BILL ANALYSIS Ó SENATE COMMITTEE ON BANKING AND FINANCIAL INSTITUTIONS Senator Marty Block, Chair 2015 - 2016 Regular Bill No: SB 577 Hearing Date: April 15, 2015 ----------------------------------------------------------------- |Author: |Hueso | |-----------+-----------------------------------------------------| |Version: |April 6, 2015 | ----------------------------------------------------------------- ----------------------------------------------------------------- |Urgency: |No |Fiscal: |Yes | ----------------------------------------------------------------- ----------------------------------------------------------------- |Consultant:|Eileen Newhall | | | | ----------------------------------------------------------------- Subject: Securities: qualification: exemptions. SUMMARY Authorizes three new securities permitting exemptions, as specified, and increases, from $300 to $1,000, the maximum allowable aggregate investment of any shareholder in shares of a consumer cooperative corporation or member in memberships of a consumer cooperative corporation. DESCRIPTION 1. Increases, from $300 to $1,000, the maximum aggregate investment that may be made by a shareholder in shares or by a member in memberships in a consumer cooperative corporation. As long as this cap is not exceeded, sales of those shares or memberships are exempt from state securities permitting laws. 2. Exempts from state securities permitting laws all of the following: a. Any offer or sale of any evidence of indebtedness, whether secured or unsecured, and any guarantee thereof, that meets each of the following criteria: i. The aggregate amount of securities sold to all purchasers by the issuer within any 12-month period does not exceed $500,000. ii. Sales to non-accredited investors are capped at SB 577 (Hueso) Page 2 of ? $1,000 in the aggregate during a 12-month period, or a greater amount determined by the Commissioner of Business Oversight. iii.Issuers may advertise the offering to California investors only, unless the offering complies with the securities laws of other jurisdictions. Issuers must take steps to ensure that any public advertising indicates that the offering is directed at California residents, or that any solicitations made to nonresidents of California comply with applicable laws of other individual states and the United States. iv. The issuer provides to DBO and purchasers and makes available to potential purchasers, all of the following: A. A cover sheet containing all of the following statements, in bold typeface no smaller than 12-point type: "Investment in a small business is often risky. You should not invest any funds in this offering unless you can afford to lose your entire investment. Potential purchasers should review information about the enterprise and offering, and consider the terms and risks of this offering before investing. After reviewing the financial information, description of the business, activities, risk factors, and development timeline, potential purchasers should consider whether success of the enterprise is realistic. No government regulator is recommending these securities. No government regulator has verified that this document is accurate or determined that it is adequate. The Commissioner of Business Oversight has in no way passed upon the merits or qualifications of, or recommended or given approval to, any person, security, or transaction associated with this offering." SB 577 (Hueso) Page 3 of ? B. The issuer's street address; telephone number; person to contact with respect to the offering; type of securities offered; financial terms of the offering; the minimum amount the issuer is seeking to raise; a description of the business of the issuer and how the issuer plans to carry out its activities; a budget for the use of proceeds of the offering; a list of the factors the issuer considers to be the most significant risks to an investor; and a description, in chronological order, or the steps management intends to take to achieve, maintain, or improve profitability during the 36 months following receipt of the offering proceeds. C. Specified financial statements of the issuer, prepared in accordance with generally accepted accounting principles, and certified by the principal executive officer of the issuer to be true and complete in all material respects. D. A written statement of information about any material legal proceedings involving the company or its officers and directors. v. Issuers may not utilize the exemption to raise funds for an enterprise dependent on the creation of a product or technology for which no fully functional prototype has been made in advance of the public offering of securities. Any fully functional prototype must be demonstrated in person to any potential investor upon request, as specified. b. Any offer or sale of any security in a transaction that meets each of the following criteria: i. The aggregate amount of securities sold to all purchasers by the issuer within any 12-month period does not exceed $2 million. ii. At least 75 percent of amounts raised SB 577 (Hueso) Page 4 of ? through the offering will be reserved or allocated to the purchase of fee title, leases of 30 years or more, purchase of an easement, construction of or improvement to real property to be used for agricultural purposes. iii. The issuer is an agricultural enterprise that is majority controlled by one or more individuals who are farmers and actively engaged in the agricultural enterprise or the issuer is controlled by a nonprofit corporation. iv. Sales to non-accredited investors are capped at either $1,000 or $5,000, depending on whether the purchaser signs a statement verifying that they have a minimum annual gross income of $50,000 or a minimum net worth of $100,000, exclusive of home, home furnishings, and automobiles. Any non-accredited investor purchasing more than $1,000 in securities must sign the aforementioned statement. Any non-accredited investor who does not sign such a statement is limited to a maximum purchase of $1,000. The Commissioner of DBO is authorized to authorize greater purchase amounts