•  Revise the franchise disclosure document delivery requirements in RCW 19.100.030 and 19.100.080 to be consistent with the delivery requirements set forth in the FTC’s Franchise Rule at 16 CFR § 436.2;
• Replace references to the “offering circular” throughout the Act with “disclosure document” consistent with the terminology used in the FTC’s Franchise Rule;
• Create two new definitions that expressly provide for electronic filings;
• Adopt the FTC’s definition of “prospective franchisee;” and
• Revise the timing for requesting a hearing from fifteen to twenty calendar days consistent with the requirements set forth in Washington’s Administrative Procedure Act at RCW 34.05.413.

 The effective date of these amendments is June 7, 2012.  If you have any questions regarding these amendments, please contact Faith Anderson by e-mail at faith.anderson@dfi.wa.gov or by telephone at (360) 725-7825.

Crowdfunding

The Internet has become an inexpensive and easy way for individuals and businesses to raise money for their activities. Congress recently passed the JOBS Act, which directs the Securities and Exchange Commission (SEC) to create rules exempting crowdfunding from the securities registration laws. Once implemented these rules will remove restrictions on start-up companies seeking investors over the Internet. Investors should be on the lookout for unscrupulous issuers and intermediaries who may attempt to engage in crowdfunding before the rules are written or misuse crowdfunding to steal from investors through false and misleading representations.

What is Crowdfunding?

Crowdfunding is an online money-raising strategy that began as a way for the public to donate small amounts of money, often through social networking websites, to help artists, musicians, filmmakers and other creative people finance their projects. The concept has recently been promoted as a way of assisting small businesses and start-ups looking for investment capital to help get their business ventures off the ground.

Traditionally, investment opportunities are offered by professionals, such as broker-dealer firms and investment advisers, who must recommend investments that are based on their clients’ investment objectives and levels of sophistication. Through crowdfunding, individuals are able to invest in entrepreneurial start-ups through an intermediary, such as a broker-dealer or a “funding portal.” By law, “funding portals” are not allowed to provide investment advice.

What is a funding portal?

A funding portal is a website, also called a “platform,” that advertises the investment opportunities and facilitates the payment from the investor to the issuer. Some portals advertise a variety of investment opportunities on one website, allowing the investor to select one or more projects in which to invest.

How Crowdfunding Works

Joe’s small business sells goat cheese made from his special pygmy goats. To keep his business afloat or to help it grow, Joe can turn to the Internet to seek online donations from the public who contribute small amounts of money and expect nothing in return. Joe usually sends a sample of his cheese as a thank you for the donation; large donors might even get a cheese named in their honor.

New legislation has directed the SEC to write rules that will change how Joe can raise money online. Once the rules are written, Joe will be able to use the Internet to raise up to $1 million each year by selling investments in his company to thousands of investors. Because Joe will be issuing shares in his company in exchange for investment capital, his supporters are no longer donors; they become investors and will expect a financial return for their investment.

Why Investors Must be Extremely Cautious About Crowdfunding Investments

• Crowdfunding investments cannot be offered legally until the SEC adopts rules to permit them. Beware of offerings that seek investments immediately.
   
• All investments have risk, but small business investments have even greater risk than normal. About 50 percent of all small businesses fail within the first five years.
   
• Issuers using funding portals to raise money may be inexperienced. Their track records maybe unproven, unsubstantiated or outright fraudulent.
   
• The information about the investment is limited to what is provided through the funding portal. Investors may need to rely on their own research to determine the issuer’s track record.
   
• Because state regulators are not allowed to review crowdfunding issuers or their offerings, full and complete disclosure may not be available to investors.
   
•  Investors may have limited legal ability to take action against the issuer should the investment not perform as represented. Due to limited regulatory oversight over these offerings, investors may be left on their own to pursue costly private lawsuits when things go wrong.
   
• Crowdfunding investments are mostly illiquid and investors must be prepared to hold their investments indefinitely. It also may be difficult or impossible to resell these securities due to the lack of a secondary market.
   
• Funding portals must be registered with the Securities and Exchange Commission (SEC), belong to a self-regulating organization (SRO), and comply with other rules the SEC may issue.
   
