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Advances in Technology May Prompt the SEC into Revising Securities’ Registration Requirements

In November of 2009, two advertising executives, and longtime fans of Pabst Brewing Company (“PBR”), attempted to purchase the company. The advertising executives made offers for the company, but could not approach the $300 million asking price. In order to raise capital for the buyout, the advertising executive utilized “crowd funding.” Crowd funding is the use of social media and the internet to organize a large group of individuals to achieve a common goal, in this instance, to raise capital for the purchase of a brewery. Accordingly, the advertising executives decided to solicit online pledges in exchange for a “certificates of ownership” and beer equal to the amount pledged. To that end, the advertising executives established the website to facilitate and centralize their fundraising efforts. They also formed a FaceBook page and Twitter account for to help generate interest and publicity for the buyout. Shockingly, the two advertising executives ultimately received pledges of $200 million from over five million people. While the $200 million dollars was not enough to purchase PBR, it was enough to catch the attention of the Securities and Exchange Commission (“SEC”), who in June of this year issued a Cease and Desist Order[1] against the two advertising executives for violation of federal securities laws.

Under the Securities Act of 1933, the offer or sale of securities is prohibited unless registered or exempt from registration.[2] The list of what constitutes a “security” for purposes of the Securities Act of 1933 is long, but its contours were fleshed out in the seminal Supreme Court case SEC v. Howey.[3] Under Howey, a “security” is defined as an exchange of money with an expectation of profits arising from a common enterprise which depends solely on the efforts of a promoter or third party. Clearly, under Howey, any crowd funding arrangement (like that conducted for PBR) in which people are asked to contribute money in exchange for potential profits based on the work of others would be considered a security. Consequently, the attempt to raise money by soliciting millions of small pledges from people on Facebook or Twitter in exchange for a “certificate of ownership” was in direct violation of the Securities Act of 1933.

Likely given the amount of time, effort and cost associated with registering their “certificates of ownership,” the advertising executives unsurprisingly ignored this requirement, and took their capital raising efforts directly to the people.[4] An alternative method of complying with federal securities laws may have been available if the advertising executives, and similarly situated crowd funders, would have used an exemption from the registration requirement, such as those afforded under Regulation D. However, given the facts and circumstances surrounding the offering, it is doubtful as to whether they would have qualified for an exemption.

Current Regulatory Framework: Rules 504, 505 and 506 under Regulation D of the Securities Act of 1933 are the most commonly used exemptions to avoid the registration requirement. Summarily, Rule 504 provides an exemption for certain offerings not exceeding an aggregate of $1 million within a 12-month period. Given the $300 million buyout price of the brewery and the amount of money that is commonly attempted to be raised by crowd funders, the $1 million cap of Rule 504 often renders this exemption unavailable. Similarly, Rule 505 oftentimes does not suit crowd funders’ purposes because this exemption is capped at offerings not exceeding $5 million within a 12-month period and places a limit on the number of investors who are not “accredited investors.”[5] While Rule 506 does not place a cap on the amount of the offering or the number of accredited investors, such an offering is limited thirty five non-accredited investors who must also meet certain sophistication requirements. Consequently, given the fact that over five million people provided funds to the advertising executives, this offering could not be exempted under Rule 506. Moreover, given that Rules 504, 505 and 506 all prohibit general solicitation or advertising of the investment opportunity, attempts at exempting crowd funding efforts under these Rules is not available.

What is On the Horizon: Loosening the restrictions on entrepreneurs’ ability to raise capital through crowd funding offers numerous benefits. For instance, crowd funding allows entrepreneurs to quickly and easily reach investors who are interested in backing their product or services, and may spur the economy through the facilitation of small business formation. Moreover, jobs are likely to be created as small businesses are born or grow through their ability to access capital through crowd funding. For these reasons, Representative Darrell Issa, Chairman of the Committee on Oversight and Government Reform, and Mary Shapiro, Chairman of the SEC, have been corresponding on ways to address changes in the securities laws governing initial public offerings and capital formation and raising.[6]

[1] SEC Enters Cease and Desist Order in Connection with Online Campaign to Buy Beer Company (June 8, 2011) available at

[2] 15 U.S.C. § 77e.

[3] SEC v. W. J. Howey Co., 328 U.S. 293 (1946).

[4] According to the SEC’s Cease and Desist Order, at least one of the advertising executives met with counsel, and it was thought that they had discussed the possibility of an initial public offering, which would have required the registration of the “certificates of ownership.” See id.

[5] Among other things, “Accredited Investors” have certain sophistication requirements but are commonly defined asnatural persons whose individual net worth, or joint net worth with that person's spouse, at the time of the purchase exceeds $1,000,000. See 17 C.F.R. § 230.215.

[6] See letter from Chairman Mary L. Schapiro to The Honorable Darrell E. Issa, dated April 6, 2011, available at