December 26, 2012 By ROBB MANDELBAUM When the Jobs Act became law in April, supporters proclaimed a new era for small businesses seeking to raise money.
The “game changer,” as President Obama put it in the Rose Garden as he signed the bill, was a provision to let small companies “crowdfund” — that is, sell stock and other securities over the Internet directly to the public. “For the first time,” the president said, “ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”
But it now seems that dawn will break late on this new age of democratic investing. The Securities and Exchange Commission appears certain to miss its end-of-year deadline for issuing regulations to put the provision into effect. And with the departure of the S.E.C. chairwoman, Mary L. Schapiro, and three of her top deputies — including two who manage the offices writing the regulations — some in the nascent equity crowdfunding industry worry that it could be 2014 before their line of business becomes legal.
The delay has frustrated many crowdfunding backers. The 270 days that Congress gave the S.E.C. to write the rules “is not a suggested timeline; it is a Congressional mandate,” said Kim Wales, an organizer at Crowdfund Intermediary Regulatory Advocates, a lobbying group formed in April to represent the new industry, in an e-mailed statement. “The S.E.C. answers to Congress, not the other way around.”
The crowdfunding provision, Title III of the Jumpstart Our Business Startups Act, creates an exception to the general rule that before a company can sell its stock to the public, it must register with the S.E.C., a process of disclosure requiring elaborate and expensive assistance from lawyers, accountants and investment bankers that most small companies cannot afford. Instead, businesses seeking less than $1 million will be able to raise capital online from small investors in a streamlined process.
But the law insists on strong investor protections, and as a result, the S.E.C. must iron out numerous issues concerning how crowdfunding companies, the intermediaries handling the transactions and even investors themselves can operate.
Small businesses, especially start-ups, are notoriously risky; in essence, the S.E.C. is writing rules that will govern a very dangerous game. “It’s actually a significant job to do the regulations in this area, so it was an unrealistic expectation that the S.E.C. would have it completed by now,” said Barbara Roper, director of investor protection for the Consumer Federation of America, which is lobbying the agency on other aspects of the Jobs Act. “I think they have 21 or 22 separate regulations to write.”
S.E.C. employees began accepting comments from and arranging meetings with interested members of the public about crowdfunding shortly after the Jobs Act became law. In those meetings, agency officials “have come in with our white papers fully highlighted, line by line, to discuss it,” said Alon Hillel-Tuch, co-founder and chief financial officer at RocketHub, a crowdfunding site that lets people and businesses raise money through donations or by offering rewards. (Current law allows sites to accept donations or deposits on a product.)
A spokeswoman for Senator Jeff Merkley, an Oregon Democrat who largely wrote the crowdfunding measure, said that the S.E.C. was grappling with the more stringent requirements courts had imposed for conducting cost-benefit analyses when writing regulations. This “has slowed down everything from Dodd-Frank to the Jobs Act,” the spokeswoman, Courtney Warner Crowell, said in an e-mail.
With data for analyzing equity crowdfunding in short supply, the S.E.C. asked RocketHub and Indiegogo, another donation-based crowdfunding service, to provide information about their operating practices and campaigns they had conducted. RocketHub complied, Mr. Hillel-Tuch said.
But Indiegogo did not, said Slava Rubin, the company’s chief executive, because it did not want to share trade secrets.
Mr. Hillel-Tuch said S.E.C. officials also requested help from Kickstarter, another leading crowdfunding site. Officials spoke with a Kickstarter executive in July, but neither the agency nor Kickstarter would comment on the meeting.
Under Title III, companies wishing to sell stock to the public will have to provide information to investors and the S.E.C., including financial disclosures that grow more extensive as the size of the offerings increases. They will be allowed to sell stock only through an intermediary: either a broker-dealer or a specialized crowdfunding Web site, or portal. The intermediaries will have to take steps to ensure that small investors are protected, even from themselves. The law limits how much a person can invest in crowdfunding in a year, depending on income and net worth.
Advocates for both investors and members of the crowdfunding industry have dissected nearly every element of the legislation. “I think there are probably 25 or 30 legitimately important issues,” said Douglas S. Ellenoff, a New York securities lawyer who is advising some in the industry. “But I think they’ve all been hashed out. They have heard issues from a variety of angles, and I think that the draft proposals are fairly advanced.”
High on the list of priorities for the portals is to make sure they face less scrutiny from regulators than broker-dealers do. “What we’re asking for is the funding portals are viewed as sort of a broker-dealer-lite sort of model, where the mandates for broker-dealers are not imposed on a funding portal,” said Ms. Wales, the crowdfunding lobbyist.
The crowdfunding interests are also warning regulators that some of the stringent investor protection measures could, if fully adopted, make crowdfunding prohibitively expensive. The law, for example, requires intermediaries to “make such efforts as the commission determines appropriate” to verify that investors have not exceeded their investment limits, across all intermediaries and stock issuers. But would-be intermediaries fear the prospect of having to confirm this independently, which could entail checking tax forms or creating a database of all investors.
The industry is likewise taking aim at a requirement that issuers raising more than $500,000 provide investors with audited financial statements. “If you’re a new business and you have to submit audited financials that you don’t have yet, it doesn’t make sense,” said Mr. Hillel-Tuch of RocketHub. The law gives the S.E.C. discretion to change this threshold, and Mr. Hillel-Tuch argued that no business seeking to crowdfund should be subject to it.
Calling the requirement unrealistic, Indiegogo’s Mr. Rubin said, “There’s no question that this is a massive deal breaker.” He urged regulators to tread lightly. “There’s a lot to do here, but why not let the industry figure it out?” he said. “Along the way there will be some ups and downs, but in the long run, like the Internet, we’ll have created an amazing industry.”
Investor protection advocates remain concerned about those downs. “The thing about crowdfunding is that it brings together unsophisticated issuers with unsophisticated investors,” said Ms. Roper of the Consumer Federation of America. “What could possibly go wrong?”
An S.E.C. spokeswoman declined to comment on the status of the rules. This month, Mr. Merkley and several other legislators wrote to Ms. Schapiro, who stepped down on Dec. 14, to urge the agency to propose rules putting the crowdfunding legislation into effect “in the most expeditious manner possible.”
Outside observers can only guess at what the commissioners — now two Democrats and two Republicans — will do next. But crowdfunding proponents say they remain optimistic, in part because they feel they have developed a good working relationship with their regulators at the S.E.C. “I believe that with the dialogue we have had with the staff, we will see proposed rules that facilitate a responsible emerging industry with a viable economic model,” said Mr. Ellenoff, the securities lawyer. “I’ve been involved in other programs where I don’t feel the same way.”