[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
CROWDFUNDING: CONNECTING INVESTORS AND JOB CREATORS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON TARP, FINANCIAL SERVICES
AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS
of the
COMMITTEE ON OVERSIGHT
AND GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 15, 2011
__________
Serial No. 112-118
__________
Printed for the use of the Committee on Oversight and Government Reform
Available via the World Wide Web: http://www.fdsys.gov
http://www.house.gov/reform
U.S. GOVERNMENT PRINTING OFFICE
73-612 WASHINGTON : 2012
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC
area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC
20402-0001
COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM
DARRELL E. ISSA, California, Chairman
DAN BURTON, Indiana ELIJAH E. CUMMINGS, Maryland,
JOHN L. MICA, Florida Ranking Minority Member
TODD RUSSELL PLATTS, Pennsylvania EDOLPHUS TOWNS, New York
MICHAEL R. TURNER, Ohio CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina ELEANOR HOLMES NORTON, District of
JIM JORDAN, Ohio Columbia
JASON CHAFFETZ, Utah DENNIS J. KUCINICH, Ohio
CONNIE MACK, Florida JOHN F. TIERNEY, Massachusetts
TIM WALBERG, Michigan WM. LACY CLAY, Missouri
JAMES LANKFORD, Oklahoma STEPHEN F. LYNCH, Massachusetts
JUSTIN AMASH, Michigan JIM COOPER, Tennessee
ANN MARIE BUERKLE, New York GERALD E. CONNOLLY, Virginia
PAUL A. GOSAR, Arizona MIKE QUIGLEY, Illinois
RAUL R. LABRADOR, Idaho DANNY K. DAVIS, Illinois
PATRICK MEEHAN, Pennsylvania BRUCE L. BRALEY, Iowa
SCOTT DesJARLAIS, Tennessee PETER WELCH, Vermont
JOE WALSH, Illinois JOHN A. YARMUTH, Kentucky
TREY GOWDY, South Carolina CHRISTOPHER S. MURPHY, Connecticut
DENNIS A. ROSS, Florida JACKIE SPEIER, California
FRANK C. GUINTA, New Hampshire
BLAKE FARENTHOLD, Texas
MIKE KELLY, Pennsylvania
Lawrence J. Brady, Staff Director
John D. Cuaderes, Deputy Staff Director
Robert Borden, General Counsel
Linda A. Good, Chief Clerk
David Rapallo, Minority Staff Director
Subcommittee on TARP, Financial Services and Bailouts of Public and
Private Programs
PATRICK T. McHENRY, North Carolina, Chairman
FRANK C. GUINTA, New Hampshire, MIKE QUIGLEY, Illinois, Ranking
Vice Chairman Minority Member
ANN MARIE BUERKLE, New York CAROLYN B. MALONEY, New York
JUSTIN AMASH, Michigan PETER WELCH, Vermont
PATRICK MEEHAN, Pennsylvania JOHN A. YARMUTH, Kentucky
JOE WALSH, Illinois JACKIE SPEIER, California
TREY GOWDY, South Carolina JIM COOPER, Tennessee
DENNIS A. ROSS, Florida
C O N T E N T S
----------
Page
Hearing held on September 15, 2011............................... 1
Statement of:
Cross, Meredith, Director, Division of Corporation Finance,
Securities and Exchange Commission; Dana Mauriello, founder
and president, Profounder; Jeff Lynn, chief executive
officer, Seedrs Limited; Sherwood Neiss, cofounder,
FLAVORx; Micheal Migliozzi, managing partner, Forza
Migliozzi, LLC; and Mercer Bullard, associate professor of
law, the University of Mississippi......................... 5
Bullard, Mercer.......................................... 62
Cross, Meredith.......................................... 5
Lynn, Jeff............................................... 36
Mauriello, Dana.......................................... 22
Migliozzi, Micheal....................................... 62
Neiss, Sherwood.......................................... 45
Letters, statements, etc., submitted for the record by:
Bullard, Mercer, associate professor of law, the University
of Mississippi, prepared statement of...................... 65
Cross, Meredith, Director, Division of Corporation Finance,
Securities and Exchange Commission, prepared statement of.. 7
Lynn, Jeff, chief executive officer, Seedrs Limited, prepared
statement of............................................... 38
Mauriello, Dana, founder and president, Profounder, prepared
statement of............................................... 24
Migliozzi, Micheal, managing partner, Forza Migliozzi, LLC,
prepared statement of...................................... 85
Neiss, Sherwood, cofounder, FLAVORx, prepared statement of... 47
CROWDFUNDING: CONNECTING INVESTORS AND JOB CREATORS
----------
THURSDAY, SEPTEMBER 15, 2011
House of Representatives,
Subcommittee on TARP, Financial Services and
Bailouts of Public and Private Programs,
Committee on Oversight and Government Reform,
Washington, DC.
The subcommittee met, pursuant to notice, at 9:34 a.m., in
room 2154, Rayburn House Office Building, Hon. Patrick T.
McHenry (chairman of the subcommittee) presiding.
Present: Representatives McHenry, Quigley, Cummings, and
Maloney.
Staff present: Molly Boyl, parliamentarian; Drew Colliatie,
staff assistant; Peter Haller, senior counsel; Ryan M.
Hambleton, professional staff member; Christopher Hixon, deputy
chief counsel, oversight; Rebecca Watkins, press secretary;
Jaron Bourke, minority director of administration; Devon Hill,
minority staff assistant; Jennifer Hoffman, minority press
secretary; Carla Hultberg, minority chief clerk; Lucinda
Lessley, minority policy director; Jason Powell and Steven
Rangel, minority senior counsels; and Brian Quinn, minority
counsel.
Mr. McHenry. The committee will come to order. This is the
Subcommittee on TARP, Financial Services and Bailouts of Public
and Private Programs. This hearing is entitled, ``Crowdfunding:
Connecting Investors and Job Creators.''
It is the practice of the Oversight and Government Reform
committee to begin with a mission statement of this committee.
We exist to secure two fundamental principles. First, Americans
have a right to know that the money Washington takes from them
is well spent. And second, Americans deserve an efficient,
effective government that works for them. Our duty on the
Oversight and Government Reform Committee is to protect these
rights. Our solemn responsibility is to hold government
accountable to taxpayers, because taxpayers have a right to
know what they get from their government. We will work
tirelessly in partnership with citizen watchdogs to deliver the
facts to the American people and bring genuine reform to the
Federal bureaucracy. This is the mission of the Oversight and
Government Reform Committee.
With that, I want to thank our witnesses for being here,
and I will begin by recognizing myself for 5 minutes for an
opening statement.
Over 2 years into an uncertain economic recovery America's
labor and capital markets continue to face unprecedented
challenges. Nearly 14 million Americans remain officially
unemployed, with an additional 11 million underemployed. And
small businesses continue to struggle to access capital despite
an endless number of Federal initiatives.
Fixing this mess will not occur overnight, nor will it be a
race by more government regulation. The purpose of today's
oversight hearing is simple: In an economic environment in
which lending to job creators and entrepreneurs remains dismal,
we must find new and modern means for capital formation to
ignite our sputtering economy.
An existing and innovative means to connect investors and
job creators is crowdfunding. Many folks have not heard this
terminology before, but crowdfunding is essentially the ability
of individuals to pool their money in support of a common
cause. Crowdfunding has traditionally taken place in the realm
of charity and the arts, but also online communities and social
networking where it could have a very positive implication for
America's small businesses and investors.
If crowdfunding sounds familiar because politicians have
been doing it for a few generations now, but it has been called
something different. In the 2008 Presidential election then
candidate Senator Barack Obama through small contributions
alone raised over $100 million. Now that is quite advanced
crowdfunding. So this makes sense, if crowdfunding can finance
a candidate's campaign and really show a matter of grassroots
support for what you are trying to achieve, if it could make a
difference there, then certainly under the Securities and
Exchange Commission we should be able it permit crowdfunding to
empower citizens to invest seed money for American
entrepreneurs and innovators.
During President Obama's speech last week I was happy to
hear when he said, ``We're also planning to cut away the red
tape that prevents too many rapidly growing startup companies
from raising capital and going public.''
The first thing I thought of when he said that was today's
hearing. I thought: Well, of course not, that is not exactly
what he is going to be talking about. The next day when the
White House released the details of the President's plan in
bullet point form, I mean sort of the broad brush of it, he
used the term ``crowdfunding.'' And so it is very timely that
we're having this hearing, and I don't think the White House
coordinated with my schedule. But I applaud the President for
finally recognizing that regulatory red tape has kept American
startups from raising capital and hiring workers. This has
never been a secret.
Unfortunately, news and information travels a bit slower
over at the SEC. Despite recent efforts to relax rules on
general solicitation and quiet periods, overall, the SEC has
resisted calls to modernize securities regulations to meet the
needs of today's economy.
For instance, recent studies show that most startups use
lines of credit, such as credit cards or home equity lines, as
the first step to finance their business. The difficulty with
this is two-fold: Fewer people have access to credit lines or
home equity sufficient to start a business. And second, small
businesses using a credit card with high interest rates, it
makes it tremendously difficult to finance a new business.
That's exactly how my dad started his business.
But these ideas often don't make it past the dinner table
for small businesses. We want to make sure that they have this
access, this opportunity to get their friends and their
neighbors involved in this process.
By updating regulations for today's economy, conventional
barriers for raising capital could be a thing of the past.
Recently as 2009, two ad executives started a crowdfunding
campaign called buyabeercompany.com to buy Pabst Blue Ribbon
Beer Co. Many folks call it PBR. By illustrating the true
potential of crowdfunding they were able to raise over $200
million in pledges from over 5 million individuals through
social networking sites such as Facebook. The average pledge
was just $40, demonstrating the impact of even small donations.
However, the SEC shut it down due to outdated--what I believe
were outdated--regulations.
This example and thousands like it highlight the fact that
America does not lack the ideas or creativity to get this
economy moving again. It simply lacks access to capital. To
rectify this tragedy in American innovation I introduced the
Entrepreneurial Access to Capital Act, H.R. 2930, yesterday.
This bill simply heeds the President's call to cut red tape for
startups and allow everyday investors to connect with
entrepreneurs.
In today's fast-paced world of innovation and innovators,
all Americans rather than just banks and venture capitalists
and so-called qualified investors, high net worth individuals,
should be able to invest in the next Google, Apple, Facebook,
their local coffee shop or their favorite beer company.
And I'm interested to hear from the witnesses today. I am
so happy that we have such a great panel. I look forward to
your testimony.
With that, I recognize the ranking member, Mr. Quigley of
Illinois, for 5 minutes.
Mr. Quigley. Thank you, Mr. Chairman. Thank you for calling
this hearing and for our witnesses being here today. We are in
agreement: job creation must be the number one priority of
Congress. But for businesses to expand and hire new workers
they need resources, they need capital. Unfortunately, billions
of dollars of capital are sitting on the sidelines because
potential investors aren't confident enough to invest.
Investors are worried of investing capital when our growth
prospects are so uncertain.
As Secretary Geithner said last week, the world economy is
in the midst of a second economic slowdown of this recovery
from the financial crisis. This is why last month zero jobs
were created and the unemployment rate remained over 9 percent.
What this means is that we have to consider any and all
ideas for raising capital to invest in new businesses and hire
American workers. Crowdfunding is one such idea. It is an
innovative proposal for raising private capital through the
power of the Internet. Crowdfunding uses small investments from
often nontraditional investors to fund startup ventures. This
is extremely important because these smaller startups often go
unnoticed by bigger institutional investors.
To the extent that crowdfunding can match ready capital
with quality investment opportunities it will be a success. I
believe our witnesses will convince even the skeptics among us
that there is enormous potential here for job creation and a
stronger, more vibrant economy.
Still even though most of us would use crowdfunding to
jump-start a new tech company or small neighborhood business,
there are legitimate concerns that exempting crowdfunding from
securities regulations would open and expand opportunities for
fraud. Just as water standards keep our water safe to drink,
financial regulations protect us against unsafe financial
products.
According to SEC Chairman Schapiro, the SEC has a dual
mandate to facilitate capital formation and protect investors.
In facilitating capital formation, we must ensure that we do
not leave investors vulnerable to fraudulent financial
products. That's why the SEC maintains strict registration
disclosure requirements for securities advertised through a
general solicitation. In the words of the Supreme Court Justice
Louis Brandeis, sunlight is the best disinfectant.
Exempting securities from these registration and disclosure
requirements is a decision that cannot be taken lightly. The
key is finding the balance between the two objectives of
capital formation and investor protection.
Crowdfunding might also expose ordinary investors to a
level of risk that is unacceptable when not accompanied by
standard registration and disclosure. The reality is that many
of these startups will fail and cause the investor to lose his
or her entire investment. We have to be careful to ensure that
investors fully understand the risk of investing in these
financial products.
My goal today is to find answers to some of these
unresolved questions. What is crowdfunding's potential for
capital formation and job creation? What is the potential for
fraud through crowdfunding? What common sense steps can we take
to minimize fraud and protect investors? What risk will
investors be exposed to through crowdfunding? And are these
risks acceptable? What other steps can we take to facilitate
capital formation and job creation?
