Comments to the SEC about Crowdfunding

A few months ago, the Securities and Exchange Commission published proposed rules which govern how equity crowdfunding is going to work in the US. The proposed rules are extensive – covering nearly 600 pages. I am not alone in spending a sec seallot of time reading the rules and making comments. There have been a great number of other people who have participated in the process. You can read all the comments here:

So now the ball is back in the SEC’s court. Hopefully we will have some final rules soon. Although it won’t be everything we want it to be, a new industry will finally come to life. And we are all lucky to be part of it.

SEC Comment Letter from Jon Frutkin (pdf)


January 30, 2014

Elizabeth Murphy, Secretary
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549

Re:          File No. S7-09-13, Release Nos. 33-9470; 34-70741, Comments regarding Proposed Rules on Crowdfunding, Title III, The JOBS ACT

Dear Ms. Murphy:

First: a compliment. Although there has been a great deal of criticism relating to the specifics of the proposed rules and their extensive breadth, the Commission has done an admirable job of developing a framework for Title III of the JOBS Act which is true to the law itself. Of course this has been an enormously complicated undertaking. It is an ongoing challenge resolving the tension between unlocking capital while ensuring transparency.

However, we must remember that less than 20 years ago, a small Internet start-up named eBay successfully convinced us that people could trust each other when paying for auction items – payments made for a product sight unseen and to a stranger somewhere around the world. A person’s character is now judged by each and every transaction, and eBay proved that while fraud could never be eliminated. But fraud is disappearing in a world where trust is earned one online transaction at a time.

A great number of comment letters have already been submitted, focusing on various parts of the hundreds of pages of proposed rules. But there is one area of particular concern: what happens the “day after”?

Last year, I wrote the book Equity Crowdfunding: Transforming Customers into Loyal Owners. There is widespread opinion that equity crowdfunding will be a powerful tool to raise funding for start-up businesses. However, my belief is that crowdfunding is a great opportunity for profitable local businesses. Equity crowdfunding turns customers into super-customers, becoming marketing evangelicals that help drive revenue. In exchange, investors will receive dividends, their share of the profits which hopefully increase over time due to the new enthusiasm for their company. With that backdrop, I have thoroughly reviewed the Commission’s proposed rules.[1] And while I obviously have opinions about many aspects of the proposed rules, I focus my comments on this one relatively narrow area.

Of significant concern is the proposed requirement, found nowhere in the JOBS Act itself, that issuers raising more than $500,000 must have an audit performed each and every year moving forward.[2] Because of the transaction costs associated with raising equity crowdfunding, I posit that nearly all of the successful rounds of funding will be in this $500,000+ category. However, the ongoing cost of annual audits is such a significant deterrent that it needs to be reconsidered prior to the finalization of the rules.

So consider a successful company; one generating a return of 12% on capital. Most investors would be satisfied with a return that is considerably greater than the average return provide by public companies. Using the mid-point of $750,000 total investment, a 12% return on capital would mean $90,000 annually to those investors. But using the rough estimate of $30,000 per audit[3], this means that fully 1/3rd of the investors return would be eaten up by an audit – every single year. This audit is in addition to whatever other compliance costs come along with the annual reporting requirements.

In short, requiring an officer’s signature under the penalty of perjury, indicating that the financial statements provided to the Commission and the investors are true and correct, is sufficient to promise punishment where fraud exists. And it prevents a solid return from being greatly depleted because of the existence of a rule that is nowhere to be found in the law.[4]

Next, I have great concern about requiring publication of an issuer’s financial reports on the company’s website[5]. Certainly there is no disagreement that this information should be public. The proposed rules contain the commonsense requirement that a Form C-AR be filed and accessible online through EDGAR. It is unquestionably reasonable for the public to be able to easily access these reports, and it is paramount that prospective investors in the secondary market can receive this information.

To comply with the law’s mandate that the investors receive these reports, an issuer can be required to provide that information directly. A company could utilize one of many alternative methods. For example, the rules could require that the issuer provide the report via email, on a website that is password protected with the login information distributed to investors, or simply by mailing using first-class mail to the investor’s preferred mailing address.

The idea that financial information is going to be prominently displayed on a company website is distasteful. Whether the company is having an up or down year, this information is irrelevant to the 99% of the visitors to their website. While looking for hours of operation, key employee bios and contact information, web visitors should not be instantly privy to financial information simply because the company at some distant point in the past utilized Title III.

And the resulting impact would be unfortunate. Companies that are extremely successful may be tempted to redeem their crowdfunders ownership interest just to avoid publishing information right on their website. Or worse, companies that may be suffering from short term issues may have less customers because of the publication of the information – resulting in a deadly sales tailspin.

The Commission would be correct to require that financial reports be distributed to crowdfunders (at least to those that the issuer has current contact information).

