[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]



 
    SEC'S CROWDFUNDING PROPOSAL: WILL IT WORK FOR SMALL BUSINESSES?

=======================================================================

                                HEARING

                               before the

       SUBCOMMITTEE ON INVESTIGATIONS, OVERSIGHT AND REGULATIONS

                                 OF THE

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                               __________

                              HEARING HELD
                            JANUARY 16, 2014

                               __________

                               [GRAPHIC] [TIFF OMITTED] TONGRESS.#13
                               

            Small Business Committee Document Number 113-050
              Available via the GPO Website: www.fdsys.gov

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                   HOUSE COMMITTEE ON SMALL BUSINESS

                     SAM GRAVES, Missouri, Chairman
                           STEVE CHABOT, Ohio
                            STEVE KING, Iowa
                         MIKE COFFMAN, Colorado
                       BLAINE LUETKEMER, Missouri
                     MICK MULVANEY, South Carolina
                         SCOTT TIPTON, Colorado
                   JAIME HERRERA BEUTLER, Washington
                        RICHARD HANNA, New York
                         TIM HUELSKAMP, Kansas
                       DAVID SCHWEIKERT, Arizona
                       KERRY BENTIVOLIO, Michigan
                        CHRIS COLLINS, New York
                        TOM RICE, South Carolina
               NYDIA VELAZQUEZ, New York, Ranking Member
                         KURT SCHRADER, Oregon
                        YVETTE CLARKE, New York
                          JUDY CHU, California
                        JANICE HAHN, California
                     DONALD PAYNE, JR., New Jersey
                          GRACE MENG, New York
                        BRAD SCHNEIDER, Illinois
                          RON BARBER, Arizona
                    ANN McLANE KUSTER, New Hampshire
                        PATRICK MURPHY, Florida

                      Lori Salley, Staff Director
                    Paul Sass, Deputy Staff Director
                      Barry Pineles, Chief Counsel
                  Michael Day, Minority Staff Director


                            C O N T E N T S

                           OPENING STATEMENTS

                                                                   Page
Hon. David Schweikert............................................     1
Hon. Yvette Clarke...............................................     6

                               WITNESSES

Jason Best, Principal, Crowdfund Capital Advisors, San Francisco, 
  CA.............................................................     2
Daniel Gorfine, Director, Financial Markets Policy, Milken 
  Institute, Washington, DC......................................     4
Mercer Bullard, MDLA Distinguished Lecturer and Associate 
  Professor of Law, Director, Business Law Institute, University 
  of Mississippi, University, MS.................................     6
DJ Paul, Co-Chair, Crowdfund Intermediary Regulatory Advocates, 
  New York, NY...................................................     8

                                APPENDIX

Prepared Statements:
    Jason Best, Principal, Crowdfund Capital Advisors, San 
      Francisco, CA..............................................    28
    Daniel Gorfine, Director, Financial Markets Policy, Milken 
      Institute, Washington, DC..................................    76
    Mercer Bullard, MDLA Distinguished Lecturer and Associate 
      Professor of Law, Director, Business Law Institute, 
      University of Mississippi, University, MS..................    82
    DJ Paul, Co-Chair, Crowdfund Intermediary Regulatory 
      Advocates, New York, NY....................................   119
Questions for the Record:
    None.
Answers for the Record:
    None.
Additional Material for the Record:
    None.


    SEC'S CROWDFUNDING PROPOSAL: WILL IT WORK FOR SMALL BUSINESSES?

                              ----------                              


                       THURSDAY, JANUARY 16, 2014

                  House of Representatives,
               Committee on Small Business,
     Subcommittee on Investigations, Oversight and 
                                       Regulations,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 10:00 a.m., in 
Room 2360, Rayburn House Office Building. Hon. David Schweikert 
[chairman of the subcommittee] presiding.
    Present: Representatives Schweikert, Chabot, Mulvaney, 
Herrera Beutler, Rice, Clarke, and Chu.
    Chairman SCHWEIKERT. Good morning. We will call our 
Subcommittee hearing to order.
    First, I would like to request that Mr. Mulvaney, the 
member from South Carolina and a member of the Small Business 
Committee, be able to participate in today's Subcommittee 
hearing.
    Without objection, so ordered.
    Welcome, Mr. Mulvaney. Thank you for participating with us.
    As we started to have a little bit of discussion before, 
this is in regards to the crowdfunding portion of the JOBS Act 
that was passed in April 2012. For some of us here, we have a 
certain emotional investing to that JOBS Act. I was blessed to 
have a couple sections of that that were a piece of legislation 
that we had been working on for about a year. One of the great 
thing about the JOBS Act, it was a truly bipartisan, bicameral 
sort of piece of work. And we built a formula where everyone 
from Maxine Waters, to Barney Frank, to Spencer Bachus, to even 
myself, found a way to communicate and grind through a series 
of small bills, and ideas for capital formation, where much of 
my frustration is first. And look, we all know the dance that 
the SEC has gone through the last two years with the chairman, 
some of the membership, some of those things. But forgive me 
for reaching down like this, in something that many of us had 
been hoping would be sort of a smaller, egalitarian opportunity 
for capital raising for the true beginning entrepreneurs, 
literally, the ones that are coming out of their basement, 
coming out of their garage, because we do have a cap of a 
million dollars. This is the proposed rule set.
    And when you start to analyze it, at least as we have from 
our office, you are starting to see total costs by the time you 
start to capitalize in your legal costs, your accounting costs, 
other mechanics, when some of your money will have a 20, 30 
percent load factor on that. At this point you are starting to 
get into the point where should you be doing it on your credit 
cards or should you be doing it with your neighborhood loan 
shark. This was not our intention. This was supposed to be the 
egalitarian access to capital because it did a couple things. 
It helped create a proof of concept because of the 
participation from either across the country or from within 
your community, but also provided a level of optionality, 
saying I need some capital up to the quarter million, up to 
this, up to that, to start our idea and sell that idea using 
today's modern society and Internet.
    That is my great frustration. One of the things I am hoping 
we will acquire from this hearing today is not only sort of an 
analysis of what is within the rule sets, the proposed rule 
sets that have come from the SEC, but understanding we have 
only a couple more weeks for comments to go in. And much of the 
testimony from here we intend as an office to package up and 
send in also as comments. So I beg of you, even beyond your 
written statements, when we hit Q&A, it is not only here is the 
problem, but also maybe a suggestion that we could relate to 
the SEC saying here is a way how you do it. Yes, you have 
investor protections but you do not create a chilling effect 
for what I am hoping is sort of the next generation of sort of 
that beginning capital race.
    Okay. When the ranking member shows up we are going to let 
her do an opening statement. So what we are going to do is 
actually go right now to our witnesses' opening statements.
    Jason Best. Our first witness is Jason Best, co-founder and 
principal of Crowdfund Capital Advisors (CCA), a consulting 
advisory firm in San Francisco and co-author of the 
Crowdfunding Investing Framework used in the original JOBS Act. 
And actually, I remember parts of these documents coming across 
my desk.
    Prior to his work in crowdfunding investment, Mr. Best was 
a successful healthcare technology entrepreneur, and most 
recently was on the executive leadership team of Kinnser 
Software, ranked by Inc. Magazine as one of the fastest growing 
private companies in the U.S. He is co-author of the book, 
Crowdfunding Investing for Dummies--you wrote that with me in 
mind, did you not--and earned his MBA from the Thunderbird 
School of Global Management in Arizona.
    Mr. Best, five minutes.

    STATEMENTS OF JASON BEST, PRINCIPAL, CROWDFUND CAPITAL 
 ADVISORS; DANIEL GORFINE, DIRECTOR, FINANCIAL MARKETS POLICY, 
 MILKEN INSTITUTE; MERCER BULLARD, MDLA DISTINGUISHED LECTURER 
    AND ASSOCIATE PROFESSOR OF LAW, DIRECTOR, BUSINESS LAW 
   INSTITUTE, UNIVERSITY OF MISSISSIPPI; DJ PAUL, CO-CHAIR, 
          CROWDFUND INTERMEDIARY REGULATORY ADVOCATES

