Advocacy Comment on SEC Crowdfunding Proposed Rule

8/13/2019 Advocacy Comment on SEC Crowdfunding Proposed Rule

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SIlffice of Advococy:-**:'g:9r-d:::::-Y] Advaca*y: ttis y*ise of small business n g,avernment

January 16.2014

VIA ELECTRONIC SUBMISSION

U.S. Securities nd Exchange CommissionAttn: Elizabeth M. Murphy, Secretary100 F Street, EWashington, DC 20549Electronic Address: ule-comments@sec. ov

Re: Crowdfunding. File Number 57-09-13

Dear Ms. Murphy:

The Office of Advocacy (Advocacy) offers the following comment o the Securities and Exchange,Commission SEC) n response o the above-referenced roposed ule issued on October 23,2013.' The SEC

issued he proposed ule to implement Title III of the JOBS Act', which established he foundation or aregulatoryitructure for startups and small businesses o raise capital through securities offerings using theIniernet hrough crowdfunding. On December 16,2013 and January 15,2014, Advocacy hosted smallbusiness oundtables o receive feedback rom small business epresentatives bout he proposed ule.

Advocacy also hosted several conference calls to hearnput from small business. Based upon this feedback

from small business stakeholders, Advocacy is concerned hat the Initial Regulatory Flexibility Analysis(IRFA) contained n the proposed ule lacks essential nformation required under the Regulatory FlexibilityAct (RFA)3. Specifically, the IRFA does not adequately describe he costs of the proposed ule on smallentities, and the IRFA does not set forth significant alternatives which accomplish he stated SEC objectivesand which minimize the significant economic mpact of the proposal on small entities. For this reason,Advocacy recommends hat the SEC republish for public comment a Supplemental RFA before proceedingwith this rulemaking. Advocacy also believes hat the SEC should ake into consideration small businessrepresentatives' suggested lternatives o minimize the proposed ule's potential impact.

Office of Advocacy

Advocacy was established pursuant o Pub. L. 94-305 o represent he views of small entities before federalagencies and Congress. Advocacy is an independent office within SBA, so the views expressed y Advocacydo not necessarily eflect the views of the SBA or the Administration. The RFA, as amended by the SmallBusiness Regulaiory Enforcement Fairness Act (SBREFA),4 gives small entities a voice in the rulemaking

http://www,sec.gov/rules/proposed/203/33-9470.pd1'.pub. L. No. 112-106, 26 stat.306 2012).5 u.s .c . g 6ol et seq.

a pub. L. 104-l7l, Title I, 110Stat. 57 1996) codified n various ectious f 5 U.S.C. 601 et seq.).


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process. For all rules that are expected o have a significant economic mpact on a substantial number ofsmall entities, federal agencies are required by the RFA to assess he impact of the proposed ule on smallbusiness and to consider ess burdensome alternatives.

The RFA requires agencies o give every appropriate consideration o comments provided by Advocacy. The

agency must include, in any explanation or discussion accompanying he final rule's publication in theFederal Register, he agency's response o these written comments submitted by Advocacy on the proposedrule, unless he agencylertifies that the public interest s not served by doing so.s

Background

On October 23,2013, the SEC ssued he proposed ule to prescribe equirements overning he offer andsale of securities hrough crowdfunding. The proposed ule would also provide a framework for theregulation of funding portals and brokers hat issuers engaged n crowdfunding are required o use.

After the SEC issued he proposed ule, Advocacy hosted wo small business oundtables and several

telephone conference calls to receive feedback on the proposal. Based on these meetings and phone calls,small businesses ocused on two areas of the proposed ule: (l) disclosure equirements and (2) intermediaryrequirements.

(l) Disclosure equirements

The proposed ule would set financial disclosure equirements or companies issuers ) that raise capitalthrough crowdfunding. If an ssuer's arget offering s $100,000 or less, he disclosure must nclude heincome tax retums filed by the business or the most recently completed year and financial statements f theissuer, which must be certified by the principal executive officer of the issuer business. f the target offeringamount s between $100,000 and $500,000, he ssuer must provide inancial statements eviewed by an

independent accountant.

If the target amount of the offering exceeds $500,000, he proposed ule would require the issuer o providetwo years of audited inancial statements when it files its initial offering materials with the intermediary andthe SEC. Although the JOBS Act does state hat issuers seeking o raise over $500,000 must provide auditedfinancial statements, ection 302(bxlxD)(iii) of the law also provides he SEC with authority to change heamount of the $500,000 hreshold by rulemaking.

