Securities and Exchange Commission Investor Advisory Committee Minutes of April 10, 2014 Meeting

The Investor Advisory Committee (IAC) met on April 10, 2014 from 10:00 a.m. to approximately 3:15 p.m. in the multipurpose room of the Securities and Exchange Commission’s headquarters in Washington, D.C. The meeting was open to the public and transmitted live by webcast.

Staff of the Securities and Exchange Commission
Lori J. Schock, Office of Investor Education and Advocacy
M. Owen Donley III, Office of Investor Education and Advocacy
Bryant Morris, Office of the General Counsel

OPENING[2]

Mr. Goettsch opened the meeting by expressing deep sorrow over the death of the IAC’s former chairman, Joseph A. Dear, and asked for suggestions on how to honor his service to the Committee. Mr. Goettsch welcomed Chair White and Commissioners Gallagher, Stein, Piwowar and Aguilar. Separately, Mr. Goettsch thanked the Commission for its April 3 announcement seeking comments on a recommendation by the Investor Advisory Committee regarding disclosure by target date mutual funds.

Chair White welcomed the Committee and also expressed her condolences over the passing of Mr. Dear. She welcomed Rick Fleming as the first SEC Investor Advocate and newest member of the IAC. Chair White then turned to recommendations made by the IAC, beginning with target date mutual funds. She noted that the Commission has reopened the comment period on target date mutual funds and was specifically seeking comment on the IAC’s recommendation. Chair White also reported that Commission staff was developing a recommendation to implement a pilot program to allow certain companies to use wider tick sizes. In addition, she said that the staff was working to address other IAC recommendations, including universal proxy ballots, data tagging, and making broker-dealers subject to a fiduciary duty when providing investment advice to retail investors. Commissioners Gallagher, Stein, Piwowar and Aguilar also welcomed the Committee and made brief comments.

Mr. Goettsch asked whether the IAC members had questions or comments. Damon Silvers asked about the Commission’s view on high frequency trading. Chair White said that market structure issues were a high priority for the Commission.

REMARKS BY THE INVESTOR ADVOCATE

Mr. Fleming described his plans for the newly established Office of the Investor Advocate, his background and his motivation to represent the interests of investors. He emphasized the legitimate role that government serves in ensuring the fair treatment of all participants, including individual investors, in the securities markets.

JANUARY 31, 2014, MEETING MINUTES APPROVAL[3]

The Committee amended the minutes to reflect that three members had dissented from the recommendation on decimalization and tick size. The Committee approved the amended minutes without objection.

ELECTION OF INVESTOR ADVISORY COMMITTEE CHAIRMAN

The Committee unanimously elected Kurt Schacht as the new Chairman. He pledged to do his best to support an investor-focused Committee voice that was organized, reasoned and impactful on the regulatory and policy process. Doing so, he said, would improve investor confidence and the integrity of securities markets.

DISCUSSION OF BYLAWS AND ADMINISTRATIVE MATTERS

Mr. Goettsch noted that the current vacancy has prompted the officers to review the bylaws. The bylaws provide that a person appointed to fill a vacancy shall serve the remainder of the term. Mr. Goettsch stated that the officers have found a potentially different reading in the statute, and he asked Bryant Morris of the General Counsel's Office to elaborate. Mr. Morris explained that the statute calls for each member to serve for a term of four years, and this was potentially in conflict with the bylaw provision (which calls for members who are appointed to serve out the remainder of a term, which would be less than four years).

Mr. Goettsch indicated that the officers and subcommittee chairs, serving as an executive committee, would continue to confer with Commission staff to explore a solution that would ensure continuity of the work of the Committee. This includes the concepts of members continuing to serve until a successor is appointed and the creation of staggered terms. Mr. Goettsch said that the officers hope to present a recommendation to the full Committee by its next meeting.

CONSIDERATION OF JOINT RECOMMENDATIONS OF THE INVESTOR AS PURCHASER AND THE INVESTOR EDUCATION SUBCOMMITTEES REGARDING CROWDFUNDING REGULATIONS[4]

Ms. Roper and Mr. Ganser presented the joint recommendations (italicized below) from the Investor as Purchaser and the Investor Education Subcommittees regarding crowdfunding regulations and invited comments and questions.

