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Office of Advococy

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Advaca*y: ttis y*ise of small businessin g,avernment

January16.2014

VIA ELECTRONIC SUBMISSION

and ExchangeCommission U.S. Securities Attn: Elizabeth M. Murphy, Secretary NE 100F Street, Washington, DC 20549 gov ElectronicAddress:rule-comments@sec. Re: Crowdfunding.File Number 57-09-13 Dear Ms. Murphy: The Office of Advocacy (Advocacy) offers the following comment to the Securitiesand Exchange, proposedrule issuedon October23,2013.' The SEC to the above-referenced Commission(SEC) in response the foundationfor a issuedthe proposedrule to implementTitle III of the JOBS Act', which established to raise capital through securitiesofferings using the regulatoryitructure for startupsand small businesses Iniernetthrough crowdfunding. On December16,2013 and January15,2014, Advocacyhostedsmall about the proposedrule. businessroundtablesto receive feedbackfrom small businessrepresentatives Basedupon this feedback business. Advocacy also hosted severalconferencecalls to hear input from small Advocacy is concernedthat the Initial Regulatory Flexibility Analysis from small businessstakeholders, (IRFA) containedin the proposedrule lacks essentialinformation required under the Regulatory Flexibility Act (RFA)3. Specifically, the IRFA doesnot adequatelydescribethe costsof the proposedrule on small entities, and the IRFA does not set forth significant alternativeswhich accomplishthe statedSEC objectives and which minimize the significant economic impact of the proposal on small entities. For this reason, Advocacy recommendsthat the SEC republish for public comment a SupplementalIRFA before proceeding with this rulemaking. Advocacy also believesthat the SEC should take into considerationsmall business alternativesto minimize the proposedrule's potential impact. representatives'suggested Office of Advocacy Advocacy was establishedpursuantto Pub. L. 94-305to representthe views of small entities before federal by Advocacy agenciesand Congress.Advocacy is an independentoffice within SBA, so the views expressed do not necessarilyreflect the views of the SBA or the Administration. The RFA, as amendedby the Small BusinessRegulaiory Enforcement FairnessAct (SBREFA),4 gives small entities a voice in the rulemaking
t http://www,sec.gov/rules/proposed/20 I 3/33-9470.pd1'. 'pub.L. No. 112-106, (2012). t26 stat.306 ' 5 u.s.c. g 6ol et seq. a pub.L. 104-l7l, Title II, 110Stat. (codified of 5 U.S.C. in various sectious 857(1996) $ 601et seq.).

process. For all rules that are expectedto have a significant economic impact on a substantialnumber of the impact of the proposedrule on small small entities, federal agenciesare required by the RFA to assess businessand to consider less burdensomealternatives. The RFA requires agenciesto give every appropriateconsiderationto commentsprovided by Advocacy. The agencymust include, in any explanation or discussionaccompanyingthe final rule's publication in the FederalRegister,the agency's responseto thesewritten commentssubmittedby Advocacy on the proposed rule, unlessthe agencylertifies that the public interest is not servedby doing so.s Background On October23,2013, the SEC issuedthe proposed rule to prescribe requirements governingthe offer and sale of securitiesthrough crowdfunding. The proposedrule would also provide a framework for the regulation of funding portals and brokers that issuersengagedin crowdfunding are required to use. After the SEC issuedthe proposedrule, Advocacy hostedtwo small businessroundtablesand several telephoneconferencecalls to receive feedbackon the proposal. Basedon thesemeetingsand phone calls, small businesses focused on two areasof the proposedrule: (l) disclosurerequirementsand (2) intermediary requirements. (l) Disclosure Requirements The proposedrule would set financial disclosurerequirementsfor companies("issuers") that raise capital through crowdfunding. If an issuer'stargetoffering is $100,000or less,the disclosure must includethe income tax retums filed by the businessfor the most recently completedyear and financial statements of the issuer,which must be certified by the principal executive officer of the issuerbusiness.If the target offering amountis between$100,000and $500,000, the issuermust provide financial statements reviewedby an independentaccountant. If the target amount of the offering exceeds$500,000,the proposedrule would require the issuerto provide two years of audited financial statements when it files its initial offering materialswith the intermediary and the SEC. Although the JOBS Act does statethat issuersseekingto raise over $500,000must provide audited financial statements, section 302(bxlxD)(iii) of the law also provides the SEC with authority to changethe amountof the $500,000thresholdby rulemaking. Additionally, the proposedrule would also mandatenonfinancial disclosuresnot required by the JOBS Act. Section 227.201of the proposedrule setsforth l0 pagesof different nonfinancial disclosuresthat would be required for issuers. The proposedrule would require issuersto discloseinformation such as: the name of eachpersonwho owns 20 percentor more of issuer's voting power; a descriptionof issuer's business and issuer'santicipatedbusinessplan; the number of issuer'semployees;the risk factors associated with the investment;the target offering amount and deadlineto reachtarget; whether investmentsin excessof the targetedamount will be accepted,and if so, how oversubscriptionswill be allocated; and the intendeduse of the proceeds.

