Five steps the SEC can take to make crowdfunding work

By Sara Hanks
May 29, 2012

A few weeks ago, President Obama signed the JOBS Act into law, making equity-based crowdfunding legal for businesses that want to raise capital in smaller amounts than traditional venture capitalists or accredited investors supply. Depending on who you ask, crowdfunding is either going to democratize access to capital and serve as a boon to small businesses across America, or it will be rife with con artists intent on bilking seniors out of their hard-earned savings.

Let’s hope the former is true. But concerns about fraud must be addressed so the emerging market can thrive without being spoiled by fraud and scams.

The Securities and Exchange Commission is currently writing rules that will govern crowdfunding and, it’s hoped, guarantee its success. (Disclosure: I worked as a securities lawyer at the SEC from 1986 to 1990.) To properly regulate crowdfunding without suffocating it at inception, the regulators at the SEC must strike the right balance between guarding against fraud and allowing the marketplace to work its will.

Here are five actions the SEC should take to help crowdfunding flourish:

  • Make crowdfunding easily searchable. Work with the industry and the applicable self-regulatory organization to create a standardized national database of crowdfunding intermediaries and businesses seeking crowdfunding that can be accessed by regulators and investors alike. Databases should include search capacity and filtering by characteristics of businesses (e.g., minority, women-owned, food-oriented, Baltimore-based, etc.).
  • Define social-media boundaries. Provide detailed guidance as to how businesses seeking crowdfunding may use social media. Companies are allowed to give notice of their offering and direct investors to the “funding portal” where it is listed, but the nature of that notice is not spelled out. Can they post on Facebook and Twitter? What impact does it have to encourage people to “like” the investment on Facebook? Is a pin on Pinterest an advertisement? Crowdfunding companies won’t be filing a prospectus with the SEC when they’re looking for funds, and information will be available through all sorts of different channels. Our new world needs new rules.
  • Allow crowdfunding portals to be selective. Thousands of wacky companies are going to spring up overnight, and portals have to be able to exercise judgment (for instance, declining groups that want to sell racist T-shirts). But if portals do exclude companies, they might be considered to be acting as “investment advisers” that have to be registered with the SEC. The SEC needs to give portals safe harbors to exercise common sense.
  • Let the private sector work. Acknowledge the important role that the private sector will play in policing crowdfunding. There are going to be companies that focus on due diligence and disclosure, like the one I cofounded, and others that try to measure the amount of risk involved. When such companies are performing a useful function in the market, they do not need to be regulated like a business seeking crowdfunding or a crowdfunding portal.
  • Don’t smother startups. The SEC must recognize it’s dealing with companies in the very early stages of development. That means it needs to accommodate the needs of startups. Startup culture is disorganized and resource-poor. The SEC should focus on the overall picture and minimize the amount of information required for investors. For example, startups should be asked to provide a list answering the question “what are the specific risks you face?” as opposed to the detailed analysis that is more appropriate for more developed companies that trade on the New York Stock Exchange.

Skepticism of crowdfunding is healthy, and it is entirely correct to assume that where money is changing hands, there will be some fraud.

But fraud is not the biggest risk that investors face. The biggest risk to investors is that most businesses fail. Investors who want to give legitimate businesses a chance, despite the very real risk of failure, are what crowdfunding is really about. It is such an American virtue: We want to give everyone an opportunity to do well, as long as they play by the rules. The SEC has about eight months left to write the rules. I do hope they work.

25 comments

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[...] Five steps the SEC can take to make crowdfunding work – Reuters Blogs (blog) [...]

What a joke, Wall Street that is….

Posted by GMavros | Report as abusive

Come on now Sara Hanks, Wall Street has been and always will be nothing but FRAUD. At best it is a Casino. I guess you have some personal interest in seeing some more business as usual.

Posted by GMavros | Report as abusive

@GMavros, we fully share your cynicism of Wall Street and business as usual. But you might be interested to learn that Wall Street was actually OPPOSED to, and lobbied very hard against, the crowdfunding bill; presumably because the bill creates a new corner of the financial world that Wall Street doesn’t own or control. Crowdfunding is anything but business as usual on Wall Street. Sara notes that there is always a risk of fraud any time money changes hands – thievery has existed since the beginning of time. But the fraudsters trying to pull off a crowdfunding scam will have more to do with the snake oil salesmen from the early 20th century than they will with big Wall Street institutions. It is simply a different magnitude of risk than the systemic risk we’ve seen playing out on Wall Street over the past decade(s) (and which, incredibly, there is more, not less of, since 2008, as “too big to fail” banks have gotten bigger).

