House Overwhelming Passes Legislation Allowing Crowdfunding and Lifting Regulation D General Solicitation Ban
The House of Representatives overwhelming passed two bi-partisan pieces of legislation designed to enhance capital formation. The Entrepreneurial Access to Capital Act, HR 2930, sponsored by Rep. Patrick McHenry (R-NC) would allow crowdfunding to finance new businesses by allowing companies to accept and pool donations of up to $1 million, or $2 million in some cases, without registering with the SEC. The legislation was approved by a vote of 407 to 17. In addition, The Access to Capital for Job Creators Act, HR 2940, was passed by a 413-11 vote to remove the general solicitation prohibition in SEC Rule 506 under Regulation D and allow small businesses to attract capital from accredited investors nationwide and globally. HR 2940 would remove the regulatory ban that prevents small, privately held companies from using advertisements to solicit investors.
Currently, the SEC regulation allows companies to raise capital as long as they do not market their securities through general solicitations or advertising. This prohibition has been interpreted to mean that potential investors must have an existing relationship with the company. In the view of Financial Services Committee Chairman Spencer Bachus (R-ALA), requiring potential investors to have an existing relationship with the company unnecessarily limits the pool of investors and severely restricts the ability of small companies to raise capital. HR 2940 would require the SEC to revise its rules to permit general solicitation in offerings under Rule 506 of Regulation D. The legislation mandates that the revised SEC rules allowing a general solicitation under Regulation D must require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors using methods determined by the Commission
HR 2940 is sponsored by Rep. Kevin McCarthy (R-CA), who said that restrictions on the manner in which capital may be raised stem from Depression-era regulations that are clearly outdated, they not only predate Twitter and Facebook, he said, but cell phones and color television. According to Rep. McCarthy, this specific regulatory obstacle, Rule 506 of Regulation D, is actively preventing job creation, which is why he introduced legislation to repeal what the lawmaker called “this burdensome solicitation prohibition.’’ In his view, the Access to Capital for Job Creators Act will help entrepreneurs and small business owners access the capital they need to be innovative, dynamic, and ultimately, help create jobs
Strong bi-partisan support was building for crowdfunding legislation and the President called for legislation on this form of capital raising. The legislation would allow companies to accept and pool donations of up to $1 million, or $2 million in some cases, without registering with the SEC. Crowdfunding describes a form of capital raising whereby groups of people pool money, typically comprised of very small individual contributions, to support an effort by others to accomplish a specific goal.
Under HR 2930 as reported to the House floor, the issuer of the securities must warn investors, including on the issuer’s website, of the speculative nature of investments in startups, emerging businesses, and small issuers, including risks in the secondary market related to illiquidity. Also, the issuer must require each potential investor to answer questions demonstrating competency in the recognition of the level of risk applicable to investments in startups, emerging businesses, and small issuers; the risk of illiquidity; and such other areas as the SEC may determine appropriate. The issuer must also maintain such books and records as the Commission determines appropriate.
The issuer must take reasonable measures to reduce the risk of fraud with respect to the transactions.
The issuer must provide the SEC with its physical address, website address, and the names of its principals and employees and keep such information up-to-date; as well as provide the Commission with continuous investor-level access to the issuer’s website. The issuer must also provide the Commission with basic notice of the offering, not later than the first day funds are solicited from potential investors, including the stated purpose and intended use of the capital formation funds sought by the issuer; and the target offering amount. In turn, the SEC must make this information available to state authorities
The issuer must state a target offering amount and withhold capital formation proceeds until the aggregate capital raised from investors other than the issuer is no less than 60 percent of the target offering amount. Moreover, the issuer must outsource cash-management functions to a qualified third party custodian, such as a traditional broker or dealer or insured depository institution;
The issuer’s website must offer a method of communication that permits the issuer and investors to communicate with one another. And, the issuer must disclose to potential investors, on the website, that the issuer has an interest in the issuance.
Originally, HR 2930 would have provided a crowdfunding exemption to SEC registration requirements for firms raising up to $5 million, with individual investments limited to $10,000 or 10 percent of an investor’s income. An amendment by Rep. Steve Stivers (R-OH), approved by voice vote, lowered the $5 million threshold to $1 million, or $2 million if you have audited financial statements.
The legislation is designed to provide smaller investors an opportunity to support startup companies that is currently not an option under SEC regulation. Rep. McHenry noted that new ideas are needed to help provide small businesses and entrepreneurs with the ability to create jobs. HR 2930 creates an exemption from SEC registration for crowdfunding. The legislation is similar to proposals advanced by the Obama Administration. Rep. Carolyn Maloney (D-NY) noted that the legislation, as amended, is consistent with the President’s proposal.
In a recent policy statement, the Obama Administration said it supports House passage of the Entrepreneurial Access to Capital Act, H.R. 2930. In the President’s September 8th Address to a Joint Session of Congress on jobs and the economy, he called for cutting away the red tape that prevents many rapidly growing startup companies from raising needed capital, including through a crowdfunding exemption from the requirement to register public securities offerings with the SEC. This proposal, which would enable greater flexibility in soliciting relatively small equity investments, grew out of the President’s Startup America initiative and has been endorsed by the President’s Council on Jobs and Competitiveness.
The policy statement notes that H.R. 2930 is broadly consistent with the President’s proposal. The legislation would make it easier for entrepreneurs to raise capital and create jobs. The Administration said that it looks forward to continuing to work with the Congress to craft legislation that facilitates capital formation and job growth and provides appropriate investor protections.