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(2) Intermediar.v Requirements The proposedrule would also set requirementsrelated to the intermediaries- funding portals and broker dealers- that issuersraising money through crowdfi.urdingwould be required to use. The proposedrule suggests that both funding portals and broker dealersshould be treatedas "issuers" that could be held personally liable for failing to meet the "due diligence" standardof the JOBS Act. Specifically, section II.A.5 of the proposal's preambleprovides that "it appearslikely that intermediaries,including funding portals, would be consideredissuersfor purposesof this liability provision."u It is noteworthy that the JOBS Act doesnot require this imposition of liability and the resulting due diligence.standard that the proposedrule appears to mandate. The proposedrule would also subject funding portals to certain additional constraintsnot applied to broker dealers. The proposedrule provides that funding portals canno_t engagein the practice of sorting or organizing crowdfunded offerings basedon subjective criteria.' However, the proposedrule would allow broker dealersto engagein this practice of sorting known as "curation." The Proposed Rule's IRFA is Deficient Because it doesnot adequately describe the impactson small entitiesand because it doesnot discuss alternativesthat might reducethose impacts,Advocaiy believesthat the IRFA containedin the proposedrule is deficient, and for this reason,the SEC should republish a SupplementalIRFA for additional public comment before proceedingwith this rulemaking. lJnder the RFA, an IRFA must contain: (1) a description of the reasonswhy the regulatory action is being taken; (2) the objectives and legal basis for the proposed regulation; (3) a description and estimatednumber of regulatedsmall entities; (4) a description and estimate of compliance requirements,including any differential for different categoriesof small entities; (5) identification of duplication, overlap, and conflict with other rules and regulations; and (6) a description of significant alternativesto the rule.o Advocacy is concernedthat because the proposedrule's IRFA is deficient, the public has not been adequatelyinformed about the possible impact of the proposedrule on small entities and whether there are significant alternativesto the proposedrule that would meet the SEC's objectivesin a lesscostly manner. The IRFA containedin the proposedrule doesnot adequatelydescribeand estimatethe coststhe proposal would impose on small entities. Additionally, the IRFA doesnot set forth significant alternativeswhich accomplishthe statedSEC objectives and which minimize the significant economic impact of the proposal on small entities. The IRFA only lists alternativesrelated to exempting small businessfrom the proposed requirements. However, the SEC statesthat thesealternativesdo not accomplishthe underlying goals of the rulemaking. Therefore,theseare not "alternatives" ibr purposesof the RFA. Moreover, the IRFA doesnot discussalternativesthat may reducethe disproportjonateeionomic impact on small entities. Becausethe IRFA does not contain an adequatedescription of alternatives,the IRFA doesnot comply with the RFA requirementthat an IRFA provide significant alternativesthat accomplish an agency's objectives.

6 htto :i/www. sec. gov/ruIes/proposed/20 13/33-9470.pdf at 280. ' ld. at233.

