The Fix Crowdfunding Act

The Jumpstart Our Business Startups (JOBS) Act of 2012 eased securities regulations in order to encourage small businesses and startups to raise capital from crowdfunding. Since then, the Securities and Exchange Commission enacted Title III of the JOBS Act which encompasses regulation crowdfunding. However, Title III has faced criticism for being unworkable.

Now, a new bill (H.R. 4855) introduced to the House by Congressmen Patrick McHenry on March 23, 2016 proposes significant changes to the JOBS Act in order to fix Title III. The Fix Crowdfunding Act (“FCA”) is aimed at improving the structure of Title III regulation crowdfunding in several ways. The FCA raises the issuer cap from Title III’s $1,000,000 in a twelve-month period to $5,000,000 in a twelve-month period. The FCA also addresses Title III’s prohibition against using Special Purpose Vehicles (SPV) to raise funds. An SPV can be a legal entity in which multiple individuals invest in a company but are represented as a single investor – giving smaller companies a more manageable account of investors. A correctly structured SPV may also facilitate professional investors in guiding inexperienced investors for better returns.

Title III exempts crowdfunded shares from Exchange Act registration, if the issuer has total assets of no more than $25,000,000. This limitation is expensive for small businesses and may deter growth companies from utilizing crowdfunding. The FCA will remove the condition for exemption to avoid such deterrence. The proposed bill also addresses liability concerns not resolved by Title III such as an “issuer” facing liability for misstatements or omissions if it is unable to show that it could not have known of the misstatement or omission even if it had exercised reasonable care. In Title III, the SEC failed to clarify whether intermediaries (Broker Dealer platforms and funding portals) are issuers, and so under Title III such intermediaries may be exposed to liability. To resolve this issue, the FCA clearly states that intermediaries are not “issuers” unless the intermediary knowingly makes any material misstatement or omission or engages in any fraudulent act.

Finally, under Title III, issuers are not allowed to solicit indications of interest from potential investors prior to filing the mandated disclosure document(s) with the SEC, which means that issuers are not allowed to “test the waters.” The FCA would allow Title III issuers to solicit non-binding indications of interest from potential investors subject to the following conditions: no investor funds can be accepted by the issuer during the initial solicitation period, and any material change in the information provided in the actual offering from the information provided in the solicitation of interest must be highlighted to potential investors in the document(s) filed with the SEC.

As a whole, the Fix Crowdfunding Act aims to protect institutional investors while giving smaller investors the opportunity to generate wealth. FCA comes as welcome news to investors who believe that regulation crowdfunding is currently unusable. Jeff Lynn, CEO and co-founder of Seedrs (a leading UK based investment crowdfunding platform) has stated that regulation crowdfunding is unworkable in its current form as it places weighty burdens on companies seeking to raise capital. According to Lynn, Title III makes crowdfunding more difficult, expensive, and time-consuming than raising money through other channels. Therefore, businesses will only turn to regulation crowdfunding once they have exhausted all other efficient channels – so ordinary investors will experience a negative selection bias in that they will only be able to invest in those businesses that cannot raise capital elsewhere.

In agreement with Lynn, a handful of business and FINRA member Broker Dealers have stated that they would not engage in the crowdfunding marketplace due to its unworkability under Title III, but they would reconsider joining the crowdfunding marketplace if the Fix Crowdfunding Act passes. If crowdfunding is unworkable under Title III, the impact of the Fix Crowdfunding Act may mean a renewed interest in Crowdfunding from all types of investors. If passed, the Fix Crowdfunding Act will promote crowdfunding by bringing together institutional and individual investors, thus fulfilling the original goal set forth in the JOBS Act of 2012.

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Roger Royse
rroyse@rroyselaw.com

Roger Royse, the founder of the Royse Law Firm, works with companies ranging from newly formed tech startups to publicly traded multinationals in a variety of industries. Roger regularly advises on complex tax structuring, high stakes business negotiations and large international financial transactions. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms, as well as Milbank, Tweed, Hadley and McCloy in New York City.
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