Press Releases

ЯPR

THE FATE OF CROWDFUNDING – WILL SMALL BUSINESSES BE CROWDED OUT BY THE SEC? by David H. Peirez and Lisa K. Doran

July 24, 2012 Posted in: Press Releases

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act, otherwise known as “the JOBS Act”. One primary component of the JOBS Act is the “CROWDFUND Act”, which is intended to enable privately owned small businesses (including start-ups and entrepreneurs) to raise as much as $1 million a year without having to go through the significant expense and demands of a public offering, a factor which has historically hampered the growth and success of small business. Through “crowdfunding” offerings, businesses are free to solicit investments of small amounts of money from a large number of investors, primarily through the Internet. The hope and expectation is that this type of funding will make capital more readily available to small businesses and startups, which will in turn foster the growth of new companies, and ultimately create jobs. Whether or not the JOBS Act will actually achieve these commendable goals, however, rests entirely in the hands of the Securities and Exchange Commission, which has until the end of 2012 to promulgate rules implementing the CROWDFUND Act. This sobering reality has many people holding their collective breath with apprehension that the SEC, in typical fashion, will be too heavy-handed in its regulation of crowdfunding, thereby quashing the very spirit of the CROWDFUND Act and thwarting its central purpose, namely, to provide financing to fledgling businesses in dire need of capital, and to create desperately needed new jobs.

It is important to note that there already exists a private placement offering exemption from registration, the Reg. D provisions promulgated by the SEC under the Securities Act of 1933. This gives smaller companies the way to raise several millions of dollars, but not over the internet or via advertising. Most Reg. D offerings are limited to “accredited investors” so the offering documents can be rather narrow yet still insulate the company making the offering from liability.

That is not to say that there are not legitimate and important policy considerations which unquestionably warrant SEC regulation of crowdfunding. There is great concern, rightly so, that crowdfunding will create significant opportunities for fraud and abuse in the private offering market, and rekindle the abusive securities analyst practices that lead to the 1990s tech stock bubble. There is further concern that unwitting investors will be vulnerable to highly speculative startups, and relaxed standards for disclosure, accounting transparency and corporate efficacy. Regulatory restrictions and constraints are essential in order to protect unseasoned investors, and are also needed to impose a meaningful degree of liability and accountability upon intermediaries, issuers and insiders so as to minimize the opportunity for a myriad of abuses such as accounting fraud, insider dealing, excessive stock dilution, and unscrupulous executive compensation packages, just to name a few.

It is clear that, in order for crowdfunding to be an effective catalyst for the growth of small business, and to avoid becoming a haven for scammers, fraud and abuse, adequate regulatory protections must be put into place. The question is whether the SEC can implement rules which effectively provide such protections without, at the same time, being so onerous as to undermine crowdfunding’s utility, appeal and feasibility for small emerging growth businesses. If the SEC does not exercise sufficient restraint in its regulation of issuers and intermediaries, small businesses will crumple under the weight of an overly burdensome and expensive regulatory regime. As a result, rather than providing a vital lifeline for small business, crowdfunding will be consigned to the fate of being just another well-intended but ineffectual, ill-fated piece of legislation that never came close to realizing its potential.