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A Look at the Proposed Amendments to the Crowdfunding Bill
editorial

A Look at the Proposed Amendments to the Crowdfunding Bill

Wednesday, the Senate cloture vote on H.R. 3606, better known as the JOBS Act, passed 76-22--the package will allow companies to offer securities to non-accredited investors via crowdfunding platforms. The JOBS Act passed the House by a 390-23 vote on March 8 and in a rare showing of bipartisan agreement on the economy during an election year. The Obama administration has expressed support for the JOBS Act, which the President intends to sign into law when the legislation reaches his desk.

Immediately after affirming the vote, Senators Jeff Merkley (D-OR), Scott P. Brown (R-MA) and Jack Reed (D-RI) proposed two additional amendments: S. 1884 from Merkley and Brown; and an amendment to S. 1844, S. 1931, from Reed. The Senators say the amendments are aimed at correcting the “deeply flawed” and “imperfect” qualities of H.R. 2930, Rep. Patrick McHenry's (R-NC) Entreprenuer Access to Capital Act, the foundation for the crowdfunding section of the JOBS Act, ensuring companies are able to raise capital and create jobs while protecting investors by reducing the risk of fraud. If either of the amendments are approved, the House and the Senate will need to address their differences before it’s sent to President Obama.

The Merkley-Brown S. 1884 amendment challenges Rep. McHenry's original House bill in a number of areas:

#1 – The House bill does not require companies requesting money to make financial disclosures. Under the amendment, companies requesting less than $100,000 would need to have the CEO of the company certify the accuracy of the financials. Companies seeking to raise between $100,000 and $500,000 would require a CPA to certify the accuracy of the financials. Companies seeking to raise over $500,000 would need to make their audited financials public.

#2 – The House bill would not make companies accountable for the accuracy of “information,” financial or otherwise. The amendment would require that companies stand behind the accuracy of information, providing due diligence protection to ensure that the information being disclosed is relevant and germane. This would give investors further protection, which is essential to create the foundation of an effective marketplace.

#3 – Under the House bill there would be no industry watchdog; under a new regulatory framework, funding platforms would need to agree that they would not take a position on any investments they are offering and that information would be presented “without spin.” The amendment would require funding portals to be registered following a process that would be more streamlined than the current process required for registering dealer and brokers.

#4 – The House bill doesn’t provide scalable investment caps, just the static 10% of annual income or $10,000 cap (whichever is less). Under the S. 1884 amendment, three different caps would be introduced: a maximum of 2% of investors’ annual gross income for individuals earning up to $40,000 a year; up to 5% for investors earning up to $100,000 a year; and a cap of 10% for those earning above $100,000.

#5 – The House bill would allow businesses to collect their crowdfunded investments the day the funding period closes, thereby not providing any time to uncover fraudulent behavior. With the amendment, there would be a three-week listing to closure period, which would allow some time for the collective “wisdom of the crowd” to identify possible fraudulent activity through feedback loops.

#6 – The House bill would allow paid promotion of investment opportunities without the need for disclosure, thereby opening the opportunity for “pump-and-dump” strategies. Under the proposed amendment, anyone promoting an investment would need to disclose if they were earning fees in connection with the entity raising the capital.

In adding the second amendment, Reed said while the Merkley-Brown amendment went some way towards addressing the risks that would be introduced if the House bill were to be approved. His amendment would close some additional exposures, not addressed by the Merkley-Brown amendment, namely tightening the definition of shareholders of record in a section of the bill that allows public companies to remove themselves from oversight by the Securities and Exchange Commission if their number of shareholders falls below a certain level. He stated that this would ensure “real shareholders” who were used to following companies via public reports were not starved of important information by allowing companies to “go dark” by easing reporting requirements.

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  • dara albright dara albright Mar 21, 2012 09:14 pm GMT

    Great, now some companies will need to crowdfund just to raise the money to pay for audited financials so that they can then raise capital via crowdfunding :-)

  • William Carleton William Carleton Mar 21, 2012 09:58 pm GMT

    Carl, so awesome you are on top of this in real time. It is hard to keep up with the twists and turns!

    I continue to feel that many crowdfunding advocates are being taken advantage of by those from the old-world, regulatory paradigm. On the surface, the objections of the regulators sound reasonable. "Accountability for omissions," "disclosures," etc. But the McHenry bill had that. Has that. The difference being, the McHenry bill is bold enough to experiment with the idea that people on the internet, on the crowdfunding platforms are going to talk with one another.

    Have a look at the following McHenry provision that Brown/Merkley would strike:

    `(12) makes available on the intermediary's website a method of communication that permits the issuer and investors to communicate with one another'

    Now why, you might ask, would Merkley/Brown want to strike that? Classic old-world view - communications should be carefully controlled. They should go through lawyers. They should not be rumor mills.

