For this webinar, we were joined by one of the leading experts in crowdfunding law in the US to present you with actionable tips on how to navigate the complex US crowdfunding regulations.
This webinar, will help you learn all about the regulations around investment crowdfunding in the US including the critical changes between different pieces of legislation such as:
- Who is allowed to invest and how much money can be raised
- Whether Internet portals can be used
- How much each investor can invest
- The degree of SEC oversight
- Whether foreign companies can participate
- What should you use for token sales
- What regulations are best suited for specific industry sectors and funds vs. individual offers
- What should you use if you want to enable secondary trading capabilities to your investors
Read the full webinar transcript here:
Katipult: Hello everyone and welcome to yet another Katipult webinar. On today’s webinar we have Mark Roderick. We are very excited to have you Mark, welcome. You can start and give a short introduction to yourself and we’ll continue from there.
Mark: I’ll try to make it brief. It was a clear, blue day when I was born… No, I am a securities lawyer and spend 127% of my time in the crowdfunding space and have for the last 5 years time-wise. That’s all I do, I represent lots and lots of folks and in all aspects of crowdfunding. From portals to issuers to investors to collaborators and consultants and all kinds of folks, in every possible aspect of US crowdfunding.
Katipult: That is very suitable for our topic today, which is everything you need to know about crowdfunding regulations in the US.
Mark: Isn’t that a coincidence?
Katipult: Exactly, I was just about to say that. It’s good to have you on and just a few details: we will be recording this webinar, the recording will be sent out afterwards and it will also be present on the website. There is a tab called webinars where you can find this webinar and all the webinars as well. Let’s get started. We can start off with some basics. Who can do investment? Is it possible for anyone or do you have to be very rich? Do you have to be rich to be rich?
Mark: Hopefully you will get richer after you invest. But it depends of course. If you ask a lawyer any question his answer is “it depends’. There are three flavors of crowdfunding under US law. In two of them anybody can invest and in one of them only so called accredited investors. A lot of your audience probably knows what an accredited investor means. It used to mean wealthy people. It means with people with the income of 200 000 or more or with the spouse – 300 000, or people with the net worth of $ 1 000 000 excluding your home. The key is those are the same definitions and exactly the same dollar amounts as when the rules were originally issued back in 1982, so that was a long time ago, 36 years ago. Of course inflation has diminished the real buying power of dollars. Not Canadian dollar I know, because you guys are luckier, but it has diminished buying power of US dollar substantially. In 1982 $200 000 was really quite a lot of money. I think with inflation adjustment it would be about $550 000 today. Almost three times, but the definition hasn’t changed. Today accredited investor doesn’t mean quite wealthy anymore, certainly doesn’t mean poor. I guess if you live in Toronto or San Francisco you think $200 000 means poor… But to get back to the question, only in one kind of crowdfunding you have to be accredited. In other two kinds of crowdfunding you do not have to be accredited.
Katipult: OK perfect. So, on that subject, how much money can actually be raised? I know the answer is going to be “depends on which regulation and which investor you are”, but let’s start with foreign accredited investor. How much can he raise?
Mark: I’ll just do something I should have done when you asked me the first question. I said there are three kinds of crowdfunding. I’ll just quickly give them captions so when I mention them in the course of this webinar they will mean the same thing each time. I am going to use the term title, title 2, title 3 and title 4 crowdfunding. Why am I going to say that? When laws are enacted in the US, the law is alike a book and different section of the law just happens to be called title. As most of you know, the crowdfunding in the US began with the so-called JOBS act, signed by Barack Obama in 2012. That law was broken up into titles and there are 3 of those that deal with crowdfunding: title 2,3 and 4 – hence title 2 crowdfunding, title 3 crowdfunding and title 4 crowdfunding. Title 2 crowdfunding, very briefly: wild, wild west. Almost no rules whatsoever, only accredited investors may participate because one of the underpinnings of the US securities laws in the last 85 years is that wealthy people can take care of themselves, whereas non-wealthy people need the paternalistic arm of the government around their shoulder and I always sound sarcastic when I say that, but it has actually worked pretty well. So that’s title 2 – wild, wild west and accredited investors only. Title 3 is sort of the new kid on the block. It is anyone can participate, all is online, it has to all be done through a licensed funding portal, this is what this brand new animal is called, like a broker dealer light. Very limited on how much a company can raise, very limited on how much you can invest, because it is brand new and basically congress is saying “Well we’ve never done this before, let’s take a step before we start drinking heavily”. Finally title 4 crowdfunding, which is like in a public offering, but a little bit smaller than a full blown public offering, but it entails going to a Securities exchange commission with a thick book, having that thick book approved back and forth with the SEC, cost relatively a lot of money and takes relatively a lot of time. So that’s title 2, title 3 and title 4. Now, to answer your next question, how much can companies raise? The answer is under title 3 they can raise a trillion dollars. They can raise any amount, no limit whatsoever on how much they can raise. Again, wild, wild west. Title 3, the company can raise $1 070 000 per year, but it is actually even more limited than that. That’s not a huge number, but it is even more limited than that, because if you Brian, are a serial entrepreneur and you have 4 different companies and they all want to raise money using title 3, the total for all of them put together can only be $1 070 000 per year. So it’s not even per company limit, it is per entrepreneur limit, so very small. Title 4. Also known as regulation A or also incorrectly known as regulation A+ - each issuer, not each entrepreneur but each issuer, can each raise $50 000 000 per year. So those are how much people can raise and of course as soon as the rules in title 3 and title 4 were issued, people already liked those limits to be higher, they’d like the $1 000 000 to go to 5, 10 or 20 million dollars, they’d like 50 to go to 75 or a 100 million. Who knows whether that will happen within our lifetime. Well, probably within yours, not within mine, but those are the current limits.
