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86–267 2014

SEC’S CROWDFUNDING PROPOSAL: WILL IT WORK 

FOR SMALL BUSINESSES? 

HEARING 

BEFORE THE

SUBCOMMITTEE ON INVESTIGATIONS, OVERSIGHT 

AND REGULATIONS 

OF THE

COMMITTEE ON SMALL BUSINESS 

UNITED STATES 

HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

SECOND SESSION 

HEARING HELD 

JANUARY 16, 2014 

Small Business Committee Document Number 113–050 

Available via the GPO Website: www.fdsys.gov 

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Congress.#13
(II) 

HOUSE COMMITTEE ON SMALL BUSINESS 

SAM GRAVES, Missouri, Chairman 

STEVE CHABOT, Ohio 

STEVE KING, Iowa 

MIKE COFFMAN, Colorado 

BLAINE LUETKEMER, Missouri 

MICK MULVANEY, South Carolina 

SCOTT TIPTON, Colorado 

JAIME HERRERA BEUTLER, Washington 

RICHARD HANNA, New York 

TIM HUELSKAMP, Kansas 

DAVID SCHWEIKERT, Arizona 

KERRY BENTIVOLIO, Michigan 

CHRIS COLLINS, New York 

TOM RICE, South Carolina 

NYDIA VELA ́ ZQUEZ, New York, Ranking Member 

KURT SCHRADER, Oregon 

YVETTE CLARKE, New York 

JUDY CHU, California 

JANICE HAHN, California 

DONALD PAYNE, JR., New Jersey 

GRACE MENG, New York 

BRAD SCHNEIDER, Illinois 

RON BARBER, Arizona 

ANN McLANE KUSTER, New Hampshire 

PATRICK MURPHY, Florida 

LORI SALLEY, Staff Director 

PAUL SASS, Deputy Staff Director 

BARRY PINELES, Chief Counsel 

MICHAEL DAY, Minority Staff Director 

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(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Hon. David Schweikert ........................................................................................... 1 

Hon. Yvette Clarke .................................................................................................. 6 

WITNESSES 

Jason Best, Principal, Crowdfund Capital Advisors, San Francisco, CA ............ 2 

Daniel Gorfine, Director, Financial Markets Policy, Milken Institute, Washington, DC ............................................................................................................. 4 

Mercer Bullard, MDLA Distinguished Lecturer and Associate Professor of 

Law, Director, Business Law Institute, University of Mississippi, University, MS ................................................................................................................. 6 

DJ Paul, Co-Chair, Crowdfund Intermediary Regulatory Advocates, New 

York, NY ............................................................................................................... 8 

APPENDIX 

Prepared Statements: 

Jason Best, Principal, Crowdfund Capital Advisors, San Francisco, CA ..... 28 

Daniel Gorfine, Director, Financial Markets Policy, Milken Institute, 

Washington, DC ............................................................................................ 76 

Mercer Bullard, MDLA Distinguished Lecturer and Associate Professor 

of Law, Director, Business Law Institute, University of Mississippi, 

University, MS .............................................................................................. 82 

DJ Paul, Co-Chair, Crowdfund Intermediary Regulatory Advocates, New 

York, NY ........................................................................................................ 119 

Questions for the Record: 

None. 

Answers for the Record: 

None. 

Additional Material for the Record: 

None. 

SBREP-219 with DISTILLER

SBREP-219 with DISTILLER

(1) 

SEC’S CROWDFUNDING PROPOSAL: WILL IT 

WORK FOR SMALL BUSINESSES? 

THURSDAY, JANUARY 16, 2014 

HOUSE OF REPRESENTATIVES, COMMITTEE ON SMALL BUSINESS, SUBCOMMITTEE ON INVESTIGATIONS, OVERSIGHT AND

REGULATIONS, Washington, DC. 

The Subcommittee met, pursuant to call, at 10:00 a.m., in Room 

2360, Rayburn House Office Building. Hon. David Schweikert 

[chairman of the subcommittee] presiding. 

Present: Representatives Schweikert, Chabot, Mulvaney, Herrera 

Beutler, Rice, Clarke, and Chu. 

Chairman SCHWEIKERT. Good morning. We will call our Subcommittee hearing to order. 

First, I would like to request that Mr. Mulvaney, the member 

from South Carolina and a member of the Small Business Committee, be able to participate in today’s Subcommittee hearing. 

Without objection, so ordered. 

Welcome, Mr. Mulvaney. Thank you for participating with us. 

As we started to have a little bit of discussion before, this is in 

regards to the crowdfunding portion of the JOBS Act that was 

passed in April 2012. For some of us here, we have a certain emotional investing to that JOBS Act. I was blessed to have a couple 

sections of that that were a piece of legislation that we had been 

working on for about a year. One of the great thing about the 

JOBS Act, it was a truly bipartisan, bicameral sort of piece of 

work. And we built a formula where everyone from Maxine Waters, 

to Barney Frank, to Spencer Bachus, to even myself, found a way 

to communicate and grind through a series of small bills, and ideas 

for capital formation, where much of my frustration is first. And 

look, we all know the dance that the SEC has gone through the 

last two years with the chairman, some of the membership, some 

of those things. But forgive me for reaching down like this, in 

something that many of us had been hoping would be sort of a 

smaller, egalitarian opportunity for capital raising for the true beginning entrepreneurs, literally, the ones that are coming out of 

their basement, coming out of their garage, because we do have a 

cap of a million dollars. This is the proposed rule set. 

And when you start to analyze it, at least as we have from our 

office, you are starting to see total costs by the time you start to 

capitalize in your legal costs, your accounting costs, other mechanics, when some of your money will have a 20, 30 percent load factor 

on that. At this point you are starting to get into the point where 

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should you be doing it on your credit cards or should you be doing 

it with your neighborhood loan shark. This was not our intention. 

This was supposed to be the egalitarian access to capital because 

it did a couple things. It helped create a proof of concept because 

of the participation from either across the country or from within 

your community, but also provided a level of optionality, saying I 

need some capital up to the quarter million, up to this, up to that, 

to start our idea and sell that idea using today’s modern society 

and Internet. 

That is my great frustration. One of the things I am hoping we 

will acquire from this hearing today is not only sort of an analysis 

of what is within the rule sets, the proposed rule sets that have 

come from the SEC, but understanding we have only a couple more 

weeks for comments to go in. And much of the testimony from here 

we intend as an office to package up and send in also as comments. 

So I beg of you, even beyond your written statements, when we hit 

Q&A, it is not only here is the problem, but also maybe a suggestion that we could relate to the SEC saying here is a way how you 

do it. Yes, you have investor protections but you do not create a 

chilling effect for what I am hoping is sort of the next generation 

of sort of that beginning capital race. 

Okay. When the ranking member shows up we are going to let 

her do an opening statement. So what we are going to do is actually go right now to our witnesses’ opening statements. 

Jason Best. Our first witness is Jason Best, co-founder and principal of Crowdfund Capital Advisors (CCA), a consulting advisory 

firm in San Francisco and co-author of the Crowdfunding Investing 

Framework used in the original JOBS Act. And actually, I remember parts of these documents coming across my desk. 

Prior to his work in crowdfunding investment, Mr. Best was a 

successful healthcare technology entrepreneur, and most recently 

was on the executive leadership team of Kinnser Software, ranked 

by Inc. Magazine as one of the fastest growing private companies 

in the U.S. He is co-author of the book, Crowdfunding Investing for 

Dummies—you wrote that with me in mind, did you not—and 

earned his MBA from the Thunderbird School of Global Management in Arizona. 

Mr. Best, five minutes. 

STATEMENTS OF JASON BEST, PRINCIPAL, CROWDFUND CAPITAL ADVISORS; DANIEL GORFINE, DIRECTOR, FINANCIAL 

MARKETS POLICY, MILKEN INSTITUTE; MERCER BULLARD, 

MDLA DISTINGUISHED LECTURER AND ASSOCIATE PROFESSOR OF LAW, DIRECTOR, BUSINESS LAW INSTITUTE, UNIVERSITY OF MISSISSIPPI; DJ PAUL, CO-CHAIR, CROWDFUND 

INTERMEDIARY REGULATORY ADVOCATES 

STATEMENT OF JASON BEST 

Mr. BEST. Chairman Schweikert, Ranking Member Clarke, and 

members of the Committee, thank you very much for the opportunity to discuss the value that crowdfunding can bring to the 

American small business community, as well as share some new 

data from the British and U.S. markets that should shed some 

light on the magnitude of what is really happening in 

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crowdfunding and how the right kind of crowdfunding regulation 

can enable a new chapter in American small business success. 

I would like to thank the members of this Committee and both 

parties within the House at-large for their bipartisan and overwhelming support of crowdfunding. 

As a co-author of The Startup Exemption Framework, I care very 

deeply about how the market evolves and want to continue to work 

with Congress and the SEC to create effective regulation for this 

market. I want to thank the commissions and staff of the SEC for 

their willingness to engage in a robust conversation with CFIRA, 

the crowdfunding industry regulatory organization, and I hope that 

CFIRA’s active engagement was able to demonstrate that the 

crowdfunding industry is focused on creating an orderly market 

with access to capital, investor protections, and appropriate regulatory oversight. 

As a tech entrepreneur and a small business owner, I have real 

experience in creating products and services raising capital and 

creating jobs. There are a number of good elements in the proposed 

regulation, but there is also a number of troubling issues. One of 

the issues I want to highlight today is the accounting requirements 

for a full CPA audit on firms raising over a half million dollars. I 

believe this places an unreasonable burden on entrepreneurs and 

small business owners and may cause there to be a soft cap on 

raising money over $500,000 due to the cost that this regulation 

would impose. 

I understand the goal of the regulation. As the size of capital 

raised increases, investors want increased disclosure and validation 

of the state of the business, and we should work to create different 

technology solutions that can help achieve that. Additionally, if I 

have to spend 30 percent of what I raise just to comply with the 

legal and accounting requirements, as you said, Mr. Chairman, it 

is sort of like am I going to use my credit cards or am I going to 

use this new opportunity? 

Now, I wanted to share, really moving to sort of looking at the 

opportunities for crowdfunding particularly in two studies, most recently a study that was done on the U.K., about the British system, 

and an example of what light touch regulatory environments can 

achieve and really what we hope it could achieve here in the U.S. 

And secondly, one of the most important questions I think is after 

a company raises the capital, what happens then? What happens 

then to the business, to follow-on investors, and to job creation? 

So first to the U.K. study. When we look specifically at this U.K. 

study, they have had three years of equity and debt-based 

crowdfunding up and running and a great deal of experience. The 

U.K. government utilized a significantly light touch approach, and 

it has been amazing to see what has developed in that marketplace. The population of the U.K. is about 61 million, so it is about 

20 percent of the U.S. population. The size of their crowd finance 

market doubled nearly between 2012 and 2013. It grew from nearly 

$800 million in size to over $1.3 billion. And this demonstrates a 

clear willingness for both buyers and sellers, investors and contributors, to want to engage in this kind of finance. Of those 2013 totals of $1.3 billion, $314 million were individuals lending to small 

business, and $45 million was equity crowdfunding. That growth 

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rate year over year was over 600 percent growth rate. And equity 

crowdfunding surpassed rewards-based crowdfunding in the U.K. 

in 2013. That is pretty amazing. 

So collectively, in 2013, in the British system, over half a billion 

dollars was delivered to early stage and small businesses. That is 

over 5,000 businesses. And the report predicts that in 2014 that 

will increase significantly. If you were to equate that in the U.S. 

market, that would be 25,000 businesses receiving money across 

the country. 

So looking at what businesses are doing post-funding, three questions. One, does crowdfunding have a positive impact on sales after 

you achieve your goal? And in fact, it does. We saw a 24 percent 

increase in sales net of the crowdfunding raised when they were 

successful. Two, were new employees hired? We found that on average, 2.2 new employees were hired for companies that successfully 

raised funds. So people are creating jobs with this money. And finally, what about follow-on investors? Will angel investors and VCs 

invest in these companies after they have raised money through 

crowdfunding? Resounding yes was the answer. Twenty-eight percent. Within 90 days of closing the round, 28 percent had already 

closed an angel round of investment, and an additional 43 percent 

were, in fact, in conversations with VCs or with angel investors. 

And so that is the data I wanted to share this morning. Again, 

I want to thank the Committee for this hearing and for your overwhelming support of crowdfunding. I look forward to your questions. 

Chairman SCHWEIKERT. Thank you, Mr. Best. 

Our next witness is Daniel Gorfine, director of Financial Markets 

Policies and legal counsel in the Washington office of the Milken 

Institute, an independent, economic think tank where he researches and has written extensively on issues related to 

crowdfunding provisions and the JOBS Act. Mr. Gorfine received 

his B.A. in Economics and International Relations, Brown University, and his law degree from the George Washington University 

School of Law. 

You have five minutes. And as you all know, five minutes. And 

when you see yellow, just start talking faster. 

STATEMENT OF DANIEL GORFINE 

Mr. GORFINE. Chairman Schweikert, Ranking Member Clarke, 

and members of the Committee, thank you for the opportunity to 

testify on implementation of Title III of the JOBS Act or what I 

will refer to as the crowd investing provisions. 

My name is Daniel Gorfine, and I am the director of Financial 

Markets Policy at the Milken Institute Center for Financial Markets. Today’s discussion fits squarely within a number of pillars 

that guide our work, including expanding access to capital and developing financial innovations. Indeed, the ultimate goal of crowd 

investing is to responsibly increase capital access for startups and 

small businesses, especially within industries or regions disfavored 

by traditional sources of capital. 

In proposing Title III rules, the SEC has largely used its discretion to positively advance that goal in the development of this market. That said, it is an open question whether the current crowd 

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investing rules will significantly increase capital formation for 

startups and small businesses. Investors will need to consider 

whether the risk-reward dynamics are sufficiently compelling and 

whether other factors, such as personal interest and an affinity are 

a sufficient draw. And for issuers and intermediaries there are concerns that the cost of a Title III raise may exceed the benefit. 

Based on these concerns, I will briefly discuss suggestions that 

may foster the development of crowd investing while limiting the 

downside risk to investors. This approach will allow for the evolution of this market and an opportunity to assess its central hypothesis that in an interconnected, Internet-centric world there, is 

wisdom in the crowd. 

Two principles from the law guide my suggestions today. First, 

that this capital-raising tool is intended to be relatively lost cost, 

and second, that the Internet can facilitate a novel form of crowdbased due diligence in investment. With these principles in mind, 

I believe as an initial matter that the most efficient way to limit 

downside risk is through emphasis on investor caps, at least until 

the market is able to prove itself. 

The SEC’s current investor self-certification approach properly 

imposes responsibility on investors. It should go further, however, 

by requiring platforms to make investors explicitly aware at the 

point of investment that the cap is not something that can be ignored but rather is required by law and intended to protect investors from the downside risk of early stage investing. Additionally, 

the SEC should consider precluding an investor who violates the 

investor caps from bringing a lawsuit against an issuer. With investor caps serving as the most effective way to limit downside 

risk, the SEC should then minimize nonstatutory disclosure requirements. The law already includes a number of baseline disclosure requirements that will help investors make investment decisions. But in aggregate, if additional disclosures are too extensive 

and ongoing reporting requirements too onerous, then the cost will 

exceed the benefit, especially given the questionable value of such 

disclosure to investors. 

The ultimate success of crowd investing hinges on the effectiveness of new vetting methodologies and criteria generated through 

the wisdom of the crowd, and evidence from overseas demonstrates 

that discerning crowd investors are likely to invest in what they 

know, existing companies with known management teams or 

known businesses and products. Accordingly, the SEC should first 

limit or require few, if any, incremental disclosures beyond those 

already required by law, and second, limit ongoing reporting requirements. A third suggestion is to permit funding portals more 

leeway to select and list offerings as well as to share data and information with investors. The law does not allow a funding portal 

to provide investment advice or recommendations. At its extreme 

interpretation, this ban could require a platform to list all offerings 

proposed by issuers. 

In order to permit platforms some flexibility to decide on which 

offerings they will list, the SEC proposes that a platform can filter 

and select offerings based on objective criteria. For example, by geographic region. It also creates a duty for a platform to exclude ofSBREP-219 with DISTILLER

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ferings that could be fraudulent or that raise investor protection 

concerns. 

The rules, nevertheless, leave a gap where a platform could have 

serious doubts about the viability of an offering but not to the level 

that it is permitted to exclude the offering from its platform. To require a platform to list an offering that it has a strong conviction 

will fail is contrary to promoting investor protection. Accordingly, 

portals should have the ability to go further in deciding with whom 

they do business, so long as they do not advertise that their platform has somehow safer or better opportunities. 

The SEC proposed rules may also prevent platforms from sharing key data and information that could assist crowd investors. As 

we have seen with the development of e-commerce platforms, such 

as eBay and Amazon, there is significant opportunity for intermediaries to glean and analyze data and develop algorithms to detect fraud or best practices and also collect user feedback. I would 

like to see the SEC explicitly permit these types of activities for 

funding portals. 

Finally, funding portals should be subject to reduced liability exposure for issue or missteps, given the portals limited promotional 

activities, limited ability to exclude offerings, and design to serve 

simply as a bulletin board. The SEC’s initial contrary interpretation of the law would likely decrease the number of intermediaries 

participating in this market, as well as increase costs due to the 

risk of litigation. If that interpretation holds, however, and a platform can be on the hook for the missteps of an issuer, then the 

platform should have greater discretion to decide on whether to do 

business with that issuer. 

I would like to thank the Committee again for having me join 

you today and I look forward to answering any questions that you 

may have. 

Chairman SCHWEIKERT. Thank you, Mr. Gorfine. 

I would like to yield to Ranking Member Clarke to introduce the 

next witness. 

Ms. CLARKE. I thank you, Mr. Chairman, and it is my honor 

and privilege to introduce to everyone here today professor Bullard. 

Professor Mercer Bullard is a securities law professor at the University of Mississippi School of Law and founder and president of 

Fund Democracy, a nonprofit investor advocacy organization. He 

has appeared before congressional committees on more than 20 occasions and is a member of PCAOB’s Investor Advisory Group and 

was a member of the SEC’s Inaugural Investor Advisory Committee. With prior experience as an assistant chief counsel at the 

SEC and practicing securities lawyer, he is an expert on the Commission’s enforcement and rule-making practices. He has a J.D. 

from the University of Virginia, a Master’s from Georgetown, and 

a B.A. from Yale. 

I want to thank Professor Bullard for appearing before us today 

and look forward to your testimony. Thank you. 

STATEMENT OF MERCER BULLARD 

Mr. BULLARD. Thank you, Ranking Member Clarke and Chairman Schweikert and members of the Committee. It is a pleasure 

to appear here today, especially a committee that is focused on 

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business, rather than securities, because what I spend most of my 

time doing is teaching students how to solve business problems. 

The Committee has asked whether the SEC’s proposal will work 

for small businesses, and I am afraid the answer is probably not, 

but it is hard to tell. But the question is somewhat unfair because 

Congress did establish extremely detailed disclosure and filing requirements that are going to make up most of the burdens that will 

be imposed by crowdfunding. And I also would add that I do not 

think the solution is reducing those because I think they are appropriate as investor protection measures to ensure this does not go 

the way of the penny stock market in terms of the reputation that 

crowdfunding develops. 

As you may know from my prior testimony, my view is that 

crowdfunding probably could work if investment minimums were so 

low and the risk of loss was small so that virtually no regulation 

at all would be required. It is not clear to me why we could not 

allow any business to offer a $100 share to a company or to an investor simply having provided a business plan on the Internet, 

leaving only the anti-fraud provisions of the securities laws and 

general consumer law to protect those investors. But the current 

law is what we have, so I will turn to some of the specific aspects 

of the SEC’s proposal and their effect on small businesses. 

One issue that we talked about before the meeting is there is a 

million dollar cap on what a crowdfunding issuer is allowed to have 

sold and the statute clearly indicates that is all securities. And the 

SEC has interpreted that to mean that it does not include all securities. It includes only crowdfunding securities. So what that means 

is somebody could go out and raise $10 million or $100 million or 

a billion dollars and then do a $1 million crowdfunding offering. 

Congress imposed that $1 million cap because crowdfunding was 

supposed to be for small issuers. It was supposed to be for issuers 

raising small dollar amounts. It was supposed to be for issuers that 

suffer from a perceived funding gap between them and larger businesses. Under the SEC’s approach, medium and large businesses 

may fill the crowdfunding space, crowding out the small businesses 

for which it was created. 

Small businesses should also be concerned about the SEC’s position on certain investor protections. The reason is that if it is easy 

for unscrupulous businesses to raise capital through crowdfunding, 

the crowdfunding market may become equated, as I mentioned, to 

the market for penny stocks, rather than the thriving market for 

exciting investment opportunities that it does have the potential to 

become. 

For example, the Commission would permit investors to offer investors who invest early a larger share of any oversubscription 

amount. The stampede effect that this promotes is precisely why 

such first come, first serve tender offers are prohibited under the 

Williams Act. What kind of businesses are going to allocate oversubscriptions on a first come, first serve basis in order to stampede 

investors to make commitments? It will be the less scrupulous ones 

that honest businesses should not want in their crowdfunding marketplace. The Commission would permit issuers to use financial 

statements that are 16 months stale. That means that you could 

start a business in December of year one, you could do a 

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crowdfunding offering in April of year three, and your financial 

statements would cover one month at the beginning of the life of 

the business covering only one out of a 17 month lifespan. 

The Commission would permit crowdfunded issuers that have 

failed to file their annual report the only post-offering obligation 

they have for up to 23 months to go ahead and make another 

crowdfunding offering. What kind of businesses are going to take 

advantage of the opportunity to file financial information that is 16 

months stale or are willing to violate the law by failing to file their 

annual report? And I believe it is the unscrupulous businesses that 

honest businesses should not want in their crowdfunding marketplace. 

Small businesses should also be concerned about investors suffering financial distress as a result of investment, which is more 

likely due to certain SEC positions. For example, the Commission 

would permit investors to self-certify the financial qualifications. 

And this will result, for example, in some investors mistakenly believing they can count their home toward their net worth, in which 

case their crowdfunding investment may end up representing a 

large part of their savings. 

Small businesses should be concerned about this issue because 

the defining feature of the crowdfunding market may end up being 

the high frequency of investments going to zero and how that plays 

out. Estimating conservatively, one quarter of crowdfunding investments are going to be worthless in three years. The data suggest 

the failure rate may be closer to one half. Imagine the reputation 

of a family of mutual funds in which one-quarter to one-half of the 

funds lost 100 percent of their value every three years. 

So how will this narrative play out? Will the losses be only a 

small part of an investor’s portfolio, money they can afford to lose? 

Or is the narrative going to be about investors who lost money they 

could not afford to lose their life savings perhaps. You can stack 

up a pile of filings and disclosure as high as the sky, but the bottom line is the success or failure of crowdfunding is likely to turn 

onto the losses that investors suffer and there are going to be a lot 

of total losses that they can afford. 

Thank you, and I would be happy to take questions that you 

might have. 

Chairman SCHWEIKERT. Our next witness is DJ Paul, cofounder of Crowdfund Intermediary Regulatory Advocates. You 

could not have come up with a shorter name? A trade association 

for crowdfunding web portals. He is also the co-chief strategy officer with GATE Impact based in New York, where he develops solutions to facilitate and expand private and alternative asset transactions. Prior to joining GATE, Mr. Paul co-founded Crowdfunder, 

a Los Angeles-based crowdfunding intermediary platform. Mr. Paul 

earned a B.A. in Philosophy from Brown University. 

Well, please wax philosophy towards us. Five minutes, Mr. Paul. 

STATEMENT OF DJ PAUL 

Mr. PAUL. Chairman Schweikert, Ranking Member Clarke, and 

other members of the Committee, thank you for the opportunity to 

testify today. It is an honor to be here. 

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Given the limited time for testimony, I will confine my comments 

to four salient issues. These four issues are certainly representative 

of the kinds of concerns which some of the industry have with respect to the proposed regulations but they are by no means exhaustive. 

First, auto requirements, which Mr. Best was good enough to 

touch on; pooled investment restrictions; intermediary participation 

restrictions; and funding portal liability. 

Auto requirements. As currently proposed, there are three tiers 

of financial disclosure requirements for Title III offerings, corresponding roughly to the amount raised. First tier is 0 to 

$100,000; second tier is $100,000 to $500,000; and the third tier is 

from $5,000 to $1,000,000. 

The first tier requires disclosure of financial statements certified 

by an executive officer of the company. The second tier requires the 

financial statements reviewed by an accountant. However, the 

third tier requires CPA-audited financials. Furthermore, these requirements for such CPA-audited financials are on an ongoing 

basis. Such audited financials to be provided to investors every 

year following a Title III raise over $500,000. 

It is worth noting that these disclosure requirements for the 

third tier are actually more onerous and exhaustive than the current requirements for Regulation D offerings, which does not mandate audited financial statements for issuers, nor ongoing annual 

audited disclosures. These overly onerous requirements for third 

tier security crowdfunding offerings may have the unintended effect of pushing potential issuers away from doing Title III entirely 

and towards perhaps Regulation D offerings which might be more 

attractive to potential issuers. 

This seems clearly inconsistent with the spirit of the original leg- islation, and in effect, creates a donut hole between $500,000 and 

$1,000,000, where offers do not utilize Title III at all. And in addition to creating an artificial market irregularity, this will also have 

the unfortunate effect of making these offerings unavailable to 

unaccredited investors since Regulation D, which is the most viable 

alternative obviously does not permit investment by unaccredited 

investors. 

Moving on to pool of investment restrictions. The proposed regulations exclude funds from utilizing Title III to raise capital, in effect requiring all crowdfunding investments to be direct investments. This rule would restrict pool of investments for hedge funds, 

private equity, from raising money through crowdfunding. While 

most of us can agree that most funds are not suitable issuers for 

crowdfunding, we believe that this restriction may be overbroad as 

it appears to restrict the fund-raising of special purpose vehicles or 

single purpose entities, investing only in a single operating company that would otherwise qualify as an eligible Title III issuer. 

This restriction does not serve to protect investors, but rather, this 

restriction actually succeeds in denying crowdfunding investors 

some of the advantages and protections afforded to other investors 

and institutions in other asset classes, particularly those utilized in 

Regulation D. 

Moving on to intermediary participation restrictions. Current 

proposed regulations would restrict intermediaries from holding inSBREP-219 with DISTILLER

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terests in the companies conducting Title III offerings on their platforms. This serves to restrict intermediaries from participating 

alongside their investors in these offerings. Rather than diminishing a theoretical conflict of interest between intermediaries and 

investors, as a practical matter this restriction effectively forbids 

alignment of interests between investors and intermediaries. This 

concept is often described as ‘‘skin in the game.’’ We believe that 

intermediaries who invest in issuers make for better alignment of 

interests. 

We believe that allowing such co-investment by intermediaries 

would have two very desirable benefits from investors. First, an investor may take comfort in knowing that the intermediary facilitating the transaction is investing in the same deal and on the 

same terms in the investment that they are considering. And second, when the intermediary has such skin in the game, that fact 

itself may encourage the intermediary to take more seriously their 

assigned roles in the marketplace. 

I see that I am running out of time, so I will just very quickly 

skip to funding portal liability just so that I will have an opportunity perhaps to answer some questions that you might have with 

respect to that. 

As the regulations are currently written of proposed, it may be 

subject to the interpretation that intermediaries are considered 

issuers within the context of the liability of any omissions that 

might be made by an issuer. This would have a rather bizarre effect of making an intermediary responsible, effectively a guarantor, 

of any offering that appeared on its platform. I think that it is pretty obvious that that would be problematic on its face, and it is 

something that we need to address in the next several weeks and 

certainly before these regulations become finalized. 