I again want to thank the chairman for calling this timely
hearing, and I yield back.
Mr. McHenry. I thank the ranking member. I'm going to keep
the introductions short since we have such a substantial panel.
Suffice it to say we have an academic, we have folks involved
in crowdfunding, and then we have a representative from the
SEC. So I will go through the introductions and then we will
swear you in and we will get started with opening statements.
Ms. Meredith Cross is the Director of the Division of
Corporate Finance at the Securities and Exchange Commission.
Miss Dana Mauriello is cofounder and president of Profunder--
ProFounder, I'm sorry. Mr. Jeff Lynn is chief executive officer
of Seedrs Limited. Mr. Sherwood Neiss--Neiss, Lord, I'm sorry--
is cofounder of FLAVORx. Mr. Michael Migliozzi is the managing
partner of Forma Migliozzi. He can correct me on that.
Mr. Migliozzi. Forza Migliozzi.
Mr. McHenry. Okay, I'm sorry. I have it written down wrong.
But Professor Mercer Bullard is the associate professor of law
at the University of Mississippi School of Law.
Thank you all for being here. It is the policy of the
Oversight and Government Reform committee that all witnesses be
sworn in, so if you will please stand and raise your right
hands.
[Witnesses sworn.]
Mr. McHenry. Let the record reflect the witnesses answered
in the affirmative. You may be seated.
So in order to have time for a discussion and questions if
you could please keep your opening statement to 5 minutes.
You'll see by the lights in front of you, green means go,
yellow means whoa, and red means stop. Whoa is a technical
term, I'm sorry to use that. But we will first begin with Ms.
Cross, you are recognized for 5 minutes.
STATEMENTS OF MEREDITH CROSS, DIRECTOR, DIVISION OF CORPORATION
FINANCE, SECURITIES AND EXCHANGE COMMISSION; DANA MAURIELLO,
FOUNDER AND PRESIDENT, PROFOUNDER; JEFF LYNN, CHIEF EXECUTIVE
OFFICER, SEEDRS LIMITED; SHERWOOD NEISS, COFOUNDER, FLAVORX;
MICHEAL MIGLIOZZI, MANAGING PARTNER, FORZA MIGLIOZZI, LLC; AND
MERCER BULLARD, ASSOCIATE PROFESSOR OF LAW, THE UNIVERSITY OF
MISSISSIPPI
STATEMENT OF MEREDITH CROSS
Ms. Cross. Chairman McHenry, Ranking Member Quigley and
members of the committee. I'm pleased to testify on behalf of
the Commission on the topics of crowdfunding and capital
formation. The SEC's mission is to protect investors, maintain
fair, orderly and efficient markets, and facilitate capital
formation.
As you know, Chairman Schapiro and I appeared before the
Oversight and Government Reform committee in May to testify on
the topic of capital formation. We noted that a critical goal
of the SEC is to facilitate companies' access to capital while
at the same time protecting investors. Companies of all sizes
need cost effective access to capital to grow and develop. And
the Commission recognizes that any unnecessary regulations may
impede their ability to do that.
At the same time the Commission must seek to ensure that
investors have the information and protections necessary to
give them confidence they need to invest in our markets.
Investor confidence and the fairness and honesty of our markets
is critical to capital formation.
To further our goals a few months ago Chairman Schapiro
instructed the staff to take a fresh look at some of our
offering rules to develop ideas for the Commission to consider
that may reduce the regulatory burdens on small business
capital formation in a manner consistent with investor
protection. The staff is in the process of conducting that
review, and in doing so, is considering the regulatory
questions posed by new capital raising strategies, including
crowdfunding.
Interesting crowdfunding as a capital raising strategy that
could offer investors an ownership interest in developing
business is growing. As you know, proponents of crowdfunding
are advocating for exemptions from Securities Act registration
requirements for this type of capital raising activity in an
effort to assist, early stage companies and small businesses.
The staff has been discussing crowdfunding among other
capital raising strategies with business owners,
representatives of small business industry organizations and
State regulators. For example, the staff has met with the
representatives of the Small Business and Entrepreneurship
Council and from the North American Securities Administrators
Association.
In addition, we anticipate that crowdfunding will be
considered by the Commission's recently announced Advisory
Committee on Small and Emerging Companies.
Current technology allows small businesses owners to easily
reach a large number of possible investors across the country
and throughout the world as a potential source of funding to
help grow and develop their businesses or ideas. This source of
capital and the ease with which an individual can communicate
with potential investors presents an opportunity for smaller
companies in need of funds. At the same time an exemption from
registration and the investor protections that come from our
disclosure requirements also could present an enticing
opportunity for the unscrupulous to engage in fraudulent
activities that could undermine investor confidence.
As a result in considering whether to provide an exemption
from Securities Act registration requirements for capital
raising strategies like crowdfunding, the Commission needs to
be mindful of its responsibilities both to facilitate capital
formation and protect investors.
In considering crowdfunding, some of the questions to
consider include: Should certain minimum information be
provided to investors? For example, should investors know the
names of the entrepreneurs, a summary of the business plan,
have a plan to use the money they raise? Should individuals or
firms with a history of securities fraud violations be allowed
to use the exemption? Should an SEC notice filing be required
so that activities in these offerings could be observed? Should
securities purchased be freely tradable? Should Web sites to
facilitate crowdfunding investing be subject to regulatory
oversight?
While the small amount of any potential crowdfunding
investment should generally limit the extent of any
individual's losses, these are issues that are among those the
Commission would need to consider in connection with any future
proposal.
In addition to looking at new capital raising strategies,
including crowdfunding, at the chairman's request the staff is
also looking at the triggers for when a company has to begin
public reporting, the restrictions on general solicitation and
private offerings and the rules governing communications in
connection with public offering.
My written testimony provides an update on our efforts. We
are committed to carefully considering these areas and
developing thoughtful recommendations for the Commission
consistent with the goals of facilitating capital formation and
protecting investors.
Thank you for inviting me here today. I look forward to
answering your questions.
[The prepared statement of Ms. Cross follows:]
[GRAPHIC] [TIFF OMITTED] 73612.001
[GRAPHIC] [TIFF OMITTED] 73612.002
[GRAPHIC] [TIFF OMITTED] 73612.003
[GRAPHIC] [TIFF OMITTED] 73612.004
[GRAPHIC] [TIFF OMITTED] 73612.005
[GRAPHIC] [TIFF OMITTED] 73612.006
[GRAPHIC] [TIFF OMITTED] 73612.007
[GRAPHIC] [TIFF OMITTED] 73612.008
[GRAPHIC] [TIFF OMITTED] 73612.009
[GRAPHIC] [TIFF OMITTED] 73612.010
[GRAPHIC] [TIFF OMITTED] 73612.011
[GRAPHIC] [TIFF OMITTED] 73612.012
[GRAPHIC] [TIFF OMITTED] 73612.013
[GRAPHIC] [TIFF OMITTED] 73612.014
[GRAPHIC] [TIFF OMITTED] 73612.015
Mr. McHenry. Thank you.
Ms. Mauriello.
STATEMENT OF DANA MAURIELLO
Ms. Mauriello. Good morning, Chairman McHenry, Ranking
Member Quigley. Thank you for having me here this morning. My
name is Dana Mauriello. I'm cofounder and president of
ProFounder, which I started with my cofounder, Jessica Jackley,
who is also the founder of Kiva, one of the first peer-to-peer
microlending sites.
We started in August 2009 a platform to allow entrepreneurs
to raise investment capital from their communities.
One of case studies that we saw that inspired us to start
this business was two of our classmates at the Stanford
Graduate School of Business that had a new technology startup
that they were beginning, and they were looking to the
classmates to see if those classmates wanted to contribute
investment capital. We are a very tight community, about 350
students. So we know each other well after 2 years of being in
class together. And within 24 hours 60 people in that class
said they wanted to put in the $1,000 cap that those
entrepreneurs had set to invest. This seems like a beautiful
story, but unfortunately their lawyers let them know that this
was impossible, in their words. And when the entrepreneurs
pressed, as entrepreneurs tend to do, they found out that it
was ``impossible because those investors were unaccredited.''
We had student debt, we did no meet the accreditation
requirements. There were also more people than their lawyers
felt could contribute. The entrepreneurs pushed and eventually
lawyers came back with Reg D 506, which would allow 35 of those
investors to contribute that $1,000 minimum.
That answer took 4 months and $20,000 to achieve. That was
an incredible inefficiency that Jessica and I witnessed. And
that's what really got us thinking about how could this be
possible that an entrepreneur with a great idea, and a
community that has the capital and wants to support them, would
have something standing in the way of being able to meet each
other. And looking back at my own personal history with small
family businesses, none of them would have gotten off the
ground if not Uncle Joe and Uncle Gene and a lot of other
friends and family members contributing. So this seemed like a
very logical answer.
So we started ProFounder with the vision of allowing
businesses to access capital and access resources that
supported their community. The solution that we came to after a
year of legal research with many counsels was Regulation D 504,
a Securities exemption that allows entrepreneurs to raise the
capital if it is less than a million dollars. It is coming from
people you have a substantial preexisting relationship with,
and you follow state-by-state Blue Sky laws.
Here's how we did that. Entrepreneurs came to our platform,
created a pitch, they created their term sheets. We offered two
term sheet templates, either equity or revenue share. It could
have been anything that was a security. And then we had a
compliance calculator that allowed entrepreneurs to say here
are the people who I want to invite. And we would spit out here
are the laws, here are the notice filings, here are the filing
fees that you need to pay. And that was no easy task because
these Blue Sky laws, which are different in every State, are
completely interdependent on each other as well. You have one
investor from Connecticut, you can only have 10 investors in
Colorado. So that was a bear to both navigate, make a technical
solution for and explain to our entrepreneurs, but we did.
We had some amazing success stories that I'm very proud to
share. Bronson and the Chang family in Honolulu, they were able
to open their second shaved ice store by raising $54,000 from
19 investors that included Bronson's freshman year roommate at
USC, their best customers at the shop, and all of their friends
and family.
Mark at Cubic Motors was able to start a motorcycle company
in San Francisco with the help of his fellow motorcycle
enthusiast friends to raise $50,000 from 16 investors that all
got these businesses started and off the ground. They are now
raising additional rounds of capital. At least two of our
entrepreneurs have gone on to raise additional capital now.
We also faced challenges, we faced a lot of challenges. And
the one that I'm most eager to talk about as an expert here is
the challenges that these companies like ours that are
facilitating crowdfunding face and how those challenges can be
alleviated. We were approached by the Department of
Corporations of the State of California to investigate our
operations, and they came to the conclusion after months of
conversation that we needed to be a broker-dealer to be
facilitating these transactions on the site because we were
providing form templates, because we had term sheets that
people could take advantage of on the site.
Whatever regulations ultimately goes into place for
crowdfunding I think it is critical to consider what can be
done for companies like ours to help facilitate. If we need to
be broker-dealers there is no way that we can help the small
entrepreneurs like Bronson and his family's shaved ice shop in
Honolulu because these due diligence requirements on us will be
too high and too onerous for us to be able to serve that
smaller client who has the greatest potential to really make a
difference, create jobs and spur the economy.
Furthermore, another problem that we faced was definitions.
There with a no clear definition for us of friends and family,
of substantial preexisting relationship. There was no
definition of sophisticated investor. Because of this lack of
definitions it made the law extremely difficult to implement.
And it made it very difficult for the counsel of the
entrepreneurs that we were working with to get on board and
feel comfortable with these changes.
In conclusion, thank you for having me here today and I
look forward to answering your questions.
[The prepared statement of Ms. Mauriello follows:]
[GRAPHIC] [TIFF OMITTED] 73612.016
[GRAPHIC] [TIFF OMITTED] 73612.017
[GRAPHIC] [TIFF OMITTED] 73612.018
[GRAPHIC] [TIFF OMITTED] 73612.019
[GRAPHIC] [TIFF OMITTED] 73612.020
[GRAPHIC] [TIFF OMITTED] 73612.021
[GRAPHIC] [TIFF OMITTED] 73612.022
[GRAPHIC] [TIFF OMITTED] 73612.023
[GRAPHIC] [TIFF OMITTED] 73612.024
[GRAPHIC] [TIFF OMITTED] 73612.025
[GRAPHIC] [TIFF OMITTED] 73612.026
[GRAPHIC] [TIFF OMITTED] 73612.027
Mr. McHenry. Thank you.
Mr. Lynn.
STATEMENT OF JEFF LYNN
Mr. Lynn. Chairman McHenry, Ranking Member Quigley,
honorable members of the subcommittee. My name is Jeff Lynn and
I am CEO and cofounder of Seedrs, a forthcoming equity
crowdfunding platform based in London. I'm also a U.S.
securities and corporate lawyer by background, having practiced
with the international firm of Sullivan & Cromwell in both New
York and London. I want to thank you for inviting me to testify
today on this very important and timely topic.
Seedrs will allow entrepreneurs to raise up 100,000 pounds
in equity capital from the crowds through an online platform.
We like to think of it as kickstarter with returns instead of
donations or lending club with equity instead of debt. Details
of how the platform works are set forth in my written
testimony.
