Crowding into crowdfunding biz has regulators worried

State regulators are worried about thousands of crowdfunding sites that might be launched as soon as the Securities and Exchange Commission sets rules for how the sites can sell securities.

A group of state officials have uncovered more than 8,500 sites with “crowdfund” in their names.

While many of the sites appear to be parking domain names, about 1,600 have some content. Of these, some are already soliciting investor and business interest in crowdfunding for when the sites get the go-ahead to raise equity, said Robert Moilanen, director of securities for the state of Minnesota, and head of the Internet Fraud Investigations project group of the North American Securities Administrators Association Inc.

Some sites are legitimate and will be sources of capital for small businesses, he said, but “there are so many others out there right now [that we’re] not convinced everyone will play by rules,” Mr. Moilanen said.

The Jumpstart our Business Startups Act of 2012, among other things, exempts from registration securities offerings of up to $1 million annually when sold to small investors through online crowdfunding portals. The law prohibits the sites from soliciting transactions, paying for solicitations, giving investment advice or handling customer funds.

Not all the nascent sites identified by state regulators have been set up for purposes of selling securities. Crowdfunding sites currently raise money for things such as local arts projects, new gizmos and charities, in exchange for some type of reward.

Unlike these rewards sites, equity-funding sites that raise money by selling securities will be a whole new ball game — a development that appears to be driving much of the proliferation.

More than 3,000 new sites or domain names popped up in May — the month after the JOBS Act was signed into law — Mr. Moilanen said.

The 8,500 number is probably a conservative estimate of potential new sites, he said, since his investigators looked only for sites with “crowdfunding” in the name.

A site name like “fundmywish” wouldn’t necessarily have been found, Mr. Moilanen said.

“Fundmywish” is owned by Conzortia Business Funding Inc. of Wyoming. Robert Dobyns, chief executive, said state regulators are “probably watching us because we are the one to watch as a leader” with about 125 domains.

“We are anxiously awaiting the arrival of Crowdfunding 2.0 — equity-based funding,” Mr. Dobyns said.

But some downplay the significance of all the new sites.

“People may be domain-squatting to grab anything with a name in it,” said Vince Molinari, chief executive of portal and technology provider GATE Technologies, and co-chairman of Crowdfund Intermediary Regulatory Advocates, a lobbying group.

“There are probably a couple hundred [sites] really trying to become active,” he said. When rules are set, “the froth will be dealt with pretty quickly.”

“A lot of them will be rolled up and bought out,” added David Marlett, executive director of the National Crowdfunding Association. For many, “their only objective is to get rolled up and bought.”

Observers expect the SEC to propose rules as early as this year, and finalize them sometime next year.

State regulators are worried that when the sites get the OK, fraudsters will prey on gullible investors via crowdfunding communities.

But those in the crowdfunding field downplay the incidence of fraud.

The major rewards-based sites, Kickstarter, Indiegogo and RocketHub, have “close to zero percent fraud,” Mr. Molinari said.

“In the completely unregulated world of donations and rewards sites, there’s a 2% to 5% fraud rate, at the most,” Mr. Marlett said. “That’s less than credit card companies.”

Mr. Marlett said funds are usually raised on an all-or-nothing basis, which requires requesters to remain on funding sites for a month or more, pitching their ideas.

“That’s a lot of days to get exposure, and for people to raise questions” about suspect offers, he said.