Tuesday, January 8, 2013

Why we need to rethink our fears of Crowdfunding.

Is fraud really the big issue in equity crowdfunding? According to this article, the SEC thinks so. As a result JOBS Act regulations allowing equity crowdfunding is being delayed by as much as a year.

Yet it exists – quite successfully, apparently – in Europe.

The problem is culture clash – regulators can’t imagine a crowd regulating itself.

They are not alone. Having sat on a panel with certain VCs I have found that some influential investors - including one facing a lawsuit for allegedly stealing an entrepreneur’s business plan – feel exactly the same way.

Yet none of these players have any idea how hard it is to get money out of the public when you don’t have the implied endorsement of a major brokerage house. So entrepreneurs have to go a long way to prove their bona fides, which is part of what makes them honest. Also, the amounts of money are laughably small – around $2,000. Besides which, people who invest in crowdfunding aren’t looking to make a killing so much as they are looking to be part of something they identify with. It’s a very different mentality. If on the other hand, they do want to make a killing they will be forced to diversify across deals, which is not a bad thing either.  

The SEC and the public should be more concerned about the return of implied endorsements that organizations like Fannie Mae or Moodies gave the mortgage industry that sank our entire economy. Or the $500 million of worthless stock Goldman Sachs for which sold the Dragon Systems (and now, arguably the basis of Siri). And let’s not get started on the amazing rip-off of the Mutual Fund and 401K system where you are being handcuffed on investing and hammered with fees.

Clearly, there will be problems with equity crowdfunding but far fewer and far less devastating than they think.

Unfortunately, these are bureaucrats and they probably don’t “get it” at the core. Also, there is regulators bias against the small and the relatively helpless. They tend to respect giants and lash out against the small. We all know that none of the scammers who undermined the economy ever went to jail. But as someone who sat on one the very few Federal juries for mortgage crime – I can tell you it was the little guy who “stole” $18,000 that got convicted while the bank that was clearly in cahoots and ripped off millions got to testify against him as if they had been victimized.

As much as I hate to see another bureaucracy emerge, Crowdfunding needs to be regulated by a new breed of or not at all for the same reason that Clayton Christensen wrote the “Innovator’s Dilemma”: you have to be willing to kill your own in order to innovate.

Bureaucrats don’t do that and so we need something that does.


David Leffler said...


The SEC is looking at this from an entirely different point of view than "let's let the market forces keep the fraudsters at bay." One need only look at their website here to see what their concerns are:
"The SEC's foundation was laid in an era that was ripe for reform. Before the Great Crash of 1929, there was little support for federal regulation of the securities markets. This was particularly true during the post-World War I surge of securities activity. Proposals that the federal government require financial disclosure and prevent the fraudulent sale of stock were never seriously pursued."
"Tempted by promises of "rags to riches" transformations and easy credit, most investors gave little thought to the systemic risk that arose from widespread abuse of margin financing and unreliable information about the securities in which they were investing. During the 1920s, approximately 20 million large and small shareholders took advantage of post-war prosperity and set out to make their fortunes in the stock market. It is estimated that of the $50 billion in new securities offered during this period, half became worthless."
And while you, Alan, and others may view their thinking is terribly outmoded, there certainly are people out there that would jump all over this, coming up with schemes that would do little more than pick the pockets of investors, all under the cover of the new crowdfunding laws.
It is hard to say for sure how it would all play out, whether there would be a major abuse or not, and finally at some point there will be only one way to find out. But some hard thinking and care in drafting the regulations under this new law is warranted. Whether the powers that be have been dragging their feet on this too long I cannot say.

David Leffler

FOUNDUPS® (Michael J. Trout, CEO) said...

Simple fact is crowdfunding doesn't work as it exist and over 95% of funds fail to raise funds. Nearly ALL Startup America CF campaigns have failed in IndieGoGo. We need a completely new startup paradigm and one could exist called the Open Startup problem is Alan... if it existed the 1% would loose out to the 99% as they would not be needed.