BILL ANALYSIS Ó
AB 2178
Page 1
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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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
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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
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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