Additionally, the proposed ule would also mandate nonfinancial disclosures not required by the JOBS Act.Section 227.201of the proposed ule sets orth l0 pages of different nonfinancial disclosures hat would berequired for issuers. The proposed ule would require issuers o disclose nformation such as: the name of

each person who owns 20 percent or more of issuer's oting power; a description of issuer's usiness ndissuer's anticipated business plan; the number of issuer's employees; he risk factors associated with theinvestment; he target offering amount and deadline o reach arget; whether nvestments n excess of thetargeted amount will be accepted, and if so, how oversubscriptions will be allocated; and he intended use ofthe proceeds.

5 u.s.c. g 6ol et seq.


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(2) Intermediar.v Requirements

The proposed ule would also set requirements elated o the intermediaries funding portals and brokerdealers that issuers aising money through crowdfi.urding would be required to use. The proposed ule

suggests hat both funding portals and broker dealers should be treated as issuers that could be heldpersonally iable for failing to meet the due diligence standard of the JOBS Act. Specifically, sectionII.A.5 of the proposal's preamble provides hat it appears ikely that intermediaries, ncluding fundingportals, would be considered ssuers or purposes of this liability provision. u It is noteworthy that the JOBSAct does not require this imposition of liability and the resulting due diligence.standard hat the proposed uleappears o mandate.

The proposed ule would also subject unding portals to certain additional constraints not applied to brokerdealers. The proposed ule provides that funding portals canno_t ngage n the practice of sorting ororganizing crowdfunded offerings based on subjective criteria.' However, the proposed ule would allowbroker dealers o engage n this practice of sorting known as curation.

The Proposed Rule's IRFA is Deficient

Because t does not adequately escribe he mpacts on small entities and because t does not discussalternatives hat might reduce hose mpacts, Advocaiy believes hat the IRFA contained n the proposed uleis deficient, and for this reason, he SEC should republish a Supplemental RFA for additional publiccomment before proceeding with this rulemaking. lJnder the RFA, an IRFA must contain: (1) a descriptionof the reasons why the regulatory action is being taken; (2) the objectives and legal basis or the proposedregulation; (3) a description and estimated number of regulated small entities; (4) a description and estimateof compliance requirements, ncluding any differential for different categories of small entities; (5)identification of duplication, overlap, and conflict with other rules and regulations; and (6) a description of

significant alternatives o the rule.o Advocacy is concerned hat because he proposed ule's IRFA isdeficient, the public has not been adequately nformed about he possible mpact of the proposed ule onsmall entities and whether there are significant alternatives o the proposed ule that would meet the SEC'sobjectives n a less costly manner.

The IRFA contained n the proposed ule does not adequately describe and estimate he costs he proposalwould impose on small entities. Additionally, the IRFA does not set forth significant alternatives whichaccomplish he stated SEC objectives and which minimize the significant economic mpact of the proposal onsmall entities. The IRFA only lists alternatives elated o exempting small business rom the proposedrequirements. However, the SEC states hat these alternatives do not accomplish he underlying goals of therulemaking. Therefore, hese are not alternatives br purposes of the RFA. Moreover, the IRFA does not

discuss alternatives hat may reduce he disproportjonate eionomic impact on small entities.Because he IRFA does not contain an adequate escription of alternatives, he IRFA does not comply withthe RFA requirement hat an IRFA provide significant alternatives hat accomplish an agency's objectives.

htto i/www. sec. ov/ru es/proposed/20 3/33 9470.pdf at 280.ld . a t233 .suscs6o : .


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Recommendations

Advocacy recommends hat the SEC revise ts IRFA to provide a description of the costs of the proposed uleand to include altematives which would accomplish ts objectives or the rulemaking. Small businessrepresentatives t Advocacy's roundtables have described wo areas of concern where a discussion of costs

and alternatives would helpprovide

the public with more adequate data o assess he impact of the proposedrule and potentially minimize the costs mposed by the proposed ule: (1) disclosure equirements and (2)intermediary requirements.

( I) Disclosure Requirements

Small business epresentatives nd owners expressed oncern o Advocacy thatthe proposed ule'sdisclosure equirements would impose high costs and burdens. In particular, small business stakeholders reconcemed about he potential costs associated with the proposal's audited inancial statements equirementfor issuers seeking o raise over $500,000 hrough a crowdfunded offering. Small business owners n contactwith Advocacy have observed hat this requirement would be problematic and burdensome because many ofthe issuers ooking to raise capital

through crowdfunding will be startups with little or no revenue o affordaudited inancial statements. Because he JOBS Act provides he SEC authority to change he threshold oraudited inancial statements, mall business epresentatives uggested hat the SEC should consideraltematives, such as raising the threshold amount, so that the proposal's audited inancial statementrequirement s less burdensome or small business.