                    STATEMENT OF JASON BEST

    Mr. BEST. Chairman Schweikert, Ranking Member Clarke, and 
members of the Committee, thank you very much for the 
opportunity to discuss the value that crowdfunding can bring to 
the American small business community, as well as share some 
new data from the British and U.S. markets that should shed 
some light on the magnitude of what is really happening in 
crowdfunding and how the right kind of crowdfunding regulation 
can enable a new chapter in American small business success.
    I would like to thank the members of this Committee and 
both parties within the House at-large for their bipartisan and 
overwhelming support of crowdfunding.
    As a co-author of The Startup Exemption Framework, I care 
very deeply about how the market evolves and want to continue 
to work with Congress and the SEC to create effective 
regulation for this market. I want to thank the commissions and 
staff of the SEC for their willingness to engage in a robust 
conversation with CFIRA, the crowdfunding industry regulatory 
organization, and I hope that CFIRA's active engagement was 
able to demonstrate that the crowdfunding industry is focused 
on creating an orderly market with access to capital, investor 
protections, and appropriate regulatory oversight.
    As a tech entrepreneur and a small business owner, I have 
real experience in creating products and services raising 
capital and creating jobs. There are a number of good elements 
in the proposed regulation, but there is also a number of 
troubling issues. One of the issues I want to highlight today 
is the accounting requirements for a full CPA audit on firms 
raising over a half million dollars. I believe this places an 
unreasonable burden on entrepreneurs and small business owners 
and may cause there to be a soft cap on raising money over 
$500,000 due to the cost that this regulation would impose.
    I understand the goal of the regulation. As the size of 
capital raised increases, investors want increased disclosure 
and validation of the state of the business, and we should work 
to create different technology solutions that can help achieve 
that. Additionally, if I have to spend 30 percent of what I 
raise just to comply with the legal and accounting 
requirements, as you said, Mr. Chairman, it is sort of like am 
I going to use my credit cards or am I going to use this new 
opportunity?
    Now, I wanted to share, really moving to sort of looking at 
the opportunities for crowdfunding particularly in two studies, 
most recently a study that was done on the U.K., about the 
British system, and an example of what light touch regulatory 
environments can achieve and really what we hope it could 
achieve here in the U.S. And secondly, one of the most 
important questions I think is after a company raises the 
capital, what happens then? What happens then to the business, 
to follow-on investors, and to job creation?
    So first to the U.K. study. When we look specifically at 
this U.K. study, they have had three years of equity and debt-
based crowdfunding up and running and a great deal of 
experience. The U.K. government utilized a significantly light 
touch approach, and it has been amazing to see what has 
developed in that marketplace. The population of the U.K. is 
about 61 million, so it is about 20 percent of the U.S. 
population. The size of their crowd finance market doubled 
nearly between 2012 and 2013. It grew from nearly $800 million 
in size to over $1.3 billion. And this demonstrates a clear 
willingness for both buyers and sellers, investors and 
contributors, to want to engage in this kind of finance. Of 
those 2013 totals of $1.3 billion, $314 million were 
individuals lending to small business, and $45 million was 
equity crowdfunding. That growth rate year over year was over 
600 percent growth rate. And equity crowdfunding surpassed 
rewards-based crowdfunding in the U.K. in 2013. That is pretty 
amazing.
    So collectively, in 2013, in the British system, over half 
a billion dollars was delivered to early stage and small 
businesses. That is over 5,000 businesses. And the report 
predicts that in 2014 that will increase significantly. If you 
were to equate that in the U.S. market, that would be 25,000 
businesses receiving money across the country.
    So looking at what businesses are doing post-funding, three 
questions. One, does crowdfunding have a positive impact on 
sales after you achieve your goal? And in fact, it does. We saw 
a 24 percent increase in sales net of the crowdfunding raised 
when they were successful. Two, were new employees hired? We 
found that on average, 2.2 new employees were hired for 
companies that successfully raised funds. So people are 
creating jobs with this money. And finally, what about follow-
on investors? Will angel investors and VCs invest in these 
companies after they have raised money through crowdfunding? 
Resounding yes was the answer. Twenty-eight percent. Within 90 
days of closing the round, 28 percent had already closed an 
angel round of investment, and an additional 43 percent were, 
in fact, in conversations with VCs or with angel investors.
    And so that is the data I wanted to share this morning. 
Again, I want to thank the Committee for this hearing and for 
your overwhelming support of crowdfunding. I look forward to 
your questions.
    Chairman SCHWEIKERT. Thank you, Mr. Best.
    Our next witness is Daniel Gorfine, director of Financial 
Markets Policies and legal counsel in the Washington office of 
the Milken Institute, an independent, economic think tank where 
he researches and has written extensively on issues related to 
crowdfunding provisions and the JOBS Act. Mr. Gorfine received 
his B.A. in Economics and International Relations, Brown 
University, and his law degree from the George Washington 
University School of Law.
    You have five minutes. And as you all know, five minutes. 
And when you see yellow, just start talking faster.

                  STATEMENT OF DANIEL GORFINE

    Mr. GORFINE. Chairman Schweikert, Ranking Member Clarke, 
and members of the Committee, thank you for the opportunity to 
testify on implementation of Title III of the JOBS Act or what 
I will refer to as the crowd investing provisions.
    My name is Daniel Gorfine, and I am the director of 
Financial Markets Policy at the Milken Institute Center for 
Financial Markets. Today's discussion fits squarely within a 
number of pillars that guide our work, including expanding 
access to capital and developing financial innovations. Indeed, 
the ultimate goal of crowd investing is to responsibly increase 
capital access for startups and small businesses, especially 
within industries or regions disfavored by traditional sources 
of capital.
    In proposing Title III rules, the SEC has largely used its 
discretion to positively advance that goal in the development 
of this market. That said, it is an open question whether the 
current crowd investing rules will significantly increase 
capital formation for startups and small businesses. Investors 
will need to consider whether the risk-reward dynamics are 
sufficiently compelling and whether other factors, such as 
personal interest and an affinity are a sufficient draw. And 
for issuers and intermediaries there are concerns that the cost 
of a Title III raise may exceed the benefit.
    Based on these concerns, I will briefly discuss suggestions 
that may foster the development of crowd investing while 
limiting the downside risk to investors. This approach will 
allow for the evolution of this market and an opportunity to 
assess its central hypothesis that in an interconnected, 
Internet-centric world there, is wisdom in the crowd.
    Two principles from the law guide my suggestions today. 
First, that this capital-raising tool is intended to be 
relatively lost cost, and second, that the Internet can 
facilitate a novel form of crowd-based due diligence in 
investment. With these principles in mind, I believe as an 
initial matter that the most efficient way to limit downside 
risk is through emphasis on investor caps, at least until the 
market is able to prove itself.
    The SEC's current investor self-certification approach 
properly imposes responsibility on investors. It should go 
further, however, by requiring platforms to make investors 
explicitly aware at the point of investment that the cap is not 
something that can be ignored but rather is required by law and 
intended to protect investors from the downside risk of early 
stage investing. Additionally, the SEC should consider 
precluding an investor who violates the investor caps from 
bringing a lawsuit against an issuer. With investor caps 
serving as the most effective way to limit downside risk, the 
SEC should then minimize nonstatutory disclosure requirements. 
The law already includes a number of baseline disclosure 
requirements that will help investors make investment 
decisions. But in aggregate, if additional disclosures are too 
extensive and ongoing reporting requirements too onerous, then 
the cost will exceed the benefit, especially given the 
questionable value of such disclosure to investors.
    The ultimate success of crowd investing hinges on the 
effectiveness of new vetting methodologies and criteria 
generated through the wisdom of the crowd, and evidence from 
overseas demonstrates that discerning crowd investors are 
likely to invest in what they know, existing companies with 
known management teams or known businesses and products. 
Accordingly, the SEC should first limit or require few, if any, 
incremental disclosures beyond those already required by law, 
and second, limit ongoing reporting requirements. A third 
suggestion is to permit funding portals more leeway to select 
and list offerings as well as to share data and information 
with investors. The law does not allow a funding portal to 
provide investment advice or recommendations. At its extreme 
interpretation, this ban could require a platform to list all 
offerings proposed by issuers.
    In order to permit platforms some flexibility to decide on 
which offerings they will list, the SEC proposes that a 
platform can filter and select offerings based on objective 
criteria. For example, by geographic region. It also creates a 
duty for a platform to exclude offerings that could be 
fraudulent or that raise investor protection concerns.
    The rules, nevertheless, leave a gap where a platform could 
have serious doubts about the viability of an offering but not 
to the level that it is permitted to exclude the offering from 
its platform. To require a platform to list an offering that it 
has a strong conviction will fail is contrary to promoting 
investor protection. Accordingly, portals should have the 
ability to go further in deciding with whom they do business, 
so long as they do not advertise that their platform has 
somehow safer or better opportunities.
    The SEC proposed rules may also prevent platforms from 
sharing key data and information that could assist crowd 
investors. As we have seen with the development of e-commerce 
platforms, such as eBay and Amazon, there is significant 
opportunity for intermediaries to glean and analyze data and 
develop algorithms to detect fraud or best practices and also 
collect user feedback. I would like to see the SEC explicitly 
permit these types of activities for funding portals.
    Finally, funding portals should be subject to reduced 
liability exposure for issue or missteps, given the portals 
limited promotional activities, limited ability to exclude 
offerings, and design to serve simply as a bulletin board. The 
SEC's initial contrary interpretation of the law would likely 
decrease the number of intermediaries participating in this 
market, as well as increase costs due to the risk of 
litigation. If that interpretation holds, however, and a 
platform can be on the hook for the missteps of an issuer, then 
the platform should have greater discretion to decide on 
whether to do business with that issuer.
    I would like to thank the Committee again for having me 
join you today and I look forward to answering any questions 
that you may have.
    Chairman SCHWEIKERT. Thank you, Mr. Gorfine.
    I would like to yield to Ranking Member Clarke to introduce 
the next witness.
    Ms. CLARKE. I thank you, Mr. Chairman, and it is my honor 
and privilege to introduce to everyone here today professor 
Bullard. Professor Mercer Bullard is a securities law professor 
at the University of Mississippi School of Law and founder and 
president of Fund Democracy, a nonprofit investor advocacy 
organization. He has appeared before congressional committees 
on more than 20 occasions and is a member of PCAOB's Investor 
Advisory Group and was a member of the SEC's Inaugural Investor 
Advisory Committee. With prior experience as an assistant chief 
counsel at the SEC and practicing securities lawyer, he is an 
expert on the Commission's enforcement and rule-making 
practices. He has a J.D. from the University of Virginia, a 
Master's from Georgetown, and a B.A. from Yale.
    I want to thank Professor Bullard for appearing before us 
today and look forward to your testimony. Thank you.

