Instant Gratification: InvestReady Provides Service to Verify Accredited Investor Status in Minutes

In the US, crowdfunding under Reg D (506c) requires proof that the investor is “accredited.” To be accredited, an individual must earn over $200,000 a year or have a net worth of $1 million or more (minus their primary residence). While the rule is widely recognized as being outdated (money≠sophisticated) it remains a requirement for participation in Reg D private placements. All crowdfunding platforms that provide Reg D offerings must comply with the rule. And not just once but repeatedly.

InvestReady, a Fintech firm that provides compliance services for both issuers and investors in the private equity market, has just announced a live beta of its “InvestReady Instant Income” service. This new service enables qualifying investors to be verified as accredited within minutes. InvestReady accomplishes this task via an “exclusive” arrangement with Verix and their tax return API.

Verix’s API allows users to confirm their identity and authorize their IRS tax transcript data to be provided directly to InvestReady, typically within 30 seconds or less. This data is then used to determine the user’s qualifications instantly, allowing for near real-time evaluations and approval of accredited status.

Adrian E. Alvarez, CEO and co-founder of InvestReady, says the ability to complete this task within seconds is a “huge leap” that will open the doors for more issuers using Reg D (506c). And he is correct. Due to the laborious nature of investor verification, many crowdfunding platforms seek to avoid Reg D (506c) and use its sister exemption that requires no verification. But these same platforms lose out on the ability to promote offerings publicly online.

“Our Partnership with InvestReady is a great step forward in our mission to build the future of financial identity verification. Verix offers effectively 100% VOI coverage in the US, real-time data, and deep detail across all income types (W-2, 1099, K-1, and more). InvestReady’s focus on building the best technology offering in their industry fits perfectly with our long term goals and we’re very excited to help power their instant income service,” explains Ben Prawdzik, CEO and co-founder of Verix.

As part of the roll-out, InvestReady is offering a promotion in time for CIS – taking place later this month in Los Angeles.

Many of InvestReady’s existing clients, which include Mercedes-Benz Financial Services, Securitize, KoreConX, LendingHome, AlphaFlow, CrowdEngine, Vertalo, and PrimeTrust, are said to be planning to use the new service.

Chad Bowles, Manager of Demand Notes and Lockbox, Mercedes-Benz Financial Services, said they can now simplify a currently laborious and time-consuming process.

“The new InvestReady Instant Income service will be an impactful upgrade to the investment process, and one that aligns perfectly with the goal of digital securities because the experience will now be significantly better for both investors and issuers,”  commented Jorge Serna, VP of Product Strategy at Securitize.

Jim Borzilleri, President of CrowdEngine, said:

“Instant Income verification is something that could benefit all our issuers and portals, this is a big step ahead for automating investor accreditation verification.”

Alvarez and his team will be handing out free investor accreditations and demoing the instant income service at CIS next week.

Quote: Private capital raising is now outpacing capital raising in our public markets, yet our Main Street investors have no effective access to investments in private capital offerings

In the US, the definition of an “Accredited Investor” is an individual who earns over $200,000 a year or has $1 million in net assets minus their primary residence. If you are married, that number moves higher. Yet, as it stands today, this definition does not take into consideration knowledge or investment acumen – a far better determinant as to whether, or not, an investment is appropriate for the individual in question.

While it should be clear to anyone with an iota of common sense that the current wealth metric is a ham-fisted approach to providing an element of investors protection (akin to being able to shoulder a significant loss), this definition has disenfranchised millions of individuals with the capacity to make their own investment decisions without the invisible hand of the federal government telling them no.

To quote a high profile regulator:

“Private capital raising is now outpacing capital raising in our public markets, yet our Main Street investors have no effective access to investments in private capital offerings.”

The importance of this quote is apparent when viewed by who actually made this statement: SEC Chairman Jay Clayton during the annual Small Business Capital Formation Advisory Committee Meeting which took place in Omaha, Nebraska last week.

Many years ago, promising early-stage firms would “go public” to raise growth capital far earlier in their business odyssey.

Apple (NASDAQ:AAPL) (then called Apple Computer) completed an initial public offering (IPO) on December 12, 1980, selling 46 million shares at $22 a pop. If you had purchased 10 shares in 1980, after various stock splits, you would have 560 shares today at a valuation of about $118,000. Not a bad return. Now, shares in Apple did not rise immediately, as the value of the firm ebbed and flowed following the years after its IPO. But the fact remains, smaller investors had a chance and choice to back a promising young firm that today represents one of the most valuable companies in the world.

If you contrast the current IPO market to the days of lore, public offerings have morphed into more of an exit opportunity instead of an entry point as the smart money (mainly VCs) seek the ultimate liquidity event. Today, there is an ocean of private capital willing to fund promising early-stage firms prior to an IPO – jumping ahead of the investment queue. So why on earth would any hot company endure the regulatory requirements and antiquated reporting demands that cost millions of dollars to do? They don’t. The loser in all of this is the smaller investor cut out from the equation of wealth creation. Either by ignorance or intent, the government mandarins have punished smaller investors in an incalculable manner.

The Accredited Investor definition does not only punish savvy investors from participating in the next big thing it also blocks individuals from participating in lower-risk asset classes such as real estate or secured loans.

The advent of online capital formation, facilitated by changes in the securities law (JOBS Act of 2012), has engendered a plethora of securities crowdfunding platforms removing friction from the investment process. Twenty years ago, it took a lot of effort to invest in real estate unless you were big money. Today, you can purchase a highly diversified portfolio of asset-backed properties generating solid returns. With a single exception, you must be deemed an accredited investor and thus mainstream America is boxed out once again.

Brew Johnson, co-founder of PeerStreet – real estate investment site, recently had this to say:

“… our goal of bringing democracy to real estate investing is, so far, only partially realized. Government regulations today are not inclusive for small individual investors. The accredited investor definition effectively categorizes the vast majority of American citizens as less than equal, shut out from many investment opportunities, including platforms like ours.”

Johnson adds:

“The resulting regulations contribute to further widening the gap between the wealthy and the middle class, as well as create illogical distortions between investment products.”

By now, it should be obvious the current definition is broken and must be changed without delay.

Currently, the SEC is pursuing a regulatory harmonization review and has published a concept release on existing securities law. One of the topics is the definition of an accredited investor. In reflecting upon Chair Clayton’s statement above, and in speaking to various insiders, it appears that the Commission is inclined to address the glaring shortcoming in the definition of an Accredited Investor. This publication says it is about time and we hope they move forward at the Commission level.

We highly recommend individuals interested in democratizing access to opportunity to comment on the SEC’s concept release. You may do so here.

Whether the definition is changed to incorporate a sophistication qualification, or eliminated in its entirety, its time for the old rule to go. Let’s hope the SEC acts independently of any looming legislation and rights this nagging wrong.

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While the Uber IPO May have Stumbled, Early Investors Still Killed it

Early stage investing is a very risky endeavor yet this is where most of the big money is made.

Today, an initial public offering (IPO) is too frequently more of an exit opportunity than a chance to generate wealth as companies wait as long as possible to pursue an IPO due to the excessive cost of becoming a “reporting” company. It was not always like that but policy mandarins have been hesitant to directly address the problem. Their rule upon regulation neglect has become a tax upon the less fortunate among us.

A good example is Uber (NASDAQ:UBER). While the Uber IPO is being viewed as a bit of a flail, as the share price immediately tanked far below the IPO price, early investors still made a killing. This means if you were fortunate enough to back Uber back in the day when it was listed on AngelList in 2010, there is a good chance you experience dramatic capital gains.

A recent tweet by Alon Goren of Goren Holm Ventures helped to bring this into perspective:

That’s right. If you had been willing to back young Uber for $50,000 you would now value those same shares at $250 million (if Alon’s math is right).

Policymakers need to make access to the masses to promising ventures like Uber a priority. Not just something only the very wealthy can access. The first stop is the broken and punitive definition of an accredited investor which has disenfranchised most of the nation for decades. Let’s start with this and go from there.

Diminishing IPOs in US Depriving Average Investors

The President of the Chartered Financial Analyst Institute, Paul Smith, has taken to the media to call out shrinking IPO markets in the US and call for the restoration of fair and secure investment opportunities for retirement savers.

