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SEC Clears a Path for a Viable Equity Capital Marketplace with Second No-Action Letter on Angel Crowdfunding

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When the SEC followed up its March 29 “No-Action” letter to an online angel investment platform with a second letter a day later addressing the same issue to a different online angel funding startup, it did something that no-action letters aren’t supposed to do: it made policy. And by successively offering to stand-down from enforcement of the onerous broker-dealer rules governing most equity offerings, it cleared a path, albeit rock-strewn and circuitous, toward a viable crowdsourced equity market – something that the agency has been unable or unwilling to do within the mandates of the JOBS Act. The message delivered by the agency in those letters to the FundersClub and AngelList online angel funding websites was that small but not insignificant amounts of investment capital may be aggregated together through online networks and restricted equity securities distributed in return, without registering as a broker-dealer or as a JOBS Act “crowdfunding portal,” FINRA’s soon-to-be Cinderella stepchild. William Carleton, an attorney that has watched the JOBS Act implementation closely and regularly writes about it at Crowdsourcing.org and his own blog, calls the publication of the two letters “momentus.” While cautioning that no-action letters only establish a “green zone” within which certain activities are allowed given specific conditions and contexts, he still nonetheless believes they were meant to sketch out a framework for exempted crowd fund-raising and investment. “[I]t is fair to say that no-action letters are rarely, if ever, as high profile as these two,” Carleton wrote.

Legal
crowdfunding

Online Angel Funding Model Greenlighted by SEC?

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While rulemaking to implement the equity crowdfunding mandates of the JOBS Act remains in limbo awaiting the seating of a new SEC chair, the agency moved last week to approve an online angel funding group’s compensation model that would be exempt from some of the JOBS Act’s more costly and vexing requirements for crowdfunding platforms. The approval of FundersClub’s “carried interest” model  paves the way for angel platforms to begin raising funds from accredited crowd investors immediately. In a No-Action letter published last week the SEC said that FundersClub’s proposed compensation model, which relies solely on carried interest in its funded companies, qualified for the angel platform exemption from registration, general solicitation and broker-dealer requirements for Title II and III equity crowdfunding platforms in the JOBS Act’s Section 201(c). The SEC’s move is significant because it allows online funding platforms that restrict their investors to bona fide accredited investors and only take compensation from the investment gains of stakes held in the platform’s portfolio companies to begin fundraising immediately without further rulemaking from the agency. The rulemaking to implement Title II-style equity crowdfunding has been stalled for seven months after the SEC released a proposed rule addressing the mandated repeal of the general solicitation rule for restricted securities which was widely criticized as opening the flood gates to fraud. Former SEC chair Mary Shapiro left the agency in December without finalizing the repeal of the solicitation rule, reportedly fearing a repeal would ruin her legacy as a securities regulator.

Legal

Tonga Ruling Sheds Light on the Bad Old Ways of the Structured PIPE Market

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Whatever the relative merits and ultimate disposition of the legal arguments Cannell Capital intends to use to appeal yet again a federal judge’s ruling that the San Francisco-based hedge fund manager violated the Section 16(b) short-swing insider trading rule and is liable to disgorge nearly $5 million in profits from a 2004 variable-priced convertible financing of a small Texas-based digital mapping company called Analytical Surveys, the public appeals by J. Carlo Cannell that his fund’s investments were long-term value-based investments that “saved the company” don’t pass the sniff test. Indeed, the most cursory inspection of the events that transpired at Analytical Surveys in the aftermath of Cannell’s involvement illustrates much of what is wrong with the structured PIPE market, then and now, from the perspective of shareholders seeking sustained growth of common equity. In an early June decision by the U.S. Second Circuit Court of Appeals in the case of Analytical Surveys vs. Tonga Partners LP, Cannell Partners LLC and J. Carlo Cannell (No. 09-2622-cv), a three-judge panel re-affirmed a 2009 district court ruling from the Southern District of New York that Cannell Capital, its sole managing member Mr. Cannell, and its fund Tonga Partners were liable for Section 16(b) trading violations in Analytical Surveys totaling $4.96 million in profit disgorgement to the company, now known as Axion International Holdings (AXIH).

Markets

Emerging Growth Capital Rebounds in Q1

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Investment activity in U.S.-listed emerging growth companies via equity private placements surged 77% in the first quarter, while the average size of new placements rose 24% to more than $5.5 million, an impressive rebound from the final quarter of 2011. Even more impressive was the flood of money into growth-oriented “unstructured” equity private placements (EPPs) in emerging growth companies by long-term fundamental investors, which rose 268% over the previous quarter to $5.88 billion, representing 73% of all capital invested via equity-linked private offerings in U.S. public companies.1

The flow of growth-oriented private placement capital into emerging growth companies2 has eclipsed traditional “structured” private placement (i.e. “financial PIPE”) activity in the EPP market in terms of the percentage of deals and dollars for the second straight quarter, as growth capital investors embrace EPPs as an efficient vehicle to acquire and nurture positions in up-and-coming public companies. Unstructured equity private placements, unlike their financially-engineered structured cousins that once dominated the EPP market, are aligned with common shareholder interests and contain no variable conversion prices, resets, pre-sold equity line puts, or offsetting hedges that disengage structured investors’ returns from those of common shareholders. Fueling this trend are venture capital, private equity and other “long-only” and long-term growth-focused investors, which have embraced the EPP market and are providing leadership in identifying and nurturing high-growth companies during their earliest stages of post-private life. These “sponsored” growth capital EPPs, which include at least one fundamental investor that is primarily a venture capital, private equity, mutual fund, family office or corporate strategic investor, accounted for 31 deals comprising $3.81 billion in capital in the first quarter, with the median placement valued at more than $15 million.