BILL ANALYSIS �
SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE
Senator Noreen Evans, Chair
2013-2014 Regular Session
AB 2096 (Muratsuchi) Hearing Date: June 18, 2014
As Amended: June 9, 2014
Fiscal: Yes
Urgency: No
SUMMARY Would create 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.
DESCRIPTION
1. Would authorize the "qualification by notification" of any
offer or sale of any security that meets all of the
following criteria:
a. The aggregate amount of securities sold to all
investors by the issuer within any 12-month period may
not exceed $1 million.
b. The aggregate amount of securities sold to any
non-accredited investor by the issuer, including any
amount sold to that investor during the 12-month period
immediately preceding the date of the transaction, may
not exceed $5,000, or a greater amount established by the
Commissioner of Business Oversight (commissioner) by rule
or order.
c. The offering must meet the requirements of federal
Rule 504 of the Securities Act of 1933 (codified in 17
CFR Section 230.504 and summarized later in this
analysis).
d. The issuer must file with the commissioner, provide
to investors, and make available to potential investors,
all of the following:
i. A Small Company Offering Registration
AB 2096 (Muratsuchi), Page 2
disclosure statement on Form U-7. The issuer must
ensure that the cover page of the Form U-7 includes
all of the following statements, in a type size of 12
points or larger: 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. The company described in this
disclosure form is seeking to raise a minimum
offering of [insert minimum offering amount]. If the
sum of the investment commitments received by the
company does not equal or exceed the minimum offering
amount by [insert date], your investment in the
company will be returned to you."
ii. Financial documents:
A. For offerings that, together with
all other offerings of the issuer within the
preceding 12-month period, have offering amounts
of $100,000 or less in the aggregate: the income
tax returns filed by the issuer for the most
recently completed year, if any; and financial
statements of the issuer, certified by the
principal executive officer of the issuer to be
true and complete in all material respects.
B. For offerings that, together with
all other offerings of the issuer within the
preceding 12-month period, have offering amounts
between $100,000 and $500,000: all financial
statements reviewed by a public accountant who is
independent of the issuer, using professional
standards and procedures or standards and
procedures established by the commissioner by
rule.
C. For offerings that, together with
all other offerings of the issuer within the
preceding 12-month period, have offering amounts
of more than $500,000: audited financial
statements.
e. The issuer must set aside all funds raised as part
of the offering in a third-party escrow account, to be
held until the minimum offering amount is reached, and
AB 2096 (Muratsuchi), Page 3
return all funds to investors, if the minimum offering
amount is not reached within one year following the
effective date of the offering.
f. Neither the issuer, a predecessor of the issuer,
affiliate of the issuer, or a long list of persons with
key roles in the issuer's management or direction may
have been disqualified as bad actors pursuant to
subdivision (d) of 17 CFR Section 230.506.
g. Any other requirement set forth by rule adopted by
the commissioner.
2. Would direct a court to award attorney's fees and costs,
and authorize a court to award treble or punitive damages,
to a prevailing plaintiff purchaser who brings an action
against any person for a violation of the bill's provisions.
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.
a. Rule 501 of Regulation D defines accredited investors
as, among other things, financial institutions, securities
broker-dealers, large pension plans, corporate entities with
assets in excess of $5 million, and other large, financially
sophisticated entities. An accredited investor also
AB 2096 (Muratsuchi), Page 4
includes:
i. Any natural person whose individual net
worth, or joint net worth with that person's spouse,
exceeds $1 million at the time of their purchase of
securities, exclusive of their primary residence; or
ii. Any natural person with an individual income
in excess of $200,000 in each of the two most recent
years, or joint income with that person's spouse in
excess of $300,000 in each of those years, together with
a reasonable expectation of reaching the same income
level in the current year.
b. Rule 504 of Regulation D authorizes the offer and sale
of up to $1 million in securities by an issuer, as long as
the offer and sale are made:
i. Exclusively in one or more states that
provide for the registration of the securities, and
require the public filing and delivery to investors of a
substantive disclosure document before the sale of the
securities (this is the provision of Rule 504 applicable
to this bill);
ii. In one or more states that have no provision
for the registration of the securities or the public
filing or delivery of a disclosure document before sale,
if the securities have been registered in at least one
state that does provide for such registration, public
filing and delivery before sale, as specified; or,
iii. Exclusively according to state law exemptions
from registration that permit general solicitation and
general advertising, as long as sales are made only to
accredited investors (this is the provision of Rule 504
that was applicable to prior bills sponsored by this
bill's sponsor).