• Crowdfunding portals claiming an accreditation or “seal of approval” from a standards program or board may not be legitimate.

The Bottom Line

It pays to be skeptical of investment opportunities you learn about through the Internet. When you see an offering on the Internet — whether it is on a funding portal, in an
online newsletter, on a message board or in a chat room — you should be cautious until you have done your homework and proven that it isn’t a scam. If you have any questions about crowdfunding offerings, contact your state or provincial securities regulator. For contact information, click here.

Download this Informed Investor Advisory
Posted: May, 2012 

Crowdfunding is an online money-raising strategy that began as a way for the public to donate small amounts of money, often through social networking websites, to help artists, musicians, filmmakers and other creative people finance their projects. Through the Jumpstart Our Business Startups (JOBS) Act, small businesses and entrepreneurs will be able to tap into the “crowd” in search of investments to finance their business ventures.

“Because the potential for fraud is significant, investors must be extremely cautious about crowdfunding investments,” said Jack E. Herstein, NASAA president and assistant director of the Nebraska Department of Banking & Finance Bureau of Securities.

Congress enacted the JOBS Act last month and directed the Securities and Exchange Commission (SEC) to adopt rules within 270 days to implement a new exemption to allow crowdfunding. Until the rules are adopted, “any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws,” according to a recent SEC release.

“Before the SEC rules are adopted, investors should beware of promoters who jump the gun by offering investments through crowdfunding now,” Herstein said. “Once exempt, crowdfunding investments will not be reviewed by regulators before they are offered to the public, nor will they be required to provide the same level of disclosures to investors or regulators required of securities offerings. Investors will need to prepare themselves to be bombarded with all manner of offerings and sales pitches.”

Herstein said Congress created a similar investor trap in 1996 with the passage of the National Securities Markets Improvement Act (NSMIA), which prohibited states from reviewing private offerings made under SEC Regulation D Rule 506 before they were sold to the public.

“Since NSMIA, the provisions of Rule 506 and other limited or private offering provisions have been used – and continue to be used – by unscrupulous promoters to fleece investors,” Herstein said, noting that state enforcement records show these offerings to be the most frequent source of enforcement cases handled by state securities regulators.

 “If history is any guide, investors can expect a similar experience with crowdfunding investments,” Herstein said. “We hope to limit the damage by raising awareness among investors of the potential pitfalls of investing through crowdfunding.”

Herstein also announced that NASAA has created a new task force to focus on Internet fraud. The Internet Fraud Investigations Project Group, within NASAA’s Enforcement Section, was formed to monitor crowdfunding and other Internet offerings. The task force is chaired by Minnesota Securities Director Robert Moilanen.

Investors with questions about crowdfunding offerings should contact their state or provincial securities regulator before investing. Contact information is available on the NASAA website here.

– NASAA –

For more information:
Bob Webster, Director of Communications
202-737-0900 

“The regulation of investment advisers long has been the shared responsibility of state and federal securities regulators. Chairman Bachus believes a self-regulatory organization for investment advisers is necessary because the federal government has not provided proper oversight over larger advisers, but his bill also would require state-registered advisers to become members of his new SRO. The creation of an SRO for state-regulated investment advisers is a misguided solution to a problem that does not exist. 

“There has never been any evidence to suggest that states have failed in their mission of regulating smaller investment advisers. Nonetheless, this bill dictates how each state should regulate smaller advisers and requires state-regulated advisers to join a national SRO. The Bachus bill is an astonishing attack on our system of federalism with no demonstrated justification. 

“While there have been marginal improvements from the draft Chairman Bachus released last September in the areas of conflicts of interest and information sharing, the nationalization of small and mid-sized investment adviser regulation would be a mistake that neither benefits investors nor promotes small business interests. Shifting their regulation to a central office would subject these small businesses to redundant regulation and add unnecessary costs to support this new bureaucracy. State securities regulators are best positioned to be the primary regulatory for small and mid-sized investment advisers.”

