House hearings focused on the implementation
of the recently-enacted JOBS Act demonstrated a consensus that the SEC regulations
implementing the Title III crowdfunding provisions will be critical in determining
the efficacy of crowdfunding as a capital-raising mechanism. The hearings were held before the Financial
Services Subcommittee of the House Oversight Committee, chaired by Rep. Patrick
McHenry (R-NC), who authored the House version of Title III, which was replaced
by a Senate version in the enacted JOBS Act. Chairman McHenry said that the
Senate version of Title III contains imperfect language. He said that the
Senate inserted provisions complicated crowdfunding and made sections of the
Act ambiguous and inconsistent.
On the day the House concurred with the
Senate Amendment to the JOBS Act, Chairman McHenry said that the Senate changes
to Title III were ill-conceived and burdensome and misguided in seeing
crowdfunding as simply unregulated activity. He pledged to work in a
bi-partisan way to fix the legislation. (Cong. Rec., Mar 27, 2012, p. H1590).
At the hearing, Chairman McHenry noted
that the SEC holds a great deal of discretion over the Title III implementing
regulations and questioned whether this discretion could place at risk the
viability of using crowdfunding. He spoke about using light-touch regulation in
the area of crowdfunding.
Professor C. Steven Bradford, University
of Nebraska Law School, said that there is a potential that regulatory cost
could make crowdfunding not feasible to use. The professor urged that the SEC
regulations implementing Title III be as light-handed and unobtrusive as
possible. Chairman McHenry said that, while the disclosure piece is important,
there is concern over the cost of compliance.
Ranking Member Mike Quigley (D-IL) said
that Title III is a welcome step forward. He also noted that the regulatory
restrictions rolled back by the JOBS Act were put in place for a reason. He
acknowledged a fear of fraud. While Congress correctly judged that there were
too many hurdles to raising capital, he observed, the SEC has to protect
investors. The Ranking Member also emphasized that the regulations implementing
the JOBS Act should not be placed before regulations implementing the
Dodd-Frank Act.
Professor Bradford said that crowdfunding
has the potential to spark a revolution in small business financing. Whether
that happens will depend a great deal on the regulatory burden in that the SEC
implementing regulations will determine the future usefulness of crowdfunding
under Title III. Professor Bradford believes that regulations should be imposed
on the crowdfunding intermediaries and not the entrepreneurs raising the funds.
Brokers and funding portals can spread regulatory costs over a large number of offerings,
he reasoned, and they will be more heavily capitalized than almost all of the
entrepreneurs using the crowdfunding sites. By contrast, the small companies
and entrepreneurs most likely to engage in crowdfunding are poorly capitalized
and legally unsophisticated.
Professor Bradford also urged the SEC to adopt
a substantial compliance rule to protect those who inadvertently violate a regulation
so that a minor technical violation will not cause the loss of the exemption. Given
the complexity of the exemption’s requirements, he noted, inadvertent
violations are likely and the consequence of even a minor violation is drastic.
He added that other Securities Act exemptions include substantial compliance
rules that protect issuers if they fail to comply with the exemption in certain
insignificant ways.
While acknowledging that nothing in the
JOBS Act itself specifically authorizes the SEC to enact a substantial
compliance rule, Professor Bradford noted that Section 302(c) of the JOBS Act
gives the SEC blanket authority to issue such rules as the Commission
determines may be necessary or appropriate for the protection of investors to
carry out Sections 4(6) and 4A of the Securities Act.
He observed that the SEC has even broader
authority in both the Securities Act and the Securities Exchange Act to exempt
any person, security, or transaction from any provision of the statutes if the
Commission determines that such exemption is necessary or appropriate in the
public interest and is consistent with the protection of investors. Professor
Bradford said that the Commission could use this authority to specify that an
issuer that reasonably believed it met the requirements of Section 4(6) or that
substantially complied with Section 4(6) would still be entitled to the
exemption, in spite of the noncompliance.
Former SEC General Counsel Brian Cartright
noted that the JOBS Act calls for SEC rulemaking to address 15 separate
matters, in addition to necessary FINRA rulemaking. How all the rulemaking is
crafted, noted the former GC, will help determine whether Title III assists
capital formation for small ventures or becomes a dead letter. The former SEC official
urged the Commission to rigorously analyze the anticipated compliance costs for
relying on Title III.
In evaluating the costs, advised the
former General Counsel, the SEC should include such items as the costs an
intermediary will incur to build and maintain a compliance infrastructure
sufficient to survive SEC and FINRA inspections, as well as any costs to
address the heightened risks arising from the higher standard of liability Title
III carries compared to other private offerings. The SEC should then determine
the estimated fraction of the proceeds that would be consumed by those costs at
varying offering sizes allowed by Title III. If, after a rigorous cost
analysis, the SEC decides that those costs could render impractical the use of
Title III, it should state this in order to alert Congress so that legislators
can consider if additional legislation is needed.