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. 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
AB 2096 (Muratsuchi), Page 5
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 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 for qualification by
notification 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 10th business day after the
application is filed or last amended, or at an earlier
time specified by the commissioner.
3. Contains several exemptions from the requirement
immediately above. While the number of exemptions is too
numerous to list, 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
AB 2096 (Muratsuchi), Page 6
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
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
AB 2096 (Muratsuchi), Page 7
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
25102(n).
COMMENTS
1. Purpose: This bill is sponsored by Small Business
California, to allow small businesses and start-ups to more
readily access capital.
2. This Bill's Approach: This bill is similar to bills
advanced by the same proponents during prior years (see
Prior and Related Legislation section below), but takes a
different approach to accomplish the sponsor's intent. In
prior years, the proponents attempted to secure an exemption
from state securities laws to authorize general solicitation
and general advertising to accredited investors. This year,
the proponents are attempting to secure a qualification by
notification, under which issuers can use general
solicitation and general advertising to attract both
accredited and non-accredited investors.
Ordinarily, the words "qualified" or "registered" suggest to
investors that an offering has undergone significant review
by either the state or federal securities regulator. Under
existing state law, there are only three ways to qualify a
securities offering, all of which require significant review
of the offering by either the SEC or DBO. Those three ways
include coordination (Corporations Code Section 25211;
involves offerings registered under the Federal Securities
Act of 1933); notification (Section 25212; involves
securities registered under Section 12 of the Securities
AB 2096 (Muratsuchi), Page 8
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 DBO for a permit that is good for one year; Section
25213; according to DBO, only 130 permit applications were
filed with the Department last year).
This bill would authorize use of the word "qualified" in
connection with offerings that would not have to undergo
extensive review by either DBO or the SEC. Issuers wishing
to utilize the qualification by notification authorized by
this bill would have to submit information about their
offering and their financial condition to DBO. The offering
would automatically become qualified, unless DBO makes an
affirmative finding within 10 business days of receiving the
notification that the proposed transaction is unfair,
unjust, or inequitable.
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. In Summary: The remainder of this analysis will describe in
detail why the proponents of this bill are seeking to use
the approach they have selected, and how that approach
compares to alternate approaches. For those who wish to
boil down the detail that follows, the following may be
useful: The value to the sponsor of the approach taken in
this bill is the bill's authorization of direct
solicitation, via the issuer's web site and other means, to
a wide group of potential investors, and its authorization
of sales of securities to both accredited and non-accredited
investors. The federal CROWDFUND Act is inadequate for the
sponsor, because it will require issuers to advertise and
sell their offerings through a middle-man, something the
sponsor wishes to avoid. A state crowdfunding exemption,
such as the laws enacted in six other states, is inadequate
AB 2096 (Muratsuchi), Page 9
for the sponsor, because state crowdfunding exemptions
require that all solicitations be intrastate, and the
sponsor believes that use of an issuer's website to directly
solicit investors is incompatible with an intrastate
limitation. Existing state law is inadequate for the
sponsor, because it restricts the types of allowable
solicitation and advertising.
5. Is This A State Crowdfunding Bill? AB 2096 would authorize
securities issuers (i.e., businesses seeking funding in
exchange for a piece of their company) to directly solicit
both accredited and non-accredited investors, both in
California and in other states that have similar laws, via
general solicitation and general advertising. Title III of
the federal JOBS Act, also known as the CROWDFUND Act, will
authorize issuers of securities to solicit accredited and
non-accredited investors, both in California and elsewhere,
via intermediaries (which the JOBS Act requires to be
broker-dealers or funding portals), using general
solicitation and general advertising, once the SEC
promulgates regulations to implement this title. On its
website, the SEC reminds issuers that it has not yet
promulgated the final regulations required of it by Title
III of the JOBS Act. "Until then, we are reminding issuers
that any offers or sales of securities purporting to rely on
the crowdfunding exemption would be unlawful under the
federal securities laws."
.
