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Former SEC Member Questions Viability of JOBS Act Crowdfunding

Tuesday, July 2, 2013
By Yin Wilczek

The Securities and Exchange Commission, in trying to create a regulatory framework for equity crowdfunding, should “go out there and talk to small local businesses” about how to make the rules work, a former member suggested June 26.

Roel Campos, a Washington-based partner at Locke Lord LLP who served as SEC commissioner from 2002 to 2007, noted that although equity crowdfunding has great potential, “how to make it work in a safe way is really key.” An early scandal would “put a damper” on the activity, he told a small-business gathering.

Campos also said he had concerns about the “utility” of crowdfunding under the Jumpstart Our Business Startups Act. Given the small amounts of funds that can be raised under the statute, the regulatory hoops that crowdfunding portals must jump through, and their potential exposure to liability, “I can't for the life of me see why anyone would want to do it,” he said.

'Serious Doubts.'
It remains to be seen whether the SEC's rules will allow for a business model in which portals can make money and build liability protection, Campos continued. Another problem, he added, is that crowdfunding issuers must deal with multiple shareholders, who must be bought out if the issuers want to grow their businesses. At this point, “I have serious doubts” that crowdfunding can take off, he said.

Campos spoke at a crowdfunding panel organized by the Minority Business RoundTable.

Title III of the JOBS Act directed the SEC to develop a new regime for equity crowdfunding. The offer and sale of crowdfunded securities must be conducted through broker-dealers or new entities known as funding portals. The capital formation statute further directed that such intermediaries must register with, and be subject to examinations by, the SEC and the Financial Industry Regulatory Authority. Issuers may raise only $1 million in any given year through crowdfunding, while the amounts that investors may invest are subject to income or net worth limitations.

Equity crowdfunding is not legal until the SEC adopts final rules under Title III. The SEC has not yet issued a proposal on the requirements.

Business Categories
SEC officials at the panel told the audience that they are aware of concerns over the future of equity crowdfunding. Gerald Laporte, chief of the SEC Division of Corporation Finance's Office of Small Business Policy, suggested that “there may be categories of businesses” for which equity crowdfunding has more potential, such as businesses “that need a customer base.”

For example, crowdfunding investors could be tapped by chefs to fund new restaurants or by people who want to set up medical clinics in rural areas, Laporte said. Individuals who are fans of the chef, or who want a clinic in their vicinity could invest in the crowdfunded securities, then guarantee the success of the ventures by visiting the new restaurant or clinic, he said.

Leila Bham, special counsel in the SEC's Division of Trading and Markets, also said the division is working on a “streamlined” approach for crowdfunding broker-dealers and funding portals. The SEC is trying to write the rules in a way that will make crowdfunding a success, she said.

Bham further urged the audience to weigh in on the rulemaking, noting that “we haven't heard enough from the small businesses that may want to use this” for their funding needs.

The SEC officials said they spoke their own opinions, which did not necessarily reflect those of the commission or other staff members.

In another suggestion to increase the likelihood of success, Campos said “an interesting approach” might be to allow nonprofit organizations to run funding portals “as a service rather than” moneymaking propositions.

Crowdfunding advocate Sherwood Neiss, co-founder of Crowdfunding Capital Advisors, said he agreed with some of Campos's observations. Equity crowdfunding in the United States could fail “if we do not develop a transparent marketplace,” he said. Neiss also agreed that crowdfunding portals do not “make much sense.”

However, Neiss predicted that crowdfunding will be a game changer because “it levels the playing field” by addressing the funding gap experienced by small businesses, and by opening up investment opportunities for retail investors. Equity crowdfunding will be a $5 billion enterprise in the United States in a matter of years, Neiss suggested. Intermediaries that can get in early on the business will be earning big commissions going forward, he said.

Neiss also noted that the activity has global reach, and the whole world is watching the SEC's development of the rules. “The world looks at this as a solution” for their funding needs as well. Neiss added that “everyone realizes that there is no one panacea,” and that crowdfunding will be but part of a “continuum” of funding.

Members of the audience similarly voiced strong support for crowdfunding, with one suggesting that the “entrepreneurial energy” to solve problems often is underestimated. He also urged the SEC to set up a whistleblower website to allow the crowdfunding industry to report problems or potential fraud as soon as possible. “A lot of us care deeply about making this work,” he said. “We're hoping that the $1 million cap can go up, and we know this means that things must work from the get go.”

Laporte, among other questions, was asked whether the SEC's rules will protect issuers. The SEC official responded that Title III says nothing about issuer protection. However, he added that once the commission adopts final rules and crowdfunding gets going, the SEC will start an educational campaign to educate small businesses on how they can take advantage of the new regime.

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