BILL ANALYSIS Ó
SENATE JUDICIARY COMMITTEE
Senator Hannah-Beth Jackson, Chair
2013-2014 Regular Session
AB 2096 (Muratsuchi)
As Amended June 9, 2014
Hearing Date: June 24, 2014
Fiscal: Yes
Urgency: No
RD
SUBJECT
Securities transactions: qualification requirements:
notification
DESCRIPTION
This bill seeks to allow for the qualification by notification
of any offer or sale of a security, if the offering meets
certain minimal requirements, including that the offering falls
under a federal exemption for limited offerings and sales of
securities not exceeding $1,000,000, and the aggregate amount of
securities sold to any investor by the issuer does not exceed
certain amounts within a 12-month time period, except as
specified. Unaccredited investors would be generally subject to
a $5,000 cap on the aggregate amount of securities they can
purchase from an issuer within a 12-month period. This bill
would effectively allow accredited investors to invest the full
$1,000,000 amount in a 12-month period.
This bill would authorize a court to award attorney's fees and
costs to a prevailing purchaser in an action brought against a
person who makes a sale in violation of the qualification
provisions prescribed in the bill, and would authorize the court
to award treble or punitive damages.
BACKGROUND
In the early 1920s, "companies often sold stocks and bonds on
the basis of glittering promises of fantastic profits - without
disclosing any meaningful information to investors." By the end
of that decade, the United States economy was devastated in the
Stock Market Crash of 1929. (SEC, Q&A: Small Business and the
(more)
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SEC, [as of Aug.
9, 2012].) In response to the crash, the U.S. Congress enacted
the first set of federal securities laws, the Securities Act of
1933 (Securities Act), and the Securities Exchange Act of 1934,
and created the Securities and Exchange Commission (SEC) to
administer those laws, both of which contain specified
registration and disclosure requirements.
Under the Securities Act, any company that offers or sells its
securities must register the securities with the SEC unless it
qualifies for an exemption under federal laws and regulation,
such as an exemption for transactions by an issuer not involving
any public offering under Section 4(2) of the Securities Act (a
private offerings exemption). (See 15 U.S.C. Sec. 77d(a)(2).)
Federal Regulations, under Regulation D, provide several
exemptions from the registration requirements, including Rules
504 and 506. Rule 504(b)(1), of particular relevance to this
bill, provides that the specified limitations of a federal rule
(Rule 502) on advertising and solicitation do not apply if the
offer and sale of securities meet certain other requirements,
such as, for example, where the security is offered or sold
exclusively in one or more states that provide for the
registration of the securities, and require the public filing
and delivery to investors of a substantive disclosure document
before the sale of the securities.
In 2012, President Obama signed into law the Jumpstart Our
Business Startups Act (JOBS Act) wherein an exception to the
general prohibition on general solicitation or advertising was
created, seeking to better enable small businesses to raise
capital. The JOBS Act required the SEC to adopt rule changes
within 90 days (in actuality, they were adopted in July 2013) to
provide that the prohibition against general solicitation or
advertising does not apply to offers and sales of securities
made pursuant to Rule 506, provided that this applies only if
the purchasers of the securities are accredited investors and if
issuers take certain reasonable steps to verify that purchasers
of the securities are accredited investors, pursuant to the SEC
regulations. Rule 506 also contains other limitations, such as
"bad actor" disqualifications.
Separately, the JOBS Act enacted Title III of the JOBS Act, the
CROWDFUND Act, which added a new section to the Securities Act,
Section 4(6), which provides an exemption from registration
requirements for certain crowdfunding transactions.
Transactions qualifying for this exemption, are transactions
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involving the offer or sale of securities by an issuer
(including all entities controlled by or under common control
with the issuer), provided that certain requirements are met.
(See 15 U.S.C. 77d(a)(6), 77d-1(a)-(b); see also Comment 3 for
more.)
Similar to federal law, the California Securities Law of 1968
makes it illegal to sell an unqualified (i.e. unregistered on
the federal level) security unless the security is exempted by
statute or federal law otherwise preempts securities
registration requirements. (Corp. Code Sec. 25110; see 57 Ca.
Jur., Securities Regulations, Sec. 13.) California law also
allows for any security registered under federal law, the
Securities Act, or under the Investment Company Act of 1940, to
be qualified by way of "qualification by notification." While
California law expressly provides for numerous exemptions to the
qualification requirement, those exemptions generally limit the
scope of both advertising and the individuals to which the
securities may be sold.