We have applied for Seedrs to be authorized by Britain's
Financial Services Authority, and assuming we are successful it
will be the first equity crowdfunding platform anywhere in the
world to be expressly approved by a major securities regulator.
We will launch initially in Britain only, with the aim of
rolling out through the rest of the European Union shortly
thereafter.
When my cofounder and I designed this model, we examined
both the United States and Britain as our potential first
target market. Both had positives and negatives, but the
overriding consideration was the current U.S. securities laws
would present an insurmountable obstacle, where securities
regulation in Britain is significantly better suited for this
financial innovation.
We are very excited about making crowdfunded equity finance
available in Britain and eventually across Europe.
Nevertheless, it is highly encouraging to see that some
lawmakers want to consider rule changes that would allow equity
crowdfunding platforms like Seedrs to operate in the United
States as well.
I believe this is a very positive development, as it will
open a powerful tool to American entrepreneurs and investors
alike, and could prove to be a key factor in boosting the
economy and creating jobs throughout the country.
At the same time it is important that any rule changes be
considered carefully, and in particular that a balance be
struck between keeping administrative burdens low enough for
these platforms to be viable while still maintaining sufficient
investor protections.
I've laid out in my written testimony a few thoughts on how
best to strike that balance based on our experience on building
Seedrs. I would like to briefly summarize the three main ones
here.
First, we think it is important that equity crowdfunding
platforms be subject to some degree of regulation. This does
not need to be highly burdensome. There are categories of
regulation currently in existence that small businesses have
been able to comply with, such as broker-dealer registration
and SEC investment adviser registration, and those could be
used as a starting point, albeit they would need significant
adaptation.
In the absence of any form of supervision though, there's
too much scope for crowdfunding platforms that lack sufficient
systems and controls to cause harm to investors. And as
importantly, many investors simply will not use platforms that
lack a regulatory seal of approval. We have been told
repeatedly about potential Seedrs investors that the fact that
we will launch only after becoming FSA authorized is absolutely
crucial to their decision to use us.
Second, we would be against imposing a limit on how much an
investor can invest in a particular startup. These platforms
can only function if larger investors are able to participate
alongside smaller ones. And a per investment cap risks
unnecessarily excluding larger investors.
At the same time, there are better ways of making sure that
investors understand the risks involved and do not get in over
their heads, such as capping aggregate investment based on the
investor's declared net worth, and requiring investors to
complete a questionnaire showing their understanding of the
risks. Seedrs will do both of these.
Finally, we think that equity crowdfunding platforms will
be most effective when they are actively involved in executing
the investment transaction and managing the investment after
completion.
The greatest risk to investors when investing in a startup
comes not when the startup fails but rather when it succeeds.
Any sensible investor knows and accepts that the odds are
significant that the business will not work out and there will
be no return of capital. However, if the startup succeeds but
due to a flaw in the way the investment was structured or
managed the investor does not get the benefit of that success,
that is a much bigger problem. This is why Seedrs will provide
a substantial level of intermediation as part of its service,
including legal due diligence, subscription agreement
negotiation, and post completion management. We expect that
other successful platforms are likely to do the same.
We do not think that these services need to be required by
law, but it is important that whatever set of rules is adopted
for crowdfunding they at least allow for and perhaps even
explicitly authorize a meaningful level of intermediation.
To conclude, Mr. Chairman, I am both encouraged and excited
by the prospect of equity crowdfunding becoming a reality in
the United States. I hope the thoughts and insights I have
shared from our experience will prove helpful as consideration
of rule changes moves forward.
Thank you for the opportunity to appear before you today,
and I would welcome the chance to respond to your questions or
to amplify or clarify these statements at any time.
[The prepared statement of Mr. Lynn follows:]
[GRAPHIC] [TIFF OMITTED] 73612.028
[GRAPHIC] [TIFF OMITTED] 73612.029
[GRAPHIC] [TIFF OMITTED] 73612.030
[GRAPHIC] [TIFF OMITTED] 73612.031
[GRAPHIC] [TIFF OMITTED] 73612.032
[GRAPHIC] [TIFF OMITTED] 73612.033
[GRAPHIC] [TIFF OMITTED] 73612.034
Mr. McHenry. Thank you, Mr. Lynn. Mr. Neiss.
STATEMENT OF SHERWOOD NEISS
Mr. Neiss. Chairman McHenry, Ranking Member Quigley, and
members of the committee, thank you for holding this hearing
today and allowing me to share an entrepreneur's perspective on
how crowdfunding investing will spur innovation among your
constituents, create jobs and help our economy grow. This
framework was just endorsed by President Obama in the American
Jobs Act.
My name is Sherwood Neiss, and I'm a entrepreneur who
started and sold the 3-time Inc 500 company and is trying to
raise capital for two more. This is my third time I have given
congressional testimony on the hurdles related to capital
formation for entrepreneurs and small businesses. This
testimony was written in conjunction with my cofounders at the
startup exemption, Jason Best, a 2-time Inc 500 entrepreneur,
Zachary Cassidy-Dorion, and Karen Kerrigan of the Small
Business and Entrepreneurship Council.
I'm going to discuss three things: First, how crowdfund
investing solves a problem of connecting entrepreneurs to
capital; second, the framework under which we suggested this
should take place; and, third, provide two examples.
As someone who has tried to raise capital in the past few
years I know how hard it is. Try going into a bank to get a
loan or a line of credit. Try finding a credit card company
that will give you a decent interest rate or try peddling your
idea to venture or private equity. They aren't focused on who
will create the majority of net new jobs, but who has the
greatest chance for a 10X return in the shortest period of
time.
So the point is there is no capital out there for the
majority of businesses. We need to hire Americans and get us
out of this recession.
A solution is crowdfunding investing. Crowdfund investing
is using equity to pool small amounts of capital from a large
number of Americans to start and expand at businesses.
Crowdfunding is nothing new to America. The Statue of Liberty
was even built thanks to thousands of small donations from
Americans. On crowdfunding investing sites entrepreneurs will
their pitch ideas, and investors decide which ideas they think
are worthy of backing. If a startup doesn't hit its funding
target, no money is exchanged.
The funding rounds will occur via SEC regulated Web sites
where entrepreneurs will be vetted and their ideas discussed
freely with other investors. Anyone with deceptive practices
and false moves will be documented and discussed by the
thousands on Facebook, Twitter and other platforms. Time and
again we see if you make a false move on the Internet it will
only take hours before millions of people know about it.
Successfully funded businesses will not only benefit from
the capital but the collective knowledge, experience and
marketing power of the people who have a vested interest in
making sure the entrepreneur succeeds. Successful businesses
will also create jobs.
The complete rules of our framework are in my written
testimony, but here are six main points. First, we propose the
creation of a funding window of up to $1 million for
entrepreneurs and small businesses.
Second, investors would have to acknowledge the risk
involved in this type of investment and that there is no
guarantee of return.
Third, once they acknowledge the above they can choose to
invest. However, investments via this window would be limited
to $10,000.
Fourth, because of the size of the crowd and the
anticipated small dollar amounts invested, we propose
eliminating the 500 investor rule, as well as broker-dealer
license requirements.
Fifth, due to the limited size these offerings should be
exempt from costly State registration.
And sixth, general solicitation should be allowed only on
registered Internet platforms where entrepreneurs and investors
can meet and people and ideas can be vetted by the crowd.
Standardized base reporting will be used to submit
information to the SEC about small businesses utilizing these
platforms.
CFI is being using in other countries successfully,
including the U.K., France, Hong Kong, and China. Over the last
5 years over $300 million has been donated on U.S. crowdfunding
sites for art related projects or entrepreneurs in the
developing world. Just think what could have been accomplished
if we used the same dollars to fund jobs and innovation in the
United States.
Here are two examples of where people have donated money to
support an entrepreneur. Imagine how many more companies we
could fund if the same investors were given potential for a
return on their investment. Three engineers created a product
that greatly improved mobile video cameras. They were turned
down by 43 vc's and banks. So they created a short video on a
Web site and solicited money via their Twitter, LinkedIn and
Facebook communities. They raised over $24,000 and announced
selling the products, creating jobs and have gained investor
interest from vc's.
And Brooke from Lancaster, Pennsylvania wanted to expand
from a small T-shirt kiosk to a larger store, but was unable to
raise capital through traditional means. So she created a video
and raised $15,000. Now she has a stand alone store and has
hired more employees.
These are just two stories but thousands are waiting based
on estimates from the SBA and the Kauffman Foundation. We
believe CFI can generate over 500,000 companies and over 1.5
million net new jobs over the next 5 years.
Americans should be allowed to invest in their communities.
Today technology makes this a possibility. The Internet with
its transparency and accountability will make this concept
thrive. In turn, the crowd will fund ideas they believe in and
these ideas will be the launching pad for thousands of
worthwhile businesses. Both parties agree on the importance of
getting capital to our entrepreneurs; our framework is at zero
government cost proposal to accomplish this.
Thank you for your time. I look forward to your questions.
[The prepared statement of Mr. Neiss follows:]
[GRAPHIC] [TIFF OMITTED] 73612.035
[GRAPHIC] [TIFF OMITTED] 73612.036
[GRAPHIC] [TIFF OMITTED] 73612.037
[GRAPHIC] [TIFF OMITTED] 73612.038
[GRAPHIC] [TIFF OMITTED] 73612.039
[GRAPHIC] [TIFF OMITTED] 73612.040
[GRAPHIC] [TIFF OMITTED] 73612.041
[GRAPHIC] [TIFF OMITTED] 73612.042
[GRAPHIC] [TIFF OMITTED] 73612.043
[GRAPHIC] [TIFF OMITTED] 73612.044
[GRAPHIC] [TIFF OMITTED] 73612.045
[GRAPHIC] [TIFF OMITTED] 73612.046
[GRAPHIC] [TIFF OMITTED] 73612.047
[GRAPHIC] [TIFF OMITTED] 73612.048
[GRAPHIC] [TIFF OMITTED] 73612.049
Mr. McHenry. Thank you. Mr. Migliozzi.
STATEMENT OF MICHEAL MIGLIOZZI
Mr. Migliozzi. Good morning and thank you, Chairman
McHenry, Ranking Member Quigley, and members of the committee.
My name is Micheal Migliozzi. I am the creative director and
managing partner of Forza Migliozzi, an advertising and brand
content agency. I am honored to have my presence requested by
this body for any assistance regardless of how small that I am
able to contribute with ideas to unleash our economy, leading
to job creation and financial recovery. I am without question
absolutely humbled to contribute what experience I have.
From my earliest memories my father told me that America is
the land of opportunity, or that you can become whatever you
want to become, through hard work you will succeed. I'm passing
this on to my two little girls. I chose advertising.
I have had the unique opportunity to work with some of the
smartest pioneering dream chasers and passionate people in
business. As an ad man, it is though I am part psychologist,
part bartender, and part clergy. It is my work to sell their
work. My career path has taken me all around this great Nation,
northwest, east and south, working for some of the best
advertising agencies in the world from New York City to
Portland, OR, creating campaigns for sneakers, sodas, sports
teams, credit cards, casinos, hotels, beer and many other
categories.
For an ad man the struggle and battle was to get to the
reward of the big idea, the 24/7 quest to solve the problem at
hand is never ending.
I came to realize that this is the struggle of the
entrepreneur as well, a 24/7 cycle of commitment to your dream,
the risk that might never see a reward, the fight to battle, or
maybe to look failure in the face and fail it to take a hike. A
few years back I took my own advice and became an entrepreneur
by opening my own advertising agency.
I'm going to get on to crowd sourcing. What is crowd
sourcing? The best definition I have ever found--excuse me,
give me a moment.
Mr. McHenry. Sure.
Mr. Migliozzi. What is crowd sourcing, the best definition
I've ever found--I'm going to have to pass for a moment.
Mr. McHenry. We will come back to you to finish up, if
that's all right. If you need some more water----
Mr. Migliozzi. Thank you.
Mr. McHenry. Mr. Bullard.
STATEMENT OF MERCER BULLARD
Mr. Bullard. Chairman McHenry, Ranking Member Quigley,
members of the subcommittee, thank you for the opportunity to
appear today to discuss the regulation of crowdfunding.
I would like to start by laying out the structure of
securities regulation in order to put crowdfunding regulation
in context. Securities transactions are generally regulated on
three levels. On the first level securities transactions are
subject to the same general commercial anti-fraud provisions
that apply to all businesses.
On the second level securities transactions are subject to
security specific anti-fraud provisions that provide increased
investor protection.
There is some general agreement that crowdfunding triggers
the first two levels of regulation which provides some degree
of investor protection. On the third level, securities
transactions are subject to public registration or reporting
requirements, and this is where crowdfunding runs into trouble.
Public registration, reporting requirements are generally
impracticable for crowdfunding. In fact many issuers find them
to be impracticable.
Congress and the SEC have created a variety of exemptions
from public registration and primary public registration
requirements, but these exemptions are also impracticable for
many forms of crowdfunding. And the most significant problems
are generally that some form of disclosure document is required
and there is a general prohibition against solicitations and
advertising in connection with the sale of securities. So the
regulatory question as to crowdfunding is whether it would be
appropriate to liberalize one or more existing exemptions or
create a new exemption to accommodate crowdfunding.
