BILL ANALYSIS                                                                                                                                                                                                    Ó



                                                                     AB 722


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          Date of Hearing:  April 28, 2015


                           ASSEMBLY COMMITTEE ON JUDICIARY


                                  Mark Stone, Chair


          AB 722  
          (Perea) - As Amended April 22, 2015


          SUBJECT:  SECURITIES TRANSACTIONS:  QUALIFICATION BY PERMIT


          KEY ISSUE:  SHOULD CALIFORNIA CREATE A NEW "CROWDFUNDING" PERMIT  
          TO ALLOW FOR THE OFFER AND SALE OF RELATIVELY INEXPENSIVE  
          EQUITY-BASED SECURITIES UNDER THE STATE'S CORPORATE SECURITIES  
          LAW WITHOUT THE CONSUMER PROTECTIONS THAT APPLY TO THE OFFER AND  
          SALE OF OTHER SECURITIES? 

                                      SYNOPSIS


          State law makes it a crime for any person to offer or sell any  
          security in this state, unless such offering or sale has been  
          qualified by the commissioner of the Department of Business  
          Oversight (DBO), or the offering or sale is allowed by an  
          express exemption from the qualification requirement.  AB 722  
          would authorize an applicant to file an application to qualify  
          for the offer or sale of a security by obtaining a  
          "crowdfunding" permit from the DBO if certain conditions were  
          met, including that the total offering of securities by the  
          applicant to be sold in a 12-month period was limited to one  
          million dollars ($1,000,000); the aggregate amount of securities  
          sold to any investor did not exceed the lesser of five thousand  
          dollars ($5,000) or ten percent of the net worth of that person;  
          and the issuer did not, directly or indirectly, conduct any  








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          unsolicited telephone solicitation of the securities. However,  
          the proposed requirements and safeguards on the sale of these  
          financial products are significantly less rigorous than either  
          current state law, or under proposed federal "crowdfunding"  
          regulations. California currently offers the Small Corporate  
          Offering Registration (SCOR) program that is designed to help  
          small businesses raise capital.  It requires that SCOR offerings  
          (one million dollars or less) must be qualified by the  
          Commissioner of DBO.  Applicants who satisfy SCOR conditions  
          must use a standard disclosure form (Form U-7).  According to  
          supporters of this bill, the SCOR program is perceived as time  
          consuming and burdensome.  Over the years, DBO has received very  
          few applications on an annual basis.  Meanwhile, the SEC is in  
          the process of adopting new regulations to implement the  
          requirements of Title III of the Jumpstart Our Business Startups  
          (JOBS) Act.  The proposed new rules, which would govern the  
          offer and sale of unregistered securities, would require issuers  
          to use funding portals and brokers as intermediaries in the  
          offer and sale of securities.  A group of 26 small business  
          organizations and advocates argue in support of this bill  
          because they say early-stage financing is critically important  
          today because with the advances in technology, seed financing of  
          even a few hundred thousand dollars can be sufficient to get a  
          small business off the ground.  AARP opposes this bill because  
          it says that the bill places the life savings of older  
          Californians at significant risk by potentially exposing them to  
          promoters of risky securities. There is wide support for this  
          bill from the small business community and local chamber of  
          commerce associations, such as the Small Business California and  
          the National Federation of Independent Business.  Organizations  
          that advocate for the elderly and consumers, including AARP,  
          CANHR, and the Public Investors Arbitration Bar Association, are  
          in opposition to this bill. 


          SUMMARY:  Creates a new qualification by permit under  
          California's Corporate Securities Law of 1968 to allow the  
          offering and sale of securities.  Specifically, this bill:  









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          1)Provides that any offer or sale of any security that meets the  
            following criteria may be qualified by permit:


             a)   An applicant may file an application for a  
               "crowdfunding" permit if it meets the following conditions:


               i)     The applicant is a California corporation or a  
                 foreign corporation, as specified; the applicant is not  
                 issuing fractional undivided interests in oil and gas  
                 rights, or a similar interest in other mineral rights;  
                 the applicant is not an investment company subject to the  
                 Investment Company Act of 1940; and the applicant is not  
                 subject to the reporting requirements of as specified in  
                 the Securities Exchange Act of 1934. 


               ii)    Provides that the total offering of securities by  
                 the applicant to be sold in a 12-month period, within or  
                 outside this state, is limited to $1,000,000, less the  
                 aggregate offering price for all securities sold within  
                 the 12 months before the start, and during the offering  
                 of the securities.  


               iii)   Offers and sales cannot be integrated with prior  
                 offers or sales of securities or subsequent offers or  
                 sale of securities, as specified.


               iv)    Prohibits the securities sold during a 12-month  
                 period to any investor from exceeding the lesser of  
                 $5,000 or 10% of the net worth of that natural person or  
                 such amount as the commissioner of the Department of  
                 Business Oversight (DBO) may provide by rule or order.