Because AB 2096 and the JOBS Act authorize general
solicitation and general advertising to accredited and
non-accredited investors, they can both be described as
securities crowdfunding measures. However, the similarities
between the federal CROWDFUND Act and this bill generally
end there. AB 2096 can be described as a state
crowdfunding bill, but cannot be described as a state
crowdfunding exemption, nor as substantially similar to the
federal CROWDFUND Act, nor as predicated on enactment of
that federal Act. Although the proponents of AB 2096
borrowed a few paragraphs from the federal CROWDFUND Act,
this bill could have been proposed prior to enactment of
that federal Act.
The table below compares key elements of AB 2096 with Title
III of the JOBS Act
--------------------------------------------------------------
AB 2096 (Muratsuchi), Page 10
| | Title III of JOBS | AB 2096 |
| | Act | |
|--------------------+--------------------+--------------------|
|Nature of |Exemption from |Qualification by |
|Authorization |registration |notification |
| |requirements of the | |
| |Securities Act of | |
| |1933 | |
|--------------------+--------------------+--------------------|
|Maximum Total Value |$1 million per |$1 million per |
|of Securities That |12-month period |12-month period |
|May Be Sold In | | |
|Reliance on the | | |
|Authorization | | |
|--------------------+--------------------+--------------------|
|Maximum Aggregate |Investors with |Non-accredited |
|Value of Securities |annual income or |investors: $5,000 |
|That May Be Sold to |net worth <$100K: |or a greater amount |
|a Single Investor |greater of $2K or |as determined by |
| |5% of annual income |the commissioner. |
| |or net worth. | |
| | |Accredited |
| |Investors with |investors: No |
| |annual income or |limit other than |
| |net worth of $100K |the $1 million cap. |
| |or more: 10% of | |
| |annual income or | |
| |net worth, not to | |
| |exceed $100K. | |
|--------------------+--------------------+--------------------|
|Is An Intermediary |Yes. Transactions |No |
|Required? |must be conducted | |
| |through a | |
| |registered broker | |
| |or a registered | |
| |funding portal. | |
|--------------------+--------------------+--------------------|
|Requirements |Broker or portal |N/A |
|Applicable to |must register with | |
|Intermediaries |the SEC and FINRA; | |
|(these requirements |provide specified | |
|will be clarified |disclosures to | |
|and may be |investors; ensure | |
|augmented by the |that each investor | |
|SEC when it |reviews specified | |
|finalizes its |education | |
AB 2096 (Muratsuchi), Page 11
|crowdfunding |information that | |
|regulations) |will be established | |
| |by the SEC by | |
| |regulation and | |
| |affirms that they | |
| |understand the | |
| |risks of the | |
| |investment they are | |
| |about to undertake; | |
| |perform background | |
| |checks on persons | |
| |with key management | |
| |roles in the | |
| |issuer's | |
| |organization; make | |
| |key information | |
| |provided by the | |
| |issuer available to | |
| |investors; ensure | |
| |that all offering | |
| |proceeds are only | |
| |provided to the | |
| |issuer when the | |
| |aggregate capital | |
| |raised from all | |
| |investors is equal | |
| |to or greater than | |
| |a target offering | |
| |amount, and allow | |
| |investors to cancel | |
| |their commitments | |
| |to invest in | |
| |accordance with | |
| |rules to be | |
| |promulgated by the | |
| |SEC; undertake | |
| |efforts to ensure | |
| |that no individual | |
| |investor exceeds | |
| |the maximum | |
| |allowable purchase | |
| |of crowdfunding | |
| |offerings; protect | |
| |the privacy of | |
| |information | |
| |collected from | |
AB 2096 (Muratsuchi), Page 12
| |investors; refrain | |
| |from compensating | |
| |promoters, finders, | |
| |or lead generators | |
| |for providing the | |
| |broker or funding | |
| |portal with | |
| |personal | |
| |identifying | |
| |information about | |
| |any potential | |
| |investors; and | |
| |prohibit its | |
| |directors, | |
| |officers, or | |
| |partners from | |
| |having any | |
| |financial interest | |
| |in an issuer using | |
| |its services. | |
|--------------------+--------------------+--------------------|
|Requirements |Issuers must file |Issuers must file |
|Applicable to |with the SEC and |with the |
|Issuers |provide to |commissioner and |
| |investors and the |provide to |
| |broker or funding |investors a Small |
| |portal all of the |Company Offering |
| |following: key |Registration Form |
| |information about |U-7. The U-7 is a |
| |the identity of the |37-page document |
