Question 8 What provision, if any, should be made for each of the following matters as they concern CSEF investors:
(i) permitted types of investor: should there be any limitations on who may be a CSEF investor
Not at all. The central tenant and the whole premise of the idea is to enable small levels of capital raising from a large number of persons. Provided a sufficient balance is struck whereby the least sophisticated investors are in an adequate position to understand the inherent risks, then there is no need to restrict such offerings to anyone else who will naturally be better equipped to do so in any event.
(ii) threshold sophisticated investor involvement (Italy only): should there be a requirement that sophisticated investors hold at least a certain threshold interest in an enterprise before it can make CSEF offers to other investors
While the logic behind the Italian approach in this regard is apparent, this should not be a general requirement for several reasons. The first is that, as the CAMAC paper itself discusses, the types of investors we expect to see participating in this market will generally be more susceptible to representations, or generally more impressionable, if only owing to the small scale of their investments and the economic and demographic factors that will be typical as a result. As such, there is nothing to stop an entity related to an issuer or an intermediary buying such securities with the intention only of compliance, public appearance and possible opportunities to manipulate prices at any given point in time. In this example, investors would have been lead astray.
In any event, an investor who invests without such an investor leading by example is more likely to have considered the investment in greater detail, and the need for such issuing entities to secure such an investor may prove prohibitive. After all, when talking typically of relatively small investment requirements, if the issuer was in a position to achieve this, in all likelihood, it would not be operating in this market. On the other hand, such investors may be prepared to take a gamble with a small investment they could write off without much harm, which in effect would mean their involvement in that particular investment does nothing more than send false signals to the market, potentially to the detriment of the majority of (smaller retail) investors.
(iii) maximum funds that each investor can contribute: should there be some form of cap on the funds that an investor can invest. In this context, there are a number of possible approaches under Issuer linked caps and under Investor linked caps
Generally speaking, the market should be as liberal as possible. However, there is of course a legitimate need to protect a new class of investors in a new market of lower disclosure. There is also a great concern for fraud and other losses accruing from ill-prepared issuers, but of course, the concern is with some, not all, investments, and should not be a bar to the industry in general.
In my view, limiting the number of CSEF issuers in which an investor can invest is too restrictive, given that an investor may invest $5 in each of one hundred entities and lose on only one investment, and that society may lose out on too many new innovations if all funds were directed towards only a select few on the basis of perhaps only the attractiveness of an intermediary’s marketing. Similarly, limiting the total monetary amount that an investor can invest in the market by any means would more than likely result in adverse or perverse outcomes.
The second approach in the US example – limiting the monetary amount that an investor may invest in each CSEF issuer in one year – seems to strike the right balance. For obvious reasons, such an approach would limit the risks to investors, encourage diversity in their portfolios, promote competition (for performance and disclosure) among issuers and intermediaries, and encourage and allow for maximum participation in (thereby enabling the greatest utility derivation from) the industry as a whole, when compared to any of the other options discussed.
(iv) risk acknowledgement by the investor: should an investor be required to acknowledge the risks involved in CSEF
Yes. Recall the idea raised in response to question 4(iv) above regarding online acceptance of terms and conditions. Such mechanisms would serve to make the investor stop and actually think about what they are doing, and to assist them in overcoming indecisiveness at an earlier stage prior to making their decision to invest. In addition, it would serve to protect genuine and honest issuers and intermediaries. Moreover, this could reduce the costs associated with regulation and enforcement to a great degree in the long run, for obvious reasons.
It may be that a more sophisticated approach to the online “click a button” type of acceptance is mandated, whereby investors must complete an online questionnaire or tutorial specifically designed to require thought and considered responses. This could be one of the functions of intermediaries – to develop, implement, assess and report.
(v) cooling off rights: should an investor have some right of withdrawal after accepting a CSEF offer
No. Put simply, this is not conducive to this market at all. Investors will typically be more indecisive, having much less experience than sophisticated investors, and therefore such an option is likely to invite and encourage withdrawals. The issuer entities will require pledged investments and certainty so that they can plan and grow, and such an option would defeat that purpose. Investors should, by way of the disclosure rules to be implemented (preferably by the intermediaries, as above), be in a position to make a conclusive and final decision the first time around.
The only exception to the above might be in the case where intermediaries are required to raise a certain amount in funds received or pledged prior to releasing this capital to the issuer. This could even be a blanket option across the board. If it were to be implemented, funds pledged or received should reach a certain level above what is actually required by the issuer, after consideration is paid to the intermediary, for example 120% of the actual net requirement. An option could then be provided, but perhaps only exercisable at a certain time to enable further raising to take place thereafter, and perhaps only in limited circumstances, such as following the mandatory disclosure of a material factor, i.e. a change in regulations affecting the particular industry and therefore the economics of the specific investment.
