July 14, 2011
New Crowd-Funding Article
I have blogged from time to time on the application of the federal securities laws to crowd-funding. See here and here. Joan Heminway and Shelden Hoffman have posted on SSRN a new draft on crowd-funding, Proceed at Your Peril: Crowdfunding and the Securities Act of 1933. I haven't read it yet; I want to complete my own rough draft on crowd-funding before I incorporate their views. But here's the abstract, for readers interested in the issue:
A promising Web-based funding model for small business firms has emerged over the past few years. Crowdfunding (as this model has come to be known) actually includes a variety of business models, all of which use the Internet to fund business ventures by connecting promoters of businesses or projects needing funding with potential funders. Most of these funders are not professional investors; instead, they are just members of the Internet “crowd” that like the business idea of a particular entrepreneur and want to help him or her out with a nominal amount of funding—even $10.
Some (but not all) manifestations of crowdfunding result in the offer and sale of interests that are securities under the Securities Act of 1933, as amended. Offers and sales of securities that are neither registered nor exempt from registration violate the Securities Act. The high cost of registration is prohibitive for small businesses that might benefit from crowdfunding. Accordingly, if crowdfunding is to achieve its optimal benefit (or even just survive or thrive), there must be some intervention. This dilemma has caught the attention of many, including the U.S. Securities and Exchange Commission (SEC).
This article first shows how crowdfunding interests may be securities under the Securities Act and describes key legal effects of that security status—including the requirement of registration (absent an exemption). The article then explains why the offer and sale of crowdfunding interests under certain conditions should not require registration and offers the principles, process, and substantive parameters of a possible solution in the form of a new registration exemption adopted by the SEC under Section 3(b) of the Securities Act.
Note: The article references a chart we have prepared that identifies and describes a number of crowdfunding Web sites. That chart is not posted with the article. It (or an updated version) may be obtained from either author.
July 14, 2011 | Permalink
Crowdfunding interests are most definitely securities (although I would debate whether peer-to-peer lending notes are as the SEC is inclined to say). That being said, I don't see any reason why there should not be an exemption for crowdfunding. No matter what the rules are, I think it is safe to say that there will be fraud in the securities world. But with a crowdfunding exemption that limits the per investor dollar amount, I think investors would be adequately protected from potential risk and the risk would be spread very wide amongst a large number of investors. Obviously there is still a chance that an interest would be totally fraudulent but at least you'd limit your loss to a small amount (e.g. less than $500 or $1000) as an investor. Hopefully the SEC will adopt a crowdfunding exemption after their consideration of the issue which supposedly is happening right now or at least will happen soon.
Posted by: Gustav | Jul 14, 2011 3:33:19 PM
It's not quite that simple. Not all crowd-funding sites involve securities. Some of them are set up on a donation basis. Others offer only small trinkets or pre-ordered products in return for the contribution. Those sites are pretty clearly not selling securities. And, because of current regulatory restrictions, those sites predominate in the U.S. right now.
I also suspect you're overly optimistic about whether and how soon the SEC will act. My guess is that a rulemaking proposal, if there is one, is several months away. And I'm not convinced this Commission will adopt any meaningful crowd-funding exemption. But I've been wrong before.
Posted by: Steve Bradford | Jul 15, 2011 11:27:11 AM