One of the best parts of my job is talking to entrepreneurs, both the entrepreneurs whose businesses are considering securities-based crowdfunding and the entrepreneurs who are starting crowdfunding platforms. The one question I hear the most from both camps is “When are we going to be able to start?”. Unfortunately, the only answer we can provide them is a bit unsatisfying: “When the SEC says you can.” This lack of clarity is arguably suppressing excitement for crowdfunding and leading to dark rumors of a conspiracy to cripple crowdfunding before it can even start. While I don’t know when the SEC will fire the starting gun for crowdfunding, I can hopefully provide some information to help you understand the process the SEC has to follow in creating the rules and better anticipate and prepare for the beginning of what will hopefully be a revolutionary new way for companies to raise money.
Part of the problem with people being confused is that we are witnessing an interesting clash of philosophies in the crowdfunding space, with the “ready-fire-aim” disruptive entrepreneurial culture and the risk-averse, “make certain it is 100% right before you let it happen” securities law culture forced into an uneasy alliance to make securities-based crowdfunding a reality. One culture is dominated by engineers and evangelists, the other by lawyers and economists, so it isn’t surprising that expectations are not going to align. This frustration has manifested itself in many ways; including concerns that crowdfunding is being sabotaged or hijacked to benefit the established financial system. While it is impossible to disprove those rumors, it appears that many of them are grounded in a misunderstanding of how the rulemaking procedure works and that the far more likely explanation is simply that the SEC is following the laws that govern it, which unfortunately move slower than we might like.
One important thing to keep in mind is that establishing the regulations for crowdfunding is a big job. Title III of the JOBS Act (.pdf), the part that puts securities-based crowdfunding on a path to legality, requires the SEC:
- create the regulations under which crowdfunding will operate,
- decide how to regulate funding portals,
- create the infrastructure (rules, forms, assignment of the registration process to an office within the SEC) for registration and oversight of portals (broker-dealers, who may also serve as crowdfunding intermediaries, are already required to register with the SEC), and
- empower a Self-Regulatory Organization (SRO), at this point presumed to be FINRA, to oversee the portals; the SRO will in turn have to register portals and create rules for their operation.
Under the statute the SEC has until December 31st, 2012 (270 days from April 5th, the date the JOBS Act was signed) to complete this, and SEC Chairman Mary Schapiro recently told Congress that she “does not foresee not meeting the deadline.” (video of hearing – comment starts around the 27 minute mark) In crafting regulations, the SEC isn’t able to operate with a free hand, creating an innovative and dynamic rulemaking process for a new economy. Rather, its procedure is itself bound by law, most especially the Administrative Procedures Act of 1947 (APA), which dictates the steps the SEC will take and is part of why things are taking so long. By understanding the SEC’s procedure we can get a better sense as to how close they are to being complete and when we can start crowdfunding (this may be familiar or painfully boring for some of you, so feel free to skip ahead).
Because the JOBS Act directed the SEC to create regulations in areas like the disclosures required of portals and entrepreneurs, the restrictions on sales of crowdfunded securities, and the procedures for funding portal registration the SEC needs to go through the rulemaking process. At a minimum under the APA the SEC is required to publicly propose rules, allow the public between 30 and 90 days to comment on the proposed rules, and then draft and publish final rules in the Federal Register for at least 30 days before the rule becomes final.
Given the complexity of the rules required for crowdfunding and the large and engaged base of support for it the SEC has elected to pursue a pre-comment period, currently ongoing, in which it solicits the views of the public on what the regulation should look like. If you haven’t done so already, this is a great opportunity to provide concise, specific, and respectful advice to the SEC. (For tips on how to do this effectively check out Sara Hanks’s blog post.) The SEC will consider this input, as well as the legal and economic analysis of its staffers, to formulate proposed rules. The next step the SEC will take is to have a public meeting for the five SEC commissioners to vote on the proposed rules. This meeting must, pursuant to the Government in the Sunshine Act of 1976, be public and while there will be debate and the Commissioners are prohibited from discussing the matter with each other in private, chances are the Commissioners’ staffs have managed to hammer out most of the details with the staffers doing the drafting beforehand. At that meeting the Commissioners are expected to vote on and approve proposed regulations.
After the meeting the proposed regulations will be opened up for public comment. While ninety days is the traditional time allotted for this process, the APA allows the SEC to shorten the comment period to as little as thirty days. Given the 270 day deadline and the pre-comment period the SEC has pursued it seems reasonably likely that the SEC will shorten the comment period. This comment period is the last opportunity for the public to directly influence the rules and people interested in crowdfunding should be actively engaged in it. Once that period is complete the SEC will consider the public comments and possibly amend the proposed rules.
