Category: JOBS Act

Republican Dysfunction Could Benefit Crowdfunding

Republican Dysfunction Could Benefit Crowdfunding — REALLY

On By crowdfundattnyIn JOBS ActLeave a comment

During my lifetime we’ve never seen political dysfunction like the dysfunction we’re seeing among House Republicans. Coming just as American leadership could be most helpful, the dysfunction is dangerous, a national embarrassment, all that and much more. Yet it might prove good for Crowdfunding.

An ally of Representative Kevin McCarthy, Representative Patrick T. McHenry of North Carolina was designated “interim Speaker” when McCarthy was dethroned. Nobody knows what “interim Speaker” means or what he or she can do, but now, with Republicans unable to agree on an actual Speaker and no other way out of the cul-de-sac, the idea is circulating to give Rep. McHenry some real power and try to run the place. 

Unprecedented? Sure. But so is the dysfunction among Republicans.

Well, it just so happens that Rep. McHenry was the leading proponent of the JOBS Act, the 2012 law that launched Crowdfunding in all its current forms. Ever since, he has also been a leading proponent of improving the law, making it easier for entrepreneurs to raise capital and for ordinary Americans to participate.

Crowdfunding isn’t exactly high up on the list of priorities for either party. But when you’re Speaker of the House of Representative, or “interim Speaker with special powers,” you get to do stuff. If Rep. McHenry holds his position, I wouldn’t be shocked to see changes to the JOBS Act attached to other legislation, even a bill to help Israel and Ukraine.

To quote someone else, there are two things you never want to see being made:  sausage and law. If the dysfunction among Republicans can help Crowdfunding and the American economy, so be it.

Questions? Let me know.

Proposed Changes To Taxation Of Carried Interests

On By crowdfundattnyIn JOBS Act, TaxLeave a comment

The Inflation Reduction Act of 2022 promises big changes to how America responds to global warming, aka climate change. But if enacted in its current form, it will also change how real estate sponsors and hedge fund managers are taxed on carried interests.

A “carried interest” or “promote” is what the sponsor gets for putting the deal together. In a typical hedge fund, the manager receives a 2% annual management fee plus 20% of the profits. In the syndication of an apartment building, the deal sponsor might receive 30% of the profits after investors have received a preferred return of 7% and all their money back. The 20% of the hedge fund manager and the 30% of the real estate sponsor are the “carried interest.”

For many years gains from carried interests were taxed as capital gains rather than ordinary income. This favorable tax treatment attracted widespread criticism, from Warren Buffett among others, and is often referred to derisively as the “carried interest loophole.”

As described here, section 1061 was added to the Internal Revenue Code to close, or at least narrow, the loophole. Under section 1061, gains from carried interests generally are treated as ordinary income if the interest is held less than three years. But in a loophole within a loophole, capital gain was preserved for most real estate syndications by excluding from section 1061 gains from the sale of property used in a trade or business, such as the ownership and operation of an apartment building.

The Inflation Reduction Act of 2022 includes two important changes to section 1061. One, the three year holding period will be extended to five years. Two, the exception for property used in a trade or business will be eliminated.

As someone famous once said, one man’s loophole is another man’s castle (or something like that). For many real estate sponsors, the carried interest is the primary source of income: annual management fees pay the bills, but the carried interest sends the kids to college. Increasing the tax rate on the carried interest by 20 percentage points or more is not trivial.

The capital gain rate is still available if the property is held for five years, but many real estate projects contemplate shorter holding periods.

If the changes are enacted in their current form, I expect sponsors will adjust the economic deal with investors. Most likely, we will see the carried interest percentage increase from around 30% to around 50%, at least for transactions where the holding period will be less than five years. For that matter, we will probably see longer holding periods for both hedge funds and real estate, as the market adjusts.

Senator Sinema of Arizona is a longtime fan of the carried interest loophole and hasn’t yet weighed in on the Inflation Reduction Act. You can bet she’s getting lots of phone calls as we speak.

Questions? Let me know.

