To use the new crowdfunding exemption, it is necessary to go through an intermediary.

An intermediary may be either a broker registered with the SEC or a “funding portal” registered with the SEC.

Funding portals do not have to be registered brokers.  They are, however, subject to the SEC’s examination, enforcement, and rulemaking authority.

A funding portal may not do the following: (i) offer investment advice or recommendations; (ii) solicit purchases, sales, or offers to buy securities offered or displayed on its website or portal; (iii) compensate employees, agents, or others persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; (iv) hold, manage, possess, or otherwise handle investor funds or securities; or (v) engage in such other activities as the SEC, by rule, determines appropriate.

Funding portals also must become members of a national securities association that is registered under Section 15A of the Exchange Act. Today, the Financial Industry Regulatory Authority (FINRA) is the only national securities association in existence that is registered under Section 15A of the Exchange Act.

The JOBS Act requires intermediaries to, among other things:

• provide disclosures that the SEC determines appropriate by rule, including regarding the risks of the transaction and investor education materials
• ensure that each investor: (1) reviews investor education materials; (2) positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and (3) answers questions that demonstrate that the investor understands the level of risk generally applicable to investments in startups, emerging businesses, and small issuers and the risk of illiquidity;
• take steps to protect the privacy of information collected from investors;
• take such measures to reduce the risk of fraud with respect to such transactions, as established by the SEC, by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person;
• make available to investors and the SEC, at least 21 days before any sale, any disclosures provided by the issuer;
• ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest;
• make efforts to ensure that no investor in a 12-month period has purchased crowdfunded securities that, in the aggregate, from all issuers, exceed the investment limits set forth in section Title III of the JOBS Act; and

• any other requirements that the SEC determines are appropriate.

Until the SEC has completed its rulemaking process, you cannot act as a crowdfunding intermediary, even if you are already a registered broker.

With great anticipation over the impending California cap and trade auction, the Cutting Edge Capital team participated in the Navigating the American Carbon World Conference held in San Francisco this past week. The conference is the annual meeting of the minds of carbon traders, regulators, policy makers, investors, and, of course, consultants like us. Given our role as market monitor trainers for regulators of the new California cap and trade system, we were keen to garner as much new information from the global contingent about carbon markets and climate change policy as possible.

This year the theme of the conference was “action” – appropriate as California prepares to launch the only economy-wide carbon market in the U.S. and the second largest carbon market in the world behind the European Union.

We at CEC are optimistic about the future of California’s carbon market. The California cap and trade program is led by the very capable Air Board Chairwoman Mary Nichols. Ms. Nichols took the stage during the official opening of the conference. Her primary focus was on the Air Board’s efforts to ensure that businesses are not overly burdened with the demands of the cap and trade regulations and to prevent any disruption in the energy system. Cap and trade is designed to drive innovation while offering lower cost alternatives through offsets and carbon credit trading opportunity. The Air Board has conducted over 150 public stakeholder engagement sessions and consulted with experts around the world bringing a tremendous amount of thought, research, and technical expertise to the current design. The cap and trade system is a major part of the Air Board’s AB32 scoping plan designed to meet the stringent emissions reduction goals set out in the legislation.

So how exactly is cap and trade expected to work? In the first phase of the program, the Air Board sets a cap on overall greenhouse gas emissions and assigns allowances to large emitters such as utility companies, oil refiners, and large industrials. The cap puts a price on pollution, creating a powerful economic incentive to find feasible ways to reduce emissions. The companies are required to monitor, report, and turn in enough allowances to cover their emissions. The market provides flexibility in how businesses can meet their allowance targets – they can invest in technology to reduce emissions, purchase allowances at auction, and/or use banked allowances from earlier years. In addition, California’s program includes the Climate Action Reserve option of applying up to 8% in offset credits from projects in approved protocols of forestry, urban forestry, livestock, and ozone depleting substances.

Proceeds from the auction will be invested in approved energy efficiency projects that will further reduce overall emissions and lead the state towards meetings its AB32 goals.

Our mission at Cutting Edge Capital is to help create sustainable communities. In an effort to foster a better understanding of carbon trading in general and new developments in California’s market, we will continue to explore other aspects of the cap and trade system in future posts. In the meantime, if you have questions, please contact us.