Smith points at “alarming changes” in US capital markets.

According to Smith, since peaking at 700 in 1996, only 100 IPOs were offered to average investors last year in the US, and total public companies available for trading by retail investors have gone from 7300 to 3600 in the same period:

“For average investors, this decline brings profound long-term consequences. Main Street investors generally are not able to invest in private markets; they lack access to companies when they might be expanding at their fastest pace.”

The trend has been accompanied by the increasing privatization of investment returns as accredited investors and VCs collect value from companies before the public can:

“Today, in the U.S. and across Europe, the big game-changing ideas are often funded privately. Many new ventures aspire to an IPO not as a start, but as the end point of their fortunes. And some never make it to the public markets, choosing to be acquired.”

Companies themselves are not necessarily being deprived of capital, says Smith:

“Private companies have not suffered, however. The private capital markets now provide more than enough capital to fund business models, particularly those in this capital-light era where companies do not require massive amounts of financing to grow and mature.”

…but retail investors are being left with dregs:

“Due to this trend, existing listed markets have become more exposed to older industries, slower-growing companies and short-termism driven by the steady beat of quarterly earnings expectations.”

The CFA makes three recommendations.

First, regulators should maintain high investor-protection standards and should not heed the siren call of deregulating risky instruments:

“We do not see public disclosure requirements as an impediment to going public, and we certainly would not encourage lowering investor protections by ‘innovations’ such as dual-class shares that disempower investors. In short, we see no obvious regulatory solution to make the public markets more attractive without damaging investor protections and market integrity.”

Second, the CFA points out that the opening of reasonable-growth investments to Main Street is a matter of urgency given the fact that retirement savers in the US are increasingly being “forced” to manage their retirement savings as benefit plans shift from “Defined Benefit CDB) to Defined Contribution (DC) plans.”

According to Smith:

“DC plans could become a professional intermediary for access to private markets. Having increasingly large parts of the capital markets off limits for retirement savers clearly disadvantages them; this must be addressed. A framework does need to be built, however, to protect investors in private markets, where disclosure standards remain low. This should be the topic of conversation between regulators and the industry: How do we build a regulated pathway for retail clients into private deals?

Third, Smith warns that private equity markets bear risks:

“Regulators should take precautionary steps to examine the systemic implications of growing private markets. Private markets, by their nature, lack the transparency of public markets and are certainly not liquid. This brings profound challenges and unseen risks.”

Smith ends by warning readers not to be “lulled” by the advent of high profile “recent S-1 filings by Lyft and Uber, declaring their intention to go public in 2019,” chicken feed which could just end up fueling heat in pre-IPO markets further:

“Should those firms go the IPO route, the listings will dominate the headlines and lull people into marking the return of public listings. Additionally, other firms may find it easier to get adequate private financing — which Main Street investors don’t have access to.”

Word on the street is that tech IPOs, in particular, have become an exit strategy for founders or acquirers seeking to dump companies on the public after they have already been milked for most of their value.

This spells trouble for future retirees, whose public pensions are also being strained:

“Unless the inequitable lack of access to private markets is addressed, retirement savers will continue to be deprived of the ability to participate in high-growth business models and further promote the sense that markets are being operated for the benefit of well-connected ‘insiders.'”

At the end of November, Securities and Exchange Commission (SEC) Chairperson Jay Clayton said he is aware of and concerned about diminishing IPO opportunities in the US:

“(T)he numbers don’t lie. We’ve gone from…8400 publicly traded companies to just over 4000. The size of companies entering the markets is much larger…(There are) multiple contributing factors to this…(that) need to look at…”

He added, “You probably shouldn’t regulate (small companies) the way you regulate top companies…” and said that public companies lose advantage when management has to spend too much time on compliance rather than growth.

Clayton said he is working on how to “streamline and reduce” the regulatory burden to companies wanting to go public while maintaining investor protections, but also insisted:

“Our securities laws have been so effective that they have grown this economy.”

He said he did not regard ICO’s as a reasonable solution to the problem, adding that he considers many of them to be in violation of US securities laws.

SEC Looks to Address “Patchwork” of Private Offering Exemptions, Staff to Comment on Accredited Investor Definition

During the 37th annual Government-Business Forum on Small Business Capital Formation, Securities and Exchange Commission (SEC) Chair Jay Clayton opened the event with a couple of interesting statements.

Clayton commented on the byzantine ecosystem that has emerged, over many decades of legislation and rulemaking, for issuers looking to raise capital in private offerings.

While perhaps routine for costly securities attorneys, the alphabet soup of regulatory code creates a jumble of legal speak that might as well be hieroglyphics for a regular person. Nuances are profound and, at times, contradictory.

This current Commission may be doing something about the statutory mishmash.

Clayton stated:

“For exempt offerings, we will be exploring the private offering framework. Our “patchwork” private offering system is complex and it is time to take a critical look to see how it can be improved, harmonized and streamlined.”

If he and his team can get it done, depending on the details, this could be a quite an accomplishment. Simplifying rules should always be a goal but simple does not mean easy. Let’s see what comes out of this initiative as it may dramatically impact online capital formation.

As for the other interesting topic of discussion, once again the definition of an accredited investor is on the docket.

Both the SEC and Congress have been discussing this for years. In fact, there currently exists a bill on Capitol Hill that may fix the current wrong.

The current definition is based on a wealth metric (individually $200k in annual income or $1 million net worth not counting your house). But students of common sense understand that a bank balance is not necessarily a measure of acumen. Most rational folks would like to see a sophistication qualification for individuals interested in investing in private opportunities.

Clayton said the SEC staff is working on a concept release to solicit input about key topics such as the accredited investor definition. The goal is to determine if the definition is “appropriately tailored to address both investment opportunity and investor protection concerns.” I think we already know the answer to that.

Let’s see what the SEC staff produces.

Paper: Two Bills in Congress May Fix the Profoundly Flawed Definition of Accredited Investor, but One Bill is Better

The current definition of an accredited investor is profoundly flawed and a travesty of rule making. Everyone knows it.

As it stands today, an accredited investors must earn at least $200,000 (jointly $300,000) or have a net worth of $1 million beyond a primary residence. What the definition does not do is accommodate the millions of people who are sophisticated individuals that have the capacity to make investment decisions on their own without the hand of the government telling them what to invest in. This harmful regulation has disenfranchised millions of people while helping to further enrich the already wealthy.

According to a recent paper by David R. Burton of the Heritage Foundation,

“Making a registered offering (often called going public) is a very expensive proposition and well beyond the means of most small and start-up companies. In addition, the costs of complying with continuing disclosure and other obligations of being a registered, public company are quite high. The securities Act, however, exempts various securities and transactions from this requirement. the exemption of the greatest importance to entrepreneurs is the exemption for private offerings.”

Thus, the exemption of choice for promising early stage firms seeking growth capital is Regulation D, a private placement exemption adopted in 1982.

According to a recent statement by Securities and Exchange Commission (SEC) Chairman Jay Clayton;

“… those amounts, however, are eclipsed by the $147 billion reportedly raised in 2017 using Rule 506(c) of Regulation D [accredited crowdfunding], the new exemption that lifted the ban on general solicitation. And even that is dwarfed by use of the traditional private placement exemption in Rule 506(b) of Regulation D to raise over $1.7 trillion in 2017.”

Reg D is an enormous market that dwarfs traditional initial public offerings (IPOs). Most promising young firms seek to avoid going public for as long as possible, due to the cost, and thus much of the gain or wealth created by early stage firms accrue to the early investors. At most, according to Burton, 7% to 10% of the US public may participate in these offerings due to the fact they are already rich. The cycle continues as the poors get cut out of the option to participate in the growth of these firms.  Burton says that “Congress should democratize access to these private offerings so that they are available to more investors.” This is an obvious solution.

After many years of inaction, Congress has finally woken up to this discriminatory flaw in the securities law. Today, there are two bills moving through the legislative process that address the dysfunctional definition of an accredited investor.

In the House, Representative David Schweikert has authored legislation: The Fair Investment Opportunities for Professional Experts Act (H.R. 1585) was passed by the House of Representatives in November 2017.

