Securities Regulation Daily Wrap Up, JOBS ACT—NASAA cautions state legislatures about crowdfunding bills, (Jan 23, 2014)

By John M. Jascob, J.D.

NASAA has cautioned state lawmakers about potential pitfalls in bills that seek to create registration exemptions under state law for crowdfunded securities offerings. In a letter to the National Conference of State Legislatures, NASAA wrote that it neither supports nor opposes state efforts to craft a state crowdfunding alternative to the federal exemption available under the JOBS Act. To the extent that some states do choose to pursue an alternative exemption, however, NASAA offered a few key recommendations in order to protect small businesses and crowdfunding intermediaries from federal securities law violations and to protect investors from undue risk and loss.

State legislation. NASAA noted that several states have already proposed or enacted their own state crowdfunding bills. The state legislation may be due in part to the SEC’s delay in rule implementation or, in some cases, industry dissatisfaction with the federal exemption itself. Three states, Michigan, Minnesota and Wisconsin, have already signed into law bills that contemplate a state registration exemption that parallels the federal exemption in some fashion. Lawmakers in Maine are currently considering an alternative approach which permits a short-form crowdfunding registration under state law that is tied to the federal exemption found in Rule 504 of Regulation D.

Compliance with federal exemptions. In NASAA’s view, some provisions of these state-level crowdfunding exemptions do not align with federal securities law and may create unanticipated registration violations for both small business issuers and internet platforms. For example, a majority of states include an explicit reference to the federal intrastate offering exemption found under Securities Act Sec. 3(a)(11) and Rule 147. State crowdfunding bills that purport to allow unrestricted offerings via the Internet, however, would not appear to comply with Sec. 3(a)(11) and Rule 147, given SEC guidance which suggests that Internet-based offerings would be deemed interstate in nature if out-of-state investors are given access to such offerings. Under these circumstances, all sales made by issuers resulting from unrestricted Internet solicitation would constitute illegal, unregistered transactions under federal law.

Compliance with broker-dealer licensing requirements. In addition, NASAA believes that most of the state crowdfunding bills fail to address adequately federal broker-dealer registration requirements. For example, bills enacted in Wisconsin and New Jersey purport to allow unregistered internet platforms to be compensated for facilitating the sale of securities, an activity which requires registration with the SEC and FINRA. Unregistered Internet platforms relying on the state exemption will thus be engaging in unlicensed sales subject to SEC action and potentially other adverse consequences.

Moreover, other state crowdfunding bills provide that crowdfunding transactions be conducted through an “intermediary” as is required by the JOBS Act. The SEC has issued guidance, however, that no intermediaries should be engaging in crowdfunding transactions under the JOBS Act exemption until the SEC’s crowdfunding rules are finalized. Even once SEC rules are finalized, registered intermediaries may still not be able to complete intrastate crowdfunding offerings, given the JOBS Act directive that a broker-dealer exemption is available only where the business is conducted solely in compliance with the federal crowdfunding rules. NASAA believes that a better state legislative approach may be to prohibit transaction-based compensation unless the intermediary is a registered broker-dealer.

Investor protection. NASAA encourages state legislatures to employ a maximum annual offering limit. For example, Kansas limits the maximum annual offering to $1 million. Similarly, NASAA discourages state legislatures from pursuing bills that do not take into account the unsophisticated nature of many potential crowdfunding investors. For example, the Wisconsin statute creates a new classification of “certified investors” who are allowed to invest unlimited sums in crowdfunded offerings without even having to meet the existing “accredited investor” definition under federal law. Creating new investor classes that conflict with the federal standards may also result in unanticipated registration violations for both small business issuers and crowdfunding intermediaries, NASAA wrote.

RegulatoryActivity: JOBSAct PrivatePlacements NASAANews