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Editor's Note: The following guest post comes to us from Craig Denlinger of CrowdfundCPA.com. It was originally posted here, and is reposted on crowdsourcing.org with permission.
In predicting the new SEC Chairman Elisse Walter's impact on Title III Crowdfunding exemption perhaps the most relevant insight Walter has provided is contained in a 2009 article regarding her position on the regulation of Broker-Dealers and Investment Advisors (EB Walter, ‘Regulating Broker–Dealers and Investment Advisers: Demarcation or Harmonization?’ (2009) 35(1) Journal of Corporation Law). In this article Walter states that the “gist of what (she is) going to say would apply equally well to other financial professionals”, so it is reasonable to infer that Walter’s views in the context of Broker-Dealer and Investment Advisor regulation would mirror her views on the regulation of funding portals, brokers, and other crowdfunding advisors. Further, it should be noted that this article is written from Walter’s ideological stance and is forward looking, rather than focused on the current regulations and legislation in place, offering an insightful view of how Walter would structure legislation if provided the opportunity.
The first point gathered from this article is that Walter feels the current legislation is outdated, cumbersome, and does not achieve its ultimate goals in the most efficient and effective manner. Walter refers to the current regulatory system as a “patchwork quilt – and a badly worn one at that,” refers to regulatory “gaps and overlaps,” and states that “some of the decisions made more than a half century ago are no longer ideal.” Likewise, Walter provided further insight to her opinion of the current securities laws in a November 2011 speech at the SEC Government-Business Forum on Small Business Capital Formation where she stated “Our restriction on general solicitation is one that bears looking at. It appears ripe for re-evaluation because of technological changes. What does general solicitation really mean in an era dominated by electronic communications? Is it a realistic concept?”
In the same speech Walter stated explicitly she is in favor of crowdfunding, calling it a “good idea” and offered her chief concerns as it becoming too big and thereby a “haven for fraud and backfire,” the necessity of an investment limit based on income, the need for anti-fraud measures, and expressly demonstrated her view that any legislation regarding crowdfunding should place the rulemaking with the SEC to “calibrate the risks of reducing regulatory burdens and the potential cost savings.”
By all accounts Walter is an advocate of the investing public and views this advocacy as pivotal to the successful operation of the capital markets through enhanced investor confidence. In the November 2011 speech Walter asserted relative to her agreement with the President’s request for review of SEC rules to eliminate any unnecessary burdens on small business capital formation “should any proposed revision to our regulations veer toward sacrificing investor protection, I submit that such revision will surely come at a cost that no one in business can afford – the loss of investor confidence.” Again in the 2009 article for the Journal of Corporation Law Walter wrote “If I recommend anything that will compromise the protection that investors receive, I surely hope that you will let me know, loudly and clearly,” and “I believe that we owe it to the Aunt Millies of the world to do all that we can to create a more rational, effective regulatory system.” Finally, and most clearly, the following is an excerpt of Walter’s remarks at the November 2012 SEC Government-Business Forum on Small Business Capital Formation:
“People often frame this discussion as “balancing” the desire for easier capital formation against the need for investor protection. But I see this as presenting a false choice, and I hope that you do as well. A vital prerequisite to efficient capital formation is a market in which investors have confidence. If allowing general solicitation results in increased incidence of fraud or sales of securities to investors that do not have the sophistication to understand the risks and merits of a particular investment, we will have failed not only investors, but small businesses as well. In other words, regulations that protect against these risks — without placing undue burdens on businesses — will benefit all participants in the capital markets. On the other hand, we should not block this change because we are afraid that harm will result; it is the responsibility of regulators (and market participants as well) to determine how to obtain the benefit of the change while safeguarding against the downside risks to investor protection and the public interest.”
Upon closer examination, Walter’s overlying views translate to a clear view of how she would ideally implement the rules for crowdfunding.
