Crowdfunding Law

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Don’t Make Investors Buy Crowdfunded Securities, Let Them

The Economist recently took note of Amanda Palmer’s viral TED video where she outlines how she has funded her music throughout her career by building relationships with an increasingly large and affectionate crowd following.  The Economist has noticed Ms. Palmer’s fundraising activities before after she successfully used a crowdfunding project to source $1.2 million (on a goal of only $100,000) related to a new CD and tour. Her TED video has now caused over 1.6 million people to also take a look at the wild and outgoing Palmer. Palmer’s primary message in her TED Talk is that musicians and the music business have been reacting to illegal music downloading and file sharing from the wrong perspective. She argues that rather than trying to figure out how to make music fans pay for music, they should be focused on letting them pay for the music they love. Crowdfunding through an internet portal is only the most recent mechanism, and likely the most successful, for Palmer to allow fans to support her work. She has used Twitter to find a free place to stay and has even been a strange street performer posing as an 8 ft. bride for photos. Palmer understood crowdfunding before Kickstarter understood crowdfunding. She has used it to give fans a portal to support her musical efforts and, in the process, to feel a sense of ownership in the results and collaboration in the process.

Her message is a timely one for regulators who are trying to figure out Title III crowdfunding. The SEC is probably struggling to figure out how to stop issuers or portals from making investors purchase crowdfunded securities. Some have suggested that the SEC would like to test crowdfunding by timing regulations such that only broker-dealers will be able to conduct crowdfunding offerings for some period of time. This really overlooks the most promising area of Title III. Broker-dealers are in the business of convincing people to buy securities much in the same way that music labels want to convince or “make” people pay for music. Internet portals that are precluded under the JOBS Act from providing investment advice to investors are not in the business of “making” people invest in crowdfunded offerings, they are designed to “let” people invest in these companies.

I have written and spoken many times on the notion that those trying to understand or regulate crowdfunded investment should first look to crowdfunding as it is being practiced in a non-investment scenario. Rather than talking amongst themselves and exclusively to broker-dealers or broker-dealer wannabes, maybe the SEC and FINRA should talk to Amanda Palmer. Main street investment crowdfunding in its most successful form will not ask how to make investors invest, it will ask how to let them.

What About Crowdfunding?

What About Crowdfunding?

My Spacecoast Business piece on where we stand with investment crowdfunding–no hype allowed

Avoid Those Urging Startups to “Get ready for Investment Crowdfunding Now”

In May of last year, the month following passage of the JOBS Act, I warned startups to watch the hypsters who were urging startups to sign up on portals and get ready for investment crowdfunding.  I pointed out that these would-be investment portals were far more interested in what they could do for themselves than what they could do for your startup.  At the time, portals were trying to show potential investors that they had deal flow and they were trying to establish their own brands.  The problem is that this was being done at the expense of startup companies that were being misled about the fact that they could count on investment crowdfunding to solve their near-term capital needs.  The reality was that anyone who knew enough about the issues that remained before investment crowdfunding could be effectively and economically used to raise capital were far too speculative and far too distant for cash-starved startups to wait.

Fast forward to now and absolutely nothing has changed.  In fact, there seems to be an even greater number of advisors, event promoters, service providers and potential portals pushing the “act now” or lose out mantra.  This is simply garbage.  My suggestion is that companies and founders use the same rules that credible modeling agencies tell parents about shady child modeling agencies.  If “getting ready” means paying someone money, you probably should take a pass.  If someone is telling you that investment crowdfunding is soon going to work for companies seeking investment, or for investment portals, or for broker-dealers, or for investors (accredited or otherwise), they are either uninformed, irrationally exuberant or ripping you off.  Pursue your other funding options as if investment crowdfunding is not your solution.  If that changes, you might want to pivot toward crowdfunding–just don’t count on it to be a solution based on what we know now.

If you are dealing with a portal this is actually raising capital now using a state securities exemption or as a broker-dealer, that is potentially a different matter.  You can check the track record and conduct due diligence on their representations.  I would also make sure an independent attorney is engaged by your company to make sure that the offering does not violate what is legal under the state law or under the laws that remain applicable to accredited investor solicitations.  As I have pointed out, there are portals out there that are, to be kind, working in a gray area.

The unfortunate reality is that many of these sales pitches are still being done by those who want to be paid now for something that is far too uncertain.  We still do not know if accredited investor crowdfunding can work for accredited investors, who may be asked to provide so much personal information to establish that they are accredited that they will refuse to invest. We still do not know if broker-dealer costs structures can accommodate the costs relating to client obligations and a whole host of issues associated with broker-dealers–especially for small offerings of less than $2 million.  We know absolutely nothing about whether the “investment portal” sector will work at all.  We know absolutely nothing about whether Title III crowdfunding will be cost-effective for issuing companies or for portals.

