Special Projects Segment: Opposition to Adopting Crowdfunding Rules
We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.
On October 23, 2013, the U.S. Securities and Exchange Commission (“SEC”) proposed the Crowdfunding Rules (the “Proposed Rules”), which were drafted in connection with Title III of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”). Title III allows private equity crowdfunding involving non-accredited investors. The SEC intends to protect investors against fraudulent offerings while facilitating capital raising under the Proposed Rules.
While many commenters support at least some aspects of the Proposed Rules, a number of corporations, crowdfunding organizations, law firms, legislators, and academics are concerned that the Proposed Rules will be ineffective in providing the investor protections intended by Congress. Ernst & Young, LLP expressed concern in its comment letter that the Proposed Rules will not benefit small businesses because a company could only crowdfund a maximum aggregate amount of $1 million in a 12-month period, which is arbitrary and unnecessarily low, limiting rather than facilitating capital raising.
EarlyShares, a smaller crowdfunding platform, echoed the concern raised by Ernst & Young and further expressed in its comment letter the need for significant modifications to the Proposed Rules in order to make them more transparent and beneficial to all participants. EarlyShares stated the expense and time required for an issuer to comply with the financial disclosures and ongoing reporting requirements “should be reduced and proportionate with the capabilities of the issuers.” EarlyShares suggested that the cost and burden of disclosure and reporting be balanced against an issuer's interest in protecting sensitive and proprietary data. Without balancing the costs and burdens, EarlyShares forewarned the Proposed Rules may deter companies from engaging in crowdfunding campaigns.
CrowdCheck, Inc., a disclosure and due diligence service provider for early-stage companies, submitted its comment letter seeking clarity as to the specific disclosure requirements. CrowdCheck also requested that “free writing” disclosures be permitted. In support of its immediate online disclosure recommendation, CrowdCheck relied mostly upon the substantial costs and burdens that small businesses would face in order to create a “text-heavy, private placement memorandum” for the offering. CrowdCheck further relied upon the fact that frequent disclosures may be required in response to the “wisdom of the crowd.” Because material disclosures may be frequent, costly, and likely in a file format that is incompatible with EDGAR, CrowdCheck urged the Commission to consider free writing disclosures.
These comment letters highlight how the Proposed Rules do not fulfill the congressional intent to help small businesses raise capital, a sentiment that is reiterated by many commenters. Crowdfunding is popular, in part, because of the low barriers to entry. Under the Proposed Rules, however, many commenters fear that issuers will face significant upfront costs, mandatory information disclosures, and numerous barriers to raising capital. If the costs and burden are not balanced with small business interests, then the possibility of a failed offering increases, leaving the organization in a worse position. It is also possible that extraordinary costs will prevent offerings from happening at all. If safeguards are not embedded to better protect all participants from associated high costs and financial risks, many organizations and individuals may be deterred from utilizing this form of equity crowdfunding.