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Industry Spotlight > Broker Dealers

Kickstarter for Wall Street? Broker-Dealers Get Into the Crowdfunding Game

By Joyce Hanson

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It’s official: the money people are rallying to the crowd-funding cause.

President Obama signed the American JOBS Act of 2012 into law on April 5, and broker-dealers are already looking for opportunities to fund entrepreneurial startups. In fact, more than 100 broker-dealers, most of which specialize in private placements, signed up to participate in a new crowdfunding portal, www.ConfidentCrowd.com, this week at the Financial Industry Regulatory Authority’s (FINRA) 2012 Annual Conference in Washington.

Michael Dinan, founder of ConfidentCrowd and chief executive of Phoenix-based investment bank Dinan & Co., said in a phone interview on Tuesday with AdvisorOne that ConfidentCrowd will be registered with the Securities and Exchange Commission, and the deals made available through the portal will be sold exclusively to FINRA-registered broker-dealers.

The idea of the portal is to screen companies seeking funding to minimize investor risk. ConfidentCrowd will provide a meeting place for member broker-dealers, businesses in need of capital and investors seeking opportunities. For investors, crowdfunding offers an opportunity for portfolio diversification, with starting investments of as much as $10,000 a year, but they should be vetted and structured by securities experts, according to Dinan.

Gary Whitehill, founder of Entrepreneur Week and a member of the Young Entrepreneur Council, said he hadn’t yet heard of ConfidentCrowd but said its financial sophistication could help it rise above other crowdfunding startups in the offing.

“One hundred broker-dealers at FINRA signing up. Wow,” Whitehill said. “Every crowdfunding platform built so far has been built by an entrepreneur, not an established company. This is the first one I’ve seen that’s from an actual corporation. It’s all about timing the market, and if this guy has already built it, why would you create another platform? I know a lot of people who are trying to rush into this space, but it’s the first time I’ve seen a broker-dealer come into this. I think it’s smart. What’s interesting about this is that you’re leveraging a network of broker-dealers.”

‘Crowdfunding Itself Is a Private Placement’

“We introduced the portal yesterday at the conference and we’ve had almost 100 broker-dealers who have signed on already,” Dinan said Tuesday. “They are mainly smaller independent broker-dealer firms that specialize in private placements. That’s important, because private placements are security transactions that must be approved by FINRA, and in fact, crowdfunding itself is a private placement.”

Since ConfidentCrowd announced the news of its launch on Monday, the site has received about a dozen inquiries from entrepreneurs. “From the responses we’ve received, we believe health care is going to lend itself well to crowdfund investing,” Dinan said.

ConfidentCrowd is now building its infrastructure and membership base of broker dealers and investors, while waiting for the SEC to make regulatory decisions about the JOBS Act during a nine-month rulemaking process.

In addition to broker-dealers, also stopping by the ConfidentCrowd booth at the conference in Washington are FINRA staff members, lawyers and wealth management firms, Dinan said.

“The JOBS Act and crowdfunding ARE clearly one of the hot topics. In every breakaway session I’ve been to, crowdfunding was mentioned either by the speakers or in the Q&A afterward,” he said. “While FINRA has not been named the self-regulating organization (SRO) to oversee crowdfunding, we believe it will be.”

According to FINRA BrokerCheck, Dinan is a broker currently employed by Ceres Capital Advisors, also headquartered in Phoenix. He is also still employed by Dinan & Co., which was founded in 1988. The firm specializes in middle-market mergers and acquisitions, with more than 300 transactions closed since its founding with a total transaction value of more than $20 billion.

Kickstarter and Regulatory Restrictions

To be sure, ConfidentCrowd is not the only player in the crowdfunding game. Before the JOBS Act’s passage, nonprofit and philanthropic fundraising efforts such as Kickstarter were legal under U.S. law. And since the beginning of May, at least two new investment-oriented crowdfunding initiatives have been announced: a partnership between EarlyShares.com and Navocate, and one by the U.S. Crowdfunding Exchange LLC, according to Reuters.

Along with the excitement come concerns about investment risk and financial literacy, said R. Paul Herman, a registered investment advisor and chief investment officer of HIP Investor, a San Francisco-based wealth manager focused on sustainability.

In the San Francisco area, “the land of Kickstarter,” crowdfunding is an active conversation, Herman said. One such conversation, he noted, revolves around the Kiva crowdfunding site co-founder Jessica Jackley and her failed attempt to launch a for-profit site, Profounder.com, due to securities law restrictions.

“What Jessica experienced before the JOBS bill’s passage and the SEC rulemaking wasn’t easy,” Herman said. “The SEC is out to protect investors, so unless you’re accredited, it’s difficult to invest in local companies. The core risk is: does the every-day investor understand all the risks of what will go wrong in a small or medium-sized enterprise? For investors to have a successful positive return will require them to act like more sophisticated or experienced venture capitalists.”

The SEC can’t kill the JOBS Act, but it can choose how many rules to put around it, Herman pointed out—which can be a good thing, considering that “there is no driver’s license for being an investor.”

Facebook and Failure

On the subject of risk, ConfidentCrowd’s Dinan said there is a risk that naïve investors will pour money into startups that they hope will become the next Google or Facebook. “The failure rate among early stage and seed entities, which are the groups that will principally use crowdfunding, is exceedingly high,” Dinan pointed out.

Worse, he said, scam artists are certain to find ways to use crowdfunding for investment fraud.

Whitehill, the New York Entrepreneur Week founder, said he isn’t worried about isolated instances of fraud, so much as that “America doesn’t understand the value of this weird quasi-French word ‘entrepreneurship’.”

The question remains whether crowdfunding can withstand the public, political and regulatory pressure that it will surely encounter, Whitehill said.

“Will mainstream America understand why crowdfunding is important? Will it hold up to regulatory pressure when something goes wrong and we need to implement a law so it never happens again? I see crowdfunding as a platform that is free and open, and there will be challenges along with it, but anybody who’s passionate about something should have the realistic opportunity to follow their passion,” he said.

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Read JOBS Act Is a Dangerously Flawed Product of a Rush to Legislate by NASAA President Jack Herstein at AdvisorOne.

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