Crowdfunding May Lead to Online “Boiler Rooms,” Warns Investment
There’s been a lot of noise in the news lately about “crowdfunding,”
a financing practice that enables startups to use small amounts of capital
from a large number of individuals to finance a new venture. Legislators
legalized crowdfunding as part of the 2012 Jumpstart our Business Startups
(JOBS) Act. Prior to the Act’s passage, only the entrepreneur him-or-herself
and individual investors with net worths of at least $1 million (excluding
their homes) could invest in non-public startups. The JOBS Act changed that.
Starting sometime this year, new companies will be able to raise start-up
capital online, through social networks like FaceBook and Twitter, and
to obtain small investments from just about anybody – regardless
of the investor’s net worth or familiarity with investment strategies.
Crowdfunding advocates hope it will boost small business growth at a time
when the national economy is still recovering. Critics (myself included)
warn that allowing
private startups to solicit investments from everyday people will only add to the ever-growing problem of investment
fraud. This is especially true when the practice could potentially allow
anyone with a website – con artists and fraudsters included –
to solicit investments online.
“It is basically going to be the wild, wild west, and we’re
just going to be flooded with
investment pitches on social media and websites,” I recently told the Springfield News-Sun. “I really think
we are looking at the 21st Century boiler rooms, where dodgy deals are
peddled in social media to unsophisticated investors.”
Heath Abshure, NASAA President and Arkansas Securities Commissioner, agrees.
“Investors soon can expect to beinundated with crowdfunding pitches, legitimate or otherwise,” he said last year.
As of Nov. 2012, there already were nearly 8,800 Internet domain names
that mentioned “crowdfunding,” and the practice isn’t
even officially allowed yet. The SEC still needs to draft regulations
to govern the practice, which likely won’t be accomplished until
April. Until then,
industry regulators are relying on crowdfunding websites to register with
FINRA and to provide details about themselves to the regulator voluntarily.
While this may be a good first step, it doesn’t really offer much
in the way of investor protection. No matter how many reputable crowdfunding
websites sign up with FINRA, there are still going to be a number of con
artists out there who will use a slick website and heavy online marketing
presence to take advantage of the everyday investors who may not be able
to tell a legitimate start-up opportunity from a fraudulent set-up. And,
as many past investment schemes have taught us, registration with a regulator
doesn’t mean there’s no potential for fraud or misconduct.
For now at least, investors will have to be extra vigilant about watching
for red flags if they want to protect themselves from fraud.
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