Crowdfunding: What Could Go Wrong?

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I really need to pay more attention to the Internet. Sorting through the musings of six  billion people all of whom seem to have decided that they need to “speak out” is often so daunting that’s it’s hard to bring myself to do it. Yet the unavoidable truth of the electronic age is that buried within all that noise is information that is both interesting and, sometimes, important. 

I made such a discovery yesterday, while reading Melanie Waddell’s June 29 AdvisorOne story of the SEC and NASAA warning that equity “crowdfunding” is not legal yet. Equity what? I know, I’m out of touch here, but with the help of Melanie’s story and a couple of reconnaissance missions onto the Web, I was able to discover that “crowdfunding” is:  a) an online vehicle for nonprofit programs and business startups to attract grassroots financing; and b) that the federal JOBS Act that passed in April included a provision known as Title III, which is intended to expand “crowdfunding” to finance small businesses. 

Melanie quoted NASAA president Jack Herstein explaining the idea this way: “…the crowdfunding concept has the potential to provide legitimate small, innovative enterprises with access to capital that might not otherwise be available.”

Now that got my attention. To my not-getting-any-younger mind, “providing access to capital” for business has traditionally been the purview of banks (when it’s pretty much of a sure thing) and brokerage firms (when there’s a bit more risk involved). And on balance, with a few hiccups along the way, they’ve been pretty good at it: we each have our own cars, fly to all points of the globe in airplanes, have CAT scanners on seemingly every medical corner and of course, now have multiple devices that enable us to connect with the Internet 24x7. 

Each of these “ideas” and millions more obtained financing from a bank and/or a brokerage firm. And this system also provides financing to more risky ventures that often shouldn’t get any: they’re called penny stocks. But apparently this system isn’t good enough for the luminaries in Washington, who have decided to take venture capital financing directly to the people, in Title III of the Jumpstart Our Business Startups Act (no, I’m not making this up). 

In short, Title III provides an exemption from securities registration for “issuers” who “offer and sell up to $1 million in securities” provided they abide by the rules for doing so set by the SEC, which has yet to do so, hence the regulators’ warning that Melanie wrote about. What’s more, these “issues” must be offered on the Internet by a “funding portal” which doesn’t have to be a registered broker-dealer but  does have to register with the SEC, abide by the SEC’s yet unwritten rules, and register with an SEC registered “national securities association,” of which there currently is only one: FINRA. 

So, the way I read this, virtually any individual or company can, without the constraints of current securities laws, raise money directly from anyone on the Internet, in $1 million increments. This could certainly be small businesses for whom “access to capital that might not otherwise be available,” whether said lack of access was for good reasons or not. It could also be for large businesses, whose risky ventures couldn’t find a more traditional source of financing. Or it could be anyone, legitimate or not so much, who can make a risky or even impossible venture sound like a good idea to the unsuspecting public. 

Maybe I’m missing something here, but aren’t the Congressmen who passed this JOBS Act the very same guys and gals who passed Dodd-Frank Act to increase the regulation of the financial and securities industry because they felt that current laws and regulations weren’t adequately protecting investors and the ever-growing army of retirees? How is creating an online investment Wild West that, by comparison, makes penny stocks look like a CD, going to help?

 

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