Businesses also seek 'crowdfunding,' so watch out

November 14, 2011|Jay Hancock

May I offer you an opportunity? I have perfected nuclear fusion in my basement, working with alligator kidneys, artisanal sea salt and a Keurig coffee maker.

Cheap, safe, boundless, pollution-free energy is at hand. All I need to build the ExxonMobil of clean power are investors. Be my startup partner. Sorry that I can't show you a business plan. Or profit and loss statements. Or how much of the company you'll own.

But trust me. We'll scale the enterprise and leverage our core competencies. PayPal accepted. Buy stock now on, and pay no attention to the account I just set up in the Cayman Islands.

If you believe this is something the government would never allow, you haven't read the papers. A few days ago, the House approved a bill that would look merely wrongheaded if we lived in ordinary times.

The Entrepreneur Access to Capital Act, however, passed by a vote of 407-17 within the fresh memory of two corporate fraud pandemics over the past dozen years. That makes it almost unbelievable.

In the name of investment and jobs, the House approved a bill with White House support that would exempt very small stock offerings not only from the Securities and Exchange Commission's registration requirements but from the purview of state regulators.

"The idea that a company could do this with no oversight is frightening because there are plenty of people out there who are willing to separate investors from their money," says Melanie Senter Lubin, Maryland's securities commissioner. "We are concerned about anything where investors have the potential of losing money or where they're making an investment without the information they need to make an informed investment decision."

There's nothing wrong with the underlying idea of "crowdfunding." Get government off the back of small business. Let the Internet connect investors with entrepreneurs. Tap a well of capital to compensate for the fact that traditional small-business financiers — banks — are largely out of the game. Put America back to work.

But as written, the bill is a call to action for every grifter and crackpot who ever dreamed of bringing the digital economy to small-time securities fraud. Kudos to Maryland Rep. Elijah E. Cummings, who cast one of the few "no" votes.

Smart investing needs good information. The Securities Act of 1933 required it, in the form of audited financial statements, annual reports and detailed prospectuses for potential shareholders. True, sometimes investors talk themselves into dumb decisions or get walked down the primrose path by corrupt third parties. But SEC registration furnishes generally accurate information for anybody who cares to check, while also limiting fairy tales told by the companies.

The Entrepreneur Access to Capital Act, on the other hand, would allow businesses to raise up to $1 million over the Web without registering with the SEC or even showing certified financial statements. Companies wouldn't need clueless credit-rating agencies or corrupt Wall Street analysts to tell whoppers about their prospects. They could deliver the baloney directly.

Companies raising $1 million to $2 million would have to show audited books. But none of the stock issued under the act would go through the usual screening process. Neither would there be requirements, as there are for hedge funds and private stock placements, that crowdfunding investors possess a minimum sophistication or net worth.

Your grandmother could buy stock in my fusion company. (Franchising opportunities are also available. Text me, Granny.)

"We're opening the door for anybody that wants to get on the Internet," says Heath Abshure, the Arkansas securities commissioner who has closely studied the bill for the North American Securities Administrators Association, which represents state regulators. "We're getting closer and closer to what the system of securities regulation was in 1929. Which is, there wasn't any."

Proponents of the bill note that crowdfunders couldn't invest more than one-tenth of their income or $10,000, whichever is smaller. That's still a lot of money for most people. And who would enforce that provision? These are unregulated offerings, remember?

Prosecutors could chase bad guys after the fact, but by then it would be too late. Scammers would be gone and on to the next con. True, if a crowdfunding bill passes the Senate and the president signs it, perhaps the SEC could write regulations making the measure not quite so user-friendly for thieves.

But should we trust the agency that repeatedly ignored warnings about Bernard Madoff? As written, the House bill offers zero protection for investors.

"If you want to argue for some lesser level of disclosure" than what a conventional stock offering needs, "that seems to be something that may make some sense," says Thomas Hazen, who teaches securities law at the University of North Carolina at Chapel Hill. "But to make it all or nothing — to say you don't need any disclosure — that to me is fraud waiting to happen."

Crowdfunding enjoys bipartisan support. The left pushes it as a way to bypass Wall Street and generate community investment. The right loves any deregulation.

But the crowdfunding song sounds kind of like the early housing bubble, when anybody who questioned what was happening was labeled anti-growth or patronizing toward investors and consumers.

Attention, congressional gerbils: Investment surges help the country only if the money gets paid back. The crowdfunding legislation as written would ensure that a lot of it won't be.

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