Crowdfunding and the limits of the SEC

By now, every securities regulator and most others are familiar with Bernie Madoff and the gaggle of modern-era con men such as Allen Stanford and Marc Dreier, all of whom were ultimately caught by joint action from various law enforcement entities, including the SEC. They unearthed fraud in the hundreds of millions and billions of dollars collectively.  These are only some of the most high-profile cases prosecuted by the SEC, and there is little doubt that the SEC basks in the media glow as any enforcement agency does when it receives favorable press.

The problem with attention-grabbing prosecutions dealing in massive scams and huge financial losses is that it leads the public to believe that only the SEC is preventing fraud. In truth, the SEC is prosecuting criminal behavior after it has occurred.  This is an important distinction because prevention happens before, and prosecution happens after, a crime occurs. While successful prosecutions arguably have some deterrent effect on future scam artists, deterrence is only a part of crime prevention.

So, if the SEC and other government agencies are unable to stop Madoff, Stanford, and Dreier before the victims are soaked, how will the SEC prevent fraud in crowdfunding?

It likely won’t. Our federal government has developed expertise and drawn on deep resources to enforce the laws against criminals after the crime has been committed. But its track record at preventing financial crimes before they occur is spotty when viewed in the most favorable light. In fact, one could argue that the monumental frauds perpetrated by Madoff, Stanford, and Dreier actually expose the strict limits of the power of the SEC–only achieving colossal verdicts that speak to the failures of preventing these individuals from defrauding others.
It is probably not an overstatement to say that the fate of crowdfunding hinges on the the degree to which the SEC appreciates the limits of its powers at preventing financial crimes. Entrepreneurs, investors, and the public are all eagerly awaiting the verdict.


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The JOBS ACT and Kickstarter

An acquaintance recently asked why Kickstarter doesn’t have to comply with the restrictions set forth in the JOBS Act. Kickstarter is a platform that charges a commission for matching donors with young businesses and creative types who otherwise encounter difficulty funding their screen plays, independent films, unusual time pieces, and more.  The JOBS Act, with the help of the SEC, governs platforms that do the same thing as Kickstarter. The only substantive difference is one between donations and investments.  Donations are basically a gesture of good will with no possibility of financial returns while investments carry the expectation of profit.

So why doesn’t Kickstarter have to comply with investment limits, criminal background checks, consumer education, and other restrictions imposed by the JOBS Act?

The short answer is that the drafters of the JOBS Act want it to reflect public policy. Our politicians believe (rightly or wrongly) that fraud is more prevalent when people are acting in their own financial self-interest. Avarice, profit-motive, investment prudence . . . by whatever name it might be called, our public policy reflects enduring and overriding concerns that financial criminals prey on the financially self-interested.

A cash gift is fire-and-forget, no recourse, and lightly regulated (if at all). Try to buy a piece of a business because it appears to a be an attractive investment, on the other hand, and you and your intended recipient must pass a variety of hurdles to ensure it’s a legitimate deal, you have been provided adequate disclosures, you can afford to take the risk, and so on.

Whether there is a meaningful difference between con men who prey on the financially motivated vs. con men who take advantage of the charitable or philanthropic-minded is a discussion for another day. The mission of the SEC is strictly focused on boiler room operations and Ponzi-schemers, not  corrupt pastors, bogus documentary movie-makers, or other fake do-gooders busily fleecing the unwary.

Are Kickstarter and the like enjoying favorable treatment by our regulators? Are crowd-funding investments justifiably being held to a higher standard? Will public policy concerns drive potentially complex and costly new SEC regulations?

Stay tuned for word from the SEC.






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Crowdfunding: next up to bat, the SEC

Barring any 11th hour amendments or cold feet, President Obama is due to sign the JOBS Act this week. The new law caps a tumultuous legislative ride for all groups looking to invest or raise money in the micro-finance world, and a couple of the expected major benefits are neatly summarized by Ryan Caldbeck in his column for Seeking Alpha.

Assuming the JOBS Act proceeds, the SEC will have a 270 day period in which to establish rules for crowdfunding that are likely to beef up safeguards for the so-called unsophisticated investors based on the September 2011 testimony offered by SEC Director Cross.  Whether the forthcoming SEC rules make crowdfunding platforms viable or not remains to be seen, as Naval Ravikant pointed out in a recent interview.

How will the new rules take shape? As always, the devil will be in the details.

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