New Massachusetts Crowdfunding Regulation and Summary and Highlights

(On January 15, 2015)

OFFICE OF THE SECRETARY OF THE COMMONWEALTH
MASSACHUSETTS SECURITIES DIVISION
NOTICE OF PUBLIC HEARING

The Massachusetts Securities Division has adopted an emergency regulation permitting intra-state crowdfunding offerings, the "Crowdfunding Exemption," located at 950 CMR 14.402(B)(13)(o). The Crowdfunding Exemption allows Massachusetts businesses to raise up to $1,000,000 over a 12-month period in a single offering conducted entirely within the state, and is tied to the federal "intrastate offering" exemption found in Section 3(a)(11) of the Securities Act of 1933 and Securities and Exchange Commission Rule 147. Pursuant to the regulatory authority conferred by M.G.L. c. 110A § 412 and as required by M.G.L. c. 30A, the Securities Division will hold a notice and comment period ending on Tuesday, March 24, 2015 and conduct a public hearing commencing at 10:00am on Tuesday, March 24, 2015 at the Massachusetts Securities Division, John W. McCormack Building, One Ashburton Place, 17th Floor, Boston, Massachusetts, 02108, before permanently adopting the Crowdfunding Exemption under the Massachusetts Uniform Securities Act, M.G.L. c. 110A.

The emergency regulation was filed with the Secretary of State on January 15, 2015. Copies of the regulation as well as a summary and highlights may be obtained by visiting the Securities Division's website. Copies are also available from Jeremy Entwistle, Esq., at the Securities Division at the above address.

Persons desiring to be heard on this matter in person should appear for the public hearing. All written comments will be subject to posting on the Securities Division website, and the Securities Division will not edit personal identifying information from submissions. Written comments will be accepted until 5:00pm on Tuesday, March 24, 2015, and may be emailed to securitiesregs-comments@sec.state.ma.us (subject: "Crowdfunding Regulation"), faxed to (617) 248-0177 (attn.: "Crowdfunding Regulation"), brought to the public hearing, or mailed to the following address: Massachusetts Securities Division, Attn: Crowdfunding Regulation, 1 Ashburton Place, Room 1701, Boston, MA 02108.

Submit a Comment

Submitted Comments

Tuesday, April 3, 2015 12:13 PM

Sir –

As you and I have discussed, I do think that having neighboring States adopt reciprocal Rule 504-based crowdfunding provisions could make crowdfunding much more useful for small businesses. This strikes me as superior to being locked into an intrastate-only approach.

I have given some thought to what reciprocal crowdfunding provisions might look like. Attached is my rough draft of a Massachusetts version and (for comparison) a Maine version.

As you know, Rule 504 allows general solicitation (a necessary attribute of crowdfunding) “in one or more states that provide for the registration of the securities, and require the public filing and delivery to investors of a substantive disclosure document before sale, and are made in accordance with those state provisions.”

When I compare the Maine and Massachusetts statutes, I find that Maine’s grants the Securities Administrator very broad authority to define the content of a prospectus for purposes of a registration by qualification. See § 16307 of the Maine Uniform Securities Act. There is no comparable provision in the Massachusetts statute, and § 303(b) seems to impose minimum content requirements that cannot be waived.

One possible approach to reciprocal crowdfunding in Massachusetts would be for the Division to rely on existing 950 CMR 13.303(A)(1) and simply require a cross-reference sheet and supplement as part of a registration statement. In this way, the Division could track the requirements of § 303(b) against whatever prospectus format happens to be used in the other State. The issuer could be required to add further information in the supplement if any 303(b) items are not otherwise presented in a satisfactory manner.

A second approach would be to use the Secretary’s broad authority to craft registration exemptions. The enclosed Massachusetts draft follows that route. As a condition to the exemption, it requires the issuer to follow qualification-like procedures – namely to preclear the offering document with the Division and to distribute the precleared document to offerees in Massachusetts. By imposing these requirements, I think this exemption should meet the Rule 504 conditions quoted above, and thus should allow for general solicitation under Rule 504. As you will see, the enclosed draft also borrows various conditions found in the Massachusetts crowdfunding exemption (950 CMR 14.402(o)), incorporating these by reference.

I have also prepared a Maine version. Its foundation differs from the Massachusetts version in one significant respect – the Maine draft is a straight qualification provision which capitalizes on the flexibility under § 16307 of the Maine Act. Note that the Maine version is longer than the Massachusetts one because I have chosen to draft this as a markup instead of incorporating key provisions by reference.

I hope the idea of reciprocal 504-based crowdfunding appeals to you and also to the Secretary. I would be happy to discuss this topic at your convenience.

-- Greg

Reciprocal Crowdfunding Exemption - MA (PDF)

Reciprocal Seed_Capital_Registration_Rule_Ch_524 - ME (PDF)

Gregory S. Fryer
Verrill Dana LLP

Wednesday, March 25, 2015 12:28 PM

Reciprocal Crowdfunding Exemption - MA (PDF)

Tuesday, March 24, 2015 4:14 PM

Comments from Ahmad Abdul-Qadir (PDF)

Tuesday, March 24, 2015 5:03 PM

Comments from Gerard P. O'Connor (PDF)

Tuesday, March 24, 2015 2:24 PM

Below is a very comprehensive submission to SEC dealing with education.
I’m on CFPA educational committee. If interested, I could send you CFPA comments about education.
Please feel free to contact me at any time.

Best regards,
Sasha
Alexander “Sasha” Gimpelson
Office: 617-996-6969 Cell: 617-309-0789
email: gimpelsona@twc.com

===========================================
February 3, 2014

Elizabeth M. Murphy
Secretary
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549-1090
Submitted via email: rule-comments@sec.gov

Re: Comments on Proposed Rule: JOBS Title III - Crowdfunding: #141-146

“The great aim of education is not knowledge but action” - Herbert Spencer.

Dear Ms. Murphy:

Thank you for the opportunity to provide comments to the Securities and Exchange Commission (the “Commission”) on its proposed amendments.

