SEC’s Regulation Crowdfunding: Benefit for Investors and Industry or Concern?
When the US SEC’s Regulation Crowdfunding rules went into effect in May 2016, a new world of crowdfunding options for the offer and sale of securities became a reality. Used for years as a funding mechanism through the internet for a range of projects, crowdfunding became an option for the sale of securities in October 2015 when the SEC adopted the new regulation. The new rules have triggered questions:
- What are the benefits of using crowdfunding as a funding option?
- What are the legal and compliance requirements?
- What is the best way to offer the sale of securities through the use of a funding portal?
- What is the potential impact on existing investor protections?
Considering the Questions
These questions and more were considered at a recent conference on Crowdfunding and Data Standards, sponsored by CFA Institute and Baruch College Zicklin School of Business. One panel discussed the implications of Regulation Crowdfunding and highlighted aspects of the regulation that make crowdfunding an attractive funding option for businesses as well as the steps intermediaries must take to create a funding portal through which securities can be offered and sold.
Kendall Americo, CEO of Bankroll Ventures and a leading expert in the legal particulars of crowdfunding, noted that the 2008 financial crisis, which led to banks being reluctant to lend, sparked companies’ interest in exploring alternative ways to raise money and ultimately gave rise to crowdfunding. He offered a “cardinal rule” for those considering funding through crowdfunding: Have 30% of the money of the target offering secured before starting the process, to indicate to potential investors that the venture already has support.
Americo also noted that crowdfunding success often benefits from three key attributes:
- Passion for the product and creating a culture that reflects that
- Smart share pricing
- Creative marketing
Finally, Americo added that when considering funding options, those interested in crowdfunding need to consider the costs and benefits of using that alternative approach. Regulation Crowdfunding, which covers the offer and sale of securities, is relatively inexpensive to use because it has few reporting requirements, but its marketing options are limited to tombstone-like ads. In contrast, Regulation A+ allows for a much broader marketing campaign and audience, but it is more costly and requires more reporting.
Sandra Clarke from the Financial Industry Regulatory Association (FINRA) Membership Application Program, led the audience through the particulars of creating a funding portal, starting with first filing an application with the SEC and then weaving through FINRA’s 60-day review and decision process. As of June 2016, 48 applications had been filed with SEC, with 11 having made their way through FINRA’s portal approval process.
What CFA Institute Thinks about Crowdfunding
CFA Institute has been following crowdfunding since the US Congress first passed the Jumpstart Our Business Startups (JOBS) Act in 2012 and charged the SEC with creating regulations to implement the mandates. Throughout this process, we have advocated an approach that carefully balances investor safeguards against capital formation incentives. Although supporting many aspects of Regulation Crowdfunding, we have expressed concerns about whether it would sacrifice important investor protections that require issuers to provide more details in registered securities offerings. For example, one concern is that investors will not receive the full range of information needed to assess an offering and understand the risks, including the risk of losing their entire investment.
To curtail potential fraud on the part of the intermediary, we also have supported such measures as giving investors the unconditional right to cancel an investment commitment within 48 hours after an offering closes and excluding issuers that do not have a business plan from the ability to use crowdfunding platforms. There are a host of other concerns about crowdfunding, including the lack of a liquid secondary market given restrictions on selling shares, especially during the first year; the lack of transparency because of insufficient information at the start of the offering; the extent to which issuers’ businesses may be affected by market risk; and the confusion that may result among investors if an issuer promotes simultaneous offerings unrelated to a crowdfunding offering.
During the conference, Americo rejected concerns about widespread potential for fraud in securities crowdfunding offerings, citing the very public nature of identifying information about the issuer. What will calm those who remain cautious about the use of securities crowdfunding? Perhaps the answer will come in three years when the SEC staff must report on the effects of crowdfunding on capital formation and investor protection.
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You may also want to check out the recommendations by the Financial Economists Roundtable, a group of distinguished senior financial economists, that recently reviewed current issues and future developments in the crowdfunding market and offered suggestions regarding the regulation of the industry. Their statement is published in the current issue of the Financial Analysts Journal: http://cfa.is/1UouveJ