I think the answer should be yes for the archetypal
crowdfunding program. This would be offerings in which
investors, individual investments were limited to a small
amount, $100 or $250. The total amount of the offering did not
exceed for example $100,000. For such de minimis investment
amounts registration and reporting requirements should not
apply. Other requirements should be imposed, including enhanced
requirements for crowdfunding broker-dealers to combat the
heightened risk of fraud.
Other types of crowdfunding, macro crowdfunding finance,--
macro finance crowdfunding if you will, raise very different
concerns. A $10,000 investment, for example, is not a de
minimis amount, it is a significant amount for many investors
and should be subject to some degree of registration and
reporting. Making it much easier for scam artists to sell
unregistered securities to families living below the poverty
line or seniors barely surviving on Social Security is usually
not good public policy.
Any macro finance crowdfunding exemption should be subject
to the regulatory cost-benefit analysis traditionally used to
evaluate registration and reporting requirements. This cost-
benefit analysis generally considers the increased risk of
fraud and the benefits to capital markets and to investors. It
also considers the relationship of any new exemption to
existing exemptions and the interest of all issuers, not solely
those of crowd funders.
The areas where reform is needed in macro finance grant
funding would be easier. Increasing the Reg A limit to $50
million is an example of why I don't believe there would be
that much dispute. But let's not do that to make crowdfunding
easier, let's do that to make Reg A work better for all types
of capital raising.
Similarly, the 500 investor trigger for reporting
obligations, the ban on general solicitation in advertising,
and the qualifications for accredited investors all need to be
reformed, but not to accommodate macro finance crowdfunding.
They need to be reformed to accommodate the full range of
issuers. The 500 investor trigger is routinely honored in the
breach. Firms with thousands of beneficial owners are often
permitted to cease public reporting. At the same time other
firms with thousands of beneficial owners are never required to
file public reports in the first place.
The ban on general solicitation and advertising is
fundamentally inconsistent with the Information Age. The
frenzied and very public trading of Facebook's 2\1/2\ billion
shares makes a mockery of this prohibition, as did the failure
of the U.S. segment of a Facebook private offering earlier this
year.
The wealth and income test for accredited investors have
not been adjusted for 20 years, and they are structurally
nonsensical. A young investor with $900,000 cannot put 10 of it
in a hedge fund, but a retired auto workers with a million
dollar portfolio living on say $40,000 a year that the
portfolio generates can drop the whole million in a hedge fund.
The investor who can afford to lose his shirt cannot invest,
but the investor who cannot afford to lose his shirt can.
In conclusion, there is micro finance crowdfunding that
simply does not implicate the public policy concerns underlying
the third level of securities regulation, registration and
reporting. The exemptions for other small issuers where
investors are risking more than de minimis amounts are
appropriate only to the extent of the cost of increased fraud,
if any, is outweighed by the benefits.
Thank you again, and I would be happy to take any questions
you might have.
[The prepared statement of Mr. Bullard follows:]
[GRAPHIC] [TIFF OMITTED] 73612.050
[GRAPHIC] [TIFF OMITTED] 73612.051
[GRAPHIC] [TIFF OMITTED] 73612.052
[GRAPHIC] [TIFF OMITTED] 73612.053
[GRAPHIC] [TIFF OMITTED] 73612.054
[GRAPHIC] [TIFF OMITTED] 73612.055
[GRAPHIC] [TIFF OMITTED] 73612.056
[GRAPHIC] [TIFF OMITTED] 73612.057
[GRAPHIC] [TIFF OMITTED] 73612.058
[GRAPHIC] [TIFF OMITTED] 73612.059
[GRAPHIC] [TIFF OMITTED] 73612.060
[GRAPHIC] [TIFF OMITTED] 73612.061
[GRAPHIC] [TIFF OMITTED] 73612.062
[GRAPHIC] [TIFF OMITTED] 73612.063
[GRAPHIC] [TIFF OMITTED] 73612.064
[GRAPHIC] [TIFF OMITTED] 73612.065
[GRAPHIC] [TIFF OMITTED] 73612.066
Mr. McHenry. Thank you, Mr. Bullard.
Mr. Migliozzi, we will return to you, if you can summarize.
I think 4 minutes left.
Mr. Migliozzi. I will pick up if I may with regards to the
entrepreneur.
So a few years back I did, I took my own advice and became
an entrepreneur by opening my own advertising agency. I now
share the same challenges and same roadblocks that many
entrepreneurs face regardless of size, purpose or industry. My
business is wholly dependent on other businesses who need to
sell their products or services. They are dependent on an end
consumer to sell to, the consumer a paycheck to spend with. As
we have seen, the cycle or the gears of this cycle have locked
up.
Crowd sourcing and advertising. What is crowd sourcing? The
best definition I ever found goes something like this. It is a
neologistic compound of crowd and outsourcing for the act of
taking tasks traditionally performed by an employer contractor
and outsourcing them through a group of people or community
through an open call to a large group of people, a crowd asking
for contributions.
Apparently I've been doing this for quite some time. We
will go on to buy a beer. This is fun.
In the fall of 2009 I read a----
Mr. McHenry. Just take your time, it is okay.
Mr. Migliozzi. All right. I'm having an allergic reaction
to medication.
Mr. McHenry. I'm sorry, I know that's very convenient for
the day you are having.
Mr. Migliozzi. Huh?
Mr. McHenry. So sorry. I know having an allergic reaction
is very convenient for testifying before Congress.
Mr. Migliozzi. Yes, I'll finish it.
Mr. McHenry. I say that with sarcasm but just take your
time. It is fine.
Mr. Migliozzi. Okay. In the fall of 2009 I read a New York
Post article about Pabst Brewing Co. was up for sale, and the
asking price was $300 million. In jest via a corporate Twitter
account I tweeted maybe we can crowd source this. And before I
could even hit the ``send'' button I knew this would be at the
very least a great case study to evaluate crowd sourcing, its
behavior, its magnitude.
My expertise is not finance, economics or law. My expertise
is in effective branding, marketing consumer behavior and
possibly a little side show regardless of medium.
I'm not here to confirm nor deny any of the findings of the
Securities and Exchange Commission's cease and desist order. I
was asked to be here to recount the important aspects of my
experiment as it relates to funding companies without
traditional financial outlets and to highlight the success it
had not in theory but in actuality.
Crowd sourcing means crowdfunding. This experiment was to
answer my questions about crowd sourcing. With such a large
amount, a $300 million asking price it would require the crowd
sourcing vehicle to be easily partaken by all, exclusively
online.
Excuse me. The goal was to stay as the focal point, a
countdown starting at a mind boggling $300 million may not be
so mind boggling as we're hearing about trillions of dollars
every day, but a very large amount just the same. What was
being asked of them, their interest to join in the largest ever
crowd sourced audience, that was their interest, came in the
form of pledging their name, email address and an unbinding
amount they were pledging and in caps ``send no money.''
It is important for me to state here that at no time was
any money ever received, nor was there any way for users to
send the money nor any way for us to collect money. How to
create enough buzz to get this into the hands of others would
be required, how long could the buzz be sustained, how would
the user take control of the conversation to generate buzz.
Transparency, any questions and their answers needed to be
anticipated and answered by viewing the site.
Of course at the onset of the experiment there was simply
no way to predict a positive outcome, far too many variables. A
one page Web site is created with full disclosure, a Twitter
account created, a press release circulated, this on or about
November 10, 2009. By December 1, 2009, over $14.75 million was
pledged.
I'm getting into the red, if I may ask for additional time.
The amount of press, press about the concept, the ease of
understanding, the genius of the experiment generated buzz
traffic sharing that by the end of 2009, the amount of pledges
had exceeded $100 million. Christmas, New Year's passed. I was
certain with the new year this would be old news. By February
22, 2010, over $200 million was pledged. What was just an
experiment was now taking up far too much of my time with press
requests, some 150 articles written, radio interviews by that
point. There was an interest by media users, etc., that this
could happen. Could it? How? What steps would need to be taken?
Pledges were still coming in. Press was still writing about
this. This experiment was turning into a solid case study and
an award winning one at that as it won for most innovative in
the crowd sourcing competition at South By Southwest in 2010.
On March 24, 2010, I received a FedEx from the SEC which
led to the shuttering of buyabeercompany.com. Those proceedings
concluded on June 8, 2011. Pabst Brewing was purchased on May
26th purchased 2010 for about $250 million, according to the
Wall Street Journal, by investor C. Dean Metropoulos. At the
time of closing buyabeercompany.com, over $282 million was
pledged by over 7 million users, averaging $38 per pledge.
My conclusion is coming. I believe this illustrates the
power of crowd sourcing or rather as it is referred here
specifically as crowdfunding. What a powerful tool whereby the
investor now becomes purchaser, brand steward, evangelist where
the brand must answer to them and live up to their every
expectation, not as a simple financial tool but as their
expansion of buying into the brand. This process could have
been easily used for the sale of Hummer GM, as seeking to shed
their division was selling this American icon to China. While
that $150 million fell through, I can't help but imagine if
crowdfunding could not have only saved this brand but the jobs,
the dealerships and the money spent on R&D, the equity built
into the marketing brand loyalty by simply opening this up to
the general public.
What started out as an experiment to test for hypothesis or
the power of social media and the propelling of a crowd toward
a common goal had become a concrete and plausible way to do
business in a landscape which moves rapidly and without
harness. For my purposes it gave me invaluable information on
consumer behavior. Hopefully other aspects of this can provide
light on how we can utilize this to fund, build, expand
businesses, the economy, leading to job creation. The
possibilities of crowdfunding for starting expanding and
purchasing companies are never ending.
Thank you.
[The prepared statement of Mr. Migliozzi follows:]
[GRAPHIC] [TIFF OMITTED] 73612.067
[GRAPHIC] [TIFF OMITTED] 73612.068
[GRAPHIC] [TIFF OMITTED] 73612.069
[GRAPHIC] [TIFF OMITTED] 73612.070
[GRAPHIC] [TIFF OMITTED] 73612.071
Mr. McHenry. Thank you. I understand the pressure of
testifying and at the same time having a health issue as well.
So we certainly understand that.
I will begin my questions and recognize myself for 5
minutes. Votes are called on the floor, so we're going to try
to get through our first round of questions and come back for
more.
Ms. Cross, the President outlined in his speech and then
the administration issued the following: Reducing regulatory
burdens on small business capital formation. The administration
also supports ``crowdfunding'' exemption from SEC registration
requirements for firms raising less than $1 million with
individual investments limited to $10,000, or 10 percent of the
investor's annual income, and raising the cap on many offerings
Reg A, that Mr. Bullard testified about from $5 million to $50
million. This will make it easier for entrepreneurs to raise
capital and create jobs.
Can you describe the SEC's perspective on the President's
recommendation in terms of the crowdfunding portion, not the
Reg A, but if you could describe the SEC's perspective on this.
Ms. Cross. Thank you for your question. I have to say first
the Commission hasn't taken a position yet. These statements
were just made. So we're discussing the matter internally at
the Commission. I'm sure we will be having more discussions in
light of the interest in the topic.
From my personal perspective I think that the key to such
an exemption would be whether it could be crafted so that there
could be cost effective crowdfunding exemption that could be--
that wouldn't present significant concerns of fraud. If so,
then I could see real benefits.
The issue you've got to watch out for is that if it becomes
viewed as a tainted market where people go to fraudulently
steal money, then that won't help anyone. So there needs to be
some sort of balancing happening on a cost effective basis
where some level of requirements, what kind of information
might be required, are there notice filings, things of that
nature, what the caps are, how much money for any individual,
all of those issues would be important so this isn't a place
where just bad actors go to steal money from people.
Mr. McHenry. Okay. And so would an annual audit be one of
those?
Ms. Cross. That's an interesting question. I don't know if
an audit is what I would be thinking of. I was thinking more in
terms of oversight of those operating the site so that at least
someone is keeping track that these companies actually exist,
that the money is coming from investors to these companies,
those sorts of things that would give you pause. If somebody
just opened up a Web site and took money and then disappeared
that would be pretty awful. So what----
Mr. McHenry. Which--not to use sarcasm, which never happens
today?
Ms. Cross. Well, I can't say whether it happens today or
not.
Mr. McHenry. Really? So I would just propose this. So based
on this the SEC would think that the eBay exchange where I
offer my used pickup truck for sale, that that transaction
would never happen without the SEC preserving and protecting
against fraud.
I'm not asking you to answer, but what's the timeframe for
the SEC to review this recommendation and how long would that
take to implement?
Ms. Cross. We're currently discussing it internally. I
don't have a timeframe, but I would expect we would want to
consider it deliberately in the near future.
Mr. McHenry. Is that 2 years, 1 year, is it 6 months?
Ms. Cross. As I said, I can't commit the Commission to a
timeframe but I would expect that it would be in the near
future.
Mr. McHenry. Back in May I asked a similar question about
accredited investors, the 500 investor cap. Any update there?
Ms. Cross. Yes. We're deep into the various work streams
that we discussed back in May. One of them is the 500
shareholder cap. We have a study underway at the Commission now
to get all the data that we need in order to be able to
determine what revisions to the cap there should be. So that's
deep underway right now.