Michael H. Shuman

For nearly a century local investing has been essentially illegal, and Wall Street has controlled all the investment options for the average investor.  Thanks to the JOBS Act that President Obama signed in the Rose Garden last week, local investing is now legal.  Like all legislation, this bill is not perfect, but for local economy advocates, it’s a great game-changer, and one we should not only be enthusiastic about but also play an active role in implementing effectively.

There has been a tremendous amount of misinformation spread about this Act, much of it by liberals I usually admire.  Jim Hightower, for example, condemns the bill for “deregulating Wall Street.”  In fact, the bill spells the end of Wall Street as we know it.  It allows the 99% of us who are not wealthy (“unaccredited investors”) to put our money in the local businesses we love, by removing what were once impossibly difficult and expensive legal barriers.  Those barriers had been so high, so poorly designed, so targeted against small business and small investors,  that they have resulted in almost none of our long-term savings – now totaling $30 trillion – going into the local half of our economy.  The JOBS Act ends this monopoly for good.

To me it’s ironic, and disappointing, that folks like Hightower, Robert Kuttner, and Eliot Spitzer were committed to the status quo and to maintaining Wall Street’s monopoly on capital.  How could such great thinkers get this issue so wrong?  Here are my top five reasons:

First, the critics misunderstood who was pushing this bill.  Kuttner, for example, blames Obama for being “always eager to curry favor with Wall Street donors…”  In point of fact, Wall Street lobbyists played at most a peripheral role.  Small business owners and “makers,” like Woody Neiss and Paul Spinrad, led the charge.  Innovative thinkers in the White House, like Doug Rand at the Office of Science and Technology Policy, played a pivotal role in shaping the President’s views about entrepreneurship.  Non-Wall Street insiders like IndieGogo, a crowdfunding web site, and the nonprofit Sustainable Economies Law Center, pushed hard as well.

Second, the critics, justifiably skeptical of wholesale deregulation, don’t like to concede that any regulation has been a failure.  But any honest assessment of  the history of securities law would observe that we basically regulated local finance out of existence while permitting Bernie Madoffs to operate freely.  For decades, the SEC has held annual meetings where small businesses have urged reforms – modest deregulations that could open up capital to small companies – and none of the suggestions have been implemented.

Here’s an example of the SEC’s intransigence: Three years ago, I recommended in a journal published by the Federal Reserve a $100 exemption from securities filings, on the argument that $100 “risked” on a small business was no more dangerous to an investor than a dinner for two at a Chinese restaurant.  A year later, Jenny Kassan, co-founder of the Sustainable Economies Law Center, and Paul Spinrad of Make Magazine,  sent a petition to the SEC to request the $100 exemption, and 150 people wrote letters of support.  Last May, at a House hearing, the head of the SEC, Mary Schapiro, was asked if she supported this exemption, and she stonewalled, saying that the SEC was convening an internal group in the autumn to “study” the issue.   It was clear that the entire securities law establishment needed to be shaken up, and to their credit, that’s what Congress and the President did in enacting the JOBS Act—Republicans and Democrats alike.

Third, the critics have tremendously exagerrated the dangers of fraud.  The casual reader of the liberal critiques might conclude that the sale of fraudulent securities is now legal, and that “boiler room” operations can bilk grandma of her life savings.  Yet state and federal laws against securities fraud are still in effect.  In fact, the JOBS Act adds a number of new provisions for preventing fraud (through registered intermediaries). Why, moreover, should anyone be banned from spending, investing, or donating a couple of hundred dollars any damn way they please?  The JOBS act exempts grandma from investing $2,000 (higher amounts, if grandma is wealthier).  I was not thrilled with the $10,000 number in the original House bill – again, I originally advocated $100 – but I think $2,000 is fine.  The law does not permit any business to take more than 10% of an unaccredited person’s income or wealth.

Fourth, the critics do not appreciate that there are other approaches to preventing fraud.  E-Bay has all but eliminated fraud through consumer and business evaluations of one another.  So have other crowdfunding sites in the United Kingdom.  In other words, the SEC’s premise – that the only way to prevent fraud is by banning unaccredited investors from making their own judgments – is flat out wrong.

Perhaps their most appalling misunderstanding is how fraudulent the status quo is.  Every day the SEC allows the Ric Edelman’s of the world to sell people on the stock market, promising 10-20% annual returns, when in fact the returns – once inflation and compounding are taken out – are closer to 3%.  These misrepresentations have convinced Americans that putting 100% of their savings into Fortune 500 companies is safer and provides a better return than investing in local business.  In reality, the stock market is becoming an increasingly dangerous and unregulated casino where trades are done by computers that cause flash crashes when they malfunction.  The JOBS Act will allow local businesses to begin to compete for a fair market share of investment dollars.