for non-accredited investors by rule or order. v. Issuers may advertise the offering to California investors only, unless the offering complies with the securities laws of other jurisdictions. Issuers must take steps to ensure that any public advertising indicates that the offering is directed at California residents, or that any solicitations made to nonresidents of California comply with applicable laws of other individual states and the United States. vi. In the case of real property purchases of land, the issuer must set aside all funds raised in a separate, third-party escrow account until entering into a contract to purchase a property. If the issuer does not enter into a contract to purchase a property within two years of the effective date of the offering, the issuer must return all proceeds to the purchasers. SB 577 (Hueso) Page 5 of ? vii. The issuer provides to DBO and purchasers and makes available to potential purchasers, all of the following: A. A cover sheet containing all of the following statements, in bold typeface no smaller than 12-point type: "Investment in a small business is often risky. You should not invest any funds in this offering unless you can afford to lose your entire investment. Potential purchasers should review information about the enterprise and offering, and consider the terms and risks of this offering before investing. After reviewing the financial information, description of the business, activities, risk factors, and development timeline, potential purchasers should consider whether success of the enterprise is realistic. No government regulator is recommending these securities. No government regulator has verified that this document is accurate or determined that it is adequate. The Commissioner of Business Oversight has in no way passed upon the merits or qualifications of, or recommended or given approval to, any person, security, or transaction associated with this offering." If the issuer is conducting the offering to raise money for the purchase of farmland, the cover sheet must also state, "The company described in this disclosure form is seeking to purchase farmland. If the sum of the investment commitments received by the company does not amount to a sum sufficient to purchase farmland by [insert date two years after beginning of offering], your investment in the company will be returned to you after 60 days to the most recent address provided." SB 577 (Hueso) Page 6 of ? B. The issuer's street address, telephone number, person to contact with respect to the offering, type of securities offered, financial terms of the offering, the minimum amount the issuer is seeking to raise, a description of the business of the issuer and how the issuer plans to carry out its activities, a budget for the use of proceeds of the offering, a list of the factors the issuer considers to be the most significant risks to an investor, and a description, in chronological order, or the steps management intends to take to achieve, maintain, or improve profitability during the 36 months following receipt of the offering proceeds. C. If the property to be purchased has been identified, a description and address of the property, an appraisal completed within the last year, and a description of all improvements to be made on the property in order to make it viable for agricultural use. If the property to be purchased has not been identified, a description of the size, location, estimated costs, and characteristics of the property the issuer is seeking. D. Income tax returns filed by the issuer for the most recently completed year, if any. E. Specified financial statements of the issuer, prepared in accordance with generally accepted accounting principles, and certified by the principal executive officer of the issuer to be true and complete in all material respects. F. A written statement of information about any material legal proceedings involving the company or its officers and directors. i. Issuers may not utilize the exemption to raise funds for an enterprise dependent on the SB 577 (Hueso) Page 7 of ? creation of a product or technology for which no fully functional prototype has been made in advance of the public offering of securities. Any fully functional prototype must be demonstrated in person to any potential investor upon request, as specified. a. Any offer or sale of any security in a transaction that meets each of the following criteria: i. At least 75 percent of amounts raised through the offering will be reserved or allocated to the purchase of solar photovoltaic panels and related equipment or wind turbines and related equipment. ii. The issuer meets any of the following qualifications: 1. The issuer is a cooperative corporation or a nonprofit mutual benefit corporation with the purpose of developing and operating one or more facilities to generate electricity for its members to install solar panels or wind turbines for its members, either by selling or leasing panels to members, or to arrange or allocate net metering credits among members. 2. The issuer is a nonprofit public benefit corporation exempt from federal income taxation pursuant to Sections 501(c)(3) or 501(c)(4) of the Internal Revenue Code and is purchasing solar panels or wind turbines primarily to meet the energy needs of the corporation. 3. The issuer is a nonprofit public benefit corporation with the purpose of developing and operating one or more facilities to generate electricity in a single city and for residents of that city, or within a similarly limited geographic area approved by the commissioner. SB 577 (Hueso) Page 8 of ? 