In short, we still do not know anything that is of practical value relating to JOBS Act modifications to securities laws.  This is driving many in Congress crazy right along with the rest of us.  But be smart in the interim and do not count on investment crowdfunding until it is proven to be workable.  By all means, do not pay money to people who are trying to profit themselves whether crowdfunding is workable for you or not.

International Franchise Association’s Position on Title III Investment Crowdfunding

This is worth a read:

Investment Crowdfunding: Small Business Capital “Blackhole” Trumps “Fiscal Cliff”

They missed the deadline.  We knew they would.  They knew the deadline was coming for months and months but they did nothing but offer platitudes.  They knew what the stakes were for a fragile recovery.  They placed another self-inflicted wound on the economy anyhow.  It turns out that at the highest levels they thought only of their own personal gain and their perceived “reputations.”  They cowered in fear of fringe minority groups who were vocal in their fear mongering.  Very little time seems to have been spent on actually doing their jobs and filling their role in the decisions already made regarding the needs of the economy and job creation.  They seem absolutely incompetent and not up to the task.

No, I’m not talking about Congress and the fiscal cliff–I am talking about the SEC.  Just like the Fiscal Cliff, the deadline passed for rule making under Title III of the Jobs Act on December 31.  Nothing has happened–not even on the Rule 506 changes that had a July 4 deadline.  Unlike the Fiscal Cliff, there was no suspense remaining that the SEC would meet the deadline.  After all, I predicted this back in May despite what was being said by the SEC at the time.  By year end, even the SEC was admitting the obvious.  At this stage, no one can reasonably predict when investment crowdfunding will be legal in the U.S. or whether what emerges will even make sense for either issuers or portals.  No detail is offered, no transparency is given.

What has emerged has been predictable.  Those that are inclined to break the rules or press the “gray areas” are using this lengthy delay to their own benefit.  After all, I have already been solicited by email for an investment of “as little as $1,000.”  Portals that raised capital and scaled operations based on the deadline are no closer to revenues than they were when the law passed in April.  Many will not survive the wait.  Clearly the bigger loss is that even when Congress acts, in a bi-partisan manner, to do something intended to help the small business owner who is starving for capital, nothing actually happens.  There is still a giant blackhole of capital funding for startup and early stage companies that the banks and institutional investors are not inclined to fill any time soon.  With all the coverage of the Fiscal Cliff, I cannot help but recognize that in this era of deep and illogical partisanship, Congress does actually do something when there is no alternative to not doing something.  Administrative agencies have no such sense of accountability.  The JOBS Act was signed into law in early April.  Government did something, in an election year no less, and the SEC has totally dropped the ball.  The deadline is now officially missed.  This is a bigger story than the Fiscal Cliff.  Congress predictably kicked the can down the road on the Fiscal Cliff.  But give credit where credit is due–at least with Congress the can actually moves.

FINRA Starts Their Process for Portal Registration

Kudos to FINRA for being proactive at its December 7 Board meeting and authorizing the issuance of an interim form seeking information from prospective funding portals intending to apply for membership with FINRA pursuant to the JOBS Act. This type of proactive approach at a time when the SEC seems disinclined to provide evidence of progress on its own rule-making is a very good sign that FINRA is on top of the task.  FINRA could be using the SEC stalls as cover for failing to move forward with activities it well knows it needs to do regardless of the content of those rules.  Instead, prospective funding portals will apparently be able to file an interim form with FINRA voluntarily FINRA will file the interim form with the SEC.  This could serve as an important early indicator of the size of this new sector.  Many have been concerned that there is no deadline for FINRA to put a portal registration process in place and that this could act to extreme advantage of existing broker-dealers who might be active in the crowdfunding space long before portals can even register.  Because those broker-dealers are existing paying FINRA members, some amount of concern seems warranted.  This may prove to be nothing more than window dressing by FINRA and I will certainly follow-up with some thoughts as to whether the process is moving forward.  However, FINRA could be saying and doing nothing right now and merely pointing to the absence of guidance from the SEC as cover.  The fact that this process has board-level attention is very positive and I commend them for doing what they can in a timely and proactive way.