I said at the outset that the bill is imperfect.  For example, the bill legalizes all kinds of crowdfunding, local and nonlocal.  I believe that local economy advocates now must start educating the public about the importance of favoring local investment.  Our argument should be that knowing the business in which one invests – knowing the products, the entrepreneur, the workforce, etc. – is the best way to prevent fraud.

It’s worth adding that after the bill was signed yesterday, 25 of the people who were most instrumental in passing the bill – none from Wall Street, by the way – got together to discuss ways we could create internal checks and balances on the marketplace, to improve quality control and help identify hucksters.   I hope that similar groups form in every community to create an honor roll of local businesses they know and trust – perhaps businesses that embrace open-book accounting – and that they then encourage residents to prioritize for their crowdfunding.

Like it or not, Wall Street’s stranglehold on investment is over.  We now have a new legal landscape that we can play a pivotal role in shaping.  Local economy advocates everywhere need to step up, not out.

The President will be signing the Jumpstart Our Business Startups Act on Thursday.  The CROWDFUND Act is part of the JOBS Act.  Here is a brief summary of the seven parts of the JOBS Act.

TITLE I—REOPENING AMERICAN CAPITAL MARKETS TO EMERGING GROWTH COMPANIES

Exempts something called “Emerging Growth Companies” from many of the disclosure, governance, and other regulations on public companies; an emerging growth company is defined as a business with total annual gross revenues of less than $1,000,000,000

TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS

Eliminates the prohibition on public solicitation and advertising for securities offerings made by private companies as long as all purchasers are accredited investors

Exempts platforms that sell securities under this rule from the requirement to register as a broker as long as they receive no compensation in connection with the sale of the securities

TITLE III—CROWDFUNDING

See separate post

TITLE IV—SMALL COMPANY CAPITAL FORMATION

Increases from $5 million to $50 million the limit on the dollar amount that can be raised in an offering under Regulation A

TITLE V—PRIVATE COMPANY FLEXIBILITY AND GROWTH

Under current law, a company that has 500 investors in any class of equity securities and $10 million in assets must register as a public company – this title increases the number of shareholders needed to trigger this requirement to 2,000 as long as fewer than 500 are unaccredited

Excludes employees that received securities as part of a compensation plan from the total investor count

TITLE VI—CAPITAL EXPANSION

Similar to Title V but applies to banks and bank holding companies

TITLE VII—OUTREACH ON CHANGES TO THE LAW

Requires the SEC to provide online information and conduct outreach to inform small and medium sized businesses, women owned businesses, veteran owned businesses, and minority owned businesses of the changes made by this Act

The name of the law is “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012″ or the CROWDFUND Act.

Here are the basic provisions:

Maximum aggregate amount that can be raised under the exemption: $1 million

Maximum amount per investor:

• For investors with less than $100,000 in annual income or net worth: the greater of $2,000 or 5 percent of the annual income or net worth of such investor
• For investors with $100,000 or more in annual income or net worth: 10 percent of the annual income or net worth of such investor

Intermediary required: The transaction must be conducted through a broker or funding portal (aka intermediary) that complies with the requirements of the Act

Requirements for intermediaries:

• register with the SEC
• register with any applicable self-regulatory organization (as defined in section 3(a)(26) of the Securities Exchange Act of 1934)
• provide such disclosures, including disclosures related to risks and other investor education materials, as the SEC shall, by rule, determine appropriate
• ensure that each investor—
• reviews investor-education information, in accordance with standards established by the SEC, by rule;
• positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and
• answers questions demonstrating an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers; an understanding of the risk of illiquidity; and an understanding of such other matters as the SEC determines appropriate, by rule
• take such measures to reduce the risk of fraud with respect to such transactions, as established by the SEC, by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person
• not later than 21 days prior to the first day on which securities are sold to any investor (or such other period as the SEC may establish), make available to the SEC and to potential investors any information provided by the issuer
• ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest, as the SEC shall, by rule, determine appropriate
• make such efforts as the SEC determines appropriate, by rule, to ensure that no investor in a 12-month period has purchased securities offered pursuant to the crowdfunding exemption that, in the aggregate, from all issuers, exceed the investment limits of the exemption
• take such steps to protect the privacy of information collected from investors as the SEC shall, by rule, determine appropriate
• not compensate promoters, finders, or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor
• prohibit its directors, officers, or partners (or any person occupying a similar status or performing a similar function) from having any financial interest in an issuer using its services
• meet such other requirements as the SEC may, by rule, prescribe, for the protection of investors and in the public interest.