For more information:
Bob Webster, Director of Communications
202-737-0900 

“This year’s conference spotlights the challenges facing investors, regulators and securities industry professionals in an era of rapid technological innovation,” said Jack E. Herstein, NASAA President and Assistant Director of the Nebraska Department of Banking & Finance, Bureau of Securities. 

Herstein announced that NASAA is honored to have Representative Maxine Waters (D-CA) address this year’s conference. Rep. Waters serves as a Chief Deputy Whip and as a member of the Steering and Policy Committee, making her an integral part of the House Democratic Leadership. She also serves as a member of the Financial Services Committee and as Ranking Member of the Subcommittee on Capital Markets and Government Sponsored Enterprises. 

This year’s conference also features two panel discussions: “The JOBS Act: Future Implications for Investors” and “Social Media for Financial Professionals.” 

The first panel brings together leading securities law experts, investor advocates and regulators to analyze the broad spectrum of changes that the JOBS Act will herald, issues that should be addressed in the implementation process and the future implications for retail investors. 

Moderated by NASAA Vice President and Arkansas Securities Commissioner Heath Abshure, the panel includes: William Black, associate professor of economics and law, University of Missouri-Kansas City School of Law; Robert Pozen, senior lecturer of business administration, Harvard Business School, and senior research fellow at the Brookings Institution; Jeffrey Mahoney, general counsel, Council of Institutional Investors; and Lynn Turner, managing director, LitiNomics, and former chief accountant at the Securities and Exchange Commission. 

During the second discussion, a panel of regulatory and industry experts will explore social media policies and practices along with the benefits and compliance challenges social media presents in today’s financial services marketplace. Moderated by Marc Minor, bureau chief, New York Investor Protection Bureau, the panel features Mitchell Bompey, executive director, Morgan Stanley Smith Barney; Scott Peterson, co-founder, Relay Social Media LLC; and Thomas Selman, executive vice president of regulatory policy, FINRA. 

The conference also features a luncheon with a keynote speaker. On-site registration begins at 10 a.m. and the keynote luncheon follows at 11:30 a.m. The general session begins at 1:30 p.m. and is scheduled to conclude at 4:30 p.m. 

For more information:
Bob Webster, Director of Communications
202-737-0900 

After considering the comments, the Franchise Project Group has concluded that, in general, the Model Exemptions strikes the right balance between the desirability to reduce compliance burdens on franchisors and the need for prospective franchisees to review a Franchise Disclosure Document in appropriate cases, in order for franchisees to make an informed investment decision. The Franchise Project Group has determined, however, in light of several comments, to propose revisions to specific Model Exemptions. Some of the proposed revisions are technical corrections or changes to form only.  Other revisions are more substantive.  Proposed revisions to the Model Exemptions open to further comments appear below.  Proposed additions to the Model Exemptions appear in underlined text.  Proposed deletions appear in strike out text.

The comment period will remain open for 30 days.  Accordingly, all comments should be submitted on or before May 16, 2012.  Comments should be submitted by email or in writing and addressed to:

Franchise and Business Opportunity Project Group

Dale Cantone, Chair
Office of the Attorney General
Division of Securities
200 St. Paul Place, 20th Floor
Baltimore, MD 21202-2020
dcantone@oag.state.md.us

NASAA Legal Department

Joseph Opron, Counsel
NASAA
750 First Street, NE, Suite 1140
Washington, DC  20002
jjo@nasaa.org

Download: Revised Proposed Model Franchise Exemptions

Background of Proposed Revisions to Model Franchise Exemptions

A.    Fractional Franchise Exemption.

In light of several comments, the Franchise Project Group determined that the language of the model Fractional Franchise Exemption should be revised to clarify that the exemption anticipates an annual filing, as opposed to a separate filing for each proposed exempt transaction. Therefore, the Project Group has revised the language of this exemption to state specifically that the exemption requires an annual notice filing that, once made, expires after a period of one year from the date of the notice of exemption, and that the exemption may be claimed for additional one year periods. 