I will end there, and I will look forward to your questions. Thank 

you again for the opportunity to testify. 

Chairman SCHWEIKERT. Thank you, Mr. Paul. 

And I was going to turn to Ranking Member Clarke and let her 

share with us her opening statement. 

Ms. CLARKE. I thank you, Mr. Chairman. And I welcome our 

witnesses and thank them for their testimony here this morning. 

With traditional capital access avenues still relatively constrained an increasing number of entrepreneurs are turning to 

crowdfunding to launch their enterprises. In 2012 alone, 

crowdfunding injected $2.7 billion into new ventures, a figure that 

will likely increase moving forward. In accordance with the 

Jumpstart Our Business Startup or JOBS Act of 2013, the SEC 

published its proposed rule for implementing the crowdfunding provisions in October of last year. While the SEC’s crowdfunding disclosure requirements are aimed at providing enough information to 

the public to facilitate prudent investment decisions and minimize 

fraud, there is some concern that some of the disclosure requirements will make crowdfunding offerings cost prohibitive. 

The SEC, for example, has estimated that it could initially cost 

$15,000 in listing fees and regulatory compliance expenditures to 

raise $50,000, thus taking resources away from business expansion 

and working capital. While these costs are likely to decrease over 

time as equity crowd funding becomes more popular, it is vital that 

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Congress monitor the SEC’s crowdfunding rollout and make 

changes if necessary to improve access to capital for small businesses, while preventing bad actors from defrauding the public. 

I would like to thank our witnesses for lending their expertise 

and insights to this second examination of today’s subject matter, 

the rule, and the SEC’s crowdfunding proposal. 

And with that, Mr. Chairman, I yield back. 

Chairman SCHWEIKERT. Thank you, Ranking Member Clarke. 

I am going to turn to Mr. Mulvaney for the first five minutes of 

questions. 

Mr. MULVANEY. Sure. Just a couple of random questions to the 

various members of the panel. Thank you, gentlemen, again for 

doing this. And thank you for participating. I do not think a lot of 

folk realize how important this is because it helps drive the national debate on the issue. So I appreciate your time. 

Mr. Paul, we will start with you, just because you said a couple 

things that stood out. You said that because of the audited financial requirements to Tier III offerings, it is actually technically 

easier of cheaper to use a Reg D offering. What does a CPA audit 

cost these days? 

Mr. PAUL. There is some debate about this. I mean, it could be 

$10,000. It could be $20,000. It could be $5,000. It is not going to 

be insignificant. There is some discussion about whether or not it 

will be streamlined. The cost of audited financials, obviously, are 

going to be contingent to some extent on how much activity the 

business—how far along it is in its business cycle. A startup, it 

would be more readily—a company that has no history, pretty 

much all that you are buying there is the CPA’s license. 

Mr. MULVANEY. And before I get to the Reg D question, how 

do you audit a company that does not exist? 

Mr. PAUL. I am not smart enough to answer that question. That 

would be a challenge. I agree. 

Mr. MULVANEY. If Mr. Schweikert and I have an idea, my understanding is that this is actually being used in the music industry a good bit. If he and I want to do a record together, we want 

to cut an album, it sounds like I would be completely excluded from 

the Tier III because I cannot audit something that does not exist, 

can I? 

Mr. PAUL. You certainly could have an accountant look at what 

you do not have and say I am certifying that you do not have the 

thing that you said you do not have. 

Mr. MULVANEY. Do not have it. Yeah, that is probably true. 

How much can I raise at a Reg D offering? 

Mr. PAUL. There is no limit. 

Mr. MULVANEY. So if it is easier to do Reg D than it is to do 

a Tier III, you wonder why anybody would do a Tier III. 

Mr. PAUL. Well, you might do it for several reasons. First of all, 

it is not clear that it is going to be necessarily less expensive. This 

is one specific requirement that exists in the Tier III of Title III 

offerings of crowdfunding that does not exist in Regulation D. 

There are other requirements in Regulation D as well. However, 

again, Regulation D is limited to accredited investors. And there 

are certain ideas, certain ventures, perhaps your record idea, that 

might be more appealing from an investor base of unaccredited inSBREP-219 with DISTILLER

12 

vestors. So that might be a motivating factor to not go up to Reg 

D. 

Mr. MULVANEY. Thank you, Mr. Paul. 

Mr. Gorfine, you said something regarding limited promotional 

activities. What are you not allowed to do as a portal? 

Mr. GORFINE. So funding portals are quite restricted in what 

they can do with the offerings that are listed on their site. So they 

cannot be going out and soliciting for that offering or sending out 

messages saying we have got this great offering on our platform. 

You should come check out your new record album company. So 

they really are the idea behind the funding portals as opposed to 

a registered broker dealer platform which would have more ability 

to kind of provide advice and recommendations. A funding portal 

is envisioned to be a bulletin board. It is a Craigslist for offerings. 

So really you just go to the platform. You will be directed to the 

platform where you can then sort through the different offerings 

but the portals themselves cannot do anything further to be promoting those offerings on their site. 

Mr. MULVANEY. Gotcha. Finally, Dr. Bullard, I am all for solving problems. I am a little concerned about creating problems that 

do not exist. If I have just raised a billion dollars in the public markets, why would I raise $250,000 on a crowdfunding site? 

Mr. BULLARD. The reason is that I would certainly think Twitter, when it was private, would think it would be a great social 

media strategy to do a million dollar funding through crowdfunding 

to reach out to its users who are accredited investors. So I think 

there are a lot of instances. 

But the issue is not necessarily whether it is a billion or $10 million or whatever. The idea is this space will be used more often by 

larger companies if you allow really large companies to participate. 

So if you allow companies that are raising $10 million into the 

space, it is going to have the effect of squeezing out or at least they 

will be competing with all the small business that it is purportedly 

designed for. So I do not know if a million is the right cap, but having no cap at all will leave the space open to whoever can pay the 

most for the services. 

Mr. MULVANEY. Right. And I guess I just look at the numbers 

of it and the math of it. This is fairly expensive money in the greater scheme of things. And that is one of the reasons we are having 

the hearing. It is not as easy and efficient and as cheap as we had 

hoped it would be to raise money through crowdfunding. So I guess 

I am struggling with why I would go raise $250,000, very expensive 

money, when I just raised some of the cheapest $100 million, billion dollars that I possibly could. So I recognize there are challenges. I am wondering if that is one of the ones we actually spend 

a lot of our time on. 

Anyway, I appreciate the Chairman’s time. I yield back. 

Chairman SCHWEIKERT. Thank you, Mr. Mulvaney. 

Ranking Member Clarke. 

Ms. CLARKE. Thank you, Mr. Chairman. I am going to yield the 

tile to Representative Chu at this time. 

Chairman SCHWEIKERT. Ms. Chu, five minutes. 

Ms. CHU. Thank you so much for yielding. 

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13 

I am a member of the Intellectual Property Subcommittee on the 

Judiciary Committee, and so I am concerned about intellectual 

property and I know the protection of intellectual property is one 

of the challenges of crowdfunding. So I have a question for anybody 

on the panel. 

Once an idea is out, the startup of small business runs the risk 

that the idea will be stolen or copied, how can inventors and artists 

protect themselves from those consequences, let us say for instance 

that a tech startup has a new technology that has not been patented but they use crowdfunding to raise capital for their venture, 

should intermediaries be required to advise or educate issuers on 

IP protections before a campaign is posted or disclosed? 

Mr. PAUL. The same risks exist whenever one raises money. 

Whether or not intermediaries should be required to advise issuers 

as to that, it is certainly something that I do not believe that the 

intermediaries that are part of our organization would have any objection to that being something that we would want to do. There 

are certainly going to be some ideas that maybe are not welcome 

or suited to the broad raising of capital through this because of intellectual property concerns. But the majority of the ideas, I think, 

can be protected. You mentioned patented. And of course, there are 

other ways of protecting ideas, and it will encourage, we hope, 

issuers to be organized and get their intellectual property, as well 

as their other issues in order prior to doing a raise in this manner. 

Ms. CHU. Mr. Best? 

Mr. BEST. In addition to Mr. Paul’s comments, I think that what 

we are also seeing on a mechanical basis and implementation are 

the fact that many crowdfunding platforms, and I would assume 

all, will have deal rooms, online deal rooms, where there is a public 

facing amount of information that anyone can see but that any IP, 

anything that would restrict it, the viewer would need to gain an 

additional level of access from the entrepreneur that they could 

pass through some sort of screen that the entrepreneur could determine this is a serious investor. This is someone who actually wants 

to make an investment in my business and I will allow that to happen. The same thing that occurs in the offline world through many 

506 offerings. 

Mr. BULLARD. Yeah. If I could just add, I would say to answer 

the question about liability, I think we need to leave intermediaries 

to just what legal rights the issuers would have under current law. 

There may be some duties that they would be impliedly having in 

that scenario, but I certainly would not make it any kind of statutory or rule-based requirement. 

Mr. GORFINE. Yeah. I would agree that this is not appropriate 

to put the requirement on a platform necessarily to educate the entrepreneur or the issuer, but I think it raises an important question which is how do we make sure that issuers and entrepreneurs 

are educated about some of the risks of a crowdfund or a crowd 

raise? So I think that education for issuers and entrepreneurs is 

going to be very important, and one suggestion I would have is that 

the SEC actually has an investor.gov website that has a lot of great 

information for investors. Perhaps through the education side of 

the SEC’s organization, you could create some information for 

issuers and entrepreneurs that they could consult before they go 

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ahead and do a crowd raise. So I think that the education component is important. 

Ms. CHU. Thank you for that. 

Professor Bullard, given the inherent riskiness of small business 

investing and the lack of investor sophistication in individual retail 

investors, it was mentioned today that the best way to limit downside risk is through an emphasis on the investor caps. However, 

the proposed rules do not require crowdfunding platforms to verify 

the income and net worth stated by the investors. What are the implications of this and furthermore, what mechanism should be used 

to ensure the compliance of the investor caps? 

Mr. BULLARD. Well, there are really two problems here. One is 

the very real possibility that people will lose a significant amount 

of money that they cannot lose. And obviously, that will have happened only because something has gone wrong in the application 

of the Act. One of the really great things the Job Act did was actually to impose percentage limits, so that implies that you can only 

put a certain amount of risk, which is a great defense to allowing 

people to take those kinds of risks. 

But people will slip through the cracks. It is inevitable. And 

something more needs to be done than simply to allow an investor 

to go on a website on an unguided basis and just say I have got 

a million dollars of net worth. And I can tell you, most investors 

are going to think that their house is included in that, which it is 

not, and most investors are going to neglect the fact that they do 

not own their house; the bank actually does. So you could have people investing perhaps all of their savings in an offering because of 

that confusion. You cannot go out and sit down in a room with an 

investor and go over all their qualifications. 

But on the other hand, Mr. Gorfine suggests that we actually sue 

investors who violate the provision. Well, you cannot violate the 

provision. The provision does not say that investors are required to 

be X. It says that issuers are not allowed to sell to those people. 

The obligation is on the part of the issuer and the intermediary, 

and they are the ones who are really responsible. So the SEC needs 

to step it up a little bit, but we all know that it cannot be sending 

lots of papers that have to be reviewed on a detail basis. 

Ms. CHU. I see my time has run out so I will yield back. 

Chairman SCHWEIKERT. Thank you for that. 

Mr. Rice, five minutes. 

Mr. RICE. I will yield. 

Chairman SCHWEIKERT. And who do you want to yield to? 

In that case I get to. And what is always dangerous here, and 

Ms. Clarke and I have teased over this in the past and I am trying 

to do questions without too much in tirades, but I do need to actually just sort of throw a personal philosophic sharing, particularly 

for my philosophy major at the end, as much of the political side 

and the latest political discussion is income disparities. But yet, in 

many ways we have diced up part of our opportunity within our society saying I am a qualified investor so I am part of this fraction 

of a fraction of a fraction represent of my U.S. population. You get 

to participate. You get to know what is going on. You get to take 

risk. But the vast majority of our society and population, you are 

walled off from opportunities. And yes, people lose money. But as 

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we have all had in our experiences, we invest in three things. One 

we do okay in and actually over time we do well in it. The other 

two go nowhere, but that is how we have built our nest egg for our 

retirements and our future. 

And as some of the rule sets become more paternalistic, my fear 

is we just expanded that income and inequality by sort of almost 

a financial apartheid where we say if you have this wealth you get 

to participate; if you do not, you do not get to even know. So I do 

have an underlying belief system here that we have sort of this 

egalitarian obligation to reach out. If you are an electrical engineer 

and you are an expert but you do not have the million dollars in 

the bank, but damn it, you have $2,000 and you are an expert. 

Should you be allowed to invest it? And that was actually one of 

my great hopes underneath the crowdfunding is how do I really 

create an opportunity society and not one that is walled off where 

you have it so you get to continue to participate. 

And this sort of makes the circle back to Mr. Paul, back to sort 

of the question. My fear was in some of the reading our office did 

within the proposed rule sets that a platform, an intermediary, 

may actually find itself within the tree of liability. Do they get to 

sort of choose who they post up? If so, do they now start to sort 

of only choose opportunities that they feel are perfectly safe or do 

they have to post up anything within their general box and geographic or these things, and do they end up carrying liability for 

a failed disclosure of someone’s bad act? 

Mr. PAUL. There are a few questions in there, so let me start 

with what I think was the first one. 

Understand that, and I am sure you do because I know you participated in the creation of the statute itself, but investment advice 

is not permitted to be given by funding portals to investors. So the 

question that you are asking about whether or not a portal can 

pick and choose which offerings it puts up gets close to the line of 

whether or not that in effect if you exclude something and you include something, if that constitutes investment advice. 

CFIRA, the organization I work with, has been working with the 

SEC to fine tune that a little bit, put a little bit more shape on exactly what that is so that we do not have a situation where all portals have to list everything, which would be a bulletin board and 

not really in keeping with what the intent was. Nor can they be 

quite so selective that it is pretty obvious that they are picking the 

winners because they cannot offer the investment advice. So I 

think that might be responsive to the first part of your question. 

Chairman SCHWEIKERT. Okay. Go onto the second part because—— 

Mr. PAUL. In terms of the liability. Yeah. The definition of 

issuer as it relates to Title III offerings is broad enough now to include not just the issuer itself but to include the portal. And then 

the liabilities that the issuer quite rightly has for being truthful 

and disclosing accurately, if the portal is considered an issuer then 

the responsibility and the liability would then fall to the portal. 

That seems overbroad. That seems like it is going to dissuade 

would-be portals from participating in the process. 

Chairman SCHWEIKERT. Can I put a hold on you at that point? 

Mr. PAUL. Certainly. 

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Chairman SCHWEIKERT. Does everyone on the panel agree 

that a clean reading of sort of the proposed rule set does that cascade of liability? 

Mr. BULLARD. What Mr. Paul is talking about is there is liability for violating Section 5, which basically means you have not complied with the exemption. As it turns out, it was not available. And 

generally, issues, the intermediaries are not going to be subject to 

that, and to the sense that they might be, that is certainly a legitimate concern. 

Chairman SCHWEIKERT. Okay. 

Mr. BULLARD. And then there is the secondary liability, which 

you are also talking about, which is material misstatements, and 

they are squarely in the crosshairs on that. And Congress specifically put 12(a)(2) in the act, so there is no question there. 

Chairman SCHWEIKERT. Mr. Gorfine, do you agree? 

Mr. GORFINE. I would say the SEC has interpreted the Title III 

to potentially impose that liability on funding portals. I think that 

there is something think it is not clear from the statute though 

whether a funding portal should fall within the purview of that 

type of liability because they are not able to fully decide who they 

are listing on their platform, and there is a limited promotional aspect of what they are doing. There is a limited solicitation aspect 

of what they are doing, which raises questions. How can you be 

held liable for the misstatement of an issuer or an admission of an 

issuer if you did not have the ultimate discretion of whether to list 

that offering on your platform or not. 

So I view this on a bit of a sliding scale. To the extent that platforms do not have the discretion to decide with whom they do business, it seems like a poor outcome for them to be liable. 

Chairman SCHWEIKERT. Mr. Best? 

Mr. BEST. I think from my perspective we believe that the portals should have the ability to decide who is and is not on their 

platform because then it becomes more than a bulletin board. 

Chairman SCHWEIKERT. But on the taking liability for if—— 

Mr. BULLARD. I agree. There is a significant disagreement we 

have not covered. 

Mr. MULVANEY. I am going to come back to you, Mr. Paul, because there were a couple things in your written testimony that 

were actually very interesting. 

Mr. Paul? 

Mr. PAUL. Yes, sir. 

Chairman SCHWEIKERT. I interrupted you when I went on my 

tirade. 

Mr. PAUL. Yes, I was not sure if that was a tirade or you were 

just looking for confirmation. 

Chairman SCHWEIKERT. Actually, believe it or not, within your 

written testimonies I have a bit of a split on the discussion of does 

the portal—what level of liability it takes for a screwed up offering 

or someone forgetting a disclosure. And so that is what I am trying 

to—— 

Mr. PAUL. It will always get back down to when there is a 

claim, if there is a claim, you know, what did the portal know and 

when? And the liability could be significant. I mean, it could be significant enough that effectively, and I mentioned this very briefly 

SBREP-219 with DISTILLER

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in my oral testimony, but it is in my written testimony, in the 

broadest interpretation the portal could be 100 percent liable for 

reimbursing an investor, even after the investor perhaps does not 

even own the security any longer, which would effectively make the 

portal a guarantor for everything that is listed on the platform. 

Chairman SCHWEIKERT. And I am concerned about the potential chilling effect and just cleaning up that language. 

Professor, you actually had—you sort of brushed alongside this. 

Can I throw a scenario at you and have you sort of game theory 

this with me? 

There are actually a group of friends and supporters, it is a Korean business association. At one time, if it was a few years ago, 

they were trying to put up a community bank but the difficulties 

and the capital that is required to that, and they have been looking 

at the idea of, hey, if we could produce a portal and we could reach 

out to the Southwest and the California market and help folk within our association group have basic capital raise and their level of 

comfort because these are often folks, either they know reputation 

wise or they know the industries, do I have problems with something that borders on a fraternal or business or chamber or specialty organization, setting up a portal saying this is what we are 

going to fund? That is the first question. Do you see anything there 

in a portal being that specific to its charter? 

Mr. BULLARD. Yeah. The disagreement is that there is no restriction on your ability to say no to issuers. That is simply incorrect. To be fair to the SEC, the investment advice issue, that goes 

to the communications with the public, the investor. Deciding who 

is going to list is a communication with the issuer. 

Chairman SCHWEIKERT. Okay. So my Korean business association—— 

Mr. BULLARD. So that is not an issue. 

Chairman SCHWEIKERT. Instead of a community bank, this is 

how we are going to help folks in our community. 

Mr. BULLARD. So there should be no problem. 

Now, you cannot say you should invest in these affinity entities 

because you will get better returns. But you can say you can invest 

in these affiliated entities and you can probably say because we 

think they have values that we share. But there is no conceivable 

possibility that you chose the group on that basis or you went out 

and you only accepted issuers you thought would be 10-baggers 

that you would be liable for that. That is simply not realistic. 

Chairman SCHWEIKERT. Well, as a professor of securities law, 

as you probably remember a decade or two ago, there was a movement to try to create specialty community banks to be able to deal 

with underserved populations. Do you see where some of this model 

could actually be part of that opportunity? 

Mr. BULLARD. Yes. But we talked before the hearing about the 

issue of whether you can actually do bricks and mortar selling, and 

I am still not totally clear on that. But I think that to the extent 

the SEC has put—— 

Chairman SCHWEIKERT. Could you explain that for everyone 

else here because this one actually could be a bottleneck. 

Mr. BULLARD. Right. Well, the SEC talks about kind of an online-only approach, and if I am correct, that would preclude you 

SBREP-219 with DISTILLER

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from running an offering out of your bank. You would still have to 

have a website, but you would not be limited to the website. Then 

I think that would severely handicap what is really the sweet spot 

of crowdfunding. That is the community business that somebody 

might want to start up based on local relationships. For example, 

the organization you mentioned. 

Chairman SCHWEIKERT. Okay. 

And Mr. Best, as the professor was just touching on, is not the 

second part of the beauty within sort of the crowd sourcing, 

crowdfunding concept, is just that? It is a proof of concept? 

Mr. BEST. Absolutely. 

Chairman SCHWEIKERT. It is not only maybe raising money in 

my community but also an A&B test of not only I can access some 

money but I can also access folks that have enthusiasm for the concept? 

Mr. BEST. Absolutely, Mr. Chairman. I think what we are seeing, there are a number of angel investors who now are beginning 

to look at crowdfunding as a qualifying step before they will look 

at a deal because do you have a customer for your product? Do you 

have a customer for your service? And being able to, whether it be 

through awards or through equity or debt, being able to establish 

that does several things. It is proof of concept of your product. It 

is proof of concept of you as an entrepreneur, the ability to execute, 

and your ability to raise capital, both very important aspects. 

Chairman SCHWEIKERT. Mr. Gorfine, in that sort of model, let 

us say I actually need a few million dollars for my concept, but I 

am going to use crowdfunding to raise $499,000. And we will discuss whether ultimately I have a soft cap, a small raise because in 

that population, most likely I am not going to have many people 

able to invest over $2,000, and at some point we really do need to 

talk that there are these investment caps already built into here 

to limit someone’s downside. But I use that as my proof of concept. 

Then I take my proof of concept, and can I then go to my qualified 

investors and raise my next $2 million and then go to more institutional money to round out my fund-raise? 

Mr. GORFINE. Yeah, I think that is right. And the SEC, I think, 

did a great job in clarifying that point. That you would be able to 

use Title III alongside or before, subsequent to, certain other exemptions. So if you think about this in its totality, what I like 

about the JOBS Act vision is that it creates this kind of seamless 

capital access pipeline, if implemented effectively, so that you can 

go from each stage of the development of a company and be able 

to access capital that suits your needs at whatever stage of development you are at so that you could certainly start with Title III 

and then potentially use that to move up to a Title IV, you know, 

Reg A-Plus type raise. 

Chairman SCHWEIKERT. Thank you. That was one of the concepts I wanted to make sure we addressed. 

Ranking Member Clarke. 

Ms. CLARKE. Thank you, Mr. Chairman. 

Mr. Paul, the SEC has estimated that commissions to intermediaries will account for about 5 to 15 percent of the 

crowdfunding issuance, higher than other funding sources such as 

public stock offerings or bond issuances. Do you expect this higher 

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cost to come down and become competitive with traditional forms 

of capital as crowdfunding expands? And then I will open it up to 

the rest of the panel. 

Mr. PAUL. I think it is going to be a competitive marketplace, 

so if you are asking if over time that these commissions, there will 

be some sort of competition, I think the answer is probably yes. I 

would, however, note that comparing the commissions for 

crowdfunding offerings to IPOs or public markets is perhaps not 

the most apt analogy. I mean, it is an appropriate one, but there 

are other types of securities that exist that might be a closer analogy. For example, Regulation D or 506, which is another type of 

private placement. And in that universe, these proposed commissions are fairly consistent. Maybe a touch higher but not quite as 

many multiples higher as the private-public markets. 

Ms. CLARKE. Would you agree with Mr. Paul’s assessment? 

Mr. BEST. I would. Yes. 

Ms. CLARKE. Okay. Professor Bullard, the rule outlines a number of investment limits based on an investor’s income level. However, you invest concerns that the rule lack an income verification 

scheme. What risk does this pose for investors interested in 

crowdfunding? 

Mr. BULLARD. The risk is not that they will invest in accordance with the rules. I think the rules are good rules, particularly 

that they limit the percentage with respect to that person’s income 

or net worth. This is a slip-through-the-cracks problem, and is most 

likely to happen when you put the entire analysis in the investors’ 

hands and you do not give them clear markers as the things they 

need to look out for. 

So, for example, one obvious one would be they should not be allowed to self-certify if there has not been a button they had to push 

saying I have not included the value of my home. They should not 

accept that they have read the investor education material which 

is required unless there are a couple screens where a box has said 

in big, bold letters the percentage of small businesses that fail to 

really drive home the point that this happens. Instead, what the 

SEC suggested is you can just click on a box that says ‘‘I have read 

this’’ and the thing is not even there or something you would have 

to scroll down 20 pages. And we all check that box all the time saying we read it, but we are lying, are we not? Right? But it is also 

crazy to think anybody is going to read these things. So the SEC 

has always been unwilling to say, well, you know, the literal letter 

of the law is the only path we can go down with no requirement. 

Just be creative and say, look, there are four or five boxes with big 

fat letters that will lay out the key things they need to think about 

and that should do it. That is the kind of thing we need to deal 

with but I think submitting a paystub should be a requirement. 

That is just too easy. Or some electronic verification of income, for 

example. 

Ms. CLARKE. So discuss that ambiguity in a rule that could 

allow large companies to raise $1 million through crowdfunding 

while simultaneously raising more via other public offerings. Can 

you elaborate on how this will impact startups and small businesses that are experiencing a funding gap and want to seek 

crowdfunding? 

SBREP-219 with DISTILLER

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Mr. BULLARD. This is the issue Representative Mulvaney raised, and I agree that the $1 million cap on the total offerings 

that a crowdfunding issuer is allowed is too low, but I think as a 

business matter—this is not an investor protection issue at all— 

but as a business matter, if you really want crowdfunding to work, 

I think that larger issuers are going to squeeze out smaller issuers. 

And you all know in the regulatory space who calls the shots. In 

the regulatory space, it is going to be the largest regulated entities. 

So if you let larger entities in this regulatory space, they are going 

to have more influence with the SEC and the rules are going to reflect their interests. So definitely, I think the $1 million is not high 

enough. I do not think the SEC has the authority to do what it is 

doing because the statute is so unambiguous, but the fact that 

somebody can be very successful raising significant amounts elsewhere, they should not be allowed to use crowdfunding because I 

think the way it is going to work is they will squeeze out the small 

businesses. 

Ms. CLARKE. Let me open this up to the rest of the panel. I 

saw, I guess, a glimmer in our eye, Mr. Paul. Would you like to 

share your thoughts? 

Mr. PAUL. It might have been a glimmer. 

Yeah. With all due respect to Professor Bullard, I just do not 

agree. I do not think that the larger issue—if the larger issuers, 

or whatever, larger entities are allowed to do crowdfunding offerings, that it is going to squeeze anybody out. It will simply make 

it a more diverse marketplace. I am trying to think of a large corporation that might choose to utilize Title III almost as a marketing opportunity or a way of extending their brand. It is still 

going to be limited to a million, at least for the time being. Why 

would we restrict that? Why is that a bad thing? Why not allow 

the opportunity to invest for unaccredited investors that would not 

otherwise have had that opportunity? I am cognizant, of course, 

that this is the Small Business Committee, and so we want to foster small businesses, and certainly Professor Bullard’s comments 

are consistent with that. However, the other side of the rationale 

for Title III was to democratize wealth creation as well. So it is not 

just democratizing the capital formation, but also democratizing 

the opportunity for investors to participate in the types of investments that they might not otherwise, and previously did not otherwise have. So I do not see the need to restrict them. 

Ms. CLARKE. Mr. Gorfine? Mr. Best? 

Mr. BEST. Well, in talking to a couple major corporations about 

this who have been interested in crowdfunding—their interest really is more on the reward side because of the rewards crowdfunding, 

like Kickstarter or using services like that because it allows them 

to raise capital—there are no limits, and far fewer restrictions. And 

knowing how general counsels at corporations tend to work, that 

would be the way that a marketing department might have a better chance at actually executing one of these campaigns. 

So I do not believe it will crowd out small businesses. I think 

that those major corporations will utilize other means, rewards or 

otherwise. 

