An investor alert went out this past spring from the California Department of Corporations asking that investors be cautious when considering "crowd-funding" opportunities.
This recent trend is a way in which capital funds can be raised for small business enterprises. It is also Internet based and provides a money-raising strategy for entrepreneurs and business opportunists. This type of funding is also a way for the general public to donate to a cause or contribute small amounts of money to an endeavor, often through social networking web sites.
While this trend and use of the Internet has some in the business community optimistic about potentially beneficial outcomes, the debate on this form of funding is on-going. The new federal Jumpstart Our Business Startups (JOBS) Act, exempts some small businesses and entrepreneurs from securities regulations in order to tap into the “crowd” in search of investments to finance their business ventures, but the practice is still regulated until the SEC issues final rules.
In a statement release to the press on May 16, officials monitoring the trend expressed their concerns. “Unfortunately, the potential for fraud is significant, so investors must be extremely cautious about crowd-funding opportunities,” said Jan Lynn Owen, Commissioner of the Department of Corporations.
This reporter got the chance to speak to Mark Leyes in the CA Dept. of Corporations media office. Leyes explained in some detail the reasons for the Commissioner's investor alert. "As a social evolution, crowd-funding is a broad-based use of the Internet. And, ideally it is kind of remarkable because this trend is being used by people one would seldom deal with," he said.
Artists, musicians, filmmakers, those with creative endeavors are using this approach to funding, especially when traditional bank venues, such as loans, lines of credit, might be reluctant to fund such an endeavor.
Claudia Polley, manager for San Francisco-based singer Amanda King thinks platforms like "Kickstarter" are legitimate. "I personally really like it and I also fund other campaigns. It's always been terrifically easy (you have to create an Amazon account and that is how payments are processed) and I've not experienced anything odd. Some of the other sites I've heard different things about. But I can only speak for Kickstarter," she said.
"Using a site like that is like making donations because usually there's no expectation from the artist only that she or he is trying to reach a goal," said intellectual properties attorney Richard Greenstone. Greenstone sees the copyright issue as a separate concern.
Yet as Leyes points out with crowd-funding in general, part of the concern that has officials worried is when it deals with securities. "That would include some form of ownership percentage or dividend pay-out," added Leyes. He was quick to clarify that "pre-selling is not included. But it does get closer and can be clever because if the product such as a music CD is not delivered than it is fraud," said Leyes.
Yet when having to do with heavy investing, where bonds are issued, etc. there has to be more disclosure, noted Greenstone. "Disclosures like that are absent in crowd-funding, as are also 'Blue Sky Laws,'" said Greenstone.
The California Dept of Corporations is asking consumers and investors to be cautious of Crowd-funding, especially now as it is not fully regulated.
Leyes noted that anything having to do with securities must be registered and of course regulated. Investing in a business through the "selling of stock or shares" is traditionally done by professional brokers or dealers who are licensed, bonded and regulated. Leyes pointed out that the everyday average person as well as small business owner could be duped into thinking that the crowd-funding goal is a 'sure thing,' when in reality it is an extremely risky venture.
“Before the SEC rules are adopted, investors should beware of promoters who' jump the gun' by offering investments through crowd-funding now,” added Commissioner Owen in her press statement. “Once exempt, the new law means that crowd-funding investments will not be reviewed by regulators before they are offered to the public, nor will they be required to provide the same level of disclosures to investors or regulators required of securities offerings. Investors will need to prepare themselves to be bombarded with all manner of offerings and sales pitches.”
Because of the lack of clear rules, now being discerned by the Securities and Exchange Commission and others, crowd-funding can be misused. Some of it may be innocent such as in raising money for charity or a cause. But, like the issue of payday lending on the Internet it is hard to track down the originators of the venture if things go wrong. Off-shore, out of state sites are hard to trace and since crowd-funding web sites (or platforms) are not required to have a license as of yet, investors and the general public have little if any recourse should the venture or charitable cause fail.
There are other risks to consider too, especially with regards to "Intellectual Properties" and copyright issues; as expressed by "Business on Main a newsletter provided through MSN.com
Commissioner Owen also announced that the North American Securities Administrators Association (NASAA) has created a new task force to focus on Internet fraud. The Internet Fraud Investigations Project Group was formed to monitor crowd-funding and other Internet offerings.
The Department of Corporations is California's investment and financing watch-dog authority. One of the primary roles of the department is to protect consumers and investors from fraud.
"The Dept. of Corporations is simply saying "don't jump into it so fast," Leyes said. "This is one of our worries," said Leyes. In the meantime the department and other agencies will be monitoring the situation as it unfolds.
Investors with questions about crowd-funding offerings should contact the Department of Corporations before investing at 1-866-ASK-CORP or visit www.corp.ca.gov for more info.