If the SEC makes significant changes to the rules that were not previously suggested as an option, it will need to open a new comment period for a reproposal of the rules. (It seems unlikely that this would happen in light of the pre-comment process and the statutory deadline.) Otherwise, the Commissioners will hold another public meeting at which they will vote to approve the final rules. Once the final rules are approved they will be published in the Federal Register and then go into effect no less than 30 days after publication.
So is that it? Will we be ready to go 30 days after the final rules are published? Not necessarily. FINRA will still need to create rules for funding portals (broker-dealers are already covered by FINRA rules) and portals will need to register with both the SEC and FINRA. Which might (or might not) be done concurrently with the rulemaking process.
(We are done with the overview of the process in case you skipped ahead)
As you can see, this is a complex and time consuming process under the best circumstances, but it is that way for a reason. The APA is designed to prioritize equity and citizen participation in the regulatory process over efficiency or expediency, which means that not only is the process not designed to go quickly, it is explicitly designed to give ample time for the public to read, understand, and comment on the regulations before they take effect (i.e. go slowly). Further, Congress has charged the SEC with protecting investors and maintaining orderly markets, which means that it can’t tolerate risk and failure the same way entrepreneurs can. This leads to an agency that is highly risk-adverse and arguably skeptical of innovation in the financial sector, and hesitant to let things happen without double and triple checking it first. Before we blame the SEC, however we should consider what happens if they get it wrong: people can lose their money, businesses can fail, and confidence in our markets, which we all rely on to keep our economy moving, can falter -- heady stuff indeed.
Another reason this is taking a long time is that there is more on the SEC’s plate than just crowd funding. The SEC has other obligations under the JOBS act, as well as other laws such as Dodd-Frank. The SEC has already said it will miss the 90 day deadline found in Title II for changing the rules on “general solicitation” for Reg. D raises (though it has announced a meeting on this issue for August 22nd) and has not finalized rules for Title IV.
However, this doesn’t necessarily mean, as some fear, that the SEC will miss the Title III deadline, or that it is intentionally delaying it. Title II had a much shorter deadline and deals with a more complex issue with more complex policy implications for other elements of the securities law, and Title IV doesn’t have a statutory deadline. As it currently stands it is entirely possible that the SEC will meet its Title III deadline event.
Of course, the SEC is only part of the battle. FINRA will also need to draft rules and register portals. There are reports that the SEC and FINRA have not had any official meetings yet to discuss crowdfunding. This may well be true, and is disappointing but does make logical sense. FINRA answers to the SEC, and will want to know how the SEC plans on regulating crowdfunding and funding portals before FINRA begins drafting its regulations, that way FINRA can be certain the regulations will be accepted by the SEC. It is unclear how long this process will take but we do know that FINRA has been talking to CFIRA, the crowdfunding industry’s regulatory initiative, and has begun a pre-comment period of its own, so at least they will not be starting at square-one when the SEC is done.
Is there anything that can be done to speed the process up? Not really. One thing you shouldn’t do is expect Congress to force the SEC’s hand. The SEC is, by design, insulated from direct pressure by Congress. The bipartisan Commission’s five members are appointed for a term of years and the agency prides itself on its political independence. The truth is there is relatively little Congress or the Administration can do to the SEC to make them speed up. Congress could pass new legislation stripping the SEC of jurisdiction, but this would be a dramatic and likely destructive move for crowdfunding and it is unlikely that there is sufficient political support for such a potentially apocalyptic act. Members of Congress can ask the SEC questions and make their displeasure known, but their power to make the SEC move quicker on crowdfunding is otherwise limited.
This is not to say however that you shouldn’t talk to your Congressman about how you think crowdfunding should operate, since it is likely there will be further crowdfunding legislation as the country gets more experience and sees what works and what needs to be corrected. Everyone should also remain engaged in the ongoing regulatory process. The SEC and FINRA are soliciting public opinion and if you haven’t submitted your concise, respectful and specific suggestion on how the regulations should look, there won’t be a better time to do so. You should also follow the news and FINRA's and the SEC’s releases for when they announce their proposed regulations. This will be the first draft that, barring considerable changes, will serve as the basis for the final rules. Finally, don’t panic; this is not going to happen overnight, and that is probably a good thing. Crowdfunding has the potential to be revolutionary, but for the revolution to survive, people, including the regulators responsible for policing the markets, need to feel comfortable with it, and one way comfort is achieved is a thorough rulemaking process where everyone feels that their voices have been heard.