In the Senate, a version of the legislation (using the same name) was introduced by Senator Thom Tillis and Senator Catherine Cortez Masto. But one version of the bill is better as the Schweikert version has a “drafting error” regarding the inclusion of “broker dealers,” a legal entity, instead of licensed individuals who work for brokers to being treated as accredited investors. While the flaw is minor, and most certainly will be addressed, it is an important factor to note. Legislation that opens up all Reg D offerings to all sophisticated investors must be the goal.

Regardless, addressing the shortcomings of the current definition of an accredited investor is long overdue. This is a fix that both parties should readily embrace as, at least in the past, benefiting one segment of the population to the detriment of another is frequently bad policy. Let’s get this rule changed.


You may read the Heritage Foundation Issue Brief “Congress Should Increase Access to Private Securities Offerings” here.

Here is the Legislation that May Finally Fix the Definition of an Accredited Investor

The current definition of an accredited investor is an anomaly based on ease of enforcement and policy inertia. The statute dictates that accredited status is based on annual income or the size of an individual’s (or couples) bank account – yet everyone understands that wealth does not equal sophistication nor financial acumen. In brief, its a stupid rule.

As the years have progressed, private markets – the realm of accredited investors – have bloomed. Public markets have stumbled. Today, most wealth is captured in promising firms before a company goes public – but that was not the case too long ago. The rule upon regulation approach pursued by policymakers has taken its costly toll, compelling firms to avoid going public until they must. But this also means that wealth has become ever more concentrated in the few – instead of the many.

Currently, there is legislation in the Senate that may finally fix this problem. The ‘‘Fair Investment Opportunities for Professional Experts Act’’ (S. 2756) is a bipartisan bill that includes a qualification based on professional experience as well as the possibility for a common sense test. A similar bill passed in the House of Representatives by a voice vote. This means pretty much everyone wants this one to pass.

While the language may change before a vote is taken it appears that, finally, at some point in the coming months the current antiquated definition will be banished to the land of bad rules from of the past.


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Real Estate Investment Platform EquityMultiple Gives up on Reg D 506c Highlighting Shortcomings in General Solicitation Rule


EquityMultiple, a real estate investment platform that caters to accredited investors has bagged general solicitation or accredited crowdfunding.

No longer will EquityMultiple publicly promote its real estate offerings online and elsewhere. Previously, EquityMultiple has leveraged Reg D 506c – a new securities exemption created by the JOBS Act of 2012. This rule allowed issuers and platforms to promote offerings on the internet – via social media and elsewhere  – in contrast to old Reg D (506b) that was barred from any advertising. And why on earth would EquityMultiple not want to promote unique and compelling investment opportunities? Because of the broken nature regarding the general solicitation rule.

Under Reg D 506c, issuers must be verified as accredited. To be considered accredited, individuals must earn $200,000+ a year in salary or have a net worth of $1 million not including their home. If you are married, that salary hurdle jumps to $300,000. Many crowdfunding platforms utilize the services of a verification business and some handled the accredited approval status on their own. But where the SEC got this one wrong is the fact that accredited status must be verified not just once but every three months. That makes absolutely no sense at all.

As EquityMultiple explains;

“We made the switch from 506(c) to 506(b) to provide a quicker, more efficient investment process – allowing prospective investors to answer a series of questions to affirm their suitability to invest and self-certify just once.  This affords a more frictionless investing experience, allowing us to automate many of the parts previously done manually, while giving us more time to guide investors to safely investing on our platform.”

EquityMultiple just wants to provide a better service at a lower cost. While the fix to Reg D 506c may seem obvious and simple to accomplish, there is little interest in cleaning things up.

As for the current definition of an accredited investor, this is a rule that needs to be flushed. Any rational individual acknowledges that sophistication and suitability is not measured by a bank statement. Simply stated, the concept of an accredited investor must change.  Fortunately, there is legislation weaving its way through the halls of Congress that may address this unfortunate regulatory error.

 

Rule 506, Reg D: Two Ways to Conform with SEC Exemption Law


According to the Securities Act of 1933, any company that sells securities must either register with the Securities and Exchange Commission (SEC) or file for an exemption. The JOBS Act 2012 provides a way for companies to use crowdfunding as a means of selling securities, but companies using this method must still comply with existing law. Regulation D of the Securities Act exempts certain companies from registering with the SEC, however, it does require them to file a Form D, which lists the officers and other details of the company selling the securities.

Rule 506 of Regulation D (Reg D) paves a way for companies to raise unlimited amounts of money from the sell of securities. The two components of Rule 506 are 506(b) and 506(c). Here’s what each component of this rule allow companies to do.

Rule 506(b) Imposes the Following Standards on Companies Selling Securities

In order to comply with the exemption rules listed in Section 4(a)2 of the Securities Act of 1933, companies using 506(b), Reg D 

  • cannot advertise or use general solicitation methods to market securities;
  • may sell to an unlimited number of accredited investors and up to 35 other investors;
  • cannot violate anti-fraud prohibitions;
  • must provide non-accredited and accredited investors with the same information;
  • and a company representative must be available to answer questions to prospective buyers.

Standards Imposed by Rule 506(c) 

There is a slight difference between Rule 506(c) of Reg D and Rule 506(b). Companies selling securities can advertise and use general solicitation methods to find prospective buyers, however, the company can sell securities only to accredited investors. The company must also take reasonable measures to verify that investors are indeed accredited investors.

Crowdfunding platforms that operate under Rule 506(c) typically ask investors to register as either an accredited investor or a non-accredited investor. Before allowing investors to make their first investment, platforms generally ask to review tax documents, W-2s, statements from financial institutions, credit reports, and other documents to prove that investors using the platforms are accredited investors. Penalties for not complying with Rule 506 can be stiff.

Where to Find a Copy of a Company’s Form D

Securities sold under both Rule(b) and Rule(c) are considered restricted securities. While these securities do not have to be registered with the SEC, the companies issuing them must file a Form D with the SEC. This form includes the following information on the company:

  • Names and addresses of company promoters;
  • Names and addresses of executive officers and directors;
  • And details about the securities being offered.

When a company files a Form D with the SEC, it becomes public information. You should search for and find Form D for any crowdfunding platform you wish to use to make investments, whether you intend to invest in real estate or other securities. All Form D documents can be found in the EDGAR database, which is operated by the SEC.

What Else You Need to Know About Securities Crowdfunding

All companies that sell securities, whether through crowdfunding or otherwise, must conform with federal law regarding the selling, advertising, and solicitation of said securities. Not only that, but companies must comply with individual state laws in each state where they operate. Be sure to check with the securities regulator in your state and learn what they know about a company before you decide to purchase securities from them.

Crowdfunding is a newer asset class but is still subject to the same securities laws as other securities. Both equity-based and debt-based crowdfunding allow companies to raise capital for growth and expansion, or for particular projects. To protect yourself from bad actors, learn as much as you can about crowdfunding before you invest in or with any company.


Allen Shayanfekr, Esq. is the CEO and Co-Founder of Sharestates.Allen is currently admitted to practice law in NY and CT. His legal expertise in securities law is paramount to Sharestates’ ability to promote and produce public and private offerings in a highly regulated space. Allen interacts regularly with the Securities and Exchange Commission, in addition to spearheading daily operations at Sharestates. Prior to launching Sharestates, Allen joined Atlantis National Services as their National Title Producer and Account Executive, holding approximately 28 Producer’s licenses across the Country. Allen’s other credentials include acting as an editor of the Municipal Lawyer (a quarterly journal published by the New York State Bar association). Allen received his J.D. Magna Cum Laude from Touro Law Center where he graduated in the top 6% of his class and his B.A. in Political Science from New York University.

2017 Holds Promise for Tax & Financing Policy for Startups

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2016 brought with it many positive developments for startups in terms of capital access and tax policy. Investment crowdfunding finally went live, a number of bills to facilitate capital formation passed the House, and the startup community galvanized around a tax bill that would make it easier for startup employees to exercise their stock options. While many of these policy changes hang in limbo going into 2017, we believe that next year holds significant promise for improvements to the tax and financing policy landscape for startups.

