Editorial Board

Crowdfunding? How About Crowdinvesting?

Why is the SEC dragging its feet in allowing entrepreneurs to sell small amounts of stock through crowdfunding websites?

Just a few bucks from each of you.

Photographer: Carla Gottgens/Bloomberg

Surely one of the most glorious absurdities of American capitalism is that it's easier to raise money online to make some potato salad than, say, to start an actual business. Of course, it should be more difficult to get people to invest in an idea than in a side dish. But it shouldn’t be this hard.

The Securities and Exchange Commission could fix this tomorrow. Congress passed a law in 2012 allowing entrepreneurs to sell small amounts of stock through crowdfunding websites. The idea was to streamline the contradictory and confusing federal and state rules about the practice, which would be faster and cheaper -- and require less bureaucratic oversight -- than formal SEC registration. 

Yet the SEC still hasn’t issued the necessary final rules to allow for this form of raising capital, mostly because it is worried that crowdfunding could make it easier for scam artists to separate investors from their money. 

The law includes adequate protections for investors. If their annual income is below $100,000, they can buy only up to $2,000 worth of shares (those with higher incomes can invest up to $10,000). Companies, which can't raise more than $1 million a year through crowdfunding, must make financial statements available online. Portals that match buyers with sellers must register with the SEC and vet entrepreneurs and investors.

All in all, it's not fail-safe -- but neither is the SEC's usual registration and reporting system. 

It is true that the Internet fosters some pretty crazy schemes, as Zack Danger Brown will attest. (He's the Ohio man who raised $55,492 online last year to make some potato salad.) Tens of thousands of more serious projects, from filmmakers and software developers to food-truck vendors and clothing designers, have raised close to $2 billion from sites such as Kickstarter and Indiegogo. But there is little upside for investors, who can be rewarded only with gifts such as free samples and movie tickets.  

More than a dozen states, meanwhile, have marched ahead with their own rules that allow the sale of securities over the Internet to investors within their borders. A dozen more are considering doing so. Instead of one uniform national rule, the U.S. is on its way to having 50. 

The SEC has shown it knows how to retrofit an archaic rule for a changing market. In May, it will liberalize a rarely used capital-formation process by allowing medium-sized companies to sell as much as $50 million in equity, up from an existing $5 million cap, without registering their securities. It also will let smaller investors get in on such mini-IPOs. 

Yes, the Internet is a whole new venue for ruses that securities regulators need to worry about. But their bigger worry should be how to adapt their rules to new financial markets, technologies and business models.