The New York State Society of CPAs is calling on the Securities and Exchange Commission to tighten its proposed regulations on crowdfunding, arguing the proposals would loosen the rules to the detriment of unwary investors.
The SEC drew up the proposed regulations in response to the Jumpstart Our Business Startups Act, or JOBS Act, which was signed into law by President Obama in 2012 with the goal of encouraging funding of small businesses in the U.S. by easing various securities and regulations. Among the provisions of the JOBS Act was rules allowing so-called crowdfunding, which allows companies to sell securities through open platforms, including Web-based programs, modeled after sites such as Kickstarter and Indiegogo that allow entrepreneurs and artists to get funding for their projects and ventures. The law requires the SEC to write rules and issue studies on capital formation, disclosure and registration requirements.
The SEC’s proposed rules would govern the offer and sale of securities under the new Section 4(a)(6) of the Securities Act of 1933 and would also provide a framework for the regulation of registered funding portals and brokers that issuers are required to use as intermediaries in the offer and sale of securities.
In a comment letter drafted by the NYSSCPA’s Litigation Services Committee and released on January 21, the Society pointed out that crowdfunding activities would bring in a different type of investor. Consumer advocates have warned since the inception of the JOBS Act that crowdfunding might attract less sophisticated investors than the type who normally participate in venture capital funds and the like, who could fall prey to Internet swindlers, stock scammers and boiler room-type operations.
“We note with concern that the Securities and Exchange Commission (SEC) is considering a tradeoff between transparency and functionality especially in connection with a new and, as of yet, untested method for offering securities to a broad cross-section of potential investors,” the NYSSCPA letter states.
“In general, the proposed regulations try to strike a balance between being pro-business for the sake of developing this new funding mechanism, and maintaining high quality of investments for the public”, said Yigal Rechtman, one of the principal drafters of the comment letter. “The focus of our response was on the section of the regulations that addressed the risk of fraud. To that end, we call on the SEC to be more specific on how it will monitor the market players without any registration, given the fraud risks that we identified”.
The NYSCPA is urging the SEC to instead take a more conservative approach when it comes to regulating these offerings and avoid creating different standards for intermediaries and issuers.
“We are not in favor using a reasonable basis’ as a sufficient standard for intermediaries that will be facilitating IPOs,” said David S. Zweighaft, one of the principal drafters of the comment letter. “Because these offerings are coming out via the internet, they will be received by a greater audience of potential investors who may or may not be sufficiently versed in financial matters to make a best or safe decision. Intermediaries will be performing a gatekeeper role in reviewing these offerings before they are disseminated to the public and therefore should be held to the prudent care’ standard, which enhances the transparency and level of responsibility expected from them.”
In its comment letter, the NYSSCPA suggested that to effectively and realistically create a system in which issuers’ representations are accepted, the intermediary should be required to conduct a certain amount of monitoring of its own. The monitoring could be similar in depth and manner to Section 404 of the Sarbanes-Oxley Act, as interpreted by PCAOB Audit Standard No. 5.