November 6, 2011
Hazen on Crowdfunding
Crowdfunding, Social Networks, and the Securities Laws – The Inadvisability of a Specially Tailored Exemption Without Imposing Affirmative Disclosure Requirements, by Thomas Lee Hazen, University of North Carolina (UNC) at Chapel Hill - School of Law, was recently posted on SSRN. Here is the abstract:
Social networks have been used as a medium for financing films and other performing arts, as well as for charitable solicitations. These and similar fundraising endeavors are known as crowdfunding. Social networks have the potential for using crowdfunding to reach large numbers of people. Since crowdfunding is designed to reach a large number of people, limiting the fund-raising request to a small amount from each donor can provide meaningful funding. The solicitation of funds as gifts or donations is a substantially unregulated activity. Crowdfunding can also be used to finance small business enterprises, which in contrast is a highly regulated activity by virtue of the securities laws.
Securities laws are designed to provide investor protection by requiring disclosure and in many instances registration. The securities laws come into play when social networks are used to make a widespread solicitation of funds for business enterprises, regardless of the amount being sought from each investor. For the most part, the exemptions from the more burdensome securities law disclosures do not apply when there is a general solicitation as is the case with crowdfunding efforts. There are a few exemptions permitting a general solicitation exist but those exemptions are conditioned on the use of an offering circular or other mandated disclosure to potential investors. There has been some discussion of providing a less onerous exemption from the securities laws to facilitate crowdfunding of business ventures. In fact, there have been a number of proposals to the SEC urging the adoption of an exemption for crowdfunding efforts.
The difficulty here is trying to balance the policy of encouraging small business formation against the investor protection goals of the securities laws. Unless new exemptions are formally adopted, crowdfunding may not provide a viable capital raising method in light of the costs of complying with securities registration or disclosure requirements. This article provides an overview of the applicable securities laws and evaluates the various proposals which their proponents argue would provide a workable exemption that would not unduly compromise investor protection. The article concludes, however, that the proposals to date do not adequately justify an exemption.
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