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               v)     States "net worth" shall be determined exclusive of  
                 home, home furnishings, and automobiles.  Other assets  
                 includes in the computation of net worth may be valued at  
                 the fair market value.  


               vi)    Requires the issuer to take reasonable steps to  
                 ensure that each investor who is a natural person who is  
                 not an accredited investor has knowledge and experience  
                 in financial business matters that he or she is capable  
                 of evaluating the merits and risks of the prospective  
                 investment. 


               vii)   Requires the issuer to file with the commissioner  
                 and provide to investors a Small Company Offering  
                 Registration (SCOR) disclosure document on Form U-7,  
                 prior to the commencement of the offering of securities.


               viii)  Requires the issuer to set aside in a separate  
                 third-party escrow account all funds raised as part of  
                 the offering to be held in escrow until that time of  
                 minimum offering amount is reached.  The issuer shall  
                 return all funds if the minimum offering amount is not  
                 reached within one year.  


               ix)    Prohibits an issuer from conducting unsolicited  
                 telephone calls.


               x)     Prohibits an issuer and others as specified from  
                 being disqualified as a "bad actor" under federal  
                 regulations.  


               xi)    Any other requirement set forth by rule adopted by  
                 the commissioner of DBO. 








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             b)   Provides that if the commissioner does not issue a stop  
               order then the qualification of the sale of the securities  
               become effective at noon of the 60th day after the filing  
               of the application.  


          2)Imposes a filing fee of $200 plus 1/5th of 2% of the aggregate  
            value of the securities sought to be sold in California for  
            qualification of the sale of securities by permit.  


          3)Requires the court to award reasonable attorney's fees and  
            costs, and authorizes the award of treble and punitive  
            damages, to a prevailing purchaser in an action brought  
            against any person who violates conditions of qualification by  
            permit.  


          4)Provides that a plaintiff is not required to plead or prove  
            that the defendant acted with scienter. 


          EXISTING FEDERAL LAW:  


          1)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.   

           2)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.   
           










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          3)Requires those who offer (i.e. advertise or market) and sell  
            securities to be licensed as investment advisers or  
            broker-dealers, unless either the transaction or the activity  
            being undertaken is exempt from the licensing requirement.
           
           4)Provides in Regulation D, one of the regulations promulgated by  
            the SEC to implement the Securities Act of 1933, a series of  
            exemptions from the registration requirements of the Securities  
            Act of 1933 and includes eight rules, denoted Rules 501 through  
            508, which are codified as 17 CFR 230.501 through 230.508.   
           
              a)   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 million, and other large, financially  
               sophisticated entities.  An accredited investor also includes:
              
                   i)        Any natural person whose individual net worth, or  
                    joint net worth with that person's spouse, exceeds $1  
                    million at the time of their purchase of securities,  
                    exclusive of their primary residence; or,
                   
                   ii)       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.
                   
              b)   Rule 504 of Regulation D authorizes the offer and sale of up  
               to $1 million in securities by an issuer, as long as the offer  
               and sale is made: 
              
                   i)        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 (the  
                    provision of Rule 504 applicable to this bill);
                   








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                   ii)       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,
                  
                   iii)      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 is the provision of Rule 504 that was  
                    applicable to prior bills sponsored by this bill's  
                    sponsor).  
                   
           1)Pursuant to the Jumpstart Our Business Startups (JOBS) Act (Public  
            Law 112-106), 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.  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.  
           
           EXISTING STATE LAW:


          1)Provides that it is unlawful for any person to offer or sell  
            any security in this state, unless such offering or sale has  
            been qualified by the commissioner, as specified below, or  
            unless the offering or sale is covered by an express  
            exemption.  (Corporations Code Section 25110.  All further  
            statutory references are to the California Corporations Code,  
            unless otherwise indicated.)

          2)Authorizes the "qualification by notification" of any security  
            issued by a person that is the issuer of a security registered  








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            under Section 12 of the Securities Exchange Act of 1934, or  
            issued by an investment company registered under the  
            Investment Company Act of 1940. (Section 25112.)  

             a)   Requires an application 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. 

             b)   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  
               tenth business day after the application is filed.  

          1)Establishes "qualification by permit," in which all  
            securities, whether or not eligible for qualification by  
            coordination under Section 25111, or qualification by  
            notification under Section 25112, may be qualified by permit  
            under this section. (Section 25113.)