In light of comments from Starbucks Corporation, the Project Group concluded that it is impractical under the model Fractional Franchise Exemption to require state administrators to determine from a notice filing whether a “reasonable basis” exists for the parties to anticipate sales volume sufficient to qualify for the exemption. Therefore, the Franchise Project Group has revised the exemption to clarify that the administrator does not evaluate, in advance, anticipated sales volume of a proposed transaction, but that, in order to qualify for the exemption, both parties to the transaction must be capable of demonstrating that the franchisee can derive 80% of its total dollar volume in sales during the first year of operation independent of the franchise relationship.

B.     Experienced Franchisor Exemption.

Starbucks Corporation commented on a requirement under the model Experienced Franchisor Exemption for franchisors to file financial statements to demonstrate net equity in every instance. Starbucks notes that when a franchisor is a subsidiary of a “corporate family” the franchisor may not have separate financial statements of its own because the parent prepares consolidated financial statements. The Project Group agrees that the exemption should clarify how a subsidiary franchisor can establish net equity when separate financial statements do not exist for this reason. As a result, the Franchise Project Group has revised the exemption to allow a franchisor to submit a statement by an officer confirming a franchisor’s net equity if the franchisor does not prepare its own audited financial statements because its parent prepares consolidated statements. 

Several state examiners expressed concern that the language of the model Experienced Franchisor Exemption may not describe accurately the financial condition a franchisor must demonstrate in order to qualify for the exemption. The Project Group intended that if a franchisor’s audited financial statements contained a going concern note, the franchisor should not qualify for this exemption.  Therefore, the Project Group has added a subsection to the exemption that audited financial statements required under the model Experienced Franchisor Exemption cannot contain a going concern explanatory paragraph.  

C.    Sophisticated Franchisee (Accredited Investor) Exemption.

Several commenters suggested that NASAA revise the model Sophisticated Franchisee Exemption to delete a requirement that prospective sophisticated franchisees be represented by legal counsel.  Commenters suggest, among other things, that franchisees can determine for themselves the need to consult legal counsel. In response, the Project Group has revised the exemption to include an optional provision, to allow each state adopting the exemption to decide whether or not to require sophisticated franchisees to have legal counsel as a condition of granting the exemption.  The Project Group determined that if different states made different policy determinations on this isolated requirement, that distinction would not be a significant detraction from the goals of uniformity.  

In addition, several commenters stated that it is unduly burdensome to require that sophisticated franchisees have financial statements prepared under U.S. GAAP, and that franchisors should be able to rely on facially valid financial statements of a sophisticated franchisee without having to assume the risk that the statements do not comply with U.S. GAAP.  The Project Group agrees, and we have deleted the requirement from this model exemption.

D.    Discretionary Exemption.

Charles Modell suggests that the requirement for claiming a discretionary exemption under the model may prove problematic for applicants and administrators.  He notes that the model Discretionary Exemption requires the submission of a proposed order of exemption, and he suggests that most applicants are not able to prepare proposed orders in the form acceptable to the administrator.  The Project Group agrees with this observation, and we have deleted the requirement in the exemption for applicants to submit a proposed order. 

WASHINGTON (April 5, 2012) – Congress and the White House have sacrificed investor protection, the North American Securities Administrators Association (NASAA) said today.

“The JOBS bill the President signed today is based on faulty premises and will seriously hurt all investors by either eliminating or reducing transparency and investor protections.  It will make securities law enforcement much more difficult,” said Jack E. Herstein, NASAA President and Assistant Director of the Nebraska Department of Banking & Finance, Bureau of Securities. “Investors need to prepare themselves to be bombarded with all manner of offerings and sales pitches.  Congress has just released every huckster, scam artist, and small business owner and salesman onto the internet,” Herstein added.

Herstein’s comments followed the signing by the President of the “Jumpstart Our Business Startups (JOBS) Act” (H.R. 3606), which was approved last month by the House of Representatives and Senate.  The White House played a key role in developing the legislation and urged its expedited passage by Congress, despite warnings voiced by securities regulators, law professors, economists, investor protection advocates, and others.

“Election-year politics have blinded Congress and the White House to the unintended consequences of their actions, which, however well intentioned could open the floodgates to investment fraud,” Herstein said.  

NASAA also expressed skepticism about the legislation’s ability to create new jobs and stimulate the economy, questioning its underlying assumption that burdensome regulations are inhibiting investment in small business and stifling job growth.