The Advisory Council was formed to address a very important need for investor education pursuant to the Jobs Act. Education is critical both for accredited and non-accredited investors for their long term success, as well as that of the Jobs Act. The advisory council consists of a group of prominent practitioners, educators and industry experts with representatives from CFPA, CFIRA & NLCFA.

The SEC has recognized this need and issued basic guidelines for equity investor education; section 4A(a)(3) of the Jobs Act states that intermediaries will be required to “provide… disclosures related to risks and other investor education materials.” However, scope and specific requirements for other materials are left vague. This is where we see a great opportunity, and would like to present the following objectives to this advisory council:

Act as advisory board to develop standards for a complete, systematic online investor education program that prepares investors to participate in the crowdfunding marketplace while mitigating potential risk of fraud
Create a BOK (body of knowledge) to meet and elaborate upon FINRA and SEC recommendations/requirements for investor education
Submit BOK to SEC to meet 90-day comment deadline.

We appreciate this opportunity to comment in advance of the proposed rulemaking for the JOBS Act. Should you have any questions or require any additional information about the Advisory Council or the contents of this letter, please feel free to contact me at 617-879-4710

Alexander Gimpelson
----------------------------------------------------------------------------
Request for Comment
Informal surveys of platforms catering to accredited investors indicate that only a fraction of signed-up investors actually invest. The experienced investors who have already been active remain active, while the majority of novice accredited investors are staying on the sidelines. We could expect similar behavior from non-accredited investors.

It is believed that one of the major reasons is simply a lack of knowledge required to be successful in investing in privately held companies. If the majority of potential investors are remaining on the sidelines, JOBS act is not likely to deliver the promise of job creation. Therefore, the objective of education should not be only making investors aware of potential risks associated with crowdfunding or simply repetition of SEC regulations, but also preparing novice investors to be comfortable in making investment decisions.

“The great aim of education is not knowledge but action” - Herbert Spencer.

141. Is the scope of information proposed to be required in an intermediary’s educational materials appropriate? Why or why not? Is there other information that we should require an intermediary to provide as part of the educational materials? If so, what information and why?

The National Financial Capability Study presents new survey findings that underscore the need to ensure all Americans have access to the education, resources and tools they need to manage their money with confidence

The requirements are dealing mainly with risks and regulations of the JOBS Act. They fail to prepare potential investors to be successful, informed and confident crowdfunding investors.
Education should cover principles of investing, fundamentals of crowdfunding, and basics of evaluating investment opportunities of privately held companies. It should guide learners through the process of making investment decisions and prepare them to be successful, informed crowdfunding investors.

143. Should we prescribe the text or content of educational materials for intermediaries to use? Why or why not? Should we provide models that intermediaries could use? Why or why not?

It is not critical what specific educational method or content is used, provided the course covers the requisite topics and meets basic pedagogical standards. It is up to the intermediary to select the appropriate method. The SEC’s responsibility is to assure that a learner has understood and is capable of applying the acquired knowledge.

The great majority of non-accredited investors have no experience in investing in early stage companies, nor evaluating the opportunities, nor conducting due diligence. Failure to learn or lack of ability to apply the knowledge will result in an unsatisfactory experience, loss of money and in the long run will damage crowdfunding.

We believe that there is only one way to assure that investors are ready to invest. When consequences of actions are significant, standardized tests are widely used. There should be a certification exam available for students once they complete the core materials.

In terms of administration, we recommend multiple choice questions which usually requires less time for test takers to answer, are easy to score and grade, provide greater coverage of material, allow for a wide range of difficulty, and can easily diagnose a test taker's difficulty with certain concepts. True/false tests that require a test taker to choose all answers that are appropriate are fair, efficient and provide feedback to the test taker. Feedback will greatly speed up the process of eradicating deficiencies.

We believe that it would be advisable for the Commission to create a standardized set of basic investor education requirements. The attached Body of Knowledge may be useful for the Commission to guide the development of the test and educational materials.

Developed by experts in crowdfunding and financial literacy, the attached Body of Knowledge curriculum explains crowdfunding in clear, straightforward language—including its properties as an alternative investment and its potential benefits and risks to investors. It offers a methodology investors can use to evaluate the suitability and legitimacy of crowdfunding opportunities.

144. Should we specifically prohibit certain types of electronic media from being used to communicate educational material? If so, which ones and why?

We believe that is wise not to put a limit or specify the type of electronic media allowed. While it is clear that it should not be a requirement, we recommend education for novice investors to be easy, flexible and convenient. For example, an eLearning format of education which delivers the highest comprehension level according to multiple studies may be useful. It will also allow short and subject-specific lectures, accessible any time anywhere at the learners pace on any device.
e-Learning encompasses technology-enhanced learning (TEL), computer-based training (CBT), computer-assisted instruction (CAI), internet-based training (IBT), web-based training (WBT), online education, virtual education, virtual learning environments (VLE) which are also called learning platforms, m-learning, digital educational collaboration, distributed learning, computer-mediated communication, cyber-learning, and multi-modal instruction. All of these formats should be permissible.

145. Should we require intermediaries to submit the educational materials to us or FINRA (or other applicable national securities association) for review? Why or why not? If we should require submission of materials, should we require submission before or after use, when they are first used, when the intermediary changes them or at some other point(s) in time? Please explain.

FINRA Educational Foundation is the most appropriate organization to review educational materials. The review of the materials should be before use and also when the intermediary changes the materials. If not, the investors will start investing without knowing that the educational materials studied were missing important points that they should know.

146. Should we require intermediaries to provide educational material at additional or different specified points in time, rather than only when the investor begins to open an account or make an investment commitment? Why or why not? If so, why would that be preferable to requiring updates on an as-needed basis? For example, should educational material be provided on a quarterly, semi-annual, or annual basis? Should this material be provided again to investors who have not logged onto or accessed an intermediary’s platform for a specified period of time? Why or why not? If so, what should that period of time be?

Intermediaries should provide educational materials when the investor begins to open an account or make an investment commitment. It is important that the investor is ready for investing when they do. The investor should take the test again if they are inactive more than one year. One year is enough for people to forget all the important materials that they learned.

