BILL ANALYSIS                                                                                                                                                                                                    Ó



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          Date of Hearing:  April 12, 2016


                           ASSEMBLY COMMITTEE ON JUDICIARY


                                  Mark Stone, Chair


          AB 2178  
          (Chiu) - As Introduced February 18, 2016


                              As Proposed to be Amended


          SUBJECT:  SECURITIES TRANSACTIONS: QUALIFICATIONS BY PERMIT:  
          LIABILITY


          KEY ISSUE:  SHOULD CALIFORNIA CREATE A NEW "CROWDFUNDING" PERMIT  
          ALLOWING FOR THE OFFER AND SALE OF RELATIVELY INEXPENSIVE  
          EQUITY-BASED SECURITIES UNDER THE STATE'S CORPORATE SECURITIES  
          LAW, EVEN THOUGH THE SECURITIES AND EXCHANGE COMMISSION RECENTLY  
          PROMULGATED REGULATIONS TO FACILITATE "CROWDFUNDING," WHICH MAY  
          MAKE THE PROVISIONS OF THIS BILL UNNECESSARY, AND CONSUMER  
          ADVOCATES REMAIN CONCERNED THAT PERMIT HOLDERS MAY USE THEIR  
          PERMITS TO TAKE ADVANTAGE OF UNSOPHISTICATED INVESTORS,  
          INCLUDING SENIORS, AND MAY NOT BE SUBJECT TO ADEQUATE REGULATORY  
          OVERSIGHT? 


                                      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  








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          express exemption from the qualification requirement.  AB 2178  
          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;  
          sales are conducted through an intermediary (either an  
          SEC-approved portal, or a registered broker); marketing  
          materials are submitted to DBO for approval; and the issuer does  
          not conduct any unsolicited telephone solicitation of the  
          securities.  Nevertheless, despite these provisions and the  
          proposed amendments in the bill, the proposed requirements and  
          safeguards on the sale of these financial products are still  
          somewhat less rigorous than either current state law, or under  
          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 the 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, on October 30, 2015, the SEC adopted new regulations  
          to implement the requirements of Title III of the Jumpstart Our  
          Business Startups (JOBS) Act, which provided for a new exemption  
          under the Securities Act of 1933 that will permit  
          securities-based crowdfunding by private companies without  
          registering the offering with the SEC.  The final rules will  
          become effective in May 2016, although the forms enabling  
          funding portals to register with the SEC became effective on  
          January 29, 2016.  The new rules, which govern the offer and  
          sale of unregistered securities, require issuers to use funding  








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          portals and brokers as intermediaries in the offer and sale of  
          securities.  


          This bill, sponsored by Small Business California, is very  
          similar to last year's AB 722 (Perea), among other measures  
          sponsored by the same group, which passed this Committee,  
          despite some concerns expressed by the Committee about AB 722's  
          failure to require offerings to be made through an intermediary.  
           However, as proposed to be amended, this bill adds that  
          requirement and also requires that marketing materials be  
          submitted for approval to DBO.  A group of 27 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.  This bill, which passed out of  
          the Banking and Finance Committee on a vote of 11-1 (with the  
          Chair of this Committee casting the sole No vote) is also  
          supported by the California State Council of Laborers.  Despite  
          the proposed author's amendments, the bill is opposed by  
          California Advocates for Nursing Home Reform and Public  
          Investors Arbitration Bar Association.  Both organizations (and  
          the Committee) are concerned that given the relatively small  
          investment offerings, unsophisticated investors, including  
          seniors, may be willing to invest in inappropriately risky  
          investments and could be targets of repeated scams, but will be  
          unable to hire attorneys to recoup their losses because of the  
          small amounts involved in individual purchases.  Also, because  
          approximately half of all small businesses fail within the first  
          five years of operating, even if a consumer obtains a judgment  
          against an issuer under this new program, the original issuer  
          may be out of business and judgment-proof. 




          SUMMARY:  Creates a new qualification by permit under  
          California's Corporate Securities Law of 1968 to allow  








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          equity-crowdfunding.  Specifically, this bill:  


          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 the applicant 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 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  
                 sales 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  








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                 Business Oversight (DBO) may provide by rule or order.


