Gary J. Ross
For regular readers of my column, you know that unlike some other columnists, for the most part, I do not write about my practice area. (Yes, though the ATL bucks are big, I do still have to go to work every day.) I thought today I would take a break from describing the clear superiority of SmallLaw and I would instead talk about crowdfunding.
The SEC’s crowdfunding rules (termed Regulation Crowdfunding, though many people will continue to call it “Title III Crowdfunding” after the chapter of the JOBS Act it is in) went into effect last Monday, so this should be somewhat timely. There has been a great deal of interest about crowdfunding, even before the JOBS Act was passed in 2012. In fact, it was included in the JOBS Act because there was a great deal of interest in it. In this case, the political system worked.
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Crowdfunding — the ability of companies to raise money through small investments by a relatively large number of people — has provided an opportunity for SmallLaw securities law practitioners such as myself to distinguish themselves, since it is an area that, for the most part, large law firms are going to stay away from, given the inability of most startups to pay Biglaw legal fees. I’m a member of the Securities Regulation Committee of my local bar association and since everyone else is either Biglaw or in-house at a Fortune 500 company, I was tapped to talk to the group about crowdfunding, and the lack of interest in the room in what I had to say made me recall certain visits to singles bars.
To explain the importance of crowdfunding, some background may be helpful. Every stock or bond or other security that a company sells to an investor has to be either registered — like in an IPO, in which the company (or “issuer”) will submit a lengthy registration statement to the SEC disclosing all kinds of information about the company — or exempt from registration. Most registration exemptions involve selling to “accredited investors,” which are defined as investors earning at least $200,000 or with $1 million worth of assets, not including a person’s house. (I’m leaving out a lot of important stuff, as this is an ATL column and should not be interpreted as legal advice.) If a security is not registered, then it has to be exempted at both the federal and the state level. Not surprisingly, the most popular federal registration exemptions “preempt” the state registration requirements, though you still might have to make a notice filing with the state and pay a fee. Regulation Crowdfunding is such an exemption.
Though many people consider compliance with securities laws a nuisance — even securities lawyers who owe their livelihoods to such laws — there is a method to the madness. The federal rules came about during the Great Depression, and though unscrupulous individuals enticing unsophisticated persons into buying stocks that had no value may not have been the driving force behind the Depression, it didn’t help, so protecting investors was surely on everyone’s mind. After all, there’s a reason the primary securities laws were released in 1933 and 1934.
The issue that the crowdfunding rules are meant to address is that the same rules shouldn’t necessarily apply to companies asking investors — even non-accredited investors — for a relatively small amount of money, as opposed to companies expecting investors to pony up $30,000 or so. Should a kid wanting to start a t-shirt business who is asking investors for $100 apiece have to pay my firm to do a full-blown IPO? While my landlord would say yes, most people would say no. Some proportionality is in order.
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Regulation Crowdfunding investments must be made exclusively through an SEC-registered broker dealer or a new “funding portal,” which has to register with the SEC and become a member of FINRA. The requirements for these crowdfunding portals have been sharply criticized as overly burdensome, but the portals are to a great extent the point. Technology has changed how much information is available and how we can access it. The securities laws were not contemplating the information age we live in now, where you can find out a lot about a company while you’re walking from your apartment to the corner bodega, assuming you can force yourself to take a break from Candy Crush. Having a non-judgmental portal sitting between investors and the companies that can provide transparency into the companies — and that will not try to rank companies based on whether or not they are advertising on the portal — is key.
With Regulation Crowdfunding, a company can raise up to a $1 million in a 12-month period without having to register its securities. How much investors can invest via Regulation Crowdfunding is dependent upon a person’s annual income or net worth, with whether an investor is above or below $100,000 in income or net worth being an important factor, and the maximum limit being $100,000 per investor in any 12-month period. Limits are per-investor, not per-company. (I’m simplifying this to such an extent that any securities attorneys reading this are probably experiencing heart palpitations right about now.)
Most securities lawyers such as myself believe the Regulation Crowdfunding rules are still too onerous and will undoubtedly be dialed back in the future. However, I am sure in the next year or two we will be reading a few sad stories about elderly or other vulnerable folks who lost money investing in a risky startup, so it will be interesting to see what happens to Regulation Crowdfunding in the future.
I’ll close by revisiting the Biglaw-SmallLaw angle. Most startups that work with Biglaw firms are founded by rich kids or those who otherwise have a leg up on other folks. In SmallLaw, we get the people who came from nothing and are making their companies happen through sheer force of will, and it can be exciting to watch. Hopefully Regulation Crowdfunding will help companies realize their potential, and offer investors a return on their money to boot.
Gary J. Ross opened his own practice, Jackson Ross PLLC, in 2013 after several years in Biglaw and the federal government. Gary handles corporate and securities matters for startups, large and small businesses, private equity funds, and investors in each, and also has a number of non-profit clients. You can reach Gary by email at [email protected].