A Crowdfunding Exemption? Online Investment Crowdfunding and U.S. Securities Regulation
TRANSACTIONS: THE TENNESSEE JOURNAL OF BUSINESS LAW
0 J.D., Brigham Young University, J. Reuben Clark Law School
EDAN BURKETT* In recent years, artists, entrepreneurs, and nonprofits (collectively “promoters”) have tapped the collaborative power of the online crowds to fund a wide range of charities, creative projects, and even investment opportunities. This phenomenon is called “crowdfunding,” or sometimes “crowd financing” or “crowdsourced capital.”1 This Article first examines the intractable conflict between investment crowdfunding and traditional U.S. securities laws and then explores possible solutions that would enable small companies to more easily raise capital through the online crowds.
INVESTMENT CROWDFUNDING AND U.S. SECURITIES
REGULATION
INTRODUCTION
crowdfunding platforms, promoters are usually given the chance to pitch their ideas
to potential funders, who then choose which projects to support.3 In exchange for a
contribution, most current crowdfunding sites only allow promoters to reward
funders with nominal perks or “thank-you” gifts.4 Because the contributions are
effectively donations, this is called “patronage crowdfunding.”5
If promoters reward funders with something more than a thank-you gift,
such as an equity share in the project itself, it is “investment crowdfunding.”6 The
principal reason most promoters do not reward their online patrons with equity
shares, or any other security, is the danger of getting entangled in complicated
securities laws.7 While the United States is “[b]y far the biggest and most
sophisticated country supporting [various forms of financial investment] . . . [f]ederal
law seems to rule out . . . online marketing for investment in return for debt or
equity.”8 For instance, it is illegal in the United States to offer or sell a “security”
without either complying with arduous registration requirements or wading through
the difficult process of obtaining an exemption.9 Promoters legitimately worry that
any investment opportunity in their project could be a security known as an
nor do they have the potential for a large enough exit. And second, there are too few venture
capitalists versus the masses of entrepreneurs who need money.”).
3 Barbara Ortutay, Raising funds? Many turn to the Web for help, PRESS OF ATLANTIC CITY, Sept. 21, 2010,
at B1, available at 2010 WLNR 18760546.
4 Kappel, supra note 1, at 376 (“In return, financial contributors typically receive ‘patronage perks’
such as use of their name in the film credits or album liner notes, advanced autographed copies of the
work, or backstage access at a performer’s show.”).
5 See Kappel, supra note 1, at 376.
6 This Article adopts “investment crowdfunding,” as opposed to “equity crowdfunding,” because
funders might get a debt-based security, or funders might not get actual equity but merely an
investment contract—e.g., Grow VC, discussed later, gives subscribers a cut of the profits, but not
equity per se.
7 See Kappel, supra note 1, at 376-77; C. Steven Bradford, Crowdfunding and the Federal Securities Laws,
2011 COLUM. BUS. L. REV. (forthcoming 2011) (manuscript at 4-5), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1916184.
8 Fellow Crowdfunders – What’s Holding You Up?, CROWDFUNDING CENTRAL (May 30, 2010),
http://www.crowdfundingcentral.com/blog_holdup.
“investment contract.”10 Being subject to securities requirements may spell the end
of a small enterprise because the costs of registration, or even obtaining the
exemption from registration, may exceed the total capital needed for the project.11
This Article is one of the first to examine the conflict between investment
crowdfunding and U.S. securities laws and to consider the circumstances under
which these laws might be changed to permit this new form of grassroots
investment. While it is clear that patronage crowdfunding is not subject to securities
regulation, most investment crowdfunding schemes are investment contract securities,
which are subject to federal and state securities laws.12 Furthermore, standard
exemptions from federal registration requirements are inadequate or inappropriate
for most types of investment crowdfunding.13
Given these problems, it is worthwhile to consider the merits of the current
proposal for a Securities and Exchange Commission (“SEC”) rulemaking to create a
crowdfunding exemption. The current proposal disregards many of the fundamental
principles of the modern securities framework, and this Article explores other
possible proposals and considers the ultimate viability of SEC action altogether.
While SEC Chairman Mary Shapiro promised Congressman Darrell Issa that the
SEC would consider a crowdfunding exemption,14 it is by no means clear that the
SEC has the time, resources, or desire to draft what is sure to be a complicated
exemption and to see it through the long rulemaking process. Ultimately, legislating
a crowdfunding exemption may be easier than obtaining an exemption through the
rule (...truncated)