The Expanded Definition Of Accredited Investor: A (First) Step In The Right Direction

On By crowdfundattnyIn Accredited Investor, JOBS Act, SEC, SEC ProposalsLeave a comment

For all the ink spilled wondering and worrying how the SEC might change the definition of accredited investor, yesterday’s announcement seems almost anti-climactic.

Perhaps the main story is what the SEC didn’t do. It didn’t limit the definition of accredited investor in any way. Everyone who was an accredited investor yesterday is an accredited investor today. In that sense the SEC continues to demonstrate its support for the private investment marketplace and give the lie to those who believe otherwise.

On the other hand, the SEC didn’t break much new ground expanding the definition, at least for now.

The principal expansion, as expected, was in adding to the list of accredited investors individuals who hold Series 7, Series 65, or Series 82 licenses. The SEC also added investment advisers registered with the SEC or any state and, more surprisingly, venture capital fund advisers and exempt reporting advisers. I say “more surprisingly” because neither venture capital fund advisers nor exempt reporting advisers are required to pass exams or otherwise demonstrate financial knowledge or sophistication.

The list of accredited investors was also extended to include:

  • Entities, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that (1) own “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act of 1940) in excess of $5 million, and (2) were not formed to invest in the securities offered;
  • Rural business development companies;
  • Family offices with at least $5 million in assets under management and their family clients, as each term is defined under the Investment Advisers Act of 1940; and
  • Knowledgeable employees of a private fund, but only with respect to investments in that fund.

Finally, the SEC clarified that existing provisions of the accredited investor definition that refer to spouses also includes “spousal equivalents,” meaning someone who has gotten under your nerves for at least seven years (actually “a cohabitant occupying a relationship generally equivalent to that of a spouse”).

While a modest first step, these additions are welcome and a harbinger of bigger things to come. The new rule explicitly invites FINRA, other industry self-regulatory authorities, and accredited education institutions to develop “certifications, designations, or credentials” that the SEC would approve for accredited investor qualification. I imagine FINRA and professional organizations will jump at the chance. If this leads to millions or tens of millions of Americans learning about securities and participating in the Crowdfunding market, well, that’s a very good thing for everyone.

The new definition will become effective 60 days after being published in the Federal Register.

Questions? Let me know.

SEC Issues Emergency Rules To Facilitate Title III Crowdfunding During Covid-19 Crisis

On By crowdfundattnyIn COVID-19, Crowdfunding, Crowdfunding Laws, Crowdfunding Portals, Equity Crowdfunding, JOBS Act, Reg CF, Regulation CF, SEC, SEC Proposals, Securities Exchange Commission, Securities Laws, Title III CrowdfundingLeave a comment

With credit markets tightened and 30 million Americans newly out of work, the SEC has adopted temporary rules to make Title III Crowdfunding a little easier from now until August 31, 2020.

The temporary rules are available here. They aim to make Title III a little faster and easier in four ways:

#1 – Launch Offering without Financial Statements

An issuer can launch the offering – go live on a funding portal – before its financial statements are available. (But investment commitments aren’t binding until the financial statements have been provided.)

#2 – Lower Standard for Some Financial Statements

An issuer trying to raise between $107,000 and $250,000 in a 12-month period doesn’t have to produce financial statements reviewed by an independent accountant, only financial statements and certain information from its tax return, both certified by the CEO.

#3 – Quicker Closing

An issuer can close the offering as soon as it has raised the target offering amount, even if the offering hasn’t been live for 21 days, as long as the closing occurs at least 48 hours after the last investment commitment and the funding portal notifies investors of the early closing.

#4 – Limit on Investor Cancellations 

Investors can cancel within 48 hours of making a commitment, but can’t cancel after that unless there’s a material change in the offering.

CAVEAT:  These rules are not available if the issuer:

  • Was organized or operating within six months before launching the offering (e., this is not for brand-new companies); or
  • Previously raised money using Title III Crowdfunding but failed to comply with its obligations.

I’m not sure how much difference these rules will make in practice. But that’s not the main point as far as I’m concerned. The main point is that with about a million other things on its plate, the SEC took the time to think about and draft these rules. The SEC must believe that equity Crowdfunding can play an important role in our capital markets.