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


               v)     Requires the applicant 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. 


               vi)    Requires the applicant to file with the commissioner  
                 and provide to investors a disclosure document, as  
                 defined, and a Small Company Offering Registration (SCOR)  
                 disclosure document on Form U-7, no less than 10 business  
                 days prior to the commencement of the offering of  
                 securities.  


               vii)   Provides a three day right of rescission.  


               viii)  Prohibits an applicant itself, or through a third  
                 party, from direct solicitation.


               ix)    Defines "direct solicitation" as any in person face  
                 to face conversation between the applicant or any of its  
                 founder, promoters, officers, directors, controlling  
                 persons, agents, or other persons acting directly or  
                 indirectly on behalf of the applicant and any investor or  
                 prospective investor or any person acting directly or  
                 indirectly on behalf of, or in regular communication  








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                 with, the investor.  


               x)     Requires the applicant 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 the  
                 minimum offering amount is reached.  The issuer shall  
                 return all funds if the minimum offering amount is not  
                 reached within one year.  


               xi)    Prohibits an applicant itself, or through a third  
                 party, from conducting unsolicited telephone calls.


               xii)   Places a fiduciary obligation on the applicant to  
                 any investor or prospective investor.  


               xiii)  Prevents the offering from being approved if anyone  
                 connected with the offering in specified capacities  
                 already is or has been disqualified under the "bad actor"  
                 provisions under federal regulations.  


               xiv)   Prohibits stock splits, stock dividends, spinoffs,  
                 or mergers for a period of two years from the close of  
                 the offering.  


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


          2)Requires DBO to either issue or deny the permit within 60 days  
            of receipt of the application otherwise the applicant can  
            demand a hearing with DBO to explain why the permit has not  
            been granted.  









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          3)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.  


          4)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.  


          5)Requires an investor, upon recession of contract after an  
            issuer is found to be in violation of permit requirements, to  
            reimburse investors for all their investments, plus interest.


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


          7)Requires sales to be conducted through an intermediary (an  
            SEC- registered portal or broker).


          8)Requires an applicant to comply with the following  
            requirements related to advertisements:


             a)   Prohibits an issuer from placing an advertisement  
               disseminated primarily in this state unless the issuer  
               discloses in the printed text of the advertisement, or the  
               oral text in the case of a radio or television  
               advertisement, that the issuer has a permit issued by DBO.


             b)   Allows DBO to require that rates of charges or fees, if  
               stated by the applicant, be stated fully and clearly in the  








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               manner that DBO deems necessary to give adequate  
               information to, or to prevent misunderstanding by,  
               prospective investors.


             c)   Prohibits an issuer from using advertising material  
               after its use has been disapproved by DBO and the applicant  
               is notified in writing of the disapproval.


             d)   Requires the issuer to maintain a file of all  
               advertising copy for a period of three years from the date  
               of its use and to make the file available to DBO upon  
               request. 


          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.  Generally speaking, the Securities Act of 1933  
            requires the offer or sale of all securities to be registered with  
            the Securities and Exchange Commission (SEC) and to be structured  
            as prescribed in federal law and regulation, unless the offer or  
            sale is covered by an exemption.  This federal act also require  
            those who offer (i.e., market) and sell securities to be licensed  
            as investment advisers or broker-dealers, unless either the  
            transaction or the activity being undertaken is exempt.  
           2)Provides for Regulation D, one of the regulations promulgated by  
            the SEC to implement the Securities Act of 1933.  Regulation D  
            authorizes 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,  








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               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.   
              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 are made exclusively in one or more states that  
               provide for the registration of the securities, and require the  
               public filing and delivery to investors of a substantive  
               disclosure document before the sale of the securities (the  
               provision of Rule 504 applicable to this bill); 


                   i)        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,  
                   ii)       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).   


           3)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; lifts the restriction on the use of general  
            solicitation and general advertising, when sales are made only to  
            accredited investors and other requirements are met.   
           4)Pursuant to Title III of the JOBS Act, otherwise known as the  
            CROWDFUND Act, lifts the restriction against use of general  
            solicitation and general advertising to both accredited and  
            non-accredited investors.   










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           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  
            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).









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             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  
               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  








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            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  
            tax year.  Alternatively, 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.
          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.  Further, between 20 and 50 people file forms with  
          DBO annually, claiming exemptions pursuant to Section 25102(n),  
          according to DBO.










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          AB 2178 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.  
           According to the author, this bill, sponsored by Small Business  
          California, seeks to allow small businesses and start-ups to  
          more readily access capital.  It is similar to bills advanced by  
          the same sponsors in previous years, including last year's AB  
          722 (Perea).  Like AB 722, it provides a "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.  Also like  
          AB 722, it uses the term "crowdfunding."  As explained below, it  
          is unclear how the sales practices anticipated by the bill would  
          be considered to be "crowdfunding."  However, as explained  
          below, AB 2178 is different from AB 722 in two ways that provide  
          significant consumer protections to potential investors.


