Crowdfunding: The Real and the Illusory Exemption
Harvard Business Law Review (Spring 2014)
64 Pages Posted: 16 Jun 2013 Last revised: 31 Jan 2015
Date Written: November 4, 2013
Crowdfunding is commonly defined as raising small amounts of capital from a large number of people over the internet. To avoid the expense of securities regulation, companies often crowdfund by giving away rewards (like a free t-shirt) instead of selling stock or other securities. In April 2012, Title III of the JOBS Act sought to change this status quo by directing the Securities and Exchange Commission (SEC) to facilitate securities-based crowdfunding through websites like Kickstarter. Congress and the President believed this would broaden access to sidelined capital and help companies grow and hire. But this “retail crowdfunding” exemption, open to all investors, was not the only means of crowdfunding in the bill. A last minute compromise, which has been largely over-looked, expanded the ability of issuers to use the private placement exemption, as revised in new Rule 506(c), to crowdfund from accredited investors. This “accredited crowdfunding” exemption provides a less regulated alternative to retail crowdfunding that is available to the same companies and more.
This article is the first to examine the impact that accredited crowdfunding will have on retail crowdfunding. It claims that accredited crowdfunding is likely to dominate and, depending on SEC action, could render retail crowdfunding superfluous or a market for lemons. But it also claims that accredited crowdfunding – when compared to traditional private placements – may face a similar lemons problem over the longer term on account of rules that discourage investors from fending for themselves. These potential problems threaten to undermine the social welfare goals of the JOBS Act: increasing access to capital, spurring business growth, and creating jobs. But the SEC can minimize these problems and promote social welfare by strengthening the bargaining incentives of accredited investors and encouraging retail investors to piggyback off of their work. The normative part of this article provides targeted recommendations that balance the need for capital formation against a novel incentives-based theory of investor protection.
Keywords: crowdfunding, private placement, JOBS Act, Rule 506, Rule 506(c), general solicitation, securities, Regulation Crowdfunding
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