On that basis, I predict that the proposals the SEC made on March 4th will be adopted soon after the public comment period expires on June 1st. And after that, who knows.

Questions? Let me know.

SEC Proposes Major Upgrades To Crowdfunding Rules

On By crowdfundattnyIn Accredited Investor, Angel Fairs, Crowdfunding, Crowdfunding Articles, Crowdfunding Laws, Crowdfunding Portals, Crowdfunding Real Estate, Demo Days, Equity Crowdfunding, General Solicitation, Integration, JOBS Act, Raising Money, Regulation A, Regulation A Plus, Regulation A Plus Primer, Regulation D offerings, Rule 506, Rule 506(b), Rule 506(c), SAFE, SEC, SEC Proposals, SPV, Title II, Title II Crowdfunding, Title III, Title III Crowdfunding, Title IV of the JOBS Act, UncategorizedLeave a comment

The SEC just proposed major changes to every kind of online offering:  Rule 504, Rule 506(b), Rule 506(c), Regulation A, and Regulation CF.

The proposals and the reasoning behind them take up 351 pages. An SEC summary is here, while the full text is here. The proposals are likely to become effective in more or less their existing form after a 60-day comment period.

I’ll touch on only a few highlights:

  • No Limits in Title III for Accredited Investors:  In what I believe is the most significant change, there will no longer be any limits on how much an accredited investor can invest in a Regulation CF offering. This change eliminates the need for side-by-side offerings and allows the funding portal to earn commissions on the accredited investor piece. The proposals also change the investment limits for non-accredited investor from a “lesser of net worth or income” standard to a “greater of net worth or income” standard, but that’s much less significant, in my opinion.
  • Title III Limit Raised to $5M:  Today the limit is $1.07M per year; it will soon be $5M per year, opening the door to larger small companies.

NOTE:  Those two changes, taken together, mean that funding portals can make more money. The impact on the Crowdfunding industry could be profound, leading to greater compliance, sounder business practices, and fewer gimmicks (e.g., $10,000 minimums).

  • No Verification for Subsequent Rule 506(c) Offerings:  In what could have been a very important change but apparently isn’t, if an issuer has verified that Investor Smith is accredited in a Rule 506(c) offering and conducts a second (and third, and so on) Rule 506(c) offering, the issuer does not have to re-verify that Investor Smith is accredited, as long as Investor Smith self-certifies. But apparently the proposal applies only to the same issuer, not to an affiliate of the issuer. Thus, if Investor Smith invested in real estate offering #1, she must still be verified for real estate offering #2, even if the two offerings are by the same sponsor.
  • Regulation A Limit Raised to $75M:  Today the limit is $50M per year; it will soon be $75M per year. The effect of this change will be to make Regulation A more useful for smaller large companies.
  • Allow Testing the Waters for Regulation CF:  Today, a company thinking about Title III can’t advertise the offering until it’s live on a funding portal. Under the new rules, the company will be able to “test the waters” like a Regulation A issuer.

NOTE:  Taken as a whole, the proposals narrow the gap between Rule 506(c) and Title III. Look for (i) Title III funding portals to broaden their marketing efforts to include issuers who were otherwise considering only Rule 506(c), and (ii) websites that were previously focused only on Rule 506(c) to consider becoming funding portals, allowing them to legally receive commissions on transactions up to $5M.

  • Allow SPVs for Regulation CF:  Today, you can’t form a special-purpose-vehicle to invest using Title III. Under the SEC proposals, you can.

NOTE:  Oddly, this means you can use SPVs in a Title III offering, but not in a Title II offering (Rule 506(c)) or Title IV offering (Regulation A) where there are more than 100 investors.

  • Financial Information in Rule 506(b):  The proposal relaxes the information that must be provided to non-accredited investors in a Rule 506(b) offering. Thus, if the offering is for no more than $20M one set of information will be required, while if it is for more than $20 another (more extensive) set of information will be required.
  • No More SAFEs in Regulation CF:  Nope.

