There’s been a lot of noise in the news lately about “crowdfunding,” a financing practice that enables startups to use small amounts of capital from a large number of individuals to finance a new venture. Legislators legalized crowdfunding as part of the 2012 Jumpstart our Business Startups (JOBS) Act. Prior to the Act’s passage, only the entrepreneur him-or-herself and individual investors with net worths of at least $1 million (excluding their homes) could invest in non-public startups. The JOBS Act changed that.
Starting sometime this year, new companies will be able to raise start-up capital online, through social networks like FaceBook and Twitter, and to obtain small investments from just about anybody – regardless of the investor’s net worth or familiarity with investment strategies.
Crowdfunding advocates hope it will boost small business growth at a time when the national economy is still recovering. Critics (myself included) warn that allowing private startups to solicit investments from everyday people will only add to the ever-growing problem of investment fraud. This is especially true when the practice could potentially allow anyone with a website – con artists and fraudsters included – to solicit investments online.
“It is basically going to be the wild, wild west, and we’re just going to be flooded with investment pitches on social media and websites,” I recently told the Springfield News-Sun. “I really think we are looking at the 21st Century boiler rooms, where dodgy deals are peddled in social media to unsophisticated investors.”
Heath Abshure, NASAA President and Arkansas Securities Commissioner, agrees. “Investors soon can expect to be inundated with crowdfunding pitches, legitimate or otherwise,” he said last year.
As of Nov. 2012, there already were nearly 8,800 Internet domain names that mentioned “crowdfunding,” and the practice isn’t even officially allowed yet. The SEC still needs to draft regulations to govern the practice, which likely won’t be accomplished until April. Until then, industry regulators are relying on crowdfunding websites to register with FINRA and to provide details about themselves to the regulator voluntarily.
While this may be a good first step, it doesn’t really offer much in the way of investor protection. No matter how many reputable crowdfunding websites sign up with FINRA, there are still going to be a number of con artists out there who will use a slick website and heavy online marketing presence to take advantage of the everyday investors who may not be able to tell a legitimate start-up opportunity from a fraudulent set-up. And, as many past investment schemes have taught us, registration with a regulator doesn’t mean there’s no potential for fraud or misconduct. For now at least, investors will have to be extra vigilant about watching for red flags if they want to protect themselves from fraud.
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