Katipult: $1 070 000 on title 3, that’s a bit of an odd number?
Mark: Well it started out being a nice round million and then it was adjusted for inflation once. That’s how it got to that odd number.
Katipult: What do you think, is it possible to be raised? I know people want it to be raised, but what do you think, it is going to be raised in the near future?
Mark: Personally I don’t believe so. You know, there is a saying that you never want t see two things being made: one is sausage and the other is law. The mechanism to raise that $1 000 000 threshold… you know, the US government today essentially can’t do anything. This item is so low on anybody’s radar, it’s just in this scheme of American civilization, if that’s not an oxymoron. It’s just not such a huge item and people are not paying attention to it. You will always get emails that say “So and so has introduced legislation to increase this limit” and that the 225 will get you on the New York subway. Probably won’t get you on the Toronto’s line. It is mere idle speculation as to whether of these limits will be increased.
Katipult: This brings us to the next question, or next talking point. It is about whether internet portals should be used. You mentioned that we need an internet portal, but that wasn’t needed on title 2 and title 4. You can actually raise money without using an internet portal.
Mark: Yes. The one where you need an internet portal as a matter of law is title 3, the new animal on the block, the $1 070 000. That’s title 3. The reason they do that: they want licensed company to be in charge of this investment process. Title 3 is so different than anything that has been allowed previously on US securities laws. There is much concern about widows and orphans being cheated by people like you and me that they wanted to make sure that all of those transactions are run through a reputable, licensed entity. That’s why there is this online requirement using title 3. Title 2 and title 4, those rules don’t say anything about online anything. You can do title 2 deals through a newspaper or through the US postal service or that old company FedEx. There is nothing online specific to title 2 and title 4. However we all know that the reason the JOBS act exist and the crowdfunding exists is that people want to raise money online. 99.9937% of these transactions do happen online and of course that’s why people need you guys, there is also nothing in title 2 or title 4 that talks about portals. You don’t need a portal legally to conduct an offering under title 2 or title 4, so if one of your listeners has a business, he or she can setup a simple little website this afternoon saying “Please invest in my company”. That would be perfectly legal title 2 offering. But, that’s not how markets work. Consumers buy stuff in retail stores because they want the retail store to make the first decision about the quality of the product before the consumer has to start making decisions. The crowdfunding world immediately became oriented around online portals. Portals that would vet deals and accumulate pre vetted deals. Just like a DSW shoe store, so that the retail investor could just walk in the door, know that he or she was going to see shoes of a certain quality and select from the shoes that are offered by the retailer that has already looked at the shoes. I don’t know if I’ve taken that metaphor too far. In any case, the market quickly became oriented around portals where investors can shop for good deals and of course, you guys write the software for the portals. So, that gave birth to your business also.
Katipult: Yes and we are very happy to help anyone in need of help. We do quite a few title 2, we have title 3 on the way as well and title 4 also, so we are in all of them. You talked about accredited investors and non-accredited investors and you touched on who can invest and how much and I think that was on all of them, but let’s hear more on accredited investors versus non-accredited investors.