We also are working on concept release on how to address
the issues with regard to a ban on general solicitation and
looking at targeted offering reforms around these issues and in
addition we just announced this week the formation of our Small
and Emerging Co. Advisory Committee so we can get their input
there as well.
Mr. McHenry. What was the impetus for creating that group?
Ms. Cross. For the committee? We've been working on forming
a committee. It is complicated to form committees under the
advisory committee rules. The purpose of it is to get--to be
able to try out ideas.
Mr. McHenry. I understand the purpose. What was the impetus
for creating it?
Ms. Cross. In order to be able to get--I'm sorry, we've
been in the process of forming it since many months ago.
Mr. McHenry. Okay, okay. Do you have a timeframe for when
this 500 investor cap will--there will be some resolution to
it?
Ms. Cross. I would say because we have to do the study to
get the data that we need to do an appropriate analysis it
would take a significant period of time. It would be sometime
in 2012.
Mr. McHenry. Mr. Quigley is recognized for 5 minutes.
Mr. Quigley. Thank you, Mr. Chairman.
Mr. Lynn, make sure I get this right, you talked about
allowing a dual set of investors, high end as well as the low.
Are you talking about the high end ones being under the normal
rules or also under crowdfunding?
Mr. Lynn. No, on our platform they will all be under the
exact same set of rules. Everybody will come in through the
platform whether they are investing 10 pounds or 10,000 pounds
or 100,000 pounds, directly to the platform.
The key point, just to try to elucidate slightly why it is
important that we have the big investors alongside the smaller
ones, is that platforms like this will not succeed if it is
only $10 or $100 investments being made through them. What will
happen is the business that is seeking capital, we will get a
lot of interest, there will be a high volume of investors, but
to try to raise $50,000 or $100,000 on the back of $10 or
similar size investments the deals simply won't get closed.
So for these platforms to function for a marketplace to
exist, we think that we need to be able to go after both the
smaller investors, but also people who might traditionally be
angels but see a value proposition in investing through a
platform like ours alongside the smaller investor.
Mr. Quigley. Why can't you do this in a system, a dual
system for the same sort of investment? The whole point of the
high end investors having so much more regulation and control
is because you are dealing with a lot more money. At least it
is one of the elements of this. Don't you now run the risk, why
would anybody go under the normal rules if the big one could go
under crowdfunding?
Mr. Lynn. Two answers. Yes, first of all, you could do two
separate systems, absolutely. You could do a system where the
smaller investors receive an additional level of protection and
the larger investors do something on a different track,
different plane. It just adds administrative complexity, and
there is no particular reason when you could have everything
under the same system where effectively, as I've said in my
testimony, we're looking at a platform where all investors get
a much more significant level of protection than they would if
they went off and bought shares in their friend's company.
The second point is investing through a platform like ours
has both advantages and disadvantages to high net worth
investors. The advantage is it is simple, it is easy and
straightforward and they don't have to do a lot of
administrative work. Many angels prefer to be able to invest in
a hands-on way, to be able to interact directly with the
entrepreneurs, to be able to go on the board, provide advice.
And we think that many angels will continue to want to use the
traditional off-line method of investing as well. We want the
choice to be there for them.
Mr. Quigley. Ms. Cross, we're on limited time because we're
due on the floor a few minutes ago. How do you begin to balance
this? You talk about the notion of at least having some rules
about this, you ticked off quite a few points. But at what
point are we right back to where we are now anyway with all the
rules and regulations that the President sort of referred to
that we want to pull away so that we encourage this kind of
investment at the small level?
Ms. Cross. That's a very important question, and I think
any rulemaking would have an appropriate balancing of the cost
and benefits. I think that the smaller the amount of money that
people could risk losing, the less regulation you would need,
the less impact it could have across the markets.
Mr. Quigley. Let me interrupt you again because we are
short. I guess the crux of my concern is that the smaller
investor--doesn't it seem like that is the less sophisticated,
less knowledge, less ability perhaps; perhaps the very person
who needs the most protection? I mean, is that a glimmer in
your mind or is that just wrong.
Ms. Cross. That's certainly a concern and you would need to
think about that. I think the notion of crowdfunding, which
again the Commission has not taken a position on, but the
notion of it is at some de minimis level, one would argue that
there isn't a need for the full panoply of regulations that
comes from securities registration, even though the particular
people may be on the less sophisticated range because they have
less to lose. And the question really is a cost-benefit
analysis.
I think it's important, though, that if it turns out all
the unsophisticated investors who don't get the information
registration would require end up defrauded, then it's going to
be an unsuccessful experiment. If, instead, it's a success,
and--then I think it does provide an opportunity for--and this
is my personal view--for another avenue to raise money cost
effectively, but it's--it's an interesting experiment that we
would need to at least keep a close eye on.
Mr. Quigley. Mr. Chairman, these are thoughts that I'd like
to get the thoughts of all the participants unfortunately, we
are now heading to the floor.
Mr. McHenry. And the chair would announce that we have
votes on the floor. It's the intention of the chair to go cast
the first vote, return back here, try to get a few more rounds
of questioning in, at which point we'll have two additional
votes thereafter.
There are Members that will be sworn in between the first
and second vote here. So we should be able to get back and have
an additional 30 minutes.
Mrs. Maloney. Point of information, Mr. Chairman. May I ask
my question and make a bolt to the floor because I don't think
I can come back?
Mr. McHenry. Yeah, I would just ask indulgence of the
Member to come back after this first series of votes because
the----
Mrs. Maloney. It is really hard for me. I can just do it
really quick right now.
Mr. McHenry. I have to go get to the floor and vote so I
can get back here. Go ahead, I will give the gentlelady a
minute.
Mrs. Maloney. First, I want to thank you for holding this
hearing. It is tremendously important, looking at the
crowdfunding exemption and how it is implemented.
An offer, a startup mentor and angel investor in the
district that I represent by the name of Marty Zwilling wrote
an interesting blog calling into question some of the virtues
of crowdfunding, and I would like to quote what he said, ``He
warns that crowdfunding places the focus on the product, not
the business model. When pitching to consumers online or off
line, the feedback will likely be on features and design. The
key success factors of the business model, meaning how you make
money, management expertise, and financial projections, will
likely get overlooked.''
And I would just like to know how the panel would respond
to what he said. He also warns that investors are not prepared
for the high risk of startups and he has--he believes that it
will be marketing to the riskiest, most speculative investments
to some of the least sophisticated. So I would like to hear
your response.
Mr. McHenry. The gentlelady's time has expired. We have
just enough time for me to get to the floor--for us to get to
the floor to vote. When we return, I will let the panel answer
that question. The committee is in recess.
[Recess.]
Mr. McHenry. The committee will come back to order. We do
have two new Members that won special elections on Tuesday
being sworn in on the floor today, right now at this moment. So
we have some time to have additional rounds of questions, and
so I will recognize myself.
Well, actually, I will let the panel answer my colleague
Mrs. Maloney's question, which pertains to fraud. If you could
begin with that, if you can recall her question from 15 minutes
ago, Ms. Cross, and we will just go right down the panel.
Ms. Cross. Yeah, I will just quickly respond. I think that
her question points out the point about whether investors will
have access to the kind of information that they need, whether
it is focused on the idea or the company in which they would be
investing, and so whether that is through the rules of the
platform or any other regulations, what kind of information
would be needed at a minimum is an important issue.
Mr. McHenry. How would the SEC deal with that?
Ms. Cross. I think it depends on the costs and benefits. I
think at the lower levels of investing, fewer requirements may
make sense. Higher levels, you would think perhaps you would
need more robust disclosure requirements.
Mr. McHenry. All right.
Ms. Mauriello. So just to address the general issue of
fraud, the idea has come up from numerous people about broker
dealership or the responsibilities of the facilitating party to
do something. And, Chairman McHenry, I think you brought up a
good analogy with eBay that if I am going to buy a car on eBay,
I am not going to ask eBay to verify that the seller of that is
legitimate. I am going to look at the reviews. I am perhaps
going to call, get references on his reputation.
So this issue of fraud is certainly not a new one that we
are facing with the idea of crowdfunding. It is a very old
idea, and while it is been well tested and well proven what the
solutions can be online, improvement of those solutions are
more based on reputation and based on crowdsourcing information
than on the facilitating party.
So, for example, if we had been a broker/dealer at the time
that some of these deals had gone through on our site and had
to do due diligence, for example, I would have had to call to
do reference checks the very same people who are doing
investments in the deal in the first place. They had more much
more information than I did at that particular time.
Mr. Lynn. I mean, I think I agree with Dana and I think an
important point as well about fraud, generally, is it is in the
interest of every one of these platforms like ours to do
everything we can to minimize the levels of fraud that occur.
Is it bad for the market? If this becomes, as Ms. Cross said,
if this becomes an environment in which sort of bad or
fraudulent companies see this as a way to raise money, I am out
of business. So there is--whatever the regulation may be, we
have a tremendous incentive and we have with Seedrs put in
place a number of very significant protections to try to limit
that.
Also, just quickly to address Congresswoman Maloney's point
about investors not being sufficiently sophisticated or not
understanding what they are getting into, I firmly disagree
with that. I think that while we do have a level of screening
on the test to make sure that truly vulnerable people do not
invest through the platform, it is not that hard to understand
that investing in startups is a very high-risk, highly illiquid
form of asset, and we think that a wide range of people are
capable of and qualify to do so.
Mr. Neiss. I concur with that. I think Congresswoman
Maloney was talking about people focusing on the product and
the business model. I just don't get why we have to keep on
pushing people down with the relentless assaults on their
intelligence. I mean, we are pretty smart people. I am going to
be partaking in these platforms. I have money tied up in an
investment group. I know how to ask questions and I know how to
educate other people that will be investing as well.
So by people like me partaking in this, we are just going
to be educating more people, which is going to raise the bar
and make it even safer for everyone.
Mr. Migliozzi. I come from the same position as yourself as
far as eBay is concerned. I look at State lotteries. A dollar
and a dream is probably one of the best tag lines in New York
State in many, many years, and most of those people funding the
lottery are not exactly sophisticated investors, nor are they
sophisticated investors in casinos. Now they are all hoping to
gain.
What we are doing, at least from what I an understanding
here, is we are preventing people from the possibility of huge
opportunities to either elevate themselves up, whether it is a
small amount of money or a large amount of money, and
preventing them making this--what we have, the land of
opportunity, is now protecting you from fraud and therefore
curtailing any possibility of getting yourself involved in a
crowdfunding or a startup or riding it all the way up.
Mr. McHenry. Mr. Bullard.
Mr. Bullard. The answer to the eBay question, which is a
good question, is really a structural one. The answer is that
for going on 100 years legislators and regulators have treated
securities transactions differently from other transactions. If
they are not different, we should repeal the Federal securities
laws, but this isn't a matter of crowdfunding regulation. That
is fundamentally a matter of whether securities transactions
are different, and I think they are.
As to whether, for example, private offering requirements--
you know, unaccredited investors are an assault on the
intelligence of Americans--again, it is so deeply embedded in
the structure of the Federal securities laws to make
paternalistic judgments about who is going to be allowed to
invest in unregistered offerings. The idea that that is somehow
just fundamentally questionable is not a crowdfunding issue.
That is an attack on the very structure of the Federal
securities laws, and maybe that is the way Congress wants to
go, but let's not pretend it is anything other than what it is.
It also shows I think, you know, the ignorance of people
who, you know, I think have good-faith businesses and want to
raise capital with respect to the amount of fraud that goes on
on the Internet, and specifically with respect to securities.
And there is no question that any liberalization of the
exemption rules will result in some incremental increase in
fraud. And you know, no one likes to say it except for someone
who is somewhat of a free agent, but the bigger issue is about
figuring what the optimum level of fraud is, and you are going
to get a lot of fraud.
And if the bill, which I appreciate, you know, starts the
conversation, is as written made into law, you'll have a
massive amount of fraud. And I can tell you, your crowdfunding
market will cease to exist because the level of fraud will
simply destroy any confidence in anyone, other than an
unsophisticated investor would be willing to participate in.
So, you know, there is a level of discussion that we are
just not recognizing here. It is about some of the fundamental
assumptions about how securities transactions are regulated,
and if that is what you object to, I think we need to put that
on the table and have the conversation about that.
Mr. McHenry. I recognize myself for 5 minutes. Thank you
for answering that question.
Ms. Cross, is this--the number one concern is fraud?
Ms. Cross. That's certainly a very important concern. We're
not talking about regulating just for regulating sake.
Mr. McHenry. What are the key concerns?
Ms. Cross. The key concern would be that investors would
part with their money to unscrupulous business operators who
just take the money and run, and that we all watched that
happen and didn't take the time and effort needed to come up
with a system that would provide a level of safety, disclosure,
oversight, some ability to watch what's going on. I think--you
know, I worry about, as I mentioned, Web sites popping up all
over the place and then disappearing, and people put in money
and then it is gone, and I think those are the concerns that I
would have.
Mr. McHenry. Okay, okay. So, for instance, as a former wise
investor in pets.com, this has happened with registered
securities where the business plan was bad. And so how do we,
Mr. Bullard, in your opinion, how do we ensure that we open
this area--it sounds like that you are willing to go with the
idea of crowdfunding with some exemption. How do we do that
while at the same time dealing with that question--that concern
of fraud?