NOTE:  The rules says the securities must be “. . . . equity securities, debt securities, or securities convertible or exchangeable to equity interests. . . .” A perceptive readers asks “What about revenue-sharing notes?” Right now I don’t know, but I’m sure this will be asked and addressed during the comment period.

  • Demo Days:  Provided they are conducted by certain groups and in certain ways, so-called “demo days” would not be considered “general solicitation.”
  • Integration Rules:  Securities lawyers worry whether two offerings will be “integrated” and treated as one, thereby spoiling both. The SEC’s proposals relax those rules.

These proposals are great for the Crowdfunding industry and for American capitalism. They’re not about Wall Street. They’re about small companies and ordinary American investors, where jobs and ideas come from.

No, the proposals don’t fix every problem. Compliance for Title III issuers is still way too hard, for example. But the SEC deserves (another) round of applause.

Please reach out if you’d like to discuss.

Improving Legal Documents in Crowdfunding: Get Rid of the State Legends!

On By crowdfundattnyIn Compliance, Crowdfunding, Crowdfunding Laws, JOBS ActLeave a comment

I see lots of offering documents like this, with pages of state “legends.” The good news is that in Crowdfunding offerings – Title II (Rule 506(c)), Title III (Regulation Crowdfunding), and Title IV (Regulation A) – you can and should get rid of them.

The legal case is pretty simple:

  • Before 1996, states were allowed to regulate private offerings. Every state allowed exemptions, but these exemptions often required legends, differing from state to state.
  • The National Securities Market Improvement Act of 1996 added section 18 to the Securities Act of 1933. Section 18 provides that no state shall “impose any conditions upon the use of. . . .any offering document that is prepared by or on behalf of the issuer. . . .” in connection with the sale of “covered securities.”
  • The securities sold under Title II, Title III, and Title IV are all “covered securities.”
  • Hence, section 18 prohibits states from imposing any conditions regarding the issuer’s offering documents, including a condition that requires the use of a state legend.

If the capitalized legends just take up space, why not include them anyway just to be safe? Take Pennsylvania’s legend as an example:

These securities have not been registered under the Pennsylvania Securities Act of 1972 in reliance upon an exemption therefrom. any sale made pursuant to such exemption is voidable by a Pennsylvania purchaser within two business days from the date of receipt by the issuer of his or her written binding contract of purchase or, in the case of a transaction in which there is not a written binding contract of purchase, within two business days after he or she makes the initial payment for the shares being offered.

If you include the Pennsylvania legend “just to be safe,” you’ve given Pennsylvania investors a right of rescission they wouldn’t have had otherwise!

Two qualifications.

First, the North American Securities Administrators Association –the trade group of state securities regulators – suggests including uniform legend on offering documents. I include this or something similar as a matter of course:

IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE COMPANY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THESE SECURITIES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THESE SECURITIES ARE SUBJECT TO RESTRICTIONS ON TRANSFERABILITY AND RESALE AND MAY NOT BE TRANSFERRED OR RESOLD EXCEPT AS PERMITTED UNDER THE ACT, AND THE APPLICABLE STATE SECURITIES LAWS, PURSUANT TO REGISTRATION OR EXEMPTION THEREFROM. INVESTORS SHOULD BE AWARE THAT THEY WILL BE REQUIRED TO BEAR THE FINANCIAL RISKS OF THIS INVESTMENT FOR AN INDEFINITE PERIOD OF TIME.

Second, some states, including Florida, require a legend to appear on the face of the offering document to avoid broker-dealer registration. Because Section 18 of the Securities Act doesn’t prohibit states from regulating broker-dealers, some lawyers recommend including those legends, while others believe those requirements are an improper “back door” way for states to avoid the Federal rule. I come out in the latter camp, but opinions differ.

Questions? Let me know.

Crowdfunding Speaking Engagements – Fall 2015

On By crowdfundattnyIn Crowdfunding Speaking Engagements, JOBS ActLeave a comment

Map of Mark Roderick

September 24th – Chicago, IL

RealCap Chicago

Real Estate Crowdfunding Conference Real Cap Chi

RealCap Chicago will provide real estate entrepreneurs the opportunity to hear from the country’s leading real estate crowdfunding platforms. Attendees will learn how to raise debt and equity online for projects including “fix and flip” single family homes, multifamily complexes, commercial buildings, and ground up development projects.