| |issuer, its key |(not including |
| |owners and |attachments) that |
| |management |includes |
| |personnel, its |information about |
| |business plan, a |the issuer, its |
| |description of the |management, and its |
| |financial condition |business plan, and |
| |of the issuer (see |about the offering, |
| |detail below); a |including a |
| |description of the |description of the |
| |stated purpose and |purpose and |
| |intended use of the |intended use of the |
| |proceeds of the |proceeds of the |
| |offering; the |offering. |
| |target offering |According to this |
| |amount, deadline to |bill's sponsor, the |
AB 2096 (Muratsuchi), Page 13
| |reach the target |two key |
| |offering amount, |requirements of the |
| |and regular updates |U-7 that are not |
| |regarding the |required by Title |
| |progress of the |III of the JOBS Act |
| |issuer in meeting |are the requirement |
| |the target |that the issuer |
| |offering; the price |describe what it |
| |to the public of |must do to meet key |
| |the securities |milestones and |
| |being offered; a |describe how it |
| |description of the |will use the |
| |ownership and |offering proceeds |
| |capital structure |if only the minimum |
| |of the issuer, and |offering amount is |
| |including a |raised. |
| |description of | |
| |specified risks to |Issuers must return |
| |purchasers. |all money raised |
| | |from investors, if |
| |Issuers are |they do not raise |
| |prohibited from |enough to meet |
| |advertising the |their minimum |
| |terms of the |offering amount. |
| |offering, except | |
| |through notices | |
| |that direct | |
| |investors to the | |
| |broker or funding | |
| |portal. Direct | |
| |solicitation of | |
| |investors is not | |
| |allowed. | |
| | | |
| |Issuers are | |
| |prohibited from | |
| |compensating or | |
| |committing to | |
| |compensate, | |
| |directly or | |
| |indirectly, any | |
| |person to promote | |
| |its offerings | |
| |through | |
| |communication | |
| |channels provided | |
AB 2096 (Muratsuchi), Page 14
| |by a broker or | |
| |funding portal, | |
| |without taking | |
| |steps to ensure | |
| |that the person | |
| |clearly discloses | |
| |receipt, past or | |
| |prospective, of | |
| |such compensation. | |
|--------------------+--------------------+--------------------|
|Financial |For offerings of |Same as Title III |
|Information That |$100K or less: |of the Jobs Act |
|Must Be Shared By |income tax returns | |
|The Issuer |filed by the issuer | |
| |for the most | |
| |recently completed | |
| |year (if any) and | |
| |financial | |
| |statements of the | |
| |issuer, which must | |
| |be certified by the | |
| |principal executive | |
| |officer of the | |
| |issuer to be true | |
| |and complete in all | |
| |material respects. | |
| | | |
| |For offerings | |
| |between $100K and | |
| |$500K: financial | |
| |statements of the | |
| |issuer, reviewed by | |
| |a public accountant | |
| |who is independent | |
| |of the issuer, | |
| |using professional | |
| |standards and | |
| |procedures for such | |
| |review. | |
| | | |
| |For offerings over | |
| |$500K: audited | |
| |financial | |
| |statements | |
|--------------------+--------------------+--------------------|
|Limitation on Sale |Securities may not |None |
AB 2096 (Muratsuchi), Page 15
|of Securities |be sold by a | |
|Purchased Through |purchaser for one | |
|An Issuer Relying |year following the | |
|on the |purchase, unless | |
|Authorization |they are sold to an | |
| |accredited | |
| |investor, as part | |
| |of an offering | |
| |registered with the | |
| |SEC, to a member of | |
| |the family of the | |
| |purchaser, or in | |
| |connection with the | |
| |death or divorce of | |
| |the purchaser. | |
|--------------------+--------------------+--------------------|
|Remedies For |Purchasers may |Remedies are those |
|Violations |bring an action at |authorized pursuant |
| |law or in equity in |to Corporations |
| |any court of |Code Section |
| |competent |25501.5 (rescission |
| |jurisdiction to |or damages, as |
| |recover the |applicable). |
| |consideration paid | |
| |for the security, | |
| |plus interest, less | |
| |the amount of any | |
| |income received in | |
| |connection with the | |
| |security, upon | |
| |tender of the | |
| |security, or for | |
| |damages, if the | |
| |person no longer | |
| |owns the security. | |
--------------------------------------------------------------
As illustrated above, there are several key differences
between this bill and Title III of the JOBS Act. Three of
the most important differences are summarized below.