Mr. Bullard. Well, I think that the analogy to pets.com is
a very apt one because, you know, we are sort of revisiting the
way we have structured the Federal securities laws, and it
comes down to the question of, you know, how much paternalism
are we going to have because it's--I would have to disagree
with Ms. Cross. It's really not about getting information into
investors' hands because the way securities laws work is
there's no amount of information you get into some people's
hands that's going to allow us to allow them to invest. It is a
prophylactic rule. It is not a do you have enough information?
A lot of these people, simply no matter how much information
you give them, the Federal securities laws have decided they're
not going to be allowed to invest in certain offerings.
Pets.com jumps through a bunch of hoops, but there are
still people who lose their shirts, sophisticated or otherwise.
So I think the answer is you've got to draw that line and
say, for example, on a de minimis level you're making a
decision that we are going to allow a lot of losses to go on.
We are also going to allow an increase in fraudulent losses,
not just people investing in pipe dreams, but good-faith pipe
dreams. We're are also going to be allowing people to lose to
scam artists.
There's a question about confidence in the markets. There's
a question about, you know, how much do you want to make
decisions for people based on individual liberty interests,
which is a real value at issue here, and I think it's
appropriate to draw a line and say were just not going to step
in at some point. But above that, I think that you've got to
think more carefully about the effect on the structure of the
markets and, you know, and what, let's say, a $10,000 exemption
would do without the right kind of restrictions.
And my--and so the most specific answer would be I think we
need to move generally more into intermediary regulation as one
of the solutions to capital raising.
Mr. McHenry. Okay.
Mr. Bullard. And the second answer, it's got to be kind of
crowdfunding specific which may militate for changing the
triggers for registerings of broker/dealers. As I mentioned in
my testimony, that's pretty much an all-or-nothing game.
Mr. McHenry. My time is short.
Mr. Bullard. Right.
Mr. McHenry. So, Ms. Mauriello, Mr. Lynn, Mr. Neiss, can
you respond to this concern?
Ms. Mauriello. Absolutely. I think if we're going to put in
protections, which you are right, there's a balance to strike,
the most effective party to be doing this--this is not the
facilitating party, it is the people themselves. So, for
example, the way that purchasers are qualified now by their net
worth, whether they're accredited or unaccredited, is that
really the best way to determine that someone can make a smart
investment decision just based on how much money they have in
the bank? I would argue not at all.
So redefining what qualified investors are in this context
of crowdfunding I think is an apt path an to go. For example,
the sophistication laws, great intention there, but if they're
not defined, they can't be used. Define sophistication allows
the sophisticated investors regardless of net worth to be able
to invest.
Someone who's local should be a qualified purchaser. If I
live next door to the coffee shop, I know more about that
coffee shop than anybody else, regardless of how much money
they have in the bank. I should be a qualified purchaser if I
know that person, so liberalizing what substantial preexisting
relationship is. The classmate example I gave earlier, if we
went to school together, I know more about you. Regardless of
what my net worth is, I should be a qualified purchaser. That's
how I would prevent fraud as well.
Mr. Lynn. I think there are two key points here. One, in
terms of, you know, the qualification to be allowed to invest--
and I agree with the previous comments--and just want to
emphasize that, you know, regardless of what the system has
been since 1933 and regardless of whether we're opening up a
broader debate here or not, there is a serious sort of over-
and under-inclusiveness to the accredited investor rules. It is
a loose proxy that has always been based on just, you know, a
very sort of loose cutoff, but it doesn't necessarily say
anything about whether people are really qualified to invest
as, Congressman, I believe you said earlier.
One of the things we do on Seedrs is before you can invest,
you take a quiz, and the quiz is a multiple choice
questionnaire and it says things like most startups succeed or
fail. Well, we think that people can get through that and it
gets to dilution and couple of other issues. We think most
people can get through that. That's a pretty good indicator,
regardless of how much money they have, of whether they will be
able to make the investment decision.
On the fraud point, which is a little different. I mean,
the qualification of investors is about whether you know your--
the risks involved and are able to take them. On the fraud
point, I disagree with you, Professor. I think that the amount
of fraud that occurs in this marketplace among good
crowdfunding platforms is actually going to be very minimal.
In our case, we are going to have substantial legal
protections in place, and we will go after, very, very quickly
and very publicly, any entrepreneur who does try to defraud the
investors. We will press criminal fraud charges against them
and we will quickly establish reputation as one of the least
favorable places to try to run a scam. I think most other
platforms are going to do very similar things, and this is
going to be a market in that environment under which very
little fraud occurs. It's yet to be seen but that's our view.
Mr. Neiss. And I would agree with Mr. Lynn and disagree
with the professor as well.
I think first and foremost anyone that's going to register
on these platforms is going to have to give over their personal
information: Social Security number, address, date of birth,
and they're going to have go through a background check to see
if they've committed any fraud. So, boom, if you've got a
checkered history, you're out.
Second of all, I personally believe most fraud to date has
been committed on a one-to-one basis where you don't have this
open network that we are advocating for on these platforms,
where the communities can come together and give a combined
opinion. Lots of voices are going to go into this, and that's
going to whittle out people from committing fraud and it's
going to expose the people that are trying to take advantage of
people on these platforms.
So I just think--and a third point, in an all-or-nothing
fashion, which is what we're advocating on these platforms, you
have to act to raise the entire amount or you get no money. You
have to hit the bar pretty high and convince everyone before
you get a dollar.
Mr. McHenry. Mr. Bullard, would you like to respond to any
of those? Is there some way to get some consensus about how we
achieve this?
Mr. Bullard. The way to achieve is you first have to start
with the member of the Mafia who decides to become a broker/
dealer and runs one of these businesses. I mean, if you want to
have a discussion about what's going to happen, put them on the
panel, because we're not talking about legitimate businesses
and what they're going to do as a matter of business practice.
What was just described here was business practices. If you
want to write them into the law, then it will work, but they're
not going to be part of the law. You say you're going to do
certain checks----
Mr. McHenry. That's why I'm asking. So to this point----
Mr. Bullard. Right. So I look to the effect of what's the
minimum necessary, and I think it's intermediary requirements
where the burden has to be placed on the intermediary. There is
no way you can make this function where you're always putting
the burden on the issuer. That's just inconsistent with the
whole idea of crowdsourcing.
Mr. McHenry. So Mr. Bullard and Ms. Cross had mentioned
this, which is establishing some criteria for intermediaries,
right? That that would be the onus of regulation and that would
be sort of an initial view of how this could work best?
Mr. Bullard. Right.
Ms. Cross. If I could, I just want to be clear. I was
expressing my views. The Commission hasn't taken this up yet.
So I view intermediary regulation as perhaps a cost-effective
way to deal with this because, for an individual company
raising $50,000, for example, putting all of the requirements
on them may be cost prohibitive. So if someone is running a
site and is, for example, taking 5 percent commission and is
running a site where they're raising billions of dollars,
perhaps, if it turned out great, then they could afford to deal
with intermediary regulation; whereas the individual company
raising $50,000, that might be the harder question. That's just
a personal view as to what might be a way forward.
Mr. McHenry. So would they be broker/dealers?
Ms. Cross. The question of broker/dealer registration
requirements depends on what their functions are. If they--
under the rules now, if they have a salesman stake, which is,
for example, commission for success, and if they deal with
client funds and securities, then they may come within the
definition. Then you would have to look and see how would
regulation work. If they're not engaging in those sorts of
activities under the Federal securities laws, it's not clear
that they would be broker/dealers, and so then maybe you would
come up with an alternative mechanism of regulation that's an
oversight-type role. It's an interesting question, what would
be the right way to approach it.
Mr. McHenry. So that broker/dealer status, Ms. Mauriello,
is that too onerous and expensive?
Ms. Mauriello. Yes. So we have no salesman stake, no
commission being charged. We're basically making no money and
still would be told that we need to be a broker/dealer but not
by the SEC, but--so I do have experience----
Mr. McHenry. You've been told that by your legal counsel?
Ms. Mauriello. By the Department of Corporations in
California. So through that process, we did learn a lot from
approaching many broker/dealers and trying to partner with
their license and learned what their criteria was and, most
important, education. We were told across the board that it was
not advantageous for them to work with us because our average
deal size was under $50,000. So the requirements in the
compliance that they would need to do as a broker/dealer, it
would not behoove them to do deals that small. So unless we're
willing to bring our deal size up to an average of, say, $5
million or more, they were not interested. So that's what we're
trying to navigate now.
Mr. McHenry. Mr. Lynn, is that your experience in Great
Britain?
Mr. Lynn. Well, it's actually the opposite. And without
having detailed knowledge of what is required of broker/dealer
registration, the FSA authorization process is a very flexible
one that looks specifically at exactly what a business is doing
and then imposes a series of requirements and regulations on
it. So far--and I say this as a business that has not yet
completed the process--that authorization process seems to have
been a very happy medium for us. The costs are not very
substantial.
To give you a sense, the entire cost of preparing the
application and filing it would be between 10,000 and 15,000
pounds, and our ongoing costs would be something like 5,000
pounds a year, which if compared to our marketing and operating
budgets aren't that overwhelming.
Mr. McHenry. That's reasonable. Is the SEC--is the question
of being a broker/dealer--how many broker/dealers do we have in
the United States roughly?
Ms. Cross. I'm going to have to get back to you with
answers to those questions. That's the trading and markets
division, so I'm not--I'm really not qualified to answer that
question. You know, I think that, to the point----
Mr. McHenry. But the cost is substantially more to be a
broker/dealer in the United States.
Ms. Cross. I would assume so. So I think, again, one of the
points I was trying to make was that in crafting a regulatory
approach, if there isn't one that's already appropriate, you
would perhaps be able to, depending on what the functions are
of the intermediary, craft regulation that fits best on a cost-
benefit basis. So I think--it may be that's it scalable the way
that it's in London. I think that's a question that would need
to be discussed.
Mr. McHenry. Okay. Mr. Neiss, in terms of your experience
with this, how can we confront this issue of fraud? What's the
legitimate way--we're looking for public policy here and that's
the idea here. I mean, the whole panel, we have a minority
witness, we have a witness from the SEC, and the whole panel is
in agreement--well, Ms. Cross has not stated an opinion on that
because that's a matter of SEC policy that she wouldn't come
forward on--on that type of whether this is a good idea or not.
So, just to state that clearly.
But even minority witness agrees that this idea of
crowdfunding is a worthy one. The structure of it really is the
question here, and so I do want to get to the structural
question. How do we structurally allow this to take place
because this--having a conduit between small investors and
small businesses I think is a worthy one. It's not the full
answer.
I mean, you know, the whole idea here is, to Ms.
Mauriello's testimony, was how do you get to that venture
capital? Well, this might be the best way, getting those
initial thousand users of Facebook to put in a couple bucks so
they can buy their first server. You know, that idea of
crowdfunding to get something initially going, public markets
are--still, we want the public markets to function. We still
want folks to, you know, have that opportunity. But how do you
get that bridge there from idea to rolling?
Mr. Neiss. Well, I think what you have to do is you have to
put a structure in place which currently exists on the
crowdfunding platforms that are out there. You have to
register, and that requires that, like I said before, that you
give certain information and then they run background checks on
you. Then you sort have to do the business model. You have your
business idea. You've got how it's going to make money, and
that's where you let the crowd take over and let them decide
which ideas they think are worthy. If they think it's worthy
and it hits that funding target, then you've got certain
mechanisms that are in place. You've got standardized
subscription review agreements and term sheets that can be used
across the board to make it easier for everyone to communicate,
and all of this happens on open platforms where there's this
communication channel that's freely open to everyone.
And I think the critical thing to come back to, there is
technology out there, like on LinkedIn, where you see the
first-degree connectivity of an individual. What we're talking
about here is community investment. It's people, it's me going
to my friends and family, that first degree people. That's part
of the anti-fraud that takes place. These are tools that are
new but can be incorporated and that people can see who are the
first-degree investors going in here, and the more percent of
those that are going in there, the higher trust that you're
going to have, because those are the people that know and
understand the entrepreneur, the investor--the entrepreneur,
the idea, and the business model.
Mr. McHenry. So, you know, in terms of a small group of
folks like on an individual basis, you--do you have this belief
that you can defraud five people but it might be more difficult
to defraud 50,000 people? Is that your mindset?
Mr. Neiss. So I started a company here based in Washington,
DC, called FLAVORx, and we flavored medicines for children. And
I went the traditional route of raising money from people, and
you know what, it wasn't easy. You have to talk to a lot of
people about what it's that you're trying to do, and I probably
could have taken advantage of a small group of people, my
closest friends and family. I don't think I would have done
that, counterproductive, but the more people I spoke to, the
more people I had to convince, the harder it was. It's the
nature of the beast.
Mr. McHenry. Mr. Lynn, is that your view?
Mr. Lynn. Absolutely. The wisdom of the crowds is a very
powerful thing, both in terms of vetting out fraud, sniffing
out the Mafia broker/dealer, as well as being able to make good
business judgments about the businesses.