                  STATEMENT OF MERCER BULLARD

    Mr. BULLARD. Thank you, Ranking Member Clarke and Chairman 
Schweikert and members of the Committee. It is a pleasure to 
appear here today, especially a committee that is focused on 
business, rather than securities, because what I spend most of 
my time doing is teaching students how to solve business 
problems.
    The Committee has asked whether the SEC's proposal will 
work for small businesses, and I am afraid the answer is 
probably not, but it is hard to tell. But the question is 
somewhat unfair because Congress did establish extremely 
detailed disclosure and filing requirements that are going to 
make up most of the burdens that will be imposed by 
crowdfunding. And I also would add that I do not think the 
solution is reducing those because I think they are appropriate 
as investor protection measures to ensure this does not go the 
way of the penny stock market in terms of the reputation that 
crowdfunding develops.
    As you may know from my prior testimony, my view is that 
crowdfunding probably could work if investment minimums were so 
low and the risk of loss was small so that virtually no 
regulation at all would be required. It is not clear to me why 
we could not allow any business to offer a $100 share to a 
company or to an investor simply having provided a business 
plan on the Internet, leaving only the anti-fraud provisions of 
the securities laws and general consumer law to protect those 
investors. But the current law is what we have, so I will turn 
to some of the specific aspects of the SEC's proposal and their 
effect on small businesses.
    One issue that we talked about before the meeting is there 
is a million dollar cap on what a crowdfunding issuer is 
allowed to have sold and the statute clearly indicates that is 
all securities. And the SEC has interpreted that to mean that 
it does not include all securities. It includes only 
crowdfunding securities. So what that means is somebody could 
go out and raise $10 million or $100 million or a billion 
dollars and then do a $1 million crowdfunding offering. 
Congress imposed that $1 million cap because crowdfunding was 
supposed to be for small issuers. It was supposed to be for 
issuers raising small dollar amounts. It was supposed to be for 
issuers that suffer from a perceived funding gap between them 
and larger businesses. Under the SEC's approach, medium and 
large businesses may fill the crowdfunding space, crowding out 
the small businesses for which it was created.
    Small businesses should also be concerned about the SEC's 
position on certain investor protections. The reason is that if 
it is easy for unscrupulous businesses to raise capital through 
crowdfunding, the crowdfunding market may become equated, as I 
mentioned, to the market for penny stocks, rather than the 
thriving market for exciting investment opportunities that it 
does have the potential to become.
    For example, the Commission would permit investors to offer 
investors who invest early a larger share of any 
oversubscription amount. The stampede effect that this promotes 
is precisely why such first come, first serve tender offers are 
prohibited under the Williams Act. What kind of businesses are 
going to allocate oversubscriptions on a first come, first 
serve basis in order to stampede investors to make commitments? 
It will be the less scrupulous ones that honest businesses 
should not want in their crowdfunding marketplace. The 
Commission would permit issuers to use financial statements 
that are 16 months stale. That means that you could start a 
business in December of year one, you could do a crowdfunding 
offering in April of year three, and your financial statements 
would cover one month at the beginning of the life of the 
business covering only one out of a 17 month lifespan.
    The Commission would permit crowdfunded issuers that have 
failed to file their annual report the only post-offering 
obligation they have for up to 23 months to go ahead and make 
another crowdfunding offering. What kind of businesses are 
going to take advantage of the opportunity to file financial 
information that is 16 months stale or are willing to violate 
the law by failing to file their annual report? And I believe 
it is the unscrupulous businesses that honest businesses should 
not want in their crowdfunding marketplace.
    Small businesses should also be concerned about investors 
suffering financial distress as a result of investment, which 
is more likely due to certain SEC positions. For example, the 
Commission would permit investors to self-certify the financial 
qualifications. And this will result, for example, in some 
investors mistakenly believing they can count their home toward 
their net worth, in which case their crowdfunding investment 
may end up representing a large part of their savings.
    Small businesses should be concerned about this issue 
because the defining feature of the crowdfunding market may end 
up being the high frequency of investments going to zero and 
how that plays out. Estimating conservatively, one quarter of 
crowdfunding investments are going to be worthless in three 
years. The data suggest the failure rate may be closer to one 
half. Imagine the reputation of a family of mutual funds in 
which one-quarter to one-half of the funds lost 100 percent of 
their value every three years.
    So how will this narrative play out? Will the losses be 
only a small part of an investor's portfolio, money they can 
afford to lose? Or is the narrative going to be about investors 
who lost money they could not afford to lose their life savings 
perhaps. You can stack up a pile of filings and disclosure as 
high as the sky, but the bottom line is the success or failure 
of crowdfunding is likely to turn onto the losses that 
investors suffer and there are going to be a lot of total 
losses that they can afford.
    Thank you, and I would be happy to take questions that you 
might have.
    Chairman SCHWEIKERT. Our next witness is DJ Paul, co-
founder of Crowdfund Intermediary Regulatory Advocates. You 
could not have come up with a shorter name? A trade association 
for crowdfunding web portals. He is also the co-chief strategy 
officer with GATE Impact based in New York, where he develops 
solutions to facilitate and expand private and alternative 
asset transactions. Prior to joining GATE, Mr. Paul co-founded 
Crowdfunder, a Los Angeles-based crowdfunding intermediary 
platform. Mr. Paul earned a B.A. in Philosophy from Brown 
University.
    Well, please wax philosophy towards us. Five minutes, Mr. 
Paul.