Investment Crowdfunding Goes Live

Congress passed the JOBS Act in 2012, which legalized investment crowdfunding for non-accredited investors, allowing anyone to invest in a startup through an online platform for the first time ever. But due to some heel dragging at the Securities and Exchange Commission (SEC), it wasn’t until May of this year that investors, issuers, and platforms were finally able to begin taking advantage of equity crowdfunding.

First 30 Days Update of Reg CF MapWe have seen a number of positive developments in the seven months since the first investment crowdfunding projects went live. Data from Crowdfund Capital Advisors shows that over $17 million has been invested in crowdfunding campaigns thus far. And of the 82 campaigns launched during the first quarter of equity crowdfunding, 20 exceeded their target amount for a success rate of 24.4 percent—more than two times the success rate of popular rewards-based crowdfunding site Indiegogo. Equity crowdfunding campaigns are also seeing higher average investment commitments than rewards-based campaigns: $810 per investor, which is more than ten times the average donation on Kickstarter. Additionally, we’ve seen much greater diversity in the geographic allocation of crowdfunded capital. While venture capital skews heavily towards California, less than one-third of the earliest investment crowdfunding dollars were made to California-owned companies.

Congressional Efforts to Improve Capital Access Landscape

Still, crowdfunding isn’t perfect, and as we’ve previously explained, we’re skeptical about how large the sector can become under the current regulatory framework.

Patrick McHenry 2Fortunately, though, there are thoughtful and dedicated members of Congress trying to address some of Regulation Crowdfunding’s pitfalls and other problematic aspects of the JOBS Act. In particular, Congressman Patrick McHenry (R-NC) has been a champion of the startup community, introducing the Fix Crowdfunding Act (H.R. 4855), which would make a number of improvements to the current equity crowdfunding landscape. We welcomed the bill’s passage in the House earlier this year but were frustrated that the heavily amended version that ultimately passed was missing a number of the startup community’s desired changes. Hopefully, in a new Congress, some of those provisions will make their way back into the bill.

In addition to the Fix Crowdfunding Act, there were a number of other bills that passed the House this year that would facilitate capital formation for startups, including the Micro Offering Safe Harbor Act and the Private Placement Improvement Act of 2016.

Of particular note was the Supporting America’s Innovators Act, also introduced by Rep. McHenry, which would remedy what’s known as the “99 Investor Problem” by raising the number of investors that can invest in angel funds from 100 to 250. Startups also welcomed House passage of the Helping Angels Lead Our Startups Act (HALOS) Act, which would loosen restrictions on startups “generally soliciting” investments at pitch events and demo days.

Stock Options Legislation

Stock CertificateLawmakers on the Hill also pursued startup-friendly tax policies in 2016.

Recognizing that stock options are a critical tool used by startups to attract, retain, and incentivize quality employees, members of the House and Senate proposed changes to the tax code that would make it easier for startup employees to exercise their options.

Support voiced by the startup community for the Empowering Employees through Stock Ownership (EESO) Act helped persuade the House to pass the bill and the Senate Finance Committee to approve it. However, the bill stalled in the final months of the year without a legislative vehicle in the Senate to which it could be attached. Fortunately, support for the bill is broad and bipartisan, and we are optimistic that it will move alongside any tax reform package that is considered by Congress next year.

Should you be an accredited investorSEC Examines Accredited Investor Definition

Finally, there was quite a bit of activity off the Hill in 2016. Many in the startup community were alarmed early in the year when the SEC signaled that it might update its accredited investor definition for the first time since 1983. While revisiting the definition after all these years is not necessarily problematic in and of itself, increasing the financial threshold (as the SEC signaled it might do) would be extremely damaging to the ability of startups to raise capital.

As we argued in comments submitted to the agency, raising the income requirements would substantially diminish the already limited pool of people eligible to fund startups. Instead, we suggested the agency expand the definition by adding qualitative measures for investor sophistication.

This expanded approach was mirrored in Congressman David Schweikert’s (R-AZ) Fair Investment Opportunities for Professional Experts Act, which passed the House earlier this month and would expand the definition of an accredited investor to include investors who may not meet the income or net-worth thresholds but have education or experience related to a particular investment or hold a securities-related license.

The White House Washington DC


Looking Ahead to 2017

With a new Congress and a new Administration beginning in January, capital access, and tax issues may be two of the most promising bright spots for the startup community next year.

Tax reform will be a top early priority for the Trump Administration and the 115th Congress, providing an opportunity to push the EESO Act across the finish line. Additionally, with an almost entirely new SEC that promises to be significantly more pro-business than under prior leadership, there will be new opportunities for startup-friendly capital access initiatives to move at the agency.

At the Congressional level, we’re hopeful that Senate leadership will prioritize the consideration of the capital access bills that passed the House with broad, bipartisan support in 2016.

While many key issues for the tech world, like net neutrality and immigration reform, are likely to face major obstacles under the new Administration, tax and finance policy could offer some much-needed wins for the startup community and may be one of the few areas where startups find success in the coming year.


The article above is part of a series of articles that Crowdfund Insider will be publishing regarding the transition in Presidential administrations. The content will focus on necessary policy initiatives to foster economic growth and job creation by encouraging capital formation for SMEs and innovative startups.

#Transition2017


emma-peckEmma Peck is a Policy Analyst at Engine, a nonprofit that supports the growth of technology entrepreneurship through economic research, policy analysis, and advocacy on local and national issues. Emma helps formulate Engine’s positions on a range of issues impacting startups and entrepreneurs, including immigration, access to capital, telecommunications, data security, IP and education. Prior to Engine, Emma worked on technology and telecommunications policy in Washington, D.C. for Senator Mark Warner (D-VA). She is originally from Richmond, VA and is a graduate of the University of Virginia.

My 2017 Crowdfunding Wish List

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2016 brought with it many developments in the crowdfunding industry, most notably the introduction of the long-awaited Title III crowdfunding. While admittedly not all crowdfunding legislation passed  was as influential, there have been significant strides made to improve existing securities regulations and to continue prying open the doors of capital and investment. There is still much more to be done however, and 2017 brings the potential for vast improvement. Here are some of the things I am hoping to see come to light in 2017.

A Seat At The Table

Christmas in Washington DC CapitolIn late 2015, the SEC Small Business Advocate Act (H.R. 3784) was introduced by Reps. John Carney and Sean Duffy, for the purposes of establishing an “Office of the Advocate for Small Business Capital Formation,” and a “Small Business Capital Formation Advisory Committee,” within the Securities and Exchange Commission (SEC).

In layman’s terms, this bill will establish a permanent office (and committee) within the SEC, whose primary purpose will be to advocate for the interests of small and medium-sized enterprises (SMEs). This would be a HUGE step forward for the crowdfunding industry and for SMEs.

Short of scattered industry chatter most of us, even us industry professionals, know little of the policy discussions that actually go on behind closed SEC doors.

More importantly, we currently have no real voice in that process. Sure there are ways to get our opinions and suggestion to the SEC such as joining advocacy groups like CFIRA, attending the annual Small Business Forum put on by the SEC, or submitting comment letters, but half the time it feels like those recommendations fall on deaf ears.

halt stop handTake the recent Rule 147 amendments for example, which is a matter of personal importance to me. Scores of letters were submitted to the SEC (including even one sent from a bi-partisan congressional group) advocating to keep the proposed amendments under the current Rule 147 safe harbor rather than create a new rule which would require each state to amend their existing crowdfunding statutes.

When it came time to present the final amendments, however, those letters seem to have been completely ignored.  Now if one of our own was behind those doors and able to advocate for positions like this it would have been much harder for the SEC to ignore such a voice. 

president-barack-obama-in-oval-officeIn writing this post I had planned to devote a section to further advocating for the passing of this bill like so many of my colleagues. However, I am ecstatic to report that H.R. 3784 was just passed by the Senate late Friday and is now on its way to being signed into law by the President. It is going to be really exciting to see who gets appointed to the new positions and just what their new roles will be. Whoever they are and whatever their formal duties are I believe these new advocates will prove to be invaluable to both SMEs and the entire crowdfunding industry.