First, the JOBS Act requires issuers to solicit investors
through an intermediary (either a broker-dealer or a funding
portal). It expressly prohibits issuers from soliciting
investors directly through their own web site. AB 2096
would allow issuers to solicit investors directly. The
AB 2096 (Muratsuchi), Page 16
sponsors of this bill believe that its authorization of
direct solicitation by issuers is the most important element
of the bill. They believe that cutting out the middle-man
can save issuers (many of which are expected to be start-ups
or other small businesses) money. They believe that the
form U-7 that issuers will have to provide to potential
investors will adequately educate those investors about the
securities they are being asked to purchase.
Opponents of this measure are concerned about the
significant degree of consumer protection that will be lost
by eliminating the middle-man. The JOBS Act requires these
middle-men to be brokers or approved funding portals. Under
existing federal law, brokers are held to a suitability
standard; they are prohibited from recommending an
investment that is not suitable for the person to whom they
are seeking to sell that security. The funding portals
authorized by the JOBS Act are required to adhere to several
provisions intended to educate potential investors about the
securities they are being asked to purchase and about the
potential risks of investing in small companies, including
the risks of illiquidity and loss of investment. The JOBS
Act places considerable responsibility for investor
protection on these middle-men, in an effort to ensure that
there is a buffer between issuers and investors.
Second, the limitations on the maximum amounts that may be
purchased by investors are different. The following table
illustrates a few examples of these differences.
------------------------------------------------------------
| Annual Income/Net | Maximum Allowable | Maximum Allowable |
| Worth of Investor | Investment (Title | Investment (AB |
| | III of the JOBS | 2096) |
| | Act) | |
|-------------------+--------------------+-------------------|
|$50,000 | $2,500 | $5,000 |
|-------------------+--------------------+-------------------|
|$100,000 | $10,000 | $5,000 |
|-------------------+--------------------+-------------------|
|$250,000 (assuming | | |
|person is not an | $25,000 | $5,000 |
|accredited | | |
|investor) | | |
|-------------------+--------------------+-------------------|
|Accredited | $100,000 |$1 |
AB 2096 (Muratsuchi), Page 17
|Investor | |million |
| | | |
------------------------------------------------------------
Third , Title III of the JOBS Act is not self-effectuating.
AB 2096 is. Although Title III of the JOBS Act contains
several rules that must be followed by issuers and
middle-men (brokers or funding portals), it will not become
effective until the SEC finalizes its regulations. This was
intended to serve as an additional layer of investor
protection, by requiring the SEC to clarify the application
of certain rules and/or add additional rules, as it saw fit
to protect investors. AB 2096 does not require the
promulgation of regulations by the commissioner in order to
become effective. Although it authorizes the commissioner
to promulgate implementing regulations, AB 2096 will become
operative on January 1, 2015, with or without those
regulations in place.
6. How Does AB 2096 Compare to Other State Crowdfunding
Exemptions? Through April 2014, six states had enacted
crowdfunding exemptions based closely on Title III of the
JOBS Act (Washington, Kansas, Wisconsin, Michigan, Indiana,
and Georgia). All of those states' laws authorize
intrastate crowdfunding solicitations, and require those
solicitations to comply with federal Rule 147 (17 CFR
Section 230.147).
Rule 147 specifies the conditions necessary for an intrastate
securities offering to be exempt from federal registration
requirements. Among its requirements, Rule 147 requires
that the issuer and all of the potential investors solicited
by the issuer must be located in the state in which the
exemption is offered.
In April 2014, the SEC issued two compliance and disclosure
interpretations (CDIs) related to Rule 147. One of those
CDIs is of particular relevance to this bill, because it is
the reason this bill's sponsor opted to seek a qualification
by notification instead of a securities law exemption such
as those enacted in other states.