Mr. GORFINE. Yeah, I mean, just to add, I tend to agree with 

that. I think let the marketplace determine what the crowd wants 

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to invest in. And I think more opportunities, more offerings and options is not necessarily a bad thing. 

And if I may, can I come back to the investor cap question that 

you were asking before? I do want to just clarify one thing. By no 

means do I think the SEC should be going after investors with lawsuits if they violate the cap. So I actually do agree to a significant 

extent with Professor Bullard that this idea of how do we make 

sure investors just understand what these caps are all about. So 

what I would propose is just literally at the point that an investor 

is about to click their commitment, there can be a popup that explains the rule and how you calculate what your cap may be, and 

just explains why that is important. So I do agree with the selfcertification aspect of it, but it could just be an explicit popup that 

occurs at the point of the commitment that explains what the parameters are. 

And my point on the lawsuits is if an investor violates that cap, 

you could consider whether they should not have the right to bring 

a cause of action against an issuer. That is what I was bringing 

up in terms of lawsuits. Just to help enforce the importance of that 

cap. 

Ms. CLARKE. Very well. Thank you. 

Just one final question, and I am going to start with Professor 

Bullard. 

The SEC cost estimates for crowdfunding do not look promising 

for small issuers. Are there ways the SEC could reduce the cost 

without impacting investor protection? 

Mr. BULLARD. That depends on to what extent the SEC believes it can disregard what was expressly required in the statute. 

And the SEC has shown a great willingness to do that in its proposal. So if that is what it is going to do, then yes. And one example that really stands out is the requirement that you explained 

how you valued the shares and how you are going to value them 

in the future, which you do not have to do anything similar for an 

IPO. And it is also sort of in contravention of the general rule that 

you are trying to sell things for the highest price you can get. Although ironically, in IPOs you are often trying to sell them for less 

than you can get in order to have an effect on the aftermarket. So 

that should go away. It is unreasonable. The very detailed instructions when explaining your capital structure should go away. The 

very detailed explanations on a dilution. What they need to know 

is you can make subsequent offerings of shares and it can result 

in reducing the value of our shares. And we have the authority to 

do that. 

So a lot of the things just are not the kinds of things that are 

going to go to the real issue here, which is that there are going to 

be a lot of losses. And who are the people who suffered those losses 

going to be? Right? And I do not think this is going to be about 

disclosure, but the cost is certainly going to go to disclosure and the 

perceived liability is going to go to that as well. 

Ms. CLARKE. Thank you, Professor. 

Is there anyone else who would want to? Mr. Best? 

Mr. BEST. Just one thing about education. I think that is one 

of the good things in the statute, was the requirement for robust 

investor education. And we have already begun seeing some of the 

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portals who are going to be implementing solutions that look very 

much like what Professor Bullard was talking about, whether they 

be a video, much like the seatbelt video you watch when you get 

on the airplane, or something that has large check boxes and really 

requires much more engagement. There were other solutions that 

used to require you to spend a certain amount of time on the page 

and sort of monitor that. 

Also, because all this is happening on websites, everything is 

tracked. And so there will be a digital footprint of everything that 

was done by that investor on those sites. And so you will know how 

many minutes they spent on each page of disclosure, how many 

times they watched the video, how many times they did everything. 

And so it will provide much more transparency than we have ever 

had before about what people are doing when they are reviewing 

documents. 

Ms. CLARKE. Very well. I yield back, Mr. Chairman. Thank you 

all for your expertise today. 

Chairman SCHWEIKERT. Thank you, Ranking Member Clarke. 

And I am going to go to Mr. Rice, but Professor, I want to chime 

in on this one just quickly. I actually see substantially more benefits for its larger organizations. From their standpoint, they get to 

do a proof of concept, but I actually also saw that as they would 

have the resources to have good documentation, good video, good 

information, maybe a nice blog that explains what they are doing. 

And it is a way of their resources helping introduce hopefully this 

next class of investor to this concept. And as we keep saying, education, education, education. Well, I would love to exploit some of 

their resources to do that. So that is where I have some optimism. 

Mr. Rice, five minutes. 

Mr. RICE. I was a tax lawyer and a CPA for 25 years before I 

came to Congress, and I represented a thousand small businesses. 

And I have seen the effect of federal securities laws on their ability 

to raise capital. For a truly small business, it simply is out of 

reach. Banks being the primary source of capital, the new DoddFrank regulations are certainly going to limit that even further. So 

this is an incredibly important concept, very innovative concept. 

Could solve a big problem of growing small businesses. I totally 

agree. 

I would ask each one of you for one suggestion. We cannot make 

this so complex and complicated and expensive that it, like the rest 

of the federal securities laws, is out of reach of the average small 

business. So I would ask each one of you for one concrete change 

or suggestion that we could do with these regulations in this law 

to make it more accessible. 

And I will start with you, Mr. Best. 

Mr. BEST. I think it would be to modify the requirement of a full 

CPA audit at above a half million to potentially the CPA review 

that was required in the $100,000 to half a million range. 

I would say in the same vein, I would limit any nonstatutory disclosure requirements, and that also includes limiting some of the 

ongoing compliance requirements. I would just add to the point on 

audits above $500,000, for a Reg A offering up to $5 million, we 

do not have that same financial audit requirement. So you want to 

kind of square how these different exemptions fit together. 

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Mr. RICE. Mr. Best, at what level would you require an audit? 

Mr. BEST. I do not have the benefit of 25 years of tax CPA experience. I just come at this as a small business person, as a small 

business owner. I think there is some level, but I think if you wanted to say that maybe at the end of year one, after you were successful at raising the capital at the end of year one and you wanted 

to then provide something back, to deliver back to those people. I 

think one of the things, too, is that these investors, because they 

are investing most of the time, historically the data we have to 

date is that 80 percent of the time these are people who are first 

or secondary connections to the small business owner who are making these either investments or contributions. And so these are people they have ongoing relationships with. And so there will be a lot 

of mandated disclosure, but what we are seeing is the people who 

are successful are the people who provide ongoing sort of fulsome 

disclosure in the course of doing business because that is what people want to know. 

Mr. RICE. Well, do not get me wrong. I hold a CPA, but I agree 

with you that an audit is an onerous requirement for a small business, particularly when it has been ongoing for five years and 

never had an audit. And so to go back and redo all that from 

ground zero to establish a starting point is ridiculously expensive 

and would prohibit any small business from being able to utilize 

this. So I agree with you and I think that that threshold, if there 

is not going to be an audit required, should be very high because 

it is going to cost so much to get the money it is not going to be 

worth it. 

Mr. Bullard? 

Mr. BULLARD. I guess the one change I would make would be to have a $100 investment maximum and then strip everything out 

except for the requirement to do it through a mediary and the requirement to have some business plan that is at least 500 words. 

Mr. RICE. I think 100 would be too small, but I hear what you 

are saying. 

Mr. BULLARD. A thousand times 100. There is your 100,000. 

Mr. RICE. Mr. Paul? 

Mr. PAUL. My suggestion would be addressing—it may seem indirect, but addressing the portal liability issue is rather crucial to 

a facilitating small business’s ability to raise money. If it is not 

clear, we may end up with perhaps the more gun-slinging actors 

participating in a market that we really do not want to be perceived that way. 

Just getting back to the audit question, the only reason that was 

not my choice was because it had already been mentioned. I think 

an audit should be required when it is required by the owners. I 

think when the market says, you know what? We are not comfortable with you, the investors, we want to see how you got here. 

When that happens then I think the company should be required 

to, but I think setting an arbitrary cut with respect to how much 

is raised feels, well, arbitrary and it should be based more on necessity and the desire of the shareholders. 

Mr. RICE. Thank you very much for your time. I completely 

agree that the way this is proceeding is going to make this pretty 

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ciate your input. I like the idea of limiting investment but I think 

$100, it needs to be significantly higher than that. 

Thank you, Mr. Chairman. 

Chairman SCHWEIKERT. And thank you, Mr. Rice. 

They are about to call votes. I think that still gives us a few minutes because as we have all learned around here the first 15 

minute vote means a half an hour. 

Mr. Mulvaney, you had a couple. 

Mr. MULVANEY. I did. Thank you. 

And I forgot, Mr. Best, you actually opened your testimony by 

talking about the British system and the theory that good ideas 

can come from anyplace. Would you just give us a quick summary 

of where you think the significant difference are between the British system and the one we have adopted and maybe someplace 

where it might be better, someplace where our system might be a 

little better? 

Mr. BEST. What is interesting about the British system is a lot 

of it has sprung up in the absence of strong regulation. And it is 

only this year that the British government will be issuing more formalized crowdfunding and crowd lending regulation. 

Mr. MULVANEY. The caps that we are talking about, the disclosure requirements, the liability rules are nonexistent? They are organic? What are they in the British system? 

Mr. BEST. Well, they are much less structured in the British 

system. And so what we are seeing is you are seeing a wide range 

of investors and lenders. Now, I will say that the products of choice 

in the U.K. tend to be the loan products, the debt-based products. 

That is about 10 times more crowd-debt as there is equity. I think 

there is a degree to which that is cultural, as well as the fact that 

for a lot of small businesses who will never have an IPO or a 10X 

multiple, asking the question where is my exit on this investment. 

If it is a debt-based product, I know that I am going to get my loan 

payment every month over the next four years. So that makes 

sense as well. 

Mr. MULVANEY. To the chairman’s issue on democratization of 

investment, you said that there is a wide array of investors in the 

British system. Tell us who they are. Who is participating in this, 

not on the issuer’s end but on the investor’s end? 

Mr. BEST. Well, on the largest debt-based platform in the U.K., 

it is called Funding Circle, they have now raised over 180 million 

British pounds. That is over a quarter billion dollars through their 

platform. And they have, I believe, it is 65,000 investors that have 

invested individuals into small businesses. And they come from a 

wide range of folks. And if you look at the average investment, it 

is about the average of about $3,000 USD. And so these are people 

who are not investing large amounts of money but are investing a 

few thousand dollars into a local business that they are familiar 

with. And I think that is a size of investment that, number one, 

we did research a couple years ago before the law passed just to 

ask people, what do you think your investment would be if you had 

this opportunity? And the number was between $3,000 and $4,000. 

So we are seeing, at least in the British system, those numbers are 

somewhat consistent. And so I think that while the limits may be 

up to 10 percent of someone’s restrictions, what we are seeing in 

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the U.K. after tens of thousands of people have used this system, 

that people are going into this fairly carefully. 

Mr. MULVANEY. I heard Professor Bullard mention in his testimony that he was concerned that something between a quarter and 

a half of these issuers, if I got that right, might fail. Do you happen 

to know the failure rate in the British system so far or not? 

Mr. BEST. No, sir. I do not know the British system. I can give 

you some data from Australia. I think that there will be failure. 

Absolutely. Businesses fail. We have never run away from that in 

this entire conversation about this. 

In the Australian system, they have had crowdfund investing, a 

form of it for now almost eight years, and the platform there is 

called the Australian Small-Scale Offering Board. And they have 

run about 145 companies through that platform, through that 

crowdfunding platform. One of the interesting things is that the 

survival rate of those businesses who have used that system has 

been 86 percent. That is kind of a very surprising high number. 

And when asked about that, the CEO of the platform has said he 

does not have the exact reason but certainly believes that adding 

structure and transparency to a business earlier than it typically 

would have as a startup, because you have to sort of have a lot 

more structure around your business because you are now offering 

this security out to the public, and also the transparency of having 

to make regular engagement with your investors, whether it be informally or formally, provides people with better decision-making 

opportunities and more transparency. I am doing this on stage. I 

have to do a better job. I have to live up to the expectations of the 

public. 

And so we will see if that plays out in U.K. system and in the 

U.S. system, but it is an interesting data point. 

Mr. MULVANEY. Fascinating. 

Thank you, Mr. Chairman. I appreciate it, gentlemen. 

Chairman SCHWEIKERT. Thank you, Mr. Mulvaney. And thank 

you for joining us. 

Just one last, a takeoff of where you were, Mr. Best, or anyone 

that wants to participate. Let us articulate so we have it on the 

record. What are the caps? It is $2,000? 

Mr. BEST. Two thousand dollars above $50,000—$50,000 to 

$100,000 in income. It is up to 5 percent of your annual income or 

net worth, and above $100,000 it is 10 percent of your annual income or net worth excluding the value of your home. 

Chairman SCHWEIKERT. Professor. 

Mr. BULLARD. There is actually a flat contradiction in the statute, so we do not really know the answer to that, which is it says 

if you are either at 100 or below as to income or net worth, you 

are subject to the lower limit. And then the next provision says if 

you are either at 100 or more. 

Also, it is not clear what the 5 percent applies to. There I think 

the SEC should interpret it to be the greater of. 

Chairman SCHWEIKERT. And Professor, did not the SEC sort 

of broach that in their rule set? 

Mr. BULLARD. Right. But they took the investor protection ambiguity and they ruled against more investor protection, allowing 

someone to invest more. But as a practical matter, what that 

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means is someone who has $100,000 in savings would be able to 

invest $10,000 instead of $5,000. It is not going to be the end of 

the world but I do not think the SEC, when there is such a clear 

ambiguity, should be erring on the side of higher investments when 

this is an investment protection provision. 

Chairman SCHWEIKERT. Last thing I wanted to share, and this 

was actually something—and those of you who have actually been 

involved in intermediaries, I am from sort of the world that believe 

that crowdsourcing of data information and crowdsourcing of 

money and other things, there is a purifying effect of information, 

sunlight, and the fact of the matter is having seen—because I have 

looked at some of the ones actually, the Netherlands, Sweden, 

Great Britain. And many of them actually had blogs running alongside of it saying, ‘‘We go to Mary’s Bakery. We like this. That is 

why we are willing to put 1,000 pounds into this.’’ It was a narrative that came with not only the posting in the investment. 

Do you believe U.S. portals will actually make sure that they 

also, if they are asking for egalitarian participation, democratization of investment as you have used the term, will also be doing 

democratization of information and comments? 

Mr. PAUL. I think absolutely. I think that it will be in both 

senses, in the example that you gave of Mary’s Bakery, customers 

will talk, ‘‘This place is great and they make great scones.’’ And 

there will be a discussion about that. But I think that there will 

also be blogs or a running dialogue about the offering itself where 

certain people will say, ‘‘All right. So I looked at the offering and 

this thing does not totally make sense to me. Does anybody have 

any clarity on that?’’ And then a dialogue, someone will respond, 

perhaps even the principal. And so I do think that there will be 

that level of transparency. 

Chairman SCHWEIKERT. Would anyone disagree with me that 

particularly in this investor class, that is the ultimate type of regulation? Because we are all comfortable going to Yelp and others to 

get portions of information. As long as they have built the mechanics within there to avoid the scamming, that access to information 

has an ultimate regulator? 

Mr. PAUL. I think it is a great contributing factor to that level 

of regulation, and I think that it may come to pass that it actually 

ends up being something that is expected in other asset classes. I 

think it is going to be very successful on Title III, and I think 5, 

10 years from now that might be one of the legacies of this entire 

legislation, is that that level of transparency is actually required 

for other things, which will be great. 

Chairman SCHWEIKERT. And now we do the scamper to go 

vote. 

Thank you for your participation today. Your testimony has 

helped us to better understand how the SEC proposal will affect 

the future of crowdfunding. As I shared with you earlier, I am a 

bit emotionally invested in this, and I really do want to move to 

this democratization of access to capital where all of our U.S. citizens have the opportunity to take risks but also benefit from that 

participation and risk. 

I will ask unanimous consent to have five legislative days to submit statements and supporting materials for the record. Do underSBREP-219 with DISTILLER

27 

stand our office also intends to take portions of this and turn it into 

the SEC as part of sort of a comment coming from us. 

Without objection, the hearing is adjourned. 

[Whereupon, at 11:28 a.m., the Subcommittee was adjourned.] 

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A P P E N D I X 

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Congressional Testimony 

United States House of Representatives 

Committee on Small Business 

Subcommittee on Investigations, Oversight and Regulations 

For the Hearing: "SEC's Crowdfunding Proposal: Will it work for small 

business?" 

Jan 16, 2014 

Chairman Schweikert, Ranking Member Clarke and members of the committee, 

thank you very much for the opportunity to discuss the function that crowdfunding 

serve in delivering much needed capital to address the funding crisis for small 

businesses in the United States. I come here today not as a lawyer or government 

official, but as an entrepreneur who has had my share of both success and failure in 

starting and building businesses. In addition to sharing that real world 

perspective, I would like to introduce some new data from the UK and US markets 

that should shed some light on the magnitude of what is taking place outside the US 

in crowdfunding to ignite significant opportunities for small businesses to get 

funding, and the very real risk we run if we overburden issuers, platforms and 

investors with overly complex regulations. There are still many opportunities to 

strengthen and improve these draft rules and an opportunity to use new 

technologies and services to enable better oversight than has ever been available 

before; but it is up to the SEC to continue working with the public and industry as it 
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finalizes its rules and Congress to determine what are the best actions to accelerate 

economic growth and create jobs in the United States. 

I'd like to begin by thanking the members of this committee and both parties within 

the House at large, for their bipartisan and overwhelming support for crowdfunding. 

It was a wonderful example of the ability for both parties to work together in 

support of small businesses and entrepreneurs, which we all know are America's 

economic engine. When entrepreneurs have access to capital to grow their 

organizations, it translates into new American jobs, economic renewal for cities and 

towns across this county through hard work and American innovation. 

As a co-author of the Startup Exemption Framework, the initial proposal for 

securities-based crowdfunding, and a close collaborator with Rep. Patrick McHenry 

and Senators Merkley, Bennett and Brown on the passage of the JOBS Act, I was 

thrilled when Title II draft rules became final and available for use and more 

recently when the SEC issued Title III draft rules for Regulation Crowdfunding. 

want to take a moment in my testimony to give my sincere thanks to Chair White, 

the Commissioners, Lona Nallengara, David Blass and the rest ofthe staff that 

worked on Titles II, Ill, for their willingness to engage in a robust conversation with 

the industry while they were drafting their initial rules. While the rule making 

process did not occur as quickly as I personally may have liked, I want this 

committee to know that senior staff at the SEC met with myself and other industry 

leaders over a dozen times, were receptive to our public comments, and were 
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responsive to our information and clarification requests during their rule making 

process. We hope that the engagement of the industry trade group that I cofounded, Crowdfunding Regulatory Intermediate Advocates (CFlRA), was able to 

demonstrate that the crowdfunding industry is very focused on creating a stable, 

orderly market. The industry will only succeed if it can grow and succeed over the 

long term, and take its place as a new asset class within the private capital market. 

We as an industry will continue to work with the SEC and the legislative and 

executive branches of government, to advocate for what we believe will best balance 

three requirements of good financial regulation: 1) providing cost-effective access 

to capital for small and medium-sized businesses 2) providing potential investors 

with protections from bad actors through both proactive education and appropriate 

regulation and 3) transparency to enable regulators and elected officials with the 

ability to provide responsible oversight and ongoing regulatory modification. 

Ongoing regulatory modification is more important and more possible today than 

ever because of the access to real time data that will now be available via 

crowdfunding platforms for both accredited and unaccredited investors. This real 

time data can enable regulators and legislators to separate fact from guesswork in a 

more efficient manner than ever before. Online platforms like Seed Invest and 

OfferBoard are providing issuers and investors with open information and near real 

time data feeds and indexes from companies like Crowdnetic help to ensure 

effective information availability, as opposed to the private capital markets of the 

past where speed and transparency may have been more a wish than a reality. I 
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hope that the SEC can use the JOBS Act, and specifically the online platforms created 

with Title II and Title III, will deliver better data, more rapidly and more easily to 

improve investor protection while delivering capital efficiently to small business. 

As a tech entrepreneur and also now a small business owner, I have real experience 

in creating products and services, raising capital and creating jobs. That is the 

perspective that I bring to this conversation. If the proposed regulations are 

implemented, there are some elements that I think are structured in ways that meet 

the needs of all three parties (investors, issuers and regulators). Two examples of 

this are: 

o Robust investor education requirements on crowdfunding platforms: Every 

investor should understand before they invest a single dollar into a small 

business or entrepreneurial venture that they are inherently high risk and 

that it is entirely possible they will looks their entire investment. They also 

should gain access to educational materials that allows them to understand 

basic due diligence questions and learn online from experts who can provide 

advice for evaluating these kinds of investments. 

o The opportunity to make parallel offerings (Regulation Crowdfunding 

offerings with other types of private offerings to accredited investors): This 

enables companies to raise capital from different audiences at the same time 

and helps companies to efficiently raise more than $lM from accredited 

investors, if they need to do so (in addition to a crowdfunding round to 

unaccredited investors). 
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However there are other elements that I believe must be modified so this market 

can reach its full potential and we will not loose our leadership position in the new 

economy. 

o The requirements for using CPA audited financials for raises above $500,000. 

o This places an unreasonable burden on entrepreneurs and small 

businesses and may cause a "soft cap" on raising money above 

$500,000 due to the cost of capital this regulatory burden imposes. I 

believe that a "soft cap" that reduces the opportunity by 50% was not 

within the legislative intent for this act. 

o I understand the goal of this regulation: as the size of the capital 

raised increases, investors will want increased disclosure and 

validation of the state of the business. However auditing a business 

with zero or very little revenue is a waste of time for both the 

business owner and the accountant. 

o Another potential issue is that it is my understanding that to have a 

full audit on a corporation usually requires that the company follow 

accrual accounting process. Most small businesses operate on a cash 

accounting process. This change also adds to the cost and to the 

increased level of sophistication required for ongoing use of accrual 

accounting. 

o Additionally, if I have to spend 30% of what I raise to just comply with 

legal and accounting requirements, will that significantly reduce the 

number oflegitimate businesses that will use this new funding 
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vehicle? At the end of the day, we don't want to create a new way to 

raise capital that ends up costing business owners more than it would 

have cost them in credit card interest fees. We must create a better, 

more efficient way to raise capital for hard working Americans. 

I believe it may reduce the positive impact of the JOBS Act but there is still ample 

opportunity to fix this issue. There must be a new way to harness technology to 

meet the needs of increased due diligence and transparency while not imposing the 

significant burden of a full audit. I have confidence that technologies are and will be 

created to lower the cost of these burdens, but in the meantime, I don't want for 

these regulations to cause a chilling effect on the industry. How can we make 

modifications to this regulation so that it does not damage this market before it can 

get started? 

To quote Douglas Ellenoff, the Managing Partner of Ellenoff, Grossman and Schole, a 

leading securities law firm in New York City, "For the last 80 years, friends and 

family - those with so called "pre-existing and substantial relationships" with 

entrepreneurs have invested billions of dollars every year, pursuant to long 

established securities law exemptions in private financings, without any meaningful 

disclosures or procedural responsibilities. Now with Title III Crowdfunding, we 

have designed an online, centralized technology-based process for more efficiently 

and responsibly managing what has been done in the offline world before - and 

doing so within full sight of Federal and State Regulators - not merely person to 

person inconsistent solicitations in kitchens and near water coolers." 
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I agree with Mr. Ellenoff, and I believe that with crowdfunding, we actually will have 

better oversight than has ever existed in the private capital markets before. 

I would like to use the rest of my testimony to deliver data-driven 

perspectives about crowd funding: 

1) Where is this market going and how will it develop 

2) The UK case study about what does a Light-Touch Regulatory Environment 

do for crowdfunding: 3 years of data released November, 2013. 

3) What happens to companies after they raise money with crowdfunding? 

New data released January 15, 2014. 

Models to understand where tbe crowdfunding market is going and how will it 

develop 

"The opportunity for regulators is to implement oversight of crowdfunding in a way 

that is data intensive and prescriptive light" (Bholat, David. 2013. The future of 

central bank data. Journal of Banking Regulation 14(3): 185-194). In October, 

2013 during the First Global Crowdfunding Academic Symposium at University of 

California, Berkeley's Program on Innovation on Entrepreneurial and Social Finance 

attended by 100 academics from 15 countries, we were able to learn a great deal 

about what is going on globally in this new form of modern finance. I think it is a 

quote worth considering for JOBS Act regulation generally, and regulation 

crowdfunding in specific. 
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While some may suggest that the current draft regulation will kill regulation 

crowdfunding, I would strongly disagree. I believe that the potential of 

crowd funding is not about a single company or single crowd funding platform. It is 

about a radical evolution of the largely institutional framework for allocating capital 

(e.g. banks, funds, foundations) to a more individually driven framework that is 

enabled via both existing and yet-to-be-created technologies. Some of these 

technologies will also have broader adoption potential throughout the rest of the 

private capital markets. This is an evolutionary path that is similar to the ways in 

which other industries in the technology space that have developed over the last 15 

years. Below are three examples of similar kinds of radical evolutions in other 

markets that were driven by innovation that created both new companies and 

industries. 

(I) Online Advertising: Redefining largely offline activities into online 

activities (e.g. the shift to online advertising and the ability to 

measure outcomes and improve results) 

(2) Social Web: Creating new and unique connections between 

individuals and brands (e.g. the social Web as a primary 

communication channel for both individuals and businesses) 

(3) Cloud Computing: Transforming the way business can and should be 

done (e.g. cloud computing - gaining significant scalability and 

efficiency at radically lower costs) 
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This thesis also leverages the convergence of these three examples to unlock the 

opportunity of the JOBS Act to build a new ecosystem in early stage finance and 

potentially the broader private capital markets. Each of these trends has created 

new business models, companies and in some cases new industries. 

Examples of radical evolutions that have disrupted established markets include: 

• Delivery of goods and services / ecommerce: Amazon 

• Moving offline tractions to online transactions: EBay 

• Facilitating payments: PayPal 

• Leveraging social networks to bring offline transactions online with 

increased scale, transparency, efficiency and with lower friction: 

Crowdfunding 

I believe that the emergence of crowdfunding may offer a similar magnitude of 

opportunity. 

In my opinion, crowdfund investing can be viewed as being analogous to the 

disruptive innovations created in the social networking, online advertising and 

online trading industries. Again, this is shifting offline institutional transactions into 

online personal transactions. Each of these industries faced initial consumer 

concern arising from the fear of fraud and the comfort with the status quo. Over 

time, however, the online advertising, online music and online trading industries 

developed sophisticated analytics, measurement tools, marketplaces, rating 

systems, provided rapid access to information, and evolved to become both 

sophisticated and commonplace industries of our daily lives. As shown in the e-
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commerce and online trading businesses, disruptive technologies can ultimately 

expand the market for a particular good or service. 1 In the case of e-commerce, the 

industry was able to achieve a 5% market penetration rate within the first 5 years. 2 

When online trading was first introduced in 1991, only about 5% of the U.S. 

population invested in publicly traded securities. By the mid 1990's, more than 20% 

of the U.S. population was engaged in the investment of public securities.3 Similar to 

e-commerce and online trading, crowdfund investing is disruptive. As shown in the 

e-commerce and online trading businesses, disruptive technologies can ultimately 

expand the market for a particular good or service.4 I anticipate that crowdfund 

investing will likely have the same impact of expanding the market for participation 

of private capital in the funding of start-ups and the SME market globally. 