A New SEC

SEC Commission Empty SeatsFor those that don’t know, the SEC is supposed to have 5 total Commissioners each of which is appointed by the President with the advice and consent of the Senate. The President also designates the Chair of the SEC. We currently only have 3 Commissioners (Mary Jo White, Kara Stein, and Michael Piwowar) and Commissioner and SEC Chair Mary Jo White has announced her intention to step down at the end of President Obama’s administration. This sets the stage for the creation of a completely new SEC.

Whether or not you agree with the upcoming Trump presidency, it’s clear that Trump is inevitably going to have a significant impact on the make-up and direction of the SEC. As President, Trump will have the ability to both appoint persons to the 3 open SEC seats (representing the new majority) and to designate the new SEC Chair. President-elect Trump’s transition team has continually touted a new era of pro-business initiatives and limited government regulation, so it is a safe assumption that his new appointees will carry similar views. Couple that with the fact that no President may simply remove a seated Commissioner and the new, pro-business, Trump majority will define the tone and direction of the SEC for at least the next  years. Take, for example, President-elect Trump’s promise to “dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation.” Even if complete repeal might never occur, the ability to appoint the majority and Chair of the SEC will clearly impact the SEC’s interpretation of existing rules and regulations under Dodd-Frank as well as the SEC’s adoption of remaining rules still required to be created under the Act (including potentially halting or delaying their adoption all together). 

While Michael Piwowar is expected to be appointed as interim Chair when Mary Jo White steps down, it is widely anticipated that Paul Atkins will be President-elect Trump’s formal pick for SEC Chair.

Atkins previously served as SEC chair from July 2002 until August 2008 and, both during and after his tenure, has been outspoken in his criticisms of many current securities regulations (including the Dodd-Frank Act). Like President-elect Trump, Atkins has advocated for less governmental regulation and more pro-business initiatives.

Paul AtkinsMore importantly for the crowdfunding industry, Atkins is pro-SME, having been quoted as saying:

“small businesses are vital to our nation’s economy .. Put simply, if we are serious about spurring strong and lasting economic growth, creating more jobs outside of Washington, D.C., and breaking down our two-tiered economy, we do not need higher taxes or more government spending – instead, the data suggest that we need more entrepreneurs and more small businesses, and we need to continue to create a sensible regulatory environment in which these firms and individuals can succeed.”

While just who will be selected to fill the other two open SEC seats is anyone’s guess, but more than likely they will share similar views to Atkins when it comes to financial regulation and SEC reform.

Again regardless of your opinion as to the President-elect or the Dodd-Frank Act, the crowdfunding industry (and the SEC in general) would clearly benefit from a more pro-business, less authoritarian, approach. While I commend Chair Mary Jo White and the rest of the SEC for getting us to this point, few would argue that the SEC’s approach toward crowdfunding and Fintech to date has been pro-business and that type of thinking is what we need to move the industry to the next level.  We really need some fresh blood and a new direction when it comes to the SEC and I am excited to see how this will play out in 2017. 

New Accredited Investors

As many of you know most offerings today (even with the introduction of Title III) are open only to individuals/entities that qualify as “accredited investors.” The problem is that the standards for qualifying as an “accredited investor” have remained relatively unchanged since the 1980s. This leaves the majority of today’s private investment opportunities open only to high net worth individuals/entities.

Grant 50 Money AccreditedUnder Section 413(b)(2)(A) of the  Dodd-Frank Act requires the SEC to re-examine the definition of “accredited investor” every four (4) years to determine whether it should be modified. While the SEC actually did conduct a review of the current definition (in 2016 of course, 2 years after it was required to under the Dodd-Frank Act) no formal decision was ever made by the SEC as to whether the definition would be revised. Needless to say, this has been a heated topic of debate. Since 2014 there have been countless articles written to induce the SEC to substantively revise and expand the current “accredited investor” definition. I have written several such articles myself but, for the first time, I am actually glad the SEC has actually failed to make a decision on the issue. Now that might sound a bit counter-intuitive but follow me for a minute.

Even if the current SEC had actually made some revisions to the “accredited investor” definition, under the current conservative and authoritative SEC regime the expansion of the definition (if any) would have be minimal at best.

Moreover, under the Dodd-Frank Act, the SEC would then have had to wait until 2018 to review the definition again (without additional Congressional authorization of course). By failing to act the current SEC has actually left the issue open for the new, incoming, pro-business SEC majority to decide.

Assuming the new SEC takes up the issue, which seems a distinct possibility, I believe the resulting changes will be far more progressive than rules we would have gotten under the current Commission. As a result, the current SEC actually did SMEs and all of us a favor by not acting.

Train Express UKPicture waiting on a crowded train platform and cursing the trains for being full as they pass only to finally get on a wide open train where you can sit and relax all the way to work. A shiny new SEC train is pulling into the station and I believe a lot of new accredited investors are finally going to get a seat.     

Correcting The Sins Of The Past

Other than the new positions created by the recently approved Small Business Advocate Act, much of the above is speculative and more of a wish list than a certainty. That being said, it should be noted that there are still several material bills which were introduced during 2016 that will hopefully be passed in 2017. These bills include:

  • The Small Business Capital Formation Enhancement Act (H.R. 4168). This bill, introduced by Reps. Bruce Poliquin and Juan Vargas, would formally require the SEC to respond to any findings and recommendations put forth by the Securities and Exchange Commission’s (SEC) annual Small Business Forum. While the Small Business Forum is an annual event, the SEC is not currently required to even acknowledge the recommendations of the attendees. Have participated in several of these forums I can tell you from firsthand experience that a lot of good ideas come out of them and tasking the SEC with formally taking note of such ideas will be of serious benefit.
  • The Supporting America’s Innovators Act (H.R. 4854). This bill, introduced by Rep. Patrick McHenry, would amend an exemption from registration under the Investment Company Act of 1940 increases the number of investors allowed for qualifying venture capital funds. This is important because not only will it help ease the use of “single purpose vehicles” (SPVs) for aggregating investor funds in offerings, but it will also ease the way for the creation of newer fund vehicles (e.g. newer micro-funds).
  • Patrick McHenry DJ PaulThe Fix Crowdfunding Act (H.R. 4855). This bill, introduced by Rep. Patrick McHenry, was originally a much more aggressive attempt to fix a number of the shortcomings under the current Title III rules. While it has since been watered down, in its current form the bill would update the Title III rules to allow for the use of SPVs for aggregating investor funds and would expand certain reporting exemptions for Title III issuers. As these are still material issues this bill will ease some of the current administrative burdens associated with using Title III.
  • The Fair Investment Opportunities for Professional Experts Act (H.R. 2187). This bill, introduced by Rep. David Schweikert, would amend the definition of “accredited investor” to include investors who have securities related licenses or whom the SEC (through FINRA) determines has the requisition knowledge or experience. While I think the language itself needs some work, ANY expansion of the current definition of “accredited investor” would be extremely beneficial.

Conclusion.

No one knows what is going to happen under President-elect Trump’s tenure, least of all me. However, if the new appointees to the SEC turn out to be as pro-business and progressive as promised, I believe we are in for some substantive changes. Changes which will benefit SMEs, investors and the economy significantly. 


 The article above is part of a series of articles that Crowdfund Insider will be publishing regarding the transition in Presidential administrations. The content will focus on necessary policy initiatives to foster economic growth and job creation by encouraging capital formation for SMEs and innovative startups.

#Transition2017


Anthony ZeoliAnthony Zeoli is a Senior Contributor for Crowdfund Insider.  He is a Partner at the law firm of Freeborn in the Corporate Practice Group. He is an experienced transactional attorney with a national practice specializing in the areas of securities, commercial finance, real estate and general corporate law. Anthony recently drafted the bill to allow for an intrastate crowdfunding exemption in Illinois.


Crowdfunding VC: Nin Desai Focuses on Investing in Tech

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After years of working for firms like Merrill Lynch and Pacific Crest, Nin Desai decided to launch her own venture Nin.VC. Seeing opportunity in the JOBS Act of 2012 that legalized various iterations of crowdfunding, Nin launched a VC-hybrid firm that allows accredited investors access investment opportunities typically not available to just anyone. Based in Chicago, Nin.VC now has an office in San Francisco to be closer to the vibrant tech startup scene.

