By Sara Hanks, CEO of Crowdcheck
CrowdCheck Inc. and CrowdCheck Law together provide a wide range of legal, due diligence, filing and documentation services for issuers and intermediaries in the online capital formation business. We were formed in response to the JOBS Act of 2012, and initially focused purely on due diligence services before expanding to a broader range of support functions for offerings using the “online exemptions” from registration – Regulation CF, Regulation A and Rule 506(c).
We now have a market-dominant presence in those services, having assisted hundreds of companies to raise funds under Regulation CF, qualified over 160 Regulation A offerings, and provided assistance with ongoing reporting requirements for scores of companies. CrowdCheck is also a recognized thought leader in the space.
This means we are in a very good position to note some of the successes and failures of crowdfunding.
On the success side, we’d like to draw attention to these issues:
The amount of money raised: On the Regulation CF side, the numbers are easier to come by. Kingscrowd and Crowdfunding Capital Advisors provide excellent information about the sums committed in crowdfunding offerings. Sherwood Neiss of CCA recently commented on the total amount committed under Regulation CF since its inception having reached $1.5 billion. The numbers for Regulation A are less accessible. You have to review companies’ ongoing reports and extract that information manually from those filings. The SEC’s Division of Economic and Risk Analysis did that in a study back in 2020. They recorded $2.5 billion as having been raised through the end of 2019. Unfortunately, DERA is not planning to repeat the study, but in light of the number of filings made under Regulation A, there is no reason to suppose that those numbers are going down. Not much compared to the IPO market in either case, but a few billion more than these small startups would have had access to a decade ago!
“Graduation” of companies into the public markets: In the early days of Regulation A we saw some companies use Regulation A as an immediate path to listing on the NYSE or Nasdaq. Most of these offerings were not successes, and one might blame short sellers or market structure failures for those, but the more interesting point is that, after a hiatus, we are starting to see companies move up to exchange listing and public company status in a more “organic” manner, first raising a funds in one or more Regulation A offerings, and then listing when they are ready.
Expansion of the universe of investables: When the JOBS Act was passed, its objective was to provide funding to small companies from their family, friends and fans. No-one was expecting the various exemptions to provide opportunities for investors to invest in fractionalized trading cards, sneakers, classic cars and racehorses. And yet, the ingenuity of the American financial industry made that happen.
And on the other side:
Compliance failures in Regulation CF: Regulation CF offerings are not reviewed by the SEC, and that shows. We’ve seen the staff of some platforms, many of whom are quite young and with no securities industry background, develop remarkable instincts for spotting red flags. And yet, based on a couple of reviews we have undertaken with respect to disclosure compliance, if one were to select ten Form Cs at random, it would be possible to identify materially misleading information or failure to comply in at least three of them. We and some of our clients have on several occasions asked the SEC Staff whether a particular offering structure worked, and been told that it didn’t and that we should not replicate it, but as far as we know, no action was taken with respect to those offerings. The areas of particular concern that we’ve noted recently are Investment Company Act issues, co-issuer and predecessor concerns, and compliance with respect to crowdfunding special purpose vehicles.
Ongoing reporting issues in Regulation CF: Regulation CF issuers are required to make annual reports, generally for three years. Maybe a third of issuers actually comply, and we’ve seen in some cases a very cynical approach to compliance. There’s no real penalty for not complying (although we understand some staffers think there is maybe a case to be made for liability under Rule 10b-5 under the Exchange Act). You can’t make an offering under Regulation CF unless any filings required for the previous two years are in order, but since you can get back into compliance simply by filing missing annual reports, some companies do just that.
Ongoing reporting issues in Regulation A: We’ve seen a disturbing number of Regulation A companies not only fail to make their ongoing reports on Forms 1-K and 1-SA, but also the annual post-qualification amendments needed to update their offering circulars when they have an open offering. Some of them have even gone on to make additional, or amended, filings. They may think the fact that the SEC qualified those filings as indicating that the staff thinks they are compliant, but that’s not the way the SEC works. Expect to see more rescission offers being made by Regulation A companies in the future!