Will Crowdfunding Beget Crowdfrauding?

Crowdfunding websites such as Kickstarter.com have helped small businesses raise millions of dollars via the Internet, and they’ve even gotten the attention of the White House. On April 5, President Barack Obama signed the Jumpstart Our Business Startups Act, which aims to create jobs by making it easier for young companies to raise money, in part by relaxing rules on companies that use crowdfunding sites. Some regulators, though, say the law may lead to losses for well-intentioned backers. “States are concerned that the fraud and scammers will come out of the closets now and start using social networking sites to rip off investors,” says Jack Herstein, president of the North American Securities Administrators Association.

Until now startups generally have been barred from selling shares on such sites in the U.S. Any funds received were considered donations, though many companies offered perks such as product samples in return. The new law lets companies sell as much as $1 million in securities a year via crowdfunding sites. Investors may profit by selling shares after a one-year holding period or if the company goes public. The websites usually charge businesses a fee or take a percentage of the money raised. Individuals contributed about $123 million through crowdfunding globally last year, almost four times the 2010 volume, according to Daily Crowdsource, a San Diego researcher.