And... The Bureaucrats Begin Spreading FUD About Crowdfunding

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.


Reader Comments (rss)

(Flattened / Threaded)

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    Glen, Aug 24th, 2012 @ 3:55pm

    Of course they have to use FUD. If they can't control the money, they will lose power. They can't have that!!!

     

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    Anonymous Coward, Aug 24th, 2012 @ 4:31pm

    your spreading fud, they are expressing concern about it, not trying to ban it, just wanting ot make sure they have things in place to protect people

     

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    Homer, Aug 24th, 2012 @ 5:50pm

    FUD?

    I prefer DUFF.

     

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    orbitalinsertion (profile), Aug 24th, 2012 @ 6:09pm

    Concerned over competition, are they? Don't like the idea of anyone horning in on their long-running and legally ensconced scams? I'm not sure about startup money per se, but the whole financial sector probably reacts to these things, when they notice, with "do not want".

     

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    John William Nelson (profile), Aug 24th, 2012 @ 6:29pm

    Fraud should be a concern . . . look at ZeekRewards

    I do work for some work with startup companies and I know enough about SEC regulations to know when a company needs to register their offerings and when they do not. (The bread and butter of most securities lawyers—avoiding registration.)

    The fact is that SEC regulations, when enforced, do a lot to protect potential investors. The goal is to provide enough information to investors to allow them to make good choices.

    This is why public offerings—such as the recent Facebook one—require so much paperwork. Even private offerings can require lots of information. If a company makes a private offering to a small group of investors which includes some unaccredited investors then you have to do a private placement memo. While not as expensive as the IPO route, you're still talking thousands of dollars worth of legal and accounting fees.

    This makes it hard for startups, but is also ensures investors are protected. The information provided during IPOs and through private placement memos can protect potential investors from fraud.

    And fraud does happen. The internet, with its vast democratizing power through the information it provides, is not a perfect tool for sorting truth from falsity, much less sound investment from fraud. The downfall and SEC actions against ZeekRewards is a great example of this. (http://www.forbes.com/sites/timworstall/2012/08/18/zeekrewards-if-an-investments-too-good-to-be-tru e-it-is/) The reality is that people still get duped. (And no, Zeekwards did not provide PPM or IPO level disclosures. Rather, it claimed it was exempt from these as their scheme did not involve securities.)

    So while I am anxious to see how the SEC addresses crowdfunding of startups with equity in play, I am also worried about the potential for fraud if the rules are not crafted in a balanced way.

    The hope is that the rules require disclosures necessary and sufficient to provide investors the information they need, but at the same time not causing too cost-prohibitive of an amount in legal and accounting fees.

    We shall see, but calling worries about FUD is not really fair. While people worrying about fraud might make fearful statements which raise uncertainty or cause people to doubt the wisdom of less rigorous reporting requirements, in this case at least there are well-documented instanced where harm has occurred to investors and participants in various investment schemes.

    FUD, on the other hand, has always seemed to me to be more about empty fears, uncertainties, and doubts backed by little to no evidence. This is not what we have here.

    (Please pardon any rambling—recovering from some kidney stones and requisite painkillers.)

     

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      The eejit (profile), Aug 25th, 2012 @ 1:30am

      Re: Fraud should be a concern . . . look at ZeekRewards

      Thanks for that. This is a legitmiate criticism of a post. And whilst I disagree, I can at least see your reasoning (with an example) of why you would come to that argument.

       

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      Ninja (profile), Aug 27th, 2012 @ 4:27am

      Re: Fraud should be a concern . . . look at ZeekRewards

      Because of something that could happen they are painting the apocalypse on the landscape. For me that's FUD. It's different to express concerns and provide ideas to deal with the problems identified and just throwing scary numbers and stories to emphasize the problem.

      Terrorism exists but does it justify all the (inefficient) security theater (TSA) out there?

       

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    Hephaestus (profile), Aug 25th, 2012 @ 1:18am

    Why do we even need regulations for this? Anyone being a scammer will get caught and the law and internet will take care of the rest. Streisand anyone....

     

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    Anonymous Coward, Aug 25th, 2012 @ 10:59am

    Sorry but I don't think your facts are quite right. The deadline that passed was for rulemaking regarding amendments to Rule 506 of Regulation D and the associated removal of historical prohibitons against general solicitation and advertising for issuers utizing this safeharbor (supposed to have happened by July 4). The deadline for rulemaking for the new Crowdfunding exemption is 12/31/12, and has been that date since the JOBS Act was signed into law on April 5.

     

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    Ben, Aug 25th, 2012 @ 12:15pm

    Well, you gotta see that's extremely terrifying. A handful of jerks from all over who don't even know each other can accomplish just about anything these days.

