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Commissioner Stein: Crowdfunding Rule Must Balance Capital Formation With Investor Protections

The SEC has been considering a proposal to establish rules for crowdfunding for close to a year-and-a-half. Despite the public statements from agency officials that they want to complete the final rule this year, it’s not clear how soon they’ll be able issue it and still balance concerns for investor protections with a viable mechanism that start-up companies use to raise investor funds.

The SEC’s effort to write a final rule to let entrepreneurs and start-up companies raise investment funding through crowdfunding has been stalled in the regulatory process for close to 18 months.

Despite SEC officials’ interest in completing the rule proposed in October 2013 in Release No. 33-9470, Crowdfunding, they face a difficult challenge in balancing concerns over fraud protections and the interest companies have in using the crowdfunding portals.

“Equity crowdfunding is a challenging concept for many reasons,” said SEC Commissioner Kara Stein in a March 5, 2015, speech at Stanford University. “It is a new regime.It does not fit neatly into our 80-year old securities law framework, which is focused on operating companies with some history. With crowdfunding, we are in many ways writing new rules and creating new markets out of whole cloth.”

As Stein sees it, the crowdfunding concept risks collapsing if investors are subjected to a wave of fraud and lose confidence in it.

“For the crowdfunding market to be successful over the long-run, it needs to be a place that is fair, effective, and where both investors and companies understand the risks,” Stein said.

The SEC could foster the establishment of crowdfunding investment vehicles that pool funds from hundreds or thousands of investors and save entrepreneurs the trouble of verifying that investors are following the rule’s investment limits. The investment pools are being employed in some foreign markets, and Stein sees potential for trying them in the U.S.

Release No. 33-9470 says the investment process has to be managed through crowdfunding portals that are registered as investment vehicles with the SEC.

At the same time that the SEC is eager to push through a final crowdfunding rule, the agency remains under enormous pressure to move quickly on the JOBS Act rules that haven’t been finalized.

At a July 2014 House hearing, lawmakers criticized the auditing requirements in the crowdfunding proposal and said they were delaying the SEC’s effort to finish the rule.Release No. 33-9470 employs the JOBS Act requirement that crowdfunding offerings of $500,000 be accompanied by audited financial statements.