While the Securities and Exchange Commission dawdles, states are rushing to adopt their own crowdfunding rules. Ironically, it may just be the thing that rescues crowdfunding from a regulatory death grip.
In 2012, President Obama signed the Jumpstart Our Business Start-ups Act, otherwise known as the JOBS Act. The law was an odd creature. It purported to open up the capital markets and create jobs by loosening regulations on initial public offerings and allowing for crowdfunding. Yet there was little evidence to support that watering down of any of these regulations would create jobs. Instead, the bill mainly appeared to be catering to special interests and was intended to show that Congress was doing something, anything, to create jobs. Crowdfunding in particular was pushed by a number of special interests that — you guessed it — wanted to start crowdfunding sites.
Crowdfunding was also the most controversial part of the bill. The S.E.C., led by Mary Schapiro at the time, submitted a letter in opposition. The reason was basically fraud. Let’s face it, in a world where a potato salad party can raise more than $50,000 on Kickstarter, people may not be investigating their investments particularly well. The S.E.C. feared that crowdfunding would instead serve as an easy vehicle to defraud people.
More important perhaps was the idea that these investments would create zombie companies — companies that weren’t frauds but that investors simply couldn’t get profit from. The S.E.C.’s protests led to some last-minute revisions to the bill, including a requirement that a crowdfunding company include audited financials when raising more than $500,000.
Congress gave the S.E.C. a deadline of December 2012 to enact the new rules. For those keeping score, that was almost two years ago. But the S.E.C. has flouted that deadline and has yet to give a green light to crowdfunding. Its only action thus far was to issue proposed rules about a year ago. Hundreds of comments later, and nothing has happened.
For some who think that crowdfunding is an invitation to fraud, this is the best outcome, for the S.E.C. to simply ignore the law.
But the crowdfunding industry is eager for guidelines. And so it has started to go to the states to work around the S.E.C.’s inertia. Under the securities laws, an offering made in a state by company from that state is exempt from the S.E.C. rules on securities offerings. This was intentional when the Securities Act of 1933 was passed. The idea was that individual states should maintain jurisdiction of offerings limited to their borders because only their residents would be affected.
Armed with this exemption, 13 states have so far enacted crowdfunding rules. As might be expected, these states have different approaches.
The S.E.C. has been focused on minimizing fraud and has pushed for strict requirements, including that issuers prepare and file with the agency audited financials and extensive disclosure. But with the S.E.C. dragging its feet on approving the rules, national crowdfunding has stalled. In the meantime, the S.E.C. has been actively bringing litigation to shut down crowdfunding platforms that are operating despite the lack of rules.
For good or bad, the states don’t seem to care as much about the fraud issue.
Consider Texas, which last month proposed its own crowdfunding rules that are deliberately more liberal than those proposed by the S.E.C. The Texas rules require no audited financials and no extensive disclosure. Instead, a Texas company can raise up to $1 million in any 12-month period, and it only has to do so through a privately run portal that vets the companies. And unlike the S.E.C.’s proposed rules, there are no annual filing requirements. Michigan, Indiana and other states that have adopted their own crowdfunding rules have similarly relaxed requirements.
The proposed S.E.C. rules, particularly those requiring audited financials and annual reporting, have been criticized as detrimental to crowdfunding because compliance costs have been estimated to consume more than 15 percent of the offering. The result is that few expect the S.E.C. to adopt regulations that allow companies to use crowdfunding effectively.
Had the S.E.C. acted in a timely fashion, it would have ended the matter because its rules would have effectively pre-empted the states from acting. But the S.E.C.’s delay has given states room to offer more viable alternatives.
Still, some states are resisting the push. Florida’s crowdfunding legislation died after the state’s financial regulator opposed it.
The states that are filling the void are undertaking the great experiment that Congress should have required in the first place. Instead of ordering the S.E.C. to adopt crowdfunding rules as it did, Congress should have instead allowed for the S.E.C. to undertake a small-scale campaign to see what worked and what did not. Instead, Congress ordered the S.E.C. to adopt strict crowdfunding rules, while the agency has resisted.
The states themselves have decided to take up the experiment. Because of state crowdfunding laws, sites now exist like CraftFund in Wisconsin, which says it was instrumental in passing the state’s crowdfunding statute. It specializes in funding food and drink companies but seems partial to craft breweries. CraftFund started in Wisconsin for its residents to invest in Wisconsin companies, but it appears to be expanding to start-ups in other states.
Another site is LocalStake, an Indiana-based site that has about 50 potential investments listed, including a number of — you guessed it — craft beer companies. But there is also Moody’s Butcher shop, which raised $220,000 from 24 people and is the only “farm to fork” local food purveyor in Central Indiana, as well as a student loan company and a few other “tech” companies.
So there hasn’t exactly been a crowdfunding stampede in these states yet. This is crowdfunding in its glory — about buzzy ideas that get attention or loyalty but perhaps don’t succeed. In this world, craft beer seems to be the sine qua non of fund-raising. Who doesn’t want to invest in their own beer?
But that may be the good thing. Perhaps the S.E.C.’s concerns are overwrought and crowdfunding doesn’t need the tighter regulation. Alternatively, perhaps crowdfunding is the refuge of fraudulent brewers. Either way, we’re about to see which narrative of crowdfunding is true and whether crowdfunding can succeed, just in particular states. The S.E.C. has delayed on crowdfunding because it doesn’t approve of it, but perhaps the S.E.C. should continue to wait simply to find out what works and doesn’t in the more adventurous states.