One of the key features of our platform--and I think this
is true of most platforms like ours--would be that, you know,
although we do run certain checks, and although there is an
intermediary process, we rely on the investors and the
investors voting with their checkbooks in 200, 300, 500, 1,000
people at a time to make judgments. We think that's
tremendously powerful, and it's--you know, the discussion
earlier about crowdsourcing in general, it really is a big part
of the power of crowdsourcing.
Mr. McHenry. Mr. Bullard, in terms of the functionality of
this, if you have registered intermediaries perhaps at a
reasonable cost basis to do it with some oversight, would
that--is that more palatable to you? Is that--you know, how
would you structure crowdfunding? If we said--what if the
President's plan said, you know, to raise up to $1 million and
you have a limitation on a percentage of annual income, or--
what would that look like? What would that dollar amount of
limitation on the amount you could raise, the limitation on the
individual, if you believe in that, if you think that's right,
how would you structure this thing if you were designing not
just the legislation but the rules for the SEC? Just walk
through that with us, if you would, indulge me with that. If
you don't wish to, I mean, I understand.
Mr. Bullard. When asked to, you know, rule the universe,
I'm always happy to.
The first thing I would do is to create two tracks. One I
would call the de minimis track. Eliminate virtually all of the
regulation at the registration reporting level and agree on
what the amount--we're going to allow somebody to blow $250 on
a dream, and even if it's a scam artist, we're just not going
to go there with registration and reporting. And as you pointed
out, we do that in commercial environments all the time. People
lose money that way in lots of difference scenarios. There's
nothing about securities market that I think justifies changing
that.
It's important to keep it on a separate track to protect it
from all of the burdens that should be applied when it's
something other than de minimis. So then I would say, okay,
let's do our traditional analysis. Using intermediary for
efficiency reasons that Meredith was describing, they can on a
one-time basis incur the fixed cost of compliance that can not
be distributed to all of the crowdfunders. So there is no other
way to really effectuate true crowdfunding unless you have that
centralization of fixed cost.
Then I would say, what's your issuer exemption? If you have
the accredited investor standard under 506, nothing new is
needed for the broker/dealer, but if you have something, say,
like your bill, then what I would add to it would be, okay, you
want to be a broker/dealer that sells these kinds of issue or
securities, here are things you need to do it. And audit was an
idea, but I question whether an audit is going to be feasible
for somebody raising only $10,000.
I think the quiz idea is an interesting one because it
really goes to--not the--I don't think it goes to the
sophistication of the investor. I think what it goes to is the
expectations of the investor, and social policy is ultimately
driven by whether when people lose their shirt, they feel that
you should have prevented it from happening. That's an
important aspect of social policy.
So I also like the idea of the wisdom of crowds. Just to
give an example, the wisdom of a crowd assumes that you have a
rule in place that requires what they're apparently doing,
which is you have to get a minimum number of people to get to a
minimum amount. I like those kinds of innovative approaches to
achieving compliance in a different way from the way the SEC
really even thinks about it. But the point is, that has to be a
rule because if it's not a rule, the person is going to go in
not subject to the wisdom of crowds, and only gets to $3,339
and then will put it in a bank account somewhere and disappear
off the Internet.
And as far as the ability to commit fraud on the Internet,
I mean, I wish that the SEC's Internet fraud person, for which
they have a specific office, were here, because they would just
flatly contradict what we're being told about what goes on in
legitimate Internet-based marketplaces. The amount of fraud
that it's being used for is rampant. It's the ideal vehicle. If
I were trying to create a fraud, I would love the opportunity
to use the Internet to do what some of the proposals that are
on the table to do, because that's precisely the way to raise
millions of dollars from 50,000 people.
Mr. McHenry. So why don't we simply from--for securities
purposes ban the use of the Internet?
Mr. Bullard. Because the Internet is also an incredibly
valuable tool for raising capital.
Mr. McHenry. Okay.
Mr. Bullard. So what you do is just--you have only portals
that have satisfied certain requirements being the places where
you can do this, and you're also putting the responsibility on
the portal, slash, broker/dealer, which is the optimal from an
efficiency point of view to place responsibility. But the
problem is broker/dealers will unite and say, oh, we don't want
this responsibility. And that's what you're hearing from Ms.
Mauriello. It's an institutional difference where they would
rather have the issuers bear that risk but it's not efficient.
Mr. McHenry. Ms. Mauriello, I'll let you respond to that.
Ms. Mauriello. Sir, I think something that has come up is
the wisdom of the crowds for this protection and how that works
versus broker/dealer. One slight variation that we have on
that's around the qualification of purchasers. So what made us
feel very safe in our issuers and purchasers is that everybody
knew each other. This was truly communities. And so I think
there is a variation on crowdfunding, which is community
funding, which is what we instituted, where you had to verify
as the issuer when you invited the purchaser, I do know you and
I know you in this way; we went to school together. And the
purchaser had to verify, yes, we did go to school, I know about
your character, I know about your acumen, and then you were
doing the investing. At no point did we allow for the general
public or for strangers to be able to invest.
So that's how we got around--not how we got around but how
we addressed in most part this fraud issue. We also went
through background checks, which Mr. Neiss has recommended, but
the fact you actually--both parties know each other I think is
the most important starting place, and then you can grow from
there on reputation.
Mr. McHenry. If a fee structure were similar to what Mr.
Lynn discussed--and granted, the pound-to-dollar conversion
changes that slightly, but not to a great degree. Let's say
it's a $10,000 registration with SEC. Is that something
bearable?
Ms. Mauriello. Sure. It's not the upfront costs that are
problematic at all. It's the ongoing due diligence requirements
and ongoing compliance requirements that are necessary for the
small deals. So I would have no problem paying an upfront fee.
That's the nature of fund-raising and making that happen. But
it's how much due diligence I'm responsible for, for even the
smallest, de minimis, if you will, deals that are happening on
the other side.
Mr. McHenry. Okay.
Mr. Bullard. If I could add just one point. Ms. Mauriello
is exactly right about the burdens of broker/dealer regulation
in the United States. Mr. Lynn pointed out one of the
differences in the U.K., that we just don't have the
flexibility to say, well, let's see what you're actually doing
here, and regulate as a broker/dealer on that basis. It's
pretty much an all-or-nothing system, in contrast with the
regulation of exchanges.
The SEC has been very innovative. You haven't heard anybody
complain about being treated as an exchange which is--the same
kind of issue arises with respect to being a broker/dealer
because there is an SEC exemption that applies.
So what--the solution to Ms. Mauriello's problem and Mr.
Lynn's problem is to have more sensitive broker/dealer
regulation that says, well, if you're only doing this and this
is your business model, this is what we want you to do in
return, especially if--and this is key--if the custody of
assets component is removed from their responsibility, then you
have eliminated a huge amount of broker/dealer regulation.
It's my understanding all of these models put custody
somewhere else, and custody is the root of many problems with
fraud; custody, meaning the person who actually holds the
dollars. That was the Madoff problem. That's really the problem
with many broker/dealer abuses.
Mr. McHenry. You know, this question of fraud, though, is
interesting because, Mr. Bullard, I was going to respond to you
before I recognized Ms. Mauriello, because the idea that the
Internet is a perfect conduit for fraud. Well, let's be honest
about it, let's shoot straight. Taking advantage of one person
is much more--you're much more able to do that rather than take
advantage of 1,000 people.
I mean, is that--because the example I would use is the
eBay. You have the exchange of very valuable goods, and
individuals get to look at that seller and that seller's
recommendation and all the information about it. So you have
some confidence with certain people, there is no confidence
with others, and the thing shakes itself out; versus the
individual who, in a parking lot, purchased an iPad that turned
out to be a piece of wood. Right? I mean, so fraud does occur.
I mean, we have had extensive--you know, the SEC has been
around for 80 years and provides a wonderful function,
wonderful amount of safety and security and disclosure and all
of that, but we also had Madoff and you also had individuals
following Madoff that submitted information to the SEC. So
there is some wisdom in crowds. There is some wisdom in crowds.
But to the question of--that you mentioned before which
is--you know, is the SEC there to mandate disclosures or to
prevent dumb people from doing dumb things, you know, for being
taken advantage of from fraud which is a larger ideological
question, and you mentioned it in those terms. I think that's
reasonable.
I've got a couple of other questions I want to hit, and I'm
not sure if we have the full--ranking member from the full
committee returning, but I want to make sure he has an
opportunity to ask questions if he does.
So you all have different approaches. So how important is
it for the SEC to create flexibility and recognize the
different models? All have some valuable attributes. We will
start with Mr. Bullard and work backward.
Mr. Bullard. Again, just--I've been using too much time
already--just again to reiterate, I think the two-tracks
approach, one of them being a de minimis approach, is the way
to really move the ball on this and make progress, at least for
those who are more into the kind of original crowdsourcing
approach where it's almost a form of social activism where you
have the investing going on.
And then, second, I think we've got to look at this as an
intermediary issue for efficiency reasons so that you can allow
crowdsourcing to maximize its potential. You've got to place
the burdens on the portal, on the central point, and then you
have to look at the issue where--the burdens you want to
relieve issuers of. You then have to convert them into a
broker/dealer context and figure out what do we need to replace
those with that broker/dealers can do much more efficiently and
do better?
And what you're hearing is a description of models that
they have chosen to adopt that work very well. I do wish the
SEC would be much more creative at looking at the kinds of ways
that eBay and these Web sites establish trust and confidence
that are not really reflected in the securities laws at all.
Mr. Migliozzi. The way I see this is that I believe that
having this wide open would allow small businesses absolutely
to--where you have a possibility of, let's say, going to an
SBA. It's almost impossible to get a loan from an SBA for a
small up-and-coming business. This would allow you that access.
I truly believe that we need to maintain some openness on this.
Transparency is key, I will have to say that. Constant
communication is key, and you will end up with--there's no way
to prevent for absolute fraud. There's going to be some cases
that are going to slip through, but I truly do believe that
transparency is absolutely something that will keep clear on
what we need to do.
Mr. Neiss. Listen, fraud, investor protection, and capital
formation were the three things that we looked at at our August
1st symposium that we held in San Francisco where we brought
thought leaders together, lawyers, professors, all interested
parties, even some crowdfunding sites, to work out our
framework in the startup exemption. That literally crafts the
rules under which another exemption, a different--like a rule
507 that would allow this to happen, and it addresses all of
these points. So it's in my written testimony.
Mr. McHenry. Thank you.
Mr. Lynn. I think in answer to the question about the need
for a flexible form of regulation, absolutely. As I say, we
have benefited I think from the flexible approach that the FSA
takes, and I have no doubt that there's a way--I don't know
what it is, but there's got to be a way to design some form of
intermediary regulation that's not as burdensome as broker/
dealer, but that nonetheless addresses a lot of these issues.
And I said in my testimony, I do support some level of
intermediary regulation. I think it is and can be the most
effective way to make this market work.
I would add one quick other point in response to Mr.
Bullard. In terms of having a separate regime specifically for
de minimis investments, if when we're talking de minimis we're
talking about $100 or $250, don't bother. I mean, there's just
no point in putting it in place. The market will never
function. Deals won't get done, and we're all wasting our time.
If de minimis is $1,000, $5,000, $10,000, I'm not sure that I
support that, but it becomes a little bit more feasible. But if
we're really expecting crowdfunding platforms to function on
the basis of $100, $250 caps, it's a waste of time.
Mr. Bullard. Even though they're already functioning in the
debt markets on precisely that basis?
Mr. Lynn. It's simply not going to happen for equity
investments and startups. People aren't going to be investing
that small of an amount. It's very different with peer-to-peer
lending when you have constant returns and a constant cycle of
interest payments. There will be--I should say--I should
clarify there will be a lot of people who will invest at that
level, just not a sufficient number in any given investment,
given the nature of equity, given the importance of high upside
versus, you know--you know, high upside versus losses in those
cases. You know, the deals just won't get completed. We've done
a lot of research around it, and that's what we'd back.
Ms. Mauriello. And I would concur at that point for what
it's worth, and I would add two more that haven't been
mentioned already about some flexibility in rulemaking which
would be very useful.
The first one, which is in the bill that you proposed, is
national preemption, and although we have automated all the
State-by-State laws, it's extremely difficult to build a
scalable platform to facilitate these things if all of the
States can put in their own laws on top this. So I very
strongly advocate and support what you said about national
preemption.
And secondarily, the most important thing for a lot of the
businesses that are using these functions, that they can raise
more capital later, as you said. This is not the end-all, be-
all to capital formation. This is step one. So ensuring that
the rules that are put in place play well together with the
other rules.
So, for example, if you're doing a 504 raise and you can
only raise up to $1 million and you want to raise a VC round 6
months later, you can't. You have to wait that appropriate
period of time. So I would encourage that to be taken into
account with rulemaking as well.
Mr. McHenry. Okay. Ms. Cross, let me state the question in
a different way because I understand the limitations you have
as an employee of the SEC, and so I know it's a unique
position, but you've always done very well testifying before
Congress and being forthright, you know, based on those
constraints, and I do appreciate that.
So is the SEC currently looking at recognizing the
different models in terms of broker/dealers, you know, that
type of model, and providing some level of flexibility?
