And… The Bureaucrats Begin Spreading FUD About Crowdfunding

Venture Capital

from the run-for-your-lives dept

We’ve been waiting patiently for quite some time now to see the SEC’s “rules” for equity crowdfunding. As you hopefully recall, earlier this year, the JOBS Act became law, and one part of that was the legalization of certain forms of crowdfunding for equity (i.e., ownership of a company). You’re probably already familiar with crowdfunding for things like pre-sales. And you may be familiar with things like crowdfunding loans, via services like Prosper and LendingClub. The JOBS Act is supposed to enable a different form of crowdfunding: for equity investments. Thus, in theory, a startup could not just let people pre-pay for a product they’re developing, but could also actually purchase a tiny bit of stock in a company. Other countries already have this, but in the US it went against SEC regulations concerning the hoops you have to jump through to offer any of your equity to the public, rather than just a smaller group of accredited investors.

There’s been a fair amount of talk about this effort, and a bunch of companies chomping at the bit to get into the market once crowdfunding for equity is officially in place. The main holdup? The SEC. As part of the law, the SEC is supposed to put forth rules for how such crowdfunding can work. But the SEC made it quite clear before the law passed that it didn’t like this idea — not one bit. So I’ve been quite curious to see what rules it would eventually put out… and so far all it’s done is keep stalling. The rules were supposed to come out yesterday (which was already postponed from the original date), but instead, the SEC pushed things back another week.

While everyone waits for the SEC rules, various state securities regulators, in the form of the North American Securities Administrators Association (NASAA), are ramping up the FUD about such equity crowfunding. They released a report on the top investment scams… and crowdfunding in general is near the top of the list. They seem especially worried that the space is quickly going to be overcome by fraud:

“The number of entities out there already pitching themselves as crowdfunding entities online has risen in a significant fashion,” said Matt Kitzi, NASAA Enforcement Section Chair and Missouri Securities Commissioner. “Just look at web domain names: it has gone from a couple hundred to well over 1,600 in the past year. They are staking up a position to enter crowdfunding market. There will be a lot more to come on this.”

In early in August, the Massachusetts Securities Division charged a Lowell, Massachusetts man for a crowdfunding scam, bilking 20 investors who thought they were investing money in a gaming site of $153,396.

Secretary of the Commonwealth William Galvin, who brought the case, wrote to the SEC urging regulators not to let the JOBS Act changes become a tool for financial fraud and abuse. “Longstanding problems in the markets for small and speculative stocks show the pitfalls of relying on the wisdom of crowds.”

Here’s the thing: there are always scammers out there. And that’s going to be a big part of the challenge for any of the platforms that are jumping into the equity crowdfunding space to deal with. They’re going to have to distinguish themselves by how they enable trust between buyers and sellers and how they prevent fraud. But, some fraud is going to happen — just as some fraud is always going to happen in just about any market. That doesn’t mean we don’t let the market itself develop.

In the end, I’m guessing that the SEC rules will be fairly strict, and may limit this kind of market. Also, contrary to some expectations, I doubt that many will see this as a true replacement for angel or VC financing. It seems like the sort of thing that will likely be more useful for small businesses (such as local businesses) rather than traditional high growth enterprises which are the kinds of “startups” that usually attract angel and venture money. Surely, some people will set up scams and get tricked. But there have been scams in the startup world for ages, and there are likely already some scams that have made it through existing crowdfunding platforms. But that’s the nature of risk. Sometimes you lose.

While most people focus on how this will compete with angels and VCs, I’d think that it’s much more a form of competition for the crowdlending platforms, since those are more about investment as well, just with debt financing, rather than equity financing. And while there certainly have been cases of fraud that came about because of those platforms, for the most part it hasn’t sunk the top players in that space, because they’ve been able to try to minimize the likelihood of fraud while educating the market on investing wisely. There’s nothing to suggest that the top players who emerge in the equity crowdfunding realm won’t be able to do the same.

Filed Under: crowdfunding, investments, jobs act, regulations, rules, scams, sec