A recent Washington Post article by Steven Overly asked "Why has hardly anyone applied for equity crowdfunding in D.C.?" This is an important question. The DC Department of Insurance, Securities and Banking can be applauded for its efforts to promote the new rules. Representatives of the Department have spoken about the new exception at a number of events and forums, including at the D.C Bar Association, at which CrowdCheck also presented.
The article in the Washington Post cites four reasons to explain the lack of uptake: the availability of non-investment crowdfunding through sites like Kickstarter and Indiegogo; general lack of knowledge about the availability of the exemption from securities registration; the requirement that the entity be organized in the District and that investors only come from the District; and the cap on the total amount of investment companies can take.
These four factors are important, but in some cases maybe not so much. Most small companies will not reach for huge sums of cash. For instance, the intrastate crowdfunding campaign for Prequel is only seeking $200,000, far below the $2,000,000 cap. The lower target makes it easier to get all the funds Prequel is looking for from DC residents only.
While the article discusses the complications that arise when only being able to sell securities to District residents, crowdfunding campaigns in DC have to comply with the federal requirements for intrastate crowdfunding too, and the federal statute covers offers and sales. Any offer of securities relying on the DC intrastate crowdfunding exemption may not be made beyond the borders of the District. Any Tweet, Facebook post, or announcement on a company’s own website that it is raising money would constitute an offer of securities. The SEC has determined that electronic communications that are not geographically constrained would violate the terms of the Section 3(a)(11)federal exemption from registration for intrastate offers and sales.
So what is the harm? In the view of the SEC, a company relying on the intrastate exemption that publicizes its offering will likely have violated Section 5 of the Securities Act. Such a finding could result in penalties against the company and could impact its ability to raise funds in the future, as violating Section 5 is an enumerated “bad act” under the SEC's Bad Actor Rule. Even if enforcement is unlikely against a small company, any investor has the right to rescind the transaction and receive return of the investor's full investment, plus interest.
This may all sound familiar because CrowdCheck has written about the limitations of intrastate crowdfunding in the past (here and here). Still, it is worth repeating again and again because CrowdCheck has seen intrastate campaigns in other states that are violating the terms of Section 3(a)(11) that could result in trouble with regulators or investors.
Intrastate crowdfunding has a lot of potential to help fund local businesses and get innovative ideas off the ground. An amendment to Section 3(a)(11) by Congress to lift the restrictions on "offers" could help make that happen before too many small companies find themselves on the wrong side of the law.