                      STATEMENT OF DJ PAUL

    Mr. PAUL. Chairman Schweikert, Ranking Member Clarke, and 
other members of the Committee, thank you for the opportunity 
to testify today. It is an honor to be here.
    Given the limited time for testimony, I will confine my 
comments to four salient issues. These four issues are 
certainly representative of the kinds of concerns which some of 
the industry have with respect to the proposed regulations but 
they are by no means exhaustive.
    First, auto requirements, which Mr. Best was good enough to 
touch on; pooled investment restrictions; intermediary 
participation restrictions; and funding portal liability.
    Auto requirements. As currently proposed, there are three 
tiers of financial disclosure requirements for Title III 
offerings, corresponding roughly to the amount raised. First 
tier is 0 to $100,000; second tier is $100,000 to $500,000; and 
the third tier is from $5,000 to $1,000,000.
    The first tier requires disclosure of financial statements 
certified by an executive officer of the company. The second 
tier requires the financial statements reviewed by an 
accountant. However, the third tier requires CPA-audited 
financials. Furthermore, these requirements for such CPA-
audited financials are on an ongoing basis. Such audited 
financials to be provided to investors every year following a 
Title III raise over $500,000.
    It is worth noting that these disclosure requirements for 
the third tier are actually more onerous and exhaustive than 
the current requirements for Regulation D offerings, which does 
not mandate audited financial statements for issuers, nor 
ongoing annual audited disclosures. These overly onerous 
requirements for third tier security crowdfunding offerings may 
have the unintended effect of pushing potential issuers away 
from doing Title III entirely and towards perhaps Regulation D 
offerings which might be more attractive to potential issuers.
    This seems clearly inconsistent with the spirit of the 
original legislation, and in effect, creates a donut hole 
between $500,000 and $1,000,000, where offers do not utilize 
Title III at all. And in addition to creating an artificial 
market irregularity, this will also have the unfortunate effect 
of making these offerings unavailable to unaccredited investors 
since Regulation D, which is the most viable alternative 
obviously does not permit investment by unaccredited investors.
    Moving on to pool of investment restrictions. The proposed 
regulations exclude funds from utilizing Title III to raise 
capital, in effect requiring all crowdfunding investments to be 
direct investments. This rule would restrict pool of 
investments for hedge funds, private equity, from raising money 
through crowdfunding. While most of us can agree that most 
funds are not suitable issuers for crowdfunding, we believe 
that this restriction may be overbroad as it appears to 
restrict the fund-raising of special purpose vehicles or single 
purpose entities, investing only in a single operating company 
that would otherwise qualify as an eligible Title III issuer. 
This restriction does not serve to protect investors, but 
rather, this restriction actually succeeds in denying 
crowdfunding investors some of the advantages and protections 
afforded to other investors and institutions in other asset 
classes, particularly those utilized in Regulation D.
    Moving on to intermediary participation restrictions. 
Current proposed regulations would restrict intermediaries from 
holding interests in the companies conducting Title III 
offerings on their platforms. This serves to restrict 
intermediaries from participating alongside their investors in 
these offerings. Rather than diminishing a theoretical conflict 
of interest between intermediaries and investors, as a 
practical matter this restriction effectively forbids alignment 
of interests between investors and intermediaries. This concept 
is often described as ``skin in the game.'' We believe that 
intermediaries who invest in issuers make for better alignment 
of interests.
    We believe that allowing such co-investment by 
intermediaries would have two very desirable benefits from 
investors. First, an investor may take comfort in knowing that 
the intermediary facilitating the transaction is investing in 
the same deal and on the same terms in the investment that they 
are considering. And second, when the intermediary has such 
skin in the game, that fact itself may encourage the 
intermediary to take more seriously their assigned roles in the 
marketplace.
    I see that I am running out of time, so I will just very 
quickly skip to funding portal liability just so that I will 
have an opportunity perhaps to answer some questions that you 
might have with respect to that.
    As the regulations are currently written of proposed, it 
may be subject to the interpretation that intermediaries are 
considered issuers within the context of the liability of any 
omissions that might be made by an issuer. This would have a 
rather bizarre effect of making an intermediary responsible, 
effectively a guarantor, of any offering that appeared on its 
platform. I think that it is pretty obvious that that would be 
problematic on its face, and it is something that we need to 
address in the next several weeks and certainly before these 
regulations become finalized.
    I will end there, and I will look forward to your 
questions. Thank you again for the opportunity to testify.
    Chairman SCHWEIKERT. Thank you, Mr. Paul.
    And I was going to turn to Ranking Member Clarke and let 
her share with us her opening statement.
    Ms. CLARKE. I thank you, Mr. Chairman. And I welcome our 
witnesses and thank them for their testimony here this morning.
    With traditional capital access avenues still relatively 
constrained an increasing number of entrepreneurs are turning 
to crowdfunding to launch their enterprises. In 2012 alone, 
crowdfunding injected $2.7 billion into new ventures, a figure 
that will likely increase moving forward. In accordance with 
the Jumpstart Our Business Startup or JOBS Act of 2013, the SEC 
published its proposed rule for implementing the crowdfunding 
provisions in October of last year. While the SEC's 
crowdfunding disclosure requirements are aimed at providing 
enough information to the public to facilitate prudent 
investment decisions and minimize fraud, there is some concern 
that some of the disclosure requirements will make crowdfunding 
offerings cost prohibitive.
    The SEC, for example, has estimated that it could initially 
cost $15,000 in listing fees and regulatory compliance 
expenditures to raise $50,000, thus taking resources away from 
business expansion and working capital. While these costs are 
likely to decrease over time as equity crowd funding becomes 
more popular, it is vital that Congress monitor the SEC's 
crowdfunding rollout and make changes if necessary to improve 
access to capital for small businesses, while preventing bad 
actors from defrauding the public.
    I would like to thank our witnesses for lending their 
expertise and insights to this second examination of today's 
subject matter, the rule, and the SEC's crowdfunding proposal.
    And with that, Mr. Chairman, I yield back.
    Chairman SCHWEIKERT. Thank you, Ranking Member Clarke.
    I am going to turn to Mr. Mulvaney for the first five 
minutes of questions.
    Mr. MULVANEY. Sure. Just a couple of random questions to 
the various members of the panel. Thank you, gentlemen, again 
for doing this. And thank you for participating. I do not think 
a lot of folk realize how important this is because it helps 
drive the national debate on the issue. So I appreciate your 
time.
    Mr. Paul, we will start with you, just because you said a 
couple things that stood out. You said that because of the 
audited financial requirements to Tier III offerings, it is 
actually technically easier of cheaper to use a Reg D offering. 
What does a CPA audit cost these days?
    Mr. PAUL. There is some debate about this. I mean, it could 
be $10,000. It could be $20,000. It could be $5,000. It is not 
going to be insignificant. There is some discussion about 
whether or not it will be streamlined. The cost of audited 
financials, obviously, are going to be contingent to some 
extent on how much activity the business--how far along it is 
in its business cycle. A startup, it would be more readily--a 
company that has no history, pretty much all that you are 
buying there is the CPA's license.
    Mr. MULVANEY. And before I get to the Reg D question, how 
do you audit a company that does not exist?
    Mr. PAUL. I am not smart enough to answer that question. 
That would be a challenge. I agree.
    Mr. MULVANEY. If Mr. Schweikert and I have an idea, my 
understanding is that this is actually being used in the music 
industry a good bit. If he and I want to do a record together, 
we want to cut an album, it sounds like I would be completely 
excluded from the Tier III because I cannot audit something 
that does not exist, can I?
    Mr. PAUL. You certainly could have an accountant look at 
what you do not have and say I am certifying that you do not 
have the thing that you said you do not have.
    Mr. MULVANEY. Do not have it. Yeah, that is probably true.
    How much can I raise at a Reg D offering?
    Mr. PAUL. There is no limit.
    Mr. MULVANEY. So if it is easier to do Reg D than it is to 
do a Tier III, you wonder why anybody would do a Tier III.
    Mr. PAUL. Well, you might do it for several reasons. First 
of all, it is not clear that it is going to be necessarily less 
expensive. This is one specific requirement that exists in the 
Tier III of Title III offerings of crowdfunding that does not 
exist in Regulation D. There are other requirements in 
Regulation D as well. However, again, Regulation D is limited 
to accredited investors. And there are certain ideas, certain 
ventures, perhaps your record idea, that might be more 
appealing from an investor base of unaccredited investors. So 
that might be a motivating factor to not go up to Reg D.
    Mr. MULVANEY. Thank you, Mr. Paul.
    Mr. Gorfine, you said something regarding limited 
promotional activities. What are you not allowed to do as a 
portal?
    Mr. GORFINE. So funding portals are quite restricted in 
what they can do with the offerings that are listed on their 
site. So they cannot be going out and soliciting for that 
offering or sending out messages saying we have got this great 
offering on our platform. You should come check out your new 
record album company. So they really are the idea behind the 
funding portals as opposed to a registered broker dealer 
platform which would have more ability to kind of provide 
advice and recommendations. A funding portal is envisioned to 
be a bulletin board. It is a Craigslist for offerings. So 
really you just go to the platform. You will be directed to the 
platform where you can then sort through the different 
offerings but the portals themselves cannot do anything further 
to be promoting those offerings on their site.
    Mr. MULVANEY. Gotcha. Finally, Dr. Bullard, I am all for 
solving problems. I am a little concerned about creating 
problems that do not exist. If I have just raised a billion 
dollars in the public markets, why would I raise $250,000 on a 
crowdfunding site?
    Mr. BULLARD. The reason is that I would certainly think 
Twitter, when it was private, would think it would be a great 
social media strategy to do a million dollar funding through 
crowdfunding to reach out to its users who are accredited 
investors. So I think there are a lot of instances.
    But the issue is not necessarily whether it is a billion or 
$10 million or whatever. The idea is this space will be used 
more often by larger companies if you allow really large 
companies to participate. So if you allow companies that are 
raising $10 million into the space, it is going to have the 
effect of squeezing out or at least they will be competing with 
all the small business that it is purportedly designed for. So 
I do not know if a million is the right cap, but having no cap 
at all will leave the space open to whoever can pay the most 
for the services.
    Mr. MULVANEY. Right. And I guess I just look at the numbers 
of it and the math of it. This is fairly expensive money in the 
greater scheme of things. And that is one of the reasons we are 
having the hearing. It is not as easy and efficient and as 
cheap as we had hoped it would be to raise money through 
crowdfunding. So I guess I am struggling with why I would go 
raise $250,000, very expensive money, when I just raised some 
of the cheapest $100 million, billion dollars that I possibly 
could. So I recognize there are challenges. I am wondering if 
that is one of the ones we actually spend a lot of our time on.
    Anyway, I appreciate the Chairman's time. I yield back.
    Chairman SCHWEIKERT. Thank you, Mr. Mulvaney.
    Ranking Member Clarke.
    Ms. CLARKE. Thank you, Mr. Chairman. I am going to yield 
the tile to Representative Chu at this time.
    Chairman SCHWEIKERT. Ms. Chu, five minutes.
    Ms. CHU. Thank you so much for yielding.
    I am a member of the Intellectual Property Subcommittee on 
the Judiciary Committee, and so I am concerned about 
intellectual property and I know the protection of intellectual 
property is one of the challenges of crowdfunding. So I have a 
question for anybody on the panel.
    Once an idea is out, the startup of small business runs the 
risk that the idea will be stolen or copied, how can inventors 
and artists protect themselves from those consequences, let us 
say for instance that a tech startup has a new technology that 
has not been patented but they use crowdfunding to raise 
capital for their venture, should intermediaries be required to 
advise or educate issuers on IP protections before a campaign 
is posted or disclosed?
    Mr. PAUL. The same risks exist whenever one raises money. 
Whether or not intermediaries should be required to advise 
issuers as to that, it is certainly something that I do not 
believe that the intermediaries that are part of our 
organization would have any objection to that being something 
that we would want to do. There are certainly going to be some 
ideas that maybe are not welcome or suited to the broad raising 
of capital through this because of intellectual property 
concerns. But the majority of the ideas, I think, can be 
protected. You mentioned patented. And of course, there are 
other ways of protecting ideas, and it will encourage, we hope, 
issuers to be organized and get their intellectual property, as 
well as their other issues in order prior to doing a raise in 
this manner.
    Ms. CHU. Mr. Best?
    Mr. BEST. In addition to Mr. Paul's comments, I think that 
