petition requesting that the Commission create an exemption from the Securities Act registration requirements for offerings with a $100,000 maximum offering amount that would permit individuals to invest up to a maximum of $100.
Director Cross said that the SEC staff has been discussing crowdfunding, among other capital raising strategies, with business owners, representatives of small business industry organizations, and state regulators. For example, crowdfunding was discussed at the Commission’s November 2010 Forum on Small Business Capital Formation. In January, the staff met with a group from the Small Business & Entrepreneurship Council advocating an exemption from registration requirements for crowdfunding offerings meeting specific requirements. In addition, in March the staff discussed crowdfunding with representatives from the North American Securities Administrators Association.
Current technology allows small business owners to easily access a large number of possible investors across the country and throughout the world as a source of funding to help grow and develop their businesses or ideas. This source of capital and the ease with which an individual can communicate with and access investors electronically presents an opportunity for smaller companies in need of funds. At the same time, of course, an exemption from registration and the investor protections provided thereby also would present an enticing opportunity for the unscrupulous to engage in fraudulent activities that could undermine investor confidence.
Director Cross listed a number of issues the SEC staff is considering ith regard to crowdfunding, such as what information about the business, the planned use of funds raised, and the principals, agents, and finders involved with the business should be required to be available to investors, and what restrictions should there be on participation by individuals or firms that have been convicted or sanctioned in connection with prior securities fraud. The staff is also exploring if an SEC filing or notice should be required so that activities in these offerings could be observed. There is also the question whether the securities purchased should be freely tradable, as well as should websites that facilitate crowdfunding investing be subject to regulatory oversight.