The UK case study about what does a Light-Touch Regulatory Environment do 

for crowdfunding: 3 years of data released November, 2013 

The creation of an ecosystem of crowdfunding is occurring globally. Outside of the 

United States, crowd funding is legal and being conducted in the United Kingdom, 

Australia, Italy, Netherlands, Denmark and Estonia. When we look specifically at 

the UK, where both equity and debt based crowdfunding have been functioning for 

the last 3 years, we learn a great deal from their experience. The UK government 

1 e-business 2.0- Roadmap jor Success, Dr. Ravi Kalakota,p.2 

http://books.google.com/books?hl=en&lr=&id=fkXSp2MeOKAC&oi=fnd&pg=PRI5&dq=As+shown+in+t 

he+ecommerce+and+online+trading+businesses,+disruptive+technologies+can+ultimately+expand+the+market 

+for+a+particular+good+or+service&ots=4BLmzjbyis&sig=E_GpPdmupBQQrxGIaAkYL4FCsOU#v=one 

page&q&f=false 

2 ibid pA 

3 3http://www.stock-trading-warrior.comlHistory-of-Online-Stock_ Trading.html 

4 See, footnote 6 
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has utilized a significantly "lighter touch regulatory environment" and the market 

has delivered very interesting results. A study released November, 2013 by The 

University of California, Berkeley, Cambridge University and NESTA provided an 

excellent map ofthe industry. I have provided the entire report in Appendix 2 of my 

testimony and I would encourage the committee members and staff to see the 

results of a light-touch regulatory environment for this new form of finance. I agree 

with Julia Groves of the UK Crowdfunding association who said that soon, 

crowdfinance will not be called "alternative finance" but rather "modern finance". 

A few key highlights from this very important study; 

More than 50 crowdfinance companies participated in the study which 

included every member of the UK crowdfunding association and every 

member of the UK peer-to-peer lending association. 

- The population ofthe UK is approximately 61M (roughly 20% of the US 

population) 

The size of the crowdfinance market nearly doubled from 2012 to 2013 from 

GBP492 to GBP939 ($797M to $1.3B) 

There is clearly a wiliness to engage in this market from both 

investors/contributors and issuers/project owners 

In 2013, of the above totals,; 

o $314M were individuals lending money to businesses (211% annual 

growth rate) 

o $45.6M from equitycrowdfunding (618% annual growth rate). 
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o Equity crowdfunding surpassed rewards-based crowdfunding in 2013 

(rewards total $33.4M) 

Collectively in 2013, crowdfinance in the UK contributed $541M in early 

stage and working capital to over 5,000 start-ups. 

The report makes "cautious predictions" that the crowdfinance market may 

grow to $2.6B with $1.37B going to provide funding for startups and SMEs 

If we extrapolated these numbers to the US, based on our population, crowdfinance 

would deliver $2.7B in start-up and small business financing to approximately 

25,000 businesses across the United States. That equates to 1 successfully 

crowdfunded company for every 12,800 in state population. 

What happens to companies after they raise money with crowdfunding? New 

data released January 15, 2014 

Now, I would like to move on to a survey just released yesterday by my firm, 

Crowdfund Capital Advisors, that focuses on post-funding activities and what is 

actually happening to companies after they complete a successful crowdfunding 

campaign. I believe one of the the benefits of crowdfunding has been that by 

sourcing money from the crowd, you can enforce structure and transparency on 

companies, earlier in their lives that can help them to demonstrate a market for 

their product or service, make potentially more informed decisions, and to help 

raise them above the noise to find follow-on investors. 

In order to learn more about what is going on post-funding in the US, UK and 

Europe, we surveyed 87 companies that were successful in raising money via 
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crowdfunding campaigns and we looked companies that had used either rewards, 

debt or equity crowdfunding to ask: 

• Does a crowdfunding campaign have any effect on sales (outside of what is 

raised from the campaign)? To do so we looked at quarter on quarter sales 

(excluding the value of the crowdfunded round) 

o Among all companies that concluded successful rewards, equity or 

debt campaigns, quarterly revenues increased by an average of 24% 

post crowdfunding (not including amounts raised by crowdfunding). 

o Of particular note: When we filtered for equity-based campaigns, we 

saw a shocking increase of 351 % quarterly revenue increase. The 

results indicate that crowdfunding positively impacts sales and those 

that run equity-based campaigns see the greatest quarterly increase. 

o Initial research from interviews turns out that the funders see 

themselves as "active investors" rather than passive investors in large, 

pubic companies and want to be "loyal to the brand" and "act as an 

extended sales force" with a "vested interest in the success" of their 

investment. 

o Crowdfunding acted as a marketing campaign that was able to not 

only raise money directly, but also raise awareness and drive 

additional sales. 

• Did the company hire any new employees following the crowdfunding 

round? And if so, how many? 
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o From our research we uncovered the average company spent 100% of 

the proceeds within 90 days of the end of the campaign. 

o Much of that money went to or was planned to go into hiring people to 

help the company accomplish the goals of the crowdfunding 

campaign. 

o 39% of companies hired an average of 2.2 new employees per 

company after crowdfunding. 

o An additional 48% of companies said they intended to use 

crowdfunding proceeds to hire new staff. 

• Has there been any activity with angel investors/groups/VC's since you 

completed the crowdfunding campaign? The resounding answer was yes. It 

seems that savvy investors are using crowd funding as a new deal flow 

engine. 

o Within three months of a crowdfunding campaign: 

o 28% of the companies had closed an angel investor or venture 

capital round. 

o An additional 43% were in discussions with institutional investors. 

o This means that a total of 71 % of companies that were successful 

with crowdfunding were had already received or were in 

conversations to accept follow on investors. 

o It provided "Social Proof' to their communities, customers and other 

investors to demonstrate they were worthy of doing business with. 
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o It de-risked follow-on investment because they had demonstrated 

they were able to both execute and to successfully raise capital before. 

o Investors (be it crowdfunders, private money or public markets) want 

to invest in companies that have a great story, a great product, a great 

business model and a great team. These were all characteristics that 

successful campaigns seemed to demonstrate. 

• Were there any other business benefits to completing a crowdfunding round? 

Respondents said there were indeed benefits other than the cash: 

o Feedback on their product that they were able to incorporate prior to 

full-scale production. 

o Marketing advice that changed their marketing plans. 

o Investor knowledge and experience that they "would have had to pay 

hefty advisor fees to receive" but instead got that "in addition to a 

check" from their investors/contributors. 

• Feedback on their product that they were able to incorporate prior to fullscale production. 

• Marketing advice that changed their marketing plans. 

• Investor knowledge and experience that they "would have had to pay hefty 

advisor fees to receive" but instead got that "in addition to a check" from 

their investors/contributors. 

Conclusion 
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My thanks again to the committee for calling holding this important hearing and for 

its continued focus on seeing that their legislative intent was executed on the JOBS 

Act. Crowdfunding is delivering on its promise in the UK and other countries 

because it is leveraging the power of technology, appropriate regulation and the 

crowd to provide better access to capital for small business and new investment 

opportunities for their citizens. The question for the United States is: will we put 

ourselves on a competitive playing field or will we restrict our economic 

opportunities by over regulating one of the most important new opportunities for 

small businesses in a generation? I hope that the SEC, in consultation with the 

Congress and the industry can strike the right balance to help our economy move 

forward again. 

Appendix 1: 

Crowdfund Capital Advisors Report: Crowdfund Investin& bas a Positive 

Impact on Company Reyenne, Investor Interest and rob Creation 
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Authors: Jason Best, Sherwood Neiss and Richard Swart 

While there are dozens of articles and columns speculating whether crowdfunding 

works or not, the research team at Crowdfund Capital Advisors has recently 

completed a study of the actual impacts of crowdfunding on companies that raised 

money using this new form of finance. 

Companies in the US, Europe and elsewhere that raised capital via rewards, equity 

and debt-based crowdfunding were questioned about the marketing benefits, job 

creation, follow-on investment and the return on investment (ROI). Key questions 

asked and findings from the survey include: 

1. Does crowd funding have a marketing benefit that translates into sales? 

a. Crowdfunded companies (via rewards, equity or debt) increased 

quarterly revenues by an average of 24% post crowdfunding (not 

including amounts raised by crowdfunding). 

b. Equity-based crowdfunding companies increased revenue by 351 %. 

2. Does crowdfunding create jobs? 

a. 39% of companies hired an average of 2.2 new employees per 

company after crowdfunding. 

b. An additional 48% of companies said they intended to use 

crowdfunding proceeds to hire new staff. 

3. Does crowdfunding deter follow-on investment? 
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a. Within three months of a crowd funding campaign, 28% of the 

companies had closed an angel investor or venture capital round. 

b. An additional 43% were in discussions with institutional investors. 

4. What was the ROI of a successful crowd funding campaign? 

a. Every hour invested in a successful crowdfunding campaign returned 

$813. 

Research Methodology 

In August 2013, our research team surveyed several hundred companies in the 

North America, Europe and Africa that had completed successful rewards, debt or 

equity-based crowdfunding campaigns from June 2012 to June 2013. The team 

randomly selected companies from major platforms including Kickstarter, 

Indiegogo. Symbid, Crowdcube, Seedrs, Wi Seed and several others. None of the 

campaigns were for philanthropic causes, meaning that each campaign had to be for 

a for-profit business to understand the impact crowdfunding has on this type of 

entity. 

We collected data from companies headquartered in the US, Canada, France, Finland, 

Ireland, the Netherlands, UK, Kenya and Namibia. Each country has its own specific 

laws regarding crowdfunding. The companies were offered anonymity or could 

select to disclose their contact information. About 8% completed an online survey 
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(n=87, complete survey replies were gathered from 73 firms). Each company was 

also offered the opportunity to conduct an in-depth phone interview with our 

researchers, and 23 ofthe 73 completed a 30-minute phone interview where the 

research team discussed their experience with crowdfunding in more detail. 

It should be noted that there might be some bias in the data since companies selfselected to participate and hence these findings represent those that had a positive 

experience with crowdfunding. 

Crowdfunding Can PrOVide Significant Capital in a Rational Manner 

• Across all forms of crowdfunding, from rewards to equity, the average 

amount raised in US dollar equivalents, was $107,810 (the mean was lower, 

$40,300, with the average skewed by some of the larger equity raises). 

• The average equity raised, in US dollar equivalents was $178,790. 

• The minimum and maximum amounts raised in US dollar equivalents via 

debt or equity crowdfunding ranged from $15,600 to $936,000. 

• Firms sold between 5% and 50% of their company for an equity round with 

an average of 15%. 
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The results show that market participants are acting in a rational manner. Issuers 

are not seeking more capital than they need and investors are not seeking 

unreasonable yields. The data also signal that debt campaigns took the place of 

traditional bank loans since this type of funding has slowed since the global financial 

crisis of 2008. 

There is a Direct Benefit of a Crowdfunding Campaign When Compared to Cost 

The average company invested 135 hours of staff time in their campaign, with an 

average of 45 days engagement. Putting this into return on hours invested, the 

average crowdfunding campaign returns $813 dollars for every hour invested. The 

average company spent just over $2,100 on the campaign itself (video, marketing, 

social media marketing, etc). From this sample, a successful crowdfunding 

campaign appears to be a very effective marketing and revenue-enhancing use of a 

firm's time and resources. 

Companies also deploy this capital quickly. The average company spent 1000/0 of 

their crowd funding raise within 90 days of the end of the campaign. This can be 

attributed to the tendency ofthe firms to (a) spend more than anticipated on 

fulfillment and (b) hiring new employees soon after successfully using 

crowdfunding. 
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The most interesting statistic in the study was quarterly revenue growth-defined 

as quarter over quarter change. This growth was calculated net of the crowdfunding 

raise. We recognize that running a crowdfunding campaign is time and labor 

intensive, so we compared revenue figures for the quarter preceding crowdfunding 

to the quarter after the close of the crowdfunding campaign. The average increase in 

quarterly revenue across all types of crowdfunding was $12,675. This represents an 

average increase of 24% quarter over quarter. 

While pledge or donation crowdfunding lead to an increase of 24% in revenues, 

equity-based crowdfunding resulted in a quarterly increase of 351 %-not including 

funds raised via the equity round. 

Crowdfunding Campaigns are Used by Smal1er Entities but Represent Job 

Potential 

The survey also considered the size of the firms: 

• The most common firm using reward-based crowdfunding only had one 

employee-the founder. 

• 15% of the firms had more than two employees, with the largest firm having 

15 employees. 

• The average company size for debt or equity campaign companies was 2.1 

employees. 
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What was the impact on job creation in these companies? 

• Among firms using rewards-based crowdfunding, the median number of new 

hires was 2.0 with a maximum of 10 new employees hired after 

crowdfunding success. 

• 28% of firms who had had success with pledge and donation-based 

crowdfunding hired new employees. 

• 39% of firms who had success with equity or debt-based crowdfunding hired 

new employees. These firms hired an average of 2.2 new employees 

• In total, 87% of firms either had, or intended to, hire new employees as a 

direct result of having raised equity or debt financing via crowdfunding. 

• The larger the firm size, the more likely the firm would reinvest 

crowdfunding proceedings into new employee hires. 

• Firms with only one employee were extremely unlikely to hire new staffthey reinvested proceeds into product development. 

This data indicate that crowd funding may be a viable form of financing for small 

teams that would not qualify for institutional financing. It may allow teams to 

practice fundraising and leverage the proceeds to hire additional resources. It may 

also signal that companies using rewards campaigns might be testing market 

validation while equity and debt campaign companies might be looking for growth 

capital. 
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Crowdfunding Success Case Study: Microco.sm 

Based in London, Microco.sm provides a portal that host's discussion forums, 

bulletin boards, and communities. CEO David Kitchen describes his portal as the 

social media platform for the introverted community, turning the notion of 

Facebook on its head. The company is scheduled to go live in mid-January 2014. 

Building on his untraditional past, David's is a true story of "rags to riches" in the 

making. Years ago, David was homeless, living on the streets of London. Turning his 

life around, he returned to school and landed jobs programming for Merrill Lynch, 

the British government and Microsoft. 

Microco.sm chose to use the crowdfunding platform Seeders to list its offering. 

Unlike other crowdfunding platforms, Seeders acts as a holding company for a 

group of investors, in turn being treated as a single investor for a given business. 

The first campaign had a fairly high threshold- £50,000 for 10 percent equity-but 

was met within 15 hours. About 90 percent of the investors were users of David's 

prototype. 

The second campaign had a threshold of £100,000 for just 5 percent equity-four 

times the price per share of the first offering-yet was met in a staggering 2.5 

hours-again with 90+ percent of investors being users of the prototype. David 
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believes that his success can be attributed to the emotional connection of 

investors who believe in him and his portaL 

Soon after the first crowdfunding campaign, several angel investors and venturecapital firms approached Microco.sm. David declined their interests and decided to 

stay on his own for a little longer. 

After the second and even more successful campaign, Microco.sm was approached 

by many of the A-grade venture-capital firms in the UK. Out of these many firms that 

approached David, only one had a concern with the number of crowdfund investors. 

That concern was quickly resolved when the firm realized that they would be 

working with only one other legal shareholder: Seeders. 

David attributes crowdfunding as a key part of Microco.sm's success thus far. 

Crowdfunding Is Not the Option ofLast Resort but Rather the First Choice 

One of the main issues in crowdfunding is whether it is a first option for firms with 

potential or ifit is used by firms that have had failures in other capital markets. 

The data on pledge and donation-based crowdfunding showed: 

• 56% of firms used crowdfunding as their first choice in fundraising. 
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• 44% of firms had tried-and some with success-to raise funds using other 

methods. 

Among UK and European firms who raised money on equity and debt platforms: 

• 52% chose crowdfunding as their first means offundraising. 

• 48% had previously tried other forms of financing. 

In this sample, the only form of financing companies had received was personal 

loans or credit financing-none had been able to raise money from the capital 

markets. 

This may indicate that crowdfunding will be used by small enterprises as the first 

means of financing. Companies that previously did not qualify for traditional 

financing may be able to use a crowd funding success as a reason to qualify for 

traditional financing later on. 

Do Professional Investors Engage with Crowdfunded Companies for Follow-on 

Investment? 

There is a consistent refrain that professional investors will not want to work with 

companies that have received crowdfunding investments. The data from this study 

suggest the exact opposite. Within three months of the closing of the crowdfund 

investing round, 28% of companies had completed a round of investment from 
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either angel groups or venture capital firms. Another 43% reported that they were 

in discussions with institutional investors. Notwithstanding any limitations from the 

nature of the survey, this data shows that success with crowd fund investing leads 

to expression of interest from professional investors rapidly after the close of 

the round. 

Several other firms reported being able to secure business or personal loans on the 

basis of their success with crowdfund investing. Success with crowdfunding opens 

the door to traditional forms of investment capital-allowing many firms to 

establish revenues, customer acceptance and demonstrate the ability to executethus gaining trust from established investors. Several founders remarked that they 

received calls from angel groups that had not even allowed them to pitch, and were 

receiving term sheets from these same angel groups on the basis of their 

crowdfunding success. Twenty-seven percent of US-based companies that had 

successfully used crowdfunding on Kickstarter or Indiegogo had secured angel 

financing within six months of closing their crowdfunding campaign. 

These findings indicate that angels and venture capital groups may look to 

entrepreneurs to prove their ability to execute and fundraise from the crowd prior 

to investing. Doing so may de-risk their investment if they can see an entrepreneur 

has traction from the crowd. 
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Crowdfunding is More than Money-Product Validation, Market Insight and 

Strategy 

During our interviews we attempted to determine how success with crowdfunding 

affected business plans, strategy and operations. We used a Likert scale to collect 

responses from companies on the degree to which crowdfunding success had 

impacted their marketing plans, business plans and plans for future financing. 

The most significant impact of crowdfunding was on marketing planning (mean of 

5.6 on 1-10 scale). Firms reported being made aware of new market opportunities, 

learning which product features resonated with funders, and gaining new insights 

into competitive products or consumer demand. Many firms that had exceeded 

their funding goals scrapped their marketing plans and created entirely new 

marketing plans based on their successful crowd funding round. 

Strategy was nearly as significantly impacted as marketing-with a mean of 4.7 on a 

scale of I-to-l O. There was a wide variation across firms but responses and 

interviews suggested that the interaction with the crowd led the founders to reevaluate their products and go-to-market strategy. 

Financing plans shifted dramatically with successful crowdfunding. Given the fact 

that these firms had either not attempted professional financing, or had been 

rejected by institutional investors, it is not surprising that many firms had not 
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considered future funding from professional investors. Many of the firms that had 

raised funds from debt and equity-based platforms reported having less interest in 

bringing institutional investors on board-essentially an attitude that "I may be able 

to go it alone", or a plan to fund growth from operations. 

Firms with success in pledge- and donation-based crowdfunding often expressed 

surprise at the degree of interest from angels or venture capital. Opinions and plans 

varied dramatically but two themes emerged: first, a sense of confidence-these 

owners believed they could raise money from private investors if they wished; and 

second, a sense of skepticism, that they were not as motivated to accept the first 

offer, that their belief in their product/service had been bolstered by their success 

with crowdfunding and that they felt they had more bargaining power in 

interactions with investors. 

Success Building on Success 

While a relatively small survey, this study shows that crowdfunding has significant 

impacts on strategy, finance, job creation and business finance, and also in how 

founders perceive themselves and their products. More research is underway to 

both validate and expand this research. Success with crowdfunding opens the door 
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to new investors and partners, and appears to boost confidence in founders. 

Contrary to expectation, it also leads to interest and investment activity from angel 

and venture capital groups. This suggests that institutional investors see success 

with crowdfunding as a strong indicator of potential success for their early-stage 

firms. 

Equity crowdfunding appears to dramatically accelerate the growth of these earlystage companies suggesting that equity crowdfunding should be considered as one 

of the main mechanisms for economic development and job growth policy 

interventions. When a relatively small investment results in several hundred 

percent growth in revenue and an average of nearly 2.2 new jobs, equity and debtbased crowd funding deserves the serious attention of policy makers. For more 

information visit www.theccagroup.com 
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Appendix 2: 

The UK Alternative Finance Benchmarking Report 

Authors: Liam Collins, Nesta, Richard Swart, University of California, Berkeley and 

Crowdfund Capital Advisors, and Bryan Zhang, University of Cambridge 

Executive Summary 

Alternative finance activities such as crowdfunding, peer-to-peer lending and 

invoice trading have emerged as a significant funding mechanism and source of 

capital in the United Kingdom in recent years. Meeting the capital needs of both 

individuals and businesses, facilitating fundraising activities for civic projects and 

social causes, alternative finance intermediaries have become online marketplaces 

where individuals, rather than institutions, work collaboratively to form capital. As 

the alternative finance market continues to grow significantly in the UK and the 

government looks to regulate the area, this benchmarking report offers a timely 

snapshot of this fledgling and dynamic sector in order to understand its size, growth 

and the fluid development of respective segments. In turn, this report aims to 

inform regulators, briefpolicymakers, update industrial leaders and educate the 

wider public about this growing and important industry. 
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This benchmarking research is a joint project between Nesta, the University of 

Cambridge and the University of California, Berkeley. It represents the first 

intensive, comprehensive and empirical country-level study of an alternative 

finance market anywhere in the world. Primary data gathering was facilitated by a 

questionnaire-based survey, which was able to capture more than 95% of all UKbased alternative finance activities such as crowdfunding, peer-to-peer lending and 

invoice trading. Results were obtained from more than 50 alternative finance 

intermediaries, including almost all members of the United Kingdom Crowdfunding 

Association (UKCFA) and the Peer-to-Peer Finance Association (P2PFA). 

Market size 

This benchmarking survey reveals that the UK alternative finance market grew by 

91 % from £492m in 2012 to £939m in 2013. Accumulatively, the overall market had 

an average growth rate of75.1 % over the last three years and contributed £1.74b of 

personal, business and charitable financing to the British economy. While the peerto-peer charitable fundraising and donation-based crowdfunding still represents the 

largest segment with £310m in 2013, the vitality and diversity of the alternative 

market is on full display. This includes peer-to-peer lending, which takes in nearly 

£287m in 2013, peer-to-business lending achieving a notable £193m, invoice 

trading platforms recording £97m, equity crowdfunding registering £28m, and 

reward-based crowdfunding attaining a further £20.5m. 
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Market growth 

Perhaps even more impressive than their already considerable transaction volumes, 

their accumulative and year-on-year growth rates are high. Equity-based 

crowdfunding grew 618% from 2012 to 2013, peer-to-business lending grew 211 % 

in the same period, while peer-to-peer grew 126%, reward-based crowdfunding 

grew 387%, invoice trading grew 167% and debt-based securities grew 170%. 

SME finance and future projection 

Collectively, the UK alternative finance market provided £463m worth of earlystage, growth and working capital to over 5,000 start-ups and SMEs in the UK 

during the period 2011-13, of which £332m was accumulated in 2013 alone. Based 

on the average growth rates of between 2011 and 2013, we can cautiously predict 

that the UK alternative finance market will grow to £1.6b next year and provide 

£840m worth of business finance for start-ups and SMEs in 2014. 

Introduction: Research Rationale, Objectives and Methodology 

The UK alternative finance market has witnessed unprecedented development, 

unparalleled innovation and unmatched growth in the years since the global 

financial crisis. As commercial banks restrict business lending and venture capital 

industries scale back on investment, a new brand of innovative, decentralized and 

potentially disruptive online financial intermediaries are burgeoning in Britain. 

From equity-based crowdfunding to peer-to-peer lending, from invoice trading to 
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reward-based crowdfunding, these alternative finance providers are supplying 

credit to SMEs, providing early-stage investments to start-ups, stimulating regional 

economies and funding worthwhile causes. The UK Government has actively 

encouraged the growth of the alternative finance sector by direct capital investment 

through the Business Finance Partnership, and the Financial Conduct Authority (the 

FCA) is currently publicly consulting on forthcoming regulation in the area. 

However, little information is presently available regarding the overall size of the 

alternative finance market or the growth of the crowdfunding, peer-to-peer and 

invoice trading transaction volumes in the UK. While there has been some industry 

reporting by for-profit organisations on crowdfunding, no independent, reliable and 

systematic academic research exists to scientifically benchmark the British 

alternative finance market. It is imperative, particularly at this early stage of the 

market development, to gather comprehensive information to briefpolicymakers, 

inform regulators and update industrial associations and other key stakeholders in 

alternative finance. It is in this context that UC Berkeley, which has the world's first 

dedicated research programme for entrepreneuriai and social finance, has 

collaborated with Nesta and Cambridge University to collect and analyse aggregatelevel data for the UK alternative finance market and produce this benchmarking 

report. 

Research Strategy and Source of Data 
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To ensure the consistency, rigour and validity of this benchmarking exercise, this 

research collected aggregate-level market data directly from alternative finance 

intermediaries via a secure web-based questionnaire. Leveraging existing research 

relationships and industry contacts, the benchmarking survey aimed to capture over 

95% of all online alternative financing activities in the UK from crowdfunding, peerto-peer lending to invoice trading. As a country-specific study, we specifically 

focused on alternative finance intermediaries that are facilitating funding for UK 

individuals and businesses. Therefore, our survey sample consists of both British 

intermediaries and some of the international platforms that have significant activity 

in the UK. The primary data submitted by individual intermediaries were then 

analysed and aggregated to provide in-depth analYSis in order to produce a 

comprehensive benchmark report. In the very few cases where primary data was 

not obtainable through survey, secondary data such as public information, annual 

reports and press releases were utilised to provide the best estimations. 

As this benchmarking research is aimed at collecting aggregate-level market data, all 

individual alternative finance intermediaries were anonymised and all identifying 

information was stripped from the analytical process. Therefore, no individual or 

particular survey participants are identified in this final report. The questionnairebased survey itself was securely hosted on a dedicated account accessible only to 

the core research team. Commercial exploitation of the data is strictly prohibited. 

Research Schedule and Survey Participants 
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The joint Berkeley-Nesta-Cambridge UK Alternative Finance Benchmarking Survey 

opened on 25 November and closed on 5 December. Results were obtained from 

more than 50 alternative finance intermediaries, including almost all members of 

the United Kingdom Crowdfunding Association (UKCFA) and every member of the 

Peer-to-Peer Finance Association (P2PFA). Judging by the quality and breadth of the 

data collected, the research team is confident that more than 95% of all online 

alternative finance activities in the UK were captured through the benchmarking 

exercise. 

Data Cleaning and Data Analysis 

All primary data was exported into an Excel spreadsheet and all intermediary 

identifying and/or confidential information was stripped from the cleaned data set. 

Based on the preferences registered by participating intermediaries, a working 

taxonomy for different segments and models of the alternative finance market was 

constructed. As a result, donation-based crowdfunding and/or peer-to-peer 

fund raising are now one category. Peer-to-peer lending and peer-to-business 

lending are now two separate models to reflect their distinctive lending functions 

and mechanisms. Invoice trading is classified as a stand-alone model, whilst 

microfinance and community shares are merged together. The other models of 

alternative finance are identified as reward-based crowdfunding, revenue/profit 

sharing crowdfunding, equity-based crowdfunding and debt-based securities, which 

all have their characteristic mechanisms, dynamics, as well as risk profiles. 

Hybridised crowdfunding activities, which leverage more than one type of 
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alternative finance model (e.g. reward and equity), were broken down and added 

separately to the above-mentioned categories. 

From the aggregated data of each alternative finance model, th~ accumulative 

transaction volumes as well as average yearly growth rates were derived for the last 

three years. The 2013 figures were predicted by each participating intermediary 

based on the trading statistics to date, captured during the survey window (25 

November-5 December) and the expected volumes for the reminder of the year. The 

total alternative finance for Small and Medium Enterprises (SMEs) in the UK were 

obtained by aggregating the empirical data from peer-to-business lending, equitybased crowdfunding, invoice trading, debt-based securities and estimated data 

(through manual and theoretical sampling) on reward-based crowdfunding. The 

total number of SMEs that raised alternative finance was derived by the same 

method, except that figures from reward crowdfunding platforms were excluded to 

research a conservative, but perhaps statistically more reliable estimation. 

The data for the number of total ventures (including all fundraising ventures for 

personal finance, business finance, social causes and project-based campaigns) and 

for the number of active investors (including donors, backers or lenders) are 

gathered directly from the survey entries provided by participating intermediaries. 

