State Crowdfunding: The SEC’s Proposed Rules

I overreacted a bit in my last blog post when I said that Washington State’s crowdfunding law might be statutorily “broken” if the SEC’s proposed rules on Rule 147 were adopted.

If you are not familiar with how the securities laws in this area are written, Rule 147 is the rule that interprets Section 3(a)(11) of the Securities Act. Almost all state crowdfunding laws that have been enacted have based compliance with their law on compliance with Section 3(a)(11).

Now the SEC has proposed that Rule 147 be removed as a safe harbor from Section 3(a)(11). Rule 147 would disappear and become its own stand-alone exemption. Section 3(a)(11) would not have an underlying set of regulations that interpret it and provide a safe harbor for compliance. This would put companies trying to raise money in a state crowdfunding offering in an tougher spot than they are in right now, because there is very little guidance under Section 3(a)(11), and application of the statute is unclear.

So by removing the Rule 147 safe harbor, the SEC is removing a pillar in the support beams for state crowdfunding.

The SEC is accepting comments on its proposed rules. The SEC in fact suggested something in its proposed rules that made a lot of sense. Here is what the SEC asked:

Should we leave existing Rule 147 in place and unchanged as a safe harbor for compliance with Section 3(a)(11) while adopting the proposed revisions to Rule 147 as a new rule instead? For example, if we were to repeal Rule 505 of Regulation D, should the Commission adopt the proposed revisions to Rule 147 as new Rule 505 of Regulation D?

This is exactly what the SEC should do (as long as moving the new proposed Rule 147 to Rule 505 also doesn’t somehow cause problems with the state crowdfunding statutes).

But the SEC should also take parts of their proposed rules that do not violate Section 3(a)(11), and they should port those into existing Rule 147. For example, proposed Rule 147 has a better, more flexible definition of what constitutes an in-state business.

If you want to know exactly why the SEC’s proposed rules would harm the Washington crowdfunding statute, this is why:

Section 3(a)(11) requires that companies using it:

  • be incorporated in the state in which they are conducting the offering; and
  • not sell OR offer any securities outside of the state in which the offering is being conducted.

The requirement that you not offer your securities across state lines is difficult. How do you advertise your offering on the Internet if you can’t make the “offer” to anyone outside of your state. The SEC would fix this problem in its proposed rules, and I applaud that. But there is no reason to upset existing Rule 147 to do so.

Dear SEC:

Please leave the existing Rule 147 safe harbor to Section 3(a)(11) in place. Please adopt your proposed rules as the new rule somewhere else that will not harm state crowdfunding statutes.

If you keep existing Rule 147 in place, you will avoid harming state crowdfunding statutes.

You asked in your proposed rules whether the Commission’s process gave states enough time to fix their statutes in light of your proposed rules. It will not. It took two years to pass Washington’s crowdfunding bill. In other states it has taken much longer. In other states people have been trying for years and still not gotten something passed. Sometimes it is not possible to get amendments to securities law statutes through a legislature even after a dozen years of effort.

Please do not upset the currently in place state crowdfunding laws. It would be unfair to the rights of the states to set their own path for the SEC to disrupt the settled expectations of existing Rule 147.

You can still improve Rule 147 at the same time. Loosening up the 80% test is a great idea. That is something that can be changed to existing Rule 147 that will not violate Section 3(a)(11).

Thank you.

Joe Wallin

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  • Jordan Rood

    Joe, I think this does a great job of explaining why the proposed rule change would mechanically cause issues with nearly every state crowdfunding exemption (which is pretty wonky).

    The one tricky part here is that to loosen the stricture of having both the “offer and sale” be intrastate as required under the statutory language of Section 3(a)(11), I think the Commission has to move Rule 147 (as either a safe harbor or standalone
    exemption), to a new (or different) section of the ‘33 Act. Which is of course, the crux of the issue in your article, as this wouldn’t match the existing state exemptions. I suppose the Commission could also provide clear guidance how to offer
    intrastate via the internet, without running afoul of the Rule, but that seems unlikely.

    I think the suggestion to repeal 505 and replace it with Rule 147 could be an efficient solution, rather than adopting a new exemption, but it depends how it would be effected. As Rule 505 is under federal Section 3(b), if the Commission just replaces the current rule there, it would still be in conflict as the Washington Act, as the exemption is specifically predicated on the offering being Section 3(a)(11) and Rule 147 thereunder.

    It’s a tough question, and I still need to get into the weeds in the SEC release, so it’s possible there’s something in there that addresses this point.

    Though, if there was a conflict, from my experience there, the DFI is very good at getting technical amendments to match changes in federal law (such as this) through the legislature, which would be a wholly different process than the more arduous task of introducing and passing a new exemption, or other substantive changes, to the state Securities Act.

    Again, good post making clear a very technical (and problematic) result of the proposed changes to the federal securities laws, it makes sense to bring this to the attention of the Commission.

    • Good thoughts Jordan. It didn’t occur to me that moving the proposed new Rule 147 to 505 and leaving the existing Rule 147 in place could still potentially upset the apple cart. I will think on that too. Thanks!