On One-Year Anniversary of Reg CF, JOBS Act Author Urges Significant Revisions

As Regulation Crowdfunding or “Reg CF,” the SEC’s extensive rules implementing the federal/interstate crowdfunding provisions (Title III) of the JOBS Act, recently marked its one-year anniversary, the congressional author of Title III, Congressman Patrick McHenry (R-NC), is now urging the SEC to essentially rewrite Reg CF.

McHenry, a leading crowdfunding industry proponent, outlines his proposal in a seven page May 15th letter to newly sworn-in SEC Chairman Jay Clayton. In his letter to Clayton, McHenry calls for a “comprehensive reform” of Reg CF, outlining in great detail 13 specific revisions to Reg CF that he believes necessary for start-ups and small businesses to fully take advantage of the opportunities that crowdfunding offers. McHenry is hardly alone in his criticism of Reg CF, as the crowdfunding community has roundly panned Reg CF as excessively regulatory in nature and far too costly for start-ups to comply with. While it is unclear if or when the SEC will respond to McHenry’s letter, the proposal should be considered as the opening salvo in what will likely be a full court press by the crowdfunding community to have the rules implementing interstate crowdfunding rewritten in a way much more favorable to the start-up and growth company sectors. Indeed, Clayton’s multi-decade background as an M&A lawyer suggests that the SEC may at least adopt a heightened focus on capital formation issues.

Importantly, McHenry’s recommendations, in his opinion, are all fully within the SEC’s rulemaking ambit, and do not require any legislative action by Congress. Specifically, the main thrusts of McHenry’s proposal are as follows:

Raise the Offering Limit. McHenry echoes the sentiment of the majority of the crowdfunding community that the current $1 million federal offering cap is woefully inadequate, noting that “many businesses cannot justify the time and cost of a Reg CF offering for the relatively small amount of capital that can be raised.” He notes that mandated 3rd-party costs such as the funding portal and escrow and transfer agents (not to mention accounting and legal expenses as well) currently consume an inordinate portion of an offering’s proceeds.

Eliminate the Accredited Investor Investment Caps. In McHenry’s view, accredited investors do not need special protection and should be allowed to invest as much as they want. Moreover, by allowing them to invest more heavily in good deals, this will send a “signal” to and thus help smaller investors benefit from the expertise of more sophisticated professional investors.

Revamp the Accounting Disclosure Requirements. McHenry cites the current accounting requirements which require compliance with GAAP as “unduly burdensome,” and calls for the replacement of GAAP with “a simple disclosure of cash on hand, and incurred liability and prior cash investment the company has received—all certified by the company’s CEO or founder.”

Relieve Advertising Restrictions. McHenry believes that the current restrictions are “needlessly complex and restrictive” and should be expanded to allow companies to “produce digital ads that direct potential investors to the company’s campaign pages” on a funding portal.

“Testing the Waters.” Testing the Waters, which is allowed under Reg A and Reg A+, should be allowed under Reg CF, according to McHenry. This would basically allow issuers to test-market their offering on a crowdfunding portal and thus obtain “indications of interest” from potential investors prior to actually commencing the formal offering.

Pooling Capital into an SPV. McHenry is advocating that start-ups be allowed to pool investor capital into an fund-style SPV or “special purpose vehicle.” According to McHenry, “having hundreds or potentially thousands of investors in a small private company can be unwieldy and a potential impediment to future financing rounds.” In turn, an SPV structure would “streamline investor participation, provide much needed credibility to attract high profile investors, and create administrative convenience.”

’34 Act Relief. McHenry further suggests that the SEC raise the ceiling (now 500 non-accredited investors and $25 million in total assets) on the current exemption accorded to Reg CF offerings from having to register as a public-reporting company under the Securities Act of 1934 and thus provide reports (e.g., 10-Ks, 10-Qs and 8-Ks).

Additional Relief. McHenry’s letter further requests that the SEC take additional action such as: (i) explicitly providing for a secondary market for Reg CF Offerings; and (ii) allowing for issuers to utilize more than one funding portal, and for those portals to split fees from that issuer.

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