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SEC Panel Recommends Exemption for Crowd-Funding

By Mari Serebrov
Washington Editor

WASHINGTON – Recognizing social media as a powerful tool that small start-ups can use to attract investors, an SEC advisory committee is advising the commission to consider an exemption from its registration requirements to permit crowd-funding.

The recommendation is one of several the Advisory Committee on Small and Emerging Companies has proposed to improve capital formation and access to public markets for small businesses. The draft recommendations are to be discussed at a committee meeting Wednesday.

Crowd-funding – the use of social media websites to solicit capital from a large number of individuals who generally make smaller investments – is used by artists, nonprofits and election campaigns. But interest in using crowd-funding to raise capital for small companies such as biotechs has gained momentum in both the private and public sector.

In the draft recommendations, the small business committee said crowd-funding could be a cost-effective way for small businesses to raise relatively small amounts of equity, but current exemptions from the registration requirements of the Securities Act would prevent a crowd-funding offering.

Two bills to correct that problem already have been passed by the House. H.R. 2930 would let private firms raise up to $2 million through crowd-funding. And a related bill, H.R. 2940, would let private companies that need to raise more than $2 million advertise their private offerings to reach a broader pool of accredited investors. (See BioWorld Today, Nov. 14, 2011.)

The Senate Committee on Banking, Housing, and Urban Affairs has held hearings on H.R. 2930, and the other bill has been placed on the Senate's legislative calendar.

The SEC advisory committee has one caveat on crowd-funding. An exemption from registration requirements to permit crowd-funding "must contain robust investor protections designed to prevent fraud, which is necessary if crowd-funding as a capital-raising tool is to succeed," it said.

The advisory committee also is recommending that the SEC implement a new registration exemption, modeled on the terms and conditions of Regulation A, that provides for public offerings of up to $50 million annually. Regulation A currently has a $5 million annual cap.

Because of that restrictive cap, "the volume of Regulation A offerings has been immaterial in recent years," the committee said. Only 24 Regulation A offering statements were filed with the SEC in each of 2009 and 2010; three were qualified by the commission in each of those years.

The new exemption should require issuers to prepare an offering statement and file it with the SEC and potential investors, the committee recommended. In setting the requirements for that statement, the SEC should consider additional disclosures that may be necessary to protect investors in light of the increased offering cap. One such requirement could be audited financial statements, the panel added.

Besides the offering statement, the committee advised the SEC to consider additional investor protections for the new exemption. These could include public filings of offering statements, periodic reporting for companies that have completed an offering and "bad actor" disqualification provisions.

But in developing the terms and conditions of the new exemption, the SEC should keep in mind the relatively smaller size and limited resources of the companies that would be likely to take advantage of the exemption, the panel said.

The committee's other draft recommendations have to do with the registration requirements and reporting obligations under the 1934 Securities Exchange Act. Questioning the appropriateness of the current triggers and thresholds for registration and reporting, the panel advised the SEC to take action immediately to amend the registration and reporting rules.

A company's obligation to register and begin public reporting under the recommended amendments would not be triggered until it had a class of securities held by 1,000 or more beneficial owners. But a company currently obligated to file SEC reports could not cease public reporting until the number of its beneficial owners dropped to less than 500.

The existing thresholds for reporting are 500 beneficial owners and assets totaling more than $10 million.

Under those thresholds, some private companies may have to register and begin reporting at a time in their development that's often not advantageous to either the company or its shareholders, the advisory committee said.

Conversely, the companies "may be driven to manage their capital raising or equity compensation activities to avoid registration in ways that may not be in the company's or its security holders' best interests," the group added.

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