Therefore, these figures are likely to be overestimated and inevitably involve double 

counting. However, as a snapshot of the UK alternative finance industry, these 
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statistics are still valuable in highlighting the depth of the market and the breadth of 

people's participation in this important economic sector. 

The Size and Growth of the UK Alternative Finance Market 

In recent years, the UK alternative finance market has more than tripled from 

£309m in 2011 to £939m in 2013. Accumulatively, the alternative finance sector has 

delivered funding of £1. 74b to UK individuals and businesses in the last three years. 

Discounting the donation-based crowdfunding and peer-to-peer fundraising for 

charitable causes, the UK alternative finance industry still contributed over £955m 

worth of personal and business finance to the British economy from 2011 to 2013. 

In 2013, all sectors of the UK alternative finance market recorded considerable 

growth and rapid expansion. These market sectors are identified by their alternative 

finance models, which are summarised and contrasted in the table below. The 

figures on the right-hand column provide a useful snapshot ofthe latest market data 

for these sectors in 2013. 

Donation-based No legally binding financial (2013) 

crowdfunding/Peer-to- obligation incurred by recipient to 

peer online fundraising donor; no financial or material £310m 
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returns are expected by the donor 

Peer-to-peerlending Debt·based transaCtions between 

individuals; mostly are unsecured 

personal loans. £287m 

Peer-to-business lending Debt-based transactions between 

individuals and existing businesses £193m 

which are mostly SMEs 

Invoice trading Firms sell their invoices or 

receivables to a pool of individual £97m 

or institutional investors 

r~~~~~--·------~~~-------------·-----+------------1 Equity-based Sale of registered security by 

crowdfunding mostly early stage firms to £28m 

investors 

Reward-based DOl1.orshave an expectation that 

crowdfunding recIpients will provide atangible 

(but non~financial)reward or £20.5m 

product in exchange fortheir 

contribution 

Debt securities Lenders receive a noncollatcralised debt obligation 

typically paid back over an £2.7m 
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extended period of time. Similar in 

structure to purchasing a bond, 

with different rights and 

obligations 

RevenuejPro~tsharlng Issuers incur an obligation to repay 

lenders, but these payments are 

variable and a function of the £l.Sm 

revenues or profits ofthe firm 

MicrofinancejCommunity Microfinance refers to the lending 

Shares of small sums to entrepreneurs 

who are often economically £O.8m 

disadvantaged and financially 

marginalised. There is a debt 

obligation incurred, but the 

amounts lent are very small. 

Community shares refer to the sale 

of shares in social enterprises 

serving a community purpose in a 

particular locality. 

The Diversity ofthe UK Alternative Finance Market 
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As the diagram below illustrates, perhaps the most encouraging indicator of the UK 

alternative finance market is its strong and diversified growth in a wide array of 

models across the board during the period 2011-2013. 

The donation sector, which consists of donation-based crowdfunding and peer-topeer online fundraising activities, remains the largest sector in the market with 

£785m funding raised through it in the last three years. This more established 

sector has shown a relatively steady growth of about 20% year on year in contrast 

to some of the other more recent models. 

For instance, both peer-to-peer lending and peer-to-business lending models 

have developed rapidly in recent years and funded £482m and £276m respectively 

over the last two years. This sector has significantly outperformed the interest rates 

available to investors with a relatively low-risk profile. The peer-to-business lending 

sector is more than doubling each year and the UK is the undisputable world leader 

of this alternative financing model. The peer-to-business lending intermediaries 

allow SMEs to receive loans from a pool of online investors in a very short period of 

time by bypassing the most complicated bank lending processes. For many firms, 

the speed with which they are able to obtain funding, often in a matter of days, 

makes this model significantly more attractive than traditional banking) The default 

rates on peer-to-business loans are also often less than that experienced by 
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commercial banks, demonstrating the ability of a crowd of investors to select and 

fund quality firms. 

Invoice trading is another relatively nascent, but no less innovative, alternative 

finance model that is burgeoning in the UK. Invoice trading intermediaries enable 

SM Es to sell their invoices or receivables to many individual or institutional 

investors and, in turn, effectively drive down the cost of funding. This sector has 

raised £137m in finance for businesses in the three years from 2011 to 2013 with an 

annualised growth rate of 487%. 

Equity-based crowdfunding grew by more than 600% between 2012 and 2013, 

from just under £4m in 2012 to slightly over £28m in 2013. This is consistent with 

the rise of equity-based activities in Western Europe and elsewher:e. Data reported 

in the World Bank report on Crowdfunding shows that, in the past three years, some 

form of equity crowdfunding has emerged in 27 nations around the world. Given the 

rapid expansion of crowdfunding markets internationally, particularly in the USA 

after the recent implementation of Title II of the JOBS Act, it is expected that equitybased crowdfunding will grow significantly over the next few years, depending on 

the policy decisions and the evolvement of the regulatory framework in the UK. Data 

reported by Paul Niderer, CEO of the Australia Small Scale Offering Board (ASSOB), 

shows that, over the past seven years of equity crowdfunding in Australia, 83% of 

funded firms are still in operation, significantly outperforming comparable firms 

who were financed using traditional means. Whilst the Australian ASSOB market 
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has structural differences from the UK, it is nonetheless encouraging to see high 

survival rates among firms raising funds through equity crowdfunding. 

Rewards-based crowdfunding is also showing explosive growth, with a growth 

rate of more than 370% year-on-year and funding £2S.6m in the last three years. 

This sector represents a significant area of growth potential as start-ups and SMEs, 

rather than just individuals, can leverage this model to conduct early marketing 

testing and pre-sell inventory, thus shortening product development time, 

demonstrating market validation and acquiring social proof. Many firms that have 

utilised reward crowdfunding can go on to approach institutional investors or 

participate in equity crowdfunding markets once they have demonstrated their 

capability. Profit/revenue sharing crowdfunding totalled £1.6m from 2011 to 

2013 and is potentially a high-growth sector, particularly for gaming development, 

music, books and other forms of entertainment ventures. 

Debt-based securities, which is an alternative finance model that offers long-term 

investment spanning normally 20-25 years, has also recorded an impressive 

accumulative growth rate of 170% in the last three years, reaching £3.7m. This 

investment model is often associated with renewable energy projects that offer a 

very low-risk-profile and make fixed-term interest payments (plus part of the 

principal) to investors every year. Microfinance and community shares financing 

by individuals or businesses in the UK is still a relatively niche activity. Looking 

forward, both have demonstrable growth potential to offer hyper-local and 
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community-based alternative funding solutions leveraging people's social and 

geographical affinities. 

The Vitality of the Alternative Finance Market for SMEs in the UK 

There is strong evidence to suggest that the alternative finance sector is already a 

meaningful and effective source of funding for SMEs in the UK. In 2011, online 

alternative finance intermediaries provided only £26.7m worth offinance to British 

SMEs. By 2013, from peer-to-business lending to equity-based crowdfunding, from 

invoice trading to revenue/profit-sharing crowdfunding, the alternative finance 

market has supplied £332m to SMEs in the UK - a more than 12-fold increase in just 

three years. Bya rather conservative estimation, without including reward 

crowd funding, more than 5,000 SMEs have utilised these alternative financing 

mechanisms in the UK between 2011 and 2013. 

On the whole, the alternative financing activities for SMEs have been growing at an 

average rate of 254% per year total finance raised since 2011. The number of firms 

participating in these markets has also been growing by an average of 139% in the 

same period. The difference between these growth rates demonstrates that firms 

have been able to raise more significant sums of money through alternative 

financing over time. 
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This significant growth in alternative finance for SMEs reflects broader national and 

international socio-economic trends. First, the global financial crisis forced many 

older adults to start companies in order to protect their retirement accounts or 

supplement their income. This trend of well-connected, well-networked adults 

starting firms in mid-life or later is a relatively new development. But, these older 

entrepreneurs often enjoy significant social networks, which they can leverage to 

finance new ventures via alternative means, an advantage recent college graduates 

usually lack. Data from the Global Entrepreneurship Monitor illustrates this trend 

and identifies a significant increase in entrepreneurial activity in the UK since 

2009.ii 

Second, in many countries, financial reforms have been instituted which, whilst 

stabilising banking and reducing risk profiles, also had the effect of limiting access 

to capital for entrepreneurs - many of whom do not have the collateral or credit 

scores necessary to secure bank financing. Eurostat data indicates that, in the UK, 

and across Europe more broadly, rejection rates for SMEs applying for loans 

increased significantly in the wake of the financial crisis.i1i 

Third, there are significant barriers that prevent many entrepreneurs from 

accessing capital based on gender, race or other non-business factors.iv Empirical 

data demonstrates that investors prefer to invest in companies that match their 

profiles - in terms of race, gender and socio-economic status. For example, in the 

United States, investors from elite venture capital firms show a strong preference to 
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invest in companies where the founders graduated from a very small set of elite 

private universities - usually preferring to invest in fellow alumni. The unintended 

effect of this homophily is that entrepreneurs who do not enjoy access to these 

networks of investors based on shared characteristics are often locked out of angel 

investing and venture capital markets. Alternative finance can be successfully 

utilised by women, minorities and other financially marginalised entrepreneurs, 

where its funding mechanisms are often more democratic and less biased. In fact, 

women entrepreneurs are found to be starting firms in significant numbers on 

alternative finance intermediariesv and they are at least as effective as men at being 

successful in meeting crowdfunding targets. 

Fourth, the widespread application of social media and web-based financial 

tranasctions has enabled entrepreneurs to seek funding directly and effective from 

their online communities and through their social relationships. Data from the 

Wharton Business School vi shows that at times 81 % of investors or donors in 

crowd funding are connected to the founders of the fundraising firm at the first or 

second degree of separation. Thus, entrepreneurs can essentially monetise their 

web of relationships, whether from existing customers or social media connections, 

to raise money directly for growth SMEs or start-ups. This monetisation of social 

networks could not have occurred without the ubiquitous presence of social media, 

coupled with the growing trust in online commerce models. The rapid growth of 

alternative finance for SMEs in the UK is a function of all of these socio-economic 
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trends and an indicator of evolving forms of entrepreneurship and enterprise in the 

digital era. 

The Power of People and the Potential of Alternative Finance 

The socio-economic foundation of alternative finance is built upon financial 

disintermediation, direct interaction and exchange between individuals without the 

need for orthodox institutions. Therefore, more than purely financial transaction 

volumes or growth trends, the breadth and depth of individuals and communities' 

engagement in this sector is fundamental to the health and sustainability of the 

alternative finance industry. 

Number of ventures funded 

In 2013, over 647,000 projects, individual or business financing campaigns were 

fully funded through alternative finance intermediaries. In 2011 and 2012, the , 

figures were just over 448,000 and 503,000 respectively, representing a steady, 

sustainable and sizable increase of 20.4% per year. Although, in actuality, these 

figures will tend to be smaller due to potential issues of doubt counting, they still 

reflect the scale and depth of a vibrant, dynamic and growing alternative finance 

sector. 

Number of new funders 

As with most social networking or social-based mechanisms, there are digital 

divides based on computer literacy, access to the Internet/Mobile technology, and 
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comfort with web-based financial transactions. Despite these well-documented 

barriers, the UK alternative finance intermediaries have attracted and sustained 

more than 9.4m active donors, backers and investors on their platforms in 2013. 

The figures for 2011 and 2012 are 6.35m and 7.69m respectively, realizing a healthy 

and steady increase of 21.5% per year. Again, these figures will be overestimated in 

the survey, as many investors, backers and donors will likely be double counted if 

they contribute funds through more than one alternative finance intermediary in 

the UK. Nevertheless, the number of people and their level of engagement with 

alternative finance activities are definitely on the rise in Britain. 

According to the benchmarking survey, most of these backers, investors and donors 

would also have participated in mostly donation and rewards-based crowdfunding 

and peer-to-peer fund raising activities. However, there is also now a sizable 

investor community for peer-to-peer, peer-to-business lending, equity-based 

crowdfunding and other forms of alternative financing activities. Collectively, they 

represent a major social movement towards an alternative paradigm of funding 

mechanisms, as well as a significant source of systematic disruption in the evolving 

financing system. 

Growth looking forward 

While one cannot make any specific predictions of growth rates based on the early 

years of a nascent industry propelled by disruptive technology, evidence from the 

rise of social media, e-commence, mobile technology and the rise of innovative 
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entrepreneurship suggests that alternative finance in the UK will likely grow to be a 

several billion-pound-a-year market within the next 3-5 years. From the 

benchmarking data to date and the global growth context, it is almost certain that 

Britain will continue to experience substantial growth in the number of campaigns, 

intermediaries, individual borrowers and lenders, and also in the total capital raised 

to fund businesses through alternative means. Based on the average growth rates of 

between 2011 and 2013, we can cautiously predict that the UK alternative finance 

market will grow to £1.6b next year and provide £840m worth of business finance 

for start-ups and SMEs in 2014. 

Endnotes: 

I ht!;p:/Iwww.nesta.org.uk/sites/defaultlfiles/banking on each other.pdf 

II htt;p:/Iwww.gernconsortiurn.org/visualizations 

iii http·l!www.nesta.org.uk/sites/gefalJltlfiles/bankjng on each other.pdf 

iv Ola Bengtsson and David H. Hsu, "Ethnic Matching in the U.S. Venture Capital" under 2nd round review 

at Journal of Business Venturing. 

v See, e.g., GENDER DYNAMICS IN CROWDFUNDING: EVIDENCE ON ENTREPRENEURS, 

INVESTORS, AND DEALS FROM KICKSTARTER, Marorn, Robb, Sade (2013). 

http://www.funginstitute.berkeley.edulsitesldefaultlfiles/Gender''1020Dynamics%20in%20Crowdfunding.pd 

f) 

vi The Dynamics of Crowd funding: An Exploratory Study, Ethan R. Mollick, University of Pennsylvania -

Wharton School, June 26, 2013, Journal of Business Venturing, Volume 29, Issue 1, January 2014, Pages 

1-16. 
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WRITTEN TESTIMONY OF 

DANIEL S. GORFINE 

DIRECTOR, FINANCIAL MARKETS POLICY 

MILKEN INSTITUTE 

BEFORE THE 

SUBCOMMITTEE ON INVESTIGATIONS, OVERSIGHT AND REGULATIONS 

COMMITTEE ON SMALL BUSINESS 

U.S. HOUSE OF REPRESENTATIVES 

"SEC'S CROWDFUNDING PROPOSAL: WILL IT WORK FOR SMALL BUSINESSES?" 

JANUARY 16,2014 

Swnmary: The Jumpstart Our Business Startups Act (the JOBS Act) employs a holistic approach to promote 

an enhanced and well-functioning capital-access pipeline for American businesses at each stage of their 

development. To fulfill this objective for startups and small businesses, the SEC - subject to the constraint of 

specific requirements set forth by Title III of the law - should foster the development of "crowd investing" by 

minimizing costs and constraints associated with this new capital-raising tool, while simultaneously limiting 

downside risk to investors through an emphasis on investor caps. This approach will allow for the evolution of 

this market innovation and the related opportunity to assess its central hypothesis: that in an interconnected 

Internet-centric world there is "wisdom in the crowd." 

Chairman Schweikert, Ranking Member Clarke, and members of the committee, thank you for the opportunity 

to testifY on implementation of Title III of the Jumpstart Our Business Startups Act (the JOBS Act) or the 

"crowd investing"') provisions. 

The ultimate goal of crowd investing is to responsibly increase capital access for startups and small businesses, 

particularly within industry sectors or geographic regions that are disfavored by traditional sources of capital. 

In proposing Title III rules, the SEC has largely used its discretion to positively advance that goal and the 

development ofa crowd investing market,' especially given the novelty of this capital-raising mechanism, the 

constraints imposed by the law itself. and the risk investors face when investing in startup companies. 

It is an open question, however, whether this new capital-raising tool will significantly increase capital 

formation for startups and small businesses. Investors will need to consider whether the risk/reward dynamics 

are sufficiently compelling, and whether other non-financial factors, such as personal interest/affinity,3 are a 

sufficient draw. For issuers and intermediaries, there are concerns that Title Ill's statutory requirements 

I In order to differentiate non-financial-return "crowdfunding" (or the donation and rewards model) and the financial-return model envisioned by 

Title III of the JOBS Act, I will use the term "crowd investing" when referring to the capital-raising model created by the law. 

l For example, there are numerous instances where the SEC uses its discretion to allow for greater participation by the crowd in this new market, 

and permits broad activities by platform intermediaries, Where there was ambiguity in interpretation of the statutory investor caps, the SEC 

proposed an interpretation that would allow investors to invest up to the greater cap limit suggested by the law. See Proposed Rule: 

Crowdfunding; Release No. 34-70741; File No. S7-09-13 (hereinafter "'Proposal Release"), at 24; Proposed 17 CFR § 227.100. And, the SEC 

proposes the creation of a fairly broad safe harbor of acceptable funding portal activities in order to enhance the utility of these portals, See id. at 

228·229; Proposed 17 CFR § 227.402. 

3 See Elizabeth M. Gerber, Julie S, Hui, and Pei-Yi Kuo, "Crowdfunding: Why People Are Motivated to Post and Fund Projects on Crowdfunding 

Platforms," Northwestern University, Creative Action Lab (2012), available at htto:Uwww.juliehulorg/\lrocontentJupJoads!2013/04/CSCW Crowdfunding Final.pdf(noting that funders of crowdfunding projects seek rewards, support creators and 

causes with similar values, and enjoy engaging with and contributing to a creative community). 
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coupled with the SEC's use of its discretion to propose additional requirements, constraints, or potential 

liability exposure may at times result in the cost exceeding the benefit of this capital-raising tool. 

Additionally, in a few cases, the SEC's proposed rules may inadvertently reduce investor protection by 

limiting what information platforms can share with investors or how they curate offerings, and not fully reflect 

the crowd-vetting dynamic that makes this innovation unique. 

Accordingly, I discuss below the potential impact of the proposed rules, and offer implementation suggestions 

that emphasize investor caps in order to limit downside risk, while decreasing overall regulatory costs and 

burdens in order to permit the marketplace time and space to develop new. methods of vetting investment 

opportunities. 

Key Regulatory Objectives 

In proposing rules implementing Title III of the JOBS Act, the SEC makes two critical observations which 

inform my testimony: first, "[t]he crowdfunding provisions of the JOBS Act were designed to help provide 

startups and small businesses with capital by making relatively low dollar offerings of securities less costly"; 

and second, "[i]ndividuals interested in the crowdfunding campaign - members of the 'crowd' - may share 

information about the project, cause, idea or business with each other and use the information to decide 

whether or not to fund the campaign based on the collective 'wisdom of the crowd. ",4 

Two principles emerge from the SEC's observations that should guide implementation of Title III. The first 

principle is the need to ensure that legal and regulatory compliance costs are properly calibrated relative to the 

sums being raised. If the overall costs to crowd-investing issuers and intermediaries are too great relative to 

the fundraising limit of$l million (and the likely lower amounts many issuers will seek to raise), then crowd 

investing will not be an economically viable capital-raising mechanism. 

Related to the issue of economic viability, it is important to view the various capital-raising tools in the JOBS 

Act holistically to ensure that each helps to foster a seamless capital access pipeline for a business along its 

various stages of development. The law appears to intend that a startup or small business might utilize Title III 

for a relatively small capital raise, and then graduate to a Title IV (Regulation A+) raise at a later stage of 

development. For this to happen, however, the costs and benefits of each capital-raising mechanism must be 

calibrated along a sliding scale, with the Title III requirements less onerous relative to Title IV in order to 

render crowd investing an attractive option for startups and small businesses. 

The second principle begins to capture the essence of what makes the crowd-investing innovation unique: 

namely the use of the Internet to connect individuals with each other and online sources of information in order 

to perform a novel form of due diligence on securities issuers. As the SEC notes, the communication channels 

afforded by the Internet (and proposed to be required on investment platforms) "should provide transparency 

and accountability, and thereby further the protection of investors."s This tenant of the crowd investing 

innovation differentiates it from traditional investment approaches, and this entire ecosystem requires space to 

develop new modes of vetting investment opportunities. 

Observations and Recommendations 

The following are observations regarding the potential impact of certain proposed rules, as well as 

recommendations drawn from the principles discussed above that would arguably promote the development of 

crowd investing for startups and small businesses, while limiting the downside risk to investors. 

4 Proposal Release at 6·7 (italics added), See also id. at 176-179. 

'Id. at 177. 

2 
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A. The Best Way to Limit Downside Risk is Through an Emphasis on Investor Caps. 

Investing in startups and small businesses is an inherently risky enterprise. The SEC in its proposing release 

highlights a number of sobering studies, including one from the Kauffinan Foundation in 20 I 0 that found that 

out of 4,022 hi-tech startups founded in 2004, nearly one-third had failed by 2008: Research also finds that 

venture-capital-backed companies may not fare much better, despite the involvement of professional 

investors.7 

The reason for relatively high failure rates amongst startups and small businesses should be obvious to 

investors: whether it be untested management teams or products, unexpected competition, or simply bad luck, 

there are numerous obstacles that must be overcome by a company to ensure success. The volatility, 

uncertainty, and unpredictability of early-stage companies lead many professional investors to focus on the 

promise of business concepts and ideas, as well as the capability of a management team, while potentially deemphasizing the importance of revenue projections. Indeed, two well-known venture capital investors note 

that "[tlhe only thing that we know about financial predictions of startups is that 100 percent of them are 

wrong."s 

Given the inherent riskiness of startup or small-business investing, the best way to limit downside risk to 

investors is through an admittedly paternalistic emphasis on investor caps - at least until the crowdfunding 

innovation has a chance to develop and demonstrate its ability to, on a relative basis, effectively vet investtnent 

opportunities. I am cautiously optimistic that crowd investing will demonstrate this ability based on results 

from overseas where crowd investing is already 'live,' and a discerning crowd has backed a relatively limited 

number of offerings largely from known management teams with known products and businesses.9 

With respect to investor caps, the current proposed SEC rules envision an investor self-certification mechanism 

whereby issuers will be able to rely on the affirmative representations of the investors. This approach properly 

imposes responsibility for compliance on the investors, but should include requirements on the intermediary 

platforms to flag for investors the importance of compliance. More specifically, investors must be made aware 

that compliance with the investor cap is not optional (or simply a requirement that can be igoored), but is both 

required by law and intended to protect them from the potential downside risk of early-stage investing. To this 

end, intermediaries should be required to provide a detailed statement regarding the parameters and importance 

of the investor caps to investors before accepting an investtnent commitment. Additionally, the SEC should 

consider precluding an investor who violates the investor caps from bringing a cause of action against an issuer 

under Section 4A( c ).10 

Ultimately, emphasizing compliance (and penalizing non-compliance) with investor caps is the best way to 

limit downside risk. As discussed in the next section, once the downside risk is capped, rather than requiring 

;; Id. at 334 (citing Alicia Robb, E.J. Reedy. Janice Ballou, David DesRoches, Frank Potter and Zhanyun Zhao, An Overview of the Kauffinan 

Firm Survey: Results from the 2004-2008 Data, Kauffman Foundation, available at 

http://www.kauffinan,orgluploadedFileslkfs_201 0 _report. pdt). 

7 ld. at 334-35. Indeed, because early-stage investing is so risky. most professional investors pursue a fund approach whereby they invest ina 

large universe of companies with the expectation that many will fail and the hope that the few successes will more than compensate for those 

failures. For this reason, I would encourage lawmakers and regulators to consider ways to facilitate retail investor participation in funds that 

invest in startup companies. 

S Brad Feld and Jason Mendelson, Venture Deals: Be Smarter Than Your Lamer and Venture Capitalist 21(2d ed. 2013). 

9 See Art Patnaude, 'Crowd funding' Takes Hold in the UK., Wall St. J., Mar. 27, 2013, available at 

http://online.wsj,com/ne'W'SIarticles/SB100014241278873247895045783&45722033Q5456 (detailing the crowdfunding success of an existing UK 

food company that raised funds through Crowdcube when it already had products available in store); see also JD Alois, 'Top Ten Equity 

CrtJWdjimding Offerings on Crowdcube, Crowdfundinsider.com, Aug. 8,2013, available at httpRWVtIWcrowdfundinsider.comI2013/08120248-

tqp·ten-equity-crowdfunding-ot)-'erings:on-egujty-crowdfunding~site:crowdcubel (demonstrating that a number of the largest equity raises on the 

UK pJatfonn Crowdcube have been by existing companies, which increases the chance for investors to develop familiarity with the management 

team, products, or services before choosing to invest). 

10 Though perhaps not necessary, other 'Ways to emphasize or strengthen enforcement of the caps include requiring investor certification under 

penalty of perjury. Alternatively, the SEC could incentivize platforms to limit pennitted investment totals per individual below the statutory cap 

or create a shared industry central database with investor investment data, by linking such practice with a safe harbor that exempts a platfonn 

from liability for an issuer's misstatement or omission ofa material fact (absent gross negligence). 

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additional traditional disclosures that will add cost with potentially little marginal benefit to investor 

protection, the SEC should focus on promoting the development of crowd-driven methods of vetting 

investment offerings. 

B. The SEC Should Minimize Non-Statutory Disclosure Requirements in Order to Decrease Costs and 

Allow the Development of Crowd-Driven Vetting Mechanisms and Criteria. 

Title III includes a number of statutory issuer disclosure requirements that reflect a minimized version of 

traditional Regulation A or public offering registration statements. There is little doubt that certain baseline 

issuer disclosures are necessary for investors to make sound investment decisions, and that well-prepared 

disclosures may provide a signal to the crowd about the competence and credibility of an issuer and its 

management team. The difficulty is in determining the right balance of required disclosures that materially 

assist investors but that do not add undue cost and burden to issuers. 

As highlighted in the second principle above, it is likely that crowd-investors will determine new criteria and 

methods for vetting offerings, and it is unclear how much they will rely on traditional, and oftentimes 

boilerplate, disclosures. The SEC properly expects that the crowd will use communication channels on 

platforms to share thoughts about an offering and ask specific questions of the issuer. I would also expect that 

the crowd will use tools outside of investment platforms, including social-networking sites and company 

websites to learn more about an issuer's management team and business, or choose to invest in companies in 

which the investor has familiarity. As we have seen from overseas examples, the maxim "invest in what you 

know" is likely to guide many crowd-investors. 

With respect to the SEC proposed rules, there are a number of additional proposed disclosures that go beyond 

those required by statute. II While each one - in and of itself - appears reasonable and intended to provide 

investors with more information, there are two potential unintended effects. The first is that in aggregate, 

together with the statutory disclosure requirements, and a substantial ongoing annual filing requirement 

regardless of the size of the offering, the overall disclosure and compliance burden for issuers begins to look 

significant, especially in light of the relatively small sums of capital that can be raised under Title III.12 This 

burden violates our first principle above and could appreciably limit the participation of issuers seeking small 

sums of money (for example, less than $100,000).13 Given the potentially small marginal benefit to investors 

of requiring startup issuers to provide traditional disclosures required of more mature companies, the additional 

costs of more disclosure (and significant ongoing reporting) may not be justified. 

