Senator Jeff Merkley (D-OR), the author of the JOBS Act crowdfunding Title said that the SEC proposed regulations implementing the crowdfunding provisions are seriously flawed and do not properly carry out legislative intent in a number of areas. In a letter to SEC Chair Mary Jo White, he said that in some instances the Commission is ignoring the plain intent of the JOBS Act and proposing the least investor protective approach possible. For example, the Senator said that permitting a funding portal to rely on the investor's representations concerning compliance with investment limits above $2,000 is a recipe for disaster for vulnerable investors and must be changed.
Self-certification would permit a single investor to be easily over-exposed to crowdfunding, he noted, an inherently high risk investment, through what could easily be check-the-box style agreements. A self-certification approach opens the door to investors being defrauded across one or more platforms, he cautioned, which is an especially serious risk in affinity fraud cases. Again, these are precisely the risks that the Act was intended to prevent.
By specifically applying the investment caps across all platforms, continued Senator Merkley, the JOBS Act contemplates the development of a central data repository, perhaps located at the relevant national securities association, where platforms can check whether investors are safely within the scope set out in the Act across the marketplace. He noted that the proposal does not establish such a repository or set forth any path towards its establishment; and thus fails to implement the plain meaning of the statutory language. Testing, supervisory oversight, and other mechanisms to ensure investors are protected should also be more fully considered.
The SEC’s approach with respect to net worth and annual income is similarly unacceptable, said the Senator, since it would put the most vulnerable investors at risk. The Act was designed to favor investor protections, he pointed out, and the statutory language gives the Commission a choice of how to interpret it. Unfortunately, the proposal has chosen to interpret the statute in the least investor friendly approach, meaning that investors may choose between the greater of their net worth or annual income for their cap calculation. That is not consistent with the overall approach of the Act, emphasized Senator Merkley, who urged the Commission to reconsider its interpretations regarding investment caps. One of the worst things that could happen to the crowdfunding marketplace, he posited, would be if ordinary investors lost large amounts on securities-based crowdfunding in its early days.
The Senator is also very concerned regarding the lack of robust mandatory corporate governance provisions. The Commission must do more to ensure fairness, and not simply the timeliness of financial statements. Under the proposal, an issuer may use financial statements for the year prior to the most recently completed fiscal year, provided that the issuer was not otherwise already required to update the financial statements and updated financial statements are not otherwise available.
If more than 120 days have passed since the end of the issuer's most recently completed fiscal year, the issuer must use financial statements for its most recently completed fiscal year. While the issuer would be required to include a discussion of any material changes in the its financial condition of the issuer, Senator Merkly fears that this could allow issuers to submit financial statements that are more than a year out of date and that cover only a very limited portion of the issuer's existence, leaving out what could be critical information for investors.
The proposal permits a funding portal to rely on the representations of the issuer concerning compliance with the Act's requirements unless the intermediary has reason to question the reliability of those representations. In his view, permitting a funding portal to rely on the representations of an issuer upends the statutory design, and in doing so potentially exposes small businesses and start-ups to increased costs of having to figure out how to comply and also potentially exposes investors to serious risks from the failure of those small businesses and start-ups to adequately comply. Such an approach also exposes the entire crowdfunding marketplace if a reputation for weak compliance or fraud develops. Instead, the senator urged the Commission to adopt standards and guidance for what funding portals must do to ensure that an issuer has satisfied the fairly simple requirements of the Act with respect to the rights investors have in securities.