Publication on the web through EDGAR is a must. But it is counter-productive for those financial statements to be on the issuer’s website. Just like publicly traded companies now, information should be obtainable. However, forcing financial reporting on an issuer’s main website is a mistake.

Although not required by the proposed rules, the Commission should carefully monitor the necessity of requiring crowdfunded companies to engage the services of a registered transfer agent.[6] Although for some companies it may not be problematic, one can imagine the mayhem that could be created once hundreds (and sometimes thousands) of new investors are trading stock on some secondary markets. The mechanisms for tracking capitalization tables (and investor contact information) are available for more sophisticated and organized business managers. But it is potentially a disaster where the company would be unable to pay dividends or make distribution of assets after selling or dissolving the company.[7]

I join with the incredibly energetic people who are actively involved in the equity crowdfunding community in offering our help. We all recognize that rule-making and enforcement cannot happen in a vacuum. And I remain available to provide further information and opinion to the Commission as crowdfunding becomes a commonly used tool to help grow and promote American business.


Jonathan Frutkin

[1] I am also the CEO of Cricca Funding, LLC. More information about our crowdfunding advisory services and commentary are available at
[2] See Crowdfunding; Proposed Rules, Release Nos. 33-9470; 34-70741 (“Proposed Rules”) at p. 92-3; §227.202 (referencing §227.201(t)).
[3] The proposed rules estimates the amount to be $28,700 which may be on the conservative side for a restaurant, car wash, landscaping company or other local business which has extensive operations and cash flows. See generally Proposed Rules at p. 368.
[4] Section 4A(b)(4) requires financial statements to be filed at least annually pursuant to rule of the Commission. It does not intimate that these financial statements should be audited or reviewed. To the contrary Section 4A(b)(1)(D), explicitly references audited and reviewed financial statements depending on the size of the offering.
[5] Proposed Rules at p. 94.
[6] Proposed Rules at p. 145.
[7] The Commission has expressed concern that because of the secondary market, the company may not know the identity or email address of the investors. Proposed Rules at p. 94-5. Ultimately, the issuer needs to know who owns the shares. The portal or broker could give this information to the issuer and/or its transfer agent upon closing. Any transferring shareholder could certainly be required to communicate the new contact information to the issuer.
Jonathan FrutkinJonathan Frutkin is CEO of Cricca Funding, LLC. He’s the author of “Equity Crowdfunding: Transforming Customers into Loyal Owners” which is available in paperback, Kindle and audio book formats.

Intrastate Crowdfunding – Integration Stands in the Way of Progress

The basic rule is that if you want to sell securities, you need to register with the SEC. That is much more demanding than it sounds; it is totally impractical for the vast majority of companies that are raising money. So the SEC has created a number of exemptions from registering a stock offering.

One of those exemptions, called the private placement exemption, allows high net worth individuals (generally called accredited investors) to invest without “going public”. Another exemption allows intrastate offerings without registering with the SEC. This means that a company can accept money from people who live within the borders of a single state, so long as the company complies with that state’s securities laws. Of course, this comports with a federal system – things that happen in just one state should just be regulated by that state alone.

To prevent a “loophole”, the SEC has taken pains to make sure that an intrastate exemption is only used for offerings that are truly made in one state. Amongst other things, the stock must be held by the purchaser for at least nine months, preventing people from acting as mere shills for an out-of-state buyer.

Easy enough, except for one thing. The SEC prohibits utilizing multiple different exemptions at the same time. This means that a company can’t raise money using the intrastate exemption simultaneously with raising money using another exemption also.

The new Georgia Peach

To avoid being an illegal offering, the company must meet a strict multi-part test which considers factors like whether the offerings are part of a single plan of financing and the money is to be used for the same general purpose. But there is a safe harbor. A company can wait six months between fundraising rounds.

The proposed rules for the federal JOBS Act avoid this problem. If a company uses federal crowdfunding, it won’t be considered “integrated” with efforts to raise money using a more traditional private placement at the same time. This means that under the federal law, a company can raise up to $1 million using crowdfunding and the rest of the money that is needed through wealthy investors.

So for somebody opening up a restaurant, bar, car dealership – or forming the high tech company – it becomes a real challenge to use intrastate crowdfunding at all. The only time that you can be sure is when you use the safe harbor. However, that usually means that you have to wait for six months before raising money from either your intrastate crowdfunding investors or your traditional accredited (wealthy) investors.

Hopefully, the SEC will realize that this integration issue could completely stomp out intrastate crowdfunding. The way to fix this problem is to include an exclusion from the definition of integration for intrastate crowdfunding offerings – just like under The JOBS Act. But if the SEC fails to do so, it wouldn’t be the first time that the federal government tried to keep all the fun for itself.
Jonathan Frutkin

Jonathan Frutkin is CEO of Cricca Funding, LLC. He’s the author of “Equity Crowdfunding: Transforming Customers into Loyal Owners” which is available in paperback, Kindle and audio book formats.

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