          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  
          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  








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          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 2178 has a cap on investments of $5,000, which  
          weakens the ability for an issuer to take an investor's  
          lifesavings, but investing in small business start-ups may be a  
          substantially greater risk than traditional investing.  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).   


          On April 5, 2012, President Obama signed landmark legislation,  
          H.R. 3606, the Jumpstart Our Business Startups Act (the "JOBS  
          Act").  The JOBS Act makes it easier for startups and small  
          businesses to raise funds.  This legislation passed Congress  
          through a 73-26 Senate vote and a 380-41 House vote.  As far as,  
          AB 2178 is concerned, Title III of the JOBS Act required the SEC  
          to develop new rules permitting capital raising by  
          "crowdfunding."  


          In October of 2013, the SEC issued the proposed crowdfunding  
          rules in a 585 page document.  The SEC struggled to create the  
          final rules that respected the flexible and democratic nature 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.  


          On October 30, 2015, the SEC adopted final rules under Title III  
          of the JOBS Act. The JOBS Act provided for a new exemption under  








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          the Securities Act of 1933 that will permit securities-based  
          crowdfunding by private companies without registering the  
          offering with the SEC.  The final rules become effective in May  
          2016 except that the forms enabling funding portals to register  
          with the SEC became effective on January 29, 2016.   
          Additionally, the SEC staff must submit a report to the SEC no  
          later than three years following the effective date of  
          crowdfunding on the impact of the regulation on capital  
          formation and investor protection. 


          Key features of the SEC's final 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-U.S. crowdfunding platforms  
               will be able to register with the SEC, subject to an  
               on-site examination.


                 Private crowdfunding offerings will be conducted  
               exclusively online through broker or funding platforms  
               developed in partnership with the Financial Industry  
               Regulatory Authority (FINRA) and registered with the SEC.


          Federal Regulation A+:  On March 24, 2015, the SEC adopted final  
          rules to implement the rulemaking mandate of Title IV of the  
          JOBS Act by adopting amendments to Regulation A.  In December  
          2013, the SEC had released a proposed rule that essentially  
          retained the current framework of Regulation A and expanded it  
          for larger exempt offerings.  Existing Regulation A provided an  
          exemption from the registration requirement of Section 5 for  
          certain smaller securities offering by private companies.  The  
          securities sold in Regulation A offering are not considered  
          "restricted securities" and are freely transferable.  The "New"  
          Regulation A provides an exemption for U.S. companies to raise  
          up to $50,000,000 in a 12-month period.  The final rules create  
          two tiers:  Tier 1 for smaller offerings raising up to  
          $20,000,000 in any 12 month period and Tier 2 for offerings  
          raising up to $50,000,000.  Tier 1 will be subject to both SEC  
          and state blue sky pre-sale review.  The finalized rules of  
          Regulation A+ should be very appealing to small businesses.  









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          Significant new Consumer Protection Measures in AB 2178, as it  
          is Proposed to be Amended. Whereas last year's AB 722 did not  
          require an SEC-registered intermediary (a portal or broker) to  
          be used for sales of these investments, proposed amendments to  
          this bill will add that requirement.  Also, unlike AB 722, this  
          bill requires an investor, upon recession of contract after an  
          issuer is found to be in violation of permit requirements, to  
          reimburse investors for all their investments, plus interest.   
          In addition, as proposed to be amended AB 2178 will require the  
          applicant to comply with the following provisions related to  
          advertising materials, which are key requirements in light of  
          the fact that permit holders will be able to engage in general  
          solicitation:


           A prohibition on placing an advertisement disseminated  
            primarily in this state unless the applicant discloses in the  
            printed text of the advertisement, or the oral text in the  
            case of a radio or television advertisement, that the  
            applicant has a permit issued by the department pursuant to  
            this section.
           A provision allowing the Commissioner of DBO to require that  
            rates of all charges or fees (including all transaction fees,  
            charges, commissions), if stated by the applicant, be stated  
            fully and clearly in the manner that the commissioner deems  
            necessary to give adequate information to, or to prevent  
            misunderstanding by, prospective investors.


           A prohibition on the use of advertising material after its use  
            has been disapproved by the Commissioner and the applicant is  
            notified in writing of the disapproval.


           A requirement to maintain a file of all advertising copy for a  
            period of three years from the date of its use. The file shall  
            be available to the Commissioner upon request. 









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          ARGUMENTS IN SUPPORT:  The sponsor, Small Business California,  
          writes the following on behalf of the coalition of 27 small  
          businesses that support this bill:


               Equity crowdfunding under federal law becomes effective in  
               May 2016 under the Jumpstart Our Business Startups Act of  
               2012.  While the JOBS Act was designed to address this  
               capital gap, it could potentially open the floodgates to  
               fraud.


