Last week the Financial Services Committee of the U.S. House of Representatives voted on a bipartisan basis to send the Entrepreneur Access to Capital Act to the floor for a vote, and state securities regulators are warning that the bill could lead to rampant fraud if it were to pass.
Sponsored by Rep. Patrick McHenry, R-N.C., the bill H.R. 2930 would deregulate crowdfunding by removing basic federal and state registration filing requirements. Crowdfunding refers to online fundraising that started as a way for the public to donate small amounts of money to help advance a project or cause. The method is being used more and more by small businesses and start-ups as they look for investors.
This bill would limit the size of the crowdfunding deals to $5 million. Individual investments would be limited to a maximum of $10,000 per person, or 10 percent of the person’s annual income, whichever is smaller.
Small businesses and start-ups could to raise up to the $5 million limit from an unlimited number of investors if the bill were to pass. The measure is meant to stimulate the economy and promote job creation.
NASAA Believes It’s A Bad Idea
The North American Securities Administrators Association, or NASAA, has made it clear it thinks this is a bad idea because it would be so easy for unsophisticated investors to get sucked into fraudulent deals. On Oct. 21, NASAA sent a letter to certain members of congress, including Spencer Bachus, R-Ala., chair of the House Financial Services Committee, and Barney Frank, D-Mass., ranking member of the committee, expressing its grave concerns.
“By prohibiting state securities regulators from being notified and reviewing investment opportunities before they are offered to the public, this bill will weaken investor protection,” said the letter, signed by Jack E. Herstein, president of NASAA and assistant director of the Nebraska Department of Banking & Finance Bureau of Securities.
The letter said that while state securities administrators certainly want to promote small business capital formation and job-growth, they believe that any framework for this kind of fundraising must be carefully and deliberately constructed, because “the potential for fraud in this area is real and potentially enormous.”
In addition, the letter said NASAA believes the appropriate place for consideration of these issues is at the state level because crowdfunding, by its nature, centers on community investment, and state regulators have the most direct interest in protecting that community. The authority to review and police these investments must remain with the states, the letter said.
NASAA is taking steps to come up with an approach. On Oct. 18, the organization’s board of directors met in Washington, D.C., and voted to establish a special Small Business Capital Formation Committee to consider steps that might be taken by state securities regulators to facilitate and promote small business capital formation, including measures relating to crowdfunding.
Herstein said in the letter that in view of the Entrepreneur Access to Capital Act, he has asked the new committee to immediately address crowdfunding, including consideration of a model rule that state securities regulators may adopt “to responsibly encourage small business capital formation through crowdfunding in ways that directly protect both the businesses and the investors engaged in this segment of the market.”
The Small Business Capital Formation Committee was scheduled to hold its first meeting last week, and is expected to make recommendations to the NASAA board early next year regarding crowdfunding and other capital formation initiatives. The committee’s chair is A. Heath Abshure, Securities Commissioner for Arkansas, who also serves as chair of NASAA’s Corporation Finance Section.
Congress Should Refrain From Preempting State Law
NASAA has asked Congress to let it examine this issue. The letter stated NASAA’s firm belief that Congress should refrain from preempting state law. It called such preemption “a very serious step,” that should not be done without a thorough examination of all available alternatives.
State securities regulators are capable of developing a sound approach to crowdfunding, the letter said, adding that Congress should allow them to protect retail investors from the demonstrated risks associated with smaller, speculative investments.
At the time that the letter was sent, the Financial Services Committee had not voted on the bill. The letter asked the Committee to avoid “rash and premature action,” but the bill was passed out of committee a few days later. The House website does not show that it has been scheduled for a vote, but a report in Investment News said the bill was expected to go to the floor this week.
Investment News Report
The report in Investment News noted that crowdfunding could fall under a federal securities law exemption known as Regulation D, which governs private placements. As it stands, Regulation D does not allow public solicitation, and limits the amounts sold to non-accredited investors. There are no such limits regarding accredited investors, who are usually large institutions, or high-net worth, sophisticated individuals.
What has the state regulators nervous, according to Investment News, is that Regulation D offerings account for most of their enforcement cases, including a number of major fraud cases in the past few years.
For example, the Stanford Financial Group allegedly raised $7 billion by issuing fraudulent certificates of deposit through Regulation D. In addition, allegedly fraudulent private deals orchestrated by Medical Capital Holdings Inc. and Provident Asset Management LLC seem to have taken down a number of independent broker-dealers. Medical Capital sold $77 million in notes, and Provident issued $485 million of preferred stock and limited-partnership interests.
Before it passed out of committee, the Entrepreneur Access to Capital Act was amended to prohibit individuals convicted of securities fraud from using the crowdfunding exemption. The bill would also require issuers to file a notice of the offering with the Securities and Exchange Commission. This notice filing would available to state regulators.
Guiliano Law Firm
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