Written by Partner Gavin Smith, Senior Associate Matt Vitins and Associate Robert Knight
In the July 2014 edition of Unravelled we discussed a report by the Corporation and Market Advisory Committee on Crowd Sourced Equity Funding (CSEF).1 The CAMAC Report proposed a new, more permissive, regulatory framework designed to support the introduction and growth of CSEF in Australia. Since then, there have been some important and long-awaited steps on the path to law reform. The Final Report of the Financial System Inquiry, delivered in November, recommended that the Federal Government 'graduate fundraising regulation to facilitate securities-based crowdfunding'.2 This was closely followed by an announcement that the Government would consult industry participants on a potential new regulatory framework for CSEF. In December, Treasury released a Discussion Paper seeking feedback on potential CSEF regulatory models.3 That makes it timely to take a closer look at the Treasury Discussion Paper, the options it considers, and what it might mean for the development of equity crowdfunding in Australia as an alternative source of finance.
CSEF is an innovative form of capital raising. In its classic form it involves a large number of people making small investments in a company or other venture through an online intermediary (a crowdfunding platform). CSEF can support access to equity financing for small businesses and projects that may not be able to attract funding through traditional channels. In turn, it is hoped that this will spark innovation, productivity growth and job creation.4
The CAMAC Report, FSI Final Report and Treasury Discussion Paper all acknowledged that current Australian regulatory settings are hostile to equity crowdfunding.5 The principal restrictions exist under the fundraising provisions of the Corporations Act 2001 (Cth), which limit public offers of equity interests and other financial products without a disclosure document. The limitation that proprietary companies must have no more than 50 non-employee shareholders is also difficult when seeking funding from the 'crowd'.
The Treasury Discussion Paper seeks feedback on a range of matters relating to CSEF and how it is regulated. The paper discusses three basic policy options:
- maintain the status quo;
- establish a regulatory framework based on the recommendations of the CAMAC Report; or
- establish a regulatory framework based on the model implemented in New Zealand.
The Discussion Paper considers the continued regulation of CSEF under the Corporations Act without any specific amendments or accommodation for CSEF. This option would leave issuers to incorporate as a proprietary company (and remain subject to the 50 non-employee shareholder limitation), or to incorporate as a public company and accept more onerous corporate governance requirements. In terms of disclosure, issuers would need to either prepare a disclosure document, or seek to rely on available exemptions under the Corporations Act, most notably, the small-scale offering exemption and exemptions that exist for sophisticated or professional investors.6 CSEF intermediaries would generally need to comply with Australian Financial Services licensing obligations or may need to hold an Australian Market Licence if they fell within the definition of conducting a financial market. If operating as a managed investment scheme (which is a model that has been proven to work for peer-to-peer lenders), CSEF intermediaries would need to comply with the requirements of Chapter 5C of the Corporations Act.
The Treasury Discussion Paper notes investors would continue to benefit from existing protections under the status quo, including the receipt of disclosure documents and, for public companies, access to audited financial reports, directors' reports and annual general meetings. It continues to note, however, that the status quo does not address existing funding challenges and barriers to CSEF. Start-ups and small businesses have a hard time making offers to the crowd. CSEF intermediaries are limited in the business models they can adopt. Investors have limited access to investment opportunities in start-ups and small businesses.
Another option contemplated by the Treasury Discussion Paper is a regulatory regime modelled on the recommendations of the CAMAC Report. The driving impetus behind CAMAC's recommendations were to balance the need to protect investors against the risks of investing in start-ups and small businesses through transparency, and the financial and administrative burden placed on early stage businesses in having to comply with current corporate governance and fundraising regimes.
The Treasury Discussion Paper contains a useful summary of the key recommendations of the CAMAC Report. The defining features of the framework include:
- for issuers: establishing a new category of public company for CSEF issuers that would have the benefit of exemptions from certain ordinary public company compliance requirements for a defined period, as well as caps on the amount that could be raised through CSEF set at $2 million in any 12-month period;
- for intermediaries: requiring intermediaries to be licensed (ie hold an AFSL), conduct limited mandatory due diligence checks and place prohibitions on activities that might create conflicts of interest (such as investing in issuers on their platform); and
- for investors: capping the amount individual investors can invest via CSEF to $2,500 in any particular issuer, and to $10,000 overall, over any 12-month period.
The CAMAC Report draws upon the experience of developments overseas, and would significantly reduce incentives for stakeholders to move offshore. Among the main criticisms of the CAMAC Report have been whether creating a new form of public company will add a layer of complexity for issuers; whether small companies with no intention of raising money through CSEF will take advantage of compliance concessions under the new regime; and whether investor and issuer caps have been set at the right level to balance investor protection and the funding needs of start-ups and small businesses.
The final option contemplated by the Treasury Discussion Paper is a CSEF regime modelled on that adopted in New Zealand. New Zealand implemented its approach to CSEF in April 2014 with its first CSEF offering completed in mid-September 2014. The New Zealand model is broadly similar to that recommended by the CAMAC Report. For example, it features issuer caps, intermediary licensing requirements, issuer due diligence obligations and requires an acknowledgement of risk by investors. However, New Zealand differs from the CAMAC Report recommendations in a number of key respects. In particular:
- there are no CSEF exemptions from public company compliance costs;
- investor caps are voluntary, with issuers and intermediaries obliged to provide different levels of disclosure depending on whether there are no or high voluntary investor caps; and
- there are no restrictions on issuer fee structures (although fees must be disclosed) or whether intermediaries can invest in issuers using their platform.
The New Zealand model benefits issuers and intermediaries by giving them greater flexibility around the operational aspects of their role in facilitating CSEF. However, it remains to be seen whether New Zealand has found the right balance between investor protection and facilitating capital raising.
Submissions on the Treasury Discussion Paper are due on 6 February 2015, with the possibility that further consultations may be conducted after that if necessary. In the meantime, players in the CSEF industry in Australia are marshalling their views and engaging in discussions with the Government. We await the Government's conclusions with interest.
- Corporations and Markets Advisory Committee, Crowd Sourced Equity Funding, Report (May 2014) (the CAMAC Report).
- Financial System Inquiry, Final Report (November 2014) (the FSI Final Report). Consistent with the high-level nature of the rest of the FSI Final Report, it did not recommend a particular model for regulating CSEF.
- The Treasury, Crowd-Sourced Equity Funding, Discussion Paper (December 2014) available at (the Treasury Discussion Paper).
- See: Treasury Discussion Paper, at [1,1]; FSI Final Report at 178.
- Treasury Discussion Paper, at ; FSI Final Report at 178; CAMAC Report at [2.3]. Although sophisticated investor and small-scale offering exemptions have been used to good effect by some platforms.
- Corporations Act, s708; Also note: ASIC Class Order 02/273.