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Crowdfunding plan may open Pandora's Box for investors

Crowdfunding plan may open Pandora's Box for investors

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Published by: Crowdsourcing.org on Apr 15, 2012
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Crowdfunding plan may open Pandora's Boxfor investors
Despite safeguards, opportunity to fund new ventures comes withrisks
By Robert J. Metzler , 04/16/12
The opportunities to separate people from their funds have increasedexponentially with the advent of the internet. No news there.
The news is that the Jumpstart Our Business Startups (“JOBS”) Act just
became law and that act contains controversial provisions designed tofacilitate equity
investment “crowdfunding” of businesses on the
The internet entrepreneurial community had widely, and somewhatnaively, hoped that Congress would enact a version of the proposedlegislation with virtually no disclosure requirements for
“crowdfunding.” Congress apparen
tly recognized, however, that withoutsome continued disclosure requirements in the new law, the MaxBialystocks and Leo Blooms of The Producers fame would soondiscover the darker power of the internet and crowdfunding. It remainsto be seen whether or not the benefits of equity crowdfunding toentrepreneurs will be recognized under the act as adopted.
“Crowdfunding,” or the pooling of funding resources for charitable and
social causes and support of artists, is not new. The commercial world,however, has recently taken notice of the power of the social media andsecure internet payment mechanisms to reach vast numbers of people tofund projects in small increments at very low cost.
Internet crowdfunding started in the music and film industries about adecade ago. Web-sites through which potential contributors may chooseamong several options for contributions have come and gone. Currentexamples of popular web-sites still in operation include Kickstarter.comand IndieGoGo.com.In the United States, internet crowdfunding has been used primarily for
“contributions” to projects rather than for investments in businesses.
Prior to the enactment of the JOBS Act, use of crowdfunding to solicitinvestments in business ventures was illegal under the securities laws.Those laws are designed to prevent both fraud and other misstatements
about the value of an investment by requiring substantial “disclosure” of 
accurate information about the offering. The increased cost of securitiesregulation since enactment of the Sarbanes-Oxley Act of 2002, however,all but brought an end to new participation in the public securitiesmarkets by most small businesses. In reaction, The JOBS Act loosensdisclosure and registration requirements on all Emerging GrowthCompanies, companies with assets of under $1 billion. Many of thoseprovisions will undoubtedly reduce the cost of securities regulation onmid-size businesses. The crowdfunding provisions of the JOBS Act,
called the “Capital Raising Online While Deterring Fraud and Unethical
Disclosure Act of 2012” or the “CROWDFUND Act,” however,
break new ground and are aimed at trying to assist the very smallest andnewest of companies raise capital on the internet.Under the CROWDFUND Act, Companies can offer up to an aggregateof $1,000,000 in securities to investors annually, and those offerings and
securities will not be subject to the securities laws’ regular disclosure
and registration requirements.
Although the language of the Act is somewhat garbled and unclear, itappears Congress is trying to say that an investor will be limited to acrowdfunding investment in any one company annually in an amount
equal to $2,000 or 5% of the investor’s annual income or net worth if 
either that income or net worth is less than $100,000. If either of (both?)
the investor’s annual income or (and?) net worth is $100,000 or more,
the annual investment limitation in one company is 10% of the
investor’s annual income or net worth, but not to exceed $100,000.
To qualify for the crowdfunding exemption, the offer of securities mustbe made through an independent, non-interested intermediary broker or
“funding portal” registered with the Securities and Exchange
Commission. Some of the specific requirements for crowdfunding arestill unknown because the CROWDFUND Act gives the SEC nine
months from the Act’s passage to adopt rules. Many believe those rules
will be more burdensome than many entrepreneurs will find bearable.Participation in crowdfunding offerings will also create liability risks forintermediaries that may cause them to forego handling crowdfunding orcharge premium amounts for the service to cover the risks.
A “funding portal” is an intermediary, presumably with an internet
presence, for offers of securities only under the crowdfundingexemption. To be a valid funding portal, the entity must be registered assuch with the SEC and may not: offer investment advice, solicit thepurchase or sale of the securities displayed on its website or portal,compensate employees based on the solicitation of such purchases or
sales, or handle any of the investors’ funds. The ultimate responsibilities
of funding portals and brokers will be fleshed out in the rules to beadopted by the SEC. The Act provides specific types of genericinformation that intermediaries, both funding portals and brokers, mustprovide to investors.

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