I hadn’t even heard about this until today and that was only because the SEC missed its rulemaking deadline. The practice was authorized as part of the JOBS Act signed in April.
From what I’ve gathered here it should work pretty much like any other crowdfunding site such as Kickstarter but the difference is that you would be betting on a business concept and were the concept to be fully funded, get an equity interest.
OK, that sounds pretty simple. And from other sources it appears that there will be a variety of anti-fraud mechanisms. For example the sites will be SEC registered, money will be escrowed, etc.
But obviously it’s a lot more complex than it appears if even the SEC is having a hard time coming up with regs.
So does anyone have info on this? I’ll even take intelligent speculation although that might get the thread bounced to another subforum.
Essentially, crowdfunding will be handled by either a registered funding portal (something like Kickstarter, everyone assumes) or a registered broker (presumably this means a registered broker-dealer like Merrill Lynch). Potential investors will have to register with each portal or broker that they are interested in doing business with. Registration will involve providing the portal or broker with information about the investor’s income and net worth. The investor will also have to review investor-education information and positively affirm that he or she understands the risk of loss of the entire investment and could bear such a loss, as well as answer “questions demonstrating—(i) an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers; (ii) an understanding of the risk of illiquidity; and (iii) an understanding of such other matters as the Commission determines appropriate.”
The issuer will prepare some sort of statement describing itself and the offering, and this will be available from the portal or broker. The statement will include the price to the public of the securities or the method for determining the price. Prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities. The total size of the offering will not be more than $1 million. A single investor’s investment in a single issuer will be subject to a maximum investment limit. The limit will be (i) the greater of $2,000 or 5% of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and (ii) 10% of the annual income or net worth
of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.
The article you linked says that Obama set a January deadline for the SEC. This is incorrect; the deadline is in the statute, and it says that rules shall be issued not later than 270 days after enactment, which works out to December 31, 2012. The rules have not even been proposed, so they obviously won’t be adopted by December 31.
One of the things I’m interested in is how much information will be required up front. I’ve only been on Kickstarter maybe a half dozen times if that and each time it’s amazed me how little information they give you in return for your money.
By contrast, if you want a startup loan from a bank (I’ll go get some tea while you’re laughing) you have to provide a bit more I believe. I seem to recall needing something like a ‘business plan’ for example. If you list your Mars tourism startup on one of these sites, are you going to have to show me a business plan? And by the way, what exactly is a business plan anyway? No never mind. I don’t really want to know.
I’m already starting to get the feeling that I’m not going to trust any of these new sites any more than I’ve trusted the Kickstarter posts I’ve seen. And I think I see the SEC’s dilemma. First, even if there are never any ripoffs - ever - a lot of these ventures are going to faceplant right out of the gate and a majority probably in the first year. But also, even legitimate failures will sometimes look bogus, so the SEC will get blamed regardless.
Second, I don’t really see how any set of rules can prevent fraud here. The SEC needed more staff just to get up to par after the financial crisis. Now they’re going to be expected to police every nickel and dime crowdsourced operation that goes bust? Yeah. It seems like putting out the welcome mat for serious, if not billion-dollar class securities fraud.
Maybe I’m overstepping by saying it this way, but I’ll say it anyway: The SEC is concerned with form and procedures, and with enforcement after the fact. They are not primarily focused on preventing fraud directly.
Even under the current system, you can publish virtually anything you want as an SEC filing. The effort will be put into convicting you after the fact, not so much into preventing you before the fact.
In some ways, it’s the reliability of the CPA that you’re really counting on to prevent fraud.
That’s a good point, especially now. The idea of enforcement is to deter through fear of prosecution. But if there isn’t any prosecution, you have a hard time instilling fear.
I don’t want to go off on a rant, but literally thousands of people, from loan officers at mortgage banks to bank CEO’s probably deserved to be prosecuted in the wake of the financial crisis and AFAIK, everyone’s gotten a walk.
I would imagine you’re right and that regardless of the rules, people inclined to commit fraud but who might have been deterred will take recent history as the guide for their actions.
The SEC is very interested in preventing fraud. It’s necessary to be realistic about what is possible, though. The crowdfunding system will limit the amount raised by an issuer to $1 million. If you’re going to have a system where the SEC, the issuer, and the portal or broker spend $500K in the aggregate on due diligence, the numbers don’t make sense.
The statute requires the portal or broker to take such measures to reduce the risk of fraud with respect to the transactions as may be established by the SEC by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer. Issuers also must provide financial statements, which must be reviewed or audited by an accounting firm if the target offering is more than $100K.
The statute spends about a page and a half (on pages 317 and 318) describing what the issuer has to disclose. I’m sure that the final SEC rules will be much more detailed, and that issuers will complain bitterly about all the information they have to provide just to raise money.
The SEC will have the authority to bring civil enforcement proceedings for securities fraud against issuers, and in egregious cases federal prosecutors may bring criminal charges. Most issuers, however, will probably be more worried about the statute’s provision of a private right of action to investors, who will be able to sue if there are material misstatements or omissions in the offering materials. An issuer and certain of its insiders will be strictly liable for any material misstatements or omissions, unless they sustain the burden of proof that such issuer did not know, and in the exercise of reasonable care could not have known, of such untruth or omission.
The crowdfunding provisions as a whole give the impression that a lot of thought was given to these issues - much more than was given to the rest of the statute.