what we are also seeing on a mechanical basis and 
implementation are the fact that many crowdfunding platforms, 
and I would assume all, will have deal rooms, online deal 
rooms, where there is a public facing amount of information 
that anyone can see but that any IP, anything that would 
restrict it, the viewer would need to gain an additional level 
of access from the entrepreneur that they could pass through 
some sort of screen that the entrepreneur could determine this 
is a serious investor. This is someone who actually wants to 
make an investment in my business and I will allow that to 
happen. The same thing that occurs in the offline world through 
many 506 offerings.
    Mr. BULLARD. Yeah. If I could just add, I would say to 
answer the question about liability, I think we need to leave 
intermediaries to just what legal rights the issuers would have 
under current law. There may be some duties that they would be 
impliedly having in that scenario, but I certainly would not 
make it any kind of statutory or rule-based requirement.
    Mr. GORFINE. Yeah. I would agree that this is not 
appropriate to put the requirement on a platform necessarily to 
educate the entrepreneur or the issuer, but I think it raises 
an important question which is how do we make sure that issuers 
and entrepreneurs are educated about some of the risks of a 
crowdfund or a crowd raise? So I think that education for 
issuers and entrepreneurs is going to be very important, and 
one suggestion I would have is that the SEC actually has an 
investor.gov website that has a lot of great information for 
investors. Perhaps through the education side of the SEC's 
organization, you could create some information for issuers and 
entrepreneurs that they could consult before they go ahead and 
do a crowd raise. So I think that the education component is 
important.
    Ms. CHU. Thank you for that.
    Professor Bullard, given the inherent riskiness of small 
business investing and the lack of investor sophistication in 
individual retail investors, it was mentioned today that the 
best way to limit downside risk is through an emphasis on the 
investor caps. However, the proposed rules do not require 
crowdfunding platforms to verify the income and net worth 
stated by the investors. What are the implications of this and 
furthermore, what mechanism should be used to ensure the 
compliance of the investor caps?
    Mr. BULLARD. Well, there are really two problems here. One 
is the very real possibility that people will lose a 
significant amount of money that they cannot lose. And 
obviously, that will have happened only because something has 
gone wrong in the application of the Act. One of the really 
great things the Job Act did was actually to impose percentage 
limits, so that implies that you can only put a certain amount 
of risk, which is a great defense to allowing people to take 
those kinds of risks.
    But people will slip through the cracks. It is inevitable. 
And something more needs to be done than simply to allow an 
investor to go on a website on an unguided basis and just say I 
have got a million dollars of net worth. And I can tell you, 
most investors are going to think that their house is included 
in that, which it is not, and most investors are going to 
neglect the fact that they do not own their house; the bank 
actually does. So you could have people investing perhaps all 
of their savings in an offering because of that confusion. You 
cannot go out and sit down in a room with an investor and go 
over all their qualifications.
    But on the other hand, Mr. Gorfine suggests that we 
actually sue investors who violate the provision. Well, you 
cannot violate the provision. The provision does not say that 
investors are required to be X. It says that issuers are not 
allowed to sell to those people. The obligation is on the part 
of the issuer and the intermediary, and they are the ones who 
are really responsible. So the SEC needs to step it up a little 
bit, but we all know that it cannot be sending lots of papers 
that have to be reviewed on a detail basis.
    Ms. CHU. I see my time has run out so I will yield back.
    Chairman SCHWEIKERT. Thank you for that.
    Mr. Rice, five minutes.
    Mr. RICE. I will yield.
    Chairman SCHWEIKERT. And who do you want to yield to?
    In that case I get to. And what is always dangerous here, 
and Ms. Clarke and I have teased over this in the past and I am 
trying to do questions without too much in tirades, but I do 
need to actually just sort of throw a personal philosophic 
sharing, particularly for my philosophy major at the end, as 
much of the political side and the latest political discussion 
is income disparities. But yet, in many ways we have diced up 
part of our opportunity within our society saying I am a 
qualified investor so I am part of this fraction of a fraction 
of a fraction represent of my U.S. population. You get to 
participate. You get to know what is going on. You get to take 
risk. But the vast majority of our society and population, you 
are walled off from opportunities. And yes, people lose money. 
But as we have all had in our experiences, we invest in three 
things. One we do okay in and actually over time we do well in 
it. The other two go nowhere, but that is how we have built our 
nest egg for our retirements and our future.
    And as some of the rule sets become more paternalistic, my 
fear is we just expanded that income and inequality by sort of 
almost a financial apartheid where we say if you have this 
wealth you get to participate; if you do not, you do not get to 
even know. So I do have an underlying belief system here that 
we have sort of this egalitarian obligation to reach out. If 
you are an electrical engineer and you are an expert but you do 
not have the million dollars in the bank, but damn it, you have 
$2,000 and you are an expert. Should you be allowed to invest 
it? And that was actually one of my great hopes underneath the 
crowdfunding is how do I really create an opportunity society 
and not one that is walled off where you have it so you get to 
continue to participate.
    And this sort of makes the circle back to Mr. Paul, back to 
sort of the question. My fear was in some of the reading our 
office did within the proposed rule sets that a platform, an 
intermediary, may actually find itself within the tree of 
liability. Do they get to sort of choose who they post up? If 
so, do they now start to sort of only choose opportunities that 
they feel are perfectly safe or do they have to post up 
anything within their general box and geographic or these 
things, and do they end up carrying liability for a failed 
disclosure of someone's bad act?
    Mr. PAUL. There are a few questions in there, so let me 
start with what I think was the first one.
    Understand that, and I am sure you do because I know you 
participated in the creation of the statute itself, but 
investment advice is not permitted to be given by funding 
portals to investors. So the question that you are asking about 
whether or not a portal can pick and choose which offerings it 
puts up gets close to the line of whether or not that in effect 
if you exclude something and you include something, if that 
constitutes investment advice.
    CFIRA, the organization I work with, has been working with 
the SEC to fine tune that a little bit, put a little bit more 
shape on exactly what that is so that we do not have a 
situation where all portals have to list everything, which 
would be a bulletin board and not really in keeping with what 
the intent was. Nor can they be quite so selective that it is 
pretty obvious that they are picking the winners because they 
cannot offer the investment advice. So I think that might be 
responsive to the first part of your question.
    Chairman SCHWEIKERT. Okay. Go onto the second part 
because----
    Mr. PAUL. In terms of the liability. Yeah. The definition 
of issuer as it relates to Title III offerings is broad enough 
now to include not just the issuer itself but to include the 
portal. And then the liabilities that the issuer quite rightly 
has for being truthful and disclosing accurately, if the portal 
is considered an issuer then the responsibility and the 
liability would then fall to the portal. That seems overbroad. 
That seems like it is going to dissuade would-be portals from 
participating in the process.
    Chairman SCHWEIKERT. Can I put a hold on you at that point?
    Mr. PAUL. Certainly.
    Chairman SCHWEIKERT. Does everyone on the panel agree that 
a clean reading of sort of the proposed rule set does that 
cascade of liability?
    Mr. BULLARD. What Mr. Paul is talking about is there is 
liability for violating Section 5, which basically means you 
have not complied with the exemption. As it turns out, it was 
not available. And generally, issues, the intermediaries are 
not going to be subject to that, and to the sense that they 
might be, that is certainly a legitimate concern.
    Chairman SCHWEIKERT. Okay.
    Mr. BULLARD. And then there is the secondary liability, 
which you are also talking about, which is material 
misstatements, and they are squarely in the crosshairs on that. 
And Congress specifically put 12(a)(2) in the act, so there is 
no question there.
    Chairman SCHWEIKERT. Mr. Gorfine, do you agree?
    Mr. GORFINE. I would say the SEC has interpreted the Title 
III to potentially impose that liability on funding portals. I 
think that there is something think it is not clear from the 
statute though whether a funding portal should fall within the 
purview of that type of liability because they are not able to 
fully decide who they are listing on their platform, and there 
is a limited promotional aspect of what they are doing. There 
is a limited solicitation aspect of what they are doing, which 
raises questions. How can you be held liable for the 
misstatement of an issuer or an admission of an issuer if you 
did not have the ultimate discretion of whether to list that 
offering on your platform or not.
    So I view this on a bit of a sliding scale. To the extent 
that platforms do not have the discretion to decide with whom 
they do business, it seems like a poor outcome for them to be 
liable.
    Chairman SCHWEIKERT. Mr. Best?
    Mr. BEST. I think from my perspective we believe that the 
portals should have the ability to decide who is and is not on 
their platform because then it becomes more than a bulletin 
board.
    Chairman SCHWEIKERT. But on the taking liability for if----
    Mr. BULLARD. I agree. There is a significant disagreement 
we have not covered.
    Mr. MULVANEY. I am going to come back to you, Mr. Paul, 
because there were a couple things in your written testimony 
that were actually very interesting.
    Mr. Paul?
    Mr. PAUL. Yes, sir.
    Chairman SCHWEIKERT. I interrupted you when I went on my 
tirade.
    Mr. PAUL. Yes, I was not sure if that was a tirade or you 
were just looking for confirmation.
    Chairman SCHWEIKERT. Actually, believe it or not, within 
your written testimonies I have a bit of a split on the 
discussion of does the portal--what level of liability it takes 
for a screwed up offering or someone forgetting a disclosure. 
And so that is what I am trying to----
    Mr. PAUL. It will always get back down to when there is a 
claim, if there is a claim, you know, what did the portal know 
and when? And the liability could be significant. I mean, it 
could be significant enough that effectively, and I mentioned 
this very briefly in my oral testimony, but it is in my written 
testimony, in the broadest interpretation the portal could be 
100 percent liable for reimbursing an investor, even after the 
investor perhaps does not even own the security any longer, 
which would effectively make the portal a guarantor for 
everything that is listed on the platform.
    Chairman SCHWEIKERT. And I am concerned about the potential 
chilling effect and just cleaning up that language.
    Professor, you actually had--you sort of brushed alongside 
this. Can I throw a scenario at you and have you sort of game 
theory this with me?
    There are actually a group of friends and supporters, it is 
a Korean business association. At one time, if it was a few 
years ago, they were trying to put up a community bank but the 
difficulties and the capital that is required to that, and they 
have been looking at the idea of, hey, if we could produce a 
portal and we could reach out to the Southwest and the 
California market and help folk within our association group 
have basic capital raise and their level of comfort because 
these are often folks, either they know reputation wise or they 
know the industries, do I have problems with something that 
borders on a fraternal or business or chamber or specialty 
organization, setting up a portal saying this is what we are 
going to fund? That is the first question. Do you see anything 
there in a portal being that specific to its charter?
    Mr. BULLARD. Yeah. The disagreement is that there is no 
restriction on your ability to say no to issuers. That is 
simply incorrect. To be fair to the SEC, the investment advice 
issue, that goes to the communications with the public, the 
investor. Deciding who is going to list is a communication with 
the issuer.
    Chairman SCHWEIKERT. Okay. So my Korean business 
association----
    Mr. BULLARD. So that is not an issue.
    Chairman SCHWEIKERT. Instead of a community bank, this is 
how we are going to help folks in our community.
    Mr. BULLARD. So there should be no problem.
    Now, you cannot say you should invest in these affinity 
entities because you will get better returns. But you can say 
you can invest in these affiliated entities and you can 
probably say because we think they have values that we share. 
But there is no conceivable possibility that you chose the 
group on that basis or you went out and you only accepted 
issuers you thought would be 10-baggers that you would be 
liable for that. That is simply not realistic.
    Chairman SCHWEIKERT. Well, as a professor of securities 
law, as you probably remember a decade or two ago, there was a 
movement to try to create specialty community banks to be able 
to deal with underserved populations. Do you see where some of 
this model could actually be part of that opportunity?
    Mr. BULLARD. Yes. But we talked before the hearing about 
the issue of whether you can actually do bricks and mortar 
selling, and I am still not totally clear on that. But I think 
that to the extent the SEC has put----
    Chairman SCHWEIKERT. Could you explain that for everyone 
else here because this one actually could be a bottleneck.
    Mr. BULLARD. Right. Well, the SEC talks about kind of an 
online-only approach, and if I am correct, that would preclude 
