The SEC and New York University recently held a dialogue on securities crowdfunding.  SEC Commissioner Kara M. Stein offered closing remarks and asked some questions that need to be answered. https://www.sec.gov/news/statement/stein-closing-remarks-sec-nyu-dialogue.html. These are my thoughts and responses to Commissioner Stein’s remarks.

Dear Commissioner Stein:

By way of background I am a securities attorney with 40 years of experience representing broker/dealers, issuers of securities and large and small investors.  I have also taught economics and finance at a well reputed business school.

My interest in securities offerings that are made directly to investors over the internet goes back to the late 1990s when the first offering was made by the Spring Street Brewery company. I have spent the better part of the last two years studying and writing about crowdfunding under the JOBS Act.

I currently advise clients who are issuers, Title II platforms and Title III portals.  I believe that crowdfunding can work and that it can be a valuable tool in aid of the capital formation process especially for smaller companies.

To this point in time, a large percentage of successful offerings involve various forms of real estate investments. The vast majority are being offered under Regulation D. Several real estate funds have raised $25-$50 million from accredited investors on Title II platforms. Thousands of smaller real estate offerings have also been successful. These offerings are proof that funding is available outside of the traditional broker/dealer sales network.

Small companies and start-ups on the other hand, have had a much more difficult time attracting investors.  Start-ups, of course, are far riskier investments than most real estate offerings.  There are far fewer investors in the market place who are looking for that risk.  Some will take on the risk if they are satisfied with the potential for the company’s success.

There has been a push to offer securities in these companies to smaller investors under Regulations A and CF on Title III portals. The question that you asked in your remarks at the SEC-NYU dialogue: “Are registered portals appropriately considering the companies and offers hosted on their platforms?” is the appropriate question to ask.

There are fewer than 2 dozen registered portals today. I have reviewed offerings on most and have had direct contact with several. The answer to your question is that some of the portals do indeed act appropriately and several clearly do not.

You can easily identify those portals that do not comply with the rules. Most of those do not have a well trained and experienced professional in the role of compliance director.  The compliance director at any Title III portal should, at the very least, have a complete familiarly FINRA’s due diligence and advertising rules.

There are several portals who do not even attempt to conduct a due diligence review. There are also several consulting firms that provide due diligence investigations to the crowdfunding industry that lack the experience or expertise to do it correctly. These consultants get a lot of work from the portals because they charge very little.

You asked whether there should be minimum and uniform standards for vetting companies seeking to be hosted on a portal.  FINRA already has very specific rules for due diligence that require the member firm to verify the facts that the issuer is presenting to investors.  New rules are not needed; just compliance with and the enforcement of the existing rules.

One FINRA member portal in particular that has specialized in Reg. A offerings has listed several issues which are questionable in terms of their disclosures and economic viability. That portal makes no attempt to vet the offerings it lists.  One of these offerings is currently the subject of an SEC enforcement action.  I cannot know if the Commission’s enforcement staff intends to sanction the portal for its participation in that offering.  In my opinion, it should.  This portal unfairly competes with the portals that take their responsibilities seriously.

This portal does not spend money on due diligence. It does not care whether the issues it lists misrepresent their prospects for success to prospective investors.  It has a track record of successful offerings because the issuers are making promises to investors that they are unlikely to keep.

You suggested that some people have registered their concern at what may be a “race to the bottom” as portals compete for offers. That is exactly what is happening.  That same portal is currently offering a one day Reg. CF workshop that provides issuers with accountants, lawyers, copywriters and other vendors to get their campaign to “go live” on the same day as the workshop with no cost.

I cannot imagine that the SEC staff or FINRA would believe that adequate due diligence is being done if the offering is going live on the same day that the portal is first introduced to the issuer. I cannot personally believe that a competent securities attorney would participate in the preparation of these offerings or that the attorney’s professional liability carrier would approve.

Your presentation also noted that FINRA had expelled a portal for listing 16 questionable Reg. CF offerings. Those offerings were essentially done with a “cookie cutter” approach. What besides a cookie cutter approach can be expected when a portal is proposing to create and list multiple offerings on a single day at a workshop?

I have singled out this portal because its conduct is so egregious that I suspect that the Commission staff has already taken note.  I am not the only person in the crowdfunding industry who would understand if FINRA or the Commission did its job and closed this portal down.  If the crowdfunding industry is to succeed, investors must be able to look to this market with confidence.

You also asked what needed to be done to ensure that crowdfunding opportunities are accessible to everyone from the businesswoman in Missouri to the immigrant in West Virginia.  I have personally been contacted by potential issuers from all over the country. I know that Title II platforms exist in many states and several portals are “under construction” outside of major money centers.

Many of these issuers lack the knowledge and skills to put together an offering that might attract investors.  They lack experienced managers, quality boards of directors and well thought out business plans.  The Small Business Administration (SBA) has an existing mentoring program (SCORE). The Commission would be doing the marketplace a service by partnering with the SBA to make accurate information about crowdfunding available to more potential issuers.

There is currently a lack of good information about crowdfunding in the marketplace and much of the information that is available is inaccurate.  Much of the information about crowdfunding is being disseminated by a remarkably small group of people.  Many of these people have no experience selling securities and treat the process as if they were selling soap powder.

You expressed a desire on behalf of the Commission to improve this marketplace. There are those who are advocating making these very risky investments more accessible to small investors. I urge the Commission to reject that approach.  The risk should be allocated to those investors who can afford to absorb the loss.

As you noted, “portals that are effective at vetting issuers and offers are important as both gatekeepers and facilitators of repeat investment.” Keeping the portals focused on that task is the best thing that the Commission can do for this market.  Investors will come when there are better offerings. Better offerings will come when the portals insist that issuers demonstrate that they have real potential for success.

Respectfully,

 

Irwin G. Stein, Esq.