“Rather than creating a transparent marketplace where investors receive trustworthy information that facilitates investment, the JOBS Act reduces the amount of reliable information available to investors.  By allowing general advertising of nonregistered offerings with little or no regulatory oversight, the JOBS Act facilitates a noisy and confused market that will diminish rather than rebuild investor confidence,” said Heath Abshure, NASAA Vice-President and Arkansas Securities Commissioner.  “At a time when a reasonable regulatory presence is necessary to rehabilitate the markets, the JOBS Act reduces the regulatory presence by preempting the states from acting to protect their citizens.”

JOBS Act’s Crowdfunding Exemption Prevents States from Policing a New and Risky Market

NASAA’s sharpest criticism was aimed at portions of the bill that require the SEC to establish a registration exemption for “crowdfunding.”  Issuers who use the crowdfunding exemption will be required to disclose a minimal amount of information to the SEC, but the bill includes a provision, strongly opposed by NASAA, that will preempt state securities regulators from reviewing or registering securities sold under the “crowdfunding” exemption in their states. 

State securities regulators do not object to the concept of crowdfunding; in fact, NASAA had since last year been working on a model rule that would permit crowdfunding while preserving a state’s ability to prevent scam artists from exploiting Main Street investors.  Because the JOBS Act preempts the states from regulating crowdfunding, the SEC will be solely responsible for policing the new market and deterring fraud.

“Lacking adequate funding, the SEC has neither the resources nor the time to effectively police these relatively small, localized securities offerings before they are sold to the public,” Herstein said. “As a result, crowdfunding offers are likely to receive little regulatory scrutiny until after a fraudulent sale has been committed. This is an investor protection disaster waiting to happen.”

Herstein said Congress made a similar mistake in 1996 with the passage of the National Securities Markets Improvement Act (NSMIA), which preempted state authority to review private offerings made under Securities and Exchange Commission Regulation D Rule 506 and created a regulatory “black-hole” by entrusting the SEC to police these offerings.

“Since NSMIA, the provisions of Rule 506 and other limited or private offering provisions are being used by unscrupulous promoters to evade review and fly under the regulatory radar with little scrutiny by the SEC,” Herstein said.  In a 2009 report, the SEC’s Office of the Inspector General concluded the agency does not give these offerings a substantive review and “does not generally take action” when it learns that issuers have failed to comply with the requirements of the Regulation D exemptions.

State enforcement records show that Regulation D Rule 506 offerings are the most frequent source of enforcement cases handled by state regulators. In the past three years, state securities regulators have reported 580 enforcement actions involving these offerings, according to NASAA’s 2011 enforcement survey.          

“The notion of crowdfunding as originally conceived is a relatively innocuous way to promote creativity,” said Steve Irwin, Chairman of NASAA’s Committee on Federal Legislation and Pennsylvania Commissioner of Securities.  “But the crowdfunding exemption enacted in the JOBS Act is rife with risk, not only for the investors who think they are getting on the ground floor of the next Google or Facebook, but for the countless targets of unscrupulous con artists playing on the unsophisticated, gullible, and vulnerable.”

“By preempting states, the JOBS Act takes the handcuffs away from state regulators and puts them on us,” Irwin added.  “Although intended to stimulate the economy, if recent history is any guide the JOBS Act may once again show how hasty and unreasonable deregulation often leads to disastrous results.” 

#####

For more information:
Bob Webster, Director of Communications
202-737-0900

WASHINGTON, D.C., April 4, 2012 — The North American Securities Administrators Association (NASAA) today announced that a settlement has been reached between Bankers Life and Casualty Company and state securities regulators concluding an investigation of unlicensed/unregistered brokerage activity by the insurance company. 

“This joint investigation is typical of the aggressive, cooperative and coordinated investor protection actions of state securities regulators and demonstrates the ongoing value of states working together to benefit investors nationwide,” said Jack E. Herstein, NASAA President and Assistant Director of the Nebraska Department of Banking & Finance, Bureau of Securities. 