Ms. Cross. What I would say--and I appreciate your kind
remarks. Thank you. What I would say is that at the staff
level, as we've been thinking through what would be the best
way to advise our Commission, we've talked about the fact that
there may be a need to have scalable regulatory approaches and,
frankly, to think about this creatively.
So, yes, from the staff level perspective, we've been
having meetings pretty regularly recently to talk through what
would be the safest way to roll this out if the Commission were
to decide that it wanted to do it on a cost-effective basis,
and questions around--depending on what the role is of the
intermediary, could you make the regulation of it scalable so
that it's cost effective?
Mr. McHenry. Have you looked at the FSA model in Great
Britain?
Ms. Cross. I read all about it last night, and I thought it
was fascinating actually, and I look forward to discussing it
with Mr. Lynn. I took his card and I think it will be very
helpful to hear what the experience is there. I think that's a
fascinating approach. It gives me less pause than the idea of
having--what really does scare me is the idea of people just
opening up sites, stealing people's money, closing the sites,
and you know, they're not even in our country, they're
someplace else, and set up fake businesses; and everybody, you
know, puts in their several hundred dollars and it's just gone.
I think that would be a real shame and would tar this market,
and so the approach that the--that he described for the FSA
sounds quite interesting.
Mr. McHenry. Even with that great diligence provided by the
SEC, fraud still does occur, and so, you know, I think it's
important the SEC keep in mind the cost-benefit analysis of
potential lost profits and lost opportunities at the same time.
But you know, is there--well, what are the SEC's regulations on
peer-to-peer lending?
Ms. Cross. First of all, I need to start by saying that I
used to represent one of the two large peer-to-peer lenders
before I came to the SEC. So I'm recused on talking about
particular peer-to-peer lenders.
The regulations that are currently being complied with by
the peer-to-peer lenders require that they file registration,
same as to register their securities that are backed by the
notes that come from the individual borrowers, and I believe
that they're not regulated as broker/dealers. I believe that
they--there are alternative trading systems that are associated
with the peer-to-peer lenders where the members can trade the
notes and that the ATS is--is run by a broker/dealer. But the
site itself, I believe the money runs through a bank; people
put their money in a bank, and so there isn't any concern that
the money would be stolen, and that's how it's done.
Mr. McHenry. Okay. And so that's to Mr. Bullard's point of
who actually possesses the assets in the transaction.
Ms. Cross. Right. It's in a bank is my understanding.
Mr. McHenry. Okay. And so that model is different than a
broker/dealer model for that peer-to-peer lending site or
account?
Ms. Cross. That's right. They're not--they're not
registered as broker/dealers is my understanding. It's been 2
years since I've been back to the Commission. So I have not
paid attention to what they've been doing lately. So that was
what the model was in the past.
Mr. McHenry. Mr. Lynn, you mentioned something earlier that
I wanted to touch on, which is you said that larger investors
should be permitted to invest alongside smaller investors. Why?
Why do you think that's worthy of beneficial proffer?
Mr. Lynn. Well, getting to the point I made about the
problem with the de minimis exemption, the key here is if we
think crowdfunding is a good thing and if we would like to see
these platforms function effectively in the market, deals have
to get completed. And I'm operating under the assumption that
most platforms will work on an all-or-nothing basis as ours
will. It's not going to be very appealing to investors to risk
putting a few hundred dollars into a business and then finding
that a business can't do anything because it didn't raise the
rest.
So assuming that these are $50,000, $100,000, maybe more,
250, 500 capital raises, they need to get completed for the
businesses to be able--for crowdfunding platforms to be able to
function. And our view, based on our research, is that the way
they will get completed will be through a mix of high volume of
smaller investors, alongside a number of larger investors being
able to invest $1,000, $5,000, $10,000, potentially even
$50,000. And what you will see in this spread across--and you
do see this to some degree with peer-to-peer lending already,
but we think it will be more pronounced given the nature and
appetite for risk in the equity markets--in the private
equity--private companies.
We think that the way that deals will get done and the only
way that they will get done is if you have some large investors
in there. As I said in response to the ranking member earlier,
you could set up a bifurcated system if you wanted to, but
there isn't really a whole lot of benefit in doing so, and it
adds additional administrative burden.
And in fact, by having larger investors come in on our
platform, they're going to go through the same--the exact same
qualifications, the exact same screening that our smaller
investors do. So, if anything, they get an additional level of
protection.
Mr. McHenry. Does the President's proposal limiting it to
$1 million raise--does that provide significant investor
protection?
Mr. Lynn. No. I mean, I don't know that it necessarily
does. I think in terms of, you know, switching from the size of
investment or investor to the size of raised per business, it's
difficult for me to foresee a whole lot of online crowdfunding
successes at much above $1 million. It's not to say that they
won't happen. Certainly, the PBR case is a great exemption and
there will be others. Our view is that the sweet spot in this
market, you know, is at hundred--in Britain 100,000 pounds or
less, here maybe $100,000 or 250- or less. And that that's
partially because that's where, you know, once you get above
those levels, that's where venture capitalists become more
active and there are a lot of other routes to capital. So we
don't see a tremendous amount of detriment to a $1 million cap,
but I'm not sure I see the advantage to it either, necessarily.
Mr. McHenry. Ms. Mauriello, do you see it the same way?
Ms. Mauriello. I would agree. Our sweet spot is around
$50,000, and again, it's two different markets. I do think
there's going to be some really outstanding cases. Eline
Kickstarter is an outstanding case of raising $1 million or
more and I applaud those and those are wonderful, but I do
think the bulk of the market is going to be in that of $50,000
to $100,000 range.
Mr. McHenry. Okay. Mr. Neiss.
Mr. Neiss. All I want to add to that is that I agree that
it's the $50,000 range, but I think the whole point of having
the million dollar in there is if you're successful at $50,000
and that's your proof of concept and you need to go out and
grow it from there, you can go back and show the crowd what you
did with that $50,000, be held accountable to that $50,000 in
an open, transparent platform, and then go out and raise
$250,000 under this framework, up to $1 million, to really get
it going. And I think the most critical thing is, the most
successful companies that come out of this will be the breeding
grounds for the VCs and the private money.
Mr. McHenry. Okay. So to go right back through the three of
you as well. The limitation, 10 percent of your income or
$10,000, do you think that's wise--a wise limitation? It's the
President's proposal, which is also in the legislation that I
filed yesterday.
Ms. Mauriello. Absolutely. I think it's very wise to have a
limit there. I would propose that the limit on percentage is
going to be more protective than the dollar limit. The dollar
limit is going to be outdated very quickly and constantly need
to be updated, whereas the percentage limit will always hold.
And I agree with Mr. Lynn--we've seen the 80/20 rule in
place--that you do need to have a few investors who are going
to carry the bulk of this, and they might be investing more
than $10,000 if that's less than 10 or even less than 5 percent
of their net worth.
Mr. Lynn. I agree 100 percent. I think that a percentage-
based limitation is fine. Our own is 20 percent of the
investor's net worth. An aggregate across the platform, 10
percent of income, I think that's all arguable. I don't see the
value and I see a lot of detriment in a dollar limit.
Mr. McHenry. Okay.
Mr. Neiss. We're in favor. We actually had it in our
exemption initially, and we took it out because we thought the
self-reporting on it was just--we left it up to the person to
be responsible with what they wanted to invest.
Mr. McHenry. Mr. Bullard.
Mr. Bullard. Yeah, I just--I think Mr. Lynn just
misunderstands my proposal.
Mr. McHenry. No, no. I wish you to answer the question I
just proposed, which is the $10,000 or 10 percent of your
income cap. Do you think that's sufficient or appropriate?
Mr. Bullard. No. I would take--I would draw a paternalistic
line that someone living below the poverty line not being
allowed to put $1,000 or $1,500 into an offering over the
Internet without substantial additional protections through an
intermediary platform other than those just voluntarily adopted
by the firm. But I would draw an income level--maybe it's
$50,000. I think it's--I agree completely with the structural
absurdity of the current accredited investor standard. We can
fix that, but going all the way down to say, you know, persons
with $10,000 in income, I think that's a mistake.
Mr. McHenry. Okay. Mr. Migliozzi, how does it make you feel
when these three crowdfunders to your right say that, you know,
it's going to be about $50,000 to $100,000 you can raise, and
with an idea you had, you got $200 million of commitments.
Mr. Migliozzi. Two hundred eighty-two million.
Mr. McHenry. Oh, 282, I'm sorry.
Mr. Migliozzi. Okay. This is--this particular case is
obviously a think big with, you know, with crowdsourcing a
brewery. I think limitations is going to limit business growth
on the amounts. I think that having the opportunity to allow
businesses to be able to get that brass ring, go a little bit
further, those opportunities should be there. I don't see why
we would want to artificially hold back entrepreneurs from
getting from point A to point B and then be able to put
themselves into the larger investment market at some point. So
I would say that in my opinion, obviously, think bigger.
Mr. McHenry. Okay. In terms of final, you know, wrapping up
here, just so everyone--for planning purposes, in terms of what
the economic impact would be if we followed the President's
proposal, you know, can you go through and just give me your
estimate? We'll start with you, Mr. Bullard.
Mr. Bullard. Well, yeah, I think you would see a
substantial increase in fund-raising over the Internet under
that approach. There's no question it would assist capital
formation. It would give investors more options than they
currently have, and it would be a kind of liberalization that I
think would be a good thing to some extent. But I think it also
would, as described in his proposal, which is this unadorned
$10,000 limit, it would open the door to a substantial amount
of fraud. I think it would inappropriately sort of eliminate
any kind of cutoff as to the sophistication and/or income of
the person investing in unregistered securities.
Mr. McHenry. Okay. Mr. Neiss.
Mr. Neiss. I just think preventing investments doesn't
equal preventing fraud, and the only protection that we can
give is an informed investor, and that's going come through
education in an open, transparent platform. I think when we get
the capital flowing based on our projections, we can create
500,000 companies in the next 5 years and employ 1.5 million
jobs--new jobs.
Mr. McHenry. Mr. Lynn.
Mr. Lynn. I mean, in terms of economic impact, I can just
tell you our estimates for Britain, which you can then multiply
by five, based on population, and maybe assume a slightly
higher entrepreneurial appetite here. You know, in Britain we
plan at scale to be able to see 1,000 to 2,000 new businesses
funded per year. Of those, we assume that somewhere between 20
and 40 percent will actually turn into something and create
some number of jobs. And you can work backward from there to
think about the sort of economic impact, and that's our
platform alone. There will be other competitors out there,
other businesses starting.
We see a vast level of nascent entrepreneurship in Britain,
in Europe, and the United States and around the world where
people would love to start a new business, have value-creating
ideas, but don't have the access to the very first capital they
need. And we think that platforms like this can help them
overcome that hurdle and be absolutely transformative for an
economy.
Mr. McHenry. Ms. Mauriello.
Ms. Mauriello. I absolutely agree. One of the statistics
that got us most excited about the potential for change in this
industry is that over $100 billion currently transacted between
friends and family informal investing networks every year. It
is the second most common way of starting your business after
your personal credit card, which you mentioned yourself.
So I see a tremendous potential to both putting more
protections on that market. Currently it has no protections.
Those are checks that cross the dinner table, that nothing's
happening around and growing at substantially the capital is
there. It just needs to be accessed.
Mr. McHenry. Thank you all for your testimony. I do
appreciate it. It is so helpful in forming policy. There is
some give and take here, but I think the input has been
absolutely fantastic and unfortunately you're here on one of
the mornings where Congress had about 20 different things going
on. And so that has been the attendance question here this
morning.
The subject matter is fascinating, absolutely fascinating.
I look at my father's example where he had a great idea and a
business partner. He had five kids and he had a garage in the
backyard. And so he's looking for money to feed those five
kids. He had an idea with his business partner, who also had
five kids who was looking for money too. The only way they
could get lending was through that new invention called the
credit card. And I still have my father's credit card that he
founded his business on. Today my brother owns that business
and runs that business with my father's business partner and he
employs about 400 people. That is the beauty of innovation and
small business.
We want to make sure that those folks have opportunities to
take their idea from the dinner table out to the markets. And
so much of the focus and discussion has been about the
accredited investor. You are talking about the folk, the guy--
Mr. Bullard, in your testimony you mention this and I certainly
appreciate that, I very much appreciate it. You have a million
dollars net worth, you're an accredited investor so you have
great access to startup companies. So Facebook, a lot of these
tech companies had these folks that had access to it, whereas
the average investor, even the superior investor who doesn't
have that high net worth doesn't have that same opportunity.
I want to make sure, and it's my thought to democratize
this process, to give the small investors the opportunity for
that upside potential, not simply to make a contribution to a
worthy charity over the Internet, but to get the upside in this
and that's the point of my legislation.
Now the structure of this I think is the point of the
discussion today, to make sure we have a proper structure so
you can root out fraud to the best of our abilities. But making
sure that investors have information and access to make an
investment are both very worthy things that I would hope that
the SEC would look diligently at and we intend here in Congress
to move forward on that as well.
Thank for your time. If you have additional remarks, you
may submit it for the record. And Members will have 7 days to
submit questions for the record and comments for the record.
With that, the committee stands adjourned.
[Whereupon, at 11:45 a.m., the subcommittee was adjourned.]