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Colleen Baker

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PhD (Wharton) Professor Baker is an expert in banking and financial institutions law and regulation, with extensive knowledge of over-the-counter derivatives, clearing, the Dodd-Frank Act, and bankruptcy, in addition to being a mediator and arbitrator.

Previously, she spent time at the U. of Illinois Urbana-Champaign College of Business, the U. of Notre Dame Law School, and Villanova University Law School. She has consulted for the Federal Reserve Bank of Chicago, and for The Volcker Alliance.  Prior to academia, Professor Baker worked as a legal professional and as an information technology associate. She is a member of the State Bars of NY and TX. Read More

I have argued that, because of excessive regulatory costs, the new crowdfunding exemption in section 4(a)(6) of the Securities Act is unlikely to be as successful as hoped. (Rule 506(c) is another story; I expect that to be wildly successful.)

We now know what the SEC anticipates. Hidden deep within the SEC’s recent crowdfunding rules proposal is the Commission’s own estimate of the likely impact of the new exemption. (It’s on pp. 427-428, in the Paperwork Reduction Act discussion, if you want to look at it yourself.)

How Many Crowdfunded Offerings?

The SEC estimates that there will be 2,300 crowdfunded offerings a year once the new section 4(a)(6) exemption goes into effect, raising an average of $100,000 per offering. That’s a total of $230 million raised each year.

How Many Crowfunding Platforms?

The SEC estimates, “based, in part on current indications of interest” (p. 380) that 110 intermediaries will offer crowdfunding platforms for section 4(a)(6) offerings. Sixty of those will be operated by registered securities brokers and the other fifty will be operated by registered funding portals. (Non-brokers may act as crowdfunding intermediaries only if they register as funding portals.)

The Fight to Survive

If the SEC’s figures are correct…

Title III of the JOBS Act, which contains the new crowdfunding exemption, is not a particularly well-drafted statute. It was put together rather quickly in the Senate as a substitute for the crowdfunding exemption that passed the House and never went through a formal committee markup. The resulting exemption contains a number of ambiguities and loopholes. I am happy to report that the SEC’s proposed rules to implement the crowdfunding exemption clear up the major statutory problems.

1. $1 Million Offering Limit Includes Only Crowdfunded Offerings

Section 4(a)(6)(A) of the Securities Act provides that the exemption is available only if

the aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption provided under this paragraph during the 12-month period preceding the date of such transaction, is not more than $1,000,000.

The “including” clause makes it unclear if only securities sold pursuant to the crowdfunding exemption are included, or if securities sold pursuant to other exemptions during the 12-month period must also be subtracted from the $1 million limit. I argued (here, at p. 200) that only crowdfunded securities should count against the limit, but conceded that this statutory language is…

I blogged yesterday about the SEC’s release of proposed rules to implement the JOBS Act crowdfunding exemption.

Both the JOBS Act and the proposed rules require that crowdfunding offerings be made through either registered securities brokers or registered funding portals. “Funding portal” is a new category of regulated entity created by the JOBS Act specifically for exempted crowdfunded offerings. The Act requires non-broker funding portals to belong to a national securities association subject to rules “written specifically for registered funding portals.” (See section 3(h)(2) of the Exchange Act, as amended by the JOBS Act.) Because of that requirement, non-broker funding portals cannot engage in crowdfunding until those rules are in place.

Somewhat overlooked in the hoopla surrounding the SEC rules proposal was the release of proposed rules by the Financial Industry Regulatory Authority (FINRA) to regulate funding portals. The FINRA notice is here and the proposed rules are here.

I hope the SEC and FINRA are careful to coordinate final adoption of the crowdfunding rules and the FINRA rules. Funding portals cannot engage in crowdfunding until they have registered under the FINRA rules. If the crowdfunding rules go into effect before funding portals can register with FINRA, brokers…

The SEC has finally released its long-awaited proposal for rules to implement the crowdfunding exemption in the JOBS Act. It’s available here. The 585-page proposal is substantial, even by SEC standards.

The statutory deadline for the SEC to adopt these rules was Dec. 31, 2012, but almost no one with a sophisticated knowledge of securities law, including me, expected the SEC to meet that deadline. I wish I had bet with some of the people in the crowdfunding community who naively expected that deadline to be met; I could have cleaned up.

