'Crowd-funding' bill stalls in Senate

Jan 1, 2012 @ 12:01 am

By Mark Schoeff Jr.

Legislation that would allow companies to raise capital online in increments of up to $10,000 per investor sailed through the House in early November by a 407-17 vote. But the momentum to allow so-called “crowd funding” has slowed considerably in the Senate, as lawmakers mull whether unsophisticated investors are vulnerable when capital formation occurs online.

In the crowd-funding process, an entrepreneur would be able to seek investors by reaching out to friends, family and larger communities through the Internet.

Currently, money for fledgling companies can be raised online only in the form of small gifts. Companies that want to raise funds through investors must register with the Securities and Exchange Commission and in the states where their securities are offered.

If crowd-funding legislation is approved by Congress, investments could be solicited online without the need to register with the SEC and, in some proposed bills, the states.

The House bill, which is supported by the Obama administration, is based on a framework developed by Startup Exemption, a grass-roots group formed to make crowd funding legal. It would allow someone with a new business idea to raise up to $5 million online annually. Individual investments would be limited to $10,000, or 10% of an investor's annual income, whichever were less. Intermediaries would not have to register as brokers.

Proponents contend that crowd funding would help startups obtain capital that they couldn't get from skittish banks still gun-shy following the 2008 financial crisis. But skeptics worry about fraudulent schemes online.

After crowd funding blasted through the House, the more measured pace in the Senate is frustrating proponents.

FRAUD CONCERNS

“We've let the conversation go from innovation, jobs and the American economy to fraud and the smallest reason not to make crowd fund investing legal,” Sherwood Neiss, co-founder of Startup Exemption, wrote in an e-mail. “We haven't shut the markets down because of the fraud perpetrated in them. We shouldn't stop people from supporting entrepreneurs either.”

Sen. Scott Brown, R-Mass., has introduced a crowd-funding bill in the Senate that would allow a company to raise $1 million over any 12-month period and limit individual investments to $1,000.

Both the House measure and Mr. Brown's bill would exempt crowd-funded securities from SEC and state regulation.

Such an exemption has drawn strong opposition from the North American Securities Administrators Association Inc., which claims that states would not be able to stop a fraud until after it were perpetrated.

Crowd-funding advocates hold that requiring an entrepreneur to file in each state where he or she were selling securities would add costs and bureaucratic hassle.

Another bill, introduced in early December by Sen. Jeff Merkley, D-Ore., would grant companies an exemption from SEC oversight but not state regulation and would limit company offerings to $1 million annually. It would set a $500 ceiling on individual investments for someone earning less than $50,000 and raise the limit to $2,000 based on higher salaries.

“Congress must be sure to do a careful and deliberate thing, which is look at investor protection,” said NASAA president Jack Herstein. “That's exactly what the Senate is doing now. You can't pass the capital formation bills without adequate investor protection. Some of these improvements [in Mr. Merkley's bill] address our main concerns,” added Mr. Herstein, who is assistant director of the Nebraska Department of Banking and Finance's Bureau of Securities.

What is certain is that the Senate is not going to rubber-stamp the House bill. Unlike the House, where each of its 435 members is up for re-election next fall, in the Senate, only one-third of its members are facing the voters in November. There is less political pressure to push through a bill touted for its job creation potential and more time to examine potential drawbacks.

“To senators, crowd funding sounds like a new idea, relatively speaking,” said Mike Chapman, a partner at D.C. Strategies, a financial services lobbying firm. “They're going to make extra certain to work with the [Securities and Exchange Commission] and their experts to explore the implications, especially for consumers, small investors [and] ordinary folks.”

Investment advisers have mixed feelings about crowd funding.

“I wouldn't completely exclude the thought of throwing it to clients as an option if it becomes legal,” Eric Clarke, president of Orion Advisor Services LLC, wrote in an e-mail. “But the investment amounts are small, and I believe the opportunities will be hard to evaluate.”

Alan Rich, a money manager with Cantella & Co. Inc., embraces the crowd-funding concept.

“There's a huge need for it,” said Mr. Rich, who pointed out that entrepreneurs are being shut out of traditional capital sources. “Banks aren't lending money. They make it very difficult for small startup ventures to get anywhere.”

Mr. Neiss, an entrepreneur himself who co-founded the medicine-flavoring company FlavoRx, acknowledges that investing in new companies is a roll of the dice.

But he argues that social media mitigates the risk. As envisioned by Startup Exemption, third-party crowd-funding platforms would have to contain comment fields and rating buttons allowing potential investors to vote on the ideas offered there.

One difference between the House bill and Mr. Brown's legislation is that the latter would not permit startups to raise funds via social-media sites such as Facebook, Twitter or LinkedIn. Issuance would be permitted solely “through a crowd-funding intermediary” such as Kickstarter.

The House bill would permit issuance through Facebook, et al. “The whole point of social media is that it is self-vetting and it will weed out fraud,” Mr. Neiss said.

mschoeff@investmentnews.com

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