A second concern is that too many requirements will inadvertently give unsophisticated investors an artificial 

sense of comfort with an offering (especially given the likelihood that the plans of an early-stage issuer will 

change or that projections will prove wrong), and may blunt the development of crowd-driven investment 

methods and criteria. Unlike a Reg A filing or a formal public offering registration, Form C will not be 

reviewed and approved by the SEC, and accordingly should not give investors a false sense that the offering is 

11 See Proposal Release at 58-65; Proposed 17 CFR § 227201 

12 See Gibson Dunn Client Memorandum, SEC Proposes Rules To Implement Crowdfunding Exemption: What Factors Will Affect/Is Success?, 

Nov. 11,2013, at 4, available at httn:l/www.gibsondunn comlpubiicationslpageslSEC-Proposes~Rules-tO:Implement~Crowdfunding-ExemptionWhat-Factors-Will-Affect-Its-Success.aspx (noting that while the SEC's proposed additional disclosures "may be advisable for the protection of 

investors, they meaningfully increase the disclosure burden on crowdfunding issuers"); Davis Polk Client Memorandum, SEC Proposes Rules/or 

Crowdfunding Intermediaries, Nov. 18,2013, at 1, available at 

http'/Iwwwdavispolkcomisitesfdefault/fileslJ I 18.13.SEC .Proposes Rules .Crowdfunding.Intermediaries.pdf("While the crowdfunding 

exemption under the JOBS Act was intended to make it less costly for small businesses to raise relatively small amounts of capital, the statutory 

requirements and Proposed SEC Rules would condition the Securities Act exemption on compliance by issuers and intermediaries with a 

significant number of potentially costly regulatory obligations [leading some to question] whether the benefits of raising capital through 

crowd funding or acting as a crowdfunding intermediary would be great enough to justity the compliance costs and potential liability risks,"). 

1J The investment platform SeedInvest has created a useful spreadsheet tool that can be used to project/estimate the anticipated cost to an issuer of 

a Title III capital raise over a period of time. See http://www.seedinvest.comlblog1crowdsourcing~title-iii=crowdfunding-cost~modeV, The 

assumptions can be changed within the spreadsheet. but even applying conservative numbers demonstrates high costs to issuers with questionable 

benefit to investor protection, Given potentially significant costs, even issuers at the higher end of the Title III range may be incentivized to 

postpone an offering until a Reg A or Reg A+ offering makes economic sense given the larger caps on a raise and unrestricted nature of issued 

securities, 

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somehow less risky or not in need of careful vetting. Moreover, the burden may simply be too great on this 

ecosystem if issuers must comply with significant disclosure requirements, and then begin responding to 

crowd-based questions and demands. 

Ultimately, the success of crowd investing hinges on the effectiveness of new vetting methodologies and 

criteria generated through the "wisdom of the crowd." Much like financial innovators are looking at new 

Internet-based methods of assessing an individual's credit-worthiness beyond traditional FICO scores,l4 the 

same can be said for crowd-investors looking at Title III investment opportunities. Beyond baseline 

disclosures as required by Title III, it is not clear that traditional SEC disclosure requirements will do much to 

assist the development of new vetting criteria and methodologies. Accordingly, overall costs would be 

reduced and the space for market development increased if the SEC errs on the side of requiring few, if any, 

incremental disclosures beyond those required by law. 

C. Investor Protection Will Be Enhanced by Enumerating Additional 'Investment Advice' Safe Harbors 

That Allow Platforms to Further Curate and Share Data and Irtformation with Investors. 

It is understandable and prudent that lawmakers do not want investors relying on an intermediary's investment 

advice or recommendations related to offerings available on that platform absent the intermediary being 

registered as an investment adviser or broker/dealer. The issue with implementing this statutory requirement is 

that neither the JOBS Act nor federal securities law define "investment advice," which is typically construed 

broadly by regulators." At its extreme, this ban could require a platform to list all offerings proposed by 

issuers. 

In order to permit platforms some flexibility to decide which offerings they will list, the SEC proposes a safe 

harbor that would permit a platform to filter and select offerings for listing based on objective criteria (for 

example, by geographic region or industry sector).l6 It also recognizes that an overly broad interpretation of 

the investment advice/recommendation ban could -- to the detriment of investor protection - prevent funding 

portals from excluding highly suspicious investment offerings. As a result, the SEC interprets the duty of a 

platform to exclude offerings that could be fraudulent or that raise investor protection fears broadly. 

While this approach is a step in the right direction, the rules nevertheless leave an ambiguous gap where a 

platform could have serious doubts ahout the viability of an offering, but not to the level that it is permitted to 

exclude the offering from its platform. Additionally, as proposed, the SEC's rules may prevent platforms from 

sharing data and information with investors that would assist the development of crowd-based vetting 

methods. Accordingly, the SEC should create the following additional safe harbors or issue guidance enabling 

the following activities. 

Firs!, the SEC should penni! funding portals wider leeway in excluding offerings when an offering technically 

satisfies objective platform criteria and cannot be said specifically to raise concerns of fraud or investor 

protection. It is troubling that the proposals note that "a funding portal ma~ not use criteria based on an 

assessment of the merits or the shortcomings of a particular issuer or offering," 7 especially when, as discussed 

below, the SEC goes on to envision potential intermediary liability for issuer missteps. 

To require a platform to list an offering that it has a strong conviction will fail is contrary to promoting 

investor protection. Instead, portals should have the ability to go further in curating offerings so long as they 

do not advertise or make statements that offerings listed on their platform are somehow safer or better than 

other platforms. If the market determines based on results that certain platforms are indeed yielding better 

investment outcomes, then I see little (if any) harm and only benefit to investors. 

14 See Katie Lobosco, Facebookfriends could change your credit score. CNNMoney, Aug. 27,2011, available at 

http://money.cnn.comI2013/08126Itechnoiogy/sociallfacebook,cfedit·score/. 

" See Proposal Release at 227 n. 585; Proposed 17 CFR § 227.402 

"See Proposal Release at 229-231; Proposed 17 CFR § 227.402. 

17 See Proposal Release at 231; Proposed 17 CFR § 227301.and 17 CFR § 221.402. 
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Second, as we have seen with the development of e-commerce platforms, such as eBay and Amazon, there is 

significant opportunity for intermediaries to glean and analyze data about offerings on the platform, develop 

algorithms to detect fraud or issuer best practices, and collect user feedback about transactions, Applied to 

funding portals, these capabilities could enable a platform to share with investors data on crowd investing 

raises and outcomes, information learned about an issuer, or even a crowd-based rating system of specific 

entrepreneurs/issuers. Without further guidance from the SEC, however, there is a risk that such informationsharing might be deemed the provision of impermissible investment advice. 

Finally, the SEC does imply in the proposed rules that a partnership between a registered broker/dealer and 

funding portal could allow a funding portal to go further in providing information to investors. 18 However, the 

parameters of what is allowable here are unclear. For example, the SEC should explicitly state that a funding 

portal is allowed to provide offering ratings from a third-party broker/dealer or credit rating agency on the 

portal website. In this way investors would be provided with important information -- for example, a credit 

rating on a debt security. 

D. AliowingJor Reduced Platform Liability Exposure Will Promote PartiCipation and Decrease Systemic 

Costs. 

While the statute is silent on intermediary liability for potential issuer missteps, the SEC reads the law to 

include for liability purposes an intermediary as "any person who offers or sells the security in such 

offering."J9 This interpretation would likely decrease the number of intermediaries willing to participate in 

this marketplace, as well as increase overall systemic costs due to the risk of litigation. 

As a preliminary matter, it is difficult to reconcile permitting an intermediary to be found liable for an issuer 

misstatement or omission, and not permitting an intermediary to exclude an offering "based on an assessment 

of the merits or the shortcomings" of the offering or its issuer. If intermediaries can be on the hook for the 

missteps of an issuer, then the intermediary should have greater discretion to decide on whether to do business 

with that issuer. 

Given the statutory silence on intermediary liability and the proposed rules limiting curation, it would make for 

sound policy to explicitly exclude intermediaries as being potentially liable for the material misstatements or 

omissions of an issuer, except for instances where the intermediary is grossly negligent. To impose potential 

liability on an intermediary would require increased due diligence into issuers, which would be costly and 

inexact given the early-stage and risky nature of these offerings. Intermediaries would need to pass along the 

cost of such due diligence to issuers, as well as purchase higher levels of insurance. Because the economic 

viability of the funding portal model is already unknown, additional costs on platforms could have a 

detrimental impact on platfonn participation. 

Accordingly, the SEC should reconsider its position on intermediary liability for an issuer misstatement or 

omission. As noted above,'o the SEC could incentivize preferred platform behavior (for example, creating a 

centralized investor database with other platforms) by linking a limitation of liability on platforms with such 

voluntary behavior. 

]g See Proposal Release at 238; Proposed 17 CFR § 227.402. 

19 See Proposal Release at 280, 

2{) See supra note 10. 

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Testimony of Mercer E. Bullard 

President and Founder 

Fund Democracy, Inc. 

and 

MDLA Distinguished Lecturer, Associate Professor of Law, and 

Director, Business Law Institute 

University of Mississippi School of Law 

before the 

Subcommittee on Investigations, Oversight and Regulations 

Committee on Small Business 

United States House of Representatives 

on 

SEC's Crowdfunding Proposal: 

Will it Work for Small Businesses? 

January 16, 2014 
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Chairman Schweikert, Ranking Member Clarke and members of the Committee, thank you 

for the opportunity to appear before you today to discuss the SEC's rule making on 

crowdfunding. It is an honor and a privilege to appear before the Committee today.* 

I am the Founder and President of Fund Democracy, a nonprofit investor advocacy group, 

and a MDLA Distinguished Lecturer, Associate Professor of Law and Director of the 

Business Law Institute at the University of Mississippi School of Law. I am also a Vice 

President of the financial planning firm, Plancorp LLC; a member of the PCAOB's Investor 

Advisory Group; and an Accredited Investment Fiduciary. I was formerly a member of the 

SEC's Investor Advisory Committee and chaired its Investor as Purchaser Subcommittee; 

an Assistant Chief Counsel in the SEC's Division of Investment Management; and an 

attorney in the securities practice of Wilmer. Cutler & Pickering (now WilmerHale). 

This testimony is based on my general experience over a number of years as an investor 

advocate. journalist. academic, regulator. financial planner. private practitioner and expert 

witness and consultant. I have been engaged in securities regulation issues from a variety 

of perspectives and attempt to provide testimony that reflects the interests of investors, 

diverse views of various constituents. and the practical exigencies of real-world legal 

practice and compliance. 

I. Introduction 

This is the second occasion on which I have testified on crowdfunding. On the first occasion 

in 2012, a bill had not gotten out of Committee. Two years later, implementing rules have 

been proposed. Some have complained about how much time this rulemaking has taken, 

but it is extraordinary how quickly the crowdfunding concept has taken on concrete form. 

On the whole, the Commission and its staff should be applauded for their hard work on this 

rulemaking. 

*1 would like to thank University of Mississippi law student Justin Bouchard for his assistance in 

preparing this testimony. 

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The title of this hearing poses the question: SEC's Crowdfunding Proposal: Will it Work for 

Small Businesses? I am afraid that the answer is probably "no." However, the question is 

somewhat unfair. Much of what is normally left to agency rulemaking has been set in stone 

by the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 

2012 ("Crowdfund Act" or "Act"). The Act is as extraordinary in its level of detail as it is 

extraordinary in the speed of its evolution. It specifically imposes numerous disclosure 

requirements that permit no leeway in their application. The Commission has very little 

wiggle room to make the Act work better for small businesses. 

However, in many respects the Commission has asserted authority to change the law 

where no such authority exists. There are many instances in which the Commission 

proposes something different from the very specific requirements of the Act. In some cases, 

the Commission asserts the authority to dilute investor protections, in other cases to 

impose additional burdens on small businesses, and in each case its approach would 

contravene specific directions from Congress. For example, the Commission is considering 

requiring CEO-certified financials for issuers with more than $100,000 in crowdfunding 

offerings,1 whereas Congress specifically directed that this requirement apply only to 

issuers that have raised $100,000 or less.2 The Commission is considering lowering the 

$2,000 minimum for investors with very low income and net worth,3 but it does not have 

the authority to amend the $2,000 minimum chosen by Congress. 

To illustrate the same over-reaching with respect to specific investor protections 

prescribed by Congress, the Commission is considering eliminating investment limits for 

accredited and institutional investors.4 This might be good policy, but it is flatly 

inconsistent with the Act's purpose of permitting greater access to investment 

1 Proposing Release at 83. 

2 Securities Act § 4A(b)(1)(D)(i)(Il). 

3 Proposing Release at 29. 

4 [d. at 28 - 29. 

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opportunities for small investors, not to mention the very specific dollar amounts set forth 

in the Act. 

There is no authority in the Act for the Commission to supplant Congress's judgment with 

the SEC's own. The provisions of the Act reflect a reasoned compromise among members of 

Congress. Members voted for or against the Act based on its specific terms, but they might 

have voted differently on the amendments being considered by the Commission. Thus, one 

general concern regarding the SEC's rulemaking is that often it does not respect the limits 

of its authority and upsets the compromise negotiated by the legislative branch. 

Another concern is that the Commission ignores the dark side of crowd behavior, choosing 

instead only to laud its strengths and virtues. The Commission praises the potential to tap 

the "wisdom of the crowd," but does not acknowledge, much less discuss, the negative 

behavior that is often associated with crowds. As the Commission knows, crowds are often 

destructive, particularly with respect to markets. 

In fact, the most-cited work on destructive crowd dynamics in markets is entitled: 

Extraordinary Popular Delusions and the Madness of Crowds. The book discusses, among 

other things, the crowd dynamics underlying the Dutch tulip mania, Mississippi Company 

bubble, and South Sea Company bubble. If its author, Charles MacKay, were alive today, he 

would most certainly be writing about the behavior of the crowd during the recent Internet 

and subprime bubbles. When thinking of crowd dynamics, Citigroup CEO Chuck Prince's 

widely quoted comment made in 2007 seems apropos: "As long as the music is playing, 

you've got to get up and dance." Will investors actually discuss hot crowdfunding offerings 

and think about them before investing? Or will they simply "get up and dance"? 

This is not to say that the promise of crowdfunding is a false one. Rather, it is to say that the 

Commission should approach rulemaking with its eyes open to the potential downside of 

crowd dynamics, especially in a market where the data show that one-third to one-half of 

investments are likely to become worthless. Instead, the Commission seems to see 

crowdfunding through rose-colored glasses. It rarely discusses how things might go wrong, 

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so one wonders whether its rulemaking adequately reflects that possibility. Crowdfunding 

will not work for small businesses if a minority of crowdfunding issuers are allowed to give 

it a bad reputation. 

The remainder of this testimony discusses specific aspects of the SEC's proposed rules. One 

aspect that should be of particular concern to small businesses is the SEC's position that the 

aggregate, 12-month $1 million limit on offerings applies only to crowdfunding offerings 

(as discussed in Part III at page 14). The SEC's position not only contravenes the plain 

meaning of the Act, it also risks allowing large- and medium-size companies to enter the 

crowdfunding market and squeeze out the startups and small businesses for which it was 

created. 

The SEC's interpretation would permit, for example, a large issuer to sell $1 billion in 

securities, then sell $1 million in crowdfunding securities, and then sell another $1 billion 

in securities, because the Commission would subject only the crowdfunding securities to 

the $1 million limit. Crowdfunding will not work for small businesses if it becomes a 

market for all businesses, regardless of size. Members of Congress who voted for the Act 

did so on the assumption that it was intended to help small businesses and not to create a 

social media opportunity for medium- and large-size businesses. Congress ensured that the 

crowdfunding market would be a market for small businesses precisely by limiting total 

securities offerings within any 12-month period to $1 million. The Commission has 

proposed to repeal this requirement, which will allow businesses of unlimited size to fill 

out the crowdfunding space, notwithstanding that they have no difficulty raising capital. 

The crowd will not be the investors, it will be the issuers, and as always is the case, the 

large will crowd out the small, just as the large currently crowd out the small in the 

securities offering space at large. Congress did not write the Act to allow large businesses 

to capture a marketplace that was designed for small businesses. The Commission may 

hear from crowdfunding intermediaries that amending the $1 million limit would improve 

crowding, but that it because they naturally prefer the largest possible crowdfunding 

market, which would generate the largest revenue. The Committee should listen closely to 

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small business's thoughts on their becoming incidental players in a market that Congress 

created for them. 

Other concerns go to the kind of reputation that crowdfunding is likely to develop under 

the SEC's rules. Various proposals would allow crowdfunding issuers to use stale financial 

statements, intermediaries to accept investment from ineligible investors, and issuers to 

engage in public advertising under the guise of a concurrent private offering. Each of these 

proposals will degrade the quality of the crowdfunding marketplace. They will also create 

an unfair advantage for less scrupulous issuers over small businesses that play by the rules. 

The overriding issue for crowdfunding is likely to be how the narrative of investors 

frequently losing their entire investment plays out. If investors are perceived as losing only 

a small part of their portfolios because of business failures rather than fraud, or if their 

crowdfunding losses are set off by gains in other investments through diversification, the 

crowdfunding market could weather large losses and thrive. However, if fraudsters are 

easily able to scam investors under the cover of a crowdfunding offering, or stale financial 

statements routinely turn out to have hidden more recent, undisclosed financial declines, 

or there are investors who can't afford the losses they incur, resulting in stories of personal 

financial distress then crowdfunding markets will never become a credible tool for 

raising capital. 

The remainder of this testimony highlights some, but by no means all of the SEC's specific 

proposals. I expect to submit a complete comment letter on the proposals, which I hope the 

Committee will consider in its oversight of this rulemaking. The sections ofthe remainder 

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of this testimony are paginated as follows: 

II. Integration with Other Offerings ........... 7 

III. $1 Million Cap on Funds Raised ............ 14 

IV. Limit on Investments by Investors .......... 23 

V. Investor Qualifications and Knowledge ....... 27 

VI. Investors' Review of Investor-Education 

Material ........................... 28 

VII. Meaning of "Investor" and "Investor and their 

Spouse" ............................ 29 

VIII. Disqualification of Crowdfunding Issuers That 

Are in Violation of the Act ................ 31 

IX. $500,000 Trigger for Audited Financials ....... 32 

X. Oversubscribed Offerings ................ 33 

XI. Stale Financial Statements . . . . . . . . . . . . . . . 34 

XII. Extension of Time to File Taxes ............ 37 

II. Integration with Other Offerings 

The problem of "integration" arises because concurrent offerings under different 

exemptions can allow an issuer to engage in permitted activities under one exemption that 

are not permitted under the other.s For example, one exemption might permit public 

advertising and allow sales only to accredited investors, while another prohibits public 

advertising but allows sales to any investor. Without integration rules, public advertising in 

the first offering could be used, in effect, to engage in indirect, illegal advertising of the 

second. In other words, by publicly advertising under the first exemption, the issuer would 

be able to reach potential nonaccredited investors where the issuer was prohibited from 

using public advertising to reach them. Unfortunately, the foregoing problem is exactly 

what the Commission would permit with respect to crowdfunding offerings. 

Crowdfunding offerings are subject to strict limits on advertising. The Act provides that 

issuers may "not advertise the terms of the offering, except for notices which direct 

5 In the SEC's words: "The integration doctrine seeks to prevent an issuer from improperly 

avoiding registration by artificially dividing a single offering into multiple offerings such 

that Securities Act exemptions would apply to multiple offerings that would not be available 

for the combined offering." Proposing Release at note 27. 

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investors to the funding portal or broker."6 Even within the context of communications on 

the website for an offering, that is, "communication channels provided by the intermediary 

on the intermediary's platform,"7 issuers may not compensate any person for promoting an 

offering unless the receipt of the compensation is disclosed "upon each instance of such 

promotional communication." 

The restrictions are necessary because, unlike private offerings in which public advertising 

is permitted,S issuers may sell crowdfunded securities to anyone. Congress believed that, if 

a desperate investor with no income and $2,000 in savings was to be permitted to invest 

their last penny in crowd funded securities, then issuers should not be allowed to lure them 

by running ads in public media. Public advertisements using exaggerated pitches -- "LAST 

CHANCE," "SALE ENDS SOON," "EVERYTHING MUST GO" - may be allowable in the 

marketplace at large, but America's century-long dominance of the world's securities 

markets is substantially attributable to prohibitions against this kind of misleading sales 

practices.9 Nothing is more likely to expose the madness of crowds than permitting public 

advertising to infiltrate the crowdfunding space. 

6 Securities Act § 4A(b )(2). The phrase "terms o/the offering means the amount of securities 

offered, the nature of the securities, the price of the securities and the closing date of the 

offering period." Proposed Rule 204. 

7 Proposed Rule 204(c). 

8 Although the "private" offering exemption was intended to limit public communications, 

the JOBS Act required that the Commission permit public advertising in "private" offerings. 

9 The kind of public advertising that has begun to emerge in the wake of rules permitting 

such advertising in private offerings illustrates what unrestrained crowdfunding 

advertising might look like. For example, a slide deck for a private offering by a fund that 

invests in Bitcoins includes a chart ("Bitcoin Upside") that shows the value of bit coins rising 

to equal the value of 5 percent of the world's gold supply ($340 billion). See Investor 

Presentation, Bitcoin Investment Trust Gan. 2014) available at 

http://www.bitcointrust.co/.Seea/so Gail Liberman, Palm Beach Discussion Group Invests 

in Single Bitcoin Gan. 12, 2014) (after initially approving investments in the Bitcoin 

Investment Trust in self-directed IRAs, Fidelity reversed its position). In the Act, Congress 

decided to limit crowdfunding issuers to making this type of claim only on crowdfunding 

platforms and their disclosure documents. 

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Nonetheless, the Commission would allow issuers to make exaggerated claims in public 

advertisements during a crowd funding offering. Issuers need only conduct their public 

advertising campaign under cover of a concurrent "private" offering. Crowdfunding issuers 

would be able to say anything, subject only to general antifraud rules, about the issuer's 

prospects in precisely the public context that Congress specifically proscribed for 

crowdfunding. Integration rules are designed to prevent precisely this method of 

circumventing the requirements of offering exemptions. Integration rules also provide 

clarity to issuers and intermediaries that have legitimate reasons for raising funds under 

different exemptions but are concerned that permitted activities under exemption might be 

viewed as violating another exemption under which they are not permitted. Clear rules 

save money while providing the foundation for a reputable, albeit risky market. 

Integration problems are addressed in a variety of ways under the securities laws. For 

example, when issuers raise funds through public and private offerings, and the private 

offering does not opt to engage in public advertising,lO the public registration statement 

could be viewed as a form of public advertising. Conversely, private communications made 

pursuant to the private offering could be viewed as offers that violate investor 

communication rules governing the public offering. The Commission has adopted a safe 

harbor that generally provides that a private offering that ceases at least 30 days before a 

registration statement is filed in a public offering will not be considered part of (be 

integrated with) the public offering. A public offering that is withdrawn at least 30 days 

before a private offering commences will not be considered part of the private offering. 

The integration safe harbor is nonexclusive; concurrent offerings will not necessarily be 

integrated. For example, the Commission has taken the position that a non-advertised 

private offering could be undertaken concurrently with a public offering if the issuer could 

10 As noted in footnote, the JOBS Act permitted public advertising in private offerings if 

securities are sold only to accredited investors. Issuers can still conduct private offerings 

and opt not to engage in public advertising subject to slightly different rules. See Securities 

Act § 4(a)(2). 

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demonstrate that the investors in the private offering were reached by means other than 

the registration statement.ll 

It is worth noting here that concerns regarding a registration statement serving as a form 

of illegal public advertising are not nearly as great as when public advertising occurs in 

connection with a private offering. The content of registration statements and other 

permissible public communications in public offerings are severely constrained, and these 

communications often would be impracticable for a billboard or advertisement in a 

newspaper, magazine or similar public media. The advertising concern is also mitigated by 

the fact that only accredited (presumably more sophisticated) investors can invest in a 

private offering, and they are less likely to be misled by publicly available information. 

Indeed, this is precisely the argument for the JOBS Act's recent elimination of the blanket 

prohibition on public advertising of private offerings -- that sophisticated investors can 

fend for themselves. 

In contrast, the problem of public advertising in private offerings being used to 

communicate with potential crowdfunding investors is heightened. Anyone can invest in a 

crowdfunding offering, regardless of their income or net worth. The potential for investor 

losses is greater with start-ups than for any other category of businesses, and low- or noincome and low- or no-net-worth investors are those who are least able to bear losses. 

These factors argue for greater integration restrictions that ensure that crowdfunding 

rules are not circumvented through the use of concurrent offerings under other 

exemptions. In addition, the ability of a business to raise capital through a private offering 

generally is not the kind business for which crowdfunding was intended; crowdfunding 

was intended to enable access to capital when not otherwise practicable, i.e., to close the 

"funding gap."12 

11 See Revisions of Limited Offering Exemptions in Regulation D, Part II.C (Aug. 3, 2007). 

12 Proposing Release at 17 (crowdfunding is intended to promote "the goal of alleviating the 

funding gap faced by startups and small businesses"). In fact, recent data published by the 

Commission itself shows that the claim that crowd funding is needed because small amounts 

of capital cannot be effiCiently raised under private offering rules is patently false. See infra 

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Where the Commission should be most concerned about fraudulent securities offerings, it 

has chosen the least protective approach. Despite the greater fraud risk in concurrent 

private and crowdfunding offerings than in concurrent private and public offerings, and the 

greater investor harm that fraud in the crowdfunding will impose, the Commission has 

proposed to impose a less restrictive standard for the former. In fact, it is not just a less 

restrictive standard; the Commission has proposed that no integration restrictions apply 

whatsoever. The only limitation that the Commission proposes to apply is that any 

"concurrent exempt offering for which general solicitation is permitted could not include 

an advertisement of the terms of an offering made in reliance on Section 4(a)(6) that would 

not be permitted under Section 4(a)(6) and the proposed rules."13 This "restriction" would 

provide no impediment to publicly advertising a crowdfunding offering under cover of a 

private offering. 

With respect to restrictions on crowdfunding advertising, the Commission states that: 

[l]imiting the advertising of the terms of the offering to the information 

permitted in the notice is intended to direct investors to the intermediary's 

platform and to make investment decisions with access to the disclosures 

necessary for them to make informed investment decisions.I4 

Permitting public advertising in concurrent offerings directly contradicts this position. 

Public advertising of other offerings will encourage investors to make crowdfunding 

investment decisions based on information that is not on the intermediary's platform. This 

public information will be more accessible than information on the intermediary's platform 

and may be more likely to be relied on that information on the intermediary's platform. 

Crowdfunding issuers will have an inventive to engage in concurrent private offerings 

precisely to enable them to reach a wider audience. This is exactly what Congress intended 

note 17. The JOBS Act's elimination of the ban on public advertising in private offerings will 

make private offerings even more amenable to small issuances. 

13 Proposing Release at 19. 

14Jd. at 109. 

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to prevent by restricting advertising to the intermediary's platform. And this is precisely 

what the Commission would permit by imposing no integration restrictions on such public 

advertising. 

The Commission interprets the following provision in the Act (the "Integration Proviso") to 

prevent it from imposing integration restrictions: 

Nothing in this section or section 4(6) shall be construed as preventing an 

issuer from raising capital through methods not described under section 

4(6).15 

Rather than suggesting that integration concerns be entirely ignored by the Commission, 

the Integration Proviso actually assumes that some degree of integration is likely, if not 

inevitable. The Proviso warns the Commission not to impose integration tests that would 

"prevent" offerings under exemptions because Congress was well aware that the 

Commission would find that some integration restrictions would be necessary to ensure 

compliance with, for example, the restriction of crowdfunding advertising to the 

intermediary's platform. Yet rather than taking the Proviso as a warning not to apply 

integration restrictions too broadly, the Commission has distorted its meaning into a 

command that no integration restrictions be applied at all. Despite the patently obvious 

loophole that permitting general solicitations in concurrent private offerings -- and even 

somewhat less problematic communications in a concurrent public offerings16 -- would 

create, the Commission has proposed to repeal. in effect, the crowdfunding restriction on 

advertising. 

15 Securities Act § 4A(g). 

16 As noted above, concurrent public offering is arguably ofless concern because the content 

of a public information made available in a concurrent public would be more regulated that 

public information in a private offering. However, a concurrent public offering, in which any 

investor could invest an unlimited amount, might beg the question of why a crowd funding 

offering that adds investor investment limits was appropriate at all. However, this is 

mitigated by the fact that public companies are not permitted to rely on the crowdfunding 

exemption and crowdfunding may not raise more than $1 million in any 12-month period. 