          2)Contains a number of exemptions from the requirement  
            immediately above.  Two of the most relevant exemptions for  
            purposes of this bill include Sections 25102(f) and 25102(n).

             a)   25102(f) provides an exemption for any offer or sale of  
               any security in a transaction that meets all of the  
               following criteria:  i) sales of the security are made to  
               an unlimited number of accredited investors and up to 35  
               other persons, who are not accredited investors; ii) all  
               purchasers either have a pre-existing personal or business  
               relationship with the offeror, or can reasonably be assumed  
               to have the capacity to protect their own interests in  
               connection with the transaction, by reason of their  
               business or financial experience, or the business or  








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               financial experience of their professional advisers; iii)  
               each purchaser represents that he or she is purchasing for  
               his or her own account, and not with a view to or for sale  
               in connection with any distribution of the security; and  
               iv) the offer and sale of the security is not accomplished  
               through the publication of any advertisement.  

             b)   25102(n) provides an exemption for any offer or sale of  
               any security in a transaction that meets all of the  
               following criteria:  i) the issuer is not a blind pool  
               issuer, as that term is defined by the commissioner; ii)  
               sales of securities are made only to qualified purchasers  
               or other persons the issuer reasonably believes to be  
               qualified purchasers; iii) each purchaser represents that  
               he or she is purchasing for his or her own account, and not  
               with a view to or for sale in connection with any  
               distribution of the security; iv) each natural person  
               purchaser is provided with a disclosure statement that  
               meets the disclosure requirements of federal Regulation D,  
               at least five business days before they purchase or commit  
               to purchase the security; v) the offer and sale of the  
               security is made by way of a general announcement, whose  
               content is strictly limited; and vi) telephone solicitation  
               by the issuer is not permitted, until and unless the issuer  
               determines that the prospective purchaser being solicited  
               is a qualified purchaser. 



          3)Defines "qualified purchasers" as those who meet one or more  
            of several criteria listed in subdivision (n).  Generally  
            speaking, these criteria describe persons with some degree of  
            financial sophistication, though the qualified purchaser bar  
            is lower than the accredited investor bar.  As an example, an  
            individual is a qualified purchaser if that person  
            individually, or jointly with their spouse, has a minimum net  
            worth of $250,000 and had, during the immediately preceding  
            tax year, gross income in excess of $100,000, and reasonably  
            expects gross income in excess of $100,000 during the current  








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            tax year.  Alternately, the term applies to individuals who  
            have a minimum net worth of $500,000, exclusive of their home,  
            home furnishings, and automobiles.  Natural persons are  
            limited to investing no more than 10% of their net worth in  
            any 25012(n) investment.

          According to DBO, between 20 and 50 people file forms with DBO  
            annually, claiming exemptions pursuant to Section 25102(n).

          4)Provides a fee of $2,500 for filing an application for  
            qualification of the sale of securities by permit.  (Section  
            25608.)

          FISCAL EFFECT:  As currently in print this bill is keyed fiscal.


          COMMENTS:  Under existing law, there are only three ways to  
          qualify a securities offering to the public, all of which  
          require significant review by either the federal SEC or the  
          state's DBO.  Those three ways include coordination, which  
          involves offerings registered under the Federal Securities Act  
          of 1933; notification, which involves securities registered  
          under Section 12 of the Securities Exchange Act of 1934, or  
          investment companies registered under the Investment Company Act  
          of 1940; and permitting, a rigorous and often costly process in  
          which applicants apply to the DBO for a permit that is good for  
          one year.  (Sections 25211-25213.)  According to DBO, only 130  
          permit applications (under Section 25213) were filed with the  
          DBO in 2013.  





          AB 722 seeks to amend the rules governing qualification by  
          permitting.  Under existing law, an applicant turns in a permit  
          application to offer securities.  The DBO has 60 days to approve  
          the application, should the review process take longer than 60  
          days, the offers automatically become effective on the 60th day.  








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          According to the author, this bill, sponsored by Small Business  
          California, seeks to allow small businesses and start-ups to  
          more readily access capital.  AB 722 is similar to bills  
          advanced by the same sponsors in previous years, but it takes a  
          different approach.  In previous years, the sponsors attempted  
          to secure an exemption from state securities laws to authorize  
          general solicitation and general advertising to accredited  
          investors.  Last year, the sponsors attempted to secure a  
          qualification by notification, under which issuers can use  
          general solicitation and general advertising to attract both  
          accredited and non-accredited investors.  This year, through AB  
          722 the sponsors are attempting "qualification by permit" under  
          which issuers can use general solicitation and general  
          advertising (excluding unsolicited telephone calls) to attract  
          both accredited and non-accredited investors.  In addition, AB  
          722 uses the term "crowdfunding."  As explained below, it is  
          unclear how the sales practices anticipated by the bill would be  
          considered to be "crowdfunding."  