Abridged Novice Investor Body Of Knowledge -

I. Introduction

· Course Objectives
· What Is the Jobs Act and What Does It Do for Me?
· Promise of Crowdfunding
· Types of Crowdfunding

II. Crowdfunding Investing in Privately Held Companies

i. How it works
ii. Investment Options in Privately Held Companies
iii. Choosing Investments
iv. Risk & Fraud
v. Due Diligence

III. Taking Action: Making an crowdfunding Investment

i. The Process
ii. Options/Vehicle

IV. Post-Investment Actions & Opportunities

iii. Working with Your New Venture
iv. Investor Rights & Obligations
v. Investor Protection
vi. Portfolio Management
vii. State & Federal Regulations

Supplemental Materials
Key Investment Concepts: Available on FINRA Investment Education Foundation website
Common Types of Investments: Available on FINRA Investment Education Foundation website
Managing Investment Risk: Available on FINRA Investment Education Foundation website
Investing Basics: Investor.gov
Investor Protection: Available on NASAA website
State Regulations: Available on NASAA website
Reading Financial Statements: SEC Beginners' Guide to Financial Statements
Financial & Investment Dictionary: NASDAQ Glossary of Stock Market Terms
Investor Tools: TBD
How Professional Investors Evaluate Opportunities: TBD
Portfolio Management: TBD

Monday, March 23, 2015 11:18 PM

March 24, 2015

The Honorable William F. Galvin
Secretary of the Commonwealth
Massachusetts Securities Division
McCormack Building
One Ashburton Place, 17th Floor
Boston, MA 02108
Re: Comments on Emergency Crowdfunding Regulations Dated January 15, 2015

Dear Secretary Galvin:

With the energy pulsing around crowdfunded securities, Massachusetts again finds itself at a turning point in history where it has chosen to lead the advancement of technology and commerce, staking early claims in future prosperity. The January 15, 2015, emergency release of the Massachusetts Crowdfunding Exemption demonstrates that the Commonwealth believes that the benefits outweigh the small and distributed amounts of risk. The exemption will help Massachusetts concentrate innovation, attract even more talent, and create jobs, all in our small—but powerful and dynamic—state. This excitement is why I chose to move from France after a successful career in construction to invest in Massachusetts. Thank you.

My aim is to eventually build a crowdfunding platform after proving that real estate crowdfunding can work in Massachusetts as the manager of an issuer myself. While other platforms and issuers are hiding behind the perceived safety of federal Regulation D offerings and the related JOBS Act provisions, the true power of crowdfunding for everyone is being ignored.

The comments that follow address these opportunities and some lingering uncertainties from my perspective as an entrepreneur of a small start-up grappling with the complex areas of securities and business law. The first round of regulations offers hope for young businesses like mine who are facing an otherwise dense and complex regulatory environment with high costs of compliance.

Crowdfunded securities might appear at first glance as simply Internet offerings of everyday “Direct Participation Programs,” but casting them as such ignores their power and significance. The difference is that this movement is democratizing capital and empowering new enterprises—an idea greater than simply generating new businesses—run by people who would otherwise be locked out of the traditional capital-raising techniques.

The old ways of overseeing security sales and salespeople and conducting merit review will need to evolve to keep pace. The technology has advanced beyond merely helping to bring buyers and sellers together in traditional deals, an issue the markets have never had a problem with. Crowdfunding can enhance the social function of investing, infusing projects with cultural “return” while employing technologies that can now, among other things:

Enhance transactional security and tracking, including escrow and other safekeeping services;
Verify participants’ identification, bad-actor records, and ability to pay;
Communicate good and bad reputations of issuers and investors;
Disseminate knowledge about misunderstood risks and uncover otherwise unknown risk;
Compare investment outcomes over time; and
Rapidly find and create market demand for efficient and profitable deal structures.
These enhancements combined bring better value and safety to the investors the Securities Division is statutorily compelled to protect. With each element of a crowdfunding exemption that restricts issuers’ and platforms’ ability to speak openly and directly about what they are doing with flexibility and good-faith sensibility, these benefits become harder and harder to provide.

My specific answers follow the quoted solicited questions below, but more generally, with the proper exemptions in place, crowdfunding platforms can assist the Securities Division and other regulators in overseeing risk and protecting investors. The regulations should allow them to develop tools to monitor the sites’ offerings and the reputations of investors and issuers without imposing unnecessary liability and burdens.

While somewhat beyond the scope of this specific regulation, the states’ exemptions should further enhance technology’s ability to discover wrongdoing, risks, and rewards. They should allow people to widely disseminate investment documentation without these acts being viewed as impermissible offerings of securities. The more visible a project is and the more people are allowed to talk openly about it, the more likely problems will be uncovered before capital vanishes.

As the Crowdfunding Exemption exists today, tethered to the SEC’s almost unworkable intrastate offering exemption, issuers and platforms can barely post an investment-related sentence without living in fear of impairing their businesses. I would encourage the Securities Division to expand the final regulation to work with more federal and state regulatory regimes. I would also encourage the Division and other regulators to advance the definition of an “offering” in a crowdfunding context to arise at the point that a dollar amount for an investment can be entered into a system, accompanied by the possibility of clicking to commit the funds. It is at that point that all risks should be visible and the offer actually made. Allowing people all over the country to see and read offering documents will bring transparency, safety, competitive financing terms, and better-structured deals overall.

With that said, I hope my specific comments below are helpful and interesting. Thank you for your staff’s dedication and attention to this important issue.

Very truly yours,

Laurent Bouzelmat

_________________________________________

1) Relationship to the Federal Intrastate Offering Exemption. The Crowdfunding Exemption is tied to the federal intra-state offering exemption under section 3(a)(11) of the Securities Act of 1933 and SEC Rule 147. That exemption is available for a security which is part of an issue offered and sold only to persons resident within a single state where the issuer of such security has been formed and is doing business in that state.

It is anticipated that most crowdfunding issuers will wish to offer securities via the Internet. Does the federal requirement that offers and sales be made only to persons resident within a single state limit the usefulness of the Exemption? Should the Securities Division consider adopting alternative or additional regulations that would work with other federal rules that permit offerings not strictly limited to a single state (for example, Rule 504 of SEC Regulation D or SEC Regulation A)?

