Over the past few months, Anthony Zeoli, Georgia Quinn, and CrowdCheck have been maintaining a chart of existing and proposed state crowdfunding statutes and rules. These state crowdfunding rules all follow a typical model:
- Short form registration at the state level;
- Issuers must comply with Section 3(a)(11) of the Securities Act and Rule 147;
- Issuers must provide basic information about the company, risk factors, and material information to investors; and
- General solicitation is permitted.
Statues like this have been in effect since Georgia and Kansas first enacted their crowdfunding rules in 2011, and ten other states have adopted similar rules. However, since 2011 only a handful of issuers have actually utilized these rules. For statutes that purport to provide “entrepreneurs with expanded access to much needed capital,” there is not much access to capital that is occurring. Still, even with clear evidence that there has not been uptake of state crowdfunding under these rules, state legislators are still under the belief that Section 3(a)(11) is the proper federal standard for state crowdfunding.
The primary reason that issuers are not using these state crowdfunding rules is the inherent limitations of the intrastate offering. Section 3(a)(11) has always been understood to be an exemption for securities offerings that are genuinely local in character. Not only must the issuer be registered and doing business in the state where it is making an offering, the securities may not be offered or sold to residents of other states. As we know, “offer” is a very broad terms that includes any attempt to sell the security, or to condition the market or arouse interest.
As such, a bootstrapping start-up that posts to Twitter that it is looking for funding has now lost the availability of the Section 3(a)(11) exemption, and may even be found to have violated Section 5 of the Securities Act—an enumerated Bad Act that could prevent the company from being able to access capital under Rule 506, and the to-be adopted Regulation A+ and federal securities crowdfunding.
That is a lot of damage from one little Tweet. No wonder very few issuers have taken advantage of these rules.
Maine, however, has taken a different course. The bill initially proposed for state crowdfunding in Maine followed the Section 3(a)(11) standard. However, in committee, the bill was changed to fit within the small offering exemption of Rule 504, specifically for the purpose of allowing solicitation methods that include social media and the internet. This is the model that states should follow if they want to make crowdfunding successful in their states.
One thing that is different about Rule 504 is that in order to engage in general solicitation, a substantive disclosure document must be filed with a state and be provided to investors. Previously, the SEC has indicated that the NASAA U-7 Form would suffice. While the disclosure requirements of the U-7 are significant, they are not impossible to comply with. Entrepreneurs with a good understanding of their own business should be able to complete the disclosures with minimal assistance from legal counsel (and I would never advise an entrepreneur to engage in any form of capital-raising without the assistance of counsel).
The switch to Rule 504 and the substantive disclosure requirement will be easy for some states that have already adopted a disclosure document for their state crowdfunding rules relying on Section 3(a)(11). For instance, the State of Washington and the District of Columbia have adopted a disclosure form that is slightly pared down from the U-7. These disclosure documents would likely satisfy the SEC’s standard for “substantive” disclosure.
States that are truly interested in providing rules by which entrepreneurs can raise money in a crowdfunding campaign would be smart to focus on the federal exemption under Rule 504. Section 3(a)(11) just doesn’t work.