    I was absolutely floored by the Oatmeal\Tesla Museum. That started with a simple article\comic admiring Tesla, and couple months and squabbles later, they pulled over a million $ towards making a Tesla museum. It took 9 days at IndieGogo.

    http://theoatmeal.com/blog/tesla_museum_1m

     

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    Anonymous Coward, Aug 25th, 2012 @ 8:14pm

    You can thank Facebook for the current situation, because their complicated avoidance of public scrutiny, and the resulting fall out on the public share prices is enough to get anyone worried.

    Simply put, Facebook and it's initial private investors used all sorts of weird tricks to allow more and more people to "pre-invest" in something that pretty much collapsed. They were price it 100 times earnings, and the current market has it at about half that and dropping. The initial share price was not supported for very long, they could barely prop it up long enough. It's been a near free fall since.

    The SEC wisely says "this is a problem" and starts looking into all forms of alternate financing, including newer concepts such as Kickstarter. They fear (correctly) that these sorts of methods could be used to rip off people, to take money and never deliver the products, or to get people to invest in a shell that does nothing except funnel money to a scammer's pocket.

    The only FUD here is anyone who thinks that the government shouldn't at least take a look, and shouldn't at least issue some guidance and advice to the public in dealing with these alternate financing methods.

    It wouldn't hurt Kickstarter too much to have to adhere to certain rules about qualifying the offers. Certainly it would hurt them less than the number of citizens and the amounts of money lost in scammer's schemes.

     

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    Anonymous Coward, Aug 26th, 2012 @ 5:47am

    and masnick still has the balls to continue writing, even after exposing himself as a complete fraud..

    Goodge give you permission to post this ??

    there should be an empeachment system for scumbag bloggers..

     

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    Steve, Aug 27th, 2012 @ 12:09am

    Fud

    Too bad that the message and purpose is getting lost in the discussion. Certainly investor scams present a concern. But the higher purpose here, IMHO, is about how to get capital into job creating small business. If the naysayers of Crowdfunding want to advance a case, then come up with another creative thought or two about capitalizing small business. There hasn't been much out of wall street ot Capitol hill. Either be part of he solution or STFU.

     

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    Steve, Aug 27th, 2012 @ 12:09am

    Fud

    Too bad that the message and purpose is getting lost in the discussion. Certainly investor scams present a concern. But the higher purpose here, IMHO, is about how to get capital into job creating small business. If the naysayers of Crowdfunding want to advance a case, then come up with another creative thought or two about capitalizing small business. There hasn't been much out of wall street ot Capitol hill. Either be part of he solution or STFU.

     

    reply to this | link to this | view in chronology ]

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    identicon
    Steve, Aug 27th, 2012 @ 12:09am

    Fud

    Too bad that the message and purpose is getting lost in the discussion. Certainly investor scams present a concern. But the higher purpose here, IMHO, is about how to get capital into job creating small business. If the naysayers of Crowdfunding want to advance a case, then come up with another creative thought or two about capitalizing small business. There hasn't been much out of wall street ot Capitol hill. Either be part of he solution or STFU.

     

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    Mike S, Aug 27th, 2012 @ 10:43am

    Political Football

    People who are proclaiming "fraud" before the rules are even drafted are simply ignorant and scared of what they don't understand.

    Moreover, they're likely a victim of fraud in the past, or have committed fraud in the past.

    Wall Street is the most powerful force on earth. Crowdfunding will likely remove some of its profits. Therefore, don't be surprised if "fraud talkers" come out of the woodwork to compare Crowdfunding to the Penny Stock Market, which is fraught with fraud.

    (see this blog post http://ppmlogix.com/blog/126-state-regulators-ask-sec-to-delay-qgeneral-solicitation-rulesq)

    The fact is... many investments into Crowdfund projects will likely be off-the-radar of the IRS and the SEC. This means NO TAX REVENUE... and NO CONTROL...

    This also means that many political games are being played with the JOBS Act...

    (see this blog post http://ppmlogix.com/blog/145-jobs-act-haunted-by-dodd-frank)

    Dodd-Frank, passed 2 years ago is still being debated at the SEC... Just like the JOBS Act!

    I predict Crowdfunding will be adopted by the SEC sometime in 2014. If Romney gets elected it may get repealed or tweaked, and if Obama stays in office he won't do anything to force the issue with the SEC.

    The SEC is ran by many conservatives who guard Wall Street... No matter how many people get behind legislation to reform Wall Street, nothing will change until the conservatives who run the SEC are removed and replaced with people who care more about Main Street than they do about Wall Street.

    JMHO

    Mike

     

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    Anonymous Coward, Aug 28th, 2012 @ 1:23pm

    Champing at the bit

    I don't know why, but the term is "champing at the bit". NPR informed me of that about five years ago. Yay NPR.

     

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