Tying the Crowdfunding Exemption to § 3(a)(11) of the Securities Act of 1933 and SEC Rule 147 is essentially a decision by the Commonwealth to make the Securities Division a sole regulator. Not only does this decision limit the resources available to detect issuer wrongdoing and investment opportunities, the exclusion limits the Commonwealth’s ability to attract outside enterprises and investors. It places the Securities Division in the primary role of protecting other states’ investors, even if those states have expressly chosen not to regulate those activities, and opens up good-faith issuers to excessive liability by creating violations under Massachusetts law for what would otherwise only be violations of federal law, or that of other states. The Commonwealth should focus its exemption and regulatory efforts on the policies that matter most to the state.

More important than opening up investment to investors from multiple states is grappling with the effect of the current definition of an “offering,” which in the past has been troublesome for issuers, investors, and regulators alike. With today’s technology, little is gained from keeping prospectuses and others disclosures from the public at large. Withholding information can actually do more harm than good. If documents are pre-reviewed by regulators and securities are offered only online, with ample safeguards in place to filter unauthorized investors, then the definition of an “offering” and the prohibitions that come with it should be limited to the time at which an investor can enter a dollar amount to be invested along with some action to commit the funds. Massachusetts should lead the way on this issue and let its citizens peer into what is taking place elsewhere.

2) Alternatives to Single-State Offering Exemption. Should the Securities Division consider adopting rules to facilitate offerings made in more than one state? If so, would regulatory cooperation and coordination among the states be desirable with respect to such offerings?

It is difficult to imagine a scenario in which an issuer or investor in the crowdfunding sphere would ask for limitations on what documents can be disseminated, where an issuer’s operations can be, and how much can be raised, either overall or per investor. They believe that technology has fundamentally changed society’s ability to uncover fraud and to build efficient and fair markets that previously required substantial regulatory intervention. The answers to both of these questions are thus resoundingly going to be: “Of course there should be coordinated flexibility!”

The ideal from these people’s perspectives is to open up the investments widely to bring transparency and competition, placing trust in the SEC and other states’ regulators. Massachusetts investors should be trusted with knowing what issuers in other states are doing by viewing investment prospectuses and with investing in other states’ issuers.

Even with the Securities Division’s continued role as one of the most active state securities regulators—intervening in areas that other states would leave to the market—the agency should at a minimum permit investors outside of Massachusetts to invest in Massachusetts enterprises without limitation. Such a move would be good for the Commonwealth and would require few additional resources to monitor the issuers’ in-state activities.

From the opposite perspective of outside issuers selling securities to Massachusetts residents, the states, including Massachusetts, have already created a system of review to allow offerings to proceed within a particular region, but its successes are not altogether clear. This geographic coordination could even belie the policies that the states seek to advance. The problem is that two adjacent states could have diametrically opposed securities policies and varying review capabilities.

In reality, the level of regulation imposed by individual states more or less falls into one of three categories: (1) merit review filing with disclosures to ensure basic quality of investment to investors (as in Massachusetts), (2) disclosure filing to ensure that all material information is disclosed, but not displacing the market’s assessment and valuation of the underlying deal structure (more in line with federal policy), and (3) no review at all.

While disclosure review is probably the best balance between investor protection and market choice, if the Securities Division is reluctant to abandon its merit review standard, the Commonwealth could at least work with the NASAA to develop a system by which states classify their goals into one of these (or similar) categories and then give full faith and credit to any other state’s regulatory review at that level. The securities could then be offered in all states that meet that standard of review or a lesser standard.

Under this system, a merit review by the Massachusetts Securities Division would allow an offering to proceed in any state, after perhaps a simple and inexpensive notice filing. An offering filed with the SEC, such as one proceeding under Regulation A, could be offered in all states not requiring merit review. The only adverse consequences of this system would be either the increase of filings within merit-review states (increased regulatory burden) or else issuers’ avoidance of merit review states altogether (decreased economic activity in stricter states).

3) Limitation on Forms of Security: Equity or Debt. The Exemption is limited to equity or debt securities. Should the Securities Division consider making the Exemption available for other forms of securities? If so, what other types of securities should be specified in the Crowdfunding Regulation? Will permitting the offer and sale of other forms of securities require issuers to provide special disclosures to investors in order to accurately disclose the characteristics of the investment?

The crowdfunding exemption should be open to all securities that aid directly in the creation and fostering of new enterprises (not just creating new businesses). If crowdfunding is about more than simply maximizing returns, seeking instead to advance societal and personal goals using democratized capital, then equity and debt are arbitrary categories. The limitation appears to be an expression that investments outside of equity and debt contain unknowable risks that do not warrant exclusion from more rigorous registration requirements, which may or may not be true.

With the corporate form declining in popularity, as more flexible limited liability companies rise, very clear and understandable disclosures about how returns are calculated and where in the priority line they are paid back become the most important elements for investors, not the category of security. For example, in many crowdfunded companies, preferred return has been the emerging paramount return structure, which falls somewhere between debt (in its calculation and priority above other equity interest holders) and equity (in its priority below creditors and unamortized payback).

The line at which certain securities—primarily derivatives—depart from the core policies of crowdfunding begins where they enter the realm of zero-sum speculation and insurance, which typically do little to bolster and protect an underlying enterprise.

4) Offering Amount Limit. The Crowdfunding Exemption permits an issuer to offer and sell up to $1,000,000 of securities in a 12-month period. (See Sec. 4 of the Exemption.) This limit increases to $2,000,000 if the issuer has audited GAAP financial statements. The Securities Division requests comments on these offering size limits. If the offering limits were raised, would the Exemption, which applies only limited requirements to crowdfunding offerings, provide adequate protections for investors and local markets?

The Securities Division also seeks comments on the requirement for issuers to obtain audited statements in order to raise between $1,000,000 and $2,000,000. The Division solicits information about the costs and/or potential benefits of requiring that audited financial statements be included in a securities offering document.