    On the other hand, ask yourself, by rejecting the wisdom of the crowd, are we getting an equity crowdfunding exemption, or are the Senators really just selling one more heavy, unmanageable, turgid, cynical small offering exemption that they know damn well will go nowhere? How many people use SCOR?

  • Ryan Feit Ryan Feit Mar 22, 2012 02:36 am GMT

    As always, great commentary Carl and Bill. Big day tomorrow.

  • Antone Johnson Antone Johnson Mar 22, 2012 02:56 am GMT

    Thank you for this helpful resource. Either amendment would be a vast improvement to the existing bill, which demonstrates such wide-eyed naivety as to be disastrous for investors.

    As a lawyer representing Internet startups for a living, I'm as true a believer as they come in the notion that "the Internet changes everything." Yet the Internet doesn't, and can't, change one critical aspect of the relationship between companies and investors: The reliability of its disclosure regarding information known only to founders. That massive information asymmetry guarantees poor outcomes overall. As an analogy, although crowds are "wise" in many contexts, one in which every member is blindfolded will not be a good trail guide unless we as a society are OK with a trial-and-error approach in which the cries of members falling off cliffs to the left and right are used as guides for the rest to stumble ahead.

    Despite SEC registration, periodic reporting, "independent" auditors, etc., nothing stopped Enron, WorldCom and others from lying through their teeth until they were bankrupt, destroying hundreds of billions in shareholder value. The Internet was ubiquitous in 2001, yet didn't miraculously prevent those problems. Why should we expect it to be different with much smaller issuers with no track record, no mandated public disclosure and no SEC registration? Are mom-and-pops uniformly saintly creatures with no Andrew Fastows among them?

    I would hate to see the amendments perish at the hands of partisan politics. Without them, this would be targeted deregulation of the market segment with the least transparency, least accountability, most meager resources and smallest individual economic incentive among investors to pursue their own due diligence and legal recourse — like shooting fish in a barrel for any enterprising fraudster.

    For detailed analysis, see my post at Gust: http://gust.com/angel-investing/startup-blogs/2012/03/19/crowdfunding-train-wreck .

  • Guest Brian Tsuchiya Mar 22, 2012 03:45 am GMT

    Carl, great job capturing this continuing saga of the JOBS Act. Today was a confusing day with the invoking of cloture. Nonetheless tomorrow starting at 12:30 EDT the Senate will vote on two amendments to HR3606 and the "passage of HR 3606 as amended, if amended" Maybe tomorrow we will know the next steps. Passage of HR 3606 identical to the House bill means it goes to The White House, approval of any amendment means it has to be approved by the House again and ends up in committee to reconcile the differences. We are one step closer.

  • Guest Joe13 Mar 22, 2012 06:33 pm GMT

    Let's see:
    they added:

    1. Audited financials: depending on the business activity, the cost could be from $20k to $250k -- so if you want to raise $110k you will need to pay for: the audit, the accountants, the senior management time, possibly security lawyers (if auditors request it). This is the biggest BS the senators could ever come with. You will be spending more time and money up front, to have a chance to raise some money.
    These idiots think that like their salaries, raising money is a given.. it's not!
    How about the risks that the company incurrs when spending so many resources that the small business doesn't have, for a 'chance' to raise some capital??
    2. wait three weeks to get your money.
    between the time and effort at 1. now you add even more time..
    The small business spent all the time and money it had - up-front! - and now, they can'd conduct any business, even if the money raising effort is successful!!
    I think this should be called the Jobs Killing Bill of the Senate of 2012

  • Guest Steve Reaser Mar 23, 2012 03:12 pm GMT

    The three week waiting period at close does seem odd; unless a company manages to somehow reach their minimum raise with lightning speed, there should already be plenty of time during the campaign for any possible fraud to come to light.

    If anything it seems like there should be a period at the *beginning* where Q&A transpires but during which investments are not yet made... but even that seems unnecessary.

    Does anyone have insight on how the 3-week period helps anything or anyone? Seems like it just hurts entrepreneurs (and crowdfunding's viability) a bit, without any upside.

  • Carl Esposti Carl Esposti Mar 24, 2012 05:13 am GMT

    Steve - I think I see where my comment for #5 might be ambiguous and misinterpreted. When I referred to "The House bill would allow businesses to collect their crowdfunded investments the day the funding period closes", what I should have said was the House bill would allow for a listing period of as little as 24 hours (as an example) and as such the listing to closure period would be too short to allow time for due-diligence by the crowd to identify irregularities or concern - the three week minimum closure period three-week listing to closure period is intended to ensure that the listing is exposed to collective wisdom for a period that is long enough to increase the likelihood of the potential for fraud to be identified.

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