It’s been 18 months since I wrote a column about the Jumpstart Our Business Startups (JOBS) Act, which President Obama signed in April 2012. As a reminder, the purpose of that law was to “increase job creation and economic growth by improving access to the public capital markets for emerging growth companies.” (You can find that column at bit.ly/17vzF45.)

Title I created an easier Initial Public Offering (IPO) on-ramp for companies meeting the new definition of an Emerging Growth Company. It was effective immediately, and has been used by several firms as they planned and executed their IPOs.

Title II called on the Securities and Exchange Commission (SEC) to lift the ban on mass advertising of private placements offered to accredited investors. In July 2013, the SEC adopted a rule making that change, which became effective in September.

Title III was the source of a significant change in policy; it amended the SEC rules to allow certain issuers to sell equity in a business through crowdfunding. During the past several years, that technique of raising money through the Internet had been used to attract funding for projects involving film, dance, art, design, and technology. It had not been used to raise equity in a business enterprise because doing so would have violated SEC rules. The Act gave the SEC 270 days to revise its rules to permit such funding for start-up companies.

After 530 days and much deliberation, the SEC recently proposed the rules governing the process of raising money through crowdfunding. That proposal is 585 pages long; it includes more than 1,100 footnotes, and asks for comments on 295 questions. It is open to public comments for 90 days; the staff and commissioners can be expected to spend another 30-60 days evaluating those comments and preparing a final rule. So it could be March 2014 before the rules governing crowdfunding will finally be in place.

What’s in the proposal? For the most part, it follows the guidelines noted in the JOBS Act.

• A company would be able to raise as much as $1.0 million in a 12-month period.
• It would have to use a crowdfunding portal operated by a regulated broker-dealer.
• Investors with less than $100,000 in annual income and net worth would be permitted to invest as much as $2,000, or 5% of their income.
• Investors with more than $100,000 in annual income and net worth would be able to invest as much as 10% of income or net worth, whichever is larger. They would be limited to investing $100,000 per year in this way.

But the proposed rule contains a few new wrinkles.

• An issuer raising more than $500,000 would have to provide audited financial statements.
• All issuers would have to provide investors with annual financial statements.
• Issuers would be prohibited from advertising, but would be allowed to direct potential investors to the appropriate broker portal.

It seems to me that the SEC may be more concerned than Congress about the potential for fraud by users of crowdfunding. Several media outlets have reported disappointment over the requirements for audited financials and annual financial reports. Producing those documents could be quite costly, especially for companies that have made the conscious decision not to use the existing rules of Regulation A and Regulation D to raise money. Both of those pathways require companies to make meaningful financial disclosures. Other commentators have noted disappointment over the limits on investing placed on small investors. Still others have voiced their fear that the nation’s major investment banks will not be interested in setting up crowdfunding portals. Only smaller, newer, inexperienced, and possibly less-capable operators will come to dominate that route of financing.  

Congressional intent is often changed markedly by the regulatory agency that issues the rules to implement a piece of legislation. I can’t wait to see if any congressmen will provide the SEC with their personal comments on this proposed rule, and whether the SEC will loosen some of its proposals to make crowdfunding as easy as its most ardent supporters hope it will become.

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Michael A. Martorelli is a Director at the investment banking firm Fairmount Partners. For additional commentary on the topics covered in this column contact him at Michael.martorelli@fairmountpartners.com  or at Tel: (610) 260-6232; Fax (610) 260-6285.