See infra Part III. 

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The Integration Proviso should be read according to what it says: integration rules should 

not prevent other offerings. Congress could have but did not use the word "delay." 

Congress could have but did not use the word "impede." Congress could have but did not 

use the phrase "interfere with." Congress was well aware that existing integration rules 

"delay," "impede" and "interfere with" securities offerings, but it chose to warn the 

Commission only against intergration rules' "preventing" other offerings. 

Congress used the term "prevent" in the sense of keeping something from happening. 

Existing integration rules do not prevent offerings, nor would any reasonable application of 

these rules to crowdfunding offerings prevent other offerings. Requiring that no public 

advertising of an offering by an issuer occur, for example, within 60 days before the 

initiation of a crowdfunding offering by that issuer could not be said to "prevent" the other 

offering. It would only require that it terminate before a subsequent crowdfunding offering. 

This rule WOUld, however, "prevent" issuers from indirectly publicly advertising their 

crowdfunding offerings. In view of the regulatory risks that crowdfunding entails, such a 

bright line rule would be preferable to a fact-based determination. It would be 

impracticable to adopt the SEC's position on concurrent public and private offerings 

because one could not demonstrate that no crowdfunding investor was solicited through 

public advertising. 

Members of Congress should urge the Commission to ensure that crowd funding rules 

do not effectively repeal the restrictions on crowd funding advertising by permitting 

public advertising in offerings that are concurrent with a crowd funding offering. 

Moreover, Congress should urge the Commission to prohibit the initiation of a 

crowd funding offering less that 60 days after a public communication in an offering by 

the same issuer. 

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III. $1 Million Cap on Funds Raised 

Congress intended that crowdfunding offerings remedy perceived difficulties encountered 

by issuers when raising small amounts of capital,17 The crowdfunding exemption was not 

intended to cover large offerings, much less issuers that routinely raised substantial 

amounts by other means. Congress accordingly limited the aggregate amount of securities 

raised by a crowdfunding issuer in any 12-month period to $1 million. It also required that 

the Commission adjust this limit at least once every five years to reflect inflation.1s Thus, an 

issuer that was able to raise $1 million through a private offering, for example, would not 

be able to avail itself of the crowdfunding exemption during the 12 months following the 

private offering, but it would be able to raise up to $1 million every year. 

17 Recently published data undermines this assumption. From 2009 - 2012, there were 

43,683 offerings under Rule 504, 505 and 506, and more than half - 22,126 - were for less 

than $1 million. See Ivanov and Bauguess, Capital Raising in the U.S.: An Analysis of 

Unregistered Offerings Using the Regulation D exemption, 2009 - 2012 at 8 (July 2013) 

available at http://www.sec.gov /divisions/riskfin/whitepapers/ dera-unregisteredofferings-reg-d.pdf. These data do not even include all alternative offering exemptions, 

much less additional offerings that will be made as a result of the removal of the ban on 

public advertising in private offerings. Thus, offerings ofless than $1 million are not just 

feasible under other offering exemption. They are routine. 

The Commission cites this data in the Proposing Release, but it provides no analysiS as to 

what types of startups and small businesses are having success with Reg D and what types 

are not. Why are some businesses able to find accredited investors and others are not? The 

fact that the accredited investor standard is based on wealth, one might speculate that some 

start-ups and small businesses are excluded from the kinds of networks in which they 

would have personal contact with accredited investors or with those who provide financial 

services to these investors. One might speculate further that crowdfunding's greatest 

potential may be its ability to remove arbitrary socio-economic constraints from capital 

allocation decisions. 

Finally, the Commission acknowledges that Reg D offerings now may be publicly advertised, 

but it does not discuss what effect this might have on the ability of start -ups and small 

businesses to raise capital under that exemption. Again, it seems that thinking about the 

effect of this change would be necessary for the Commission to engage in informed 

rulemaking. ' 

18 Securities Act § 4A(g) (1). 

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This $1 million cap is not limited to non-crowdfunding offerings. Congress makes that 

expressly clear in the Act. The relevant provision Act states as follows: 

(6) transactions involving the offer or sale of securities by an issuer 

(including all entities controlled by or under common control with the 

issuer), provided that-

(A) the aggregate amount sold to all investors by the issuer, including 

any amount sold in reliance on the exemption provided under this 

paragraph during the 12- month period preceding the date of such 

transaction, is not more than $1,000,000; ... .19 

Paragraph (6) applies to "the offer or sale of securities by an issuer," and subparagraph (A) 

limits "aggregate amount sold to all investors by the issuer" to "not more than $1,000,000." 

By its terms, "the offer and sale of securities" would mean all securities, including 

crowdfunding securities, a point further reinforced by the reference to "all" investors (not 

just crowdfunding investors). 

However, there is a potential ambiguity. The limit might be viewed as ensuring that issuers 

that are able to raise $1 million by other means should not be able to avail themselves of 

the crowdfunding exemption. Under this interpretation, an issuer could, consecutively 

within a 12-month period, issue $500,000 in crowdfunding securities, $500,000 in 

privately offered securities, and $500,000 securities. If the $1 million in crowdfunding 

securities were not aggregated with the private offering, the second $500,000 offering 

would be permitted. Congress intended that crowdfunding securities be included in 

applying the $1 million cap. It intend that the issuer be free to raise additional capital 

through noncrowdfunding means, but ifit was able to raise $1 million in a 12-month period 

it should not be allowed to exploit the crowdfunding's lowered investor protection at least 

until 12 months has passed. 

19 Securities Act § 4(a)(6). 

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Congress decided to make it absolutely clear that crowdfunding securities were to be 

included in the aggregate $1 million capzo and accordingly added the clarification that is 

italicized and bolded below: 

(A) the aggregate amount sold to all investors by the issuer, including 

any amount sold in reliance on the exemption provided under this 

paragraph during the 12-month period preceding the date of such 

transaction, is not more than $1,000,000 ... Z1 

In the event that it was not clear that the "aggregate amount sold" included crowdfunding 

securities, Congress stated expressly that these securities were included. There was no 

need to explain that the "aggregate amount sold" included securities issued in other 

offerings. Indeed, the fact that Congress believed it necessary to note that crowdfunding 

securities were "included" must mean that Congress also believed that other securities 

were included in the "aggregate amount sold." It is an obvious rule of statutory 

construction, easily understood by any lay person, that the term "including" means 

"illustrative of," and not, for example, "limited to."zz 

20 See Willheim v. Murchison, 342 F.2d 33, 41 (2d Cir. 1965) ("Definitions in securities and other 

legislation often use the word 'include' out of abundant caution, and this serves a clear purpose 

when one or more of the things stated as included would not be so in the ordinary meaning of the 

term defined .... "). 

21 Securities Act § 4(a)(6)(A). 

22 See, e.g., Fed. Land Bank of St. Paul v. Bismarck Lumber Co., 314 U.S. 95, 99-100,62 S. Ct. I, 

4, 86 L. Ed. 65 (1941) ("We recently had occasion under other circumstances to point out 

that the term 'including' is not one of all-embracing definition, but connotes simply an 

illustrative application of the general principle. (citing Phelps Dodge Corp. v. National Labor 

Relations Board, 313 U.S. 177,189, 61 S.Ct. 845, 850, 85 L.Ed. 1271,133 A.L.R.1217; 

Helvering v. Morgan's, Inc., 293 U.S. 121, 125, 55 S.Ct. 60, 61, 79 L.Ed. 232); Stansell v. 

Revolutionary Armed Forces of Colombia, 704 F.3d 910, 915 (11th Cir. 2013)("When a 

statutory definition declares what a term "means" rather than "includes," any meaning not 

stated is excluded. Colautti v. Franklin, 439 U.S. 379, 392-93 & n. 10, 99 S.Ct. 675, 684 & n. 

10,58 L.Ed.2d 596 (1979). This is because the term "means" denotes an exhaustive 

definition, while "includes" is merely illustrative. United States v. Probel, 214 F.3d 1285, 

1288-89 (11th Cir.2000)."); Citizens for Responsible Gov't State Political Action Comm. v. 

Davidson, 236 F.3d 1174, 1190-91 (lOth Cir. 2000) ("Colorado is among "the overwhelming 

majority of jurisdictions" that read the word "includes" as "a term of extension or enlargement 

when used in a statutory definition." Colorado Common Cause v. Meyer, 758 P.2d 153, 163-64 

(Colo. 1988) (en banc)."); Dong v. Smithsonian Inst., 125 F.3d 877, 880 (D.C. Cir. 1997) ("We 

recognize, of course, that the word "includes" normally does not introduce an exhaustive list but 

16 
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merely sets out examples of some "general principle." Federal Land Bank of St. Paul v. Bismarck 

Lumber Co., 314 U.S. 95,100,62 S.Ct. 1,4,86 L.Ed. 65 (1941)."); Federal Election Com'n v. 

Massachusetts Citizens for Life, Inc., 769 F.2d 13, 17 (1"Cir.1985) ('nA term whose 

statutory definition declares what it 'includes' is more susceptible to extension of meaning 

by construction than where the definition declares what a term 'means.' It has been said 'the 

word "includes" is usually a term of enlargement, and not of limitation." ... It, therefore, 

conveys the conclusion that there are other items includable, though not specifically 

enumerated ... (quoting N. Singer, 2A Sutherland Statutes and Statutory Construction 133 

(4th ed.1984) (quoting Argosy Ltd. v. Hennigan, 404 F.2d 14,20 (5th Cir.1968))); United 

States v. Mass. Bay Transportation Authority, 614 F.2d 27, 28 (1st Cir.1980) ("Includes is 

not a finite word of limitation."); Bautista v. Star Cruises, 286 F. Supp. 2d 1352, 1360 (S.D. Fla. 

2003) aff'd, 396 F.3d 1289 (lith Cir. 2005) ("Plaintiffs' interpretation of the Convention Act 

overlooks the significance of the word "including" in § 202. "A term whose statutory definition 

declares what it 'includes' is more susceptible to extension of meaning by construction than 

where the definition declares what the terms 'means.' " Singer, supra, § 47:07. In fact, "the word 

'includes' is usually a term of enlargement, and not of limitation ... It, therefore, conveys the 

conclusion that there are other items includable, though not specifically enumerated by the 

statutes." See Argosy Limited v. Hennigan, 404 F.2d 14,20 (5th Cir.1968) (internal citations 

omitted). Based on these principles of statutory construction, the term "including" instructs that 

the transactions, contracts and agreements described in § 2 of the FAA are covered by the 

Convention Act, as well as other arbitration agreements that arise out of commercial legal 

relationships."); Argosy Ltd. v. Hennigan, 404 F.2d 14,20 (5th Cir. 1968) ("In both of these 

statutes, we think the word 'including' is not to be restricted to the 'rate and amount of duties 

chargeable,' but read in relation to the phrase, 'all decisions entering into same.' 'The word 

'includes' is usually a term of enlargement, and not oflimitation.' United States v. Gertz, 9 Cir. 

1957, 249 F.2d 662, 666. It therefore conveys the conclusion that there are other items includable, 

though not specifically enumerated by the statutes."); United States v. Gertz, 249 F.2d 662, 666 

(9th Cir. 1957) ("The word 'includes' is usually a term of enlargement, and not of limitation. As 

stated in Federal Land Bank of St. Paul v. Bismarck Lumber Co., 314 U.S. 95, 100, 62 S.Ct. 1,4, 

86 L.Ed. 65, "including' is not one of all-embracing definition, but connotes simply an illustrative 

application of the general principle."); Braun v. Wal-Mart Stores, Inc., 2011 PA Super 121,24 

A.3d 875, 963-64 (Pa. Super. Ct. 20 II); ("With respect to the term "include," "[t]he term 

'include' is to be dealt with as a word of 'enlargement and not limitation.' " Pa. Human Relations 

Comm'n v. Alto-Reste Park Cemetery Ass'n. 453 Pa. 124, 130-31,306 A.2d 881, 885 (1973) 

(alterations omitted); accord Samantar v. Yousuf - u.s. --n. 10, 130 S.Ct. 2278, 

2287 n. 10, 176 L.Ed.2d 1047, 1062 n. 10 (2010)."); Vassiliu v. Daimler Chrysler Corp., 178 N.J. 

286, 295, 839 A.2d 863, 868-69 (2004) ("Rather, "the word 'includes' is usually a term of 

enlargement, and not of limitation .... It, therefore, conveys the conclusion that there are other 

items includable, though not <ipecifically enumerated [.r 2A Norman Singer, Sutherland 

Statutory Construction § 47:07 at 231 (6th ed. 2000) (internal quotation marks and footnote 

omitted); accord Fraser v. Robin Dee Day **869 Camp, 44 N.J. 480, 485, 210 A.2d 208, 210-11 

(1965)."); Brown v. Scott Paper Worldwide Co., 143 Wash. 2d 349, 359, 20 P.3d 921, 926 (2001) 

("RCW 49.60.040(3) contains the word "includes," which is a term of enlargement."); Ornelas v. 

Randolph, 4 Cal. 4th 1095, 1101,847 P.2d 560, 563 (1993) ("The statutory definition of 

'recreational purpose' begins with the word 'includes,' ordinarily a term of enlargement rather 

than limitation." (citing People v. Western Air Lines, Inc. (1954) 42 Cal.2d 621, 639, 268 P.2d 

723; 2A Sutherland, Statutory Construction (4th ed. 1973) § 47.07, pp. 81-82.»; Matter of Estate 

of Corwin, 1987-NMCA-100, 106 N.M. 316, 317, 742 P.2d 528, 529 ("This appeal requires us to 

apply principles of statutory construction. We find the correct approach in 2A N. Singer, 

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However, the Commission interprets the term "including" to mean "limited to." Of course, if 

the only securities that Congress intended the $1 million to apply to were crowdfunding 

securities, then it would have said: . 

the aggregate amount of securities sold in reliance on this exemption 

during the 12-month period preceding the date of such transaction, is 

not more than $1,000,000, 

and not what Congress actually said: 

the aggregate amount sold to all investors by the issuer, including 

any amount sold in reliance on the exemption provided under this 

paragraph during the 12- month period preceding the date of such 

transaction, is not more than $1,000,000.23 

Yet the Commission interprets "including" to mean "only." I am not aware of any support 

for this interpretation of "including" in this context. Courts have consistently interpreted 

"include" and "including" to be a nonexclusive example of the set of things that it follows. 

The sentence, "All cars must be registered, including blue cars" cannot mean that only blue 

cars must be registered. The sentence, "All felons must report to their parole officer, 

including felons who have served sentences of less than one year" cannot mean that 

murderers are not required to report to their. parole officers. 

Sutherland Statutory Construction Section 47.07 (Sands 4th ed. 1984): 'A term whose statutory 

definition declares what it "includes" is more susceptible to extension of meaning by construction 

than where the definition declares what a term "means." It has been said "the word 'includes' is 

usually a term of enlargement, and not of limitation. 0 • 0 It, therefore, conveys the conclusion 

that there are other items includable, though not specifically enumerated. 0 0 0'" (Footnote 

omitted.) This rule has found support in other jurisdictions. Federal Land Bank of st. Paul v. 

Bismarck Lumber Co., 314 U.S. 95, 62 S.Ct. 1,86 L.Ed. 65 (1941); Smyers v. Workers' Compo 

Appeals Bd., 157 CalAppJd 36, 203 Cal.Rptr. 521 (1984); Schwab v. Ariyoshi, 58 Hawaii 25, 

564 P.2d 135 (1977); Janssen V. Janssen, 331 N.W.2d 752 (Minn. I 983)."). 

23 See Coastal Barge Corp. V. Coastal Zone Indus. Control Bd., 492 A.2d 1242, 1246-47 (DeL 1985) ("We 

are mindful of the fact that the General Assembly used the words 'bulk product transfer facility means' 

rather than 'bulk product transfer facility includes' and that a term whose statutory definition declares 

what it 'includes' is more susceptible to extension of meaning by construction than where the definition 

declares what a term 'means.'" (citing 2A. Sutherland, Statutes and Statutory Construction § 47.07 (4th 

ed. 1984)). 

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Congress knows how to limit a provision to crowdfunding offerings. In fact, Congress 

proved as much in this very same Act and to a similar offering limitation. Section 4A(a) (8) 

requires crowdfunding intermediaries to comply with SEC rules designed: 

to ensure that no investor in a 12-month period has purchased 

securities offered pursuant to section 4(6) that, in the aggregate, 

from all issuers, exceed the investment limits set forth in section 

4(6)(B) .. " 

This provision prohibits the sale of crowdfunding securities - and only crowdfunding 

securities -- to an investor if the sale would result in the investor's total purchases in the 

preceding 12 months exceeding the investor investment limits (5% of net income, etc.). 

Thus, an investor whose income and net worth are less that $40,000 purchased his 

investment limit of $2,000, a different issuer could not sell the investor another dollar in 

crowdfunding securities until 12 months had passed. 

This limit is important here because it shows that Congress knew how to draft a 12-month 

dollar limit that applies only to aggregate sales of crowd funding securities. It use the 

words: "has purchased securities offered pursuant to section 4(6) that, in the aggregate, .. 

,," It did not say: has purchased securities, including those offered pursuant to section 4(6) 

that, in the aggregate, .. ,," Congress used different terms to impose separate 12-month 

dollar limits on sales of only crowdfunding securities for a reason. It specifically identified 

crowdfunding securities and only crowdfunding securities where the limit applied only to 

crowdfunding securities. In contrast, it used "including" in the $1 million issuer cap to 

clarify that crowdfunding securities were "included" in the aggregate amount but not the 

only securities to which the provision applied. The only rational reading of the $1 million 

issuer cap is that it applies to all securities sold by the issuer. 

The Commission's interpretation of the $1 million cap provision also violates the spirit and 

intent of the Act. The Commission's interpretation would allow, for example, an issuer to 

raise $1 billion in a private or public offering and follow up with a $1 million crowdfunding 

offering. Conversely, a business could raise $1 million and immediately follow that with a 

$1 billion private of public offering. Every large issuer will consider whether it would be an 

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effective social strategy to conduct a crowdfunding offering in order to "reach out" to their 

small shareholders while the issuer is a conducting a concurrent private offering from 

which small investors would be excluded. 

It could not have been further from Congress's intent to help startups and small businesses 

by creating an exemption for billion-dollar businesses. The Commission contends that: 

requiring aggregation of amounts raised in any exempt transaction - would 

be inconsistent with the goal of alleviating the funding gap faced by startups 

and small businesses because it would place a cap on the amount of capital 

startups and small business could raise.24 

How, exactly, is there a "funding gap" for a business that raises millions or even billions in a 

mere 12 months through non-crowdfunding offerings? Such a business definitionally does 

not have a "funding gap." N or is it a startup or the kind of small business for which 

Congress created the crowdfunding exemption. The SEC's statement also exaggerates the 

facts because the cap would apply only during the 12-month period; issuers would be free 

to engage in offerings outside of the 12-month window. My plain reading of the statute 

discussed above is not, as the Commission contends, "inconsistent" with the statute 

because no reasonable person would argue that the crowdfunding exemption was created 

to enable large businesses to raise capital. 

Moreover, the Commission also stated that the: 

offering exemption in Section 4(a)(6) was designed to help alleviate 

the funding gap and the accompanying regulatory concerns faced by 

startups and small businesses, many of which may not be familiar 

with the federal securities laws. 25 

24 Proposing Release at 17. 

2STd. at 269. 

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The startup or small business that is "not familiar with the federal securities laws" is not 

the business that would be able to raise substantial capital through a private offering and 

other methods. 

The Commission stated further: 

and: 

and: 

As discussed above, the crowdfunding provisions of the JOBS Act, 

which we would implement through this proposed regulation, were 

designed to help alleviate the funding gap and accompanying 

regulatory concerns faced by small businesses by making relatively 

low dollar offerings of securities less costly and by providing 

crowdfunding platforms a means by which to facilitate the offer and 

sale of securities without registering as brokers, with a framework for 

regulatory oversight to protect investors. 

We understand that Title III was designed to help alleviate the funding 

gap and accompanying regulatory concerns faced by startups and 

small businesses in connection with raising capital in relatively low 

dollar amounts.26 

[T]he crowdfunding exemption] is intended to alleviate the funding 

gap and accompanying regulatory concerns faced by startups and 

small businesses in connection with raising capital in relatively low 

dollar amounts. 

It is unclear why the Commission believes that interpreting a statute to allow businesses to 

raise more than $1 million in a 12-month period reflects its view that crowdfunding was 

"designed" or "intended" for small businesses "making relatively low dollar offerings of 

securities" or offerings in "relatively low dollar amounts." 

It is not reasonable to read the Act as intended to help businesses that raise tens, hundreds 

or even thousands of millions of dollars by allowing them to raise an extra $1 million 

through crowd funding. In contrast, it is entirely logical to read the statute to mean that 

261d. at 11. 

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Congress decided that $1 million was more than a "low dollar amount." Under the SEC's 

interpretation, billions of dollars would qualify as a "low dollar amount." 

The effect of allowing medium-size and large businesses to engage in crowdfunding will be 

to squeeze out the small businesses for which it was intended. Crowdfunding 

intermediaries, which have actively lobbied Congress on crowdfunding would prefer the 

largest market possible. However, the effect of allowing any non-public company to engage 

in crowdfunding will be to perpetuate the competitive disadvantage of the smallest 

businesses that crowdfunding was designed to remedy. The Commission's interpretation of 

the provision benefits medium-size and large buSinesses, and crowdfunding 

intermediaries, at the expense of startups and small businesses. 

The Commission attempts to support its interpretation by referencing the Integration 

Proviso, which, as discussed above, is clearly intended to address the problem of using one 

offering to circumvent the rules of another, concurrent offering. First, the $1 million limit is 

not ambiguous; it allows for only one reasonable reading. Second, the Integration Proviso 

refers to "preventing" offerings, whereas the $1 million cap would only limit the amount 

raised and even then for no longer than 12 months. It would "prevent" nothing. The 

Commission states: 

An issuer that already sold $1 million in reliance on the exemption 

provided under Section 4(a) (6), for example, would be prevented 

from raising capital through other exempt methods and, conversely, 

an issuer that sold $1 million through other exempt methods would 

be prevented from raising capital under Section 4(a)(6). 

This is incorrect, however, because an issuer would never be subject to the limit for longer 

than 12 months. An offering would never be prevented; it could only be delayed. 

The $1 million cap provision states that the "aggregate" amount of "securities" "sold to all 

investors" shall not exceed the $1 million limit in any 12-month period. These terms are 

unambiguous. The SEC's interpretation makes a mockery of Congress's plain English use of 

the phrase in the provision: "including any amount sold in reliance on the exemption 

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provided under this paragraph." The only rational interpretation is that the term 

"including" means that the category of offerings to which the $1 million cap applies 

"includes" crowdfunding offerings. It is irrational to interpret the term "including" 

crowdfunding offerings to mean "only" crowdfunding offerings, just as it would be 

irrational to twist the meaning of a statute to enable billion-dollar businesses that conduct 

billion-dollar offerings the ability to rely on the crowdfunding exemption. Finally, the 

Commission's interpretation flatly contradicts its repeated characterization of the entities 

for which crowdfunding was intended as "small businesses" raising "small dollar amounts" 

in order to remedy existing "funding gaps." 

Congress should communicate to the Commission that the Act was intended to provide 

a limited crowd funding exemption for low dollar-amount offerings by startups and 

businesses that might otherwise experience a genuine funding gap. Congress should 

explain to the Commission that the $1 million "aggregate" limit on the "offer and sale 

0/ securities" (not only crowd funding securities) to "all" investors (not just 

crowd funding investors) reflects the understanding o/Congress that a business that is 

able to raise more than $1 million within a mere 12 months is not the kind o/fundinggap business or low-dollar amount offering contemplated by the Act. 

IV. Limit on Investments by Investors 

Virtually every member of Congress who has spoken about the Act has affirmed the 

importance of investor protection, and the Act's most important investor protection 

provision is its limit on the amount that investors may invest. This provision is critical 

because typically one-third to half of small businesses fail within the first few years of their 

founding.27 Crowdfunding businesses may have a higher concentration of businesses that 

were rejected by angel investors, which suggests that their failure rate may be even higher, 

27 The data varies greatly as to small business failure rates, but most show about a 40 to 50 

percent failure rate after three years. See, e.g., Scott Shane, Small Business Failure Rates by 

Industry: The Real Numbers, www.smallbiztrends.com (Sep. 24, 2012). The Commission 

cites various studies that show Similarly high failure rates. See Proposing Release at 335 

("There is broad evidence that many of these potential issuers are likely to fail after 

receiving funding."). 

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a view with which the Commission agrees.28 Thus, a substantial percentage of investments 

made in small businesses will be worthless within a few years. Investors in these firms will 

lose their entire investment. 

Small business failures are not typically the result of fraud. They are business failures that 

result from incompetence and/or inexperience. This means that, no matter what 

disclosures are provided, sophistication tests are applied, or intermediary rules are 

adopted, about half of crowdfunding investments in crowdfunded startups may be a total 

loss. This would not necessarily reflect negatively on crowdfunding, although one hopes 

that crowdfunding would result in improved survival rates. The only way to protect 

investors from excessive losses is to limit the amount that they are permitted to invest. 

The Act imposes two forms of investment limits on crowdfunding investors as follows: 

• The aggregate dollar amount of investments in any 12-month period in securities of 

a single crowdfunding issuer (including crowdfunding securities); and 

• The aggregate dollar amount of investments in all crowdfunding securities in any 

12-month period. 

In each case the dollar limit is the same: between $2,000 and $100,000, depending on the 

investors' wealth and net worth. Thus, the limits protection investors against the two 

primary risks: (1) issuer risk (the risk that a single crowdfunding issuer will fail), and (2) 

crowdfunding risk (the risk of investing in crowdfunding offerings by multiple issuers). In 

addition, the limits are generally based on a percentage of net worth/income. which more 

closely aligns the dollar amount at risk on one hand. with the ability of the investor to bear 

the loss on the other. This is a significant improvement over the application of investment 

limits in other scenarios. In contrast, the SEC's Reg D allows an investor with $1 million in 

28 See id. at 335 ("Because we expect that issuers that would engage in offerings made in 

reliance on Section 4(a)(6) would potentially be in an earlier stage of business development 

than the businesses included in the above studies. we believe that issuers that engage in 

securities-based crowdfunding may have higher failure rates than those in the studies cited 

above."). 

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new worth to bet all of it on a single offering, while an investor with only $999,999 can 

invest nothing. While the particular dollar limits that Congress chose are questionable 

(they allow someone with no income and $2,000 in assets to invest their last penny in a 

crowdfunding offering), and over a number of 12-month periods any crowdfunding 

invesors could experience devastating losses, Congress should be applauded for designing 

a structure that provides greater protection against financially devastating losses. 

The Commission recognizes the investor protection purpose of the limits on crowdfunding 

investments by investors. It stated in the Proposing Release: 

Congress provided important investor protections for crowdfunding 

transactions under Section 4(a)(6), including individual investment 

limits. 29 

However, where there is any ambiguity in the operation of these investor protection limits, 

the Commission seems to have opted to interpret them to permit larBer investments by less 

wealthy investors. Under the status quo, issuers may sell securities to investors who are 

below certain net worth and income floors only pursuant to a public offering and under a 

limited number of exemptions. Where the law departs from the status quo with respect to 

the protection of investors, as is the case with crowdfunding, it is incumbent that any 

reduction in investor protection occur only where the law is clear. Where there is doubt, 

the regulator should err on the side of the status quo unless Congress has expressed its 

clear intent. However, the Commission seems to view every provision of the Act as 

intended to increase access to capital for small businesses without any regard for investor 

protection goals (notwithstanding that weak investor protection is likely to under the 

crowdfunding market and hurt small businesses). 