This does not mean that crowdfunding fraud is not a legitimate concern. To the contrary, as founding members of the CrowdFund Intermediary Regulatory Advocates, we and other industry participants (including Sara) are working with the SEC to come up with a workable set of rules for the industry. You might be surprised to learn that these organizations are actually advocating FOR sensible regulation of the industry. We recognize that it is not in anybody’s interest (except for the scammers perhaps) for the system to be too lenient — a moderate amount of regulation is needed, and welcomed, in order to create a crowdfunding system that is sustainable in the long run. Each intermediary has its own take on things, but for example, we invite you to review Funding Launchpad’s comments to the JOBS Act, which we posted directly on the SEC’s website: http://fundinglaunchpad.com/2012/05/fund ing-launchpad-sec-comments/

Contrast that with the self-serving lobbying of big Wall Street firms, and you will see what we mean when we say that crowdfunding is not financial industry business as usual.

As Sara notes, there are legitimate concerns about crowdfunding, and we as an industry have to address them. We are working with the SEC to do precisely that. However, we also have to educate the public that all financial services are not created equal, and that investment crowdfunding for equity or debt is NOT Wall Street as usual; to the contrary, it is a grassroots reaction to Wall Street as usual, a new way forward, borne of a collective frustration with business as usual on Wall Street.

We invite you to ask tough questions, challenge our premises, push us to defend the industry. But we ask that the crowdfunding industry be evaluated on its own merits, and not be lumped into, and presumed guilty by association with, Wall Street.

Shane Fleenor
Founder and Chief Legal Officer
Funding Launchpad (created by Vim Funding, Inc)

Posted by FundingpadCLO | Report as abusive

[...] U.S. oversight of derivatives may bolster defenses against JPMorgan-type losses Five steps the SEC can take to make crowdfunding work Stocks » Regulatory News » Markets » Media » Financials » Industrials » Technology [...]

I think crowdfunding is a good idea. I hope the SEC can regulate it without strangling it. Wall street will attempt to influence it heavily to regulate it out of existence or into their control.
Use cash, starve a Bankster!

Posted by tmc | Report as abusive

[...] U.S. oversight of derivatives may bolster defenses against JPMorgan-type losses Five steps the SEC can take to make crowdfunding work Stocks » Regulatory News » Markets » Media » Financials » Industrials » Technology [...]

I think it’s premature to say that equity crowdfunding done correctly will have any negative impact on future rounds of financing. I hope that equity-crowdfunding in the U.S. will be as popular and as successful as it has been in the UK over the past 6 months.

On EarlyShares (our crowdfunding platform), crowdfunding investors are pooled together into an new single entity and that entity invest as a single member into the crowdfunded company, one vote, one approval for future rounds, one shareholder. We have found that VC’s and Angel Groups like this structure and can see great value in getting access to companies where they are not the only investor!

It can be very beneficial for angels and VC’s to be part of a crowdfunded company, especially during the crowdfunding round, probably most important is the interest “validation of product/service” from a large number of consumers.

Even though we might only be able to present companies in January 2013, we are already working with companies seeking funding, we encourage entrepreneurs to apply now, and not wait as it takes a while to get approved.

To apply go to http://www.earlyshares.com/start

Posted by MauriceLopes | Report as abusive

Nice article, Sara. And @GMavros, I don’t think many would disagree that Wall Street is an unfair system. But it is equity-based Crowdfunding that will help democratize the flow of capital, bring equality to the capital markets and return them to the lifeblood of our economy: America’s small businesses. Why should Joe Average Investor be legally limited to investing his OWN money in public companies? Why should larger caps possess an unfair advantage raising capital in the U.S.? Larger caps that, by the way instead of creating US jobs, simply deploy that capital overseas in exchange for tax breaks and cheaper labor. Crowdfunding is a giant leap forward. Feel free to check out http://www.nowstreetjournal.com for additional information.

Posted by NowStreet | Report as abusive

[...] this week, Reuters published an editorial titled “Five steps the SEC can take to make crowdfunding work“. Shane Fleenor, Funding Launchpad’s Chief Legal Officer, added comments reminding [...]

@FundingpadCLO; @NowStreet; etc;

I sincerely appreciate your honesty & legitimate arguments.
Yes, Crowdfunding would be a great alternative to business as usual, but from past experience anything that would compete against the Banksters & their likes would be immediately infiltrated and end up under their control. Our congress, our Supreme Court & even the Presidency are already under their control. We have to first address these root cause for our present predicament, otherwise no matter how good & great new concepts might be they will never succeed.

Posted by GMavros | Report as abusive

[...] JOBS (Jumpstart Our Business Startups) Act has yet to be approved by the SEC. Here’s some things they might want to consider during that [...]

[...] Five steps the SEC can take to make crowdfunding work (blogs.reuters.com) [...]

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