Nin is active with Venture FWD (FWD = For Women and Diversity) – a conference scheduled to take place later this month. Venture FWD is seeking to draw attention to the incredible work being done everyday by women and minority entrepreneurs. At this first  event, Nin will be speaking to women entrepreneurs about fundraising and venture capital/crowdfunding. Nin is also affiliated with Alpha Capital Partners as well where she is Strategy & Corporate Development Advisor for the Chicago-based PE firm.

Recently Crowdfund Insider caught up with Nin to get an update on Nin.VC and her vision for her crowdfunding/VC approach.


Crowdfund Insider: You are using Title II of the JOBS Act for Accredited Crowdfunding. Tell us more about what NIN.VC is doing?

Nin Desai: NIN.VC is a first of its kind crowdfunded technology venture capital fund that is offering its membership interests pursuant to Rule 506(c) of Regulation D under the Securities Act of 1933 as contemplated by Title II of the JOBS Act.

NIN Ventures Technology (QP) Fund is currently only open to “accredited investors” who can invest in our fund with a minimum amount of $100,000 using multiple investment options like 401k, Defined benefit plan, digital currencies (E.g. Bitcoin, Litecoin, Dogecoin), or a regular checking / savings account.

Disruption iPadCrowdfund Insider: What type of companies does NIN Ventures invest in?

Nin Desai: NIN.VC invests in Series A & B rounds of 3D printing, the 4th industrial revolution, cloud computing, virtual reality, financial services, education software, and other disruptive technology companies within the United States.

A disruptive technology is an innovation that changes an existing industry and also helps create a new market and value network, displacing an earlier technology or a way of doing business.

Crowdfund Insider: How are you different from other investment crowdfunding platforms?

Nin Desai: NIN.VC is a hybrid between Crowdfunding Portals and a traditional venture capital fund. We have the best of both worlds – our investors get to directly invest and enjoy direct returns like they would with any Crowdfunding portals, and our entrepreneurs get the support like they would at the traditional venture capital fund.

If you take the top few billion dollar startups and average the age of those entrepreneurs at the founding, it’s less than 30 years when they embarked on the journey of changing their industries. At that stage, an entrepreneur needs lot more than just financing, for example, domain expertise, PR & marketing, recruiting, an exit strategy, and we able to provide them all that with the help of our network of partners; which is not the case with Crowdfunding portals.

nin-desai-3Crowdfund Insider: How are you sourcing deals?

Nin Desai: At NIN.VC we start with an entrepreneur because entrepreneurs build companies and not the other way around. According to Pitchbook, “One-third of U.S. startups that raised Series A round of funding in 2015 went through an accelerator.” Accelerators play a valuable role in the venture capital ecosystem by vetting and training young startup founders and, in turn, creating more quality companies. So we have made an active effort on our end to build relationships with incubators, accelerators, universities, etc. in and out of town to get access to the best quality deal flow.

Crowdfund Insider: What are some of the qualities that you look for an entrepreneur or company? Also, do you have any tips for entrepreneurs raising capital via a Crowdfunding portal or venture capital in general?

Nin Desai: Being an entrepreneur is the hardest job in the world and entrepreneurs face varied challenges when it comes to taking their disruptive technologies to market.

The few attributes that we look for in an entrepreneur is the ability to dream big, experience and expertise in their industry, ability to communicate with the team and outside, flexibility to adapt to a fast changing environment, and certain personality traits like being focused, dedicated, disciplined, and working hard to accomplish their goals.

As long as the company has certain ingredients like a good management team, a disruptive technology, a viable product, and a revenue-generating strategy that form a basic foundation that leads to long-term success … We at NIN.VC like to invest in companies that are going to stand the test of time.

For-profit companies should keep all these things in mind whether they are fundraising via a Crowdfunding portal or venture capital firm. For entrepreneurs raising capital using a Crowdfunding portal, I would recommend trying to avoid a messy cap table. For Non-Profit businesses, donation or reward based Crowdfunding is a good option.

Crowdfund Insider: What is the vision for NIN Ventures moving forward?

Nin Desai:  NIN.VC is currently only open to “accredited investors.” However, we would like to make ourselves available to everyone and truly democratize venture capital.

Everyone should have the right to invest like Harvard or Yale and the Big League, but the current regulation and the JOBS Act does not allow “non-accredited” investors to be a part of our fund. Hopefully, we will see some change and progress on that front in the future.

An Explanation of Title II, Accredited Crowdfunding (Video)

Billboard-Advertising-General-Solicitation OnlineThe JOBS Act of 2012 legalized three different variations of investment crowdfunding. Title III or Reg CF, allows for anyone to invest in smaller companies that are raising up to $1 million.  Title IV, or Reg A+, allows issuers to raise up to $50 million from both accredited and non-accredited investors but requires a higher degree of disclosure and ongoing reporting.  Title II updated existing Reg D rules to allow for “general solicitation” (SEC-speak for advertising) ushering in the first iteration of raising capital online or accredited crowdfunding.  Under Reg D 506(c) only accredited investors may participate in the offer but allows an unlimited amount of capital to be raised. This is the most popular vehicle to raise money for private companies and a huge market at around $1 trillion a year.  Under Reg D 506(c), platforms must verify investors qualify as accredited investors thus creating an additional hurdle for issuers. VerifyInvestor, a company that provides accredited investor verification has crafted a short video that quickly and simply explains Title II accredited crowdfunding. The video is embedded below.


Reg D: Congress Must Act to Allow Sophisticated Investors Access to Private Placements

Should you be an accredited investorUnder Reg D more than a trillion dollars is raised each year for companies that are not publicly traded. This market is huge – far larger than the annual rate of IPOs. Yet these private placements are only available to “accredited investors”: Individuals who earn $200,000+ a year or maintain a net worth of $1 million (minus one’s primary residence). There is a widely circulated presentation created by Andreessen Horowitz that indicates much of the wealth created by young companies has already been captured before a company finally goes public (if it ever gets that far). So an IPO has become more of an exit for early investors. Retail investors are left with tepid growth. Thus the vast majority of the population is blocked from a potential source of profound wealth creation – an incredible act of disenfranchisement.

Finfair David BurtonDavid Burton, a Senior Fellow for Economic Policy at the Heritage Foundation, has published a paper that outlines how things work today. He also explains what must be done.  Burton states;

“Congress should address this problem by providing bright-line rules for determining who is sophisticated and therefore eligible to invest in Regulation D private placements. This would increase the number of people who are allowed to invest in private firms, broadening the options available to investors and helping entrepreneurs to raise capital.”

Burton notes that a bill, labeled the Fair Investment Opportunities for Professional Experts Act, has passed the House.  This may fix the issue but, as it is worded now, leaves too many ambiguities increasing the risk that the authors legislative intent may get lost in the regulatory shuffle.

Burton clarifies things, stating;

“[the bill should] be improved by broadening the definition of who would qualify as sophisticated by specifying the educational, licensure, or accreditation attainment that would make a person eligible, while allowing financial regulators the option of further broadening who qualifies. It should also minimize the role of FINRA.”

We concur.

Policy makers on Capitol Hill should read this document.

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ACSEC Submits Final Recommendations on Definition of Accredited Investor

ACSEC Sarah Hanks and Stephen GrahamThe SEC Advisory Committee on Smaller and Emerging Companies (ACSEC) has submitted its final recommendations to the Commission regarding the definition of an accredited investor. ACSEC has continued to advocate on behalf of its thesis that the SEC “should do no harm” and not reduce nor diminish the private offering ecosystem.  The private markets are huge – probably over $1 trillion annually. If you compare this amount to annual amount of IPOs you start to understand the economic importance of private offerings.

Laura Yamanaka at ACSECACSEC is of the opinion the pool of investors eligible for private offerings should be expanded. While there are some policymakers who want to keep private offerings the realm of only the very wealthy, thus disenfranchising the majority of the US population, ACSEC sees value in expanding the current definition.