This bill, sponsored by the California Small Business, seeks to
allow for general advertising and solicitation of the public by
issuers for up to $1 million in securities by filing an
application with the Commissioner of Business Oversight, if
certain minimal requirements are met. These offerings would not
have to be registered under federal law, nor would they have to
be qualified as is otherwise required under California law. Nor
is this bill providing for an exemption from California's
qualification requirements. Instead, the bill would allow for
these public offerings to be "qualified by notification."
This bill was heard in the Senate Banking & Financial
Institutions Committee on June 18, 2014, and was passed on a 7-2
vote.
CHANGES TO EXISTING LAW
Existing federal law provides for the Securities Act of 1933,
which establishes a framework for regulating the offer and sale
of securities and ensuring the protection of investors that
purchase those securities. Generally speaking, the Securities
Act of 1933 requires the offer or sale of all securities to be
registered with the Securities and Exchange Commission (SEC) and
to be structured as prescribed in federal law and regulation,
unless the offer or sale is covered by an exemption. (15 U.S.C.
Secs. 77e, 77d.) This federal act also requires those who offer
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(i.e., market) and sell securities to be licensed as investment
advisers or broker-dealers, unless either the transaction or the
activity being undertaken is exempt.
Existing federal regulation , Regulation D, promulgated by the
SEC to implement the Securities Act of 1933, authorizes a series
of exemptions from the registration requirements of the Act and
includes eight rules, denoted Rules 501 through 508. (17 C.F.R.
Sec. 230.501 et seq.)
Existing federal regulation , Rule 501 of Regulation D, defines
accredited investors as, among other things, financial
institutions, securities broker-dealers, large pension plans,
corporate entities with assets in excess of $5,000,000, and
other large, financially sophisticated entities. It also
includes:
any natural person whose individual net worth, or joint net
worth with that person's spouse, exceeds one million dollars
at the time of the purchase, exclusive of their primary
residence; or
any natural person with an individual income in excess of
$200,000 in each of the two most recent years, or joint income
with that person's spouse in excess of $300,000 in each of
those years, together with a reasonable expectation of
reaching the same income level in the current year. (17
C.F.R. Sec. 230.501.)
Existing federal regulation , Rule 502 of Regulation D, in
relevant part prohibits, except as provided in Rule 504(b)(1),
the offering or selling of the securities by any form of general
solicitation or general advertising including, but not limited
to, the following:
any advertisement, article, notice or other communication
published in any newspaper, magazine, or similar media or
broadcast over television or radio; and
any seminar or meeting whose attendees have been invited by
any general solicitation or advertising, as specified. (17
C.F.R. Sec. 230.502(c).)
Existing federal regulation , Rule 504 of Regulation D, exempts
from federal registration offers and sales of securities made by
specified issuers if, among other things, the offering meets
specified limitations on the manner of offering (general
solicitation and advertising limits) and specified limitations
on resale, and the aggregate offering price does not exceed one
million dollars, as specified. Rule 504(b)(1) also, however,
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authorizes the offer and sale of up to $1,000,000 in securities
by an issuer, as long as the offer and sale are made:
exclusively in one or more states that provide for the
registration of the securities, and require the public filing
and delivery to investors of a substantive disclosure document
before the sale of the securities;
in one or more states that have no provision for the
registration of the securities or the public filing or
delivery of a disclosure document before sale, if the
securities have been registered in at least one state that
does provide for such registration, public filing and delivery
before sale, as specified; or,
exclusively according to state law exemptions from
registration that permit general solicitation and general
advertising, as long as sales are made only to accredited
investors (this provision would not be applicable under this
bill as this bill applies to accredited investors). (17
C.F.R. Sec. 230.504(b)(1)(i)-(iii).)
Existing federal law , pursuant to the Jumpstart Our Business
Startups (JOBS) Act, authorizes the use of general solicitation
and general advertising in certain circumstances not previously
authorized. Title II of the JOBS Act, operative September 23,
2013, lifted the restriction against use of general solicitation
and general advertising, when sales are made only to accredited
investors and other requirements are met. (See Rule 506 of
Regulation D.) Title III of the JOBS Act, otherwise known as
the CROWDFUND Act, will lift the restriction against use of
general solicitation and general advertising to both accredited
and non-accredited investors, once the SEC promulgates final
regulations implementing that title. (See Public Law 112-106.)
Existing federal law , Title III of the JOBS Act added "Section
4(6)" to the Securities Act, which provides an exemption from
registration requirements for certain crowdfunding transactions.
