Legal crowdfunding is coming, as I explained in the first part of this series. Thanks to the Jumpstart Our Business Startups (JOBS) Act, investors big and small will soon have new ways to buy shares in startups and other small companies. This should be very good for growing companies and for the economy overall, but there’s peril for individual investors from scammers likely to be operating in the early days of this new law.
Most concerns hearken back to the Banking Act of 1933, enacted to bring order and regulation to the banking industry during the Great Depression. It was the collapse of the banking industry, not the stock market crash, that did most of the damage during the Depression. Also called the Glass-Steagall Act, it established federal insurance for bank deposits, keeping banks in the savings business and out of investing, leaving the trading to stock brokers and investment banks, which were not allowed to take deposits. Glass-Steagall along with the Securities Act of 1933 and the Securities Exchange Act of 1934 established a regulatory structure that many people thought worked well until 1999 when parts of Glass-Steagall were repealed by the Gramm-Leach-Bliley Act. Sorry for all the legislative history, folks, but you can’t tell the players without a program.
I am not at all sure that we can fully blame the financial bust of 2008 on the repeal of Glass-Steagall, since a lot of bank shenanigans started before that 1999 repeal. Still there’s a place for financial regulations and the protection of smaller investors and the JOBS Act might well open up a number of problem areas even for the best-intentioned entrepreneurs.
Let me give you an example. This week IndieGoGo, a crowdfund originally intended to support makers of independent (non-studio) films, raised $15 million to expand operations under the JOBS Act. That’s good, right? But a cold breeze is simultaneously rushing through the Indy film community as filmmakers — who have always had to raise money in dribs and drabs — deal with the possible reality that under the JOBS Act they’ll have to reveal possible risk factors to their investors as the SEC requires presently of larger companies.
The old trend was to pitch your movie. The new trend might be pitch your movie then explain how the money — every cent — could be easily lost if anyone dies in the making of the film, if anyone sues for almost any reason, if the weather is too bad, if the star walks out, if, if, if… Hey, this is hard work!
But it won’t be hard for everyone because in the early days of crowdfunding some people will get away with underestimating risks, overselling equity like in The Producers, etc. This is the fear being spread — that crowdfunding will bring out the crooks and the con men.
Of course it will, but then so did the transit of Venus this week. Crooks and con men will always be with us.
What’s misunderstood in this is how much we weren’t being protected under the old rules. I am a so-called Qualified or Accredited Investor and have for many years invested in startups as an angel. This is based on my income and/or net worth and is supposed to mean that I have enough money to survive a bad investment or two and am sophisticated enough to be responsible for my own bad decisions. A key point of the JOBS Act is that it removes this requirement allowing anyone to invest in startups.
Now here’s the important part: no entrepreneur, company, fund, or government agency has ever asked me to prove that I have what it takes to be an accredited investor. In my experience, which is pretty broad, this primary requirement that keeps little people from being involved in private equity is based entirely on the honor system.
If we look at how the current system is run, then, all those little guys who have been feeling excluded could have probably been included if only they’d pushed harder.
Frankly, I was operating as a qualified investor long before anyone even asked me the question — before I even knew the requirement existed. It’s possible, too, that in some of those early days I may not even have been qualified, not that it mattered to me in my glorious ignorance.
Just as Citibank owned Smith Barney before it was theoretically allowed, so too lots of startup investors may have been making and losing money in violation of rules they didn’t even know existed.
What’s changed with the JOBS Act and crowdfunding is that what was happening all along is now going mainstream. And going mainstream means that there will be more abuses and more little investors affected, good and bad.
The trick to making this more good than bad is in how the system is designed. And by that I don’t mean how the regulations are written. We can’t rely on the politicians to fix everything because they tend to be self-important dolts. Fortunately there’s a lot we can do ourselves to make crowdfunding a huge success.
And that’s what I’ll cover in the third and final part of this series, tomorrow.
You mention the “honor” system. The folks looking for investors, asking them if they are “qualified,” would actually prefer that you lie about that. Then, when you lose all of your investment through the startup’s incompetent management, you won’t be able to sue — because you lied about being a qualified investor.
It’s dangerous to be funded by outside investors all the time… especially when they want you to go public…
Most of the institutions that went under in the housing collapse weren’t really covered by Glass Steagall. Investment banks Lehman Brothers, etc would still have gone under.
The problem with repealing Glass Steagall was not the banks that failed. It is the banks that were not allowed to fail. Deposit taking banks should be stodgy and conservative. Now we have massive banks, holding the public’s money, and betting on derivatives and other risky instruments. When the investments pay off, they pay out massive bonuses. When the risks are realized and they risk failure, they come begging to the government.
Overall, I prefer the old system.
Me too. Now we have low interest rates but nobody can get a loan, so what’s the point?
The problem with the old system was that the safe banks weren’t paying an interest rate competitive with the investment banks and other investments. They were and always have been an alternative to stuffing your money in your matress. There is nothing wrong with safety, it’s just that there wasn’t enough demand for it when the invesment banks did there job. I was advised to buy so-called junk bonds in the 80’s and given a verbal guarantee of safety. They did indeed turn out to be very safe while paying double digit rates because the investment back did its homework. Of course, as more and more people discovered them the rates dropped.
[…] Here is a link to the second part where Cringe talks about a weakness of the current system. […]
>We can’t rely on the politicians
We can’t because for every Gary Cooper there is a banker mob armed with baseball bats that will kneecap anything that spoils the party. Two examples:
Despite threats (of redlining the state) from the Banks Governor Roy Barnes was able to pass the Georgia Fair Lending Act in April 2002 – it lived only a year.
