BILL ANALYSIS Ó
AB 722
Page 1
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
AB 722
Page 2
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:
AB 722
Page 3
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.
AB 722
Page 4
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.
AB 722
Page 5
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.
AB 722
Page 6
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);
AB 722
Page 7
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
AB 722
Page 8
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
AB 722
Page 9
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
AB 722
Page 10
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.
AB 722
Page 11
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
AB 722
Page 12
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
AB 722
Page 13
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. |
AB 722
Page 14
| |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 | |
AB 722
Page 15
| |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 | |
AB 722
Page 16
| |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 |
AB 722
Page 17
| |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
Page 18
| |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
AB 722
Page 19
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
AB 722
Page 20
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.
AB 722
Page 21
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
Page 22
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
Page 23
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
Page 24
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
Page 25
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
AB 722
Page 30