We are discussing possible Rulemaking Regarding Crowdfunding under the JOBS Act.

On October 23, 2013, the Securities and Exchange Commission (“SEC”) issued its proposed Crowdfunding rules (“Proposed Rules”) in response to Title III of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”). The rules are designed to permit general solicitations to non-accredited investors through brokers or over crowdfunding platforms. The rules seek to protect investors against fraudulent offerings while facilitating capital raising. The public comment period closed on February 3, 2014, and the SEC has not issued final rules. 

The SEC received over 500 public comment letters. Some remarks supported the Proposed Rules. Many, however, expressed concern the regulations would stifle startup companies.

The Rules would require audited financial statements for issuers offering more than $500,000 in securities through a crowdfunding offering.  Moreover, the new rules state that financial statements must be reviewed by a Certified Public Accountant (“CPA”) for offerings between $100,000 and $500,000.  CPAs generally endorsed the mandatory reporting requirements imposed on companies using the exemption.

Many CPAs, however, echoed the reservations expressed in Ernst & Young’s comment letter that urged the SEC to reconsider requiring startup companies to report two years of U.S. GAAP-based financials because the requirement was onerous and expensive. As an alternative, Ernst & Young recommended, and the American Institute of Certified Public Accountants (“AICPA”) mainly concurred, that startup companies should be permitted to report their financials by using an Other Comprehensive Basis of Accounting (“OCBOA”). The AICPA comment letter specifically noted the “crowdfunding provisions of the JOBS Act were designed to help make raising capital through securities offerings less costly for startups and small businesses” and asserted that the use of an OCBOA would help advance that goal.

The North American Securities Administrators Association, Inc. (“NASAA”) also submitted a comment letter, which noted the importance of a “balanced regulatory approach that minimizes unnecessary costs and burdens on small businesses while providing meaningful investor protection from fraud and abuse.” NASAA supported the efforts to protect investor privacy, grant investors the ability to cancel investment transactions, require job creation reporting, provide for transparent, independently audited financial statements, and bar bad-actors from crowdfunding. NASAA nevertheless warned the Proposed Rules created unnecessary statutory ambiguity. NASAA posited the JOBS Act clearly required funding from all sources to be limited to a $1 million ceiling. The SEC’s proposal, however, provided for a $1 million cap that looked only to other crowdfunding offerings during the prior 12 months. NASAA feared this interpretation could potentially allow for abuse by large companies and distort congressional intent.   

Comments in support of the Proposed Rules shared some commonality in their concerns. Ernst & Young, the AICPA, and NASAA urged the SEC to consider underlying congressional objectives. They stressed, as did many other commenters, that overregulation could make equity based crowdfunding too onerous and expensive for startup companies. They also warned this provision should be cautiously tailored to prevent abusive practices by larger companies.

Despite the importance of investor protections, many proponents of the new regulations feared that the costs of compliance with the Proposed Rules would outweigh the benefits.  As a result, small businesses and startups would be unable to use the exemption as a source of capital raising.