Crowdfunding: Fleecing the American Masses

Abstract

As our economy continues to sputter along like a beat-up station wagon, politicians in Washington are searching for new ways to boost its prospects. Many, including President Barack Obama, are looking to spur small business growth as a solution to our economic woes. However, such growth is stymied by the lack of capital available to small businesses. As Representative McHenry stated, “lending to job creators and entrepreneurs remains dismal, [and] we must find new and modern means for capital formation to ignite our sputtering economy.” Such “ignition” will come from crowdfunding, or at least politicians seem to think so. Crowdfunding is a means of capital formation that connects entrepreneurs with investors over the Internet. Entrepreneurs can post their business plans on crowdfunding websites, and anybody connected to the Internet can contribute, or invest, in these companies. However, there is catch; investors are limited in the types of returns they can receive from their capital contributions. Currently, investors cannot receive any form of security, because “crowdfunding does not mesh with federal securities regulation[s].” The Securities Act of 1933 makes it illegal to offer or sell any security unless the issuer has complied with the registration requirements under section 5 of the Act or has met a registration exemption. “Entrepreneurs seeking debt or equity financing through crowdfunding will often be selling [unregistered] securities,” as compliance with the registration process is too expensive for most entrepreneurs and the Act’s exemptions do not fit with the crowdfunding model. As such, there is a tremendous push in Washington to create a new exemption for securities issued through crowdfunding. Unfortunately, the movement to exempt crowdfunded securities overlooks the devastating consequences of such an exemption. This article discusses why securities offerings using crowdfunding should not be exempted from the registration requirements of the federal securities laws. First, the article introduces the concept of crowdfunding and the five different categories of crowdfunding. Then it discusses the registration requirements under the Securities Act of 1933, why registration is not feasible for most crowdfunded ventures, and the conflicts between crowdfunding and the current registration exemptions. Finally, the article discusses why crowdfunding should not be exempted from the registration requirements, specifically focusing on how such an exemption would severely weaken investor protections and open the door for fraud to permeate the market.