Rules on crowdfunding and on how to verify what makes an accredited investor by the Jumpstart Our Business Startups (JOBS) Act, to be written by the Securities and Exchange Commission (SEC), were the focus of a House hearing on Thursday.
At the joint hearing held by the House Financial Services Capital Markets Subcommittee and the Subcommittee on TARP and Financial Services Bailouts, Rep. Scott Garrett, R-N.J. (left), chairman of the Capital Markets Subcommittee, said that he was “dismayed” with the SEC’s recent decision to seek public comment on its proposal on private-offering promotion under the JOBS Act.
“After missing its initial 60-day requirement for the implementation of the General Solicitation part of the bill,” the SEC “again delayed implementation” of that segment of the agency’s Rule 506 “even after the staff had proposed moving forward with an interim final rule,” Garrett said. “This type of delay on what is a very simple and straightforward requirement from Congress is completely unacceptable.”
But Rep. Maxine Waters, D-Calif., asked those testifying on the panel if SEC Chairwoman Mary Schapiro’s decision to seek a 30-day comment period on the proposal was a good idea, arguing that the SEC rulemaking process allows for a comment period.
Robert Thompson, professor at Georgetown University Law Center, agreed that it was the correct move, and responded that “by not seeking public comment, the SEC was increasing the risk of litigation.” The SEC, he said, “has to worry about if this rulemaking will stand up to litigation.”
After repeated complaints, SEC Chairwoman Mary Schapiro decided to back away from issuing the rule and instead put the rule out for public comment. The agency was barraged with complaints from groups like the North American Securities Administrators Association (NASAA) and Americans for Financial Reform (AFR) for circumventing its traditional practice of putting rules out for comment before issuing them.
In putting Rule 506 out for comment, Schaprio explained that the rule “is one of the exemptions that has been widely used by U.S. and foreign issuers to raise capital without registering their securities offerings.” In 2011, she said, “the estimated amount of capital raised in these types of exempt offerings was just over $1 trillion, which is comparable to the amount of capital raised in registered offerings during this same period.”
When the commission adopted Rule 506 more than three decades ago, the agency said, “the issuer, or any person acting on its behalf, could use the exemption only if they were not offering or selling securities through general solicitation or general advertising,” Schapiro explained.
The JOBS Act, however, directs the SEC “to lift this prohibition as well as a similar prohibition contained in Rule 144A of the Securities Act,” she said, and with respect to Rule 506 offerings, the Act “directs the Commission to permit such general solicitation, provided that all purchasers of the securities are accredited investors.”
The JOBS Act further says that the SEC’s rule “shall require the issuer to take reasonable steps to verify” an investor’s accredited status, using such methods as determined by the agency. The Hedge Fund Association (HFA) told the SEC in a Sept. 13 comment letter that the agency must “specifically tell private fund managers what they will need to do to safely verify whether investors are accredited, should they want to advertise” after the JOBS Act rules are finalized.
Richard Heller, chairman of the HFA’s Regulatory and Government Advisory Board and author of the letter, said that “the SEC’s pragmatism is notable in its ‘reasonable steps’ standard, but managers need to know that what they are doing is legal before they will take advantage of new opportunities given by this law.”
The HFA suggested that the SEC define a “safe harbor,” or a provision within the regulation which will eliminate managers’ liability under the law in connection with verifying investor accreditation should they perform those activities within certain defined standards. Ideally, says the group, “in order to comply it should be sufficient for an asset manager to receive a signed subscription agreement from an investor in which that person unequivocally affirms that he or she is an accredited investor.”
Since the JOBS Act took effect, Matt Kitzi, Missouri Securities Commissioner and chair of NASAA’s Enforcement Section, said that “the number of entities pitching themselves as crowdfunding vehicles online has risen dramatically—from a couple hundred to about 1,700.” However, he noted, “none of the domain name holders can do anything until rules are written” regarding crowdfunding. That’s what the Securities and Exchange Commission (SEC) is grappling with now. NASAA expects such rules to come next year.
Jeffrey Van Winkle, a partner at Clark Hill PLC, speaking on behalf of the National Small Business Association, told lawmakers that the passage of the JOBS Act “demonstrates a broad bipartisan understanding that existing securities laws pose an unreasonable burden on the ability of small firms to access the capital markets, harming economic growth and job creation.”
He said the National Small Business Administration is “deeply concerned that either the SEC or FINRA or both will impose such a high regulatory burden on issuers and crowdfunding portals that important aspects of the JOBS Act may become a dead letter.” This, he continued, “would frustrate the intent of Congress and the president. It would have a severely adverse impact on the ability of small firms to raise the capital necessary to create jobs and to play a major role in improving the U.S. economy.”
Moreover, he argued, “there are important indications that the SEC and FINRA are moving too slowly to implement the JOBS Act.”