I read with interest Mr. Stuhldreher’s April 13 article on the JOBS Act. On balance, I view the JOBS Act as greatly facilitating the raising of legitimate capital by startup businesses — those that are too small to attract venture capital funds but which are the engines of local job growth.
Companies whose offerings are limited to investors meeting certain levels of financial sophistication — called Accredited Investors now — will be able to use a website, Facebook page and emails to reach these investors. Although Pennsylvania has permitted this type of communication for over 15 years, its utility was hampered by federal restrictions on general solicitation. With these restrictions removed, companies don’t have to worry about offering securities across state lines where sales are limited to these types of investors.
Conversely, a SEC exemption for offerings of $1 million or less, known as Rule 504, has been around since the early 1980s, but its utility has been hampered by states not having a similar exemption. States were concerned that Rule 504 had no mandatory disclosure requirements and persons with prior criminal convictions or securities laws violations could use that exemption.
The “crowdfunding” provision in the JOBS Act has more investor protection provisions than Rule 504, plus it addresses the state issue by preempting these offerings from the registration requirements of each state’s securities laws. Because this provision now gives certainty to companies seeking investors in multiple states, it could become a useful capital-raising tool.
To address investor protection, the crowdfunding provision, among other things, requires a small business issuer to:
- Offer securities only through a SEC registered broker or funding portal.
- Limit the amount of funds accepted from any single investor.
- Provide minimum required disclosures to investors.
- Provide reviewed or audited financial statements for offerings of $100,000 or more.
- Give investors a right of rescission.
- Not meet any SEC disqualification provision.
- Refrain from advertising offering terms (but can direct persons to a funding portal).
- Restrict resales of the securities.
Historically, financial intermediaries have been disinclined to help small businesses with capital raising due to liability concerns and low profit margins. The JOBS Act sought to make it appealing for financial professionals to assist small business.
The JOBS Act promotes use of funding portals that act as a public “matchmaker” of investors and small business investment opportunities. Funding portals will be exempt from state broker-dealer registration except the state where the funding portal has its principal place of business, but state rules cannot exceed the scope of SEC rules. Although funding portals will be exempt from state registration, they must undertake certain investor protection functions, such as providing disclosure and conducting background checks on officers, directors and promoters.
The second innovation is increasing the limit of small public offerings exempt from SEC registration from $5 million to $50 million. It is hoped that this attracts more interest from the investment banks to undertake smaller offerings. Also, companies can “test the waters” to gauge potential investor reaction before engaging in the time and expense of a public offering.
Pennsylvania has allowed “testing the waters” for well over a decade, but not all states did. Therefore, its utility was marginal for those wanting to “test the waters” on an interstate basis. Although the JOBS Act did not preempt state jurisdiction over these indications of interests that are deemed to be “offers” of securities, it requires the Comptroller General to conduct a study on the effect of state securities laws in this area.
By updating federal law and addressing state law issues, the JOBS Act makes it easier for companies seeking investors across state lines while providing important investor protections. Since the act requires the SEC to adopt a number of new rules, it will be some time before companies can take advantage of these changes but at least the legal foundation has been laid.
During my tenure as a former state securities regulator in Pennsylvania, we focused on promoting legitimate capital formation for small businesses. From that perspective, I view the JOBS Act as a positive development.
—G. Philip Rutledge, Bybel Rutledge LLP, Lemoyne