(vi) subsequent withdrawal rights (Italy only): should an investor have some further withdrawal right subsequent to the offer
For the reasons set out above, this should not be a general option. However, it could be an option in the event of a breach by an issuer or intermediary, particularly if some form of real and liquid security has been provided to the regulator and can be utilised relatively easily to enable the purchase of the securities back from the investor, for example. In the absence of a breach or any misconduct, investors should have the option to sell back to the issuer only (perhaps also the intermediary, subject to the above), but only provided there is a willingness and ability on the part of the issuer (or intermediary).
(vii) resale restrictions: should there be restrictions for some period on the on-sale of securities acquired through CSEF
Yes. Generally, for the reasons set out in the two preceding answers. In addition, there is no escaping the fact that, unless additional disclosure requirements are imposed (which is not conducive, as discussed above), then such an option would enhance the risks to investors. The option to resell to the issuer or intermediary should always remain, provided of course those parties are willing and able to repurchase. Recalling the discussions above in relation to issues of timing and the purpose of enabling these entities to reach the next or more conventional stages, a time limit does seem appropriate, after which investors could be free to resell. This would ensure stability for the entity, allow for adequate mechanisms to be put in place to avoid equity dilution and ensure that whatever form of disclosure is eventually mandated cannot be circumvented.
(viii) reporting: what ongoing reporting should be made by the intermediary and/or issuers to investors in regards to their investment
As discussed above, it is generally desirable for intermediaries to fulfil reporting functions, in a manner discussed above in response to question 4(iv). In addition to this, what would be more useful is if the short-term business plan and targets were disclosed, to some extent, to be used as a benchmark for investors to track the progress of their investment. Obviously commercially sensitive information would need to be protected, but it may be that certain high-level information could be published, and progress monitored and measured against goals at various intervals of time.
(ix) losses: what recourse should investors have in relation to losses resulting from inadequate disclosure
See response to (x) below.
(x) remedies: what remedies should investor have in relation to losses results from poor management of the enterprise they invest in
We have discussed above the idea that issuers and intermediaries should be liable to repay an investment plus interest in the event of certain conduct, and that directors or other officers might be personally liable and may have to provide enforceable security to the regulator for this purpose.
There does not appear to be any reason why investors should have redress by way of a wider range of remedies than currently exist, particularly if any cap is to be imposed on the amount each person can invest.
(xi) any other matter?
I will leave this open for further comment as discussions progress…
Question 8 What provision, if any, should be made for each of the following matters as they concern CSEF investors:
(i) permitted types of investor: should there be any limitations on who may be a CSEF investor
Not at all. The central tenant and the whole premise of the idea is to enable small levels of capital raising from a large number of persons. Provided a sufficient balance is struck whereby the least sophisticated investors are in an adequate position to understand the inherent risks, then there is no need to restrict such offerings to anyone else who will naturally be better equipped to do so in any event.
(ii) threshold sophisticated investor involvement (Italy only): should there be a requirement that sophisticated investors hold at least a certain threshold interest in an enterprise before it can make CSEF offers to other investors
While the logic behind the Italian approach in this regard is apparent, this should not be a general requirement for several reasons. The first is that, as the CAMAC paper itself discusses, the types of investors we expect to see participating in this market will generally be more susceptible to representations, or generally more impressionable, if only owing to the small scale of their investments and the economic and demographic factors that will be typical as a result. As such, there is nothing to stop an entity related to an issuer or an intermediary buying such securities with the intention only of compliance, public appearance and possible opportunities to manipulate prices at any given point in time. In this example, investors would have been lead astray.
In any event, an investor who invests without such an investor leading by example is more likely to have considered the investment in greater detail, and the need for such issuing entities to secure such an investor may prove prohibitive. After all, when talking typically of relatively small investment requirements, if the issuer was in a position to achieve this, in all likelihood, it would not be operating in this market. On the other hand, such investors may be prepared to take a gamble with a small investment they could write off without much harm, which in effect would mean their involvement in that particular investment does nothing more than send false signals to the market, potentially to the detriment of the majority of (smaller retail) investors.
(iii) maximum funds that each investor can contribute: should there be some form of cap on the funds that an investor can invest. In this context, there are a number of possible approaches under Issuer linked caps and under Investor linked caps
Generally speaking, the market should be as liberal as possible. However, there is of course a legitimate need to protect a new class of investors in a new market of lower disclosure. There is also a great concern for fraud and other losses accruing from ill-prepared issuers, but of course, the concern is with some, not all, investments, and should not be a bar to the industry in general.
In my view, limiting the number of CSEF issuers in which an investor can invest is too restrictive, given that an investor may invest $5 in each of one hundred entities and lose on only one investment, and that society may lose out on too many new innovations if all funds were directed towards only a select few on the basis of perhaps only the attractiveness of an intermediary’s marketing. Similarly, limiting the total monetary amount that an investor can invest in the market by any means would more than likely result in adverse or perverse outcomes.