               AB 2178 offers both entrepreneurs and investors a safer  
               means of filling the "capital gap" that exists for smaller  
               early-stage seed capital offerings and "jumpstarting" these  
               companies so that they can become candidates for larger  
               rounds of financing.  


               AB 2178 would add to the California Corporate Securities  
               Laws specific conditions under which the Department of  
               Business Oversight would review and issue a permit for a  
               crowdfunding offering in California.  AB 2178 would also  
               prohibit telephone solicitations, but otherwise allow  
               companies to communicate with potential investors directly,  
               even investors with whom they have no prior relationship. 


          ARGUMENTS IN OPPOSITION:  Despite the proposed amendments to the  
          bill, California Advocates for Nursing Home Reform remain  
          opposed for the following reasons:


               CANHR is concerned that AB 2178 will open the way for  
               unscrupulous promoters who target seniors who are  
               interested in improving their financial situation or those  
               suffering cognitive impairments.  Senior "investors" are at  
               particular risk of putting their money in questionable  








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               business opportunities.  The recently released brain study,  
               "How Does Aging Affect Financial Decision Making?" Keith  
               Jacks Gamble, Patricia Boyle, Lei Yu and David Bennett,  
               Center for Retirement Research of Boston College, January  
               2015, Number 15-1, confirms that declining cognition, which  
               is a common occurrence in the elderly, is associated with a  
               significant decline in financial literacy.  . . .  These  
               same poor decision makers display defective autonomic  
               responses reminiscent of that previously established in  
               patients with acquired prefrontal lesions.  The Iowa data  
               demonstrates that a substantial number of seniors have  
               compromised real-world judgment and decision-making  
               abilities. 




               There can be no doubt that seniors will be solicited to  
               participate in the fund raising opportunities AB 2178 makes  
               way for.  Given that currently 50 percent of new small  
               business fail, even when they are legitimate businesses,  
               there can be no doubt that a substantial number of seniors  
               will lose their money. Passage of AB 2178 would attract  
               many new unscrupulous players to a market that already has  
               more than its share of bad actors.  Although there is merit  
               in making it easier to get investors to chip in their  
               resources to launch new and innovative products and ideas,  
               it is too great a risk to remove the protection of the  
               Department of Business Oversight.  




          Public Investors Arbitration Bar Association similarly remains  
          concerned about the potential for AB 2178 to be abused by  
          unscrupulous issuers and provides the following non-exhaustive  
          list of changes or additions that would ease its concerns:










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                 A mandatory one-way attorneys' fee shift in favor of  
               investors.  




                 Mandatory treble damages in cases in which an investor  
               proved a violation of Corp. C. Section 25400, et seq., or  
               liability under Section 25501, et seq. 




                 Provide that an offering under AB 2178 will not be  
               approved if it contains a forced arbitration provision, a  
               class action waiver, a jury trial waiver, or other  
               provisions designed to limit investor rights and remedies,  
               including choice of law and choice of forum clauses.




                 [T]he uncollectability of amounts that are awarded.  The  
               GAO reported on that issue in the SRO arbitration context  
               in the late 1990s and early 2000s. . . PIABA recently  
               released a report about it that is getting some attention  
               in Washington.  Arbitration awards against broker-dealers  
               and associated persons are not the only sources of  
               uncollectable judgments.  PIABA is open to suggestions  
               regarding how this problem might be addressed in the  
               context of offerings under AB 2178.




                 [N]othing in the bill requires that investment dollars  
               be used in such a way as to lead to job creation in  








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               California.  While that is not a direct part of PIABA's  
               mission, it might help indirectly in the form of enhanced  
               transparency.  It is easier to confirm the reality of  
               representations regarding a business operating in  
               California than it is to confirm representations regarding  
               a business operating primarily in Hong Kong, for example.   
               PIABA is open to ideas regarding this issue as well.  


          Questions & Concerns with AB 2178, even as Proposed to be  
          Amended.  The Assembly Banking and Finance Committee raised a  
          number of concerns in its February 18, 2016 analysis that are  
          also concerns of this Committee:


          1)The federal Crowdfunding rules became final in October, 2015.   
            We now have a process set up in place nationwide to conduct  
            equity crowdfunding.  Why does California need its own  
            crowdfunding process?  Considering, these final rules are so  
            new, isn't it too early to cast a shadow on federal  
            Crowdfunding.  The SEC is required to issue a report in 3  
            years.  Should California wait to reevaluate the success or  
            lack of success of federal Crowdfunding after the first report  
            is released?  