The banks and Bush used what is known as “preemption.” It is a legal doctrine that can be invoked when federal and state authority over business conflict.The feds prevailed in repealing state regulation:
https://www.msnbc.msn.com/id/27121535/ns/business-us_business/t/states-warned-about-impending-mortgage-crisis/
The Credit Card Disclosure Act of 2009 attempted to slow the loan sharks but they keep swimming.
Does the JOBS Act do away with audits? This will be so easy. Amnesia at a national level:
http://en.wikipedia.org/wiki/Arthur_Andersen#Enron_scandal
It sounds like there will be many new career opportunities in the Attorney General’s offices of each state. I see a lot more problems, investigations, ….
Given your experience in the subject would you care to comment on that:
https://www.businessweek.com/news/2012-06-07/firstenergy-says-it-s-fixing-a-leak-at-ohio-nuclear-plant
I can’t remember the sources, but I’ve heard the same from various angles: Those who lose money in the markets are the small investor.
Looking at the investments and if you’re expecting an output from those (ie, return on investment) then something somewhere must be getting input to the system. For you to be taking more out of the investment someone else must be putting in money for you.
Moving on to Crowdfunding, you’ve got to apprecitate the above: The small investor is the one who always looses out. Some will do very well from this, some might even keep their shirt, but the majority will walk away empty.
Politicians didn’t control the banks to prevent the last crash, even though the warnings were clear. Looks like the same mistakes will be repeated once again.
Maybe we shouldn’t expect politicians to control banks just to facilitate our own greedy desires. You stated earlier a simple truth we conveniently overlook when it comes to money (paraphrased): You can’t get something for nothing.
All the dirty bankers and loan sharks in the world can’t force people to take loans. We chummed the waters in which we swam.
One possibly positive area for crowd-funding is in app development. It doesn’t take millions to develop an app – unlike the ‘dot.com” era – sometimes just a couple of thousand. The time to market is lightning speed and the possibilities are endless. I’m seriously considering starting an “app development fund” in Austin. There are scillions to be made and anyone can get a piece of the action.
I can’t help be notice you are considering developing a “fund” rather than an “app”.
Actually, I have 5 apps that i want to develop. I’m an interface designer, & finding programmers & funding is a real problem –
You only need funding if you wish to pay the programmer to develop the app and go away. But if you can make a compelling case that you will make money and you are willing to share the profits, you should be able to find a good engineer who is willing to take the chance with you.
the issue with crooks and con men is that when there is some investigation and prosecution in place, the small-time guys will move on to selling “driveway sealcoating” and “roof maintenance” and “appliance extended warranties” instead of dealing in direct finance.
when our boy Phil Gramm bullheaded through the repeal of Glass-Steadman, it kind of removed the level of investigation and prosecution that kept the small fry from learning how fraud, misappropriation of funds, and Ponzi schemes were built. the small-timers got enough training to get into the big finance arena with their cockamamie schemes to get sorta-securities and bogus bonds rated AAAA. (step 1: grease everybody’s palm.)
just now, Spain’s banks have been given a lifeline by the EC for 100 million euros because they are still filled with crapola masquerading as CDO^3s of mortgages and governmental sureties covering CDO^3s of mortgages. the stuff of 2008 was sold worldwide, and other governments got into floating crapola themselves… the only question is whether this is the Panic of 2012 or of 2013.
there are two solutions… (1) starve the bad out by contracting economies. that worked well, didn’t it, in 1933… (2) inflate the bad out by printing money until the bearings burn out in the presses. that worked real well in Germany in the 20s, didn’t it… .
I think the speed with which you raise and dismiss “crooks and con men” leads you to overlook a subtle point about the misalignment of individual goals with the purported goals of Obama’s–or any government’s purported purpose (to increase the general welfare).
Call me a cynic, but I think that the cultural climate isn’t so supportive of a general increase in welfare. In fact, owing to basic human nature, the very existence of more opportunities to increase individual welfare, at the expense of the rest or not, means people will take those opportunities.
The real challenge is how do you reward people for thinking of others’ interests? Is there any way to do it that will increase the chance that they will forego the chance to do better by screwing over strangers? You don’t have to be a crook to be self-interested, you just have to ignore the negative consequences of your (legal) actions.
Yiwu export agent on ywagent.com is an agent that can help you to purchase products in China without any problem like complex procedure or lack communication and any other problems that may emerge in the future. So that you will get the products you want favorably and successfully.
By using the Yiwu agent you have to be abundantly absolute in artful your claimed acquirement above-mentioned to creating any blazon of best and have to abatement all added accuse for accurate profit. Starting your claimed aggregation in added area or nations from in which you are branch to acceptation the appurtenances all-important alert ascertainment in some from the things.
Decidedly with commendations to exporting or importing any appurtenances from added countries, you have to verify affairs and affairs guidelines of the two federal governments and accordingly have to actuate added aspects like customs assignment forth with added tax.
I was abundantly alert if I accept started out my claimed aggregation for which I activated to acceptation appurtenances from Yiwu agent which could be a part of the better banker boondocks in china. All of us accept that the Ceramics has the greatest broad bazaar abode with the apple with greatest across bulk and big bulk of consign ratio. Antecedent you accept to admit the appropriate ability for the aggregation and accept to activate acquisition assets to activate the accurate address of creating assisting aggregation deal.
Though learning the essential knowledge about Yiwu agent, I guess that you must have much good opinion on it, and try this agent next time when you are going to buy some important or expensive products.
WTF!
@Bill. I agree with your sentiment and expression. It seems like this guy is lost in here and is trying to recruit some members. kinda ironic.
[…] one we learned how important crowd funding can be for helping tech startups and the economy. In part two we worried about how criminals and con men might game the eventual crowdfunding system when it […]