          Is This Actually Crowdfunding?  Crowdfunding is a collective  
          cooperation of people who network and pool their money and  
          resources together, usually via the internet, to support efforts  
          initiated by other individuals or organizations. Crowdfunding  
          literally attracts a "crowd" of people, each of whom makes a  
          small contribution to a business by donating money towards an  
          online funding target.  Crowdfunding has become a popular and  
          alternative method of raising finance for a business, real  
          estate investments, projects or ideas and has become popularized  
          online by sites such as Kickstarter, Wefunder, Crowdfunder, and  








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          RockthePost.


          


          Crowdfunding is a means to raise money by attracting relatively  
          small individual contributions from a large number of people.   
          In recent years, crowdfunding websites have proliferated to  
          raise funds for charities, artistic endeavors and businesses.  
          These sites do not offer securities, such as an ownership  
          interest or share of profits in a business.  Rather, they raise  
          money in the form of donations, or in return for the product  
          being made and delivered to the donor.  





          While the goal of this measure is admirable--providing increased  
          access to capital for small businesses--the risks associated  
          with the measure could be at the expense of those most  
          vulnerable, un-sophisticated non-accredited and accredited  
          investors.  AB 722 has a cap of $5,000 which weakens the ability  
          for an issuer to take an investor's lifesavings, but small  
          business investments have even greater risk than normal.  About  
          50 % of all small businesses fail within the first five years  
          according to a crowdfunding warning document issued by the North  
          American Securities Administrators Association (NASAA).   





          AB 722 does not provide for a platform or portal to solicit  
                                                                                   accredited and non-accredited investors.  AB 722 does require  
          issuers to place the investment in a third-party escrow account  
          instead but the measure is vague on who the escrow holder would  
          be, what protections would exist and what disclosures would be  








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          required by the escrow holder.  Since a platform is not used it  
          is not clear what method an issuer would use as far as general  
          solicitation and general advertising under AB 722.  Title III of  
          the JOBS Act along with AB 722 expands securities to  
          equity-based crowdfunding.  The public most often views  
          crowdfunding as donation based.  


          
          Chart below lays out important pieces of both Title III of the  
          Jobs Act and AB 722
          


           ------------------------------------------------------------------ 
          |                        | Title III of JOBS  |       AB 722       |
          |                        |        Act         |                    |
          |------------------------+--------------------+--------------------|
          |Nature of Authorization |Exemption from      |Qualification by    |
          |                        |registration        |Permit              |
          |                        |requirements of the |                    |
          |                        |Securities Act of   |                    |
          |                        |1933                |                    |
          |------------------------+--------------------+--------------------|
          |Maximum Total Value of  |$1 million per      |$1 million per      |
          |Securities That May Be  |12-month period     |12-month period     |
          |Sold In Reliance on the |                    |                    |
          |Authorization           |                    |                    |
          |------------------------+--------------------+--------------------|
          |Maximum Aggregate Value |Investors with      |Non-accredited      |
          |of Securities That May  |annual income or    |investors:  $5,000  |
          |Be Sold to a Single     |net worth <$100K:   |or a greater amount |
          |Investor                |greater of $2K or   |as determined by    |
          |                        |5% of annual income |the commissioner.   |
          |                        |or net worth.       |                    |
          |                        |                    |Accredited          |
          |                        |Investors with      |investors:  No      |
          |                        |annual income or    |limit other than    |
          |                        |net worth of $100K  |the $1 million cap. |








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          |                        |or more:  10% of    |                    |
          |                        |annual income or    |                    |
          |                        |net worth, not to   |                    |
          |                        |exceed $100K.       |                    |
          |------------------------+--------------------+--------------------|
          |Is An Intermediary      |Yes.  Transactions  |No                  |
          |Required?               |must be conducted   |                    |
          |                        |through a           |                    |
          |                        |registered broker   |                    |
          |                        |or a registered     |                    |
          |                        |funding portal.     |                    |
          |------------------------+--------------------+--------------------|
          |Requirements Applicable |Broker or portal    |N/A                 |
          |to Intermediaries       |must register with  |                    |
          |(these requirements     |the SEC and FINRA;  |                    |
          |will be clarified and   |provide specified   |                    |
          |may be augmented by the |disclosures to      |                    |
          |SEC when it finalizes   |investors; ensure   |                    |
          |its crowdfunding        |that each investor  |                    |
          |regulations)            |reviews specified   |                    |
          |                        |education           |                    |
          |                        |information that    |                    |
          |                        |will be established |                    |
          |                        |by the SEC by       |                    |
          |                        |regulation and      |                    |
          |                        |affirms that they   |                    |
          |                        |understand the      |                    |
          |                        |risks of the        |                    |
          |                        |investment they are |                    |
          |                        |about to undertake; |                    |
          |                        |perform background  |                    |
          |                        |checks on persons   |                    |
          |                        |with key management |                    |
          |                        |roles in the        |                    |
          |                        |issuer's            |                    |
          |                        |organization; make  |                    |
          |                        |key information     |                    |
          |                        |provided by the     |                    |
          |                        |issuer available to |                    |