There’s a 90-day comment period. (Giving people 90 days to comment on a 585-page proposal that it took 18 months to draft is chutzpah.) Because of that, adoption before the end of this year is impossible. [I corrected this. The original post said 60 days.]

I am happy to report that SEC staff members have read my two articles on crowdfunding and the JOBS Act crowdfunding exemption (available here and here). Those articles are cited several times in the release. I will be interesting to see if the staff actually acted on any of my recommendations or accepted any of my interpretations in drafting the rule.

The JOBS Act offers two new opportunities to offer securities on the Internet without Securities Act registration. Both the Rule 506(c) exemption and the new crowdfunding exemption could be used to sell securities on web sites open to the general public. But could a single web site offer securities pursuant to both exemptions at the same time (assuming the SEC eventually proposes and adopts the regulations required to implement the crowdfunding exemption)?

Background: The two exemptions

Rule 506(c) allows an issuer to publicly advertise a securities offering, as long as the securities are only sold to accredited investors. Rule 506(c) is not limited to Internet offerings, but it could be used by an issuer to advertise an offering on an Internet site open to the general public—as long as actual sales are limited to accredited investors.

The new crowdfunding exemption, added as section 4(a)(6) of the Securities Act, allows issuers to sell up to $1 million of securities each year. The offering may be on a public Internet site, as long as that site is operated by a registered securities broker or a “funding portal,” a new category of regulated entity created by the JOBS Act.

Could a single intermediary…

In the last 30 years, it has become incredibly important whether or not investors in securities offerings are accredited investors. An issuer can sell securities to accredited investors without registration (and without alternative disclosure requirements) under both Rule 506 and new Rule 506(c) of Regulation D.Accredited investor status also matters in determining whether an issuer is a reporting company under the Exchange Act. A company must register under the Exchange Act only if it has 2,000 record holders of a class of equity security or “500 persons who are not accredited investors.” Exchange Act sec. 12(g)(1)(A).

But the SEC may have taken a wrong turn when it defined the term to make individuals “accredited investors” based solely on the absolute level of their net worth or annual income.

The Section 4(a)(2) Exemption

Section 4(a)(2) [formerly, section 4(2)] of the Securities Act of 1933 exempts from registration “transactions by an issuer not involving any public offering.”

The leading case interpreting that statutory exemption is SEC v. Ralston Purina Co., 346 U.S. 119 (1953). In that case, the Supreme Court indicated that the availability of the exemption turns on “the need of the offerees for the protections afforded by registration.&rdquo…

The SEC’s new Rule 506(c) exemption, mandated by the JOBS Act, allows issuers to solicit anyone to purchase securities, through public advertising or otherwise, as long as they only sell to accredited investors (or investors that the issuer reasonably believes are accredited investors). For most individuals, accreditor investor status depends on the investor’s annual income and net worth.

The crowdfunding exemption added by the JOBS Act allows issuers to sell securities to anyone, accredited or not, but the amount of securities each investor may purchase depends on the investor’s net worth and annual income. (For more on the new crowdfunding exemption, see my article here.)

Because of these requirements, it is important under both exemptions to know the net worth and annual income of each investor.

NOTE: Many people are referring to Rule 506(c) as “crowdfunding” but
the actual crowdfunding exemption is something different. Brokers and
others selling under Rule 506 began calling that crowdfunding as a
marketing ploy to capitalize on the popularity of crowdfunding. Some
academics have adopted that usage, which I think is unfortunate and only
leads to confusion.

The simplest way to deal with these requirements would be to allow investors to self-certify. If an…

Should we flip the way we teach Business Associations?

Last week I asked whether law schools are teaching the law of securities regulation, particularly Securities Act exemptions, backwards. I proposed that the current rule-by-rule approach be flipped to a more topical approach. This week, I’m asking the same question about Business Associations, but I’m much less sure of the correct answer.

The basic Business Associations course at most law schools today includes much more than the law of corporations. Most Business Associations courses cover partnerships and limited liability companies, and often limited partnerships and agency law as well. 

The leading publishers offer a number of business associations casebooks, but their basic organizational structure is the same: each entity is covered separately. A typical casebook might, for example, begin with partnership law, then cover the law of corporations, then limited liability companies. The topics covered for each entity are similar: formation, management, fiduciary duty, the liability of investors, exit rights, and so on. 

Why not flip this organizational structure and organize business associations courses by substantive topic rather than by entity? We could begin with a chapter on formation that discusses how all of the entities are created. A chapter on management…