“Crowdfunding”: An Idea Whose Time Has (Legally) Come?

By DC Sanders

The idea of crowdfunding has been around for some time, but is only now getting traction among lawmakers who can bring about the loosening of Securities and Exchange Commission (SEC) restrictions and make the practice a readily available option for startups to generate investment revenue.

Even before the name “crowdfunding” was coined around 2001, it has been a regular practice in charitable circles where a large network of donors contributes smaller individual amounts toward the cause. In more recent years – especially after the Internet’s cultural revolution – the idea has been applied in different ways including the funding of: band recordings and concert tours, journalistic enterprises including the controversial WikiLeaks, film production, political campaigns and blogging. A number of organizations have sprouted up with platforms where investors and ideas meet but the legality of these arrangements remains clouded in many cases.

Crowdfunding and the SEC

The crowdfunding concept runs afoul of the SEC when it involves investing funds with the expectation of obtaining a return on the investment. Under these conditions, the organization’s solicitation of donations must be registered and that can be prohibitively expensive for small operations. The idea is to protect investors from being scammed, but there is movement to ease restrictions to make it easier to engage in crowdfunding as a legitimate fund raising tool for businesses.

Right now, there are three competing ideas on what new SEC regulations should look like. One of those plans, the Entrepreneurial Access to Capital Act, HR 2930, introduced by Rep. Patrick McHenry (R – N.C.), has made it out of both a subcommittee of the U.S. House of Representatives Financial Services Committee (HSFC), and the full Committee itself. Competing proposals – with a similar basis but varying details – are being offered by SEC Chairwoman Mary Shapiro and President Barack Obama.

HR 2930, passed by the HSFC yesterday, sanctions crowdfunding to finance new businesses by allowing companies to accept and pool donations of up to $1 million, or $2 million in some cases.

This is certainly not the last word in the life of the bill, which has yet to go through the process of becoming law. It may change to accommodate the many proposals. However, it is a crucial step towards the legalization of crowdfunding for all small businesses and startups.

The Ideas

The original intent of McHenry’s bill allowed an unlimited number of contributors to invest a total of $5 million to a crowdfunded start up, but individual funding would be limited to the lesser of $10,000, or 10 percent of that person’s annual income.

Even though HR 2930 made it out of subcommittee on a narrow margin of 18 to 14 (without Democratic support), there appears to be bipartisan agreement that SEC rules should be updated to reflect changing times and will better enable small businesses and startups to take advantage of the burgeoning crowdfunding idea. As always, though, the devil will be in the details.

Earlier this year, Shapiro signaled support for crowdfunding as a component of micro-financing. She suggested total investments be capped at $100,000 and individuals be limited to giving  $100 each.

So far, Obama’s proposal that crowdfunding be limited to total revenue collections of no more than $1 million seems to be the middle ground in the growing debate.

With the HSFC decision today, crowdfunding is closer than ever to being adopted.

DC Sanders covers legal affairs and the business community. He is particularly interested in intellectual property issues and small business. When he isn’t writing, Lonnie can be found browsing Law QA.

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  • http://www.wac6.typepad.com William Carleton

    I agree. The bill has steam in the House. Barney Frank famously remarked at the committee markup that the bipartisan (at the committee level) support of the bill would not make the news because there wasn’t enough partisan controversy about it – no one likes to hear that reps are getting along. That said, there is still language to be worked out on how to word preservation of state fraud authority. But it all could happen (in the House) this week.

    • Anonymous

      Thanks Bill. It strikes me as pretty odd that on the one hand the Congress is trying to ease up financing restrictions, by considering allowing crowd funding, removing the general solicitation band, etc., while at the same time the SEC is about to ruin 506 for everyone through the bad actor regs…

      • http://www.wac6.typepad.com William Carleton

        Joe, double check me, but I think a bad actor provision got included in the crowd funding bill at the full committee markup. Which is a good thing in my view.

        • Anonymous

          Bill, here it is: http://financialservices.house.gov/UploadedFiles/102611hr2930green.pdf. It is not the concept. It is the regulatory implementation that threatens to destroy 506.

          • http://www.wac6.typepad.com William Carleton

            Yeah, that’s it. The bill will be amended yet again before it reaches the house floor. Rep. McHenry, the sponsor, and Rep. Perlmutter, who withdrew his amendment that would have nixxed the provision preempting state law, agreed to work together to come up with language to preserve state fraud authority, or something in that vein. 

            If you want to see an (unofficial) restatement of the bill as approved by the House Financial Services Committee last Wednesday (including all the amendments that were approved, but not yet including additional language on the scope of existing state fraud jurisdiction), I posted one on JDSupra: http://www.jdsupra.com/post/documentViewer.aspx?fid=655d2b4c-cb7b-492f-91da-42c2548dbfb7

 
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