          2)AB 2178, if enacted, could allow and promote "regulation  
            shopping."  Issuers/Applicants can determine whether to  
            register to adhere to federal regulations or state securities  
            regulations.  Even if California's crowdfunding has better  
            investor protections, why would this point matter, since  
            issuers would have the ability to choose the weaker  
            regulations? 


          3)AB 2178 provides 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  








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            DBO be able to enforce?


          Despite the significant additional consumer protections in AB  
          2178 that were not in previously introduced crowdfunding and  
          alternative permit bills, the Committee remains concerned that  
          given the relatively small investment offerings, unsophisticated  
          investors, including seniors, may be willing to invest in  
          inappropriately risky investments and could be targets of  
          repeated scams.  Because of the relatively small amounts (that  
          may nevertheless represent a significant percentage of the  
          investor's liquid assets, especially in the case of multiple  
          investments), investors will be unable to hire attorneys to  
          recoup their losses because of the small amounts involved in  
          individual purchases.  Also, because approximately half of all  
          small businesses fail within the first five years of operating,  
          even if a consumer obtains a judgment against an issuer under  
          this new program, the original issuer may be out of business and  
          judgment-proof.


          In an ideal world, sufficiently improved investor remedies could  
          stand as a serious deterrent to fraud and wrongdoing, and  
          offerings under California law, as a result, could come to be  
          viewed by investors (and therefore by issuers) as being  
          preferable to those under the JOBS Act.  If additional consumer  
          protections and investor remedies were added to this bill (such  
          as a prohibition on class action waivers, forced arbitration,  
          and issuer's choice of venue), as well as even more stringent  
          penalties for violation (such as mandatory treble damages and  
          attorney fees to defrauded investors) the deterrent effect  
          against abuse of the new crowdfunding permit would be real and  
          not easily evaded.  Therefore, the author may wish to consider  
          these proposed additional amendments to address these concerns  
          as the bill moves forward.


          PRIOR SIMILAR LEGISLATION:  AB 722 (Perea, 2015) created a new  
          qualification by permit under California's Corporate Securities  








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          Law of 1968 to allow equity-crowdfunding.  This bill died in the  
          Assembly Appropriations Committee.

          AB 2096 (Muratsuchi, 2014) 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.  This bill  
          died in the Senate Appropriations Committee.  

          AB 783 (Daly, 2013) provided that an issuer can offer or sell  
          securities using any form of general solicitation or general  
          advertising.  This bill died in the Assembly Banking and Finance  
          Committee.

          AB 2081 (Allen, 2012) provided that an issuer can offer or sell  
          securities using any form of general solicitation or general  
          advertising.  This bill died on the Senate Floor. 

          SB 875 (Price, 2010) exempted from qualification offerings or  
          sales of securities using a general solicitation or general  
          advertisement, provided the transaction meets specified  
          requirements, including a requirement that the sales are made to  
          accredited investors.  This bill died in Senate Banking and  
          Financial Institutions Committee. 

          AB 1644 (Campbell & Briggs, 2001) 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.  This bill failed passage in Assembly  
          Banking and Finance Committee.

          REGISTERED SUPPORT / OPPOSITION:



          Support









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                                                                    Page  24





          Small Business California (sponsor) 


          Bay Area Council


          California Asian Pacific Chamber of Commerce


          California Association of Competitive Telecommunications  
          Companies 


          California Association of Micro-economic Opportunity 


          California Black Chamber of Commerce 


          California Disabled Veteran Business Alliance


          California Fence Contractors Association


          California Hispanic Chambers of Commerce


          California Metals Coalition 


          Flasher Barricade Association


          Golden Gate Business Association


          Greater Geary Boulevard Merchants & Property Owners Association









                                                                    AB 2178


                                                                    Page  25






          National Association of Women Business Owners - Sacramento  
          Valley


          National Federation of Independent Business 


          Northern California Independent Booksellers Association 


          North East Mission Business Association  


          Plumbing Heating Cooling Contractors of California 


          San Francisco Builders Exchange


          San Francisco Chamber of Commerce


          San Francisco Committee on Jobs


          San Francisco Council of District Merchants Association 


          San Francisco Locally Owned Merchants Alliance


          San Francisco Small Business Network


          Small Business Majority


          Small Manufacturers Association of California








                                                                    AB 2178


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          South Bay Entrepreneurial Center (SBEC) 




          Opposition
      

          California Advocates for Nursing Home Reform 


          Public Investors Arbitration Bar Association 




          Analysis Prepared by:Alison Merrilees / JUD. / (916) 319-2334