This approach is reflected in the SEC's position on the investment limits in Section 

4(a)(6)B), in which there is a flat contradiction in the application of the investment limits. 

Subparagraph (B)(i)'s limit applies "if either the annual income or the net worth of the 

29/d. at 12. 

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investor is less than $100,000." Subparagraph (B)(ii)'s limit applies "if either the annual 

income or the net worth of the investor is equal to or more than $100,000." The provisions 

are clear as long as an investor's income and net worth are both below or both equal to or 

above $100,000. However, if one is below $100,000 and the other is equal to or above 

$100,000, both standards apply. Such a patent drafting error is, ironically, a reflection of 

the dark side of crowd psychology. Dozens of experts, perhaps hundreds, failed to detect 

this error during the drafting phase because we believed that the Emperor certainly could 

not be walking the streets with no clothes on. Nonetheless, the contradiction exists, and the 

Commission cannot adopt rules without resolving it. 

Normally, one would resolve such a contradiction in way that furthers the goal of the 

particular provision. The Commission states expressly that this is an investor protection 

provision, yet it has interpreted it to provide less investor protection rather than more. The 

Commission's justification for its position is that "this clarification would give effect to the 

provision and would be consistent with Congressional intent in providing investment 

limitations."3o However, taking the opposite position would also be consistent with this 

intent. Virtually any interpretation would impose investment limitations, which renders 

the SEC's explanation is meaningless. The question is what the limit should be when an 

investor has less than $100,000 in income but at least a $100,000 net worth, or vice versa. 

More precisely, the primary investor protection concern is for the investor with a small 

income or no income who has managed to save $100,000. This person may be a retiree 

living exclusively or primarily on Social Security who is particularly vulnerable to 

investment scams and has no means of recovering from losses.31 Thus, the Commission's 

interpretation would allow such a retiree with an annual income of $25,000 and $100,000 

in assets to invest $10,000 in a crowdfunding offering, whereas an investor-protection 

30ld. at 24. 

31 In contrast, a person who earns more than $100,000 in three consecutive years is likely to 

be in much better position to absorb a 100 percent loss. There is no basis, however, in 

interpreting Subparagraph (B) differently for income and net worth. 

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oriented interpretation would limit her investment to $5,000. Admittedly, Congress clearly 

decided that it is appropriate for a retiree living on Social Security with only $100,000 

saved to make a $5,000 investment, which certainly makes the SEC's position seem benign 

in comparison. But that is not the rulemaking issue. What is difficult to understand is why 

the Commission would choose to exacerbate an already bad situation by interpreting a 

contradiction in an investor protection provision in a way that further reduces investor 

protection.32 This is difficult to understand, in part, because the Commission provides no 

discussion of the potential harm to investors from its position. The more that vulnerable 

crowdfunding investors experience financial distress as a result of crowdfunding, the less 

likely it is that the crowdfunding market will succeed. The SEC's position is not doing small 

businesses any favors. 

Congress should amend the Act to clarify that if either an investor's net worth or 

income is below $100,000, then the $2,000/ S percent investment limit applies, or 

communicate to the Commission that, pending clarification by Congress, the 

contradiction in the Act should be interpreted consistent with its investor protection 

purpose. 

V. Investor Qualifications and Knowledge 

The Commission has proposed that intermediaries be permitted to rely on the 

representations of investors regarding their eligibility to invest. The Commission must be 

mindful of imposing unnecessary burdens on crowdfunding, but in this respect it is 

imperative that stronger procedures be required when confirming investors' eligibility. 

One problem is that investors will routinely consider the value of their home in calculating 

their net worth, and may even neglect to reduce that amount by any outstanding mortgage. 

Intermediaries should be required to obtain specific confirmation regarding the investors' 

32 In a belated letter to Congress, former SEC Chairman Shapiro expressions her concerns 

regarding the inadequacy of investor protections under crowdfunding.lf this did not 

include minimizing the investment amounts made by the most vulnerable Americans, it is 

hard to imagine to what she was referring. It appears that the SEC's pOSition seems to have 

taken sharp turn since 2012. 

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calculation, such as an account statement that shows the value of an investor's securities 

account or one or more pay stubs that show their income. These documents can be sent 

electronically without an unreasonable burden on the investor. At minimum, investors 

should be asked specifically about whether they have included the value of their home in 

their calculation. 

A second problem is that investors will have an incentive to inflate their net worth or 

income both to establish their eligibility and to increase the amount they are permitted to 

invest. For example, an investor with a $90,000 net worth may represent that the investor 

has a $1 million net worth in order to be allowed to invest at the 10% level and invest all of 

it, rather than $5,000 allowed under the Act. The total reliance on self-certification ignores 

the fact that these are not just limits on issuers; the limits also effectively constrain 

investors ability to invest in certain offerings. Self-certification does not take investor 

eligibility because it imposes absolutely no controls on investors' ability to circumvent the 

limits, and it imposes no obligation on the part of issuers or intermediaries that they are 

not being circumvented. This approach creates a mutual incentive to require as little 

information as possible so as to provide the greatest freedom to both sides. 

In view of the likelihood that investors will lose their entire crowdfunding investment, the 

Commission should implement procedures to ensure that investors can afford to lose their 

entire investment. 

VI. Investors' Review oflnvestor-Education Material 

The Act requires that intermediaries "ensure that each investor reviews investor-education 

materials," which the Commission appears to have suggested may be satisfied by having 

the investor check a box that they have reviewed the material. However, the investoreducation provision imposes a direct requirement that investors "review" information, 

whereas Congress require only that investors "positively affirm" their understanding of the 

risk of a total loss and their ability to bear such a loss. Allowing an investor to check a box 

stating that the investor has reviewed investor-education materials applies a "positively 

affirms" that Congress chose not to apply in this case. 

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Anyone who uses a computer routinely checks boxes stating that they have read licensing 

terms and other disclosures when they know that they have not. They will do the same 

with respect to investor-education materials. The check-the-box approach is especially odd 

because an intermediary could easily determine whether the relevant document had been 

opened or the investor has actually scrolled past the first few lines. This would 

demonstrate that the investor had not reviewed the information, but the intermediary 

would be allowed to ignore this information. The Commission should not accept this 

approach as satisi'ying the "review" requirement. 

It is impracticable, of course, to require intermediaries watch over investors to confirm 

that they have read investor-education materials. However, it would be practicable to 

require investors to take a quiz that demonstrated that they had reviewed it, a method that 

the Commission has suggested could be satisfactory. This quiz could be combined with the 

quiz that intermediaries are otherwise required to administer to confirm each investor's 

understanding of liquidity risk and the risk of investing in small businesses. Alternatively, 

the Commission could require that the investor scroll through a series of web pages that 

show only one or two short sentences in a large font setting forth the most important 

investor-education facts, with a button confirming that they have read them and a link to 

more information related to that web page. 

VII. Meaning of "Investor" and "Investor and their Spouse" 

The investment limit under the Act applies to the "aggregate amount sold to any 

investor."33 The same provision refers in subparagraph (B) (i) to "the annual income or the 

net worth of the investor." Subparagraph (B)(ii) also refers to "the annual income or the net 

worth of the investor." In each case, the term "investor" is singular. None of the foregoing 

provisions refers to "investors." None of the foregoing provisions states or even implies 

that the term "investor" should be interpreted to mean and "investor" and their spouse. 

33 Securities Act § 4(a)(6)(8). 

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Nonetheless, the Commission chose to interpret the singular "investor" to include the 

"investor's" spouse.34 The SEC's only justification for interpreting a singular noun to 

represent a couple is that it: 

believe [ s J that this approach is consistent with the rules for 

determining accredited investor status because the accredited 

investor definition contemplates both individual and joint income and 

net worth with a spouse as methods of calculating annual income and 

net worth.35 

This explanation might make sense but for the fact that it is not the accredited investor 

standard that is being applied. It is the investment limit for investments in crowdfunding 

offerings, where Congress chose to use the singular term "investor." 

Nor is the SEC's position consistent with its own accredited investor definition. The 

accredited investor definition requires at least $200,000 in income for an individual 

investor, but the joint income requirement is higher, at $300,000. Even assuming that it has 

the authority to replace Congress's crowdfunding standard for a single investor with a 

standard for singles and couples, which it does not have, the Commission has violated its 

own position that the minimum for a couple should be SO percent higher. 

Rather than recognizing that Congress clearly chose not to adopt this aspect of the 

approach to joint net worth and income that appears in the definition of accredited 

investor, the Commission seems to have decided that Congress should have adopted this 

approach. 

34 On a related matter, the Commission asks whether the 5 percent limit should apply to the higher 

or lower of the investor's income or net worth. The Commission is correct that is not expressly 

stated in subparagraphs (8)(i) and (ii). It would be reasonable, ifnot necessary,§ to interpret the 

placement of the phrase "the greater of' immediately preceding the $2,000 and 5 percent limits to 

mean that the phrase also applies to "the annual income or the net worth." 

35 Proposing Release at 25 

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This is also despite the fact that Congress knew very well how to apply the accredited 

investor definition when it believed that the standard was appropriate. Congress did 

precisely that when the standard that it provided that crowdfunding net worth and income 

should be "calculated in accordance with" the calculation of net worth and income for an 

accredited investor. Thus, Congress specifically chose the accredited investor calculation 

methodology (e.g., the exclusion the value ofa home in calculating net worth) but not 

accredited investor treatment of a couple's income of net worth, yet the Commission seems 

to believe that this was a mere Congressional oversight that it is the SEC's prerogative to 

fix. 

Congress should reiterate to the Commission that the singular term "investor" means a 

single investor and urge the Commission not to exceed its authority by amending the 

Act to create a crowd funding standard for the net worth or income of couples until and 

unless Congress has directed it do so. 

VIII. Disqualification of Crowdfunding Issuers That Are in 

Violation of the Act 

Congress granted the Commission express authority to prohibit certain issuers from 

relying on the crowdfunding exemption. The Commission proposes to exclude issuers that 

have not provided to investors the annual reports that are required under the Act following 

a prior crowdfunding offering. In my view, issuers that have demonstrated an inability to 

comply with the only obligation that continues after a crowdfunding should not be allowed 

to engaged in another crowdfunding offering until they have come into compliance. The 

delivery of the annual report is entirely within the control of the issuer. Its inability to 

make this disclosure shows that it should be relied upon to make appropriate disclosures 

in the course of new offering. 

However, the Commission has proposed to disqualify issuers only if they have not filed and 

delivered their two most recent reports. Under this standard, an issuer could go 23 months 

and 30 days without having filed a report; indeed, it might never have filed a report. There 

is no reason that an issuer that is currently delinquent on the filing or delivery of one 

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report, much less two should be allowed to avail itself of the crowdfunding exemption. 

Permitting such issuers to participate in the same market as small businesses that do 

comply with the law will only degrade investor confidence in the crowdfunding market and 

create an unlevel playing field by imposing costs of some issuers that are not imposed on 

others. 

Congress should endorse the SEC's exclusion of certain issuers that are delinquent on 

their annual reporting obligation under the Act and encourage the Commission to 

prohibit an issuer from relying on the crowd funding exemption until the issuer is 

current on its annual reporting obligation. 

IX. $500,000 Trigger for Audited Financials 

The Act requires that a crowdfunding issuer provide audited financial statement if the 

amount of the offering exceeds $500,000. However, it also authorizes the Commission to 

establish some other amount. This means that the Commission could raise or lower this 

amount, yet the Commission describes this authority as permitting only an increase in the 

amount.36 The Commission should acknowledge that this authority also allows for a 

reduction in this amount and that it will, in fact, reduce the amount if subsequent events 

warrant such a reduction. 

Such an increase or reduction may be appropriate in the future, but the Commission does 

not currently have any analytical or empirical basis to do so. Debt crowdfunding, such as 

offered by Prosper.com and LendingClub.com, has been operational for years, may offer 

insight into the relevance of financial statement standards in the crowdfunding context. 

Gift-based crowd funding sites have enough of an operating history they also might shed 

light on this question. However, the only current basis for the audited financial trigger is 

the specific dollar amount of $500,000 provided by Congress. In view of the current lack of 

36 Proposing Release at note 31 ("C/ Securities Act Section 4A(b)(1) (D)(iii) (giving the 

Commission discretion to increase the aggregate target offering amount that requires 

audited financial statements)."). 

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any basis for second-guessing this standard, the Commission should neither raise nor 

lower the $500,000 trigger. However, it should promptly establish information collection 

and analysis procedures in order to ensure that it has the capacity to evaluate changes in 

the $500,000 trigger in the future. 

X. Oversubscribed Offerings 

The Commission has proposed that issuers be required to disclose how they will allocate 

shares in oversubscribed offerings, but otherwise grants them the discretion to decide how 

the allocation will be done. One issue is that this is not what the proposed rule says, which 

is that issuers must disclose whether it: 

will accept investments in excess of the target offering amount and, if 

so, the maximum amount that the issuer will accept and whether 

oversubscriptions will be allocated on a pro-rata, first come-first 

served, or other basis.37 

Read literally, this provision would permit an issuer to disclosure that it will allocate 

oversubscriptions on a basis other than pro rata or first-come, first-served and provide no 

other guidance. 

This is a rather minor point relative to the more important question of whether to prohibit 

allocations based on a first-come, first-served basis. The Williams Act and rules thereunder 

specifically prohibit tender offers for public companies from being made on a first-come, 

first-served basis. Rule 14d-8 requires that tender offers be made on a pro rata basis 

because first-come, first-served offers have the potential to create a stampede effect.38 This 

would be an appropriate standard to apply to crowdfunding oversubscription allocations. 

37 Proposed Rule 201(h). 

38 See San Francisco Real Estate Investors v. Real Estate Invest. Trust of Am., 692 F.2d 814, 817 

(1st Cir. 1982) ("When Congress enacted the Williams Act in 1968, it recognized that an offeror 

who hoped to gain control of a target firm might well rely on a 'stampede' effect. The offeror 

would encourage shareholders to decide in its favor by offering a high price for only a portion of 

the outstanding shares and making that price available. "). There are other anti-stampede 

provisions under the Williams Act, including minimum offer period and withdrawal rights. 

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The stampede effect is, of course, a reflection of a less appealing form of crowd dynamics. 

As Senator Merkley has stated, the Act's provisions "are designed to allow investors the 

chance to carefully consider offerings, permitting the 'wisdom of the crowd' to develop, 

rather than perhaps just the 'excitement of the crowd.'" The Senator was referring here to 

withdrawal rights, which are also important in mitigating the stampede effect (the 

Commission has proposed a withdrawal right up to 48 hours before the deadline for an 

offering39). However, issuers will have an incentive to use a first-come, first-served 

approach to allocating oversubscribed offering to pressure investors to act quickly without 

thinking. This could be mitigated by requiring pro rata allocations. 

Congress should encourage the Commission to require that oversubscribed offerings 

be allocated on a pro rata basis, as is required under the Williams Act, in order to 

prevent the stampede effect that allocation on a first-come, first-served basis may 

create. 

XI. Stale Financial Statements 

The Act requires that crowdfunding issuers provide financial statements to investors. This 

information will be critical in helping the crowd evaluate issuers, but it will not be helpful if 

the information is stale. Stale information is of particular concern here because many 

issuers will have a very short operating history. For example, if an issuer with a calendar 

fiscal year begins operations in December and makes an offering the following June. then 

the financial statement from its most recent fiscal year would cover only one month, i.e., 

one-seventh of the lifespan of the business. 

The Act does not indicate how current the financial statements must be. The Commission 

has proposed that financial statements need only be as recent as the end of the issuer's 

39 Proposed Rule 304(a). The Act requires that issuers provide a "reasonable opportunity" 

to cancel their orders prior to sale, Securities Act § 4A(b)(1)(G), and 48 hours prior to the 

deadline meets this requirement. 

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most recent fiscal year. During the first 120 days of an issuer's fiscal year, the financial 

statements need only be as recent as the end of preceding fiscal year. In the latter scenario, 

the issuer with a calendar fiscal year that began operations in December in Year 1 could 

submit financials covering only that month for a crowdfunding offering beginning as late as 

April of Year 3. The financials would be 16-months stale and cover only one month in the 

issuer's 17 -month lifespan. 

The SEC's proposal will substantially dilute the value of crowdfunding financials. The 

requirements permit extremely stale information relative to the life of a firm to be the basis 

for an investment decision by nonaccredited investors. It is unclear how the wisdom of the 

crowd will be able to evaluate a firm based on financial information that may be effectively 

irrelevant to an issuer's current financial condition. 

The Commission correctly notes that an issuer must disclose any material changes that 

have occurred since the date of the financials. For example, issuers must disclose material 

changes in reported revenue and net income. However, requiring such disclosure without 

also requiring that the information be provided in the format of a financial statement 

undermines the purpose of using financial statements in the first place. A financial 

statement is, in effect, a standardized way of organizing information that facilitates 

interpretation and comparison. A generalized disclosure about changes in revenues and net 

income does not satisfY this standard. It promotes the dissemination of financial 

information in obtuse. inconsistent formats. Enforcement of the requirement to correct of 

material changes would be far more difficult than enforcement of a clear financial 

statement standard. 

If changes in financial information were unlikely, this might not be a significant problem, 

but early stage businesses are very likely to experience changes in their financial 

information over short periods. These changes will be critical information because they 

will be both current and reflect the possible direction of the business. This SEC's approach 

is also problematic because it leaves substantial discretion to issuers to update financial 

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information when the changes are positive, while not disclosing information when it is 

negative. 

The Commission should require that crowdfunding issuers provide truly current 

financials. These need not necessarily meet the same degree of formality. For large 

offerings, the Commission could require that issuer provide their audited financial 

statements for the two most recently ended fiscal years plus non-audited (e.g., CEOcertified) financial statements40 through the end of the month that ends no more two 

months before the month in which the offering begins (e.g., an offering any day in March 

would require financials ending in January). It should not be burden for an issuer what is 

otherwise providing audited financial statements. 

For smaller offerings that have less burdensome financial statement requirements under 

the Act, a modified standard for providing current information might be appropriate. 

However, permitting issuers to sell shares off of financial statements that may be 16-

months stale, especially where that 16-month period may represent almost the entire 

lifespan of the business, will not facilitate the development of an efficient market. Issuers 

will exploit the opportunity to make offerings based on stale information and thereby 

dilute investor confidence in crowdfunding. 

Congress should inform the Commission that requiring only financial in/ormation as 0/ 

the end o/the most recent fiscal year, which may be 16-months stale at the time o/the 

offering, will provide investors with inadequate in/ormation to evaluate investments 

and undermine confidence in the crowd funding marketplace. Congress should 

encourage the Commission to require that issuers provide the most current financial 

in/ormation practicable, even i/ the most current in/ormation complies with a lower 

standard. 

40 The Act's financial statement reqUirement could be read to require current financial statements 

or only the most recent financial statements. In light of this lack of clarity, the Commission should 

be viewed as having the authority to impose a reduced requirement for current financials or to 

require that current financials be provided that meet the Act's standard. 

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XII. Extension of Time to File Taxes 

The Act requires that issuers raising $100,000 or less in a 12-month period file a copy of 

their most recently "filed" tax return. The Commission interprets this requirement literally, 

which means that issuers that have obtained an extension to file their returns would not be 

subject to this requirement. The Commission asks whether issuers should be allowed 

circumvent this requirement simply by obtaining an extension of time to file. 

In my view, it is reasonable to interpret the date a tax return is "filed" as a date not later 

than the deadline for the filing. The Commission should adopt this interpretation in order 

to prevent issuers from improperly evading the tax return filing requirement. Alternatively, 

the Commission could impose this interpretation when the issuer has never filed a tax 

return in order to ensure that at least one tax return is available. 

On a related issue, the Commission asks whether issuers should be permitted to redact 

personal identifying information. The purpose of filing tax returns is to provide investors 

with useable information on which to base an investment decision. To the extent consistent 

with this purpose, the Commission should permit the redaction of personal information. 

37 
119 

Congressional Testimony of 

David J. Paul 

Co-Chair and Co-Founder of CfIRA 

(Crowdfunding Intermediary Regulatory Advocates) 

Chief Strategy Officer of Gate Global Impact 

before the United States House of Representatives 

Committee on Small Business 

Subcommittee on Investigations, Oversight and Regulations 

For the Hearing: 

‘‘SEC’s Crowdfunding Proposal: Will it work for small business?’’ 

January 16, 2014 

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To Chairman Schweikert, Ranking Member Clarke, and other 

honorable members of the Committee: 

As all of you are aware, Congress passed the Jumpstart Our 

Business Startups Act (the JOBS act) on March 27, 2012 which 

was signed into law on April 5, 2012. 

Very shortly thereafter, on April 20, 2012, I organized what may 

have been the first meeting between representatives of the 

crowdfunding industry and the Security and Exchange Commission. Since that first meeting, CfIRA has enjoyed an ongoing and 

productive dialog with both the SEC staff and the commissioners 

up to, and subsequent to, the release by the SEC of the proposed 

Title 3 crowdfunding regulations on October 23, 2013. 

While it would be difficult to say that the crowdfunding industry 

speaks with a singular voice, it is fair to say that the overall consensus among the industry is that the SEC has done a diligent and 

thoughtful job creating the proposed regulations. In general, we remain hopeful that Title 3 crowdfunding, when it comes online later 

this year, will prove to be an effective and robust new asset class, 

matching small businesses with individual investors in a safe and 

productive marketplace. 

With that said, there are certain aspects of the proposed regulations which may be amiss and which we hope to address and modify. Some of these concerns will be the subject of my testimony. 

Given the limited time for testimony, I will confine my comments 

to four salient issues. These four issues are certainly representative 

of the kinds of concerns which the industry has with respect to the 

proposed regulation, but these are by no means exhaustive: Audit 

Requirements, Pooled Investment Restrictions, Intermediary Participation Restrictions, and Funding Portal Liability. 

Audit Requirements 

As currently proposed, there are three tiers of financial disclosure requirements for Title 3 offerings, corresponding to the 

amount raised: 

First Tier: $0 - $100,000 

Second Tier: $100,000 - $500,000 

Third Tier: $500,000 - $1 million 

The First Tier requires disclosure of financial statements certified by an executive officer of the company. The Second Tier requires financial statements reviewed by an accountant. 

However, the Third Tier requires CPA audited financials. Furthermore, the requirement for such CPA audited financials is on an 

ongoing basis, with such audited financials to be provided to investors every year following a Title 3 raise of over $500,000. 

It is worth noting that these disclosure requirements for the 

Third Tier are actually more onerous and exhaustive than the current requirement for Regulation D offerings which does not mandate audited financial statements for issuers, nor ongoing annual 

audited disclosures. 

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These overly onerous requirements for the Third Tier of security 

crowdfunding offerings may have the unintended effect of pushing 

potential issuers away from doing Title 3 crowdfunding offerings 

above $500,000 entirely, and instead will make Regulation D offerings more attractive to potential issuers. 

This seems clearly inconsistent with the spirit of the original legislation. In effect, this may create a ‘donut hole’ between $500,000 

and $1 million where offerors do not utilize Title 3 at all. 

In addition to creating an artificial market irregularity, this will 

also have the unfortunate effect of making these offerings unavailable to unaccredited investors, since Regulation D offerings utilizing Title 2 are not available for investment by unaccredited individuals. 

Pooled Investments Restrictions 

The proposed regulations exclude funds from utilizing Title 3 to 

raise capital, in effect, requiring all crowdfunding investments to 

be direct investments. This rule would restrict pooled investments, 

or hedge funds and private equity funds from raising money 

through crowdfunding. 

While we may agree that most funds may not be suitable issuers 

for crowdfunding, we believe that this restriction is overbroad as it 

appears to restrict the fundraising of Special Purpose Vehicles or 

Single Purpose Entities (SPE’s) investing only in a single operating 

company that would otherwise qualify as an eligible Title 3 issuer. 

This restriction does not serve to protect investors, but rather 

this restriction actually succeeds in denying crowdfunding investors 

some of the advantages and protections afforded to other investors 

and institutions in other asset classes, particularly those utilized in 

Regulation D offerings. 

Intermediary Participation Restrictions 

Current proposed regulations would restrict intermediaries from 

holding interests in the companies conducting Title 3 offerings on 

their platforms. This serves to restrict intermediaries from participating alongside their investors in these offerings. 

Rather than diminishing a theoretical ‘conflict of interest’ between intermediaries and investors, as a practical matter this restriction effectively forbids alignment of interests between investors 

and intermediaries. 

This concept is often described as ‘‘skin in the game.’’ We believe 

that intermediaries who invest in issuers make for better alignment of interests. We believe that allowing such co-investment by 

intermediaries would have two very desirable benefits for investors. 

First, an investor may take comfort in knowing that the intermediary facilitating the transaction is invested in the same deal 

and on the same terms in the investment they are considering. Second, when an intermediary has such ‘‘skin in the game’’ that fact 

itself will encourage intermediaries to take more seriously their assigned role in the marketplace. 

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While we are aware that an intermediary’s investing in a deal 

may be perceived by an investor as a tacit endorsement of that deal 

(perhaps to the exclusion of others in which the intermediary has 

not committed its firm’s capital) and that this tacit endorsement 

may itself be construed as ‘‘investment advice’’, we do not believe 

that this is necessarily the case. 

But even if such a determination were to be made, we believe 

that this ‘‘investment advice’’ restriction should not be applied to 

all intermediaries. At most, this restriction should be limited to 

Funding Portals and not to Broker-Dealers conducting Title 3 

crowdfunding offerings, as Broker-Dealers are not restricted from 

offering investment advice in Title 3 crowdfunding offerings. 

It is also worth noting that Broker-Dealers are not restricted 

from owning positions in other types of offerings in which they support, including Title 2 Regulation D offerings. So the restriction on 

Broker-Dealer financial participation triggered by Title 3 offerings 

may have the undesired effect of disencouraging Broker-Dealers 

from bringing Title 3 offerings at all. 

Funding Portal Liability 

Section 4A(c)(2) of the Securities Act provides that an ‘‘issuer’’ 

will be subject to liability if it fails in either of the following two 

criteria: (1) if an issuer makes an untrue statement of material fact 

or omits to state a material fact; (2) if an issuer does not sustain 

the burden of proof that such issuer did not know, and in the exercise of reasonable care could not have known, of such untruth or 

omission. 

While this may seem reasonable and proper for companies 

issuing securities, as written, the regulations suggest that funding 

portals themselves can be broadly included in the definition of 

issuers. 

If this interpretation proves accurate, then a funding portal as 

well as each of its directors, principal executive officers and other 

employees involved in an offering, may potentially have personal liability for every transaction conducted on its platform. 

The proposed consequence for a violation under this provision is 

to allow an investor to recover the amount of his or her investment, 

even if he or she no longer holds the security. 

To put a fine point on this, this would mean that if the platform 

does one hundred $1 million deals, then each of a portal’s affiliated 

persons would have $100 million in personal exposure. A portal effectively becomes a guarantor for every single statement in every 

offering document of every offering on its platform. 

To say that this liability issue may have a chilling effect on anyone considering creating a portal may be something of an understatement. Indeed, each employee of a funding portal will have to 

make a decision as to whether they are comfortable exposing themselves, and potentially their families, because of the personal liability involved. 

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It is not hard to imagine this liability potential resulting in an 

adverse selection, where conservative market players are scared 

away and only aggressive players are willing to take on this risk. 

Clearly, this would not be in the best interests of the market as 

a whole. 

Respectfully submitted, 

David J. Paul 

Co-Chair - CfIRA 

CSO - Gate Global Impact 

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