By restricting crowdfunding, the FCA has thrown the baby out with the bathwater

Edward Griffiths, partner at law firm DLA Piper, argues that new proposals from the FCA are in direct conflict with the democratic nature of crowdfunding

On 27 January 2014, Securities and Exchange Commission (SEC) Chair Mary Jo White gave the keynote address to the 41st Annual Securities Regulation Institute. In her speech, she discussed the important role that crowdfunding would play during 2014 in the United States. In late 2013, the SEC unanimously supported proposed legislation under the Jumpstart Our Business Startups Act (JOBS Act) so that companies could offer and sell securities through the medium of crowdfunding.

White's comments in conjunction with the SEC's earlier announcement present a big step in the United States to recognise crowdfunding as a legitimate method to raise capital. Within the JOBS Act, Title III created an exemption to bypass the provisions which govern selling securities to individuals. This aims to address what many see as a funding gap for start-ups between the 'family and friends' round of funding to the seed round.

Under the proposed rules:

• A company could raise up to a maximum aggregate amount of $1m through crowdfunding over a twelve month period.

Investors over a 12-month period could invest up to:

• $2,000 or 5 per cent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000; or

• 10 per cent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Investors are to be protected through the regulation of intermediaries. Under the JOBS Act there is a condition that crowdfunding transactions occur on SEC approved and registered platforms, referred to as a 'funding portals'. Thus, intermediaries will be obligated to, inter alia, educate investors, take active measures to limit the potential of fraud, as well as, provide information on the securities being issued and the issuer themselves.

Not to be outdone by the SEC, in the UK, the Financial Conduct Authority (FCA) released consultation paper 13/13 on its approach to crowdfunding and 'similar activities' (including P2P lending). This consultation was a welcomed steer from stakeholders, as crowdfunding now represents a market worth about £360m in the UK

Among proposals outlined in the paper are requirements that crowdfunding portals shall be restricted in the type of retail clients they communicate direct offers of financial promotions in unlisted shares or debt securities to.

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By restricting crowdfunding, the FCA has thrown the baby out with the bathwater

Edward Griffiths, partner at law firm DLA Piper, argues that new proposals from the FCA are in direct conflict with the democratic nature of crowdfunding

The type of retail clients would include: 'sophisticated' investors (those that are certified or self-certify, as such); those who are certified as high net worth investors; investors who agree that they will seek investment advice; and those who certify that they will not invest more than 10 per cent of their net investible portfolio in such types of securities. This is in conjunction with the requirement to disclose important information about the investment, thereby using education as a safeguard for investors.

The FCA posits that this reflects a prudent position in a market where "...100 per cent capital loss is more likely than not...' and 50-70 per cent of new businesses fail in their early years".

Taking into consideration that one of the overall aims of crowdfunding is to allow the average person to invest in companies they would otherwise not have access to, the proposals could be seen as being in direct conflict with the democratic nature of crowdfunding.

By espousing restrictions on the type of investor that can participate to those investors who are 'sophisticated' and of high net worth, the FCA, although minded to protect the public, might have thrown the baby out with the bathwater.

This is in contrast to the bullish stance which it seems the SEC is projecting. Bearing that in mind, both regimes seek to limit overall investment to a 10 per cent cap, the SEC basing the figure on net worth (for those in the upper category), while the FCA on total portfolio. It will be of great interest to see how both regimes will operate as the respective frameworks materialise, with the FCA set to publish their rules in a Policy Statement Feb/March 2014 in response to the consultation.

Regardless, crowdfunding is flourishing in both jurisdictions and it is here to stay.

Of recent note, Seedrs has been an interesting case, having just expanded its funding opportunities to include European companies, as well as crowdfunding for its own growth. The UK tech community is clearly behind the idea, with the likes of the City of London, UK Trade and Investment and UK Business Angels Association, all backing various crowdfunding initiatives.

The take-home message is that crowdfunding is now clearly a genuine means for start-ups and SMEs to build their business and the recent approaches from both the SEC and FCA add further credence to this exciting and egalitarian method of finance.

Edward Griffiths is a partner at law firm DLA Piper