How to Wreck a Law: How the SEC Thwarted the Will of Congress and the President with Crowdfunding
Guest Blog: Sentinel Business Owner, Jonathan B. Wilson
In a rare moment of bipartisan unity, both sides of Congress came together in the passage of the 2012 Jumpstart our Business our Business Start-ups Act (JOBS Act). The JOBS Act was supposed to make it easier for startups to raise capital from investors through stock offerings conducted over the internet.
In the U.S., offers and sales of securities are governed by the Securities Act of 1933. The Securities Act requires that every offer and sale of securities either be registered, or exempt from registration. “Registered” securities are (generally speaking) those that have been registered with the SEC, usually through an initial public offering (IPO).
In contrast, most “exempt” securities transaction take place under the “private sale” provisions of the Securities Act, which permit a sale of securities “by an issuer not involving any public offering.” With the advent of the Internet, however, Congress wanted to make it possible for startups to offer their securities online, even though doing so would constitute a “public offering.”
Authored in large part by Congressman Patrick McHenry (R-NC) and co-sponsored by members of both parties, the JOBS Act passed Congress in March, 2012 with overwhelming bipartisan majorities.
In a signing ceremony at the White House on April 5, 2012, President Obama happily approved the law saying, “this bill is a potential game changer…For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”
Notwithstanding this clear direction from the Executive and Legislature, unelected bureaucrats in the Securities and Exchange Commission (SEC), took more than three years to implement the law, adopting regulations preventing the law from having its intended effect.
How Crowdfunding Was Supposed to Work
It was intended to be simple. Congress wanted to create jobs by amending 80 year-old securities laws to make it easier for small businesses to raise capital.
To change the law, Congress amended the Securities Act of 1933 through the 2012 JOBS Act by creating several new exemptions. The “crowdfund” provisions exempt a securities offering from registration if (1) the securities sold in one year are $1 million or less and the amount sold to any individual investor is below a specific threshold, (2) the offering is conducted through a broker or a funding portal that meets certain requirements, and (3) the issuer provided investors with specific disclosures about its business and the risks involved.
Because Congress wanted the new law quickly to reduce unemployment, Congress ordered the SEC to issue its regulations within 270 days after enactment of the law.
What the SEC Did
Quickly after passage of the JOBS Act the appointed SEC Chair Mary Schapiro made it clear that she disagreed with the fundamental premise of the bill – empower individuals to invest in startups. Schapiro feared that she would be “tagged with an anti-investor legacy” if she implemented the JOBS Act within the 270-day deadline specified by Congress in the law.
Left-leaning consumer-advocacy groups, like the Consumer Federation of America, corresponded with Schapiro privately, asserting that online investing would encourage fraud. The SEC followed the lead of left-leaning groups and began a lengthy public discussion process that delayed implementation of the law for more than three years.
The SEC ultimately created a system that was far more complicated and expensive than Congress intended. The SEC’s regulations require issuers:
- To disclose more information than was required by the law.
- To provide investors and the SEC with ongoing financial reports and disclosures that was not required by the law.
- To restrict their communications about their offerings to specific channels facilitated by licensed crowdfunding portals.
Through these regulations, what was supposed to be an easy-to-understand and easy-to-utilize process has become a highly-complicated procedure that few business persons can manage without professional help.
Even the question of how issuers may advertise and promote their offerings is heavily regulated. Startups routinely tout their progress and plans in order to attract business partners and investors. Before a startup begins a crowdfund offering, however, the SEC’s Final Rule prohibits the company from having “meetings with potential investors or giving out any information on forums which offer “sneak peeks”. The Final Rule prohibits “public announcements about the offering” and public discussions about “intentions to do a crowdfunding offering.”
The SEC’s regulations empower it to ban a company’s officers, directors and principal stockholders from using the crowdfunding rules, or other private exemptions, if they participate in an offering that violates the SEC’s rules. As a result, a violation not only imperils the startup’s offering but risks a corporate “death sentence” for those officers, directors and stockholders involved. What business person is going to risk his or her future career in order to raise no more than $1 million through crowdfunding?
Because the SEC’s regulations are so complex, small businesses cannot hope to engage in equity crowdfunding without lawyers to guide them through the process. By increasing the cost of compliance, the SEC made equity crowdfunding much less helpful to small business than Congress intended.
All of this demonstrates how the federal bureaucracy can, both intentionally and unintentionally, implement laws in ways that run contrary to the intentions of the elected politicians who are supposed to write the laws.
Jonathan B. Wilson is a partner in the Atlanta, Georgia law firm of Taylor English Duma where he advises business clients on corporate law, securities and mergers and acquisitions.