Although crowdfunding could spur capital investments, there are numerous potential pitfalls. State securities regulators, pre-empted from reviewing or registering securities sold under the "crowdfunding" exemption, are up in arms. Under the rules of the JOBS Act, the states complain that investment disclosures and state enforcement authority may be too limited.
The North American Securities Administrators Association has issued at least two alerts about crowdfunding-which it fears will be plagued by scam artists jumping the gun on SEC rules. The association also warns that half of small businesses fail in the first five years. Investors must rely on their own research amid little disclosure. Crowdfunding investments are mostly illiquid and may be impossible to sell on the secondary market, and portals claiming to have an accreditation seal of approval may not be legitimate.
NASAA advises small start-up businesses seeking to take advantage of the forthcoming crowdfunding exemption to seek the advice of a qualified securities attorney familiar with both federal and state laws. The exemption, it warns, does not change federal and state securities law disclosure requirements-including the requirements that companies disclose all material facts and risks to investors. Failure to comply with these rules could subject a business to multi-million-dollar civil and criminal fraud claims.
A business's broker or funding portal that fails to comply with SEC rules on the Crowdfund Act also could void the exemption, subjecting a business to liability for an unregistered offering. Small businesses, the NASAA warns, should be wary of crowdfunding platforms that are careless about making adequate disclosures. Meanwhile, a business owner could find that having several other owners could take his or her time and energy away from running the company. Plus, venture capital companies and private equity funds may not invest in a company that already has many small investors, curtailing a promising young company's access to serious investors.
Others have warned that the crowdfunding platform could allow a company's competitors to easily obtain information about it for a minimal investment. Nor should it be forgotten that the new crowdfunding intermediaries themselves are small businesses, subject to market risk.
Scott Sanborn, the chief marketing officer for the Lending Club, a San Francisco-based technology platform, says that with the onset of crowdfunding, financial advisors had better prepare for client questions on a broad range of exotic investments.
The JOBS Act was slated to spawn new SEC rules eliminating prohibitions on solicitations to accredited investors. The SEC told Congress in June that it would miss the July 4 deadline for that change, but hoped to act on a proposal in the near future.
When the Crowdfund Act converges with those relaxed advertising rules for private placements, clients who are already bombarded with a broad range of investment opportunities will be inundated.
Take the Lending Club. That company might expand into other types of debt, like auto loans or business loans, according to Sanborn. Equity offerings might also be in the cards. "I could foresee a world where even options advisors themselves become aware of or will multiply advertising to investors and advisors!" he adds.
Sanborn says the Lending Club has no plans to change its current business model. But it expects to take advantage of regulatory changes to use its Web site to promote additional investment opportunities.