The SEC will exempt funding portals, conditionally or unconditionally, from the requirement to be licensed brokers, as long as they become members of a national securities association and do not

• offer investment advice or recommendations;
• solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;
• compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal;
• hold, manage, possess, or otherwise handle investor funds or securities; or
• engage in such other activities as the SEC, by rule, determines appropriate

Requirements for issuers:

• file with the SEC and provide to potential and existing investors and the intermediary—
• the name, legal status, physical address, and website address of the issuer;
• the names of the directors and officers (and any persons occupying a similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer;
• a description of the business of the issuer and the anticipated business plan of the issuer;
• a description of the financial condition of the issuer, including, for offerings that, together with all other offerings of the issuer under the crowdfunding exemption within the preceding 12-month period, have, in the aggregate, target offering amounts of—
• $100,000 or less—(I) the income tax returns filed by the issuer for the most recently completed year (if any); and (II) financial statements of the issuer, which shall be certified by the principal executive officer of the issuer to be true and complete in all material respects;
• more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures for such review or standards and procedures established by the SEC, by rule, for such purpose; and
• more than $500,000 (or such other amount as the SEC may establish, by rule), audited financial statements;
• a description of the stated purpose and intended use of the proceeds;
• the target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
• the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities;
• a description of the ownership and capital structure of the issuer, including—
• terms of the securities of the issuer being offered and each other class of security of the issuer, including how such terms may be modified, and a summary of the differences between such securities, including how the rights of the securities being offered may be materially limited, diluted, or qualified by the rights of any other class of security of the issuer;
• a description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;
• the name and ownership level of each existing shareholder who owns more than 20 percent of any class of the securities of the issuer;
• how the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions; and
• the risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions, including additional issuances of shares, a sale of the issuer or of assets of the issuer, or transactions with related parties; and
• such other information as the SEC may, by rule, prescribe, for the protection of investors and in the public interest;
• not advertise the terms of the offering, except for notices which direct investors to the intermediary’s web site
• not compensate or commit to compensate, directly or indirectly, any person to promote the offerings without taking such steps as the SEC shall, by rule, require to ensure that such person clearly discloses the receipt, past or prospective, of such compensation, upon each instance of such promotional communication
• not less than annually, file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer, as the SEC shall, by rule, determine appropriate, subject to such exceptions and termination dates as the SEC may establish, by rule
• comply with such other requirements as the SEC may, by rule, prescribe, for the protection of investors and in the public interest.

Transferability: Securities issued pursuant to the crowdfunding exemption may not be transferred for one year after purchase except back to the issuer, to an accredited investor; as part of a registered offering; or to a family member

Automatically becoming a public reporting company when a certain number of shareholders and asset amount is reached: securities acquired under the crowdfunding exemption will be exempted, conditionally or unconditionally depending on what the SEC does in its rulemaking, from this cap (which was increased from 500 investors to 2,000 by the JOBS Act – see future blog post on this subject!)

State preemption: the states are not allowed to require registration of offerings that are exempt under the crowdfunding exemption; however the can require notice filings and fees in the state that is the issuer’s principal place of business and in any state in which purchasers of 50 percent or greater of the aggregate amount of the issue are residents

Adjustment for inflation: Dollar amounts under the exemption will be adjusted not less frequently than once every 5 years to reflect any change in the Consumer Price Index

How long until the SEC finishes its rulemaking?  You’ll notice numerous places in the law that mention rulemaking by the SEC; until the SEC completes the rulemaking process, the law cannot go into effect; the statute gives the SEC nine months to complete the rulemaking process but there are no penalties if they do not complete the rulemaking within this time, so it is difficult to say how long it will take.

As we announced in our previous newsletter, Cutting Edge Capital has been selected by the California Air Resources Board (CARB) to lead the Market Monitor Training for the state’s new cap and trade system.  Since our announcement, we keep encountering the question “so…what does that mean?”