 

The ACSEC recommendations are listed below:

  • The core of the Advisory Committee’s 2015 recommendation regarding the definition of “accredited investor” in Rule 501 remains the same: the overarching goal of any changes the Commission might consider should be to “do no harm” to the private offering ecosystem.
  • The Commission should not change the current financial thresholds in the definition except to adjust on a going–forward basis to reflect inflation.
  • The Commission should expand the pool of accredited investors to include individuals who have passed examinations that test their knowledge and understanding in the areas of securities and investing, including the Series 7, Series 65, Series 82 and CFA Examinations and equivalent examinations. The Commission also should explore ways to allow participation by potential investors with specific industry or issuer knowledge or expertise who would not otherwise be considered accredited investors.
  • The Committee would support expanding the definition to take into account measures of non-financial sophistication, regardless of income or net worth, thereby expanding rather than contracting the pool of accredited investors.
  • Simplicity and certainty are vital to the utility of any expanded definition of accredited investor. Accordingly, any non-financial criteria should be able to be ascertained with certainty.
  • The Commission should continue to gather data on this subject for ongoing analysis of what attributes best encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.

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Mary Jo White: SEC Staff Continues to Closely Monitor Reg CF, Reg A+

Mary Jo White at ACSECTwo important elements of the JOBS Act are Title III and Title IV.  These two portions of the act created Reg CF, retail crowdfunding, and Reg A+, a scaled disclosure exemption for companies to raise up to $50 million.  In the opening remarks of the SEC Advisory Committee on Small and Emerging Companies (ACSEC) yesterday (July 19),  SEC Chair Mary Jo White gave a quick update on both securities exemptions. White said a “diverse range of companies” are using Reg CF. As of yesterday, 12 funding portals had been approved, over 60 issuers have filed a Form-C, and $4.4 million has been raised in total.

Under Reg A+, over 100 filings have been submitted to the SEC with the Commission qualifying nearly 50.  Later in the day, it was revealed that $2 billion in targeted funding was included in the 100 Form 1-A’s with $840 million associated with the approved filings.

ACSEC meets to discuss issues that may be arcane to many but vital to all. Smaller companies are the lifeblood of the economy. Policy makers and regulators ignore SMEs at the country’s peril.

The other item mentioned by Chair White was the ongoing review of the definition of an accredited investor. White reported the SEC is working on further recommendations for the Commission. This follows the in-depth report from late last year.

While there are some organizations seeking to make the accredited investor definition less inclusive, there is growing acknowledgment the current approach is dysfunctional creating a division between the haves and have-nots. The ongoing interest of the SEC under Chair White’s guidance is an encouraging sign.

Chair Whites Remarks Opening the ACSEC Meeting are Republished Below

July 19, 2016

Thank you, Steve and Sara, and welcome back, everyone.  These dog days of summer often motivate people to get out of Washington D.C., so we appreciate that you are here today.  I will make just a few short comments on each of your agenda items and a word on what has happened so far in the crowdfunding space.

Your agenda today starts with a discussion of the Accredited Investor definition, obviously an issue of great importance, which we are very focused on.  We have received some 40 comment letters on the staff study of the definition and as the staff is working on further recommendations for the Commission, I look forward to your thoughts and recommendation.  Your feedback is obviously very important and helpful.

Your agenda today also focuses on Regulation A+.  It was just over a year ago – in June 2015 – that the Commission’s amendments to Regulation A+ went into effect.  We have had over 100 offering statements filed with the Commission, with even more issuers taking advantage of provisions in the rules that allow for non-public staff review of draft offering statements before publicly filing.  Since the effective date of the final rules, the Commission has qualified nearly 50 of those offering statements.  This is a very interesting and dynamic space, and I look forward to today’s discussion and especially the presentation by participants who are directly involved in this market.

As was mentioned, last month the Commission proposed amendments that would increase the financial thresholds in the “smaller reporting company” definition.  As you know, the “SRC” definition has been of keen interest to this Committee for some time and the subject of prior Committee recommendations, which go beyond the reach of the Commission’s current proposal in some respects.

If adopted, the proposal would expand the number of companies that can qualify for certain existing scaled disclosures provided in the SEC’s regulations by raising the public float threshold from its current level of $75 million up to $250 million and the annual revenues threshold, in the absence of a public float, from less than $50 million to less than $100 million.  The objective of the proposal, which would raise the financial thresholds in the definition as I indicated, is to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections, such as those provided by section 404(b) of Sarbanes-Oxley.

The Commission will benefit greatly from the thoughts and public comments we receive on the SRC proposal, from you and all constituents, including investors and companies, as well as the comments we receive on our Regulation S-K concept release, which explores the scaled disclosure requirements for SRCs, among many other areas.  Your input, along with input from investors, issuers and other affected market participants, will help inform any changes to the scaled disclosure system or other changes to our disclosure requirements.

I also wanted to provide a very quick update on another of our recent rules to facilitate small business capital formation.  Regulation Crowdfunding went into effect on May 16, just two days before your last meeting.  I can report that a very diverse range of companies are using the crowdfunding exemption and that, as of July 18th, there had been over 60 offerings with a total of $4.4 million in funds committed by investors.  Twelve funding portals have registered with the Commission and become members of FINRA.  For our part, SEC staff continues to closely monitor the Regulation Crowdfunding and Regulation A+ markets and are available to answer questions.

Thank you again for being here today.  I look forward to your discussion and input.

Here is the Draft ACSEC Letter to the SEC on Definition of Accredited Investor

ACSEC Sarah Hanks and Stephen GrahamBelow is the draft letter from the Advisory Committee on Small and Emerging Companies (ACSEC) regarding the definition of an Accredited Investor. The Committee is working on the details now with one of the suggestions being a test of sophistication that allows a work-around from the current rule that bases qualification solely on wealth metrics.  ACSEC is taking a “do no harm” stance while seeking more thoughtful entry points for more individual investors.

Mark Walsh at ACSECWhile ACSEC has not finalized their recommendations it appears committee members will propose a more holistic approach to the definition that allows qualification on a professional basis, alongside some sort of formal test to gain accredited status.

“Investor Protection Means Protection from Fraud, Not From Loss”

While the devil is in the details, expanding the definition of an accredited investor is something that needs to be done as the current definition disenfranchises millions of potential investors who clearly have the capacity to manage their own investment decisions.

 

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SEC ACSEC Meeting to Review Reg A+, Elio Motors Experience

Paul ElioThe SEC Advisory Committee on Small and Emerging Companies (ACSEC) has published its agenda for its meeting next week and it should be a more interesting gathering.

As part of the ACSEC program, the SEC Division of Corporate Finance will deliver an update on the utilization of Regulation A+, as enacted under Title IV of the JOBS Act, and the first year’s results.  The update will also include a presentation by Paul Elio, CEO and Chairman of Elio Motors, a company that raised almost $17 million under Reg A+.  Elio then proceeded to list its shares on the OTC Markets OTCQX making it the first crowdfunded security to go from public solicitation under Reg A+ to a publicly traded security.  Daniel Zinn, General Counsel of OTC Markets, will also present on secondary trading of Reg A+ shares.

Elio Motors, for individuals unaware of the firm, is a manufacturer of a three-wheel vehicle that seeks to provide affordable and economical transportation to the masses. The vehicle expects to begin production at some point in the coming months.

Mary Jo White ACSEC MeetingBeyond the Reg A+ update, ACSEC will consider the definition of an “Accredited Investor, as discussed during their previous meeting in May. There will also be a review of the proposal to amend the “Smaller Reporting Company” definition.

The ACSEC meeting will be held at the SEC offices in Washington, DC and is open to the public. The SEC will also be live-streaming the event on the SEC website. The meeting will commence at 930AM on Tuesday, July 19th.

The entire agenda is reproduced below.

AGENDA

9:30 a.m. Co-Chairs Stephen Graham and Sara Hanks call meeting to order

  • Introductory Remarks by Chair Mary Jo White and Commissioner Kara Stein

10:00 a.m. Consider “Accredited Investor” Definition Recommendation as discussed at May 18th Meeting

10:30 a.m. Regulation A+ Update and Review

  • Update from SEC Division of Corporation Finance staff on the usage of Regulation A+ in its first year
  • Presentation from Paul Elio, CEO and Chairman of Elio Motors Inc., a company that conducted a Regulation A+ offering
  • Discussion by Committee Members

12:00 p.m. Lunch Break1:30 p.m.

