Influential Panel to Weigh Tighter Crowdfunding Limits

NEW YORK (The Deal) -- The Securities and Exchange Commission is considering a controversial measure that would allow for the first time smaller investors to make private capital allocations through "crowdfunding" portals - a key provision in the JOBS Act that seeks to ease restrictions on entrepreneurs so they can raise capital cheaply.

Before the SEC adopts its rule on the subject, the agency must first consider a series of investor protection recommendations expected to be voted on at an April 10 meeting of its influential investor advisory committee. The panel is a key advocacy group that meets regularly at the SEC in sessions attended by top agency officials, including commission Chairwoman Mary Jo White.

The SEC proposal, which posed 295 questions and is hundreds of pages long, provides exemptions from SEC registration and disclosure rules to allow small businesses to raise up to $1 million annually from smaller investors.

The advisory committee is set to make its mark on a controversial provision in the proposal that allows investors to contribute up to 10% of their yearly income or assets to these startup companies if they have a net worth of $100,000 or they earn $100,000 annually. Individuals who earn less than $100,000 a year or have less than $100,000 in net worth will be able to invest up to $5,000 per company annually.

According to people familiar with the situation, the panel is expected to vote on a recommendation that would allow investors to allocate 10% of their yearly income or assets only if they have both an annual income of $100,000 and a net worth of the same amount.

Academics and investor protection advocates said they worry the most about individual investors who have no annual income but could be permitted, based on the SEC's current proposal, to invest 10% of their net worth.

"A person who has no income but has a $100,000 net worth could be a retired person living on social security," said Mercer Bullard, an associate professor at the University of Mississippi School of Law. "An SEC that believes that kind of person should be permitted to invest in the higher limit is not an investor-protection agency."


Barbara Roper, director of investor protection at the Consumer Federation of America and a member of the investor panel, argued that the JOBS Act gives the SEC some flexibility on this provision and that the agency should err on the side of greater protection.

"A more legitimate reading of the statute would be to limit the potential for unaffordable losses," Roper said.

The panel's suggestions are not binding with the commission but carry significant weight with the agency's commissioners, and their recommendations are often incorporated in rules.

However, Kim Wales, founder and CEO of New York-based Wales Capital, said the SEC should continue to allow investors to allocate 10% of their yearly income or assets even if they only have a $100,000 net worth. She argued that the risk remains minimal because of the $10,000 of net-worth limit. Wales added that these types of investors would likely allocate their capital to multiple crowdfunding deals as a means of diversifying their portfolio and limiting their risk. Changing the rules to require $100,000 of net worth and a $100,000 annual income may keep qualified accredited investors out of crowdfunding deals and drive them into private placement transactions.

Instead, Wales recommended that the SEC consider eliminating the cap on accredited investors' allocations to crowdfunding deals. This change may reduce the total number of investors in some crowdfunding deals from potentially over 1,000 to a few hundred, and that move would help facilitate the entrepreneur's ability to obtain a key follow-up round of financing from venture capitalists.

"If you are an accredited investor you should be allowed to invest more in crowd-funding deals," she said. "VC investors may not want to go into a deal when there are over 500 investors in it already. The more investors you have the more cumbersome it is to put a deal together that would bring in a top level VC investor."


Advisory committee members may also seek some restrictions on companies that conduct crowdfunding offerings in conjunction with their private deals.

At issue is a new rule allowing hedge funds and startup firms to publicly advertise their efforts to raise capital through private placements.

The new ad rule only applies to investments made by high-net-worth investors. The concern among investor-protection advocates is that a company could circumvent an ad restriction ban that exists for crowdfunding offerings by integrating those type of deals with new private placement transactions where solicitation is permitted.

One real estate crowdfunding company suggests a scenario involving a $5.5 million deal of which $5 million would be provided by approved accredited investors and $500,000 would be allocated to smaller investors through the crowdfunding approach. Investor advocates worry that, in such a scenario, an unaccredited investor could learn about the private placement investment opportunity through an advertisement but is then shifted to a simultaneous crowdfunding offer because they don't meet the net-worth qualifications for the private placement deal.

Critics contended that integrated offers could act as a loophole to draw in some lower-net-worth investors who really can't afford to take the risk. One approach to limit their concerns could be to impose a delay of one or two months between a crowdfunding offering and a private placement deal.

"What you are doing is putting out public advertisements to the masses of investors when at the end of the day your [private placement] offering can only be sold to accredited investors," said one advocate.

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