In making the Crowdfunding Exemption available to issuers relying on other federal exemptions, the most important change should allow Regulation A issuers to raise up to $5 million under the same financial reporting terms as required by the SEC.

The requirement of audited financial statements might not provide the level of protection sought. Businesses with little financial history are not going to be more transparent and safe with the stamp of perfection from an accountant. The scale of capital between $1 million and $2 million, while doubled, might not be so extreme for an audit to pass a cost-benefit analysis.

5) Investment Limitations. Under Sec. 5 of the Crowdfunding Exemption, most investors may invest up to the greater of $2,000 or 5% of income or net worth. The percentage investment limit is higher for investors with higher incomes or net worths. The limitation included in the Exemption substantially resembles the limit included in the SEC’s proposed regulations for the federal crowdfunding exemption. Is this investment limit an effective way to control the risk of an investor over-investing in a crowdfunding offering? Should the limit be higher or lower?

The Exemption will be lost if the issuer sells securities to any investor in excess of the investment limitations. Should the issuer be permitted to meet this standard based on a good faith reasonable belief about the purchaser’s income and/or net worth? If the issuer can meet the requirement based on good faith reasonable belief, should the issuer be required to take reasonable steps to verify the income and/or net worth of purchasers?

Unlike the SEC’s proposed crowdfunding rule, the Crowdfunding Exemption does not attempt to limit the amount an investor may invest in crowdfunding offerings as a category. Should the Securities Division consider adding a limit that would apply to investors’ investments in crowdfunding offerings as a category?

The generous limits proposed here lose luster when issuers and crowdfunding platforms are held to strict compliance. The ability to verify incomes and net worths of investors in large numbers is complicated. People without scanners could be prevented from investing, and people with very basic tools could create documents to lie about their situations. The Securities Division should not prioritize spending resources on protecting investors who lie repeatedly. Other tools exist to deal with related issuer wrongdoing as well.

At a very minimum, the regulation should expressly state that no verification of income or net worth is required for any investment up to $2,000. Any investor starts there by virtue of being at least 18 years of age. Other common documents and tools could expand upon this simplicity. For example, an accredited investor with a certification letter from an accountant or attorney should be allowed to invest up to $20,000 without additional documentation, as the minimum income that such a person would have to have is $200,000 per year. Limited liability companies and partnerships should be allowed to invest at least $2,000 per member (minus any individual contributions), and corporations should be judged on their own income (perhaps with a representation that the corporation is not investing to subvert the individual limitations).

While a basic representation that an individual has adequate resources to invest more than $2,000 might be too simplistic, several representations, perhaps with actual dollar values and references to documentation from which those figures are drawn, should be adequate for many investors. For example, pull down boxes could show a list of income-demonstrating documents (ranging from tax filings to paystubs) and a period for which that income is earned (weekly, biweekly, monthly, etc.); a corresponding text box could ask for the exact amount of income for that period. The system could then annualize the income figure to determine the amount that the investor can commit. If the income is for a prior year, an additional representation could be required that the investor’s current income is not lower than that amount.

If the Securities Division decides not to abandon the strict compliance standard, or chooses a hybrid, it should promulgate clear and workable rules about what kinds of documentation are acceptable evidence and allow for good-faith compliance. These standards could perhaps intensify for higher investment amounts where the costs of compliance will drop (as fewer investors’ financial situations will require greater scrutiny).

No overall investment limit should be placed on crowdfunding as a category. Such a limit is wholly unworkable from the perspective of issuers and of platforms. The best approach would be to require suggested guidelines about excessive investments. For example, an investor representing that she makes $85,000 per year could have a customized suggestion presented to her that she should not invest more than 15% ($12,750) of her income in all crowdfunded securities. Investors should be trusted to know how much is too much.

Net worth limits are largely meaningless except for very wealthy clients. For example, student loan obligations can exceed six figures for many people, even if their actual monthly payments are lower than people with far lower principal amounts.

As one final point on the topic of per-issuer limitations, crowdfunding platforms—particularly those engaged in more of an investment-banking-type model—would benefit from a clear signal that their participation in more than one offering would not invoke these limits.

6) Excluded Types of Issuers. Under sec. 6, the Exemption is not available to: blank check/blind pool offerings; investment companies; hedge funds or similar investment vehicles; '34 Act reporting companies; companies engage in oil, mining, or other extractive industries. The Securities Division solicits comments on these limitations.

As stated above, crowdfunding is about creating new enterprises. If an issuer cannot demonstrate a direct connection to fostering new enterprises, then the crowdfunding exemption should not be available as a work around existing registration laws.

7) Minimum Offering Amount requirement. Sec. 8 of the Crowdfunding Exemption requires the issuer to establish a minimum offering amount that is needed to accomplish the business plan. The minimum offering amount shall be not less than 30% of the maximum offering amount. The Securities Division requests comments on all aspects of this requirement, including the 30% standard for a minimum offering amount.

This limitation is a reasonable as a risk trade off in states that would otherwise conduct more intense reviews of new securities. Crowdfunding should be available to enterprises that can be visualized. If a project could operate on less than 70% of the amount sought, then the amount sought could simply be reduced. This limit requires issuers to consider very seriously the capital necessary to launch their businesses. The final Crowdfunding Exemption should give clear guidance on how a “testing the waters” campaign can be used to ensure that enough interest exists to risk getting to this threshold.

8) Escrow of Funds until Minimum Offering Amount is Reached. Pursuant to Sec. 9 of the Crowdfunding Exemption, funds raised in a crowdfunding offering must be placed in an escrow account at an insured bank until the minimum offering amount is reached. The Securities Division requests comments on the practicability of this escrow requirement. Should the Securities Division consider any alternatives to requiring that escrowed funds be held in an insured bank account?

Technology is in place to accomplish these escrow arrangements, which are not unreasonable. Perhaps other solutions could be workable as well, but the escrow market appears to have jumped on this opportunity.

9) Bad Actor Disqualification. The disqualification language in Sec. 10 of the Exemption is modeled on the bad actor disqualification under Rule 506 of SEC Regulation D. The Securities Division requests comments on this provision.

These requirements are not unreasonable as long as there is a procedure in place for consideration of an exception that is fair, and disclosed, to investors.