The Chicago-based company agreed that it, along with its BLC Financial Services, Inc. (BLCFS) subsidiary, will not engage in the hiring, training or supervision of any registered representatives or investment adviser representatives through March 31, 2015. 

“During this ‘quiet period,’ Bankers Life has agreed not to engage in a violative activity and must refrain from all brokerage activity. The firm also has agreed to hire an independent consultant to verify compliance,” Herstein said. 

Bankers Life also agreed to withdraw the registration of its brokerage subsidiary with the Securities and Exchange Commission and will terminate its membership with FINRA. 

The state investigation determined that in 2005, Bankers Life entered into an agreement with UVEST Financial Inc. under which Bankers Life insurance agents who became licensed as registered representatives and/or investment adviser representatives of UVEST would provide brokerage and investment advisory services out of the insurance firm’s branch offices. In 2010, Bankers Life entered into a similar arrangement with ProEquities, Inc., a broker-dealer based in Birmingham, Alabama. 

State investigators determined that Bankers Life engaged in brokerage and investment adviser activity, despite not being registered, by affiliating with licensed brokers or other firms and directing the operations, hiring, training, production selection and sales techniques of those firms.           

State securities regulators determined that Bankers Life received approximately $21 million from the two brokerage firms for variable annuity and securities transactions and investment advice between 2005 and 2011. 

The settlement calls for Bankers Life to pay $9.9 million to be disbursed among the states where its dual agents were located between 2005 and 2011. The firm also agreed to pay $375,000 to reimburse the states for the cost of the investigation, $260,000 in past licensing and registration fees, and $106,000 to cover the cost of state audits to ensure compliance with the consent order. 

Similar settlements were reached with UVEST and ProEquities. UVEST agreed to pay $750,000 and ProEquities agreed to a payment of $435,000 for their role in the relationship with Bankers Life. 

“This action resulted from multi-state investigation of Bankers Life led by the Office of Securities of the Maine Department of Professional & Financial Regulation with invaluable assistance from the Bureau of Securities Regulation of the New Hampshire Department of State, the Division of Securities of the Missouri Office of the Secretary of State, and the Vermont Department of Banking, Insurance, Securities & Health Care Administration,” Herstein said. “NASAA applauds their efforts to bring this matter to a swift resolution.” 

NASAA is the oldest international organization devoted to investor protection. Its membership consists of the securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico.

For more information:
Bob Webster, Director of Communications
202-737-0900 

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires investment advisers with assets under management of between $25 million and $100 million to switch from federal to state registration by mid-2012. Under the new law, investment advisers currently registered with the Securities and Exchange Commission must notify the agency of their eligibility to remain registered by March 30, 2012. Investment advisers that are no longer eligible for registration with the Securities and Exchange Commission must switch to state registration by June 28, 2012. 

“State securities regulators are pleased to provide this new resource, which is further evidence of our dedicated effort to assist advisers in making the switch from SEC to state registration,” said Jack E. Herstein, NASAA President and Assistant Director of the Nebraska Department of Banking and Finance Bureau of Securities. 

The online IA Registration Resource is available on the IA Switch Resource Center on the NASAA website at www.nasaa.org. The resource contains information about individual state registration fees, financial and bonding requirements, requirements for sole proprietorships and branch offices, de minimis requirements and other required documents. 

“Investment advisers and their counsel should consult the laws and rules in each state in which they are registering to verify the accuracy of the information,” Herstein said, noting that NASAA is providing the information as a convenience and not as legal advice. 

To further assist advisers in the switch from SEC to state registration, Herstein announced that NASAA has extended its coordinated review initiative by one month to April 30. 

The Investment Adviser Coordinated Review Program is open to SEC-registered investment advisers switching their registration to between four and 14 states. Under Dodd-Frank, investment advisers registered in 15 or more states can remain with the SEC. To participate, eligible investment advisers must complete and submit the Coordinated Review Form found in the IA Switch Resource Center on the NASAA website in addition to filing all materials required by the states in which the adviser is applying for registration. There is no additional cost to use the program. 