Fair enough, considering that California’s program will be the first cap and trade system in the country. The program is essentially a set of regulations and market mechanisms designed to incent the state’s heaviest polluters to slash CO2 emissions to 1990 levels by 2020.  The goal of the program is to reduce emissions while driving innovation towards a low carbon economy.  The potential upside for emerging clean tech businesses capitalizing on two key market drivers, unprecedented regulation and a new carbon market, will surely capture the attention of progressively minded states to follow California’s lead.

Starting in 2013, large emitters (power plants, refineries, and cement plants) will be given an allowance for carbon they can emit in the form of annual credits based on emission reduction benchmarks.  Emissions cuts for manufacturers of transportation fuels begin in 2015. If a company doesn’t use all of its credits, it can sell, or “trade” them.  If a company knows in advance that it will emit too much carbon, it can buy credits or carbon offsets. The auction essentially places a price on pollution.

In addition to cutting down on emissions, a successful cap and trade program is expected to have the added benefit of boosting clean tech entrepreneurs, who will soon have a built-in market for their service.  According to a recent paper in The Energy Journal, “a desirable climate change policy should provide polluting industries with strong incentives to take early preventive actions.”  Industries that embrace the change and take early action with innovative solutions will capitalize on new opportunities.

So what’s the big deal about Cap and Trade?  It is the key to facilitate California to achieve emission reductions mandated by the Global Warming Solutions Act commonly known as AB32.  We know that under business as usual conditions with current technology, California cannot meet the reduction levels mandated by AB32, particularly with expected increases in population.  California’s cap and trade system is designed to create an efficient allocation of emissions allowances through auctioning, with transparent system oversight and minimal disruption to the power markets.  CARB projects the size of the market to be $550 to $1 billion during the 2012-2013 fiscal year on the basis of a conservative price of $10 per share…. That’s the big deal.

Have you ever wondered what kind of company would consistently publish so many great books?

Berrett-Koehler Publishers (BK) publishes books that create new paradigms and challenge long-held beliefs.  No wonder, since their mission is to Create a World That Works For All.

Something that is less well known about BK is how the business is structured to reflect its values.  BK has worked hard to make it possible for ALL of its stakeholders – authors, employees, customers, and other community members – to actively participate in, benefit from, and own a piece of the business.

In 2005, BK conducted a direct public offering of stock using the SCOR form.  The minimum investment was $800, which made it possible for even non-wealthy customers and other stakeholders to invest.  Today, BK has almost 250 shareholders.

To ensure that BK’s authors have an active role in the business, BK supported the creation of BK Authors Cooperative, Inc., an independent cooperative of BK authors.  The coop holds annual events and provides organized feedback to BK on operations.

Several BK employees have purchased BK stock.  But all long-term employees have a stake in the company through an Employee Stock Ownership Plan that the company contributes stock to each year.

BK has implemented another innovation: a trading platform for its stock to create the possibility of liquidity for its investors.  This is very important for a company that has no intention of ever selling out to a larger, less mission-driven publisher.  The platform is private to ensure compliance with securities law.

BK’s long-term vision is that the company will be owned one-third by employees; one-third by authors; and one-third by customers, service providers, suppliers, and other stakeholders.

BK is truly creating a company that works for all!

The Architecture of Extractive and Generative Ownership

Extractive Ownership                                      Generative Ownership

One day we will look back and ask why did everybody’s ‘stuff’ look just like everyone else’s, only in a different color or surface design? Something’s going on. The uniformity of mass production and the narrow range of centrally-mandated design choices are loosening their hold on us.

Manufacturing, how products are designed and by whom, is changing in profound ways.

Computer-controlled tools like 3D printers, milling machines and laser cutters are mostly available in costly, high-end versions, but there is a movement to create affordable versions of these tools that sit on the desktop. Admittedly, these desktop tools have fewer capabilities than their industrial counterparts, but they are already powerful enough to do remarkable things. Several projects for developing better and cheaper laser cutters have been funded through the crowdfunding website Kickstarter, each for several thousand dollars. MakerBot Industries, founded in 2009 makes consumer-priced 3D printers and offers kits to build them for about $1,000.

Publisher Tim O’Reilly’s Make Magazine, started in 2005, caters to a 21^st century hobbyist culture. It promotes making, crafting and tinkering as a type of grassroots movement. Make Magazine and its annual fairs have popularized an ‘open source’ approach to sharing designs and ideas.

