Why The SEC Delay Over Crowdfunding Rules is Stifling Bitcoin Innovation

Brian Klein is a partner at the Los Angeles-based litigation boutique Baker Marquart LLP, the chair of the Bitcoin Foundation’s legal advocacy committee (although he is not writing here on behalf of the foundation), and a former US federal prosecutor. This article was co-authored alongside Molly White, a partner at McGuireWoods LLP in Los Angeles and a former SEC enforcement attorney.

Crowdfunding has undoubtedly become an important way for emerging and innovative companies to raise money. Look no further than Soylent (the high-profile and controversial food replacement product), which raised millions through crowdfunding.

Not surprisingly, entrepreneurs are developing bitcoin-powered companies and applications that could revolutionize both the crowdfunding field and the cryptocurrency space.

With the assistance of the bitcoin protocol, a company that wants to crowdfund can potentially avoid using current and perhaps more costly third-parties like Kickstarter and Indiegogo.

Examples of bitcoin crowdfunding platforms that are in development include Mike Hearn’s Lighthouse app and Joel Dietz’s Swarm (which describes itself as 'the Facebook of crowdfunding').

Unfortunately, crowdfunding’s (and thus bitcoin’s) ability to reach its full potential is stalled, for the time being. This is because the SEC has not yet issued rules that would allow crowdfunding as a way to sell equities in a company (ie: stock).

In April 2012, Congress enacted the Jumpstart Our Business Startups Act (or JOBS Act), legislation meant to make it easier for small businesses to raise money. One way that Congress sought to do that was to allow companies to use crowdfunding to raise up to $1 million in a 12-month period.

However, because Congress believed crowdfunding could increase the possibility of investment fraud, it put in place some significant limitations. Those measures include limiting the amount of money that an investor can invest – up to $2,000 or 5% of the investor’s annual income (whichever is greater) – as well as requiring companies to crowdfund through an intermediary and to make certain disclosures to potential investors.

Congress also directed the SEC to issue rules to implement fraud protection.

Crowdfunding through an intermediary means working with either a registered broker-dealer or a funding portal registered with the SEC. For a crowdfunding website to qualify as a funding portal and sell equities, that website will have to be a member of FINRA, be registered with the SEC, and be subject to SEC examinations. As for the disclosure requirements, they will be substantial.

In October 2013, the SEC proposed rules to govern the offer and sale of securities through crowdfunding. If those rules are enacted (as is expected), a company will have to disclose:

It is now June 2014. When Congress enacted the JOBS Act in April 2012, it gave the SEC 270 days – until January 2013 – to adopt its rules. With that date now long past, and with the passage of eight months since the SEC proposal, one can only hope that the rules will be finalized by the end of this summer.

In the meantime, offering securities in a crowdfunding campaign, regardless of the country of origin, may and likely does violate SEC regulations, among other potential problems. Failing to wait for the SEC to finish its rule making risks an SEC investigation and significant adverse consequences, potentially even criminal consequences.

The SEC needs to enact the crowdfunding rules as soon as possible. Doing so will help everyone, including bitcoin enterprises that are developing crowdfunding applications, or that are hoping to tap into crowdfunding for raising money. Innovation should not have to wait any longer.

Crowdfunding image via Shutterstock