In its April 10, 2014 CDI, the SEC answered the question, "Can
an issuer use its own website or social media presence to
offer securities in a manner consistent with Rule 147?" The
SEC wrote: "Issuers generally use their websites and social
AB 2096 (Muratsuchi), Page 18
media presence to advertise their market presence in a
broad, indiscriminate manner. Although whether a particular
communication is an 'offer' of securities will depend on all
of the facts and circumstances, using such established
Internet presence to convey information about specific
investment opportunities would likely involve offers to
residents outside the particular state in which the issuer
did business."
Although the CDI does not include an outright ban on use of
direct solicitation via an issuer's website or social media
presence, the CDI does raise significant questions about how
such solicitation could be structured to remain in
compliance with Rule 147. Because this bill's sponsor is
seeking to allow issuers to directly solicit potential
investors via their websites, it views the SEC's April 2014
CDI as problematic, and is seeking to avoid its application
to this bill.
7. Why Is Existing State Law Inadequate For This Bill's
Proponents?: Qualification by permit (Corporations Code
Section 25113) is a rigorous process, which would likely be
too costly for the businesses this bill is intended to help.
Claiming an exemption pursuant to Corporations Code Section
25102(f) requires the business that is soliciting funds to
either have a pre-existing personal or business relationship
with the investors who are being solicited, or requires the
business to hire a financial adviser, who can bridge that
relationship gap by reaching out to the wealthy individuals
or to their financial advisers. This bill's sponsor
believes that 25102(f) is unworkable for the businesses that
this bill is intended to help, because they are typically
too small or too new to have pre-existing personal and
business relationships with wealthy people. They are also
unlikely to have the money necessary to hire a financial
adviser to help bridge that gap. 25102(f) is also
unattractive to these businesses, because it does not allow
the use of advertising.
Section 25102(n) is also unappealing to these businesses, though
for different reasons. This section authorizes the use of
very limited advertising - too limited to be of much use to
a business seeking to raise funds from investors it does not
know or investors who are unfamiliar with the business or
AB 2096 (Muratsuchi), Page 19
its business model. The advertising authorized by Section
25102(n) is known as tombstone advertising. To be allowable
under 25102(n), a tombstone ad must include the name of the
securities issuer; the full title of the security to be
issued; the anticipated suitability standards for
prospective purchasers; a statement that no money or other
consideration is being solicited or will be accepted, that
an indication of interest made by a prospective purchaser
involves no obligation or commitment of any kind, and that,
if the issuer is required to deliver a disclosure statement
to the prospective purchaser, no sales will be made or
commitment to purchase accepted until five business days
after delivering the disclosure document and subscription
information to the prospective purchaser; and a statement
that, "For more complete information about (name of issuer)
and (full title of security), send for additional
information from (name and address) by sending this coupon
or calling (telephone number)." The advertising may
additionally include a brief description of the business of
the issuer, its geographic location, and the price of the
security to be issued. No other information is allowed in
the advertisement.
8. Summary of Arguments in Support: This bill is sponsored by
Small Business California and supported by several chambers
of commerce and other business-oriented trade associations.
These organizations observe that, while large businesses
have access to capital sources in the public and private
equity markets, existing California law makes it difficult
for small businesses to access vital sources of funding.
This bill will aid the fast-growing companies, known as
gazelles, which create most of California's jobs, but are
too early-stage for bank loans and have exhausted friends,
family, and credit card sources. The sponsor and proponents
write, "AB 2096 would make it possible [for small
businesses] to access a funding market that will accommodate
the needs and realities of these small businesses and at the
same time, offer significant protections for investors that
go above and beyond consumer protections written in the
federal JOBS Act exemption for crowdfunding." The sponsor
believes that bill will require companies to provide
substantially greater disclosures to investors than are
required under proposed rules implementing the federal
crowdfunding exemption.
9. Summary of Arguments in Opposition:
AB 2096 (Muratsuchi), Page 20
a. AARP is opposed to this bill on grounds that it will
place the life savings of older Californians at
significant risk through its authorization of direct
solicitations of seniors. "Successful savers are not
necessarily sophisticated investors. Entities that
cannot raise capital from lending institutions or venture
capital sources should not be turned loose on an unwary
public without the appropriate oversight."
b. The Public Investors Arbitration Bar Association
(PIABA), a national association of attorneys who
represent victims of investment fraud and stockbroker and
financial planner misconduct, also opposes the bill.