4. The issuer is an entity owned or entirely controlled by tenants in multitenant housing, and the issuer has entered into a contract with the owner of the property to install solar panels on the property on which the multitenant housing is located. iii. The aggregate amount of securities sold to all purchasers by the issuer within any 12-month period does not exceed $2 million. iv. Issuers may advertise the offering to California investors only, unless the offering complies with the securities laws of other jurisdictions. Issuers must take steps to ensure that any public advertising indicates that the offering is directed at California residents, or that any solicitations made to nonresidents of California comply with applicable laws of other individual states and the United States. v. Sales to non-accredited investors are capped at either $1,000 or $5,000, depending on whether the purchaser signs a statement verifying that they have a minimum annual gross income of $50,000 or a minimum net worth of $100,000, exclusive of home, home furnishings, and automobiles. Any non-accredited investor purchasing more than $1,000 in securities must sign the aforementioned statement. Any non-accredited investor who does not sign such a statement is limited to a maximum purchase of $1,000. The Commissioner of DBO is authorized to authorize greater purchase amounts for non-accredited investors by rule or order. i. The issuer provides to DBO and purchasers and makes available to potential purchasers, all of the following: A. A cover sheet containing all of the following statements, in bold typeface no smaller than 12-point type: "Investment in a small business is often risky. You should not SB 577 (Hueso) Page 9 of ? invest any funds in this offering unless you can afford to lose your entire investment. Potential purchasers should review information about the enterprise and offering, and consider the terms and risks of this offering before investing. After reviewing the financial information, description of the business, activities, risk factors, and development timeline, potential purchasers should consider whether success of the enterprise is realistic. No government regulator is recommending these securities. No government regulator has verified that this document is accurate or determined that it is adequate. The Commissioner of Business Oversight has in no way passed upon the merits or qualifications of, or recommended or given approval to, any person, security, or transaction associated with this offering." B. The issuer's street address, telephone number, person to contact with respect to the offering, type of securities offered, financial terms of the offering, the minimum amount the issuer is seeking to raise, a description of the business of the issuer and how the issuer plans to carry out its activities, a budget for the use of proceeds of the offering, a list of the factors the issuer considers to be the most significant risks to an investor, and a description, in chronological order, or the steps management intends to take to achieve, maintain, or improve profitability during the 36 months following receipt of the offering proceeds. C. Specified financial statements of the issuer, prepared in accordance with generally accepted accounting principles, and certified by the principal executive officer of the issuer to be true and complete in all SB 577 (Hueso) Page 10 of ? material respects. ii. Issuers may not utilize the exemption to raise funds for an enterprise dependent on the creation of a product or technology for which no fully functional prototype has been made in advance of the public offering of securities. Any fully functional prototype must be demonstrated in person to any potential investor upon request, as specified. SB 577 (Hueso) Page 11 of ? EXISTING FEDERAL LAW AND REGULATION 1. Provide 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. 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: a. 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 b. 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. 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 SB 577 (Hueso) Page 12 of ? 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 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, or unless the offering or sale is covered by an express exemption (Corporations Code Section 25110). 2. Authorizes several exemptions from the requirement to obtain a securities permit from DBO prior to offering or selling securities in this state. Two of the most relevant exemptions for purposes of this bill include Corporations Code 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 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. According to the Department of Business Oversight (DBO), between 20,000 and 35,000 people file forms with DBO SB 577 (Hueso) Page 13 of ? annually, claiming exemptions pursuant to Section 25102(f). In 2013, approximately 18,000 exemption filings were made in connection with securities offerings of $1 million or less. 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. Qualified purchasers are 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 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 SB 577 (Hueso) Page 14 of ? 25102(n). COMMENTS 1. Purpose: This bill is sponsored by the Sustainable Economies Law Center (SELC) to reduce barriers in California law that are currently limiting the ability of community-rooted, small businesses to raise money from investors. 2. Background: This bill addresses an issue that has been heard by this Committee several times during prior years. It would authorize entities seeking to raise money from investors to use general solicitation and general advertising to pitch both accredited and non-accredited investors in California. By authorizing exemptions from state securities permitting requirements, the bill would allow entities seeking to raise money from investors to avoid the costly and sometimes lengthy securities permitting process. In lieu of applying for and complying with the terms of a permit, an entity seeking to raise money utilizing one of the exemptions authorized by this bill would have to comply with a set of rules specific to the exemption they wished to use. Although the specific rules differ from exemption to exemption (see comparison table in a subsequent section), they generally place a cap on the total amount of money each entity may raise and require each entity to provide specified disclosures to prospective investors. This bill's exemptions are structured in ways intended to prevent the imposition of costly compliance burdens on issuers (i.e., the entities seeking to raise money). The bill's exemptions are also premised on the expectation that prospective investors will carefully read and consider the disclosures they are provided, and will be able to look out for their own best interests when evaluating whether, and how much, to invest. There is no expectation that the Department of Business Oversight (DBO) will examine entities that utilize these exemptions to ensure that these entities are complying with the rules. Instead, responsibility for enforcing the terms of exemptions rests largely with investors; it is up to an individual investor to file a complaint against an issuer with DBO or to file suit against SB 577 (Hueso) Page 15 of ? that issuer in court, if the investor believes that an issuer is failing to adhere to the rules applicable to that issuer. 