you from running an offering out of your bank. You would still 
have to have a website, but you would not be limited to the 
website. Then I think that would severely handicap what is 
really the sweet spot of crowdfunding. That is the community 
business that somebody might want to start up based on local 
relationships. For example, the organization you mentioned.
    Chairman SCHWEIKERT. Okay.
    And Mr. Best, as the professor was just touching on, is not 
the second part of the beauty within sort of the crowd 
sourcing, crowdfunding concept, is just that? It is a proof of 
concept?
    Mr. BEST. Absolutely.
    Chairman SCHWEIKERT. It is not only maybe raising money in 
my community but also an A&B test of not only I can access some 
money but I can also access folks that have enthusiasm for the 
concept?
    Mr. BEST. Absolutely, Mr. Chairman. I think what we are 
seeing, there are a number of angel investors who now are 
beginning to look at crowdfunding as a qualifying step before 
they will look at a deal because do you have a customer for 
your product? Do you have a customer for your service? And 
being able to, whether it be through awards or through equity 
or debt, being able to establish that does several things. It 
is proof of concept of your product. It is proof of concept of 
you as an entrepreneur, the ability to execute, and your 
ability to raise capital, both very important aspects.
    Chairman SCHWEIKERT. Mr. Gorfine, in that sort of model, 
let us say I actually need a few million dollars for my 
concept, but I am going to use crowdfunding to raise $499,000. 
And we will discuss whether ultimately I have a soft cap, a 
small raise because in that population, most likely I am not 
going to have many people able to invest over $2,000, and at 
some point we really do need to talk that there are these 
investment caps already built into here to limit someone's 
downside. But I use that as my proof of concept. Then I take my 
proof of concept, and can I then go to my qualified investors 
and raise my next $2 million and then go to more institutional 
money to round out my fund-raise?
    Mr. GORFINE. Yeah, I think that is right. And the SEC, I 
think, did a great job in clarifying that point. That you would 
be able to use Title III alongside or before, subsequent to, 
certain other exemptions. So if you think about this in its 
totality, what I like about the JOBS Act vision is that it 
creates this kind of seamless capital access pipeline, if 
implemented effectively, so that you can go from each stage of 
the development of a company and be able to access capital that 
suits your needs at whatever stage of development you are at so 
that you could certainly start with Title III and then 
potentially use that to move up to a Title IV, you know, Reg A-
Plus type raise.
    Chairman SCHWEIKERT. Thank you. That was one of the 
concepts I wanted to make sure we addressed.
    Ranking Member Clarke.
    Ms. CLARKE. Thank you, Mr. Chairman.
    Mr. Paul, the SEC has estimated that commissions to 
intermediaries will account for about 5 to 15 percent of the 
crowdfunding issuance, higher than other funding sources such 
as public stock offerings or bond issuances. Do you expect this 
higher cost to come down and become competitive with 
traditional forms of capital as crowdfunding expands? And then 
I will open it up to the rest of the panel.
    Mr. PAUL. I think it is going to be a competitive 
marketplace, so if you are asking if over time that these 
commissions, there will be some sort of competition, I think 
the answer is probably yes. I would, however, note that 
comparing the commissions for crowdfunding offerings to IPOs or 
public markets is perhaps not the most apt analogy. I mean, it 
is an appropriate one, but there are other types of securities 
that exist that might be a closer analogy. For example, 
Regulation D or 506, which is another type of private 
placement. And in that universe, these proposed commissions are 
fairly consistent. Maybe a touch higher but not quite as many 
multiples higher as the private-public markets.
    Ms. CLARKE. Would you agree with Mr. Paul's assessment?
    Mr. BEST. I would. Yes.
    Ms. CLARKE. Okay. Professor Bullard, the rule outlines a 
number of investment limits based on an investor's income 
level. However, you invest concerns that the rule lack an 
income verification scheme. What risk does this pose for 
investors interested in crowdfunding?
    Mr. BULLARD. The risk is not that they will invest in 
accordance with the rules. I think the rules are good rules, 
particularly that they limit the percentage with respect to 
that person's income or net worth. This is a slip-through-the-
cracks problem, and is most likely to happen when you put the 
entire analysis in the investors' hands and you do not give 
them clear markers as the things they need to look out for.
    So, for example, one obvious one would be they should not 
be allowed to self-certify if there has not been a button they 
had to push saying I have not included the value of my home. 
They should not accept that they have read the investor 
education material which is required unless there are a couple 
screens where a box has said in big, bold letters the 
percentage of small businesses that fail to really drive home 
the point that this happens. Instead, what the SEC suggested is 
you can just click on a box that says ``I have read this'' and 
the thing is not even there or something you would have to 
scroll down 20 pages. And we all check that box all the time 
saying we read it, but we are lying, are we not? Right? But it 
is also crazy to think anybody is going to read these things. 
So the SEC has always been unwilling to say, well, you know, 
the literal letter of the law is the only path we can go down 
with no requirement. Just be creative and say, look, there are 
four or five boxes with big fat letters that will lay out the 
key things they need to think about and that should do it. That 
is the kind of thing we need to deal with but I think 
submitting a paystub should be a requirement. That is just too 
easy. Or some electronic verification of income, for example.
    Ms. CLARKE. So discuss that ambiguity in a rule that could 
allow large companies to raise $1 million through crowdfunding 
while simultaneously raising more via other public offerings. 
Can you elaborate on how this will impact startups and small 
businesses that are experiencing a funding gap and want to seek 
crowdfunding?
    Mr. BULLARD. This is the issue Representative Mulvaney 
raised, and I agree that the $1 million cap on the total 
offerings that a crowdfunding issuer is allowed is too low, but 
I think as a business matter--this is not an investor 
protection issue at all--but as a business matter, if you 
really want crowdfunding to work, I think that larger issuers 
are going to squeeze out smaller issuers. And you all know in 
the regulatory space who calls the shots. In the regulatory 
space, it is going to be the largest regulated entities. So if 
you let larger entities in this regulatory space, they are 
going to have more influence with the SEC and the rules are 
going to reflect their interests. So definitely, I think the $1 
million is not high enough. I do not think the SEC has the 
authority to do what it is doing because the statute is so 
unambiguous, but the fact that somebody can be very successful 
raising significant amounts elsewhere, they should not be 
allowed to use crowdfunding because I think the way it is going 
to work is they will squeeze out the small businesses.
    Ms. CLARKE. Let me open this up to the rest of the panel. I 
saw, I guess, a glimmer in our eye, Mr. Paul. Would you like to 
share your thoughts?
    Mr. PAUL. It might have been a glimmer.
    Yeah. With all due respect to Professor Bullard, I just do 
not agree. I do not think that the larger issue--if the larger 
issuers, or whatever, larger entities are allowed to do 
crowdfunding offerings, that it is going to squeeze anybody 
out. It will simply make it a more diverse marketplace. I am 
trying to think of a large corporation that might choose to 
utilize Title III almost as a marketing opportunity or a way of 
extending their brand. It is still going to be limited to a 
million, at least for the time being. Why would we restrict 
that? Why is that a bad thing? Why not allow the opportunity to 
invest for unaccredited investors that would not otherwise have 
had that opportunity? I am cognizant, of course, that this is 
the Small Business Committee, and so we want to foster small 
businesses, and certainly Professor Bullard's comments are 
consistent with that. However, the other side of the rationale 
for Title III was to democratize wealth creation as well. So it 
is not just democratizing the capital formation, but also 
democratizing the opportunity for investors to participate in 
the types of investments that they might not otherwise, and 
previously did not otherwise have. So I do not see the need to 
restrict them.
    Ms. CLARKE. Mr. Gorfine? Mr. Best?
    Mr. BEST. Well, in talking to a couple major corporations 
about this who have been interested in crowdfunding--their 
interest really is more on the reward side because of the 
rewards crowdfunding, like Kickstarter or using services like 
that because it allows them to raise capital--there are no 
limits, and far fewer restrictions. And knowing how general 
counsels at corporations tend to work, that would be the way 
that a marketing department might have a better chance at 
actually executing one of these campaigns.
    So I do not believe it will crowd out small businesses. I 
think that those major corporations will utilize other means, 
rewards or otherwise.
    Mr. GORFINE. Yeah, I mean, just to add, I tend to agree 
with that. I think let the marketplace determine what the crowd 
wants to invest in. And I think more opportunities, more 
offerings and options is not necessarily a bad thing.
    And if I may, can I come back to the investor cap question 
that you were asking before? I do want to just clarify one 
thing. By no means do I think the SEC should be going after 
investors with lawsuits if they violate the cap. So I actually 
do agree to a significant extent with Professor Bullard that 
this idea of how do we make sure investors just understand what 
these caps are all about. So what I would propose is just 
literally at the point that an investor is about to click their 
commitment, there can be a popup that explains the rule and how 
you calculate what your cap may be, and just explains why that 
is important. So I do agree with the self-certification aspect 
of it, but it could just be an explicit popup that occurs at 
the point of the commitment that explains what the parameters 
are.
    And my point on the lawsuits is if an investor violates 
that cap, you could consider whether they should not have the 
right to bring a cause of action against an issuer. That is 
what I was bringing up in terms of lawsuits. Just to help 
enforce the importance of that cap.
    Ms. CLARKE. Very well. Thank you.
    Just one final question, and I am going to start with 
Professor Bullard.
    The SEC cost estimates for crowdfunding do not look 
promising for small issuers. Are there ways the SEC could 
reduce the cost without impacting investor protection?
    Mr. BULLARD. That depends on to what extent the SEC 
believes it can disregard what was expressly required in the 
statute. And the SEC has shown a great willingness to do that 
in its proposal. So if that is what it is going to do, then 
yes. And one example that really stands out is the requirement 
that you explained how you valued the shares and how you are 
going to value them in the future, which you do not have to do 
anything similar for an IPO. And it is also sort of in 
contravention of the general rule that you are trying to sell 
things for the highest price you can get. Although ironically, 
in IPOs you are often trying to sell them for less than you can 
get in order to have an effect on the aftermarket. So that 
should go away. It is unreasonable. The very detailed 
instructions when explaining your capital structure should go 
away. The very detailed explanations on a dilution. What they 
need to know is you can make subsequent offerings of shares and 
it can result in reducing the value of our shares. And we have 
the authority to do that.
    So a lot of the things just are not the kinds of things 
that are going to go to the real issue here, which is that 
there are going to be a lot of losses. And who are the people 
who suffered those losses going to be? Right? And I do not 
think this is going to be about disclosure, but the cost is 
certainly going to go to disclosure and the perceived liability 
is going to go to that as well.
    Ms. CLARKE. Thank you, Professor.
    Is there anyone else who would want to? Mr. Best?
    Mr. BEST. Just one thing about education. I think that is 
one of the good things in the statute, was the requirement for 
robust investor education. And we have already begun seeing 
some of the portals who are going to be implementing solutions 
that look very much like what Professor Bullard was talking 
about, whether they be a video, much like the seatbelt video 
you watch when you get on the airplane, or something that has 
large check boxes and really requires much more engagement. 
There were other solutions that used to require you to spend a 
certain amount of time on the page and sort of monitor that.
    Also, because all this is happening on websites, everything 
is tracked. And so there will be a digital footprint of 
everything that was done by that investor on those sites. And 
so you will know how many minutes they spent on each page of 
disclosure, how many times they watched the video, how many 
times they did everything. And so it will provide much more 
transparency than we have ever had before about what people are 
doing when they are reviewing documents.
    Ms. CLARKE. Very well. I yield back, Mr. Chairman. Thank 
you all for your expertise today.
    Chairman SCHWEIKERT. Thank you, Ranking Member Clarke.
    And I am going to go to Mr. Rice, but Professor, I want to 
chime in on this one just quickly. I actually see substantially 
more benefits for its larger organizations. From their 
standpoint, they get to do a proof of concept, but I actually 
also saw that as they would have the resources to have good 
documentation, good video, good information, maybe a nice blog 
that explains what they are doing. And it is a way of their 
resources helping introduce hopefully this next class of 
investor to this concept. And as we keep saying, education, 
education, education. Well, I would love to exploit some of 
their resources to do that. So that is where I have some 
