This ad will close in

Regulators Wrangle Over How to Protect Crowdfunding Investors

Regulators Wrangle Over How to Protect Crowdfunding Investors
Image credit: Shutterstock

At the heart of the debate over how to write the rules for the next generation of crowdfunding is how much regulators should seek to protect small investors.

Under the Jumpstart Our Business Startups Act, known as the JOBS Act, small investors would be able to invest only a portion of their net worth. What rulemakers can't agree on is how to determine an investor's net worth.

One option is to have investors report their own net worth, a route known as "self attestation."

Another alternative is having crowdfunding portals or a third-party, such as a broker or accounting firm, verify the net worth of potential investors and have an independent database track all equity-crowdfunding investments. The Securities and Exchange Commission declined to comment.

Related: Crowdfunding Industry On Fire: Trends to Watch

Either option has its shortcomings. Self-attestation would effectively render the small-investor protection clause of the law toothless. “The debate comes down to this: Do we care about the part of the law that says you are limited to how much you can give?” says David Marlett, founder and executive director of the National Crowdfunding Association, an industry advocacy group.

The alternative, which require determining an individual’s net worth, would be a complex process that could potentially derail the immediacy of equity crowdfunding, says Marlett, who has been involved in rulemaking discussions with lawmakers, regulators and industry advocates. Many investors would likely object to having an agency examine their assets and debts to assign a net worth, he says.

Related: Crowdfunding Goes Mainstream: Why Donald Trump and Google Are Supporting Grassroots Financing

“You would kill everything, grind it to a stop, you might as well not even let any unaccredited investors [crowdfund],” says Marlett. “Crowdfunding is an instantaneous, ‘Hey, I want to go help this,’ kind of deal, not, ‘Hey, I want you to help me crowdfund, but here are these six forms you got to fill out and you’ve got to show your tax returns.’ For what? $500. 'Sorry, no, thanks. See ya!' ” says Marlett.

However, if everyone is eligible to declare their own net worth without documentation, small investors may be able to effectively circumvent any investing limits. “If the SEC goes with a system based on self-certification, they will have abandoned their responsibility,” says Barbara Roper, director of investor protections at the Washington, D.C.-based Consumer Federation of America. Congress was clear, she says, that it wanted to include rules protecting small investors from losing their life’s savings.

Related: Raising Money Through Crowdfunding? Consider These Best Practices for Success

“If they can’t offer crowdfunding in a way that is responsible and limits potential harm to investors, then it shouldn’t exist,” says Roper. “In crowdfunding, we say that anybody can invest in these most speculative of companies, most of which, through no fraud or ill-will, will fail. And we are going to let average Americans risk their retirement savings on these kinds of investments, and the least we should do is put some restrictions around that to minimize potential losses,” she says. She supports a system with an independent net worth verification and a database to track all crowdfunding pledges.

Currently, equity crowdfunding is limited to accredited investors, typically wealthy individuals and institutions. Opening online equity crowdfunding to anyone with cash and willingness is one of most popular provisions of the JOBS Act. The SEC has already missed rulemaking deadlines established when the bill was passed in April last year.

Related: Crowdfunding Platform Offers Entrepreneurs Access to Money and Mentorship

Marlett also supports having an independent third party maintain a database. In his plan, net worth would be self-reported to a central database, which would also track investor pledges on all crowdfunding portals. The database would ping regulators when small investors try to invest more than permitted under the still-to-be written rules. The portals would be required to register with the database. He says that this system could still, admittedly, be gamed, but it would serve as a “speed bump” in slowing down fraudsters, who Marlett calls “smile-and-dial” guys, seeking to persuade small investors to part with their money.

In the end, Marlett expects the SEC to opt for self-attestation, but he says he will continue to push for a third-party pinging system. “We do have a choice. I have been in those rooms, those bullpens with the smile-and-dial guys. I know how they are. And if you can slow them down, it can make a difference, a significant difference,” Marlett says.

Related: The Startup Money Hunt: When Entrepreneurs Bring In Investors (Infographic)

Catherine Clifford is a senior writer at Entrepreneur.com.

Loading the player ...

Tim Ferriss on Mastering Any Skill

Ads by Google