3. What Are General Solicitation and General Advertising? As their names imply, general solicitation and general advertising are not targeted. They 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. 4. What is an Accredited Investor? The term "accredited investor" is generally used as a proxy for a sophisticated investor, but can also include people whose financial sophistication may not match their income or wealth. The term includes several different entities with considerable financial experience, including financial institutions, securities broker-dealers, large pension plans, and corporate entities with assets in excess of $5 million; it also includes certain high-wealth or high-income individuals. Pursuant to SEC Rule 501, and as summarized above, an accredited individual includes both of the following: a. 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 b. 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. This definition can include financially savvy individuals with annual income or net worth above the listed amounts; it can also SB 577 (Hueso) Page 16 of ? include senior citizens who have successfully saved for their retirements, sole proprietors whose business income exceeds $200,000 in two consecutive years, young professionals who take well-paying jobs right out of graduate school, and others whose financial sophistication may not match their income or wealth. 5. Discussion: This bill contains four provisions - one change to the rules governing consumer cooperative corporations and three new securities permitting exemptions. For clarity, the consumer cooperative corporation provision is discussed separately from the permitting exemptions. The permitting exemptions are described together, to aid in comparing and contrasting their similarities and differences. Increase in Maximum Dollar Value of Shares and Memberships In Consumer Cooperative Corporations: Existing California law caps the maximum aggregate investment that may be made by a shareholder in shares or by a member in memberships in a consumer cooperative corporation. As long as this cap is not exceeded, sales of those shares or memberships are exempt from state securities permitting laws. The cap of $300 was placed in California law, effective January 1, 1984. The sponsor of this bill is seeking to increase the cap from $300 to $1,000 to give consumer cooperative corporations greater ability to raise funds from their members, without running afoul of California's securities laws. By allowing consumer cooperatives to solicit needed financing from their own members, rather than from non-member, professional investors who will want to control the direction of the co-op, the sponsor is seeking to give co-ops greater ability to raise capital in ways that align with their values and structures. Staff notes that if the $300 cap had been allowed to increase with inflation since 1984, it would equal $695 in 2015, lower than the proposed increase to $1,000. Three New State Law Permitting Exemptions: The table below compares and contrasts the key requirements of the three permitting exemptions this bill would authorize. SB 577 (Hueso) Page 17 of ? ------------------------------------------------------------- | | General | Agricultural | Solar/Wind | | | Purpose | Exemption | Exemption | | | Exemption | | | |-------------+---------------+---------------+---------------| |Maximum |$500,000 |$2 million |$2 million | |Amount That | | | | |Can Be | | | | |Raised | | | | |During Any | | | | |12-Month | | | | |Period | | | | |-------------+---------------+---------------+---------------| |Nature of |Debt |May be equity |May be equity | |Offering | |or debt |or debt | |-------------+---------------+---------------+---------------| |Limitation |No |Must be |Must be one of | |on Who the | |controlled by |four types of | |Issuer May | |a nonprofit |entities: 1) a | |Be | |corporation or |co-op or | | | |an |nonprofit | | | |agricultural |mutual benefit | | | |enterprise |corporation | | | |majority |seeking to | | | |controlled by |develop and | | | |farmers |operate one or | | | | |more | | | | |electricity-gen| | | | |eration | | | | |facilities; 2) | | | | |A nonprofit | | | | |public | | | | |benefit | | | | |corporation | | | | |seeking to use | | | | |solar or wind | | | | |power to meet | | | | |its energy | | | | |needs; 3) A | | | | |nonprofit | | | | |public benefit | SB 577 (Hueso) Page 18 of ? | | | |corporation | | | | |seeking to | | | | |build and | | | | |operate one or | | | | |more | | | | |facilities to | | | | |generate | | | | |electricity | | | | |for residents | | | | |of a single | | | | |city; or 4) An | | | | |entity owned | | | | |or entirely | | | | |controlled by | | | | |tenants in | | | | |multi-tenant | | | | |housing, which | | | | |has entered | | | | |into a | | | | |contract with | | | | |the owner of | | | | |the property | | | | |to install | | | | |solar panels | | | | |on the | | | | |property. | |-------------+---------------+---------------+---------------| |Limitation |No, but money |At least 75% |At least 75% | |on Use of |cannot be |of money |of the money | |Money Raised |raised for an |raised must be |raised must be | | |enterprise |allocated to |allocated to | | |dependent on |the purchase |the purchase | | |creation of a |or lease of |of solar | | |product or |land or an |photovoltaic | | |technology for |easement or |panels and | | |which no fully |for |related | | |functional |construction |equipment or | | |prototype has |of or |wind turbines | | |been made |improvement to |and related | | |prior to the |real property |equipment. | | |offering. |to be used for | | | | |agricultural | | | | |purposes. | | |-------------+---------------+---------------+---------------| SB 577 (Hueso) Page 19 of ? |Maximum |$1,000 |$1,000 if |$1,000 if | |Amount a | |their gross |their gross | |Non-Accredite| |income |income | |d Investor | |<$50,000 or |<$50,000 or | |May Invest | |net worth |net worth | | | |<$100,000; |<$100,000; | | | |$5,000 if they |$5,000 if they | | | |sign a |sign a | | | |statement |statement | | | |verifying |verifying | | | |gross income |gross income | | | |>$50,000 or |>$50,000 or | | | |net worth |net worth | | | |>$100,000. |>$100,000. | |-------------+---------------+---------------+---------------| |Maximum |No cap |No cap |No cap | |Amount an | | | | |Accredited | | | | |Investor May | | | | |Invest | | | | |-------------+---------------+---------------+---------------| |Limited to |Yes, unless |Yes, unless |Yes, unless | |California |solicitations |solicitations |solicitations | |investors |to |to |to | |only? |nonresidents |nonresidents |nonresidents | | |comply with |comply with |comply with | | |federal law or |federal law or |federal law or | | |other states' |other states' |other states' | | |laws |laws |laws | |-------------+---------------+---------------+---------------| |Types of |Cover sheet |Cover sheet |Cover sheet | |Information |with specified |with specified |with specified | |That Must Be |warnings and |warnings and |warnings and | |Shared With |cautionary |cautionary |cautionary | |Potential |recommendations|recommendations|recommendations| |Investors |; key |; key |; key | | |information |information |information | | |about the |about the |about the | | |issuer and the |issuer and the |issuer and the | | |intended |intended |intended | | |use(s) of the |use(s) of the |use(s) of the | | |money sought; |money sought; |money sought; | | |specified |specified |specified | | |financial |financial |financial | SB 577 (Hueso) Page 20 of ? | |statements; |statements; |statements. | | |information |information | | | |about material |about material | | | |legal |legal | | | |proceedings |proceedings | | | |involving the |involving the | | | |issuer or its |issuer or its | | | |management, if |management, if | | | |any. |any. | | | | | | | | | |Additionally: | | | | |Income tax | | | | |returns filed | | | | |by the issuer; | | | | |key | | | | |information | | | | |about the | | | | |property being | | | | |sought; | | | | |promise to | | | | |refund | | | | |investors' | | | | |money if the | | | | |intended use | | | | |of that money | | | | |is the | | | | |purchase of | | | | |farmland, and | | | | |sufficient | | | | |funds for the | | | | |purchase are | | | | |not raised | | | | |within two | | | | |years. | | |-------------+---------------+---------------+---------------| |Must File |Yes, but there |Yes, but there |Yes, but there | |Notice of |is no penalty |is no penalty |is no penalty | |Exemption |for failing to |for failing to |for failing to | |With DBO |do so. |do so. |do so. | | | | | | ------------------------------------------------------------- Who These Exemptions Are Targeting: This bill is intended to allow cooperatives, farms, and nonprofit organizations to SB 577 (Hueso) Page 21 of ? raise money from investors in their communities. According to this bill's sponsor, many investors who wish to invest in such enterprises are not seeking high returns on their investments; instead, they are seeking to help their communities by enabling the creation and growth of such enterprises. "Mission-driven enterprises often wish to raise capital from their local community, such as extended networks of friends, colleagues, customers, and fans. This extended network surrounding any popular enterprise often includes both accredited and non-accredited investors." Sponsor's Logic For Failing to Cap Investments By Accredited Investors: SB 577 proposes to cap amounts that non-accredited investors may invest. It does not propose caps on investments by accredited investors. According to this bill's sponsor, the limits on non-accredited investors are intended to ensure that less wealthy investors are not exposed to more risk than is appropriate for their level of wealth. The sponsor believes that imposing such restrictions on accredited investors would force entrepreneurs to either choose to solicit accredited investors only (as is already authorized under existing federal law) or to solicit both accredited and non-accredited investors but be limited by restrictions that are more appropriate for less wealthy investors. At the present time, Title II of the federal JOBS Act authorizes issuers to use general solicitation and general advertising to solicit investors, when the investment is limited only to accredited investors, and when the issuer takes reasonable steps to verify that purchasers are accredited. The sponsor claims that imposing limits on the amount of money that accredited investors may invest would be inconsistent with Title II of the JOBS Act. SB 577 (Hueso) Page 22 of ? 