Behind this seal, they see no evil. Photographer: Joshua Roberts/Bloomberg
SEC Is an Easy Mark for Crowdfunders
Remember liar’s loans? Get ready for liar’s stocks.
The Securities and Exchange Commission has set Oct. 23 as the date it will unveil its latest plan for crowdfunding. Bloomberg News has a story with an early look at one of the critical details: Small businesses raising money by selling stock over the Internet wouldn’t have to verify that their shareholders comply with individual investment limits set by federal law, according to people with direct knowledge of the SEC’s proposal who asked not to be named.
If the SEC goes through with this, it makes you wonder what the point was of putting those limits into the law in the first place. Just as banks are supposed to follow certain lending criteria to make sure their customers have the ability to repay their loans, the point of verifying whether investors are financially qualified is to make sure they can afford to lose whatever money they plunk down when they buy shares.
Under the Jumpstart Our Business Startups Act, businesses using crowdfunding could raise no more than $5,000 a year from someone with a net worth of less than $100,000. Investors with net assets of more than $100,000 could put in as much as 10 percent of their annual income or net worth, up to a maximum of $100,000 a year. Those limits won’t matter much if the SEC’s proposal goes through, because the companies that are raising the money won’t have to check. Instead, it would be up to the investors alone to decide whether to comply –- assuming that they understand the boilerplate they’re signing.
The reason limits like this exist is to protect easy marks from swindlers. Maybe there is an argument for letting everyday folks invest in any hare-brained, illiquid scheme that they want without any means-testing. But that isn't what Congress claimed to be doing when it loosened the reins on crowdfunding and made it easier for fly-by-nights to part suckers from their money. If Congress believed restrictions based on net worth and income were necessary, it’s only logical that companies selling stock to members of the public should have to abide by them.
The business owners and stock promoters that would benefit from a no-verification system say it’s too hard to check whether prospective investors are financially qualified, and that doing so interferes with their ability to raise money quickly and seamlessly. Just wait till some of their unsophisticated relatives get sucked into a sleazy investment scheme –- like this Florida gambit selling something called the “water atomic engine” -- and see how some of them feel then.
The SEC’s highest calling and foundational reason for being is to protect investors. Congress isn’t making it any easier for the SEC to carry out that mission. But that doesn’t mean the commission should give up on its responsibility here.
(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter.)