Earlier today, the Securities and Exchange Commission issued a set of proposed regulatory changes as part of the implementation of the JOBS Act. The Act, which is supposed to simplify the process for raising capital for startups, gave us the promise of disrupting the venture capital industry. Instead, the SEC has tied up the JOBS Act in red tape, by moving slowly and stalling the implementation of the regulations.
Prior to the JOBS Act, companies that were raising capital had to register the fundraising with the SEC — but they were never allowed to publicly advertise the fundraising in places like newspapers or online. This meant that the number of people who learned about the investments were much smaller. The disruptive nature of the JOBS Act, though, is that it will allow companies to tell everyone that they are raising money, meaning that the number of potential investors increases dramatically.
As a precaution against everyone investing based entirely off of the hype of a given pitch, though, the SEC has mandated that accredited investors are the only ones eligible to invest in privately owned, early-stage companies filing for the advertising ban exemption. To become accredited, the SEC has a few rules on the books as part of the proposed changes. Investors must have a net worth of over $1 million, or, investors must have an annual income of over $200,000.
These rule changes may end up being a pain in the side of crowdfunding groups, as the SEC is being intentionally vague on who is liable for determining eligibility. The Commission has decided that instead of putting approved regulatory organizations like broker-dealers or the SEC itself in charge of determining if investors are accredited, the onus for determining eligibility should be placed on issuers — the entities that are actually handing out the stock.
Taking responsibility and being liable for the determining if investors are accredited or not is a big problem for the issuers. The process is costly and time-intensive, and if they mess up, they will have violated SEC regulations. As a result, the issuers will likely end up turning to broker-dealers to take care of the eligibility process, while at the same time retaining the liability for any mistakes made.
The concern over liability isn’t news to the SEC, though. As noted in footnote 53 of the proposed regulations, “Several commentators, in fact, have recommended that the Commission take action to facilitate the ability of issuers to rely on third parties to perform the necessary verification.” Despite the recommendation, though, the SEC is still putting the liability at the doorstep of the issuers.
This footnote hints at a future where issuers aren’t directly liable for any rule-breaking, but because this isn’t actually a part of the rules, it just makes the situation even murkier. If third-parties will be held responsible down the road, why aren’t they being held responsible from the get-go? And why are issuers being handed the short-straw in all of this? These mixed signals are a nightmare for companies looking to be involved in the crowdfunding process. After all, if it’s not clear if you’re violating regulations, how do you avoid breaking the law?
I spoke with DJ Paul, the COO of Crowdfunder, and he shared with me that even after speaking to his company’s lawyers, it’s not clear who is actually liable if an investor ends up not being accredited. For companies that are trying to be innovative while also working within the confines of securities laws, this can become a big (and possibly expensive) headache.
Another issue with the proposed rules is that there is no specification as to how issuers can advertise the sale of securities. According to Bill Clark, cofounder of crowdfunding-focused broker-dealer MicroVentures, there is the possibility that other issuers will advertise securities with overhyped statements like, “the next revolution in social networking,” which would be more attractive to investors than simply stating that the facts of the fundraising. This could mislead investors, and there’s no clear protection in the proposed regulations.
The delays and vague regulations aren’t going unnoticed by those in power, though. As Patrick McHenry, a sitting member of the House of Representative’s Committee on Oversight and Government Reform, told SEC Chairman Mary Schapiro in a letter to the Commission (PDF),
“…by issuing a proposed rule, rather than an interim final rule, the Commission is unlikely to finalize the rule until next year. By kicking the can down the road, you are abdicating your responsibility to follow the law, failing to fulfill your sworn commitment to this Subcommittee, and ignoring the will of Congress and the President of the United States.”
There isn’t a clear motivation for why Schapiro and the SEC are pushing the implementation back, or why there is a delay in implementing an interim final rule. Every side of the debate has weighed in, from the broker-dealers, to state regulators, to companies wishing to have the JOBS act implemented. At this point, the act should be going full steam ahead, and yet its being delayed yet again.
[Photo Credit: Scott*Eric on Flickr]