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May 12, 2014

Frustration Rises Over Crowdfunding Rules

By Ruth Simon and Angus Loten | Wall Street Journal

Unhappy with results so far of the two-year-old Jumpstart Our Business Startups Act, some Republican lawmakers are pushing for changes that could weaken investor protections. They argue that entrepreneurs find some of its provisions too burdensome.

The so-called JOBS Act modified U.S. securities laws, increasing the number of investors a private firm may have, to 2,000 from 500, for instance, and eliminating some hurdles for companies seeking initial public offerings.

It also lifted the "general solicitation" ban preventing entrepreneurs from advertising sales of equity in their small, private companies to wealthy individuals, known as "accredited investors." Another provision, yet to take effect, will allow small companies to raise funds from average investors online through a process known as "equity crowdfunding."

Enacted in April 2012, President Barack Obama hailed it as a potential "game-changer" for small, private businesses eager to raise money. Congress left it to the Securities and Exchange Commission to set final rules on how provisions of the new law would be implemented, a task the agency has yet to fully complete.

The JOBS Act’s benefits so far have been ho-hum, in the eyes of some of its critics. Thus, several House Republicans now are putting forth "JOBS Act 2" proposals, arguing that legislation Congress passed in 2012 is too restrictive for small firms.

Their proposals are a long shot, with little likelihood of being enacted into law this year, in part because there is little appetite to further roll back the securities laws in the Democratic-controlled Senate. But the discussion underscores a sense of disappointment and frustration with how the JOBS Act is playing out. In congressional testimony Tuesday, Securities and Exchange Commission Chair Mary Jo White said that completing key rule making required by the JOBS Act was a top priority.

One big problem, critics say, is that it will be difficult for entrepreneurs to tap their social networks to raise money to buy equipment, add staff or upgrade to a new office building under the law’s "equity crowdfunding" provision. A hallmark of the 2012 law, the equity crowdfunding provision isn’t expected to become effective until later this year because the SEC is still hashing out final rules allowing companies to sell equity stakes in businesses to everyday investors through social media and the Internet.

Rep. Patrick McHenry (R., N.C.) said he plans this week to introduce proposed revisions to the 2012 law in what he dubs the "Equity Crowdfunding Improvement Act of 2014" legislation. The proposal, still in draft form, would increase the amount a private company could raise under equity-crowdfunding to $5 million from $1 million, and boost the amount entrepreneurs could raise without providing audited financial statements to $3 million from $500,000.

"It’s a humbling process to find that the law you support won’t work in practice," said Mr. McHenry, who championed the original crowdfunding legislation. Mr. McHenry said he doesn’t believe the proposed changes will weaken investor protections.

Another proposal would ease the requirements on crowdfunding websites by allowing them to select which offerings to list without being liable for fraud by the listing companies. Currently, only wealthy individuals who are considered "accredited investors" can buy shares online from these sites. Others, with less financial resources, can make contributions in exchange for rewards, such as coffee mugs and T-shirts.

Alon Hillel-Tuch, a co-founder of RocketHub, a New York-based crowdfunding website for startups and other projects, said he has met with Rep. McHenry and other lawmakers to discuss proposed changes to the JOBS Act, such as proposals that would lessen the liability that websites like his would face in the event of investor fraud, once equity-crowdfunding is allowed.

Some say it is way too soon to start tinkering with the JOBS Act, or to declare it a failure. "We haven’t put that legislation to the test yet," said Washington State Securities Administrator William Beatty.

"We need to have some experience with [equity crowdfunding] before we take away the safety net," said John Coffee Jr. , a securities law professor at Columbia University. "This is a new and dramatically different procedure with a high potential for fraud."

Response to the new marketing freedoms following the removal of the general solicitation ban in September has been lukewarm at best. Crowdnetic, a crowdfunding market data and technology firm, said that 2,834 private issuers are currently trying to use the new advertising freedoms to raise money on the seven online investing platforms it tracks. But just 394 of them have reported receiving any commitments from investors, and just 64 say they have secured promises totaling more than $500,000.

According to a separate analysis by the SEC, lifting the so-called general solicitation ban has resulted in nearly 900 new offerings that raised a combined $10 billion. Over the same period, 9,200 offerings were filed by small firms under the old rules, raising a total of more than $233 billion, the agency said. The SEC looked at disclosure statements made by companies, which are required to file with federal securities regulators within 10 days after completing their fundraising under the new rules.

"One wonders why the new [rule] has not caught on more widely," said Keith Higgins, director of the SEC’s division of corporate finance, at the annual meeting of the Angel Capital Association in Washington, D.C., last month, citing as one potential barrier a requirement that small firms verify that the investors they attract are accredited.

A draft proposal by Rep. Scott Garrett (R-N.J.), expected to be introduced in May, seeks to fine-tune the new marketing freedoms for entrepreneurs, in light of the new solicitation rules. He wants, for instance, to make it tougher for the SEC to cancel an entrepreneur’s offering in instances where regulators believe the company didn’t take reasonable steps to verify that investors meet net worth standards.

Mr. Garrett also said he doesn’t believe the changes will weaken investor protections, a spokeswoman said.

Ron Wilson, chief executive of Hylete, a two-year-old maker of performance cross-training apparel based in Solana Beach, Calif., raised $750,000 in debt and equity this year, taking advantage of a provision that let him publicize Hylete’s securities offering on its website as well as on Facebook, Twitter, LinkedIn and the online investing platform

That was a step in the right direction, he said, but it didn’t go far enough: "The real opportunity is opening it up to the everyday investor," he added, referring to the equity crowdfunding possibilities that are still to come.

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