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Statement on the Adoption of Regulation Crowdfunding

Commissioner Kara M. Stein

Oct. 30, 2015

Let me join in praising the hard work of the staff. Getting crowdfunding up and running may seem like a simple endeavor, but it has been a big undertaking. While it has been three and a half years since the bill was signed into law, I know these last weeks have been intense for many of you. So thank you to Sebastian Gomez Abero, Julie Davis, Amy Reischauer, Eddie Aleman, Heather Seidel, Joe Furey, Tim White, Joanne Rutkowski, Erin Galipeau, Devin Ryan, Bryant Morris, Dorothy McCuaig, Janice Mitnick, Simona Mola Yost, Vladimir Ivanov, Anzhela Knyazeva , and the entire team for your dedication and hard work.

As the Commission adopts it today, Regulation Crowdfunding will enable small businesses to raise up to $1 million[1] through a regulated intermediary in mostly small amounts over the Internet. The CROWDFUND Act, which forms Title III of the JOBS Act, sought to pioneer a new way for small businesses to raise small amounts of capital. At the same time, it recognized that, for the market to thrive over the long run, certain basic investor protections are critical.[2]

These investor protections are not just important to the college student, to the grandmother, and to the working mom who jump on the Internet wanting to experiment with crowdfunding. They also protect the small businesses that want a reliable market to raise capital. If investors don’t feel the market is safe for them to invest, there won’t be much capital raising going on there.

To that end, some of the most important investor protections in any securities offering are the gatekeepers that can identify and ameliorate problems before investors lose their money. In part, crowdfunding is an experiment in seeing whether the “crowd” can serve as its own gatekeeper. I hope it can, but I also believe the crowd will benefit from a little help in identifying and rooting out fraud. That’s why I have long pushed for a modest but important role for accountants and the broker-dealers and funding portals that will run the platforms.

With regard to accounting, today’s rule is a compromise. It hews to the statutory approach that requires an accountant to review the issuer’s financial statements for offerings above $100,000 and an accountant to audit the issuer’s financial statements for offerings above $500,000. But, it grants an exception to the requirement for a full audit for the very first offering.

For background, a review is a limited check of the financials by an accountant. It basically says, “I haven’t seen anything wrong here.” An audit, on the other hand, is a proactive check where the accountant tests inputs and opines on the accuracy of the financial statements. The benefits of testing, affirmatively opining, and the additional disclosures of the notes to the financials have long made audited financial statements the foundational document of public offerings. Their value is especially apparent where the public has limited ability to independently “kick the tires” of the company.[3]

At the same time, I am cognizant of the cost concerns of an audit. Accordingly, I think the Commission’s approach today is a reasonable place to start.

With regard to intermediaries, they too have a role to play. As repeat players in the market, broker-dealers and funding portals are well-positioned to know what to look for and help ensure that the offering complies with the law. To that end, today’s rules permit a broker-dealer or a funding portal to rely on the representations of the issuer unless the intermediary has reason to question the reliability of those representations.[4] While I might have preferred stronger language, I am cognizant of the challenges in setting out a more proscriptive standard at this time.

Moreover, as the preamble makes clear, the Commission takes seriously the intermediary’s obligations to assess whether it may reasonably rely on the representations. To quote, “the specific steps an intermediary should take to determine whether it can rely on an issuer representation may vary, but should be influenced by and tailored according to the intermediary’s knowledge and comfort with each particular issuer.”[5] In short, an intermediary will need to do a little bit of work to gain confidence that the small business is what it says it is. Intermediaries will also need to develop written policies and procedures for how they will execute these obligations.

There are other incentives built into the structure of the law itself that should also encourage intermediaries to conduct some level of due diligence on issuers.[6] Thus, I am comfortable supporting the measured approach put forward today, and I look forward to seeing how market practice evolves. We may also learn from the examination work of the Commission staff and self-regulatory organizations (SRO) — one of the major benefits of utilizing regulated intermediaries. As we gain experience, we should be prepared to adjust requirements in this area.

Because start-ups and small businesses are inherently risky investments, the CROWDFUND Act also establishes aggregate investment caps. I am pleased that the Commission today is heeding the intent of Congress to adopt a more conservative approach for these caps. Caps will not be easy to monitor. But, there are things we can do. For example, the data on platforms will be in a form that the Commission and the SRO can access and analyze electronically. Thus, the Commission and the SRO should be able to spot potential issues and take action to protect investors.

Surprising as it may seem, another challenge is how to protect crowdfunding investors when a business actually does well. Angel and venture investors are able to protect their interests through a variety of levers. However, the crowd may be unable, practically speaking, to negotiate for or utilize the same types of levers. As a result, the crowd could see its investments heavily diluted in follow-on offerings.

To address this, today’s rules give the crowd a little extra help by aligning the interests of the intermediary with that of the crowd. Specifically, the rules enable an intermediary to take a position in the issuer as compensation for the offering, provided that the securities it takes have the same terms, conditions, and rights as the crowd.[7] This approach has multiple benefits as it also responds to the demands of small businesses that wanted to be able to compensate intermediaries by allowing them to take a stake in the company.

Today’s rules, I believe, are a measured approach to the challenging task before us. Yet, I do not see our work as complete. I am comfortable with today’s Regulation Crowdfunding in no small part because the Commission is requiring the staff to conduct a three-year look-back study to evaluate how the market develops. If we have gone too far in one direction or the other, I hope that this study can help us identify and respond to problems.

I am committed to making crowdfunding work to the best of its potential, for both small businesses and investors. I intend to keep a close eye on this space. And, I hope the Commission will be ready and willing to act, should the need arise. Let’s see how this experiment works.

[1] After adjusting for inflation, eventually more. See Securities Act of 1933 § 4A(h)(1), 15 U.S.C. § 77d-1(h)(1)(2012).

[2] See Regulation Crowdfunding, 6-7 (Oct. 30, 2015).

[3] Indeed, accounting emerged to address precisely that need — to have the accountant serve as the eyes and ears of the investor in far off companies, such as the British investor in U.S. railroads. See Gary John Previts, A History of Accountancy in the USA: The Cultural Significance of Accounting (1998).

[4] Regulation Crowdfunding, Rule 301(a) (Oct. 30, 2015).

[5] Regulation Crowdfunding, 171-72 (Oct. 30, 2015).

[6] See Regulation Crowdfunding, footnote 643 on page 171 (Oct. 30, 2015).

[7] Regulation Crowdfunding, Rule 300(b) (Oct. 30, 2015).

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