Meet The Future of Real Estate Capital

“The rapid growth of real estate crowdfunding platforms can be attributed to both the low minimum investments of $100 – $10,000 as well as the transparency which both developers and investors now benefit from as they compare terms and opportunities on platforms, and even across platforms, ” Jorge Newbery said. “The ease and speed of investing on the platforms is seductive. Online capital raising is the future of real estate finance.” There are over 75 real estate crowdfunding platforms active in the United States, which several additional platforms planning to launch soon.

Click here for the full conference agenda.

MY SESSION: The Evolution of Online Capital Raising

Moderator: Mark Roderick, Flaster Greenebrg PC @CrowdfundAttny 

Panel Members:

  • AdaPia d’Errico, Patch of Land @Adapia
  • Jordan Fishfeld, Peer Realty @PeerRealty
  • Eve Picker, Small Change
  • Scott Jordan,HealthiosXchange @HealthiosX
  • Bhavik Dani, EquityRoots @EquityRoots

Click here for more information or to register. Stay connected #RealCapChi

October 13th – October 15th – Fairmont Royal York Hotel – Toronto, ON Canada

NAIOP Commercial Real Estate Conference 2015

NAIOP is taking its fall meeting north of the border for the first time since 1996 and you won’t want to naiopmiss the energy and enthusiasm in one of Canada’s fastest growing cities.

Toronto is home to NAIOP’s second largest chapter and is excited to host commercial real estate professionals from across North America at this leading industry event.

  • DEALS: Nearly 1,000 industry and association leaders who’ve come together to share strategies, make contacts and learn new ideas.
  • CONNECTIONS: Broaden your network in unlimited networking and business-building opportunities, including special events and receptions. Meet partners showcasing the latest innovative tools that can advance your business.
  • TRENDS: 15+ education sessions, featuring nationally recognized speakers, trainers, and industry experts, who discuss timely topics and critical issues to your business.

Click here for the full conference agenda.

MY SESSION: Crowdfunding and New Ways of Raising Capital (October 14th)

Moderator: Mark Roderick, Flaster Greenberg PC @CrowdfundAttny

Panel Members:

Click here for more information or to register. Stay connected #Crecon15

October 22nd – Builders League of South Jersey – Cherry Hill, NJ

Crowdfunding for Real Estate – News Ways of Raising Capital

8:30 – 10:30 A.M.

blsjEvent Details:

The internet has arrived in the capital formation business! In case you haven’t heard, Crowdfunding is a way to fund a project or venture by raising many small amounts of money from a large number of people, typically via the Internet. Explore its growth from small investments to large, how the process is managed, the risk and reward factors, and what the future holds. Learn about the potential for builders/developers and how New Jersey compares to other states.

*Free to all BLSJ Members/$25 Non-Members

To register, email Marlene Spencer at marlene@blsj.com

October 26th – Trump International Hotel Las Vegas – Las Vegas, NV

4th Annual GCCB Conference – REGULATION A PLUS MASTER CLASS

gccbThis very special event will sell out quickly and space is limited. Join us for the country’s first REG A PLUS Master Class training for professionals under the JOBS Act. We will kick off this event on Sunday night with a special Dinner for our sponsors and VIP attendees.

This is your opportunity to learn from the best and the brightest experts in the industry how you can integrate this new securities offerings directly into the professional services that you offer your clients . And this will help you stand out as one of the first experts in Title IV of the JOBS Act, REG A PLUS in your city or state.

This is a first mover advantage you don’t want to miss.

Speakers:

Click here for more information or to register. Stay connected #GCCB2015

You Can Use Subsidiaries Without Violating the 100 Investor Rule

On By crowdfundattnyIn 100 Investor Rule, Crowdfunding, Investment Advisers Act of 1940 (IAA), Investor, JOBS Act, LLCsLeave a comment

crowdfunding_investorEveryone knows the “100 investor rule” is a thorn in the side of Crowdfunding portals. The good news is you can still use subsidiaries to protect yourself from liability.

