Tag Archives: texas crowdfunding

Can A Crowdfunding Issuer Sell Its Own Securities?

Securities Cash  Register

Some states, including Texas, require all securities to be sold through licensed brokers. Do these state laws mean that Crowdfunding issuers can’t sell their own securities? Do they have to use a “clearing broker” instead?

For Title III the answer is easy. Securities under Title III may be offered and sold only through a licensed broker or a licensed funding portal. If you’re selling through a licensed broker then you’re complying with the state law, and section 15(i)(2)(A) of the Securities and Exchange Act of 1934 prohibits states from regulating funding portals in their businesses as such.

For Title II (Rule 506(c)) and Title IV (Regulation A), the answer is less clear. The issue is especially acute under Title IV, just because of the number of investors.

Section 18(a)(1) of Securities Act

Added to the law in 1996, section 18(a)(1) of the Securities Act of 1933 provides that:

Except as otherwise provided in this section, no law, rule, regulation, or order, or other administrative action of any State or any political subdivision thereof requiring, or with respect to, registration or qualification of securities, or registration or qualification of securities transactions, shall directly or indirectly apply to a security that is a covered security.

Because the term “covered security” includes securities offered under Rule 506(c) and Regulation A (also Title III, for that matter), the law clearly prohibits states from requiring the registration of a Crowdfunding offering. But does it also prohibit states from regulating who sells the securities?

Here’s the statute again, with extra words removed:

No law requiring registration or qualification of securities transactions shall apply to a covered security.

A sale of a security is definitely a “securities transaction.” So here’s the question:  does a state law that requires the sale to be effected through a licensed broker amount to requiring “registration or qualification” of the sale? Many smart people conclude that it does, making any such law unenforceable. That’s why you can go online today and find issuers offering securities directly to investors, despite state laws saying otherwise.

But there’s plenty of room for doubt. When a state says that all securities must be sold through licensed brokers, maybe it’s not requiring “registration or qualification” of the transaction; maybe it’s not regulating the sale at all. Maybe, instead, the state is regulating the person making the sale. Because section 18(a)(1) of the Securities Act doesn’t prohibit states from regulating brokers, the way section 15(i)(2)(A) of the Exchange Act prohibits them from regulating funding portals, maybe these laws aren’t affected.

For good measure, I’ve read academic articles arguing that the 1996 law amending section 18(a)(1), and stripping states of their historic regulatory authority over most securities offerings, was an unconstitutional extension of the Commerce Clause of the U.S. Constitution.

What’s At Stake

If an issuer violates a state law by selling securities directly to investors, the issuer could be subject to state enforcement action, i.e., fines and penalties.

The greater risk, in my opinion, is the risk of claims from investors. If a widow in Texas loses money she might not accept her loss graciously. She (or her heirs, or the trustee in her Chapter 7 bankruptcy case) might look for a way to recoup her loss. And if she can show that the issuer violated Texas law, the court may find a right of rescission, i.e., the right to get her money back. The court might even extend that right against the principals of the issuer personally, especially if they were engaged in selling activities.

I imagine the widow on the stand, asking for recourse against the New York based issuer, backed by an amicus curiae brief filed by the Texas Board of Securities and the National Association of State Securities Administrators. Given the room for ambiguity in the statute, I’m not thrilled with my odds.

And even if you win, there’s the time and cost of defending yourself, and the sleeping-well-at-night factor, also.

What To Do

The simplest solution is to sell through a clearing broker licensed in every state.

Another solution is to sell through a clearing broker only in states that require it (I don’t have a list, but maybe a reader does and can share it).

If an issuer doesn’t want to spend the money on a clearing broker, it might decide not to sell securities in any state that requires use of a broker, although that includes some big states.

Or an issuer, guided by counsel, might reasonably decide to live with the uncertainty in the law and sell securities anyway. Just make sure your insurance would cover the widow’s claims.

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My thanks to Jillian Sidoti, Esq. and Anthony Zeoli, Esq., who provided valuable insight.

Questions? Let me know.

Intrastate Crowdfunding After Title III

CF WordclouldOn one hand, the SEC just proposed several changes to Rule 147 that will make intrastate Crowdfunding easier:

  • We used to worry, at least a little, about the language in Rule 147 saying that you couldn’t offer securities to anyone outside the state. How does this work when your offers are made with the Internet, we wondered? The SEC just proposed eliminating that requirement.
  • If you were doing an intrastate offering in Texas, Rule 147 used
    to require using a Texas entity – not Delaware, for example. No more.
  • If you’re doing an intrastate offering in Texas, you have to show you’re doing business in Texas. The new proposals would make that easier.
  • The new proposals would also simplify and rationalize the rules around (1) the “integration” of offerings (combining an intrastate offering with other offerings), (2) verifying that investors are residents of the state, and (3) re-sales of securities purchased in an intrastate offering.

All that is great, and should really help the intrastate Crowdfunding market (although I take to heart Anthony Zeoli’s excellent caveat here.)

On the other hand, the SEC also proposed a $5 million cap on intrastate offerings, which seems very important in light of Title III.

