The House Financial Services Committee has approved a so-called “crowd funding” bill that would allow entrepreneurs and promoters to solicit up to $1 million of investor capital over the internet without any disclosure requirements, or $2 million if they file audited financials. Individual investments would be made through social media websites and limited to $10,000 or 10% of income. The bill is being criticized by state regulators and other experts who have seen it all and see the internet fraud coming.
Mercer Bullard, law professor at the University of Mississippi, who testified before the House panel against the bill, said: “This is tailor-made for Internet fraud.”
Arkansas securities commissioner Heath Abshure said, “We’re re-creating the Wild West,” adding: “The issuer I see is a guy with four or five computers in his basement who’s going to wire that money overseas as soon as he gets it.”
Jack Hernstein, president of the North American Securities Administrators Association, whose members are the 50 state regulators, said: “If I’m a crook, I’d be licking my chops over this.”
Meredith Cross, director of the SEC’s Division of Corporation Finance, told a House subcommittee that crowd funding investors typically have little investment knowledge and little or no ability to negotiate for protections (most likely would not have the first clue as to what to negotiate for). Ms. Cross pointed out that a 1992 exemption that allowed public offerings of up to $1 million to non-accredited investors with no required disclosures (like the crowd funding bill would) resulted in such rampant fraud that it was recognized to be a mistake. “There was a tremendous amount of manipulation and fraud activity that emanated from that mistake,” according to one securities attorney.
Private (Reg D) offerings, which present similar problems of poor disclosure, lack of transparency, illiquidity and potential for fraud, make up most of state regulators’ fraud cases. State regulators filed 256 fraud cases related to private offerings last year.
The bill is even more surprising because of several recent major fraud cases involving private offerings. Those cases involved the sale of $77 million of Medical Capital notes, $485 million of Provident Royalties securities that the SEC determined were ponzi schemes, as well as and $7 billion of fraudulent Certificates of Deposit sold through Stanford Financial Group. Scores of broker-dealers that sold such fraudulent private offerings are no longer in business.
The federal securities laws, which currently prohibit unregistered public offerings like crowd funding schemes, replaced the old caveat of “let the buyer beware” with the requirement of full and fair disclosure of all material risks. The enactment of the crowd funding bill would bring us back to “buyer beware,” said Mr. Abshure.
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