Walter has discussed the need for harmonization of regulations for Broker-Dealers and Investment Advisors and has expressed her primary concern as the need for a uniform and well defined fiduciary standard for all financial professionals, quoting former SEC Commissioner Annette Nazareth “there (is) a natural interrelationship between brokerage and providing information and advice about investments.” A belief echoed in several Walter publications and speeches is that retail investors should not bear the burden of understanding – the regulations should be harmonized and uniform such that arbitrary terms do not dictate differing responsibilities and fiduciary obligations. Walter categorically states that uniform regulation is necessary for effective regulation and to provide the investing public with ample understanding of the capital markets and its service providers. One can infer from Walter’s strong views on the need for harmonization of Broker-Dealer and Investment Advisor regulations that she will incorporate a similar approach with crowdfunding rules and regulations.
This topic of harmonization provides a strong basis for speculation of other crowdfunding rules and regulations that could result under Walter’s direction. In the 2009 article Walter states that “every financial professional should be subject to a uniform standard of conduct”. Walter elaborates that such standards of conduct should absolutely include a fiduciary responsibility to investors and that this responsibility includes acting categorically in the best interests of investors. Further, Walter states that “what the fiduciary duty requires may also depend, in certain respects, on the sophistication of the investor.” Therefore, specific to crowdfunding, Walter’s views are likely to provide extensive regulations on fiduciary responsibilities, independence, and conflicts of interest, particularly for portals and brokers.
Portals and brokers should also expect similar, or perhaps more robust, registration requirements to those levied on Broker-Dealers and Investment Advisors. In discussing her ideal harmonized registration requirements for Broker-Dealers and Investment Advisors in the 2009 article Walter speaks of a unitary system for registration, a vetting process for new registrants, and a requirement for a registrant to “demonstrate that it has the operational capacity to carry on its proposed business.” Additionally, Walter sees the most important disclosures to the investing public from Broker-Dealers and Investment Advisors concern fees, compensation, and conflicts of interest. Portals and brokers should expect sweeping rules and regulations concerning disclosure of these items, likely in the registration process.
Further ideological regulations under a harmonized regulatory environment discussed in Walter’s 2009 article include:
· Licensing requirements: Walters states in the 2009 article there “should be licensing requirements for all associated persons,” including “(passing) a proficiency test and appropriate continuing education requirements. It should be expected that similar licensing requirements to that which are required for Broker-Dealers and Investment Advisors will be required for crowdfunding, and considering Walter’s views on harmonization it is possible they will be the same requirements.
· Centralized Database: The 2009 article suggests that investors should be provided “access to a centralized database containing the disciplinary and employment history of all financial firms and their personnel.” Considering the investment limit regulations in the legislation perhaps the SEC will mandate a more comprehensive centralized database requiring ongoing reporting of investors and financial information on transactions closed by portals and brokers as well.
· SRO membership: The article contains in depth discussions of the need for self-regulatory organizations (SROs) charged with enforcement and standard-setting authority. Walter asserts her feelings that the SEC’s resources are limited and its focus should remain on oversight and inspection. However, her opinions in this article are such that one is inclined to infer the SRO will report to and be overseen by the SEC. Again, given Walter’s views on harmonization of regulations it is reasonable to assume this SRO will be associated with or part of FINRA and perhaps also associated with PCAOB for reporting requirements. Walter views enforcement as the teeth of the regulations and envisions an SRO as serving the role of protecting investors and making investors whole through punitive measures.
· State regulatory involvement: In the context of overlaps between Broker-Dealer and Investment Advisor regulations Walter expressed concern over regulatory overlap creating inefficiencies and stated that addressing such overlaps are high on the SEC’s agenda. One can assume that this view will carry onto crowdfunding rulemaking and thereby provide further protections for Title III from State laws.
In my opinion, Walter ultimately seems in favor of crowdfunding but feels it will require very strong oversight and regulation. She has demonstrated that while she will not sacrifice investor protection she is very open to seeking the most efficient and effective measures to satisfy the ultimate goal of a protected investing public.
1. EB Walter, ‘Regulating Broker–Dealers and Investment Advisers: Demarcation or Harmonization?’ (2009) 35(1) Journal of Corporation Law
2. Remarks at the 2012 SEC Government-Business Forum on Small Business Capital Formation, by: Commissioner Elisse B. Walter.
3. Remarks at the 2011 SEC Government-Business Forum on Small Business Capital Formation, by: Commissioner Elisse B. Walter.