Several perspectives on the SEC’s new crowdfunding proposal

Our friends at BALLE gathered together a range of responses to the SEC’s proposed rules to govern direct investment in companies via crowdfunding platforms.  We’ve been touting this change for several months, and are excited about the potentials here, especially for facilitating investment in small local companies.  However, as is often the case as good ideas wend their way through the regulatory maze, what comes out the other end is not always quite what we may have hoped or imagined it would be.

Currently, companies seeking public investment must be registered with the SEC, a costly and involved prospect, but one that originated in response to the bad old days when fraudsters bilked hard-working Americans out of their life savings via investment opportunities in baldly invented companies (ah, for the simplicity of making up a company for Aunt Dee to purchase shares of in her living room, rather than having to employ the sharpest minds of a generation to invent convoluted new investment instruments traded among giant banks!).  The very rich are already allowed to invest in small privately-held companies; this “venture capital” avenue provides initial seed funding for new companies, the majority of which end up failing, with a few succeeding wildly enough to keep venture capitalists in the black.  Opening the door to allow those with moderate incomes to invest in smaller or start-up companies carries many risks, along with many opportunities.  The SEC proposal aims to limit such speculative investment to a small portion of any individual’s annual income, and to create some oversight by channeling investment through new and existing crowdfunding portals, which themselves must be SEC-registered.  Not surprisingly, many observers are not impressed by the ways the SEC proposal balances these risks and benefits.

Click on through for our brief summary of the key points made by the five commentators that BALLE points to.

Amy Cortese points out that the release of the proposed rules is just the (long overdue) first step in a lengthy process that begins with a 90-day public comment period, followed by SEC staff assessment of the comments and revising the proposal (likely taking at least a few months) before sending it to the SEC commissioners for final approval.  

The Washington Post offered the most useful overview of the proposals, with a step-by-step summary of the the good and bad news for entrepreneurs and investors alike.

Crowdfund Insider rings several skeptical and disappointed notes, finding the proposed rules to be potentially onerous for funding portals and far less useful for investors than they might be.  In particular, while Congress specified that funding portals could not offer investment advice, the rules go further by not allowing portals to curate or apply their own discernment to the offerings they list; any and all offering must be included, creating a sort of “Craig’s list” of all submissions:

The JOBS Act (but not the proposed rule) appears to allow room for a funding portal to apply its own qualitative listing standards as a condition to listing – so long as, once listed, the funding portal does not play favorites by making investment recommendations.

We leave crowdfunding in risky startups to the “wisdom of the crowd”, but don’t allow licensed funding portals to make a quality cut for its portal – it must take on all comers unless they detect the aroma of fraud or the company’s management have a “record.” Who does the SEC think it is protecting by this rule. Certainly not investors!

Indeed, the rules also require funding portals to “take such measures to reduce the risk of fraud,” including background checks on officers, directors, and large stockholders.  This combination of a requirement to take all listings, along with an ambiguous responsibility to ferret out fraud could, in the view of Crowdfund Insider, take many funding portals “a couple of steps closer to the cliff of extinction,” leaving this exciting new investment platform largely in the hands of current Wall Street giants.

The Harvard Business Review posted a broadly enthusiastic response to the new proposals, focusing on the potential game-changing benefits of direct investment more than on the nuts and bolts of the proposal.  Interestingly—and perhaps consistent with the challenges noted above—they mention that “a spokesperson for Kickstarter said the company does not plan to take advantage of the new rules to allow campaigns to sell equity.”

The New York Times’ Dealbook, while apparently harboring significant doubts about the value of allowing moderate income people to risk their money in the venture capital environment where most companies fail to thrive, notes that the SEC rules are less ambitious or experimental than they might be, thanks in large part to recent legal challenges of SEC rules by Eugene Scalia (son of Supreme Court Justice Antonin).  His successful challenges have been based on the claim that SEC rules are arbitrary if they cannot be shown to have a statistically valid benefit (most famously for SRI investors, a challenge from Scalia shot down SEC rules that would allow direct nomination of directors by shareholders).  The Times’ piece notes that “The court opinion has also led the commission to adopt a bunker mentality. Rather than risk yet another rule being overturned, the S.E.C. has instead preferred to adhere to the most conservative view of Congress’s dictates. The result has been less innovation.”

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Jim Cummings

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