Robert K. Ranum Securities

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Congress Considers “Crowdfunding” and Other Changes in Securities Laws

By: ROBERT K. RANUM

January 2012

Several bills changing federal securities laws to make it easier for emerging companies to raise money are percolating in Congress. In a remarkable display of bipartisan support, the House of Representatives passed a crowdfunding bill (H.R. 2930) on November 1, 2011, by a vote of 407 - 17, and crowdfunding bills have also been introduced in the Senate (S. 1791 and S. 1970). “Crowdfunding” can be generally described as raising money from a large number of small investors via the internet in a manner similar to websites such as Kickstarter and Kiva. Other Senate bills propose to raise the 500 shareholder threshold at which companies are required to register under the Securities Exchange Act of 1934 (S. 1824) and eliminate the ban on general solicitation and advertising in private placements (S. 1831). Still another bill seeks to provide emerging growth companies with less a burdensome regulatory pathway or “on-ramp” to the public markets without compromising investor protection (S. 1933).

This flurry of activity to change decades-old law is driven by the desire to create jobs and the conviction that most jobs are created by small companies. Those advocating the changes argue that government should remove the roadblocks that prevent small businesses from getting the cash that they need to grow and thrive. Others worry that removal of the so-called roadblocks will leave investors more vulnerable to fraud and that increasing fraud will make it more difficult for even legitimate ventures to raise money. If the House vote on H.R. 2930 is an indication of the balance politicians are willing to strike between removing regulatory roadblocks and investor protection, we may see significant new securities laws adopted in 2012.

The House and Senate crowdfunding bills would eliminate the traditional private placement restrictions on general solicitation and the number of non-accredited investors in order to allow the offerings to be sold over the internet to a large number of investors. Under current law, private placements may not be offered by any means of “general solicitation or general advertising” which includes communications in newspapers, magazines, or broadcast over television or radio or over the internet. Current private placement rules also limit the number of investors that may purchase in the offering, although investors meeting certain financial criteria, known as “accredited investors,” are not subject to the limitation. Crowdfunding offerings are not subject to these limitations provided the offerings limit the amount of money that can be invested by each investor and the aggregate amount that can be raised by the company pursuant to the crowdfunding exemption during any twelve month period. The bills also permit a crowdfunding “intermediary” to receive compensation from the company for helping to sell the company’s securities, without requiring the intermediary to be licensed as a broker under federal securities laws.

The following table compares key provisions of H.R. 2930 and S. 1791.

The crowdfunding bills do not count the investors in such offerings against the 500 shareholder threshold after which any company with over $10 million in assets is forced to register under the Securities Exchange Act of 1934 and thereby become a public reporting company. This requirement has become a subject of increasing concern in recent years as the regulatory burdens of public company reporting have increased and fewer companies are willing to take on those burdens. In addition to the crowdfunding bills, a separate bill (S. 1824) addresses this issue by raising the 500 shareholder threshold to 2,000, thereby allowing private companies to have many more shareholders before they are required to comply with the SEC’s public reporting regime. Critics argue that raising the threshold will leave significant numbers of shareholders without the protection provided by regular disclosure under SEC rules.

The bill creating a less burdensome “on-ramp” to the public markets (S. 1933) grew out of work conducted by an IPO Taskforce formed in early 2011 to examine the challenges facing the troubled market for IPOs. The bill would establish a new category of issuer, called an “emerging growth company” (EGC) that has less than $1 billion in annual revenues at the time of SEC registration. These companies would benefit from a temporary regulatory on-ramp designed to provide EGCs with a smooth entryway into the IPO market. This on-ramp status would last only for a limited period of one to five years, depending on the company’s size, and it would encourage EGCs to go public while ensuring that they achieve full compliance later as they mature. Among other things, S. 1933 delays obligations to obtain an auditor’s report on internal controls under Rule 404(b) of Sarbanes Oxley, reduces the audited financial statement requirement from three to two years and reduces the level of compensation disclosure. In addition, the bill loosens restrictions on publication of research on the newly public ECGs and allows for confidential filing of registration statements. The breadth of the issues addressed reflects a thoughtful, nuanced approach to reducing burdens for emerging companies.

Taken together, these bills represent a remarkable level of political energy to attack problems in our economy by changing securities law, as well as an unwillingness to wait for the SEC to address these issues through regulation. While it is difficult to predict which, if any, of these bills might become law, the vote in the House on H.R. 2930 demonstrates that both parties can coalesce around legislation that they perceive to be in favor of emerging business and jobs, jobs, jobs.