The basics of the 100 investor rule:

  • A company engaged in the business of investing in securities is an “investment company” and subject to burdensome regulation under the Investment Act of 1940.
  • A “special purpose vehicle” formed by a portal to invest in a portfolio company is engaged in the business of investing in securities.
  • There’s an exception: if the SPV has no more than 100 investors, it’s not an investment company.

Today, most deals on Crowdfunding portals are funded with fewer than 100 investors and qualify for the exception. But that’s because most Crowdfunding deals are still small, i.e., less than $2 million. As the deals get bigger and, most important, as we start to see pools of assets rather than individual assets, SPVs will no longer be available. Already, they’re not available for Regulation A+ deals.

In the absence of an SPV, investors will be admitted directly to the issuer’s cap table. But what if the issuer owns one or more subsidiaries? Will the issuer itself be disqualified as an investment company?

Here’s an example. Suppose NewCo is raising $25 million to acquire 10 properties, and we expect 1,000 investors. We’d like to put each property in a separate subsidiary because (1) we might want to finance them separately, and (2) we don’t want the liabilities arising from one property to leak into another property. But would that make NewCo an investment company, holding the stock (securities) of 10 subsidiaries?

Fortunately, the answer is No.

For purposes of deciding whether NewCo is an investment company, the rule is that you ignore securities issued by any company that NewCo controls, as long as the company itself is not an investment company.

That means NewCo can put Business #1 in Subsidiary #1, Business #2 in Subsidiary #2, and so on and so forth, without becoming an investment company. Most likely, NewCo will hold each property in a separate limited liability company, serving as the manager of each.

Don’t fool around with investment company issues. A company that becomes an investment company without knowing it can face a world of trouble, including having all its contracts invalidated.

Questions? Let me know.

Why the Jobs Act Broker-Dealer Exception Doesn’t Matter (Much)

On By crowdfundattnyIn Broker-Dealer, Crowdfunding, JOBS ActLeave a comment

US CApitol Building Illuminated at Night

Under section 201(c) of the JOBS Act, an electronic platform is not required to register as a broker-dealer solely because the platform offers securities under Title II, co-invests in the securities, or provides due diligence services or standardized documents. That’s good.

What Congress giveth, however, Congress can taketh away. The exemption from broker-dealer registration is not available if:

  • The platform or anyone associated with the platform receives compensation in connection with the purchase or sale of securities; OR
  • The platform helps to negotiate deals; OR
  • The platform requires issuers to use its standardized documents; OR
  • The platform is separately compensated for giving investment advice; OR
  • The platform or anyone associated with the platform takes possession of investor funds or securities; OR
  • The platform or anyone associated with the platform is disqualified under the “bad actor” rules.

Theoretically, the JOBS Act broker-dealer exemption paved the way for Crowdfunding platforms to sell securities free from the constraints of Depression-era securities laws. In practice, however, platforms have found it very difficult, almost impossible, to build a profitable business around the exemption because of all the gaps in the exemption and the list of things you can’t do.

For example:

  • To claim the exemption, a platform may not receive any compensation in connection with the purchase or sale of securities. That doesn’t just mean “transaction-based compensation” like commissions, it means any compensation. If the platform receives a carried interest or promote, for example, the exemption disappears.
  • From a business perspective it makes sense for the platform to employ an investor-relations specialist, someone to reach out to prospective investors. But if that person receives any compensation, even a salary, the exemption disappears.
  • Suppose the platform organizes a special-purpose entity for its investors and negotiates the terms of the deal with the issuer. Buzz! The exemption disappears.
  • The exemption doesn’t even apply to employees of the platform. If they engage in activities that are not protected by SEC Rule 3a4-1, they themselves could be required to register as broker-dealers.
  • Even if you qualify for the Federal exemption, it doesn’t mean you’re exempt from state broker-dealer registration.