Crowdfunding Twinkies involves Opportunism and Distraction

It seems as though every major news story is now followed by a crowdfunding story attempting to ride those coattails.  The Hostess bankruptcy is a good example. I’m obviously a big believer in crowdfunding.  I am a believer in what it is now and I am a believer in what it could become as a mechanism to unlock business capital if the SEC and FINRA process preserve the legislative intention of the JOBS Act. I am even optimistic about what crowdfunding could do in a bankruptcy context.  However, as we wait for the SEC to figure out the rules, crowdfunding is also being used as a buzzword simply for getting PR or site visits.

As to the Hostess bankruptcy, one group immediately posted a campaign to buy Hostess, or pledge to buy Twinkies or some other outlandish plan to raise $500 million.  That’s $500 million!  The only thing that outlasts the life span of a Twinkie would be to run a successful crowdfunding campaign for $500 million.  Most took it for the PR stunt that it was although at least one local news source thought the PR stunt was a good idea.  I am sure there were some good intentions somewhere but this type of self promotion erodes the crowdfunding brand before real crowdfunding investment has a chance to establish itself as a sector.  I wonder how many Hostess employees saw the press and actually got their hopes up that their job could be preserved.

More recently, Forbes has run a column which jokingly (presumably) suggests that unions should themselves crowdfund the purchase of Hostess.  I assume this is a joke even though the quality of Forbes journalism has gotten so shoddy that entirely serious stories often seem to be in jest.  In any event, these are the things I suppose we will have to survive until the rules for investment crowdfunding become known.  Only then will we have genuine stories of what can be done with investment crowdfunding . . . of course, unless the SEC kills it.

Girl Scouts Sell Lots of Cookies: SEC Regulation of Title III Crowdfunding

I wonder whether the SEC understands that Title III investment crowdfunding is inextricably linked to social entrepreneurship.  It is essential to understanding how a balanced approach for regulation is necessary in this area.  Title III is a natural evolution of the rewards-based crowdfunding that has already established itself to be hugely successful and largely free from fraud or abuse.  People have used crowdfunding, on a worldwide basis, to solicit and receive billions of dollars in capital for ideas and projects–all without any possibility of an investment return.  I don’t think the SEC has any concept of how to think about this and why it is relevant to Title III crowdfunding.  Here is an example anyone can relate to: the Girl Scouts sell a tremendous number of $2.00 boxes of cookies for $3.50 (and those cookies are coming your way right now). We do not need government regulators to protect us from the Girl Scouts.

Large numbers of people have established that, when they relate to a proposed project, they will back that project with money without any expectation of a financial return. There is a return on this “investment,” but it is related to the intangible benefit of knowing that you have helped something that you care about get done. I have often compared it to a modern-day barn raising.  I predict that there is a much larger group of people who will invest in companies or projects through Title III crowdfunding than those who have already established that they will give money for rewards-based crowdfunding. The Girl Scouts have already proven it. When a Girl Scout comes to your door, they could ask you for a donation instead of asking you to buy a box of cookies.  What Girl Scouts know is that a far larger number of us will overpay $1.50 for a box of cookies than those that will simply donate $1.50 without buying cookies.  In both instances, the Girl Scouts are getting $1.50 to help their noble cause (note: this is just an example–I do not know what margin the Brownies have on their cookies).  However, by selling the cookies, there is a good faith component that shows that the Girl Scouts are doing something and the buyer is getting something back.  Here’s the point–it is not an entirely financial transaction.  As a complete aside, the Boy Scouts are now falling in line and taking this to an extreme. You know what I mean if you bought the $15 bag of cheese popcorn that I bought this year.

I don’t need the government to direct the Girl Scouts to inform me that I could buy better cookies for less money (and I certainly do not need them to tell me the $15 popcorn is only worth a buck ninety-nine).  I understand that.  I want to buy the overpriced cookies and I want the particular Girl Scout to feel the satisfaction of having sold them to me (and so no, I do not buy them from the parent at the office that is doing the child’s work–just my own peeve).

Title III crowdfunding will share some similarities with buying Girl Scout cookies. Rather than overpaying for the crowdfunded investment, I will invest in social enterprises that have business models that I would like to see be successful. I will do that with a full understanding of the risks, the percentages of success or failure and the fact that I will most likely never see my investment back–let alone any financial return on my investment.  I will do the same thing for businesses that are being started by people I want to support in starting their own business (and I hope that a few of them are some of those enterprising Girl Scout cookies salespeople)–even if I think their business is uninteresting or unlikely to be successful.  The fact that the business operator is willing to share a return on my investment if it is successful will be enough for many people to back the project in a way they would not have done if they had no ownership interest at all.  The investment component is the box of cookies.  I don’t need the cookies. I was not looking for cookies.  I will buy the cookies and support the cause.