6. Summary of Arguments in Support: a. The Sustainable Economies Law Center (SELC) is sponsoring this bill, which it has named the "Local Economies Securities Act." SELC writes, "Small businesses, which are critical to our economy, need more options to access capital. Meanwhile, investors are increasingly interested in putting their money in local, community-based enterprises instead [of] investing through distant financial institutions. Currently, California securities law makes it very expensive and time-consuming for a small business to obtain the permit necessary to be able to legally communicate about its investment needs to a broad audience. SB 577 will create modest exemptions from those requirements for small businesses that comply with reasonable disclosure requirements and other restrictions. We are especially excited that the bill recognizes the need to develop more small-scale farms and community-owned renewable energy enterprises in California by designating additional exemptions designed for those types of enterprises in particular...more and more Slow Money networks in California are gathering groups of investors interested in investing in local, sustainable food and agricultural enterprises instead of Wall Street." b. National Crowdfunding Services, Roots of Change, and 350 Santa Barbara echo SELC's concern that California's securities laws make it extremely difficult for California small businesses to make investment opportunities publicly available. Although existing California law is intended to protect investors from overly risky investments, it inadvertently creates a system where larger businesses have more financing options, while smaller enterprises, especially those rooted in low- to moderate-income communities, have fewer options for financing, and thus fewer development opportunities. Furthermore, under existing California law, ordinary individuals are shut out from investment opportunities in which they may wish to participate. c. Slow Money Northern California and Slow Money South Bay would like to connect sustainable food enterprises SB 577 (Hueso) Page 23 of ? with local investors, and believe that existing securities law prevent entrepreneurs from speaking out at Slow Money meetings about their fundraising endeavors. Among the diverse array of attendees at their monthly meetings are many local investors who are interested in making investments that align with their values, even if that means taking on more risk or making lower returns compared to investing through large financial institutions. SB 577 would enable food entrepreneurs in the Slow Money network to speak more openly about their investment needs and give more investors access to the kinds of investment opportunities they want. 7. Summary of Arguments in Opposition: None received. 8. Amendments: The amendments below are grouped into two categories: a) technical and clarifying amendments necessary to ensure that the bill does what the author and sponsor intend it to do, and b) substantive amendments intended to bolster the investor protections in the bill and reduce unintended, potentially negative consequences. a. Technical and Clarifying Amendments: i. Ensure the correct use of terms, and ensure consistency in the key requirements of the different exemptions. Page 24, line 21 and page 33, line 9, strike "company" and insert: issuer, and add the following language on page 36, between lines 32 and 33, "(D) A written statement of information about any material legal proceedings involving the issuer or its officers and directors." ii. Clarify the uses of money raised using the agricultural exemption. On page 30, strike lines 4 through 7 and insert: (1) At least 75% of amounts raised through the offering will be reserved or allocated to any of the following, for agricultural purposes: purchase of fee title to real property, lease of 30 years or more of real property, purchase of an easement on real property, construction of real property, or improvement to real property. SB 577 (Hueso) Page 24 of ? iii. Require appraisals to be performed by qualified persons. Page 32, line 28, after "year" insert: by a California licensed or certified appraiser iv. Eliminate unnecessary language. Page 33, strike lines 10 through 20. v. Clarify the definition of "related equipment" in the context of the solar and wind energy exemption. The sponsor is proposing to clarify this exemption by replacing the words "related equipment" with a reference to "equipment necessary for the storage and transmission of energy generated by the solar panels or wind turbines." Page 33, delete lines 36 and 37 and insert: panels, wind turbines, or equipment necessary for the storage and transmission of energy generated by the solar panels or wind turbines." vi. Clarify what is meant by language describing the first type of issuer who may utilize the solar and wind energy definition. The sponsor proposes to strike page 34, lines 5 through 10, and insert the following: (A) The issuer is a cooperative corporation or nonprofit mutual benefit corporation with one or more of the following purposes: (i) Developing and/or operating facilities that produce solar or wind energy for its members; (ii) Selling or leasing solar photovoltaic panels or wind turbines to its members or installing solar photovoltaic panels or wind turbines for its members; (iii) Allocating net metering credits among its members. SB 577 (Hueso) Page 25 of ? b. Substantive Amendments Intended to Bolster Investor Protections: i. This bill places no limit on the amount of money that accredited investors may invest with an issuer. As noted above, not all accredited investors are sophisticated investors. For that reason, this Committee may wish to ask the author to cap the amount that an accredited investor may invest with any single issuer, to minimize the possibility that an unsophisticated, accredited investor could lose his or her life savings via an investment authorized by this bill. One option: cap the amount that any accredited investor may invest with any issuer at 5% of that investor's net worth. (Thus, an accredited investor with a net worth of $1 million would be limited to investing $50,000 in any single investment authorized by this bill. Wealthier accredited investors could invest greater amounts). ii. Two of this bill's exemptions (the agricultural exemption and the solar/wind energy exemption) distinguish between two types of non-accredited investors: those with minimum annual gross income of $50,000 or minimum net worth of $100,000 (who are authorized to invest up to $5,000) and those with gross income less than $50,000 or net worth less than $100,000 (who are capped at investing $1,000). Using an annual gross income threshold of $50,000 or a net worth of $100,000 as a measure of financial capacity in a high-cost state like California may be