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Rumored SEC Proposal Would Ease Requirement for Investor Income Verification

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Business writer Dave Michaels, writing in Bloomberg's Businessweek has penned a piece under the headline, "SEC to Issue Crowdfunding Proposal Easing Investor Verification."

The article explains that "Small businesses raising money by selling shares over the Internet wouldn't have to verify that their backers comply with individual investment limits under a U.S. regulatory proposal set for a vote as soon as next week."

The article is potentially confusing to those trying to follow the numerous changes now being rolled out that affect capital formation for emerging growth companies. My hope in writing this is to eliminate that potential confusion.

The 2012 JOBS Act, among its other efforts, was intended to make possible securities-based crowdfunding on a nationwide basis. Title III of the JOBS Act created a comprehensive system by which private companies could sell securities (equity or debt) to investors in the U.S. on licensed "crowd-fund portals". Investors would be limited in the amount of money they could invest in a crowdfunded offering based upon their income levels.

Congress directed the SEC to adopt regulations implementing Title III within 270 days after the law's enactment. More than 1.5 years have elapsed and the SEC still has not adopted those necessary regulations, although SEC Chair Mary Jo White has been quoted to say that she expects those regulations out by the end of 2013.

The Bloomberg article describes a "regulatory proposal" that would expressly relieve issuers of securities in crowdfunded offerings from having to verify the income levels of participating investors.

Importantly, no regulatory proposal has yet been released to the public, and Dave Michaels notes that he is relying on unnamed sources within the SEC "with direct knowledge of the matter who asked not to be named because the proposal hasn't been made public." Assuming that the rumor is true, however, it is also important to understand what this proposal would, and would not, cover.

Although crowdfunding under Title III of the JOBS Act prohibits investors from making investments greater than their income-related levels, that prohibition is only one of several requirements. Even if the rumored proposal were adopted, that would not allow companies to start issuing securities in crowdfunded offerings any time soon. The SEC would still need to adopt all of the other regulations required to implement crowdfunding, including a comprehensive description of the licensing requirements for the yet-to-be-defined "crowd-fund portals". Because the licensing of the crowdfund portals is likely to fall within FINRA's purview, even the completion of the SEC's rules will not be enough to implement crowdfunding because FINRA would also be required to adopt procedures for portal licensing. Once adopted, potential portals would need to complete the FINRA licensing process before launching, a process that would likely take months.

So, while a proposed rule that relieved issuers from a duty to verify an investor's income would be a step forward, it would not come anywhere close to completing the regulatory work needed to implement crowdfunding under the JOBS Act.

It's also important for those following these issues to understand how investor income verification is a separate topic from accredited investor status as it relates to Regulation D.

Before the advent of crowdfunding, private offerings under Regulation D were the primary means of capital formation for emerging growth companies. Under the mandates of the JOBS Act the SEC has recently adopted regulations making it possible for private companies to issues securities under Regulation D through public solicitations under Rule 506(c). One of the requirements of these new "public/private" offerings is that all of the participating investors be accredited investors (a category that is defined by either the investor's income or net worth). A key element of the new Regulation D rules is that securities issuers must take additional steps to verify the status of each investor as an accredited investor through a process that might require the issuer to verify the issuer's income.

The proximity of Dave Michael's rumored income verification rule for crowdfunding with the accredited investor status verification rule under Regulation D could become confusing for some. Even if the rumored proposal eliminated a duty on the part of an issuer to verify income for compliance with Title III of the JOBS Act, that proposal would have no bearing on the issuer's duty to verify accredited investor status (via income or net worth) for purposes of an exempt private offering under Regulation D.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


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