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          |                        |investors; ensure   |                    |
          |                        |that all offering   |                    |
          |                        |proceeds are only   |                    |
          |                        |provided to the     |                    |
          |                        |issuer when the     |                    |
          |                        |aggregate capital   |                    |
          |                        |raised from all     |                    |
          |                        |investors is equal  |                    |
          |                        |to or greater than  |                    |
          |                        |a target offering   |                    |
          |                        |amount, and allow   |                    |
          |                        |investors to cancel |                    |
          |                        |their commitments   |                    |
          |                        |to invest in        |                    |
          |                        |accordance with     |                    |
          |                        |rules to be         |                    |
          |                        |promulgated by the  |                    |
          |                        |SEC; undertake      |                    |
          |                        |efforts to ensure   |                    |
          |                        |that no individual  |                    |
          |                        |investor exceeds    |                    |
          |                        |the maximum         |                    |
          |                        |allowable purchase  |                    |
          |                        |of crowdfunding     |                    |
          |                        |offerings; protect  |                    |
          |                        |the privacy of      |                    |
          |                        |information         |                    |
          |                        |collected from      |                    |
          |                        |investors; refrain  |                    |
          |                        |from compensating   |                    |
          |                        |promoters, finders, |                    |
          |                        |or lead generators  |                    |
          |                        |for providing the   |                    |
          |                        |broker or funding   |                    |
          |                        |portal with         |                    |
          |                        |personal            |                    |
          |                        |identifying         |                    |
          |                        |information about   |                    |
          |                        |any potential       |                    |








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          |                        |investors; and      |                    |
          |                        |prohibit its        |                    |
          |                        |directors,          |                    |
          |                        |officers, or        |                    |
          |                        |partners from       |                    |
          |                        |having any          |                    |
          |                        |financial interest  |                    |
          |                        |in an issuer using  |                    |
          |                        |its services.       |                    |
          |------------------------+--------------------+--------------------|
          |Requirements Applicable |Issuers must file   |Issuers must file   |
          |to Issuers              |with the SEC and    |with the            |
          |                        |provide to          |commissioner and    |
          |                        |investors and the   |provide to          |
          |                        |broker or funding   |investors a Small   |
          |                        |portal all of the   |Company Offering    |
          |                        |following: key      |Registration Form   |
          |                        |information about   |U-7.  The U-7 is a  |
          |                        |the identity of the |37-page document    |
          |                        |issuer, its key     |(not including      |
          |                        |owners and          |attachments) that   |
          |                        |management          |includes            |
          |                        |personnel, its      |information about   |
          |                        |business plan, a    |the issuer, its     |
          |                        |description of the  |management, and its |
          |                        |financial condition |business plan, and  |
          |                        |of the issuer (see  |about the offering, |
          |                        |detail below); a    |including a         |
          |                        |description of the  |description of the  |
          |                        |stated purpose and  |purpose and         |
          |                        |intended use of the |intended use of the |
          |                        |proceeds of the     |proceeds of the     |
          |                        |offering; the       |offering.           |
          |                        |target offering     |According to this   |
          |                        |amount, deadline to |bill's sponsor, the |
          |                        |reach the target    |two key             |
          |                        |offering amount,    |requirements of the |
          |                        |and regular updates |U-7 that are not    |
          |                        |regarding the       |required by Title   |








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          |                        |progress of the     |III of the JOBS Act |
          |                        |issuer in meeting   |are the requirement |
          |                        |the target          |that the issuer     |
          |                        |offering; the price |describe what it    |
          |                        |to the public of    |must do to meet key |
          |                        |the securities      |milestones and      |
          |                        |being offered; a    |describe how it     |
          |                        |description of the  |will use the        |
          |                        |ownership and       |offering proceeds   |
          |                        |capital structure   |if only the minimum |
          |                        |of the issuer, and  |offering amount is  |
          |                        |including a         |raised.             |
          |                        |description of      |                    |
          |                        |specified risks to  |Issuers must return |
          |                        |purchasers.         |all money raised    |
          |                        |                    |from investors, if  |
          |                        |Issuers are         |they do not raise   |
          |                        |prohibited from     |enough to meet      |
          |                        |advertising the     |their minimum       |
          |                        |terms of the        |offering amount.    |
          |                        |offering, except    |                    |
          |                        |through notices     |                    |
          |                        |that direct         |                    |
          |                        |investors to the    |                    |
          |                        |broker or funding   |                    |
          |                        |portal.  Direct     |                    |
          |                        |solicitation of     |                    |
          |                        |investors is not    |                    |
          |                        |allowed.            |                    |
          |                        |                    |                    |
          |                        |Issuers are         |                    |
          |                        |prohibited from     |                    |
          |                        |compensating or     |                    |
          |                        |committing to       |                    |
          |                        |compensate,         |                    |
          |                        |directly or         |                    |
          |                        |indirectly, any     |                    |
          |                        |person to promote   |                    |
          |                        |its offerings       |                    |








