On April 5, 2012 President Obama signed the JOBS Act into law.
Some of the rules went into effect immediately, such as the ability of an Emerging Growth Company to file a registration statement and seek confidential treatment during the review process. For this process the EGC would avail itself of the new Securities Act Section 6(e). The SEC issued, albeit limited, guidance on this process for EGC’s yesterday, April 10, 2012.
Within 90 days of the signing of the Act (i.e. mid July), the SEC is required to issue enabling rules as to other portions of the Act, including rules related to general solicitation and advertising under Regulation D. Finally, the SEC has up to 270 days (beginning of 2013) to release rules relating to the new crowdfunding exemption and crowdfunding platform portal regulations.
Crowdfunding Has Been Around For Several Years
It seems to many that the JOBS Act appeared, was enacted into law and is zooming forward practically overnight. That is not the case. In fact, crowdfunding, in various forms, has been around for several years. Up until now it was illegal to offer equity in return for the investment, but preselling products was ok (even for start-ups) and donations were ok as examples.
Thankfully, a band of visionaries recognized an opportunity, defined their goal, and saw it through into law. One of those groups is Startup Exemption, an organization consisting of three individuals. Sherwood Neiss one of the founders of Startup
Exemption gave an interview to crowdsourcing.org which I had the pleasure of reading yesterday. As an aside I recommend crowdsourcing.org as an intellectual, credible source of both positive and negative information on the JOBS Act. In his interview, Mr. Neiss artfully explained why many of the naysayers concerns about rampant fraud resulting from crowdfunding, are unfounded and in my opinion just attention seeking pessimism (the three most outspoken opponents are William Black, Eliot Spitzer and Andrew Ross Sorkin – enough said!
Crowdfunding as a Fraud Deterrent
Anyway, as explained by Mr. Neiss, the way crowdfunding works, really sets up a deterrent for fraud. As we all know, equity based crowdfunding will only occur through accredited intermediaries who are regulated by the SEC and the new SRO, The Crowdfund Intermediary Regulatory Association (CFIRA). So as only those sites that have been accredited and submitted applications and gone through an approval process with the SEC and CFIRA will be able to act as intermediaries for crowdfunding.
In addition, to seek crowdfunding on an accredited, regulated site, an Issuer must go through an application and approval process. This process includes background checks on the Issuers and its officers, directors and principals. The current bad boy provisions associated with Rules 504 and 505 offerings will apply and it is expected the SEC will enact additional prerequisites, including possibly a minimum credit score. Those with negative administrative or criminal backgrounds related to fraud will be excluded.
In addition, the offering amounts are limited. Yes, you can seek to raise up to $1million but most offerings will be much less (many as low as $50,000). A criminal would have to go through a complete application process and background check and create a fake business plan and detailed documentation, with the penalty of jail time, for a relatively small amount of money. For real criminals, there are easier ways.
The most important deterrent is that the money raised comes from friends, families and people already known by the Issuer. There isn’t some unknown pool of investors waiting to write checks for a business enterprise that may or may not be legitimate. The intermediary uses the Issuer’s own social media contacts to solicit an investment. That is, it is the Issuer’s Facebook, LinkedIn, IGoogle, databases, etc., are solicited for investment dollars. By shear design, entrepreneurs are less likely to take advantage of people they actually know, and unscrupulous players won’t be able to exploit unsuspecting strangers.
Crowdfunding will be the hero, not the culprit.
Of course, as with any private offering, investors will have to traverse some minor hurdles in order to invest. They will be required to provide detailed personal information, including financial statements, and will have to respond to multiple questions acknowledging that they genuinely know the issuer and understand the nature of the investment.
There are built-in protections against fraud. That doesn’t mean it won’t happen, but crowdfunding has more deterrents to fraud than many areas of the traditional, widely accepted securities industry including, short selling and options trading. Crowdfunding scenarios are far more difficult to exploit and manipulate.
As noted above, the information in this blog came mainly from the interview Mr. Neiss gave to crowdsourcing.org. It is a paraphrase that includes my own words and feelings, thus the lack of quotations.
The Author
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.
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