10) Required Disclosures. Under Sec. 11 of the Crowdfunding Exemption, issuers are required to provide certain disclosures. The regulation also reminds issuers of their obligation to provide full and fair disclosure of all material facts relating to the offering.

Would it be appropriate for the Exemption to spell out more details about required disclosures? Would such disclosure requirements provide useful guidance to issuers? Should the Securities Division consider requiring the use of a disclosure form? Are the specified items of disclosure sufficient to protect investors’ interests in crowdfunding transactions?

Examples of disclosures would be useful. A form for the Crowdfunding Exemption itself might not provide greater clarity and could even hamper full disclosure. If the exemption is expanded to work alongside Regulation A at the federal level, the NASAA Form U–7 could become a de facto crowdfunding form.

Also, the Massachusetts Crowdfunding Exemption could benefit from guidance on how the statements of policy of the North American Securities Administrators Association will affect the Securities Division’s merit review under the Massachusetts Crowdfunding Exemption. See 950 CMR 13.305.

11) Specific Required Risk Disclosures. Section 12 of the Exemption requires that specific risks of crowdfunded securities be disclosed, particularly the risks that that there will probably be no ready market for the securities and that the securities will be illiquid. The Securities Division requests comments regarding these disclosures.

These disclosures are reasonable, but if copied and used over and over may be overlooked. Part of the problem is that Direct Participation Programs are viewed as inherently risky because of the lack of liquidity from an often-impermissible sale, even if there is greater cash liquidity flowing from the business. Knowing that your investment is going to be locked up is important, but the underlying investments should be evaluated on their own merits. The securities regulators should avoid the corresponding message that investments that can be readily bought and sold on an open market are inherently less risky.

12) Annual Reporting by the Issuer. Sec. 14 of the Exemption requires that issuers provide a report to the Securities Division after 12 months, or when the offering has been completed or terminated. The Securities Division requests comments on this requirement.

This requirement is not unreasonable.

13) Ongoing Company Reporting. The Crowdfunding Exemption does not mandate that issuers provide ongoing reports to investors about the business and financial condition of the company. Should the Exemption require such reports? If the Exemption does not require such reports, will there be any way for investors to receive ongoing information about the issuer?

The Securities Division should permit the market and its technologies to guide reporting topics and frequency to investors. Issuers are not going to want to keep people in the dark and thus risk unnecessary lawsuits. They should be compelled to justify properly any lack of communication. Communication should be openly available online, through social media, email, and other media.

14) Sellers of Crowdfunding Securities. Unlike the proposed SEC rules for crowdfunding, the Crowdfunding Regulation does not require the use of a crowdfunding portal to offer and sell crowdfunded securities. Only broker-dealers may receive compensation for offering and selling securities. At this time, it is anticipated that issuers would sell their own crowdfunding offerings or that they would be sold through licensed broker-dealers.

The Securities Division seeks information about how it is anticipated that these offerings will be sold. Should the Crowdfunding Exemption require or permit the use of a crowdfunding portal to offer and sell the securities? If so, what would be the characteristics of such a portal? What kinds of regulation and registration should apply to such a portal?

Because crowdfunding is largely automated and funds are protected in escrow, little is gained from requiring a broker-dealer to be involved in a crowdfunded issuance, even though in many instances it appears that they will need to be under current broker-dealer law. They can be expensive and necessarily slow down the issuance process. Unfortunately, the amount of money that statutorily defined Crowdfunding Portals will be able to make might not be enough to justify the liability costs and the responsibilities placed on them by Congress. The SEC should work with FINRA and the states to rethink a new model outside the current regulatory regimes, which look like alien landscapes when trying to apply crowdfunded securities to them.

For example, a viable software-as-a-service model could emerge for individual issuers to use. States could also build their own platform and compensation guidelines as well if a proper intrastate carve-out of the broker-dealer regulations becomes workable in the eyes of the SEC and FINRA. Overall, having platforms involved at least in some small capacity with issuances will greatly help issuers and reduce risk to investors, but the current regulatory structures are too onerous and expensive to justify the level of involvement they would be capable of providing.

15) Investor Feedback – The “Wisdom of the Crowd.” The Crowdfunding Exemption currently does not require that there be an Internet-based forum for potential investors to comment on and discuss these offerings. Should such a forum be required under the Exemption?

Most platforms and issuers are concerned about dissemination of proper disclosures and about not misleading investors in online discussions. The regulators should open up a clear space for communication without liability and then permit the market to decide its extents. Make it clear that leaving up a statement by a third-party will not result in liability of the issuer if left public and without comment by the issuer. Otherwise, what will likely happen is a sterile Q&A section with responses from the issuer with references to page numbers of the offering statements. This lifeless effort benefits no one. Issuers may additionally be afraid that a new issue will come to life in these discussions that will require additional filings and disclosures. The regulations should allow them to disseminate this information quickly and easily, without fear of retribution for all but the most egregious of intentional fraud.

Monday, March 23, 2015 4:07 PM

Comments from J. Scott Colesanti, LL.M. (PDF)

Monday, March 23, 2015 3:47 PM

Comments from Gregory S. Fryer (PDF)

Wednesday, March 18, 2015 10:31 AM

Comments from Gerald Niesar (PDF)

Monday, March 09, 2015 6:06 PM

Comments from William Michael Cunningham (PDF)

Monday, March 09, 2015 12:41 PM

Thank you for the opportunity to submit public comment on this matter. My name is Tim Rowe, and I'm the Founder and CEO of Cambridge Innovation Center. We operate what we believe to be the largest shared space for startup companies in the world. I was active in the public debate regarding the crowdfunding exemption embedded in the Job Act, testified twice before Congress on the issue, and was honored to be present at the Rose Garden when President Obama signed the bill into law. I also serve as a Venture Partner with New Atlantic Ventures, a mid-sized venture fund with headquarters in Massachusetts and Virginia, and I serve on the Board of the New England Venture Capital Association, and was the Founding President of the Kendall Square Association, the association of the (principally innovation oriented) organizations located around MIT. I am an MBA and not a lawyer. I speak to these issues from a public policy perspective. My perspective is developed from my public and private roles in connection with innovation and startups.

