April 17, 2012
I appreciate the opportunity to comment to the SEC before rulemaking begins. My comments concern the crowdfunding provisions in the JOBS Act. I am a veteran entertainment attorney with 35 years of experience. I am a former law professor, author of six books, and serve as an expert witness and arbitrator.
I have represented, and continue to represent, numerous filmmakers as well as film investors. Among the articles and books I have authored is an article published in 2000 in the Vanderbilt Journal of Entertainment Law Practice titled The Hollywood Shuffle: Protecting Film Investors.
I mention this because I am as interested in protecting investors as filmmakers. I have observed first-hand how difficult it can be for fledgling filmmakers to raise funds legally. I welcome the opportunity for them to utilize crowdfunding. Before the JOBS Act, crowdfunding has been used to solicit donations, not investments. Even with this limitation, it has proven successful in funding artistic endeavors.
The purpose of the implementing rules should be to make it administratively simple for entrepreneurs to raise capital while requiring complete transparency and full disclosure to protect investors. Portals should be required to conduct due diligence to deter fraudulent activities, and to educate potential investors about the risks and nature of their investment. The portals should be subject to conflict of interest rules so they treat all projects fairly, and the portal should be obliged to fully disclose to investors and filmmakers how they are compensated. Term sheets should be required that plainly and concisely explain how investors can be diluted, whether there are any liquidation preferences, how decisions are made, etc.
Investment funds should be placed in escrow as kickstarter.com does. If sufficient funds are not raised to complete the project by the deadline, 100% should be returned to the investors. Once the minimum threshold has been met for the release of funds, monies should be transferred to a bank account held by a federally insured bank. Bank statements should be available for all investors to review upon their request. On completion of the film the filmmaker should be required to provide a final cost report to all investors specifying exactly how all the funds were spent. No more than ten percent of the funds should be disbursed by the filmmaker as cash. All other expenses should be by check or credit card so there is documentation of the expense. After production any investor should have the right, at their expense, to audit the books. There should be a specified deadline for the filmmaker to complete the project. Filmmakers or portals should be required every 90 days to send a brief status report to all investors until the motion picture has been released.
Filmmakers should be required to disclose the use of any finders, agents, representatives, what kinds of insurance they will carry, a story synopsis or the script, a line item budget, and whether a completion bond will be secured. Completion bonds are generally not available for film projects whose budgets are less than one million dollars.
Most filmmakers I have met are strongly motivated to make the best film possible. They want the money to be spent up on the screen, rather than on travel and accommodation expenses that dont affect the quality of the film. Legitimate filmmakers have a strong incentive to treat their investors fairly because they know they may be going back to them for their next project.
Many of those that invest in artistic endeavors are motivated not so much by the economics of the investment as a passion for the project, filmmakers or subject matter. People dont in a motion picture because they think it is a prudent financial decision, and most dont invest more than they can afford to lose. The restrictions on the amount that non-accredited investors can invest mitigate the dangers. Those investing larger sums tend to be more sophisticated and can afford professional advisors to help them review projects.
People who invest in films often don't articulate all their motives but the primary motive is rarely financial. The investor may find it exciting to participate in the movie making process, wants to visit the set, attend the wrap party or the premier screening. Or perhaps the investor wants to see their name on the screen as a producer, or feels it is important that a certain story be told. When one realizes that internet gaming company Zynga earns hundreds of millions of dollars by selling virtual goods, it does not take a great leap of imagination to envision that people might be willing to invest in a motion picture if the experience is satisfying, even if not financially rewarding.
There should not be a requirement for audited financial returns for new endeavors. A new business does not have any books or records to review. Most filmmakers interested in crowdfunding have limited resources and those resources are better spent on the film than on accountants. There should be complete disclosure of the full names and city of residence of the filmmakers, writer and director for each project. The portals should share the names, city of residence and email addresses with other investors in each project so that investors can communicate with one another, unless an investor elects to withhold their contact information.
Regulatory requirements must be minimal or you defeat the whole purpose of crowdfunding. Most of the regulatory and reporting burdens should be placed on the portals. Whatever rules are adopted should be written in plain language so they are easy to understand. Filmmakers are artists who often have limited business experience. Investors may not know how to conduct due diligence and may not even know what information they should ask for. Therefore, portals should develop standardized questionnaires that entrepreneurs can complete to disclose relevant information to potential investors.
The SEC should develop its own informational brochures to educate the public about the financial risks of crowdfunding, and suggest how investors can conduct due diligence to protect themselves. Portals could be required to link to the SEC web pages providing this information to consumers.
People involved in scams try to hide their identity. They often set up companies to hide behind, use those companies to raise funds, and then abandon the companies when the law begins to catch up with them. Whenever I see a website where no individuals are named, no street address is disclosed, I am suspicious of whether this is a legitimate concern. Using portals to vet projects and promoters is an excellent idea. Portals have an incentive to weed out shady characters because if investors are burned, the word will get around and it will hurt the reputation of the portal and deter other investors. A scamster may flee but the portal wants to stay in business. As crowdfunding develops, so too will a community that will share information about any questionable operators. Just as Tripadvisor.com distributes customer reviews and photos to encourage hotels to improve their services, I expect similar websites to develop to monitor and report on investments in artistic endeavors. The public can look up a persons credits on IMDB.com and discover who his or her past collaborators were. I would strictly prohibit any persons or companies convicted of fraud or having any criminal record from participating as portals or as promoters seeking funds.
Films and other artistic endeavors should be treated differently than traditional businesses. Projections of revenue for film projects are completely speculative and worthless. No two films are alike and therefore it is impossible to predict the success of any film based on such projections. Filmmakers are story tellers and the key to success is having a story that resonates strongly with audiences. No one has ever found a way to accurately predict audience taste. And increasingly, the audience is an international one, making it even more difficult to determine which stories audiences will find entertaining. Many American independent films earn most of their revenues from audiences abroad.
Law Offices of Mark Litwak Associates
433 N. Camden Drive
Beverly Hills, CA 90210