                                                                     AB 722


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          |                        |through             |                    |
          |                        |communication       |                    |
          |                        |channels provided   |                    |
          |                        |by a broker or      |                    |
          |                        |funding portal,     |                    |
          |                        |without taking      |                    |
          |                        |steps to ensure     |                    |
          |                        |that the person     |                    |
          |                        |clearly discloses   |                    |
          |                        |receipt, past or    |                    |
          |                        |prospective, of     |                    |
          |                        |such compensation.  |                    |
           ------------------------------------------------------------------ 
          


          General Solicitation & General Advertising.  As their names  
          imply, general solicitation and general advertising are not  
          targeted to a particular potential investor.  The solicitations  
          reach an audience that includes both accredited and  
          non-accredited investors.  According to the SEC, general  
          solicitation includes advertisements published in newspapers and  
          magazines, public websites, communications broadcasted over  
          television and radio, and seminars where attendees have been  
          invited by general solicitation or general advertising.  Use of  
          an unrestricted, and therefore publicly available, website also  
          constitutes general solicitation.  General advertising is  
          general solicitation made by means of an advertisement.  
          


          SCOR.  California's SCOR program, established through  
          legislation in 1986, requires that SCOR offerings (one million  
          dollars or less) must be qualified by the commissioner of DBO.   
          Applicants that satisfy SCOR conditions can use the Form U-7  
          disclosure document from the NASAA.  However, SCOR applicants  
          must provide the financial information required by the DBO  
          rather than those required by Form U-7.  The current SCOR  
          program is perceived as time consuming and burdensome and is  








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          looked upon as unsuccessful.  Over the years, DBO has received  
          very few applications on an annual basis. 





          AB 722, instead of working within the SCOR program and improving  
          the existing qualification by permit, layers a new permit  
          application process on top of the SCOR program. While the SCOR  
          program also only applies within the state, this bill would  
          allow sales and offerings "within or outside the state."  


          


          Background.  On April 5, 2012, President Obama signed landmark  
          legislation, H.R. 3606 (the "JOBS Act").  The JOBS Act makes it  
          easier for startups and small businesses to raise funds.  Title  
          III of the JOBS Act requires the SEC to develop new rules to  
          allow raising capital by "crowdfunding."  SEC is still in the  
          rule-making process and is due to publish final regulations  
          before non-SEC accredited investors can start financing small  
          businesses.  


          


          In October of 2013, the SEC issued the proposed crowdfunding  
          rules in a 585 page document.  The JOBS Act creates an exemption  
          from the registration requirements of the Securities Act of 1933  
          that provides for a form of securities crowdfunding.  The SEC  
          has not taken lightly the role of establishing a brand new type  
          of financial intermediary and a whole new regulatory process  
          which is why it is estimated the final rules will not be  
          released until October, 2015.  The SEC has struggled to create a  
          set of rules that respected the flexible and democratic nature  








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          of crowdfunding (which makes it so appealing to very small and  
          early stage start-up companies) while also implementing  
          sufficient regulation to satisfy consumer and investor  
          protection critics who fear that investment crowdfunding is far  
          too open to abuse and fraud.  





          Key features of the SEC's proposed rules:



           A company will only be able to raise a maximum aggregate  
            amount of $1 million through crowdfunding offerings per  
            12-month period.

           Companies raising less than $500,000 through crowdfunding  
            within any 12-month period will need to share financial  
            statements and income-tax returns with their investors and  
            those raising more than $500,000 will be obligated to provide  
            audited financial statements to investors.



           Investors with an annual income or net worth of less than  
            $100,000 will be permitted to invest a maximum of $2,000 or 5%  
            of their annual income or net worth (whichever is greater) per  
            12-month period.



           Investors with an annual income or net worth equal to or  
            greater than $100,000 will be permitted to invest up to 10% of  
            their annual income or net worth (whichever is greater) per  
            12-month period up to a total maximum of $100,000 in  
            securities.









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           Companies conducting a crowdfunding offering will need to file  
            certain information with the SEC, the relevant intermediary  
            facilitating the crowdfunding offering and potential  
            investors.