Transactions qualifying for this 4(6) exemption, are
transactions involving the offer or sale of securities by an
issuer (including all entities controlled by or under common
control with the issuer), provided that: (1) the aggregate
amount sold to all investors by the issuer, including any amount
sold in reliance on the exemption provided under this paragraph
during the 12-month period preceding the date of such
transaction, is not more than $1,000,000; (2) the aggregate
amount sold to any investor by an issuer, including any amount
sold in reliance on the exemption provided under this paragraph
during the 12-month period preceding the date of such
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transaction, does not exceed the greater of $2,000 or five
percent of the annual income or net worth of such investor, if
the annual income or the net worth of the investor is less than
$100,000, or 10 percent of the annual income or net worth of
such investor, not to exceed a maximum aggregate amount sold of
$100,000, if the annual income or net worth of the investor is
equal to or more than $100,000; and (3) the transaction is
conducted through a broker or funding portal that complies with
specified requirements for intermediaries the issuer complies
with specified requirements for issuers (requiring that issuers
and intermediaries that facilitate transactions between issuers
and investors in reliance on Section 4(6) provide certain
information to investors and potential investors, take certain
other actions and provide notices and other information to the
SEC). (See 15 U.S.C. Sec. 77d(a)(6).)
Existing federal law , Title III of the JOBS Act, also added:
Exchange Act Section 3(h), which requires the Commission to
adopt rules to exempt, either conditionally or
unconditionally, "funding portals" from having to register as
brokers or dealers pursuant to Exchange Act Section 15(a)(1);
disqualification provisions under which an issuer would not be
able to avail itself of the Section 4(6) exemption if the
issuer or other related parties, including an intermediary,
was subject to a disqualifying event; and
Exchange Act Section 12(g)(6), which requires the Commission
to adopt rules to exempt from the registration requirements of
Section 12(g), either conditionally or unconditionally,
securities acquired pursuant to an offering made in reliance
on Section 4(6).
Existing law , California Securities Law of 1968, provides that
it is unlawful for any person to offer or sell in this state any
security in an issuer transaction, except as specified, unless
such sale has been qualified by the Commissioner of Corporations
(Commissioner), as specified, or unless the security or
transaction is covered by an express exemption or is not subject
to qualification. (Corp. Code Sec. 25110.) Existing law
provides for a private right of action for violation of Section
25110 of the Corporations Code requiring qualification with the
Commissioner, or for violation of a condition of qualification,
as specified. Existing law also provides for joint and several
liability for specified parties where such a violation has
occurred, including, among others, any person who materially
assists in any such violation. (Corp. Code Secs. 25503, 25504,
25504.1.)
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Existing law authorizes the qualification by notification of any
security issued by a person that is the issuer of a security
registered under the Securities Exchange Act of 1934 or issued
by an investment company registered under the Investment Company
Act of 1940, as specified. Existing law requires an application
for qualification by notification to contain the maximum amount
of securities proposed to be offered in California; consent to
service of process; information about any adverse order,
judgment, or decree entered in connection with the offering by
another state regulator, the SEC, or a court (if applicable);
and any additional information required by rule of the
commissioner. Existing law provides that if no stop order or
other order postponing or suspending the effectiveness of any
qualification is in effect, qualification of the sale of the
securities automatically becomes effective, and the securities
may be offered and sold in accordance with the application, on
the 10th business day after the application is filed or last
amended, or at an earlier time specified by the commissioner.
(Corp. Code Sec. 25112).
This bill would expand the above provision to allow for
"qualification by notification" of any offer or sale of any
security that meets all of the following criteria, independent
of whether or not the security otherwise is a registered
security under federal law:
The aggregate amount of securities sold to all investors by
the issuer within any 12-month period is not more than
$1,000,000.
The aggregate amount of securities sold to any investor by the
issuer, including any amount sold during the 12-month period
preceding the date of the transaction, does not exceed $5,000,
or a greater amount as the commissioner may provide by rule or
order, unless the investor is an accredited investor as
defined under federal law.
The offering meets the requirements of the federal exemption
for limited offerings and sales of securities not exceeding
$1,000,000 in Section 230.504 of Title 17 of the Code of
Federal Regulations.
