Franklin, Andrews, Kramer & Edelstein

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SEC Boots Up for Internet Age

APRIL 9, 2011
By JEAN EAGLESHAM And JESSICA HOLZER
http://online.wsj.com/article/SB10001424052748704843404576251160999848924.html?mod=WSJ_business_whatsNews

Federal securities regulators are weighing demands to make it easier for fast-growing companies to use social networks such as Facebook and Twitter to raise money by tapping thousands of investors for very small amounts of shares.

The Securities and Exchange Commission is looking at adapting its rules to encourage Internet-age techniques for small companies raising capital. The issue is part of a wider review by the agency into whether to ease decades-old constraints on share issues by closely held companies.

The use of "crowd-funding" techniques has spread in recent years from artists looking to fund creative works to entrepreneurs trying to expand their firms. In a typical example, a company looking to raise $100,000 would use an Internet site to invite investors to buy as much as $100 of shares each.

If all goes well, small companies can raise cash relatively cheaply, while investors get a stake in an innovative business with limited downside risk. The SEC is now considering calls to relax its rules to make it easier for companies to use crowd-funding without having to undergo the full panoply of disclosure and other legal requirements required by the securities laws for share issues.

The agency has "been discussing crowd-funding and possible regulatory approaches" with small-business representatives and state regulators, Mary Schapiro, SEC chairman, said in a letter to a lawmaker on Wednesday.

A petition calling for the securities rules to be eased for crowd-funding share issues of up to $100,000 has been backed by almost 150 organizations and individuals, Ms. Schapiro wrote.

But the SEC chairman stressed the need to ensure that any waiver of the normal rules doesn't offer a free pass to enterprising fraud operators. Ms. Schapiro cited a previous experience with easing regulatory controls for small-scale share issues.

The SEC in 1992 allowed share issues of as much as $1 million to be exempt from many legal constraints, such as full disclosure of financial information. The agency also allowed these issues to be open to ordinary investors, in contrast to the normal requirement for share issues in closely held companies to be limited to investors with a net worth of at least $1 million.

But the experiment was in effect abandoned in 1999, "in light of investor-protection concerns about fraud," Ms. Schapiro said.

While crowd-funding might cap the extent to which any individual can be defrauded—with a typical $100 limit on individual investments—the evolution of the Internet since the 1990s also has increased the opportunities for online scams.

"In developing any potential exemption for crowd-funding, it will be important to consider this [1990s] experience and build in investor protections to avoid the issues created under the prior exemption," Ms. Schapiro wrote.

The SEC's wider look at easing various rules on share issues by closely held companies, reported Friday in The Wall Street Journal, drew a mixed response.

Supporters of the review welcomed the agency's decision to consider raising the limit of 499 on the number of shareholders that closely held companies can have before having to open their books to the public. They argued that removing restrictions on fund raising by fast-growing companies would help the overall economy.

"Lifting or refining this rule could significantly improve the ability of companies to raise capital without creating risks that the SEC should be concerned with," said Rep. Darrell Issa (R., Calif.), the House Oversight Committee chairman who was the recipient of Ms. Schapiro's letter detailing the review.

But others are concerned that allowing bigger companies to remain closely held isn't in the wider interest of investors. Former SEC Chief Accountant Lynn Turner said he feared lifting the cap would allow companies that are "more hoopla than they are substance" to raise capital based on limited disclosures. "A whole lot of investors could be harmed," he said.

Ms. Schapiro said the review was in the "very early stages."

Offering rules are decades old, she told an audience of business journalists in Dallas. "It makes sense for us … to take a look at whether our rules have kept pace with changing market dynamics."

Write to Jessica Holzer at [e-mail]

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