           Private crowdfunding offerings will be conducted exclusively  
            online through a registered broker or funding platform  
            (portal). Funding platforms will be required to register with  
            the SEC. Non-US crowdfunding platforms will be able to  
            register with the SEC, subject to an on-site examination.



           Registration rules for crowdfunding platforms, which were  
            developed in partnership with the Financial Industry  
            Regulatory Authority (FINRA).   FINRA released its set of  
            proposed rules, the Funding Portal Rules.





          According to the Small Business Administration, "The SEC  
          released the notice of proposed rulemaking for Title III of the  
          JOBS Act on November 5, 2013.  The proposal requested comments  
          on title definitions, investment limits, how income and net  
          worth are calculated for individuals, intermediaries, and many  
          other topics. The comment period closed February 3, 2014 after  
          receiving nearly 500 comments from individuals and  
          organizations.  The SEC has not finalized the equity-based  
          crowdfunding rule yet, but has set a date of October 2015 to  
          take final action.  This will provide prospective platforms,  
          investors, and small business entrepreneurs with the assurances  
          they need to go forward in planning for a future with  
          equity-based crowdfunding."








                                                                     AB 722


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          NASAA.  AB 722 requires an issuer to file with the administrator  
          (commissioner of DBO) a small company offering registration  
          disclosure document on Form U-7.  The form is found at the NASAA  
          website:   
          http://www.nasaa.org/industry-resources/corporation-finance/scor- 
          overview/scor-forms/.   The form goes into detail, among other  
          things, the type of investment, potential risks to the investor,  
          the offering amount, and the deadline to reach the offering. 


          


          Arguments in Support:  A group of 26 small business  
          organizations and advocates argue in support of this bill  
          because they say early-stage financing is critically important  
          today because with the advances in technology, seed financing of  
          even a few hundred thousand dollars can be sufficient to get a  
          small business off the ground.  





          arguments in opposition:  AARP opposes this bill because it says  
          that the bill places the life savings of older Californians at  
          significant risk by potentially exposing them to promoters of  
          risky securities.





          Questions & Concerns Raised About This Bill by the Banking and  








                                                                     AB 722


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          Finance Committee:





          1)Should California enact intrastate crowdfunding or should the  
            Legislature wait until after the SEC finalizes the federal  
            crowdfunding rules in October, 2015?   The SEC proposed rules  
            have been touted as being too stringent which may hinder those  
            who actually use it.  Some would say this is intentional to  
            deter fraud and scams under this new framework.  Ultimately,  
            the question is whether or not California needs to establish  
            its own crowdfunding framework which may be more lax and/or  
            conflict and if so, is that good?  AB 722 if enacted would  
            allow and promote "regulation shopping."  Issuers can  
            determine whether to register to adhere to federal regulations  
            or state securities regulations.  

          2)The economy is recovering, the unemployment rate is down, the  
            federal government acted, is there still a need to act on a  
                                                                             statewide level to produce more ways to raise capital?  In  
            addition, the U.S. Treasury just gave the California State  
            Treasurer $55,218,250 in federal funds from the JOBS Act to  
            provide access to capital to small businesses through the  
            California Pollution Control Financing Authority and the  
            California Infrastructure and Economic Development Bank.  This  
            is the second of three disbursements.  Are small businesses  
            capitalizing on these funds?





          3)As noted above in "other states," the states that have adopted  
            a crowdfunding framework are states that are desperately  
            trying to attract and lure in new businesses.  California is  
            known as the start-up epicenter.  According to a recent study  
            by Radius, a San Francisco technology company that collects  








                                                                     AB 722


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            small business data in the U.S. of the top 12 places to  
            establish a start-up in 2014, California had three cities  
            which included:  San Diego as number 1, San Francisco as  
            number 6 and San Jose as number 12.  Are small businesses  
            really struggling to establish themselves in California?  The  
            small businesses that would need to use crowdfunding may be  
            the types of businesses that have exhausted all other options  
            and if so, are these the type of businesses we want  
            established in California soliciting to potentially vulnerable  
            unsophisticated investors?

          4)AB 722 makes clear that the securities sold could be "within  
            or outside California."  Wouldn't anything outside California  
            conflict with federal rules? Other states who have enacted  
            state crowdfunding proposals only apply intrastate.  How will  
            DBO be able to enforce?





          Committee Concerns.  The Committee concurs with the Assembly  
          Banking and Finance Committee in its analysis of AB 722:  
          California should only offer its own legal framework for  
          crowdfunding if the framework is at least as protective as Title  
          III of the JOBS Act against potential abuse.  The sponsors have  
          informed the Committee that they believe that Title III does not  
          provide enough protection.  If this is so, then this bill should  
          contain the elements of Title III, as well as additional  
          protections.  Therefore, the Committee may consider asking the  
          author to consider the following conceptual amendments to the  
          bill when and if it moves forward from this Committee:





             1.   Consistent with Title III of the JOBS Act, transactions  
               must be conducted through an intermediary that is either an  








                                                                     AB 722


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               SEC-registered broker or an SEC- registered funding portal.  
                Private crowd-funding offerings will be conducted  
               exclusively through the registered funding portal or  
               broker. 