I believe an effective crowdfunding exemption creates more opportunity for job creation in Massachusetts and in other states. Evidence shows that crowdfund investors have distinctly different goals than traditional investors of risk capital. Traditional investors (e.g. venture capital funds) invest to achieve high economic returns. In contrast, crowdfund investors often invest with a goal of helping a friend, associate, neighbor, etc. get off the ground with a new business, or to help a business do something they believe is important or valuable to society, and thus they have limited expectation of or need for classical returns. Given that the total size of their investment is small relative to their income, they are in a position to lose their investment entirely, and are typically prepared to do so in order to achieve their goal. Given these differences, crowdfunding potential represents a radically new and important source of funding that could make possible investments that were never possible before, when investments principally required the likelihood of classic economic returns.

So, my overall comment is: thank you for your work seeking to write rules to make this valuable new source of investment a reality in Massachusetts.

I have done my best to address the specific questions you have posed below:

1) Relationship to the Federal Intrastate Offering Exemption. The Crowdfunding Exemption is
tied to the federal intra-state offering exemption under section 3(a)(11) of the Securities Act of
1933 and SEC Rule 147. That exemption is available for a security which is part of an issue
offered and sold only to persons resident within a single state where the issuer of such security
has been formed and is doing business in that state.

It is anticipated that most crowdfunding issuers will wish to offer securities via the Internet.
Does the federal requirement that offers and sales be made only to persons resident within a
single state limit the usefulness of the Exemption? Should the Securities Division consider
adopting alternative or additional regulations that would work with other federal rules that permit
offerings not strictly limited to a single state (for example, Rule 504 of SEC Regulation D or
SEC Regulation A)?

--> Yes it is important to be able to raise funds from multiple states. All of the efforts I have seen in this area focus on raising funds over the Internet, which is inherently multi-state. It should be noted that investors may also be overseas.

2) Alternatives to Single-State Offering Exemption. Should the Securities Division consider
adopting rules to facilitate offerings made in more than one state? If so, would regulatory
cooperation and coordination among the states be desirable with respect to such offerings?

--> The whole purpose with crowdfunding is to eliminate red tape with respect to very small investments. So I would encourage the States to find models that basically eliminate the need for the party raising funds to consider state-level issues. Perhaps the states could agree on a common format for these raises, and a single filing (if any) for all states. Evidence from existing crowd-fund sites in the US (such as kickstarter, prosper) and overseas (where crowdfunding is not restricted in many countries today) is that there is de minimus fraud. The Economist wrote some time back that the likely reason for this is the level of transparency that the Internet provides. The federal rules require the use of a trusted intermediary (crowdfund portal) to manage this process, effectively for the purpose of providing this transparency. This is a solid approach.

3) Limitation on Forms of Security: Equity or Debt. The Exemption is limited to equity or debt
securities. Should the Securities Division consider making the Exemption available for other
forms of securities? If so, what other types of securities should be specified in the Crowdfunding
Regulation? Will permitting the offer and sale of other forms of securities require issuers to
provide special disclosures to investors in order to accurately disclose the characteristics of the
investment?

--> I have not considered this question enough to provide an informed answer. I would only say: do what you can to make this simple, and eliminate complexity/red tape. If we create a system that requires expert legal advice to administer, it will defeat the purpose. Create a system that can be done automatically, entirely over the web (no meetings with lawyers required, no special documents to be drafted in a custom way).

4) Offering Amount Limit. The Crowdfunding Exemption permits an issuer to offer and sell up
to $1,000,000 of securities in a 12-month period. (See Sec. 4 of the Exemption.) This limit
increases to $2,000,000 if the issuer has audited GAAP financial statements. The Securities
Division requests comments on these offering size limits. If the offering limits were raised,
would the Exemption, which applies only limited requirements to crowdfunding offerings,
provide adequate protections for investors and local markets?

The Securities Division also seeks comments on the requirement for issuers to obtain audited
statements in order to raise between $1,000,000 and $2,000,000. The Division solicits
information about the costs and/or potential benefits of requiring that audited financial
statements be included in a securities offering document.

--> Those of us who helped create the federal exemption took the view that these were fine limits to begin with. Lets start small, and see how it goes. If it goes well, sure, lets expand the limits.

5) Investment Limitations. Under Sec. 5 of the Crowdfunding Exemption, most investors may
invest up to the greater of $2,000 or 5% of income or net worth. The percentage investment limit
is higher for investors with higher incomes or net worths. The limitation included in the
Exemption substantially resembles the limit included in the SEC’s proposed regulations for the
federal crowdfunding exemption. Is this investment limit an effective way to control the risk of
an investor over-investing in a crowdfunding offering? Should the limit be higher or lower?

The Exemption will be lost if the issuer sells securities to any investor in excess of the
investment limitations. Should the issuer be permitted to meet this standard based on a good
faith reasonable belief about the purchaser’s income and/or net worth? If the issuer can meet the
requirement based on good faith reasonable belief, should the issuer be required to take
reasonable steps to verify the income and/or net worth of purchasers?

Unlike the SEC’s proposed crowdfunding rule, the Crowdfunding Exemption does not attempt to
limit the amount an investor may invest in crowdfunding offerings as a category. Should the
Securities Division consider adding a limit that would apply to investors’ investments in
crowdfunding offerings as a category?

--> My advice is "keep it simple". The danger is creating legislation that creates legal exposure or liabilities for offerers because of the way the regs are written. The federal regs received a lot of scrutiny. The easiest thing to do would be simply to mimic them. Either way, keep it simple. The goal of the category limitation was to protect the proverbial "grandparent" from being hoodwinked by unscrupulous individuals, limiting their total exposure. It should be noted that we don't currently limit how much one can bet at a casino (arguably less safe for the investor, and less socially beneficial). So there is certainly an argument that says no limit is needed.

6) Excluded Types of Issuers. Under sec. 6, the Exemption is not available to: blank
check/blind pool offerings; investment companies; hedge funds or similar investment vehicles;
'34 Act reporting companies; companies engage in oil, mining, or other extractive industries.
The Securities Division solicits comments on these limitations.

