Commission balances spurring investments with protecting investors.
Last year, entrepreneurs across the country cheered the announcement of the CROWDFUND Act, a federal statute that will enable start-up businesses to raise funds from investors through specialized Internet portals. However, the Securities and Exchange Commission (SEC) is behind schedule in creating the regulatory framework to implement the statute, leaving unanswered several questions about the legal status of crowdfunding.
Crowdfunding involves the collective efforts of numerous, and often disparate, individuals to combine their resources and fund a project. As a part of the Jumpstart Our Business Startups Act (JOBS Act), the CROWDFUND ACT legalized some forms of this money-raising technique. Congress intended this legislation to stimulate economic growth and small business innovation by relaxing securities regulations for small, growing companies.
In general, the federal securities laws and regulations impose registration requirements on companies seeking to sell equity to the public, often limiting investment to “accredited investors” that are presumably well informed about the nature of their investments. The JOBS Act allows startups to offer their securities to unaccredited investors—up to $1 million in funds—through certain approved intermediaries without complying with these costly requirements.
A petition submitted to the SEC last year indicated that traditional registration costs, which may exceed tens of thousands of dollars, can be prohibitive to many startup companies. Crowdfunding advocates maintain that exempting startups from the typical SEC requirements would allow entrepreneurs to take advantage of more freely flowing investment capital.
Supporting small businesses through crowdfunding, entrepreneurs argue, would lead to new products in the market and stimulate economic growth. Small business owners point to the tremendous success of crowdfunding platforms in test cases, such as one Washington, D.C. start-up that successfully solicited investor pledges of over $300,000 in just two hours last month.
Crowdfunding advocates have become discouraged by the SEC’s delay and have reportedly received only minimal updates on the status of its rulemaking process. The JOBS Act mandated that the SEC announce its regulatory guidelines by the end of last year, a deadline that the SEC missed. The rulemaking process may be further delayed by personnel changes within the SEC, including the departure of former Chair, Mary Schapiro.
Despite the impatience of industry professionals, the SEC has indicated that the Commission is attempting to balance its “dual responsibilities of capital formation and protecting investors.” The Commission has expressed concern with the “uncertainty” and “information asymmetry” that can characterize new businesses. These attributes increase the importance of making relevant information available to less savvy investors who would like to take advantage of the CROWDFUND Act. The North American Securities Administrators Association (NASAA) has echoed this concern, issuing a crowdfunding advisory warning against “unscrupulous individuals attempt[ing] to cloud the crowdfunding market with bogus offerings.”
The SEC reportedly plans to impose disclosure requirements as well as other investor protections to combat fraudulent activities on online funding sites. Some projections indicate that crowdfunding scams are becoming increasingly harmful. For example, last year a scam artist swindled dozens of investors who thought they were buying a stake in an online gaming startup out of over $150,000.
Crowdfunding advocates recognize the potential for fraudulent activity, but they also hope that the Commission will not overregulate equity crowdfunding in a misguided attempt to prevent what they believe to be a few isolated scams. Alan Patricof, a prominent venture capitalist with Greycroft Partners, explained that “the fraction of people that will be dishonest will pale in comparison to the number of honest, hard-working, worth-while businesses that will get started.” Too many regulatory requirements, crowdfunding advocates worry, may render the crowdfunding provision of the JOBS Act completely ineffective, as many small businesses will be unable to afford compliance.
Even if the SEC does announce its regulatory scheme in the coming months, crowdfunding advocates will face one final regulatory hurdle. The JOBS Act includes a requirement that the Financial Industry Regulatory Authority (FINRA), a non-governmental organization, set forth its own guidelines for crowdfunding portals. The Act specified no deadline for the FINRA rules, so the statutory requirement of these forthcoming regulations casts an additional shadow of uncertainty over the future of crowdfunding. Tim Rowe of the Cambridge Innovation Center has predicted that FINRA will not announce its own regulatory initiatives until the SEC completes its rulemaking process.
The SEC has indicated that it will provide the required regulatory guidance “as soon as possible.”
In the meantime, the Commission will continue to accept public comments on the JOBS Act, including its crowdfunding initiatives.