1:30 p.m. Regulation A + (Continued)

  • Presentation by Daniel Zinn, General Counsel, OTC Markets Group regarding secondary trading of Regulation A+ shares

2:30 p.m. SEC Proposal to Amend the “Smaller Reporting Company” Definition

  • Briefing from SEC Division of Corporation Finance staff regarding the Commission’s proposal issued June 27, 2016 to amend the “Smaller Reporting Company” Definition
  • Discussion by Committee Members

3:30 p.m. Adjournment

NASAA Tells SEC to Make Definition of an Accredited Investor Less Inclusive

Should you be an accredited investorThe North American Securities Administrators Association (NASAA) has published a comment letter expressing their opinion on the definition of an Accredited Investor.

As mandated by Dodd-Frank, the Securities and Exchange Commission (SEC) must review the current definition on a periodic basis. As it stands today, only individuals earning at least $200,000 a year or with a net worth of over $1 million (minus one’s primary residence) may participate in Reg D private placements.  The definition has come under fire of late as a growing segment of policy officials are recognizing the flawed nature of rule as it has disenfranchised the majority of the population in gaining access to some of the most lucrative investments available. These same investments may be intrinsically more risky than some other investments as expected returns are accordingly higher.

Recently the Advisory Committee on Small and Emerging Companies (ACSEC) convened at the SEC headquarters to discuss the current definition. One SEC Commissioner asked if the definition should be removed in its entirety – a move that would match some other developed countries.  Yet the lobbying group that represents the state securities administrators is bucking the trend.

In their comment letter, NASAA President Judith Shaw expressed the opinion that current financial thresholds should be raised today and indexed on a rolling basis to account for inflation.

Judith Shaw at SEC IACAs most people understand, a wealth metric is not a guarantee of skill or sophistication. But incorporating a test of sophistication is something NASAA apparently does not prefer;

“Qualification as an accredited investor absent any sort of experiential requirement does not objectively satisfy the sophistication requirement. The Commission should require a minimum of five years of experience in the field corresponding to the professional designation or credential to ensure an individual has obtained sufficient industry experience to demonstrate financial sophistication. Allowing an avenue to accredited investor status absent experience paves the way for people who are merely successful test takers to qualify as accredited investors.”

While pointing to Reg D offerings as being consistently associated with fraud, NASAA representatives have admitted in the past they do not have quantifiable data on criminal acts.

Wrapping the NASAA opinion under the guise of investor protection may be indicative of a fear of relevance. The state regulators do play an important role in hunting down acts of fraud within their borders – something that should be lauded.  But as more promising young companies have avoided going public due to excessive cost and compliance the capital gains have followed.  NASAA members should be working on crafting a rule that is more inclusive and less exclusive and only for the rich. Blocking people from investing in potentially lucrative investments should not be on the list of state securities administrators tasks.

 

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SEC Commissioner Piwowar Nails it in Remarks to ACSEC Discussion on Accredited Investor Definition

Michael Piwowar ACSEC 2“Should the Commission consider doing away with the notion of a so-called “accredited investor” altogether?”

The above question is posed not by this digital publication but by a sitting SEC Commissioner, Michael S. Piwowar.

The Commissioner was speaking at the recent gathering of the Advisory Committee of Small and Emerging Companies (ACSEC) which convened largely to discuss the current definition of an accredited investor.

As it stands today, being accredited means an individual is able to review and decide whether or not they want to invest in certain private placement offers. Companies that are not yet listed on a public market mostly raise capital under Regulation D but only the accredited may join in. The definition was created to save people from themselves and block individuals that earn less than $200,000 a year or have a net worth of one million dollars (minus a primary residence) from making bad (risky) investments. No acknowledgment of experience or sophistication required.  Yet in some other countries, such hard line barriers do not exist.

As required by the Dodd-Frank Act, the SEC must review the current definition periodically.  The SEC is fulfilling this mandate and, at least on the surface, appear poised to rectify a longstanding act of disenfranchisement of much of the population.

Piwowar, for his part, took a very logical approach. Noting that prohibiting non-accredited investors from investing in high-risk securities is the same thing as prohibiting them from investing in high-return securities, the government is, in effect, becoming an investment advisor.

The Commissioner points to the fact the government has created a “privileged class”. This misappropriation of power means “the government may actually exacerbate wealth inequality and hinder job creation and economic growth.”

Piwowar is correct in asking the Committee, and Commission, to look further as the current policy may be harming “the very investors the policy is intended to protect.”

The remarks are republished in their entirety below.


 

Commissioner Michael S. Piwowar Remarks at ACSEC Meeting May 18, 2016

Thank you, Sara [Hanks] and Stephen [Graham]. First, I want to welcome everyone — our new committee members, as well as our returning members. I was unable to attend your first meeting in February, but you have hit the ground running. Today’s agenda is quite ambitious and I look forward to hearing the discussions and seeing any resulting recommendations. The committee will be discussing, among things, the accredited investor definition and Regulation D. In fact, the Commission adopted the notion of a so-called “accredited investor” in 1982 when it adopted Regulation D.

In a few minutes, staff in our Division of Corporation Finance will make a presentation of their December 2015 report on the review of the accredited investor definition. Section 413 of Dodd-Frank directs the Commission to review the definition of accredited investor as it applies to natural persons to determine whether it should be adjusted or modified. The staff report fulfills the statutory mandate by providing valuable information on the history of the accredited investor definition and important insights on alternative regulatory approaches. After the staff presentation, the Committee will discuss the accredited investor definition. I am sure that there will be a lively discussion about alternative accredited investor definitions.

But I want to ask the Committee to consider going beyond that discussion after today’s meeting before making any recommendations. Take a step back and ask the question: should the Commission consider doing away with the notion of a so-called “accredited investor” altogether? As I have said before, it essentially divided the world of private offering investors into two arbitrary categories of individuals — those persons who were accorded the privileged status of being an “accredited investor” and those who were not. In short, if you made $200,000 or more in annual income or had $1 million or more in net worth, then you were in the privileged class and could choose to invest in the full panoply of investments, whether public or private. If not, the government decided that, for your own protection, you were restricted access to these private investments.

The Committee has the opportunity to move beyond the artificial distinction between so-called “accredited” and “non-accredited” investors and challenge the notion that non-accredited investors are in fact “being protected” when the government prohibits them from investing in high-risk securities. For example, the Committee could do as I do and appeal to two well-known concepts from the field of financial economics. The first is the risk-return tradeoff. Because most investors are risk averse, riskier securities must offer investors higher returns. This means that prohibiting non-accredited investors from investing in high-risk securities is the same thing as prohibiting them from investing in high-return securities.

The second economic concept is modern portfolio theory. By holding a diversified portfolio of assets, investors reap the benefits of diversification; that is, the risk of the portfolio as a whole is lower than the risk of any individual asset. I do not have the time today to give a full lecture on the mathematics and statistics of portfolio diversification, so I will just assure you the correlation of returns is key. When adding higher-risk, higher-return securities to an existing portfolio, as long as the returns from the new securities are not perfectly positively correlated with (move in exactly the same direction as) the existing portfolio, investors can reap higher portfolio returns with little or no change in overall portfolio risk. In fact, if the correlations are low enough, the overall portfolio risk could actually decrease.

These two concepts show how even a well-intentioned investor protection policy can ultimately harm the very investors the policy is intended to protect. Moreover, restricting the number of accredited investors in the “privileged class” can have additional (or what economists call “second-order”) effects. The accredited investors may enjoy even higher returns because the non-accredited investors are prohibited from buying and bidding up the price of, high-risk, high-return securities. As a result, small businesses face higher costs of capital. Remarkably, if you think about it, by allowing only high-income and high-net-worth individuals to reap the risk and return benefits from investing in certain securities, the government may actually exacerbate wealth inequality and hinder job creation and economic growth. This is just one suggestion for the Committee to consider after today’s meeting. In any event, I look forward to an informative discussion.

Thank you.