The issuer files with the commissioner, provides to investors,
and makes available to potential investors the following:
o A Small Company Offering Registration disclosure
document on Form U-7, prior to the commencement of the
offering of securities. The issuer must ensure that the
cover page of Form U-7 includes all of the following
statements, in bold typeface no smaller than 12-point type:
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(1) the Commissioner of Business Oversight has in no way
passed upon the merits or qualifications of, or
recommended or given approval to, any person, security,
or transaction associated with this offering;
(2) the company described in this disclosure form is
seeking to raise a minimum offering of [insert minimum
offering amount]; and
(3) if the sum of the investment commitments received by
the company does not equal or exceed the minimum offering
amount by [insert date] your investment in the company
will be returned to you.
o Specified financial documents as follows:
(1) for offerings that, together with all other
offerings of the issuer within the preceding 12-month
period, have offering amounts of $100,000 or less in the
aggregate: the income tax returns filed by the issuer
for the most recently completed year, if any; and
financial statements of the issuer, certified by the
principal executive officer of the issuer to be true and
complete in all material respects;
(2) for offerings that, together with all other
offerings of the issuer within the preceding 12-month
period, have offering amounts between $100,000 and
$500,000: all financial statements reviewed by a public
accountant who is independent of the issuer, using
professional standards and procedures or standards and
procedures established by the commissioner by rule; and
(3) for offerings that, together with all other
offerings of the issuer within the preceding 12-month
period, have offering amounts of more than $500,000:
audited financial statements.
The issuer must set aside all funds raised as part of the
offering in a separate third party escrow account, to be held
in escrow until the time that the minimum offering amount is
reached. If the minimum offering amount is not reached within
one year of the effective date of the offering, the issuer
shall return all funds to investors.
Neither the issuer, a predecessor of the issuer, affiliate of
the issuer, nor specified persons with key roles in the
issuer's management or direction have been disqualified as bad
actors pursuant to subdivision (d) of 17 CFR Section 230.506.
Any other requirement set forth by rule adopted by the
commissioner.
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This bill would authorize courts to award treble or punitive
damages and require courts to award attorney's fees and costs to
a prevailing purchaser in an action brought against any person
who violates existing law prohibitions against offering or
selling securities in this state without being either qualified
or expressly exempted, for failure to comply with the provisions
of this bill.
COMMENT
1. Stated need for the bill
According to the author:
Small businesses are the backbone of the U.S. economy,
accounting for over two-thirds of new jobs nationally.
Unfortunately, California small businesses often lack access
to capital and rely heavily on bank financing, credit-card
debt, and tapping into their home equity and limited personal
finances for additional liquidity. The recent financial crisis
exacerbated this issue, and as a result small businesses faced
many challenges including declining business income and
reduction of their business credit line.
Offers and sales of securities must be qualified in California
Department of Business Oversight. However[,] in some cases,
offers or sales of security may be exempted from qualifying
with the Department. The most commonly used exemption for
raising capital in private offerings is Section 25102(f) of
the California Corporations Code. This section, however[,]
requires the investor to have a preexisting personal or
business relationship with the company or one or more of its
officers, directors or controlling persons, and prohibits
general solicitation or advertising of the offering.
These limitations on solicitations adversely impact small
businesses, especially women, minority-owned businesses and
disabled-veteran business enterprises that often do not have
preexisting relationships with capital sources or
high-net-worth relationships. Nor do they have the ability to
hire an investment banker who would be willing to raise modest
amounts of less than $1 million. While large businesses have
access to capital sources in the public and private equity
markets, the current laws in California make it difficult for
small businesses to access this vital source of business
funding. [ . . . ]
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AB 2096 seeks to allow start-up and emerging small businesses
to find investors who can provide capital to help them grow
and create jobs. This bill would add an equity crowdfunding
provision to the California Corporate Securities Law, and
would allow companies to contact potential investors, while
also allowing them to continue to use intermediary parties to
access capital. It will also provide investors with more
comprehensive disclosures than required under the JOBS Act.
AB 2096 would also include much needed investor protections.
To protect investors who are not "accredited" investors, such
as many senior citizens, AB 2096 places a limit of $5,000 on
the amount that a non-accredited investor may invest as well
as disclosure requirements.
In support, the sponsor of this bill, Small Business California,
and a coalition of supporters argue that "AB 2096 is designed to
allow start-up and emerging growth companies to find investors
who can provide the fuel for start-ups that have the capacity to
grow fast and create jobs, and to develop innovative new
technologies that will make our state more competitive in the
global economy." The proponents argue that the bill will
include investor protections that are lacking from the JOBS
Act's crowdfunding exemption. They assert that "[t]he proposed
California exemption will require companies to provide
substantially greater disclosure than is required under proposed
rules for implementing the federal crowdfunding exemption.
Finally, the proposed state legislation includes
disqualification under Rule 503(a) of Regulation D of the
Securities Act of 1933 (so-called 'bad boy' rules)." Lastly,
the proponents argue that "[w]hile large businesses have access
to capital sources in the public and private equity markets, the
current laws in California make it difficult for small
businesses to access this vital source of business funding."