Further, small business stakeholders expressed oncerns about he potential costs and burdens associatedwith the proposal's nonfinancial disclosures. However, the IRFA contained n the proposed ule provides noestimates of the costs hat disclosure equirements would impose.

Small business epresentatives t Advocacy's roundtables proposed alternatives o the nonfinancialdisclosure equirements hat may minimize costs.

One alternative o the proposed ule's nonfinancialdisclosures suggested y a small business owner is that the SEC could adopt a simple question and answerformat for nonfinancial disclosures similar to the format used n disclosures or Regulation A offerings. Thequestion and answer ormat would be less burdensome or small business ssuers while still providing theSEC with the information it is seeking under the proposed ule.

Another potential alternative suggested y a small business epresentative s that the SEC could developstandard, boilerplate disclosures or some of the more complicated nonfinancial disclosures, such as riskfactors. Permitting small business ssuers o use standard disclosures would serye as a less burdensomealternative hat still accomplishes he pulposes of this rulemaking. Because he proposed ule's nonfinancialdisclosures are not required by the JOBS Act, Advocacy encourages he SEC to develop alternatives hat wouldbe less burdensome or small business.

(2) Intermediary Requirements

As described above, he proposed ule appears o impose statutory ssuer iability on intermediaries. This ispotentially a large expense or intermediaries hat the IRFA does not estimate. For example, n order for anintermediary o avoid liability to a purchaser on the basis of an issuer's false or misleading offering materials,the intermediary would likely need o conduct an expensive and ime-consuming due diligence on the issuer's


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offering materials. This liability standard would be especially burdensome or funding portals because rokerdealers will already have these procedures n place under requirements set by the Financial IndustryRegulatory Authority (FINRA). Small business o\\mers and representatives ave suggested o Advocacy thatthe SEC should clariff that broker dealers and funding portals would not be subject o personal iability as anissuer.

In addition to personal iability being particularly costly for funding portals, he proposed ule would imposeanother cost on funding portals that the IRFA does not describe: he prohibition of funding portals to curateon the basis of subjective actors. The prohibition on curation s burdensome bdcause t would place fundingportals at a competitive disadvantage o broker dealers who may curate offerings under the proposal).Moreover, if funding portals are not permitted to screen ssuers on the basis of subjective actors, he fundingportals could potentially be exposed o greater isk of personal iability for the offers on the portal.

Small business owners and representatives ecommended o Advocacy an alternative o the proposed ule'srestriction on funding portals' ability to curate. These small businesses uggested hat the SEC create a safeharbor for funding portals to cwate on the basis of subjective actors hat do not engage n activities thatcould be treated as solicitations. Another suggested lternative would be for the SEC to permit fundingportals to curate on the basis of subjective actors so long as he portals disclosed o the public that itscuration does not constitute a recommendation egarding he advisability of any investment on the fundingportals. Both of these suggestions erve as alternatives hat may reduce he costs and burdens of the proposedrule that the SEC should consider.

Conclusion

Advocacy is concemed hat the SEC's proposed ule and IRFA lack essential nformation needed o properlyinform the agency's decision making. Specifically, the IRFA does not adequately describe he costs of theproposed ule on small entities, and the IRFA does not set forth significant altematives which accomplish hestated SEC objectives and which minimize the significant economic mpact of the proposal on small entities.For this reason, Advocacy recommends hat the SEC republish for public comment a Supplemental RFAbefore proceeding with this rulemaking.

By republishing a Supplemental RFA, small businesses will have more adequate data o assess he potentialimpact of the proposed ule. Further, he SEC will gain vaiuable nsight into the effects of the proposed uleon small business. Advocacy also believes hat the SEC should ake into consideration small businessrepresentatives' suggested lternatives hat may minimizethe proposed ule's potential impact.

Advocacy is committed to helping the SEC comply with the RFA in the development of the proposed ule.Therefore, Advocacy stands eady to assist he SEC n the completion of a Supplemental RFA.


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Advocacy looks forward to working with the SEC. If you have any questions or require additionalinformation please contact me or Assistant Chief Counsel Dillon Taylor at (202) 401-9787 or by email [email protected]. ov.

Sincerelv.

Winslow Sargeant, h.D.Chief Counsel or Advocacy

l, )7U {- \*--'

Dillon TaylorAssistant Chief Counsel Advocacy

Copy to: The Honorable Howard Shelanski, AdministratorOffice of Information and Regulatory AffairsOffice of Management and Budget

Documents

Advocacy Comment on SEC Crowdfunding Proposed Rule