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Securities-Law Obstacles to Crowdfunding to Raise Business Capital

10.07.11

Crowdfunding as a method of raising capital for business ventures has received a fair amount of attention over the last year or so.  It has been advocated – in principle, at least – by a number of bloggers and internet commentators.  The obstacles to it posed by the securities-registration requirements of the federal Securities Act of 1933 and of the various state securities laws have been the subject of a number of blog posts or entries and even scholarly papers.  The Chairman of the Securities and Exchange Commission promised, in a letter to Representative Darrell Issa dated April 6, 2011, that the SEC staff would study and address crowdfunding as part of its review of the SEC’s capital-formation regulations. (On this point, also see the post “SEC Takes a Look at Capital Raising.”)

The SEC pursued two persons who proposed to raise $300 million by crowdfunding to acquire Pabst Brewing Company, and those persons agreed to a Cease and Desist Order by the SEC dated June 8, 2011 (PDF).  Last month, Representative Patrick McHenry introduced a bill, H.R. 2930, to amend the Securities Act to provide an exemption from registration for securities issuances of up to $5 million that involve individual investments of less than $10,000 or 10% of the investor’s annual income, whichever is less.  The bill would also provide for federal preemption of state laws requiring securities registration and for an exception to the requirement under the Securities Exchange Act of 1934 that an issuer register its securities held by 500 or more holders of record.

The bill is clearly the result of some thought about how the current federal and state securities laws make crowdfunding for business-capital raising impractical (or, without the required registrations, illegal).  For example, the bill reflects that a federal exemption from securities registration under the Securities Act alone would not be sufficient.  Like the SEC’s existing Rule 504 exemption, state securities laws would require registration of any crowdfunding effort that involved or constituted a public securities offering.

Without otherwise commenting on the bill, however, it appears that the amendments proposed by the bill would not be sufficient to really permit crowdfunding for business-capital-raising under the securities laws.  As Professor C. Steven Bradford has persuasively argued in his working paper, Crowdfunding and the Federal Securities Laws, it is likely that, under the SEC’s standards, if the existing websites that conduct crowdfunding were to do so for capital-raising purposes, those sites or their operators would be considered securities brokers or investment advisers under the federal securities laws.  If so characterized under federal securities laws, it is also likely that they would be considered securities brokers or investment advisers under various state securities laws.

OUR TAKE:  To enable crowdfunding as a method of raising capital for business ventures, legislation would need to address not only existing securities-registration requirements, but also existing federal and state laws and regulations governing securities intermediaries such as brokers and investment advisers.

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