2. Bill would deregulate California securities law in a manner
that potentially misleads investors and leaves seniors and
Main Street consumers vulnerable in hopes of helping start-ups
raise money through public advertisement and solicitation
This bill seeks to allow a person to raise up to $1 million in
securities for his or her business by way of advertising and
soliciting the general public for up to $5,000 per investor and
unlimited amounts to accredited investors, without having been
qualified as is traditionally required of securities offered and
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sold in California, and without having to seek an exemption
under California securities law. Rather, these securities would
be "qualified by notification"-a process otherwise reserved for
securities issued under federal law. AB 2096 would require that
the person seeking to raise capital under the provisions of this
bill provide a U-7 form making a specified disclaimer, and
certain financial documents to investors and potential
investors. Significantly, the bill contains no requirement for
ongoing disclosures to investors after funds are received and
used, as are required under the JOBS Act's crowdfunding title,
Title III.
Title III of the JOBS Act, known as the CROWDFUND Act, allows
start-ups and small businesses to raise no more than $1,000,000
in a 12-month period from solicited accredited and
non-accredited investors, through the use of registered
broker-dealers or funding portals as intermediaries, using
general solicitation and general advertising. Title III also
places limitations on this authorization, which operate to
protect investors, such as by providing investment caps allowing
investors to invest the greater of $2,000 or five percent of the
person's annual income or net worth, if the person's annual
income or net worth is less than $100,000 and 10 percent of
annual income or net worth not to exceed $100,000 if the
person's annual income or net worth is $100,000 or more. Title
III also requires that an issuer use an intermediary such as a
registered broker or funding portal (which are required to
provide educational materials and disclosures as prescribed by
rule to investors, as well as having investors verify their
understanding of the risk involved with crowdfunding offerings),
and requires that issuers file with the SEC and provide
investors specific disclosures. These disclosures not only
include the initial offering document, but they also require
on-going reporting of business operations, periodic updates,
amendments in the event material changes to the initial offering
are made, and annual financial statements. Such disclosures
provide investors important information that goes to the
financial condition and capital structure of the issuer, as well
as the stated purpose and intended use of the proceeds and the
target offering amount. Additionally, the SEC is expected to
issue final rules for the crowdfunding provisions of the JOBS
Act later this year.
As noted in Comment 1, this issue raised by this bill is in part
being framed as addressing the harm done by the federal JOBS
Act's crowdfunding exemption, by providing a more
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investor-protective California alternative. The author asserts
that:
The federal JOBS Act [ . . . ] created an exemption from
federal registration of securities offerings for equity
crowdfunding. In October 2013, the Securities Exchange
Commission (SEC) proposed long-awaited rules to implement the
new crowdfunding exemption. Equity crowdfunding, whereby a
company offers equity or a return on investment, is not legal
until the SEC adopts in final its proposed rules.
However, the SEC proposed rules do not allow the issuer to
advertise or use other means of general solicitation to find
investors. Instead, the rules limit the issuer to using a
notice that informs investors that it is conducting an
offering, and may only provide a brief description of the
company and the offering, and direct investors to the URL of
the intermediary crowdfunding site or platform. This limited
notice prevents small businesses from accessing capital.
Additionally, the JOBS Act crowdfunding exemption has very few
disclosure requirements to the investors, and could
potentially open the floodgates to fraud.
In contrast, the author argues that AB 2096 would allow start-up
and emerging small businesses to find investors who can provide
capital to help them grow and create jobs by adding an equity
crowdfunding provision to the California Corporate Securities
Law, allowing companies to contact potential investors
(including through the use of intermediary parties), and
providing investors with more comprehensive disclosures than
required under the JOBS Act. "To protect investors who are not
'accredited' investors, such as many senior citizens, AB 2096
places a limit of $5,000 on the amount that a non-accredited
investor may invest as well as disclosure requirements."
Directly contradicting this assertion, as reflected in Comment 3
below, opponents to this bill, such as AARP and the Public
Investors Arbitration Bar Association (PIABA), argue that this
bill will actually put those very seniors at risk, as many
seniors fall into the category of accredited investors due to
having accumulated a lifetime's worth of wealth that qualifies
them to become accredited investors irrespective of having
displayed any business acumen.
Staff notes that even if this bill is aimed at providing a
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better, more regulated, alternative after federal de-regulation,
the federal government has not yet released its final
regulations on the crowdfunding portion of the JOBS Act (Title
III). Arguably, to approve this legislation before it is seen
exactly what regulations the issuer must comply with in order to
fall under the crowdfunding exemption of the JOBS Act is
premature. Consumer Attorneys of California, in a letter of
concern, strongly suggests that because of the major changes to
the law that have resulted from the passage of the JOBS Act
which allow companies to advertise broadly when conducting
private placements, and in light of the fact that the
regulations implementing the Act have not yet been issued, the
Legislature should wait until it can evaluate the federal law
and its impact. "It doesn't make sense at this point to pass
legislation that may conflict or be superseded by the federal
law. The SEC proposed regulations for the crowd funding
exemption under Title III of the JOBS Act last October. The
public comment period closed this past February, and final
regulations are expected later this year."