optimism.
    Mr. Rice, five minutes.
    Mr. RICE. I was a tax lawyer and a CPA for 25 years before 
I came to Congress, and I represented a thousand small 
businesses. And I have seen the effect of federal securities 
laws on their ability to raise capital. For a truly small 
business, it simply is out of reach. Banks being the primary 
source of capital, the new Dodd-Frank regulations are certainly 
going to limit that even further. So this is an incredibly 
important concept, very innovative concept. Could solve a big 
problem of growing small businesses. I totally agree.
    I would ask each one of you for one suggestion. We cannot 
make this so complex and complicated and expensive that it, 
like the rest of the federal securities laws, is out of reach 
of the average small business. So I would ask each one of you 
for one concrete change or suggestion that we could do with 
these regulations in this law to make it more accessible.
    And I will start with you, Mr. Best.
    Mr. BEST. I think it would be to modify the requirement of 
a full CPA audit at above a half million to potentially the CPA 
review that was required in the $100,000 to half a million 
range.
    I would say in the same vein, I would limit any 
nonstatutory disclosure requirements, and that also includes 
limiting some of the ongoing compliance requirements. I would 
just add to the point on audits above $500,000, for a Reg A 
offering up to $5 million, we do not have that same financial 
audit requirement. So you want to kind of square how these 
different exemptions fit together.
    Mr. RICE. Mr. Best, at what level would you require an 
audit?
    Mr. BEST. I do not have the benefit of 25 years of tax CPA 
experience. I just come at this as a small business person, as 
a small business owner. I think there is some level, but I 
think if you wanted to say that maybe at the end of year one, 
after you were successful at raising the capital at the end of 
year one and you wanted to then provide something back, to 
deliver back to those people. I think one of the things, too, 
is that these investors, because they are investing most of the 
time, historically the data we have to date is that 80 percent 
of the time these are people who are first or secondary 
connections to the small business owner who are making these 
either investments or contributions. And so these are people 
they have ongoing relationships with. And so there will be a 
lot of mandated disclosure, but what we are seeing is the 
people who are successful are the people who provide ongoing 
sort of fulsome disclosure in the course of doing business 
because that is what people want to know.
    Mr. RICE. Well, do not get me wrong. I hold a CPA, but I 
agree with you that an audit is an onerous requirement for a 
small business, particularly when it has been ongoing for five 
years and never had an audit. And so to go back and redo all 
that from ground zero to establish a starting point is 
ridiculously expensive and would prohibit any small business 
from being able to utilize this. So I agree with you and I 
think that that threshold, if there is not going to be an audit 
required, should be very high because it is going to cost so 
much to get the money it is not going to be worth it.
    Mr. Bullard?
    Mr. BULLARD. I guess the one change I would make would be 
to have a $100 investment maximum and then strip everything out 
except for the requirement to do it through a mediary and the 
requirement to have some business plan that is at least 500 
words.
    Mr. RICE. I think 100 would be too small, but I hear what 
you are saying.
    Mr. BULLARD. A thousand times 100. There is your 100,000.
    Mr. RICE. Mr. Paul?
    Mr. PAUL. My suggestion would be addressing--it may seem 
indirect, but addressing the portal liability issue is rather 
crucial to a facilitating small business's ability to raise 
money. If it is not clear, we may end up with perhaps the more 
gun-slinging actors participating in a market that we really do 
not want to be perceived that way.
    Just getting back to the audit question, the only reason 
that was not my choice was because it had already been 
mentioned. I think an audit should be required when it is 
required by the owners. I think when the market says, you know 
what? We are not comfortable with you, the investors, we want 
to see how you got here. When that happens then I think the 
company should be required to, but I think setting an arbitrary 
cut with respect to how much is raised feels, well, arbitrary 
and it should be based more on necessity and the desire of the 
shareholders.
    Mr. RICE. Thank you very much for your time. I completely 
agree that the way this is proceeding is going to make this 
pretty much useless to small businesses unless we make changes. 
I appreciate your input. I like the idea of limiting investment 
but I think $100, it needs to be significantly higher than 
that.
    Thank you, Mr. Chairman.
    Chairman SCHWEIKERT. And thank you, Mr. Rice.
    They are about to call votes. I think that still gives us a 
few minutes because as we have all learned around here the 
first 15 minute vote means a half an hour.
    Mr. Mulvaney, you had a couple.
    Mr. MULVANEY. I did. Thank you.
    And I forgot, Mr. Best, you actually opened your testimony 
by talking about the British system and the theory that good 
ideas can come from anyplace. Would you just give us a quick 
summary of where you think the significant difference are 
between the British system and the one we have adopted and 
maybe someplace where it might be better, someplace where our 
system might be a little better?
    Mr. BEST. What is interesting about the British system is a 
lot of it has sprung up in the absence of strong regulation. 
And it is only this year that the British government will be 
issuing more formalized crowdfunding and crowd lending 
regulation.
    Mr. MULVANEY. The caps that we are talking about, the 
disclosure requirements, the liability rules are nonexistent? 
They are organic? What are they in the British system?
    Mr. BEST. Well, they are much less structured in the 
British system. And so what we are seeing is you are seeing a 
wide range of investors and lenders. Now, I will say that the 
products of choice in the U.K. tend to be the loan products, 
the debt-based products. That is about 10 times more crowd-debt 
as there is equity. I think there is a degree to which that is 
cultural, as well as the fact that for a lot of small 
businesses who will never have an IPO or a 10X multiple, asking 
the question where is my exit on this investment. If it is a 
debt-based product, I know that I am going to get my loan 
payment every month over the next four years. So that makes 
sense as well.
    Mr. MULVANEY. To the chairman's issue on democratization of 
investment, you said that there is a wide array of investors in 
the British system. Tell us who they are. Who is participating 
in this, not on the issuer's end but on the investor's end?
    Mr. BEST. Well, on the largest debt-based platform in the 
U.K., it is called Funding Circle, they have now raised over 
180 million British pounds. That is over a quarter billion 
dollars through their platform. And they have, I believe, it is 
65,000 investors that have invested individuals into small 
businesses. And they come from a wide range of folks. And if 
you look at the average investment, it is about the average of 
about $3,000 USD. And so these are people who are not investing 
large amounts of money but are investing a few thousand dollars 
into a local business that they are familiar with. And I think 
that is a size of investment that, number one, we did research 
a couple years ago before the law passed just to ask people, 
what do you think your investment would be if you had this 
opportunity? And the number was between $3,000 and $4,000. So 
we are seeing, at least in the British system, those numbers 
are somewhat consistent. And so I think that while the limits 
may be up to 10 percent of someone's restrictions, what we are 
seeing in the U.K. after tens of thousands of people have used 
this system, that people are going into this fairly carefully.
    Mr. MULVANEY. I heard Professor Bullard mention in his 
testimony that he was concerned that something between a 
quarter and a half of these issuers, if I got that right, might 
fail. Do you happen to know the failure rate in the British 
system so far or not?
    Mr. BEST. No, sir. I do not know the British system. I can 
give you some data from Australia. I think that there will be 
failure. Absolutely. Businesses fail. We have never run away 
from that in this entire conversation about this.
    In the Australian system, they have had crowdfund 
investing, a form of it for now almost eight years, and the 
platform there is called the Australian Small-Scale Offering 
Board. And they have run about 145 companies through that 
platform, through that crowdfunding platform. One of the 
interesting things is that the survival rate of those 
businesses who have used that system has been 86 percent. That 
is kind of a very surprising high number. And when asked about 
that, the CEO of the platform has said he does not have the 
exact reason but certainly believes that adding structure and 
transparency to a business earlier than it typically would have 
as a startup, because you have to sort of have a lot more 
structure around your business because you are now offering 
this security out to the public, and also the transparency of 
having to make regular engagement with your investors, whether 
it be informally or formally, provides people with better 
decision-making opportunities and more transparency. I am doing 
this on stage. I have to do a better job. I have to live up to 
the expectations of the public.
    And so we will see if that plays out in U.K. system and in 
the U.S. system, but it is an interesting data point.
    Mr. MULVANEY. Fascinating.
    Thank you, Mr. Chairman. I appreciate it, gentlemen.
    Chairman SCHWEIKERT. Thank you, Mr. Mulvaney. And thank you 
for joining us.
    Just one last, a takeoff of where you were, Mr. Best, or 
anyone that wants to participate. Let us articulate so we have 
it on the record. What are the caps? It is $2,000?
    Mr. BEST. Two thousand dollars above $50,000--$50,000 to 
$100,000 in income. It is up to 5 percent of your annual income 
or net worth, and above $100,000 it is 10 percent of your 
annual income or net worth excluding the value of your home.
    Chairman SCHWEIKERT. Professor.
    Mr. BULLARD. There is actually a flat contradiction in the 
statute, so we do not really know the answer to that, which is 
it says if you are either at 100 or below as to income or net 
worth, you are subject to the lower limit. And then the next 
provision says if you are either at 100 or more.
    Also, it is not clear what the 5 percent applies to. There 
I think the SEC should interpret it to be the greater of.
    Chairman SCHWEIKERT. And Professor, did not the SEC sort of 
broach that in their rule set?
    Mr. BULLARD. Right. But they took the investor protection 
ambiguity and they ruled against more investor protection, 
allowing someone to invest more. But as a practical matter, 
what that means is someone who has $100,000 in savings would be 
able to invest $10,000 instead of $5,000. It is not going to be 
the end of the world but I do not think the SEC, when there is 
such a clear ambiguity, should be erring on the side of higher 
investments when this is an investment protection provision.
    Chairman SCHWEIKERT. Last thing I wanted to share, and this 
was actually something--and those of you who have actually been 
involved in intermediaries, I am from sort of the world that 
believe that crowdsourcing of data information and 
crowdsourcing of money and other things, there is a purifying 
effect of information, sunlight, and the fact of the matter is 
having seen--because I have looked at some of the ones 
actually, the Netherlands, Sweden, Great Britain. And many of 
them actually had blogs running alongside of it saying, ``We go 
to Mary's Bakery. We like this. That is why we are willing to 
put 1,000 pounds into this.'' It was a narrative that came with 
not only the posting in the investment.
    Do you believe U.S. portals will actually make sure that 
they also, if they are asking for egalitarian participation, 
democratization of investment as you have used the term, will 
also be doing democratization of information and comments?
    Mr. PAUL. I think absolutely. I think that it will be in 
both senses, in the example that you gave of Mary's Bakery, 
customers will talk, ``This place is great and they make great 
scones.'' And there will be a discussion about that. But I 
think that there will also be blogs or a running dialogue about 
the offering itself where certain people will say, ``All right. 
So I looked at the offering and this thing does not totally 
make sense to me. Does anybody have any clarity on that?'' And 
then a dialogue, someone will respond, perhaps even the 
principal. And so I do think that there will be that level of 
transparency.
    Chairman SCHWEIKERT. Would anyone disagree with me that 
particularly in this investor class, that is the ultimate type 
of regulation? Because we are all comfortable going to Yelp and 
others to get portions of information. As long as they have 
built the mechanics within there to avoid the scamming, that 
access to information has an ultimate regulator?
    Mr. PAUL. I think it is a great contributing factor to that 
level of regulation, and I think that it may come to pass that 
it actually ends up being something that is expected in other 
asset classes. I think it is going to be very successful on 
Title III, and I think 5, 10 years from now that might be one 
of the legacies of this entire legislation, is that that level 
of transparency is actually required for other things, which 
will be great.
    Chairman SCHWEIKERT. And now we do the scamper to go vote.
    Thank you for your participation today. Your testimony has 
helped us to better understand how the SEC proposal will affect 
the future of crowdfunding. As I shared with you earlier, I am 
a bit emotionally invested in this, and I really do want to 
move to this democratization of access to capital where all of 
our U.S. citizens have the opportunity to take risks but also 
benefit from that participation and risk.
    I will ask unanimous consent to have five legislative days 
to submit statements and supporting materials for the record. 
Do understand our office also intends to take portions of this 
and turn it into the SEC as part of sort of a comment coming 
from us.
    Without objection, the hearing is adjourned.
    [Whereupon, at 11:28 a.m., the Subcommittee was adjourned.]