The second approach in the US example – limiting the monetary amount that an investor may invest in each CSEF issuer in one year – seems to strike the right balance. For obvious reasons, such an approach would limit the risks to investors, encourage diversity in their portfolios, promote competition (for performance and disclosure) among issuers and intermediaries, and encourage and allow for maximum participation in (thereby enabling the greatest utility derivation from) the industry as a whole, when compared to any of the other options discussed.
(iv) risk acknowledgement by the investor: should an investor be required to acknowledge the risks involved in CSEF
Yes. Recall the idea raised in response to question 4(iv) above regarding online acceptance of terms and conditions. Such mechanisms would serve to make the investor stop and actually think about what they are doing, and to assist them in overcoming indecisiveness at an earlier stage prior to making their decision to invest. In addition, it would serve to protect genuine and honest issuers and intermediaries. Moreover, this could reduce the costs associated with regulation and enforcement to a great degree in the long run, for obvious reasons.
It may be that a more sophisticated approach to the online “click a button” type of acceptance is mandated, whereby investors must complete an online questionnaire or tutorial specifically designed to require thought and considered responses. This could be one of the functions of intermediaries – to develop, implement, assess and report.
(v) cooling off rights: should an investor have some right of withdrawal after accepting a CSEF offer
No. Put simply, this is not conducive to this market at all. Investors will typically be more indecisive, having much less experience than sophisticated investors, and therefore such an option is likely to invite and encourage withdrawals. The issuer entities will require pledged investments and certainty so that they can plan and grow, and such an option would defeat that purpose. Investors should, by way of the disclosure rules to be implemented (preferably by the intermediaries, as above), be in a position to make a conclusive and final decision the first time around.
The only exception to the above might be in the case where intermediaries are required to raise a certain amount in funds received or pledged prior to releasing this capital to the issuer. This could even be a blanket option across the board. If it were to be implemented, funds pledged or received should reach a certain level above what is actually required by the issuer, after consideration is paid to the intermediary, for example 120% of the actual net requirement. An option could then be provided, but perhaps only exercisable at a certain time to enable further raising to take place thereafter, and perhaps only in limited circumstances, such as following the mandatory disclosure of a material factor, i.e. a change in regulations affecting the particular industry and therefore the economics of the specific investment.
(vi) subsequent withdrawal rights (Italy only): should an investor have some further withdrawal right subsequent to the offer
For the reasons set out above, this should not be a general option. However, it could be an option in the event of a breach by an issuer or intermediary, particularly if some form of real and liquid security has been provided to the regulator and can be utilised relatively easily to enable the purchase of the securities back from the investor, for example. In the absence of a breach or any misconduct, investors should have the option to sell back to the issuer only (perhaps also the intermediary, subject to the above), but only provided there is a willingness and ability on the part of the issuer (or intermediary).
(vii) resale restrictions: should there be restrictions for some period on the on-sale of securities acquired through CSEF
Yes. Generally, for the reasons set out in the two preceding answers. In addition, there is no escaping the fact that, unless additional disclosure requirements are imposed (which is not conducive, as discussed above), then such an option would enhance the risks to investors. The option to resell to the issuer or intermediary should always remain, provided of course those parties are willing and able to repurchase. Recalling the discussions above in relation to issues of timing and the purpose of enabling these entities to reach the next or more conventional stages, a time limit does seem appropriate, after which investors could be free to resell. This would ensure stability for the entity, allow for adequate mechanisms to be put in place to avoid equity dilution and ensure that whatever form of disclosure is eventually mandated cannot be circumvented.
(viii) reporting: what ongoing reporting should be made by the intermediary and/or issuers to investors in regards to their investment
As discussed above, it is generally desirable for intermediaries to fulfil reporting functions, in a manner discussed above in response to question 4(iv). In addition to this, what would be more useful is if the short-term business plan and targets were disclosed, to some extent, to be used as a benchmark for investors to track the progress of their investment. Obviously commercially sensitive information would need to be protected, but it may be that certain high-level information could be published, and progress monitored and measured against goals at various intervals of time.
(ix) losses: what recourse should investors have in relation to losses resulting from inadequate disclosure
See response to (x) below.
(x) remedies: what remedies should investor have in relation to losses results from poor management of the enterprise they invest in
We have discussed above the idea that issuers and intermediaries should be liable to repay an investment plus interest in the event of certain conduct, and that directors or other officers might be personally liable and may have to provide enforceable security to the regulator for this purpose.
There does not appear to be any reason why investors should have redress by way of a wider range of remedies than currently exist, particularly if any cap is to be imposed on the amount each person can invest.
(xi) any other matter?
I will leave this open for further comment as discussions progress…