Ultimately, even if the federal government has taken such a
drastic step towards deregulation, it does not mean that such a
change is appropriate in California. Assuming, momentarily,
that this bill would in fact provide greater regulation than the
federal government does with respect to crowdfunding, and
assuming that issuers would elect to use California's more
onerous crowdfunding qualification process than its lax federal
counterpart, it remains undeniable that this bill would
nonetheless result in a deregulation of California's own
securities law. This is particularly troubling, given the
arguably increased chance of failure of new start-up companies
that have gone through absolutely no merit review vetting
process by the Commissioner of Business Oversight. Again, as
noted in Comment 3 below, adequate investor protections against
fraud are crucial, as successful savers are not necessarily
sophisticated investors. As such, this bill fundamentally
raises a policy question as to whether this Legislature should
deregulate California securities laws at the risk of misleading
investors and leaving seniors and consumers vulnerable, in hopes
of helping start-ups raise money through public advertisement
and solicitation.
SHOULD CALIFORNIA WEAKEN ITS SECURITIES LAW THAT CURRENTLY
PROTECTS SENIORS AND CONSUMERS?
3. Opposition to this bill from seniors, consumer rights
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group, and attorneys for victims of investment fraud
The Consumer Federation of California, in opposition,
writes that "AB 2096 would create a form of crowdfunding in
California that allows for the general solicitation and
general advertising of exempt security offerings by
issuers, including those who would otherwise be
disqualified as a 'bad actor' under federal law.
Specifically, this bill allows an issuer to solicit to an
un-accredited investor for up to $5,000 and allows 'bad
actors' who have a history of harming investors to solicit
through crowdfunding. This bill diminishes investor
protections and exposes the most vulnerable, un-experienced
and non-accredited consumers to risky securities."
Also in opposition to the bill, the AARP adds that "this
proposal places the life savings of older Californians at
significant risk by potentially exposing them to promoters of
risky securities. AARP is concerned that allowing general
solicitation and general advertising of exempt security
offerings diminishes investor protections and places seniors at
a significant risk. Successful savers are not necessarily
sophisticated investors. Entities that cannot raise capital
from lending institutions or venture capital sources should not
be turned loose on an unwary public without appropriate
oversight."
PIABA writes that "[o]n a daily basis in our practices [as
attorneys who represent victims of investment frauds and
stockbroker and financial planner misconduct], we see
devastating losses resulting from violations of investor
protection laws and regulations that govern the securities
industry and issuers of securities. Disproportionately, those
losses fall on elderly and vulnerable savers and investors."
PIABA's letter in opposition further emphasizes the following
points:
First, PIABA argues that under longstanding California law, the
only securities deemed "qualified by notification" have been
securities of the federal SEC reporting companies (i.e. large,
public, companies) and "investment companies" (generally mutual
funds and the like) subject to strict federal regulation under
the Investment Companies Act of 1940. If AB 2096 is enacted,
PIABA warns, "qualification by notification" under California
law will no longer refer to securities that don't need
California oversight because of the extensive federal oversight
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to which they already have been and are being subjected. Moving
forward, it would mean something else entirely: "securities that
have not received any federal scrutiny or oversight whatsoever
and have not received any of the state scrutiny and oversight
that the word "qualification" has meant for at least the 45
years since California Corporate Securities Law was enacted."
In other words, "securities of start-ups or cookie-cutter
investment programs will be able to be sold as 'qualified by
notification' just like the large publicly-held companies that
for decades have worn that label legitimately. It is not fair
to trick California's saving and investing public with such a
radical and illogical change." PIABA asserts that the bill would
invariably mislead potential investors who have long understood
that a registered or qualified offering "has received
substantial scrutiny from regulators who are knowledgeable about
the pitfalls of investment programs and can require promoters to
structure things in a way that makes failures and catastrophic
losses less likely."
Relatedly PIABA argues that the June 9th amendments to the bill
to add language to the U-7 form that the "Commissioner of
Business of Oversight has in no way passed upon the merits or
qualifications of, or recommended or given approval to, any
person, security, or transaction, associated with this offer"
will do nothing to remedy the concern about misleading the
public about whether the offering is "qualified" in the
traditional sense. Essentially, PIABA argues that just by using
the term qualified for these offerings, no matter what
disclosures you provide to the point that the Commissioner has
not in fact ruled on the merits or qualifications of the
offering, sophisticated investors will believe that the offering
has been qualified, and unsophisticated parties will assume that
qualified is preferred because it is better than "unqualified."