inappropriate. In the alternative, staff suggests the "qualified purchaser" approach already contained in the exemption authorized by Corporations Code Section 25102(n). The qualified purchaser definition describes non-accredited investors who are believed to have some degree of financial sophistication. The qualified purchaser bar is lower than the accredited investor bar, but still high enough to capture people who can afford to invest in SB 577 (Hueso) Page 26 of ? potentially risky ventures. Section 25102(n) defines a "qualified purchaser" as one who 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. Alternately, the term applies to individuals who have a minimum net worth of $500,000, exclusive of their home, home furnishings, and automobiles. Section 25102(n) also caps the maximum investment of each qualified purchaser at 10% of their net worth. Suggested amendment: Insert the qualified purchaser definition in place of the proposed $50,000 net worth/$100,000 gross income threshold in the current version of the bill (page 30, lines 17 through 25 and page 34, lines 31 through 39). iii. All three exemptions require the issuer to file a notice of transactions with the commissioner, but none of the exemptions specifies the penalty for failure to file this notice. To ensure that failure to file the notice carries a stiff penalty, staff suggests conditioning the availability of the exemption on submission of the notice, an approach that is used in Corporations Code Section 25102(n). Page 28, line 10, page 31, line 23, and page 35, line 34, after the period, insert: "The exemption from qualification afforded by this subdivision is unavailable if an issuer fails to file the notice within a time period specified by the commissioner by rule. Neither the filing of the notice nor the failure by the commissioner to comment thereon precludes the commissioner from taking any action that the commissioner deems necessary or appropriate under this division with respect to the offer and sale of the securities." An alternate approach that is less punitive on issuers who fail to file would pattern penalty SB 577 (Hueso) Page 27 of ? language on the approach used in Corporations Code Section 25102(f). If that approach is preferred, the language would read, "The failure to file the notice or the failure to file the notice within the time specified by the rule of the commissioner shall not affect the availability of the exemption. Any issuer that fails to file the notice as provided by rule of the commissioner shall, within 15 business days after discovery of the failure to file the notice or after demand by the commissioner, whichever occurs first, file the notice and pay to the commissioner a fee equal to the fee payable had the transaction been qualified under Section 25110. Neither the filing of the notice nor the failure by the commissioner to comment thereon precludes the commissioner from taking any action that the commissioner deems necessary or appropriate under this division with respect to the offer and sale of the securities." iv. All three exemptions require the issuer to provide prospective investors with "a list of the factors the issuer considers to be the most significant risks to an investor." To ensure that investors are made aware of all potential risks, and not just those risks that the issuer believes to be the most significant, the following amendment is suggested: Page 28, lines 36 through 38, page 32, lines 21 and 22, and page 36, lines 21 through 23, strike "a list of the factors that the issuer considers to be the most significant risks to an investor" and replace it with "a list of the risks of the investment that are known to the issuer, annotated to reflect which of those risks the issuer believes to be the most significant." v. With one narrow exception involving the fee title purchase of farmland, none of the exemptions require issuers to set aside the money they raise, by placing it into a third party escrow account until the minimum amount sought is obtained. Similarly, with one narrow exception involving the SB 577 (Hueso) Page 28 of ? fee title purchase of farmland, none of the exemptions require issuers to refund money to investors, if less than the minimum amount sought is raised. Escrowing money raised from investors until the minimum amount sought is raised, and requiring issuers to return that money to investors if their offerings are ultimately unsuccessful in raising the minimum amount sought, will better protect investors. If an issuer needs a certain amount of money to achieve its stated goals and raises less than that amount, investors are unlikely to realize value from their investment, because the issuer will not, by definition, have enough money with which to achieve the goals for which it sought to raise money. Staff suggests giving issuers one year in which to meet their minimum fundraising goals. Page 29, between lines 21 and 22, insert: (7) The issuer sets aside in a separate third-party escrow account all funds raised as part of the offering, to be held in escrow until the time that the minimum offering amount is reached. If the minimum offering amount is not reached within one year following the effective date of the offering, the issuer shall return all funds to investors. Page 32, strike lines 9 through 15, and insert the following on page 33, between lines 9 and 10: (11) The issuer sets aside in a separate third-party escrow account all funds raised as part of the offering, to be held in escrow until the time that the minimum offering amount is reached. If the minimum offering amount is not reached within one year following the effective date of the offering, the issuer shall return all funds to investors. Page 36, between lines 32 and 33, insert: (10) The issuer sets aside in a separate third-party escrow account all funds raised as part of the offering, to be held in escrow until the time that the minimum offering amount is reached. If the minimum offering amount is not reached within one year following the SB 577 (Hueso) Page 29 of ? effective date of the offering, the issuer shall return all