Mark: OK, let’s talk about that. So, title 2, again going down our list, title 2 is accredited investors only and there is no limit on how much an accredited investor can invest. Again, the concept is that accredited investors are smarter and I definitely say that with tongue in cheek. But, they can afford to hire expensive lawyers and expensive accountants that can give good advice. The law allows accredited investors to invest any amount without limit in title 2 deals. You can take your entire net worth and invest it in a new social media app under title 2 if you so choose. I’m going to leapfrog over title 3 and come back to it because it is so much more complicated. In title 4 deals accredited investors can also invest as much money as they would like, because they are wealthy, so they can afford it. On the other hand, in title 4 deals non- accredited investors can’t invest as much as they would like. They are limited for each title 4 deal and I’ll say again, title 4 and regulation A are synonymous and there is no such thing as regulation A+. In those deals, a non- accredited investor is limited to the greater of 10% her income or 10% of net worth. When you think about it, that’s actually quite a lot to invest in a particular deal. I’m not sure I would recommend it, but there is that legal limit. Now coming back to title 3, the limits are incredibly complicated and they apply equally to both accredited and non- accredited investors for some reason that no one knows. They are very complicated, it depends on how much money you make, what percentage, lots of other factors. The reality is that it’s a low number. Nobody can invest much money in a title 3 deal, which is another thing that makes title 3 sort of challenging for issuers, because with these limits they have to find a lot of investors. You can’t find just a few folks willing to invest a lot of money because they are not allowed to invest a lot of money. In title 3 you have to find lots of investors, 3 or 4 times as many or maybe more than you would have to find in a title 2 deal. Now, one thing I will point out, because every time this issue is discussed, someone mentions the incongruity in limiting how much a non- accredited investor can invest in whatever – the new social media app, a local real estate project, a local brewery – being so careful to make sure that that widow or orphan doesn’t lose much money in that tile 3 investment, whereas the same widow or an orphan can take a trip to Las Vegas or Atlantic City and basically gamble his or her entire net worth over night. It has been suggested that these things don’t make any sense and that there shouldn’t be any limits. Why do we care how someone loses their money? Buying an expensive car, why is that different than investing in a title 3 deal? But there is an answer to that quandary. The answer is that government cares very deeply about the integrity of the securities markets and the faith of the public in the securities markets. Securities markets are so integral and critical to the American economy. The casino industry is not critical to American economy. The public knows that when it goes to Las Vegas it’s going to lose money, so the American capital markets are the most transparent and most successful capital markets in the world and that’s not coincidental. The fact that American securities laws are the most stringent in the world and the fact that we have the most successful capital markets in the world, these things go hand in hand. The government has an interest in ensuring that the public keeps its faith in the integrity of the capital markets. That’s why those limits exist. Of course, I’m not saying that limits should be what they are, maybe they should be higher, I don’t know, but that is the explanation. You didn’t ask me that question, but that was my soapbox answer.
I will also say that this is why you are seeing in US crowdfunding market so many so called side by side offerings. One issuer is simultaneously raising money under both title 3 and title 2. Why is that happening? It is happening because of those investor limits. There may be an accredited investor who wants to invest let’s say $50 000 in the issuer’s offering, but if she invests using title 3 maybe she is only going to be allowed to invest $8000 just because of those limits. So what we do, as you well know, is set up two offerings side by side. One title 2 and one title 3. When the traffic streams in from the internet, we ask if investor is accredited and if he is we direct hat stream toward the title 2 offering and we let her invest $75 000 dollars. Those limits are driving economic behavior, as of course one may have anticipated.
Katipult: We have all these rules that someone needs to make sure these rules are upheld. We have the SEC. What level of oversight do they actually provide?
Mark: They provide at very low level of oversight. There is another general sort of misconception that I will clear: the SEC was actually put in charge more or less of writing the crowdfunding rules. Congress and the JOBS act said “Well we think it should look something like this”, it was something like drawing a sketch of a house on a napkin with a marker and hen handing it to the builder, the SEC, and saying “Build something that looks like that”. It actually took SEC a couple of years to write the rules. They did a remarkably thorough and liberal, I use that word approvingly, job drafting the rules – meaning they made crowdfunding pretty darn easy, relative to what they could have done. In fact, at almost every critical juncture when faced with a choice between making crowdfunding easier or more difficult, they always made it easier. They went so far as, in the regulation A rules, they made it so easy that they were sued by the State Security administrators that wanted them to make it harder. So, hats off to the SEC and I say that at every possible opportunity, for doing such a good job with the regulations. Now, having put the regulations out there, the SEC does not, just as similar to every other government oversight organization, have manpower. The SEC is regulating securities market that does trillions of dollars business annually. It is not going to be devoting a lot of manpower to title 3 crowdfunding portal, raising $172 000 for the local brewery. This is the misconception that what you have to worry about when you are building a portal or conducting a securities offering, is that the SEC is going to intervene – no. What you do have to worry about, the reason you comply with the laws, is because you are concerned about civil lawsuits from your investors. As long as you make money for everyone, everyone is happy and no one gets sued. Since crowdfunding began, the economy in general and real estate economy in particular, real estate comprising at least 90%of the volume of crowdfunding, has been up, up, up. At some point, it is going to go down a little. When it goes down, when investors lose money, the investors or their estates, or their brother in law who happens to be a banker or a civil lawyer, looks for ways to get the money back. If you have failed to comply with these rules it gives those disgruntled investors the opportunity to bring a successful claim against you. This is something say very, very freely. We are not doing this because we’re primarily concerned with the SEC, we are doing it to protect ourselves from claims from disgruntled investors. Key point.