Others who take the time to read the language, PIABA fears, will
assume that this is just boilerplate language "because it is
well known that 'qualified' means the offering has received
meaningful scrutiny." To this end, PIABA argues that despite
the sponsor's effort to frame this bill as a "qualification" or
"qualification by notification" bill, this is ultimately a bill
geared at creating an exemption to the qualification
requirements that these companies would otherwise have to comply
with under existing law.
Second, PIABA expresses significant concern with the risk that
this bill poses to investors, and namely accredited investors,
whose status relates more so to their age and accumulated wealth
AB 2096 (Muratsuchi)
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over a lifetime, than to their business acumen. Specifically
PIABA argues that the permission granted by AB 2096 for general
solicitation and advertising "represents a dramatic rollback in
the longstanding protection of California's savers and
investors. This kind of advertising that will be used if AB
2096 passes will put large numbers of Main Street savers and
investors at risk, whether they are accredited investors or not.
But accredited investors will be at the greatest risk, because
the limits on the amount invested will not apply to them. And
being an 'accredited investor' is by no means any kind of
protection against fraud and wrongdoing. Rather, one's status
as an 'accredited investor' is based primarily on an outdated
computation of net worth. It offers no guarantee or even
likelihood of investment sophistication or the ability to
evaluate risky but legitimate startup ventures, let alone the
profusion of highly speculative, cookie-cutter capital-raising
programs that will spring up to take advantage of the new
exemption. Because it indicates far less about investment
acumen than it does about assets, accredited investor status
correlates best with age. Elderly retirees make up a
disproportionately large percentage of people who meet the
definition of accredited investors [ . . . ]." Similar to the
AARP, PIABA argues, "one should question whether businesses
should be permitted to find capital for ventures that are too
risky for traditional funding sources by targeting the life
savings of senior citizens and retirees who cannot replace the
savings they lose."
In a letter of concern, the Consumer Attorneys of California
(CAOC) writes that "AB 2096 makes major changes to California
law on securities transactions. Current law requires that
certain securities offered or sold in California be either
qualified (through an application process with the Commissioner
of Corporations), or to be exempt. (Corporations Code Sec.
25110.) Our concerns stem from the foreseeable consequence of
weakening the current law. Given the intricacies of securities
law and our nation's repeated bad experiences with an
under-regulated financial services industry, changes that
further deregulate securities offerings must be scrutinized
closely and the proponents should be required to show by clear
evidence the necessity for and safety of their proposed changes.
We do believe the bill could benefit from a closer look at
foreseeable consequences including harm to seniors who qualify
as 'accredited investors' based on their assets, but who do not
have the financial sophistication to protect their life
savings."
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4. Fundamental issues regarding ability of purchasers to seek
redress
Although this bill includes opportunity for a prevailing
investor to recoup attorney's fees and permits courts to also
grant treble and punitive damages, this Committee should
consider whether there is a likelihood of an investor actually
recovering any amount of the money lost to the issuer, given
that an unscrupulous, or unlucky (given that these are start-up
ventures) issuer may not have any funds from which to pay the
damages owed pursuant to this bill. That difficulty arises from
the reality that any investor is unlikely to question a
transaction as long as the business is successful (and there is
a return on investment). If a business that was portrayed as
promising suddenly fails (thus leaving the person with a
valueless security), investors may at that point seek legal
advice to examine the transaction. Thus, any investor seeking
to bring an action for violation of this bill likely would be
doing so against a business that is having serious financial
trouble either after a potentially significant amount of time,
or immediately after they were unable to even get off the ground
running. Due to the lack of assets, or the potential lapsing of
the applicable statute of limitations in the alternative, those
injured investors could face significant difficulties in
recovering any damages lawfully owed to them under the
enforcement provisions of this bill.
ARE INVESTORS LIKELY TO RECOVER FOR A VIOLATION OF THIS BILL IF
THE BUSINESS HAS FAILED?
5. Existing options for raising capital under California
securities laws
As noted in Comment 1, part of the impetus for this bill is the
claim is based upon the assertion that while large businesses
have access to capital sources in the public and private equity
markets, the current laws in California make it difficult for
small businesses to access this vital source of business
funding.
First, there is an argument to be made that perhaps this state
should not allow general advertising and solicitation of
offerings, under the potentially misleading misnomer of
"qualified" or "qualified by notification" offerings where no
such merit review has been performed to actually qualify a
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security under California law and where there has been no
compliance with the registration requirements under federal law.
