The JOBS Act’s crowdfunding provisions were once one of the most eagerly anticipated items contained in that Act. Many companies and their advisors had high hopes that these crowdfunding provisions would open up new arenas for financing smaller companies while easing the costs and challenges associated with securities regulatory compliance. These hopes and dreams have been substantially curtailed as the SEC’s proposed crowdfunding rules (issued in 2013) did not provide the anticipated relief. The SEC received a significant number of comments on these proposed crowdfunding rules, and these comments were predominantly critical due to the perceived regulatory and cost burdens that the proposed Rules seemed to contain.
Hope springs eternal, however, and many people are still eagerly awaiting the SEC’s final crowdfunding regulations to determine if the SEC will adopt a more reasonable position that may be useful to small companies seeking financing. The Federal crowdfunding exemption from registration will not be effective until the SEC issues these final regulations. Many people just want to know what they are actually dealing with here and whether crowdfunding will offer any viable opportunities for small company financing. Somewhat surprisingly given the significant amount of attention and publicity that crowdfunding has generated, the SEC still has not issued those final regulations despite the JOBS Act’s deadline. This situation has caused a significant amount of frustration in the corporate finance community.
Given the uncertainty regarding the status of Federal crowdfunding regulation, some states have seen an opportunity and have taken somewhat bold steps in establishing crowdfunding exemptions on the state level. The states moving ahead of the SEC is somewhat unusual, but it appears that the initial impact of these state crowdfunding initiatives may be economically beneficial to these states.
The predominant model for these state crowdfunding structures is the creation of an intrastate crowdfunding exemption from registration. The states have been very creative in their efforts, as they appear to have used the strong desire for a useful crowdfunding regulatory structure to create state structures that will help to provide economic growth in the states. This is also very compatible with the nature of crowdfunding – since many crowdfunding projects are smaller and localized, they may not be affected by being required to be contained in any one state.
The participating states have mainly modeled their crowdfunding regulations to be compatible and consistent with anticipated Federal crowdfunding regulations. This was necessary since the states cannot override or ignore the SEC when it finally issues its crowdfunding regulations. Most of these state regulations appear to be designed to work in harmony with the longstanding Federal intrastate provisions, Section 3(a)(11) of the Securities Act and the associated Rule 147 (which facilitates and clarifies compliance requirements under Section 3(a)(11)). The intrastate offering exemption has been of limited utility to issuers, but it may offer some real benefits when used in conjunction with these state crowdfunding initiatives.
Some of these states have taken an aggressive position by reducing some of the restrictive provisions contained in the proposed Federal regulations. These provisions, such as the requirement of audited financial statements in some situations and the use of a “funding portal”, are among the most unpopular provisions of the proposed Federal regulations, and some of the state regulatory schemes have removed these requirements. Some state regulations also increase the $1 million cap on exempt crowdfunding transactions. In some cases this increase may be substantial.
States that have enacted their own crowdfunding regulatory structures include Alabama, Georgia, Indiana, Kansas, Michigan, Washington, and Wisconsin. Other states, including Florida and Texas, have pending legislative or other action in play that could lead to a state crowdfunding exemption. Many of these states have kept the $1 million offering limit consistent with the proposed Federal regulations, but some states raise this limit if the issuer has audited financial statements. The proposed regulations in New Jersey take a very aggressive position on this offering limit – the limit is set at $1 million, but that amount does not include any funds provided by accredited investors. You can find some helpful metrics and charts on the various state crowdfunding exemptions in Alixe Cormick’s recent blog post.
One concern in this context is whether the an issuer’s website or social media usage or the use of a third party portal would invalidate a state exemption because these items would make information about an offering available to residents of other states and thus violate the required intrastate nature of these offerings. The status of these issues is far from clear, but the SEC did offer some guidance in an April 21, 2014 Compliance and Disclosure Interpretation. Questions 141.04 and 141.05 of that CD&I may be helpful here. The use of separate web pages, disclaimers, and other procedures as discussed in those Questions may be useful to issuers although they will likely not provide complete comfort.
I applaud these states both for recognizing an economic opportunity and for taking the initiative. It is too early to determine how much, if any, significant positive economic impact will result from these state crowdfunding structures. These crowdfunding offerings will generally be small and will not produce substantial economic advantages unless issuers generate a high volume of offerings, but any measures that give small companies another potential financing alternative are positive. The states’ actions might also influence the SEC as it works toward the final Federal crowdfunding regulations.
The SEC could still take steps that would reduce or eliminate the positive effects of these state programs, and in any case these state regulatory structures will need to be consistent with whatever Federal regulatory requirements are finally imposed. At a minimum, however, these programs may reward the progressive and forward-looking states which had to foresight to adopt them with some positive economic effects by fostering the growth of small companies.