--> I agree with these limitations.

7) Minimum Offering Amount Requirement. Sec. 8 of the Crowdfunding Exemption requires
the issuer to establish a minimum offering amount that is needed to accomplish the business
plan. The minimum offering amount shall be not less than 30% of the maximum offering
amount. The Securities Division requests comments on all aspects of this requirement, including
the 30% standard for a minimum offering amount.

--> This is a reasonable limit, and I don't think it should be considered particularly restrictive. The goal of a minimum limit is to ensure that no projects go forward with clearly too little funds to have any chance of success.

8) Escrow of Funds until Minimum Offering Amount is Reached. Pursuant to Sec. 9 of the
Crowdfunding Exemption, funds raised in a crowdfunding offering must be placed in an escrow
account at an insured bank until the minimum offering amount is reached. The Securities
Division requests comments on the practicability of this escrow requirement. Should the
Securities Division consider any alternatives to requiring that escrowed funds be held in an
insured bank account?

--> This is not unreasonable, but do ensure that an alternative option would be for the offerer to hold off drawing any funds from would-be investors until the threshold is cleared, and then draw all down at once, eliminating the expense and complexity of the escrow process.

9) Bad Actor Disqualification. The disqualification language in Sec. 10 of the Exemption is
modeled on the bad actor disqualification under Rule 506 of SEC Regulation D. The Securities
Division requests comments on this provision.

--> I have not studied this issue but this sounds reasonable.

10) Required Disclosures. Under Sec. 11 of the Crowdfunding Exemption, issuers are required
to provide certain disclosures. The regulation also reminds issuers of their obligation to provide
full and fair disclosure of all material facts relating to the offering.

Would it be appropriate for the Exemption to spell out more details about required disclosures?
Would such disclosure requirements provide useful guidance to issuers? Should the Securities
Division consider requiring the use of a disclosure form? Are the specified items of disclosure
sufficient to protect investors’ interests in crowdfunding transactions?

--> Again, the goal here should be to keep things simple. A disclosure form could be fine. Just make sure there is no language in the law that effectively means you have to hire an outside expert to navigate this section (lest you inadvertently leave out some advisable boilerplate).

11) Specific Required Risk Disclosures. Section 12 of the Exemption requires that specific risks
of crowdfunded securities be disclosed, particularly the risks that that there will probably be no
ready market for the securities and that the securities will be illiquid. The Securities Division
requests comments regarding these disclosures.

--> Again, please design it so that a parent with no legal or business training can navigate whatever you put in there, easily. Imagine a soccer mom or dad decides to launch a catering business. Can they easily and simply navigate your rules, entirely over the internet? If the answer is "no", your regs are too complex.

12) Annual Reporting by the Issuer. Sec. 14 of the Exemption requires that issuers provide a
report to the Securities Division after 12 months, or when the offering has been completed or
terminated. The Securities Division requests comments on this requirement.

13) Ongoing Company Reporting. The Crowdfunding Exemption does not mandate that issuers
provide ongoing reports to investors about the business and financial condition of the company.
Should the Exemption require such reports? If the Exemption does not require such reports, will
there be any way for investors to receive ongoing information about the issuer?

14) Sellers of Crowdfunding Securities. Unlike the proposed SEC rules for crowdfunding, the
Crowdfunding Regulation does not require the use of a crowdfunding portal to offer and sell
crowdfunded securities. Only broker-dealers may receive compensation for offering and selling
securities. At this time, it is anticipated that issuers would sell their own crowdfunding offerings
or that they would be sold through licensed broker-dealers.

The Securities Division seeks information about how it is anticipated that these offerings will be
sold. Should the Crowdfunding Exemption require or permit the use of a crowdfunding portal to
offer and sell the securities? If so, what would be the characteristics of such a portal? What
kinds of regulation and registration should apply to such a portal?

--> So, the reason we required a portal in the federal regs was that we believe that it ads accountability and transparency to the transaction. If you will, it introduces a "grownup" into the room. Ebay very effectively allows transactions between complete strangers, often at high values, with very little fraud. It does this principally through its reputation ranking system. If you remove this from the equation, you get Craigslist. While craigslist works, particularly for low-value items, and it is much loved, it is also the home of a fair amount of fraud and mis-behavior. My view is that a portal should be required. Many such portals have been built in the past couple of years, and we can anticipate healthy competition from the private sector to provide this portal function. These portals should be licensed by the securities division of operated under the state law. The licensure should be simple and minimalist, however it should state that the portal must provide a log of any allegations or claims of fraud against it on a regular basis. If a given portal either does not report, or reports but has a high incidence, they should be subject to delicensure. I envision a world in which the portals become quite specialized, e.g. a crowd-fund portal specialized in restaurants. It could provide tools for investors to evaluate business plans, location value, etc. This would substantially deepen the value and effectiveness of this funding mechanism.

15) Investor Feedback – The “Wisdom of the Crowd.” The Crowdfunding Exemption currently
does not require that there be an Internet-based forum for potential investors to comment on and
discuss these offerings. Should such a forum be required under the Exemption?

--> Yes, it should be required. This is what ensures transparency, and helps eliminate fraud. These topics received great debate and scrutiny at the federal level. The best thing to do is to follow that lead, in my opinion. The thing to be careful of in the federal example is that by giving rulemaking authority to the SEC and FINRA, the feds essentially mired crowdfunding in red tape, and it has yet to see the light of day. I wouldn't do that. Make it simple and launch it. This is the spirit of crowdfunding: let people risk a small amount of money on highly risky investments as a way of helping a friend, having an impact, and growing the economy. We can afford to see how this experiment unfolds. The sky has not fallen in places like England where this is already legal. Lets start the experiment here.

Thank you!
Tim

--
Tim Rowe
Founder and CEO
Cambridge Innovation Center

Friday, January 23, 2015 6:09 PM

Peter-

I saw that Massachusetts just passed it's intrastate exemption regulation. Looks promising. I really hope it gains traction and helps the small business community in your State thrive.

Cheers, Jeff