For more information:
Bob Webster, Director of Communications
202-737-0900 

WASHINGTON (March 22, 2012) – Congress and the White House have sacrificed investor protection for politics and are in danger of repeating a legislative mistake that has allowed promoters of fraudulent securities offerings to steal millions of dollars from investors since 1996, the North American Securities Administrators Association (NASAA) said today. 

“The JOBS Act passed today by the Senate remains the fundamentally flawed product of a rush to legislate. It ignores the united and urgent pleas of leading national consumer and investor advocates not to roll back critical investor protections,” said Jack E. Herstein, NASAA President and Assistant Director of the Nebraska Department of Banking & Finance, Bureau of Securities. 

“This legislation will needlessly expose Main Street investors to greater risk of fraud by creating new jobs for promoters of Internet investment scams. Unfortunately, many investors may be harmed before this mistake is corrected,” Herstein said. 

Herstein’s comments followed the approval of the Senate’s amended version of the “Jumpstart Our Business Startups (JOBS) Act” (H.R. 3606), which was approved earlier this month by the House of Representatives. The amended legislation has been sent back to the House. 

“Election-year politics have blinded Congress and the White House to the unintended consequences of their actions, which however well intentioned could open the floodgates to investment fraud,” Herstein said. 

“NASAA appreciates the efforts of those in the Senate who attempted to strengthen investor protections in certain areas. But we are deeply troubled that this bill fails to correct the oversight gap in the House-passed legislation by needlessly preempting states from reviewing crowdfunding offerings before they are sold to investors,” Herstein said. Crowdfunding is an Internet-based fundraising technique promoted by the White House as a new tool for raising money for small and startup businesses.  

“Preempting state authority is a very serious step and not something that should be undertaken lightly or without careful deliberation, including a thorough examination of all available alternatives. In its quest for deregulation, the Senate rushed to judgment.” Herstein said. “In 2004, the Bush Administration preempted numerous state consumer financial protection laws in order to facilitate greater ‘financial innovation,’ especially in mortgage lending.  Most of us remember how that experiment ended, but it seems that Congress has already forgotten.” 

State securities regulators do not object to the concept of crowdfunding, Herstein added, noting that NASAA has since last year been working on a model rule that would permit crowdfunding while preserving a state’s ability to prevent scam artists from exploiting Main Street investors. 

“Lacking adequate funding, the SEC has neither the resources nor the time to effectively police these relatively small, localized securities offerings before they are sold to the public,” Herstein said. “As a result, crowdfunding offers are likely to receive little regulatory scrutiny until after a fraudulent sale has been committed. This is an investor protection disaster waiting to happen.” 

Herstein said Congress made a similar mistake in 1996 with the passage of the National Securities Markets Improvement Act (NSMIA), which preempted state authority to review private offerings made under Securities and Exchange Commission Regulation D Rule 506 and created a regulatory “black-hole” by entrusting the SEC to police these offerings. 

“Since NSMIA, the provisions of Rule 506 and other limited or private offering provisions are being used by unscrupulous promoters to evade review and fly under the regulatory radar with little scrutiny by the SEC,” Herstein said.  In a 2009 report, the SEC’s Office of the Inspector General concluded the agency does not give these offerings a substantive review and “does not generally take action” when it learns that issuers have failed to comply with the requirements of the Regulation D exemptions. 

State enforcement records show that these offerings are the most frequent source of enforcement cases handled by state securities regulators. In the past three years, state securities regulators have reported 580 enforcement actions involving Regulation D Rule 506 offerings, according to NASAA’s 2011 enforcement survey.           

“Under current law, states can only take action after a fraudulent sale is made. That’s little comfort to an investor whose money has been stolen,” Herstein said. “The Senate missed an opportunity to avoid making the same mistake with crowdfunding. Instead of preempting states, Congress should allow the states to take a leading role in implementing an appropriate regulatory framework for crowdfunding,” Herstein said. 

“Expanded access to capital markets for startups and small businesses can be beneficial if done reasonably and only if investors are confident that they are protected, that transparency in the marketplace is preserved and that investment opportunities are legitimate,” Herstein said. “States are the only regulators in a position to effectively police the small emerging crowdfunding market and protect its participants.”

For more information:
Bob Webster, Director of Communications
202-737-0900