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Recommendations Advocacy recommendsthat the SEC revise its IRFA to provide a description of the costsof the proposedrule and to include altemativeswhich would accomplishits objectives for the rulemaking. Small business representatives at Advocacy's roundtableshave describedtwo areasof concernwhere a discussionof costs and alternativeswould help provide the public with more adequatedata to assess the impact of the proposed rule and potentially minimize the costsimposed by the proposedrule: (1) disclosurerequirementsand (2) intermediary requirements. ( I ) DisclosureRequirements Small businessrepresentatives and owners expressed concernto Advocacy thatthe proposedrule's disclosurerequirementswould impose high costs and burdens. In particular, small businessstakeholders are concemedabout the potential costs associated with the proposal's audited financial statements requirement for issuersseekingto raise over $500,000through a crowdfunded offering. Small businessowners in contact with Advocacy have observedthat this requirementwould be problematic and burdensomebecause many of the issuerslooking to raise capital through crowdfunding will be startupswith little or no revenueto afford audited financial statements. Becausethe JOBS Act provides the SEC authority to changethe threshold for audited financial statements, small businessrepresentatives suggested that the SEC should consider altematives, such as raising the threshold amount, so that the proposal's audited financial statement requirement is lessburdensome for small business. Further, small businessstakeholdersexpressed concernsabout the potential costs and burdensassociated with the proposal's nonfinancial disclosures.However, the IRFA containedin the proposedrule provides no estimatesof the coststhat disclosurerequirementswould impose. Small businessrepresentatives at Advocacy's roundtablesproposedalternativesto the nonfinancial disclosurerequirementsthat may minimize costs. One alternativeto the proposedrule's nonfinancial disclosuressuggested by a small businessowner is that the SEC could adopt a simple "question and answer" format for nonfinancial disclosuressimilar to the format used in disclosuresfor Regulation A offerings. The question and answerformat would be less burdensomefor small businessissuerswhile still providing the SEC with the information it is seekingunder the proposedrule. Another potential alternative suggested by a small businessrepresentative is that the SEC could develop standard,boilerplate disclosuresfor someof the more complicatednonfinancial disclosures,such as risk factors. Permitting small businessissuersto use standarddisclosureswould seryeas a less burdensome alternativethat still accomplishesthe pulposesof this rulemaking. Becausethe proposedrule's nonfinancial disclosuresare not required by the JOBS Act, Advocacy encourages the SEC to develop alternativesthat would be lessburdensome for small business. (2) Intermediary Requirements As describedabove,the proposedrule appears to impose statutoryissuer liability on intermediaries. This is potentially a large expensefor intermediariesthat the IRFA doesnot estimate. For example,in order for an intermediary to avoid liability to a purchaseron the basis of an issuer's false or misleading offering materials, the intermediary would likely need to conduct an expensiveand time-consuming due diligence on the issuer's

broker offering materials.This liability standardwould be especiallyburdensomefor funding portals because Industry Financial by the place set procedures requirements in under dealerswill already have these to Advocacy that have suggested Regulatory Authority (FINRA). Small businesso\\mersand representatives the SEC should clariff that broker dealersand funding portals would not be subjectto personalliability as an issuer. In addition to personalliability being particularly costly for funding portals, the proposedrule would impose anothercost on funding portals that the IRFA does not describe:the prohibition of funding portals to curate on the basis of subjective factors. The prohibition on curation is burdensomebdcauseit would place funding portals at a competitive disadvantage to broker dealers(who may curate offerings under the proposal). portals permitted to screenissuerson the basis of subjectivefactors, the funding are not Moreover, if funding portals could potentially be exposedto greaterrisk of personalliability for the offers on the portal. recommendedto Advocacy an alternativeto the proposedrule's Small businessowners and representatives portals' that the SEC createa safe These small businesses suggested ability to curate. restriction on funding harbor for funding portals to cwate on the basis of subjectivefactors that do not engagein activities that alternativewould be for the SEC to permit funding could be treatedas "solicitations." Another suggested portals to curate on the basis of subjectivefactors so long as the portals disclosedto the public that its curation does not constitute a recommendationregarding the advisability of any investment on the funding portals. Both of these suggestionsserveas alternativesthat may reducethe costsand burdensof the proposed rule that the SEC should consider. Conclusion Advocacy is concemedthat the SEC's proposedrule and IRFA lack essentialinformation neededto properly inform the agency's decision making. Specifically, the IRFA doesnot adequatelydescribethe costsof the proposedrule on small entities, and the IRFA does not set forth significant altemativeswhich accomplishthe statedSEC objectives and which minimize the significant economic impact of the proposal on small entities. For this reason,Advocacy recommendsthat the SEC republish for public comment a SupplementalIRFA before proceedingwith this rulemaking. will have more adequatedata to assess the potential By republishing a SupplementalIRFA, small businesses impact of the proposedrule. Further, the SEC will gain vaiuable insight into the effects of the proposedrule on small business. Advocacy also believesthat the SEC should take into considerationsmall business alternativesthat may minimizethe proposedrule's potential impact. representatives'suggested Advocacy is committed to helping the SEC comply with the RFA in the developmentof the proposedrule. Therefore, Advocacy standsready to assistthe SEC in the completion of a SupplementalIRFA.

Advocacy looks forward to working with the SEC. If you have any questionsor require additional information pleasecontact me or Assistant Chief Counsel Dillon Taylor at (202) 401-9787or by email at gov. Dillon.Taylor@.sba. Sincerelv.

Winslow Sargeant, Ph.D. Chief Counsel for Advocacy

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Dillon Taylor Assistant Chief Counsel Advocacy

Copy to:

The Honorable Howard Shelanski,Administrator Office of Information and Regulatory Affairs Office of Managementand Budget