PIABA believes that allowing general solicitation and
general advertising of securities offerings that have not
undergone meaningful regulatory scrutiny, as this bill
proposes to do, will diminish investor protections and is
likely to lead to enormous losses for California's most
vulnerable savers and investors.
PIABA has two fundamental concerns with the bill. First,
it authorizes companies wishing to utilize general
solicitation and general advertising to become qualified
through notification. Under existing rules, investors
know that a registered or qualified offering has received
substantial scrutiny from regulators who are
knowledgeable about the pitfalls of investment programs
and can require promoters to structure offerings in a way
that makes failures and catastrophic losses less likely.
AB 2096 will allow use of the word "qualified" by issuers
whose offerings have not received extensive regulatory
scrutiny.
The disclosure language added to the bill on June 9th does
nothing to address PIABA's concerns. PIABA believes
that, even if someone reads the disclosure on the front
of the offering document, he or she will likely disregard
it as boilerplate, because sophisticated investors
generally understand that the word "qualified" means the
offering has received meaningful scrutiny.
Unsophisticated investors will think that "qualified"
means good, because it sounds positive, and certainly
sounds better than "unqualified."
PIABA's second fundamental concern with the bill relates to
AB 2096 (Muratsuchi), Page 21
its authorization of general solicitation and general
advertising to both accredited and non-accredited
investors. "PIABA understands that businesses sometimes
need additional capital. Our concerns are the people who
are the sources of that capital and the methods by which
they are approached. The concerns are greater when the
target population, by virtue of age, cannot reasonably
expect to recoup losses and when those most likely to say
'yes' to an investment 'opportunity' lack the investment
acumen necessary to evaluate the offerings." Aggressive
advertising is very effective when directed at
non-professional investors, who will be the vast majority
of offerees under the proposed bill. The initial sales
pitch drives the yes-or-no decision. An advertisement
that makes promises is likely to be relied upon, even
though the inches-thick, official documents the investor
is required to sign will disclaim the representations
made in the ads or by the salespeople.
Echoing the concerns of AARP, PIABA writes, "one should
question whether businesses should be permitted to find
capital for ventures that are too risky for traditional
funding sources by targeting the life savings of senior
citizens and retirees who cannot replace the savings they
lose."
Finally, PIABA states, "Nothing in the bill requires the
companies raising the money (called 'issuers') to use the
money in a way that creates jobs anywhere, let alone in
California. There is nothing to prevent the promoters
behind the issuers from setting up a series of
cookie-cutter entities to raise money for tax shelter
programs or other programs that simply move assets around
and benefit primarily the promoters at the expense of
seniors and the rest of the saving and investing public."
10. Prior and Related Legislation:
a. 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
AB 2096 (Muratsuchi), Page 22
steps to verify were accredited investors. Never taken
up by the author in the Assembly Banking & Finance
Committee.
b. AB 2081 (Allen), 2011-12 Legislative Session:
Substantially similar to AB 783. Failed passage on the
Senate Floor.
c. 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.
d. AB 1644 (J. Campbell), 2001-02 Legislative Session:
Substantially similar to AB 783. Failed passage in the
Assembly Banking & Finance Committee.
LIST OF REGISTERED SUPPORT/OPPOSITION
Support
Small Business California (sponsor)
California Artisanal Distiller Guild
California Asian Pacific Chamber of Commerce
California Association of Micro Enterprise Opportunity
California Association of Competitive Telecommunications
Companies
California Disabled Veteran Business Alliance
California Fence Contractors' Association
California Chapter of American Fence Association
California Metals Coalition
Coalition of Small and Disabled Veteran Businesses
Flasher Barricade Association
Greater Geary Boulevard Merchants & Property Owners Association
Marin Builders Association
National Federation of Independent Business
North East Mission Business Association
San Francisco Chamber of Commerce
San Francisco Council of District Merchants Association
San Francisco Builders Exchange
Small Business Majority
South Bay Entrepreneurial Center
Torrance Area Chamber of Commerce
Opposition
AB 2096 (Muratsuchi), Page 23
AARP
Consumer Federation of California
Public Investors Arbitration Bar Association
Consultant: Eileen Newhall (916) 651-4102