By Moshe Silver
The SEC finally issued the Crowdfunding rules required under the 2012 JOBS Act (“Jumpstart Our Business Startups.” Who knew Congress could be so cute, so inventive…?) Release 2015-49 says the new Rules “provide investors with more investment choices.” The new rule updates and expands the old Regulation A, which permits public equity sales of up to only $5 million. It raises that cap to $50 million and cuts lots of additional red tape. Showing they are every bit as witty as Congress, the SEC calls the expanded Reg A “Reg A+,” and it’s already scoring high with the Crowdfunding community.
This tenfold expansion of the public offering rule could be seen as long overdue – the $5 million cap has been in place for a long time. The radical part of Reg A+ is something Congress didn’t mandate, but that the Commission threw in themselves.
Under Reg A+, issuers will no longer have to register their offering in every state in which investors reside. These procedures are called the “Blue Sky” laws, made famous in a 1917 Supreme Court opinion describing flim-flam artists offering “speculative schemes which have no more basis than so many feet of blue sky.” The blue sky laws are one of the state securities regulators’ main sources of leverage, giving them the ability to prevent a security from being sold to residents of their state.
Under the old rules, a company wishing to raise up to $5 million in ten states had to go through eleven registrations: one for the SEC, and one in each state. This is obviously incredibly time consuming and runs up attorney fees. And while it has prevented serious frauds, there are famous cases of offerings that didn’t make it through the blue sky process. For example, Apple Computer’s IPO was not permitted to trade in Massachusetts because regulators thought it too risky, while Salomon Bros had to re-do the first-ever offering of asset-backed securities at the last minute over blue sky issues. Under Reg A+, anyone can invest, and the stock will be registered and transferrable immediately. Unlike now, issuers will be able to advertise, and it appears that the old restriction on numbers of shareholders will be lifted.
Thus, it looks like small companies could advertise their offerings online direct to investors and raise $50 million in $100 increments.
Among the obvious pitfalls of these offerings are the likelihood of illiquid investments, and the apparent lack of investor protections when suitability requirements are relaxed and issuers are free to flog their wares with far less oversight that what is required of the average mutual fund offering.
There remain significant moving parts to work out, but chair White’s announcement really gets the Crowdfunding ball rolling. Two years ago, former SEC chair Arthur Levitt called for caution, warning that without strong SEC oversight, Crowdfunding could become a mechanism for fleecing the average investor. Needless to say, state regulators are up in arms over a central-government power grab that, they claim, makes it impossible for them to prudently protect their citizens.
Some thoughts:
- Arthur Levitt is one of our heroes – the man who made the investment markets safe for the Little Guy. His words should be heeded, and heeded carefully, and we’re eager to hear his thoughts now.
- State regulators tend to stay in their jobs for the long haul, unlike the SEC where a larger percentage move on to jobs in the private sector. When they are good, state regulators have a fingertip-fine sense of what goes on on their watch. And unlike the SEC, if you don’t like your state regulator, you can move to another state.
- From a States-versus-Washington point of view, it strikes us as odd that folks screaming bloody murder that we’re being “nanny-stated” to death by programs such as universal healthcare that try to share some of the toys evenly, are only too happy to see the state’s own nanny – in the imposing person of Mary Jo White – wade into the nursery and take the toys away.
One thing is for certain: this will unleash a massive wave of creativity as Wall Street and the entrepreneurial community come up with new ways to raise money, distribute securities and, by creating new forms of exchanges, provide liquidity for their investors. There will be tremendous opportunities for both companies and private investors, and this new initiative could come close to actually achieving its public policy objective of providing real benefit for the economy and for the markets. Fortunes will be made and –for sure – lost, and there will also be excesses, dumb mistakes and a few serious frauds.
It’s a brave new crowded world. Keep your wits about you.
Moshe Silver is a Managing Director at Hedgeye Risk Management and author of Fixing a Broken Wall Street.