funds to investors. vi. Regardless of whether the author accepts the amendments suggested in paragraph v immediately above, the cover sheet required to be provided to investors, informing them their money will be returned to them if insufficient funds are raised to purchase farmland within two years after the beginning of the offering, requires clarification to achieve the sponsor's intent and modification to better protect investors. As drafted, investors whose money is intended to be used to purchase farmland, but whose money is not spent because insufficient funds are raised to purchase farmland, are told that their money will be returned to them no earlier than 60 days following failure of the issuer to raise sufficient funds. It is unclear why investors should have to wait that long to receive their money. If the amendments suggested in paragraph v above are accepted, lines 6 through 15 on page 32 should be deleted for consistency. If the author fails to accept the amendments suggested in paragraph v above, the following language should be substituted for lines 6 through 15 on page 32: (iv) Where the goal of the issuer in conducting the offering is to purchase fee title to farmland, the offering must state "The company described in this disclosure form is seeking to purchase farmland. If the sum of the investment commitments received by [the issuer] does not amount to a sum sufficient to purchase farmland by [insert date two years after beginning of offering], your investment will be returned to you within 30 days following that date. It is your responsibility to notify the issuer if your address changes, to ensure you receive any refund due to you. Notification regarding a change in address may be made by either of the following methods: [insert at least two methods by which the issuer may be contacted regarding a change in address]" SB 577 (Hueso) Page 30 of ? vii. This bill requires issuers using the agricultural exemption to provide prospective investors with copies of their income tax returns for the most recently completed year, if any. The bill lacks this requirement under the other two exemptions. The sponsor would prefer to delete this requirement where it appears in the agricultural exemption, rather than adding it to the other exemptions. However, it is unclear how this requirement would be burdensome on issuers, as the issuer's tax returns should be readily available. Staff suggests adding this requirement to the other two exemptions, as follows: Page 29, between lines 2 and 3, and page 36, between lines 26 and 27, insert: (C) The income tax returns filed by the issuer for the most recently completed year, if any." viii. Page 30, lines 8 through 11: This language within the agricultural exemption requires the issuer to either be a nonprofit organization (undefined, and with no specific mission or purpose) or an agricultural enterprise, majority-controlled by one or more farmers who are actively engaged in the enterprise. Failure to narrow the types of nonprofit organizations that may act as issuers may represent a loophole that could be exploited in ways unintended by this bill's author and sponsor. In response to this concern, the sponsor is proposing to limit the availability of the agricultural exemption to farmer-controlled agricultural enterprises and to nonprofit public benefit corporations, rather than to nonprofits generally. The logic is that nonprofit public benefit corporations do not have shareholders or otherwise benefit private individuals. Page 30, line 11, strike "organization" and insert: public benefit corporation SB 577 (Hueso) Page 31 of ? ix. As drafted, the bill does not require issuers seeking to raise money using the solar/wind energy exemption to provide investors with any documentation that the use of solar or wind energy is appropriate in the location(s) the issuer wishes to place solar panels or wind turbines. The following amendment would require this type of documentation: Page 36, line 19, after "issuer," insert: justification that solar panels or wind turbines, as applicable, are appropriate in the location where the issuer is seeking to place them, 9. Prior and Related Legislation: a. AB 722 (Perea), 2015-16 Legislative Session: Would authorize a new way to obtain a securities permit allowing the offer or sale of securities advertised by means of general solicitation and general advertising to both accredited and non-accredited investors, as specified. Pending a hearing in the Assembly Banking and Finance Committee. b. AB 2096 (Muratsuchi), 2013-14 Legislative Session: Would have authorized "qualification by notification" of offers or sales of securities advertised by means of general solicitation and general advertising to both accredited and non-accredited investors, as specified. Held on the Senate Appropriations Committee Suspense File. c. AB 783 (Daly), 2013-14 Legislative Session: Would have authorized a state securities exemption for persons seeking to offer or sell securities using any form of general solicitation or general advertising, including unsolicited telephone calls to a person's residence or cellular telephone, provided that sales of the securities were made only to persons who the issuer took reasonable steps to verify were accredited investors. Never taken up by the author in the Assembly Banking & Finance Committee. d. AB 2081 (Allen), 2011-12 Legislative Session: SB 577 (Hueso) Page 32 of ? Substantially similar to AB 783. Failed passage on the Senate Floor. e. SB 875 (Price), 2009-10 Legislative Session: Substantially similar to AB 783. Never taken up by the author in the Senate Banking, Finance & Insurance Committee. f. AB 1644 (J. Campbell), 2001-02 Legislative Session: Substantially similar to AB 783. Failed passage in the Assembly Banking & Finance Committee. SB 577 (Hueso) Page 33 of ? LIST OF REGISTERED SUPPORT/OPPOSITION Support Sustainable Economies Law Center (sponsor) The Greenhorns National Crowdfunding Services Roots of Change 350 Santa Barbara Slow Money Northern California Slow Money Santa Barbara Slow Money South Bay Opposition None received -- END --