State securities regulators warned senators today about the potential dangers of legislation that would allow start-up firms to raise capital over the Internet.
A bill introduced by Sen. Scott Brown, R-Mass., that would enable online capital formation in small increments, also known as “crowd-funding,” was one of several measures designed to ease Securities and Exchange Commission registration rules for small companies that was explored at a Senate Banking Committee hearing.
The North American Securities Administrators Association opposed a crowd-funding bill approved by the House, 407-17, in early November, because it would not require issuers to register with a state before seeking investors over the Internet.
The organization said that under the bill, states would not be able to prevent fraud before it happens, but would only be able to respond after investors are hurt. It has similar qualms about Mr. Brown's measure.
“Brown's bill is better than the House bill, but it still has some major flaws, one of which is pre-emption,” Jack Herstein, NASAA president and assistant director of the Nebraska Department of Banking and Finance Bureau of Securities, said after the hearing.
The panel meeting, coming so quickly after House action on the SEC-registration bills, demonstrates bipartisan interest in the notion that entrepreneurs should have easier access to capital in order to build their companies and boost the sluggish economy.
In his testimony, Mr. Brown said that his bill offered more investor protections than the House version. His measure would allow stock offerings of up to $1 million and limit individual investors to $1,000 purchases per offering annually.
Under the House bill, companies can pool up to $1 million without registering with the SEC and investors can purchase up to $10,000 in securities or 10% of their annual income.
Mr. Brown called crowd-funding a “powerful new tool” for raising capital.
“Its potential to create jobs is enormous,” Mr. Brown told the Senate committee.
Although he said that he backs facilitating access to capital for small businesses, Mr. Herstein said in prepared testimony that Congress must move in a “careful and deliberate fashion” on crowd-funding legislation.
“Main Street investors should not be treated as the easiest source of funds for the most speculative business ventures,” Mr. Herstein said. “The law should not provide lesser protections to the investors who can least afford to lose their money.”
Another problem with the crowd-funding legislation is that it exempts intermediaries from having to register with federal regulators before hawking the start-up shares, according to John Coffee, professor of law at Columbia University.
It could lead to a situation where unlicensed, nefarious salesmen “who look like Danny Devito,” could set up shop in a bar or coffeehouse and peddle risky offerings to unsophisticated investors.
“In its current form, [Mr. Brown's] bill could be called the Boiler Room Legalization Act of 2011,” Mr. Coffee told the Senate committee.
The SEC is reviewing crowd-funding, according to Meredith Cross, director of the Division of Corporate Finance.
She told senators that among the questions the agency is considering are what limitations should be placed on the aggregate amount of funds that can be raised, what information should be available to investors and to what extent should crowd-funding websites be subject to regulation.
A crowd-funding proponent said that regulators misunderstand the process.
It doesn't need heavy oversight because the “many-to-many” nature of the issuers' websites, where hundreds of people can comment on a firm, essentially provides crowd wisdom about the legitimacy of the offer, according to Sherwood Neiss, chief advocate for the Startup Exemption.
“There's built-in protection,” Mr. Neiss said after the hearing.