                            A P P E N D I X


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                   Congressional Testimony of

                         David J. Paul

                Co-Chair and Co-Founder of CfIRA

        (Crowdfunding Intermediary Regulatory Advocates)

          Chief Strategy Officer of Gate Global Impact

       before the United States House of Representatives

                  Committee on Small Business

   Subcommittee on Investigations, Oversight and Regulations

                        For the Hearing:

     ``SEC's Crowdfunding Proposal: Will it work for small 
                          business?''

                        January 16, 2014
    To Chairman Schweikert, Ranking Member Clarke, and other 
honorable members of the Committee:

    As all of you are aware, Congress passed the Jumpstart Our 
Business Startups Act (the JOBS act) on March 27, 2012 which 
was signed into law on April 5, 2012.

    Very shortly thereafter, on April 20, 2012, I organized 
what may have been the first meeting between representatives of 
the crowdfunding industry and the Security and Exchange 
Commission. Since that first meeting, CfIRA has enjoyed an 
ongoing and productive dialog with both the SEC staff and the 
commissioners up to, and subsequent to, the release by the SEC 
of the proposed Title 3 crowdfunding regulations on October 23, 
2013.

    While it would be difficult to say that the crowdfunding 
industry speaks with a singular voice, it is fair to say that 
the overall consensus among the industry is that the SEC has 
done a diligent and thoughtful job creating the proposed 
regulations. In general, we remain hopeful that Title 3 
crowdfunding, when it comes online later this year, will prove 
to be an effective and robust new asset class, matching small 
businesses with individual investors in a safe and productive 
marketplace.

    With that said, there are certain aspects of the proposed 
regulations which may be amiss and which we hope to address and 
modify. Some of these concerns will be the subject of my 
testimony.

    Given the limited time for testimony, I will confine my 
comments to four salient issues. These four issues are 
certainly representative of the kinds of concerns which the 
industry has with respect to the proposed regulation, but these 
are by no means exhaustive: Audit Requirements, Pooled 
Investment Restrictions, Intermediary Participation 
Restrictions, and Funding Portal Liability.

    Audit Requirements

    As currently proposed, there are three tiers of financial 
disclosure requirements for Title 3 offerings, corresponding to 
the amount raised:

    First Tier: $0 - $100,000
    Second Tier: $100,000 - $500,000
    Third Tier: $500,000 - $1 million

    The First Tier requires disclosure of financial statements 
certified by an executive officer of the company. The Second 
Tier requires financial statements reviewed by an accountant.

    However, the Third Tier requires CPA audited financials. 
Furthermore, the requirement for such CPA audited financials is 
on an ongoing basis, with such audited financials to be 
provided to investors every year following a Title 3 raise of 
over $500,000.

    It is worth noting that these disclosure requirements for 
the Third Tier are actually more onerous and exhaustive than 
the current requirement for Regulation D offerings which does 
not mandate audited financial statements for issuers, nor 
ongoing annual audited disclosures.

    These overly onerous requirements for the Third Tier of 
security crowdfunding offerings may have the unintended effect 
of pushing potential issuers away from doing Title 3 
crowdfunding offerings above $500,000 entirely, and instead 
will make Regulation D offerings more attractive to potential 
issuers.

    This seems clearly inconsistent with the spirit of the 
original legislation. In effect, this may create a `donut hole' 
between $500,000 and $1 million where offerors do not utilize 
Title 3 at all.

    In addition to creating an artificial market irregularity, 
this will also have the unfortunate effect of making these 
offerings unavailable to unaccredited investors, since 
Regulation D offerings utilizing Title 2 are not available for 
investment by unaccredited individuals.

    Pooled Investments Restrictions

    The proposed regulations exclude funds from utilizing Title 
3 to raise capital, in effect, requiring all crowdfunding 
investments to be direct investments. This rule would restrict 
pooled investments, or hedge funds and private equity funds 
from raising money through crowdfunding.

    While we may agree that most funds may not be suitable 
issuers for crowdfunding, we believe that this restriction is 
overbroad as it appears to restrict the fundraising of Special 
Purpose Vehicles or Single Purpose Entities (SPE's) investing 
only in a single operating company that would otherwise qualify 
as an eligible Title 3 issuer.

    This restriction does not serve to protect investors, but 
rather this restriction actually succeeds in denying 
crowdfunding investors some of the advantages and protections 
afforded to other investors and institutions in other asset 
classes, particularly those utilized in Regulation D offerings.

    Intermediary Participation Restrictions

    Current proposed regulations would restrict intermediaries 
from holding interests in the companies conducting Title 3 
offerings on their platforms. This serves to restrict 
intermediaries from participating alongside their investors in 
these offerings.

    Rather than diminishing a theoretical `conflict of 
interest' between intermediaries and investors, as a practical 
matter this restriction effectively forbids alignment of 
interests between investors and intermediaries.

    This concept is often described as ``skin in the game.'' We 
believe that intermediaries who invest in issuers make for 
better alignment of interests. We believe that allowing such 
co-investment by intermediaries would have two very desirable 
benefits for investors. First, an investor may take comfort in 
knowing that the intermediary facilitating the transaction is 
invested in the same deal and on the same terms in the 
investment they are considering. Second, when an intermediary 
has such ``skin in the game'' that fact itself will encourage 
intermediaries to take more seriously their assigned role in 
the marketplace.

    While we are aware that an intermediary's investing in a 
deal may be perceived by an investor as a tacit endorsement of 
that deal (perhaps to the exclusion of others in which the 
intermediary has not committed its firm's capital) and that 
this tacit endorsement may itself be construed as ``investment 
advice'', we do not believe that this is necessarily the case.

    But even if such a determination were to be made, we 
believe that this ``investment advice'' restriction should not 
be applied to all intermediaries. At most, this restriction 
should be limited to Funding Portals and not to Broker-Dealers 
conducting Title 3 crowdfunding offerings, as Broker-Dealers 
are not restricted from offering investment advice in Title 3 
crowdfunding offerings.

    It is also worth noting that Broker-Dealers are not 
restricted from owning positions in other types of offerings in 
which they support, including Title 2 Regulation D offerings. 
So the restriction on Broker-Dealer financial participation 
triggered by Title 3 offerings may have the undesired effect of 
disencouraging Broker-Dealers from bringing Title 3 offerings 
at all.

    Funding Portal Liability

    Section 4A(c)(2) of the Securities Act provides that an 
``issuer'' will be subject to liability if it fails in either 
of the following two criteria: (1) if an issuer makes an untrue 
statement of material fact or omits to state a material fact; 
(2) if an issuer does not sustain the burden of proof that such 
issuer did not know, and in the exercise of reasonable care 
could not have known, of such untruth or omission.

    While this may seem reasonable and proper for companies 
issuing securities, as written, the regulations suggest that 
funding portals themselves can be broadly included in the 
definition of issuers.

    If this interpretation proves accurate, then a funding 
portal as well as each of its directors, principal executive 
officers and other employees involved in an offering, may 
potentially have personal liability for every transaction 
conducted on its platform.

    The proposed consequence for a violation under this 
provision is to allow an investor to recover the amount of his 
or her investment, even if he or she no longer holds the 
security.

    To put a fine point on this, this would mean that if the 
platform does one hundred $1 million deals, then each of a 
portal's affiliated persons would have $100 million in personal 
exposure. A portal effectively becomes a guarantor for every 
single statement in every offering document of every offering 
on its platform.

    To say that this liability issue may have a chilling effect 
on anyone considering creating a portal may be something of an 
understatement. Indeed, each employee of a funding portal will 
have to make a decision as to whether they are comfortable 
exposing themselves, and potentially their families, because of 
the personal liability involved.

    It is not hard to imagine this liability potential 
resulting in an adverse selection, where conservative market 
players are scared away and only aggressive players are willing 
to take on this risk. Clearly, this would not be in the best 
interests of the market as a whole.

    Respectfully submitted,

    David J. Paul
    Co-Chair - CfIRA
    CSO - Gate Global Impact

                                 
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