Here’s how the SEC answered a question about the scope of the exemption:

QUESTION

May an entity, such as a venture capital fund or its adviser, operate an Internet website where it lists offerings of securities by potential portfolio companies (in compliance with Rule 506), co-invest in those securities with other investors, and provide standardized documents for use by issuers and investors, rely on Securities Act Section 4(b) to not register as a broker-dealer?

ANSWER

Yes. These activities are permitted under Section 4(b), subject to the conditions set forth in Section 4(b)(2), including the prohibition on receiving compensation in connection with the purchase or sale of securities. As a practical matter, we believe that the prohibition on compensation makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker-dealer registration.

That’s pretty clear.

Now, the fact that a platform doesn’t qualify for the JOBS Act exemption doesn’t automatically mean the platform has to register as a broker-dealer. Whether the platform has to register as a broker-dealer would be tested under the body of laws stretching back 80 years. My point is that the JOBS Act exemption itself will be irrelevant for most platforms.

As someone once said, Crowdfunding is nothing more or less than the Internet come to the capital formation industry. Crowdfunding platforms sit astride the Internet pipeline directly connecting entrepreneurs with investors. Matching buyer to seller, they function as “brokers” in the most fundamental sense of the word.

In this sense, changing the business practices of a Crowdfunding platform to comply with the JOBS Act broker-dealer exemption is like pounding a round peg into a square hole. Pound long and hard enough and it’s possible. But it’s far better to run the platform business the way you want to run it, i.e., to make the most money. If you have to register as or affiliate with a broker-dealer, just do it.

Questions? Contact Mark Roderick.

Crowdfunding And Fiduciary Obligations

On By crowdfundattnyIn Crowdfunding, Crowdfunding Laws, Fiduciary Obligations, JOBS ActLeave a comment

The term “fiduciary obligations” sends a chill down the spine of corporate lawyers – although some may object to using the word “spine” and “corporate lawyer” in the same sentence.

A person with a fiduciary obligation has a special legal duty. A trustee has a fiduciary obligation to the beneficiaries of the trust. The executor of an estate has a fiduciary obligation to the beneficiaries of the estate. The fiduciary obligation is not an obligation to always be successful, or always be right, but rather an obligation to try your best, or something close to that. A trustee who fails to anticipate the stock market crash of 2008 has not breached her fiduciary obligation. A trustee who fails to read published reports of a company’s impending bankruptcy before buying its stock probably has.

A person with a fiduciary obligation is required to be loyal, to look out for the interests of those under her care, to put their interests before her own.

By law and longstanding principle, the directors of a corporation have a fiduciary obligation to the corporation and its shareholders. In the classic case, a director of a corporation in the energy business took for his own benefit the opportunity to develop certain oil wells. Foul! cried the court. He has breached his fiduciary obligation by failing to pass the opportunity along to the corporation, to which he is a fiduciary.

Modern corporate statutes allow the fiduciary obligations of directors to be modified, but not eliminated, even if all the shareholders would sign off. If the corporation is publicly-traded, the exchange likely imposes obligations on the director (and the President, and the CEO, etc.) in addition to the fiduciary obligations imposed by state corporate law.

Which takes us to Crowdfunding. crowd funding word cloud

Most deals in the Crowdfunding space are done in a Delaware limited liability company. The Delaware Limited Liability Company Act allows a manager – the equivalent of a director in a corporation – to eliminate his fiduciary obligation altogether. If I’m representing the sponsor of the deal then of course I want to protect my client as fully as possible. And yet, I’m not sure that’s the best answer for the industry overall.

The U.S. public capital markets thrive mainly because investors trust them, just as the U.S. consumer products industry thrives because people feel safe shopping (that’s why securities laws and consumer-protection laws, as aggravating as they can be, actually help business). My client’s investors may or may not pay attention to the fiduciary duty sections of his LLC Agreement, but I wonder whether the Crowdfunding market as a whole can scale if those running the show regularly operate at a lower level of legal responsibility than the managers of public companies. Will it drive investors away?

Part of my brain says that it will, and yet, over the last 25 years or so, as corporate laws have become more indulgent toward management and executive pay has skyrocketed, lots of people have wondered when investors will say “Enough!” It hasn’t happened so far.

Questions? Let me know.