Moreover, staff notes that California law, as is, is not without
options for small start-ups seeking to raise capital. Under
existing Section 25113 Government Code, the securities permit
process allows for all securities to be qualified by permit and
thereafter offered and sold to the general public as long as
certain minimum standards are met, such as review by the
Commissioner for investor suitability and due diligence
standards. For small businesses seeking to raise up to
$1,000,000 during a 12-month period from the public, in addition
to the general securities permit process, there is also the
availability of what is known as the Small Company Offering
Registration (SCOR) permitting process. Under this process, and
just as would be required under this bill, a form U-7 must be
completed by the business. Under this SCOR permit, a start-up
could offer and sell to the public, up to $2,500 per investor,
without facing the net worth or suitability requirements that
would otherwise apply. Unlike with this bill, however, SCOR
permit offerings must be reviewed and approved by the
Department. (See Gov. Code Sec. 25113(a)-(b), Cal. Code Regs.
Sec. 260.140.01.)
6. What is crowdfunding ?
According to the SEC, crowdfunding "is a new and evolving method
to raise money using the Internet. Crowdfunding serves as an
alternative source of capital to support a wide range of ideas
and ventures. An entity or individual raising funds through
crowdfunding typically seeks small individual contributions from
a large number of people. A crowdfunding campaign generally has
a specified target amount for funds to be raised, or goal, and
an identified use of those funds. Individuals interested in the
crowdfunding campaign - members of the 'crowd' - may share
information about the project, cause, idea or business with each
other and use the information to decide whether or not to fund
the campaign based on the collective "'wisdom of the crowd.'"
(SEC's Proposed Rules on Crowdfunding (Oct. 2013)
[as of
Jun. 20, 2014] p.6, internal citations omitted.)
Staff notes that it is unclear whether this bill is a
crowdfunding bill, as it permits general solicitation and
advertisement of securities offerings within specified limits
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but does not otherwise have any provisions specifically
pertaining to crowdfunding activities, unlike the JOBS Act-which
requires, for example, that an intermediary, such as a
registered broker-dealer or funding portal be used (e.g.
Kickstarter).
Support : California Artisanal Distiller Guild; California Asian
Pacific Chamber of Commerce; California Association of
Micro-Economic Opportunity; California Association of
Competitive Telecommunications Companies; California Disabled
Veteran Business Alliance; California Fence Contractors'
Association; California Chapter of American Fence Association;
California Metals Coalition; Coalition of Small and Disabled
Veteran Businesses; Flasher Barricade Association; Greater Geary
Boulevard Merchants & Property Owners Association; Marin
Builders Association; National Federation of Independent
Business; North East Mission Business Association; San Francisco
Chamber of Commerce; San Francisco Council of District Merchants
Association; San Francisco Builders Exchange; Small Business
Majority; South Bay Entrepreneurial Center; Torrance Area
Chamber of Commerce; one individual
Opposition : AARP; Consumer Federation; Public Investors
Arbitration Bar Association
HISTORY
Source : Small Business California
Related Pending Legislation : None Known
Prior Legislation :
AB 783 (Daly, 2013) would have authorized a new exemption for
persons seeking to offer or sell securities using any form of
general solicitation or advertising, including unsolicited calls
to a person's residence or cellular phone, provided that sales
of the securities were made only to persons who the issuer took
reasonable steps to verify were accredited investors. The bill
died in the Assembly Banking & Finance Committee.
AB 2081 (Allen, 2012), similar to AB 783, would have created an
exemption to allow issuers to offer or sell securities using any
form of general solicitation or advertising, and to make
unsolicited calls to a person's residence or cell phone, if
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reasonable steps were taken prior to the call to verify that the
person is an accredited investor, and the transaction met
certain requirements. The bill failed passage on the Senate
Floor.
SB 875 (Price, 2010), similar to AB 783, would have exempted
securities offerings or sales using general solicitation or
advertising if the issuer believed, after reasonable inquiry,
the person is an accredited investor and the transaction met
certain requirements. The bill died in the Senate Banking &
Financial Institutions Committee.
AB 1644 (Campbell and Briggs, 2001) was similar to AB 783. The
bill failed passage in the Assembly Banking and Finance
Committee.
Prior Vote :
Senate Banking & Financial Institutions Committee (Ayes 7, Noes
2)
Assembly Floor (Ayes 75, Noes 0)
Assembly Appropriations Committee (Ayes 17, Noes 0)
Assembly Banking & Finance Committee (Ayes 12, Noes 0)
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