             2.   Issuer/Applicant may only offer or sell a security if  
               the issuer provides the investor, the intermediary, and the  
               DBO with a substantial disclosure documents BEFORE the sale  
               of the security.  The disclosure documents should be at  
               least as extensive as those required by Title III of the  
               JOBS Act.


             3.   Consistent with Title III of the JOBS Act, direction  
               solicitation should be prohibited.

             4.   Eliminate the existing section that allows an  
               issuer/applicant to begin offering securities after 60 days  
               if the DBO fails to act.  Instead, require that the DBO  
               either issue or deny the permit within 60 days.  If the DBO  
               fails to either issue or deny the permit within 60 days,  
               then the applicant may demand a hearing with the DBO to  
               explain why the permit has not been granted. 

             5.   The investor should have a 72-hour right of rescission. 

             6.   Suitability standards should be required for all sales  
               of these products and should be standardized, as their name  
               implies and as the JOBS Act requires, not adopted on an ad  
               hoc basis as this bill allows.  

             7.   The bill should clarify that the seller has a fiduciary  
               duty to all purchasers and potential purchasers of these  
               products, as brokers have to their clients under the JOBS  
               Act.  
          


          Previous Legislation.  AB 2096 (Muratsuchi) (2014 Legislative  








                                                                     AB 722


                                                                    Page  26





          Session) would have created a new way in which a person seeking  
          to offer or sell securities could qualify their offering, by  
          authorizing the "qualification by notification" of offers or  
          sales of securities advertised by means of general solicitation  
          and general advertising, as specified.  Died in the Senate  
          Appropriations Committee.  


          AB 783 (Daly) (2013 Legislative Session) provides that an issuer  
          can offer or sell securities using any form of general  
          solicitation or general advertising.  Died in the Assembly  
          Banking and Finance Committee.





          AB 2081 (Allen) (2012 Legislative Session) provides that an  
          issuer can offer or sell securities using any form of general  
          solicitation or general advertising.  Died on the Senate Floor. 





          SB 875 (Price) (2010 Legislative Session) would have exempted   
          from qualification offerings or sales of securities using a  
          general solicitation or general advertising, provided the  
          transaction meets specified requirements, including a  
          requirement that the sales are made  to accredited investors.   
          Died in Senate Banking and Financial Institutions. 





          AB 1644 (Campbell & Briggs) (2001 Legislative Session) would  
          have exempted from qualification offerings or sales of  
          securities using a general solicitation or general advertising,  








                                                                     AB 722


                                                                    Page  27





          provided the transaction meets specified requirements, including  
          a requirement that the sales are made to accredited investors.   
          Failed passage in Assembly Banking and Finance Committee.


          Double Referral.  This measure was passed by the Assembly  
          Banking and Finance Committee by a vote of 9-2 (with one  
          abstention). 


          


          REGISTERED SUPPORT / OPPOSITION:




          Support


          California Asian Pacific Chamber of Commerce


          California Association of Competitive Telecommunications  
          Companies (CALTEL)


          California Association of Micro-economic Opportunity (CAMEO)


          California Black Chamber of Commerce


          California Disabled Veteran Business Alliance


          California Fence Contractors Association









                                                                     AB 722


                                                                    Page  28






          California Hispanic Chamber of Commerce


          California Metals Coalition (CMC)


          Coleman & Horowitt LLP


          Flasher Barricade Association


          Golden Gate Business Association


          Greater Geary Boulevard Merchants & Property Owners Association


          National Federation of Independent Business (NFIB)


          North East Mission Business Association (NEMBA)


          Northern California Independent Booksellers Association (NCIBA)


          Plumbing Heating Cooling Contractors of California (PHCC)


          San Francisco Builders Exchange


          San Francisco Chamber of Commerce


          San Francisco Council of District Merchants Association (SFCDMA)









                                                                     AB 722


                                                                    Page  29






          San Francisco Locally Owned Merchants Alliance


          San Francisco Small Business Network 


          Small Business California (SB-Cal)


          Small Business Majority


          South Bay Entrepreneurial Center (SBEC)


          SpanishOne Translations, Inc.




          Opposition


          AARP


          California Advocates for Nursing Home Abuse (CANHR)


          Public Investors Arbitration Bar Association




          Analysis Prepared by:Khadijah Hargett / JUD. / (916) 319-2334











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