Recommendations

The Committee recommends that the Commission adopt regulations implementing crowdfunding that are both consistent with the statute and commensurate with the risks inherent in allowing early stage start-up companies to sell securities based on limited information to unsophisticated, low net worth investors. To achieve that goal, the Commission will need to strengthen its proposed rules in several key areas. The Committee believes the following changes are needed to better ensure that investors understand the risks of crowdfunding and avoid unaffordable financial losses.

Recommendation 1

The Commission should, as an initial matter, adopt tighter restrictions on the amounts that investors can invest in crowdfunding. Specifically, the Committee recommends that the Commission initially use a “lesser of” approach to setting investment limits (as explained below), with the exception that investment limits for accredited investors be calculated using the “greater of” methodology. If experience suggests that crowdfunding is a success for investors, the Commission can consider whether to expand the amount that individual investors can place at risk by adopting a “greater of” methodology.

Recommendation 2

The Commission should strengthen the mechanisms for the enforcement of the investment limits in order to better prevent errors and evasion. To reduce errors in calculating investment limits, the Committee recommends that intermediaries be required to create a tool that investors would use to assemble the underlying data on which investment limits are calculated and to perform the calculations electronically. The Committee also recommends that the Commission view the provision allowing reliance on investor representations to enforce compliance with investment limits across platforms to be a temporary one. The Commission should monitor the effectiveness of this approach in order to determine whether it should be continued or whether a more stringent enforcement mechanism is needed.

Recommendation 3

The Commission should clarify and strengthen the obligations of crowdfunding intermediaries to ensure compliance by issuers with the crowdfunding title and relevant regulations. The Commission should clarify the requirements for background checks. It should also clearly affirm the right of portals to “curate” offerings, including the right to reject offerings based on a variety of factors, without automatically triggering regulation as a broker-dealer. In revising the compliance obligations of intermediaries, the Commission should consider adopting a tiered approach – based on such factors as the size of the offering, permitted investment amounts, and participation by individuals with a record of securities law violations – in order to minimize regulatory costs where the risks are smallest and maximize protections where risks are greatest.

Recommendation 4

The Commission should take further steps to ensure that educational materials clearly convey the required information and are reviewed and, to the degree possible, understood by investors.

Recommendation 5

The Commission should withdraw its proposed definition of electronic delivery, which fails to ensure that investors actually receive the required disclosures and educational materials, and continue to rely instead on the strong and effective policy for electronic delivery adopted by the Commission in the mid-1990s.

Recommendation 6

The Commission should require crowdfunding offerings to be integrated with offerings in reliance on a separate exemption where needed and appropriate to prevent evasion of regulatory requirements.

After discussion, the Committee agreed to change the word “Findings” to “Preliminary Observations” at the beginning of the document and the Supporting Rationale to Recommendation 3. In addition, the Committee approved the following amendments (changes underlined).

Recommendation 3

The Commission should clarify and strengthen the obligations of crowdfunding intermediaries to ensure compliance by issuers with the crowdfunding title and relevant regulations. The Commission should clarify the requirements for background checks. It should also clearly affirm the right of portals to “curate” offerings, including the right to reject offerings based on whatever factors the portal deems appropriate (including the issues of liquidity and dilution referred to in our Preliminary Observations), without automatically triggering regulation as a broker-dealer. In revising the compliance obligations of intermediaries, the Commission should consider adopting a tiered approach – based on such factors as the size of the offering, permitted investment amounts, and participation by individuals with a record of securities law violations – in order to minimize regulatory costs where the risks are smallest and maximize protections where risks are greatest.

Supporting Rationale to Recommendation 4

Instead of allowing intermediaries to rely on the representations of investors that they have reviewed the material, the Commission should consider requiring or encouraging the material to be presented in the form of participatory education such as an interactive questionnaire that investors are required to complete successfully before being allowed to invest through the intermediary’s portal.

Fifth Bullet of Findings

Recognizing these and other risks associated with crowdfunding, Congress included a number of provisions in the crowdfunding title of the JOBS Act designed to address those risks. These include first and foremost provisions to limit the amount individuals can invest through crowdfunding, ~~to make crowdfunding intermediaries responsible for~~ to give crowdfunding intermediaries a role in ensuring compliance by issuers, and to educate investors about the risks of crowdfunding.

[2] For purposes of these minutes, descriptions of discussions have been grouped and listed seriatim, even though the discussions of different items overlapped on occasion.