Katipult: Very good. We have these three titles, how does it work with foreign companies? Are there specific titles they can participate in, is it overall a no-go or can it actually work?
Mark: Foreign companies, let’s see, I’ve never come across one of them. Again, title 2,3 and 4. Title 2 – anybody can use it. Any company, anywhere in the world. Title 3 has to be US. The investors don’t have to be US, that’s why people are sometimes confused. Non US investors can invest under any of these, title 2,3 and 4. That’s a key point as far as US laws are concerned anyway. So, title 2 – any company can use it. Title 3 – companies formed in the US. Title 4, interestingly – company has to be managed in either US or this foreign country: Canada. Now, how Canada snuck in to the title 4 regulation, I’m sure there is a historic reason. It’s not Mexico, it’s not member of the North American Free Trade Agreement. Not Mexicans, Canadians can use title 4 for some reason. This issue does come up, because companies from other countries would like to use title 4 and they ask “Well what does it mean to be managed in the US? What if we have a post office box?”. The answer is no, that isn’t good enough. Best answer is that the people who actually run the company have to wake up in the US or Canada every morning. That is the best answer to question whether you are US or Canadian managed. It doesn’t mean you have to operate there. For example, US mining company that has its headquarters in Ottawa let’s say, formed in US, headquarters in Ottawa, all of its mines are in Africa – that company is allowed to use title 4 because it is managed here. It doesn’t have to operate here.
Katipult: OK, perfect, thanks for that. Now going a bit into token deals. I hear a lot of different versions of what you should, can and shouldn’t do, so that’s why I would like to ask you about this: what you should do if you want to do a token sale? Which of the regulations you should use, are you allowed to use any of them? Of course, it depends if you are doing a utility or a security token, what should you do, what are your thoughts on that?
Mark: Well, I’ll first give you a glib answer: if you are doing a token sale, you better do it soon, because the steam seems to be coming out of the market rapidly. Raise the money while it is still possible. Great question. It depends. Are you surprised that I would say that? The first thing it depends on, of course, as probably all of your listeners have heard probably 400 times, is whether the token is a security. Since I have the opportunity, my favorite metaphor about tokens is the movie theater company. You are going to create a company that is going to build a chain of movie theaters and you have two ways that you can raise capital for that chain. One is you can sell stock in your company, the old fashioned way, or sell bonds or self preferred stock. The other way, if you think about it, you could sell little blue movie tickets. Each one can get you an admission to a movie if and where the theaters are ever built. Token is nothing more than a little blue ticker and I’m sure there are some of your listeners who just had strokes, they probably live in Los Angeles, to hear a super, super cool think like a token referred to as a little blue movie ticket, But that is what most tokens are. They are simply a substitute for something that you get in the future. It may be really cool, digital thing you get, like the right to store your digital assets on subterranean servers protected by nuclear weapons or something, but they really are little blue movie tickets. Those are utility tokens, they are not securities, they are just a presale of something, an admission ticket. If you are just selling little blue movie tickets by and large, and all the lawyers out there please don’t freak out at my over-generalization, and people are buying them because they want to see a movie someday, those are not securities at all under US securities laws and therefore you don’t need title 2,3 or 4 to sell them. Those things happen, people presell magazine subscriptions for example. They are not securities, just presold items and there have been some of them sold. However, to answer your question directly, it has never been clear to some of us why anyone would buy that little blue movie ticket. If this theater hasn’t been built yet, do I really want to buy little blue movie ticket? I think that may have been a very short lived cycle in the capital market and I think that most investor are going to insist in the future on not getting little blue movie tickets.
Note: due to connection issues this was the endpoint of the webinar. The rest of the material is covered in “US Crowdfunding Regulation Part 2”.