I’m not talking about huge money here and the JOBS Act ensures that people cannot invest large sums under this exemption. What the SEC needs to understand is that these annual caps ARE THE GOVERNMENTAL PROTECTION.  I think the annual caps on this investment category are actually far too small.  I hope Mayor Bloomberg never tries to limit the number of cookie boxes I can buy from Girl Scouts.

I think I understand why this seems so hard for the SEC to gets its head around.  As a former prosecutor, I understand that when you spend all of your professional time fighting criminals, you begin to think everyone is a criminal.  Because you know infinitely more than the average person about the minority of people who willfully and routinely break the law, you see indicators of crime everywhere and you assume criminal behavior as the rule, rather than the exception.

To its credit, the SEC has now moved from an era where there was virtually no enforcement to an era of relevance. Unfortunately, they have also been unable or unwilling to go after the people who have recently orchestrated amongst the largest frauds in history.  They have been feckless and willing to settle for embarrassing slaps on the wrist.  Even where they have alleged fraud (and presumably believe they can proved it) they have failed to seek consequences commensurate with fraud.  Apparently, at the highest levels they have been more concerned with their own personal “legacies” as opposed to doing what the law requires them to do.

What will the legacy be for Title III crowdfunding?  Will it be that the SEC respected the law and provided for the fostering of a new source of investment capital that is directed to socially responsible businesses and Main Street businesses in a way that banks will not now do and Wall Street never cared about doing?  Will it be that the SEC killed the exemption by swinging a sledge-hammer at a fly?  If so, it would be another example of different rules for the “haves” and “have nots.”  On Wall Street, you can actually commit monstrous fraud and steal client funds and the SEC will give you the equivalent of a shame on you note.  For “too big to fail” banks, you can be bailed out and you can loan money only to those who do not need the loans.  On Main Street–you’re on your own because we do not trust you enough to let you raise money from friends, family and supporters.  If so, watch out Girl Scouts.

And Now for the SEC Update on Investment Crowdfunding . . . Bueller . . . Bueller . . . Bueller . . .

Well, after the SEC’s much anticipated Annual Government-Business Forum on Small Business Capital Formation yesterday, I’d hoped to post something of value regarding the state of the SEC’s effort to write the rules necessary for Title II and Title III crowdfunding.  After all, there was a fair amount of build-up that this event would be THE forum for an SEC update as to timing and substance of pending regulations and the title of the opening session was “JOBS Act Implementation.”  The update on implementation is: no update.  After spending most of yesterday listening by webcast and teleconference and exactly one week in advance of Thanksgiving, I am most thankful that I did not waste money on a flight to Washington.  Standing ready to take notes on the most important information, my computer screen was essentially blank at the end of the day.  Being much more diligent than I (and undoubtedly a better typist), Bill Carleton has an excellent live blog summary here.  My summary of the SEC position is rather simple: There are lots of issues. We are working on those issues. We do not know when we will get through the issues.  We will get back to you.  Stay Tuned.

Today there is absolutely nothing I can report that is of value to those who are wondering when any form of investment crowdfunding will be implemented under the JOBS Act.  Further, there is nothing I can report as to whether it is likely that any form of investment crowdfunding will be worth conducting, either for issuers or portals, after those rules are written.  No such luck.  There were plenty of questions raised (as with any public event, they ranged from good to asinine).  I do appreciate the time of the moderators who attempted to field questions, tried to fight through people on the phone who did not know how to operate their mute buttons and tried to provide something of value to those who were attending or listening.

Don’t get me wrong, I want the SEC to take time if they need time to get it right.  Brian Knight at Crowdcheck makes that point well here.  I, however, got more of a sense yesterday that the SEC is simply over thinking the issues and that the general regulatory instinct to build a fortress in advance of any sign of a conflict is carrying the day.  Just a hunch–but it seems increasingly likely.  The reality is that we don’t have to be overwhelmed by the potential issues of investment crowdfunding. As Jonny Sandlund has said before, the world has plenty of data showing the boogey men just don’t exist in investment crowdfunding.  Never-the-less, we Americans always think we invented everything and that nothing has been decided until we decide.  Perhaps the only good news is that the SEC is aware that their delay benefits those that are doing general solicitations in the US already.  According to Meredith Cross, if you are jumping the gun “You may hear from us, and you may already have heard from us.”  At least maybe those who are willing to play outside the rules during this period of delay will be held to account.  Stay Tuned.

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