Sunday, November 06, 2011

House Floor Colloquies Define Key Terms in Crowdfunding Legislation

The House passed the Entrepreneurial Access to Capital Act, H.R. 2930. Sponsored by Rep. Patrick McHenry (R-NC),and Chair of the TARP and Financial Services Subcommittee, the legislation allows crowdfunding under which companies are permitted to pool up to $1 million without the expense of registering with the SEC or up to $2 million if the company provides investors with audited financial statements. Individual contributors are limited to $10,000 or 10 percent of the investor’s annual income, whichever is less. In addition, H.R. 2930 creates a regulatory structure of investor protection around this new, innovative form of financing with substantial intermediary requirements or issue requirements if there is no intermediary. The terms crowdfunding and intermediary are not defined in the legisaltion.

In a colloquy with Chairman McHenry, Rep. Perlmutter (D-CO), noting that H.R. 2930 creates a new exemption from registration under the Securities Act for what Congress calls ‘‘crowdfunding’’ securities but does not define that term, submitted a definition for the record that crowdfunding refers to a technique for raising money over the Internet in relatively small amounts from a large number of people. Chairman McHenry generally agreed, adding that the intention is to have an Internet portal of sorts, but this could be done on any mass basis. But the legislation specifies that the disclosures have to be very clear, and the SEC is authorized to specify additional pieces.

In colloquies with Rep. Ed Perlmutter (D-CO) and Rep. Scott Garrett (R-NJ), Chair of the Capital Markets Subcommittee, Chairman McHenry clarified the intent of the legislation with regard to intermediaries. These intermediaries are not intended to be broker-dealers, he emphasized. They are there to provide a low-cost conduit for capital formation, he said, and a means to do that. That is the intention. And all the investor protections outlined in the legislation with regard to the intermediaries, and on how they are to operate, are there to enable them to be both low-cost but also preserve individuals’ capital and make sure their investments are appropriately taken care of.

The intent is, if you are going to raise $50,000 from 5,000 people, it has to be a low-cost basis of doing that; and the traditional broker-dealer model is not efficient at those lower cost basis fundraising opportunities or equity-raising opportunities. Rep. Garrett added that you may not find the interest by the broker-dealer community if you are talking about a $25,000 or $50,000 or $100,000 enterprise and that is another reason why broker-dealers are not envisioned to be intermediaries under HR 2930.

Agreeing with that statement, Rep. McHenry added that traditional broker-dealers will not be in this market. The congressional intent with these low-dollar issuances, that have not been a traditional part of the action on Wall Street in the modern era, is to carve out this opportunity for small businesses. Rep. Perlmutter understands that the intermediary will be the platform, the conduit, and not the custodian, of the funds. But one of the responsibilities of the intermediary is to outsource the cash management responsibilities to qualified third-party custodians such as broker-dealers or insured depository institutions, which was a concern that Congress had as the legislation moved through committee, who is holding the money and can they be trusted, and will they release the money at the right time.

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