Title III Crowdfunding allows any issuer anywhere to raise up to $1 million from non-accredited investors who live anywhere in the world. With Title III Crowdfunding available, why would an issuer use intrastate Crowdfunding? There are only two possible reasons:

  • You’re allowed to raise more money in the intrastate offering
  • The process of the intrastate offering is faster/cheaper/easier

Once the hi-tech folks get their hands around Title III, I think we’re going to see the process becoming faster, cheaper, and easier than it looks now, making Title III comparable (maybe even superior) to intrastate Crowdfunding from that perspective.

Then it just comes down to how much you can raise. If I am a small issuer – raising less than $1 million, for example – why would I use the intrastate law of my state when I can use Title III instead and appeal to the whole universe of investors? Case in point:  New Jersey enacted an intrastate Crowdfunding law just this week – with a $1 million limit. Why would a New Jersey business use that law, with Title III on the books and the gold and silver of Manhattan right across the Hudson River?

And if I’m a software developer wondering what kind of platform to build, isn’t the scale tipped in favor of Title III?

The scales will tip further that way when Congress increases the limit of Title III from $1 million to something higher. Although the SEC can always raise the limit for intrastate Crowdfunding as well, the future probably belongs to Title III.

Questions? Let me know.

WHY FINANCIAL FIRMS ARE JOINING THE CROWD, BY JOY SCHOFFLER, PRINCIPAL OF LEVERAGE PR

Crowdfunding is a marketing vehicle. Sure, it’s a great way for entrepreneurs to raise money and a great way for investors to find institutional-quality deals. But above all Crowdfunding is about marketing. And that’s why financial firms – venture capital firms, investment banks, private equity firms, and others – are moving into the space.

When I was the director of a private equity firm, we spent our time doing what all investment firms do, working to broaden the firm’s investor base and find more and better deals. Because of the legal constraints that have been in place since the early 1930s, we (and everyone else) had to rely on private networks. While we developed a large private network, the process of manual network development is slow by design.

With the passage of the JOBS Act, everything has changed. Now, investment firms can take what was essentially a marketing function and move it online, using tools and marketing best practices to build their networks.

Today I run a public relations firm, Leverage PR, which works at the intersection of technology and finance. With my background Fin-Tech I’ve naturally gravitated to Crowdfunding and serve in leadership roles in the industry, including serving on the board of CFIRA, the leading trade association. From that vantage point I can see the trends in both technology and finance. Without doubt, one of the most pronounced trends is that financial firms are moving into Crowdfunding, with established players launching their own portals or partnering with others.

Here are the six leading factors encouraging financial firms to join the Crowd:

Reason #1: Adding to the Capital Stack – Raising money is hard. Even established firms with a base of institutional money need smaller investors to augment the capital stack or fill holes. If done properly, with the right public relations, launching a Crowdfunding platform is a wonderful way to get in front of new bases of potential investors and prove expertise in an industry.

Reason #2: Marketing Automation – Private equity has, by and large, stayed in the marketing Stone Age. Some of the biggest firms still use spreadsheets to track current investors and monitor prospective investors. In contrast, the best Crowdfunding platforms have embraced the power of marketing automation. They set up investors on drip marketing campaigns from the minute they sign up. They learn what each investor likes and doesn’t like using data from the site. They convert small investors into larger investors. They use technology to create the economies of scale that make dealing with smaller investors possible and profitable.

Reason #3: Improve and Automate Investor Relations – When many of us in private equity first heard of Crowdfunding we imagined a nightmare of dealing with hundreds of investors. The opposite is true. A Crowdfunding platform provides a better customer platform. In fact, we’re seeing established private equity firms launch portals solely for investor relations post close.

Reason #4: More and Better Deals – Early entrants into the space who are marketing their Crowdfunding portal are not only seeing a deeper and wider investor pool but are also seeing increased deal flow. Even if firms are launching only to do their own deals they are generating interest and traffic from other in their space who are bringing them deals.

Reason #5: Partnerships – Innovative companies are partnering with Crowdfunding platforms across a number of sectors to identify potential acquisition targets, effectively using the platforms as quasi-outsourced R&D. We believe this trend, already begun by firms like Healthios Exchange and CircleUp, will continue and intensify. R&D is expensive and risky. Crowdfunding offers a better and cheaper alternative. View More: http://votiveimage.pass.us/leveragepr

Reason #6: Get Ahead of the Curve – Technology is changing everything and private equity is no exception. While we don’t know what private equity will look like in 10 years, we’re sure it will be online.

As we look forward to 2015, I’m excited about what lies ahead. While it’s true that the JOBS Act opened a world of opportunities for new, innovative players, it also gives established financial firms the tools to expand market reach, lower minimum investments, and bring technology to manual processes.

Joy Schoffler, principal of Leverage PR, is a nationally recognized author and speaker on financial services communications. An active member of the Crowdfunding community Joy sits on the board of CFIRA.org a leading Crowdfunding advocacy association. Before launching Leverage, Joy served as director of acquisitions for the Inc. award-winning private equity firm The PPA Group. Joy has written for a number of publications including Entrepreneur.com, Social Media Monthly and MarketingProfs. She is also a contributing author for the Wiley-published Bloomberg Media book “Crowdfunding: The Ultimate Guide to Raising Capital on the Internet.”

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