Communal workshops, called ‘maker spaces’, are popping up around the country and indeed, around the world.  Many maker spaces are chartered as not-for-profit Fab Labs and Hackerspaces, or for-profit TechShops. There’s even an emerging trend where public libraries are hosting maker spaces as in the case of the Fayetteville Free Library in New York State.  Many of these maker spaces offer classes to their members and the public on topics such as electronics, programming, crafts and many other skills. Various consortia of these maker spaces are interconnected via the internet, so they can share ideas and best practices.

New companies like Shapeways and Ponoko, founded in 2007 and 2009, respectively, give users online personal factory services. Users upload or select product design files, and the service fabricates the design into a three-dimensional object and ships the finished product to the user.

A Few Thoughts on 3D Printers

In traditional mass production, it is difficult to produce small batches of a product because of the re-tooling costs. To obtain ‘economies of scale’ requires sacrificing product design and re-design flexibility.

In contrast, 3D printers can alter the printed shape of each unit produced without incurring the costs to re-tool and re-balance the production line.

3D printers apply successive layers of material until the desired object emerges (‘printed’), without the use of specialized tooling. These devices are fascinating to watch and there is an almost science-fiction like quality to watching a finished, three-dimensional part emerge in real-space. It’s a popular category on YouTube.

Industrial 3D printers have existed since the 80’s and their high cost (ranging from several hundred thousand dollars to more than a million dollars) has kept them confined to large institutions that can afford them. They’ve been used mainly in the aerospace, medical and automotive industries to produce prototypes for testing design assumptions, rather than used to produce large quantities of the finished product directly.

It’s likely that in the next few years, 3D printers will be developed that can economically produce high unit runs of finished goods, while altering the printed shape of each unit produced. If 3D printing, or ‘additive manufacturing,’ as it is also called, becomes a mainstream system for directly producing finished goods, it may supplant our current system of mass production and break the link between shape complexity and cost.

I have blogged before (“Memberships as Securities”) about how in some states, the definition of a security is so broad that almost any attempt to raise money including pre-selling, no interest loans, memberships, gift certificates, etc. could fall within the purview of the securities laws.  California was the first state to adopt this alternative, broader definition of a security, and 16 jurisdictions have followed.  The test used in these states is called the risk capital test and basically says that any time an offering is made to the public that asks people to put money at risk to fund a business venture, it will be considered a security.  (Note that states that use this test also use the more common test of whether there is an expectation of a profit – they apply both tests and if something meets the definition of a security under either test, it will be deemed a security.)  To illustrate the principle, here is a summary of two cases in which the courts found the capital raising strategy to NOT be a security.  The take home message seems to be that you need to have something valuable like diamonds or gold securing your investors’ money if you want to fall outside the securities laws in California!

In Moreland v. Department of Corporations, the court found that the sale of gold ore and a contract to refine the ore was not a security under the risk capital test even though “the promotional materials given to the public by appellant included the following statement: ‘The reason for selling the gold at this price is to raise the capital for a new milling and refinery plant . . . .’”[1]  The Department of Corporations argued that the intended use of the proceeds demonstrated by this statement satisfied the requirement under the risk capital test that the funds “be used for a business venture or enterprise.”[2]  The court disagreed, stating, “Superficially, this may be so since the construction of a mill and refinery is essential to the conduct of appellant’s intended mining, milling and refining operations. However, it is equally true that every purchaser of a product from a seller, who reinvests the proceeds of the sale in his business operations, contributes to a seller’s business capital. Notwithstanding, such a contribution is an investment in the purchased product and not a contribution of risk capital to a business enterprise within the normal scope of securities regulation.”[3]

In Hamilton Jewelers v. Department of Corporations, the court held that the following offering did not constitute a security under the risk capital test: “’Hamilton Jewelers invites you to invest in a ONE CARAT DIAMOND for only $500, and if anytime [sic] within a three year period you elect to return the Stone, Hamilton will return to you the full purchase price plus 5% interest calculated daily from the date of purchase.  A diamond investment of $500 will return $578.81 in cash at the end of a three year period.’”  The court reasoned that even though the offer to pay interest on an investment would normally fall within the definition of a security, in this case the investor’s capital was not at risk because the investor had a diamond worth at least $500.  The court stated, “The customer, being adequately secured, would have placed no ‘risk capital’ with Hamilton; and, therefore, the transaction would not come within the regulatory purpose of the Corporate Securities Law even though 5 percent interest might ultimately be paid to the customer.”[4]