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Crooks Lick Their Chops Over 'Crowdfunding' Bill

Meanwhile, issuers seeking to raise capital honestly would be sucked into a regulatory muck.

Mercer Bullard, 11/22/2011

In a rare instance of bipartisanship, the House of Representatives approved a White House endorsed crowdfunding bill--the Entrepreneur Access to Capital Act--earlier this month by a vote of 407 to 17. The bill is being hailed as a boon to capital markets, but no one has answered a basic question about its impact:

Exactly how will capital markets be improved by allowing a family of four living below the poverty line and seniors surviving only on Social Security, in each case with an annual income of, for example, $15,000, to invest their life-savings of $1,500 in an unregistered securities offering?

The bill permits issuers to raise up to $1 million annually ($2 million with audited financials) without registering the securities or even subjecting intermediaries who distribute the securities to regulation as brokers. Investors can invest up to $10,000 or 10% of their annual income in a single offering, whichever is less. There is no restriction on general solicitation or advertising. In sizing up the bill, Jack Herstein, president of the North American Securities Administrators Association, hit the nail on the head: "If I'm a crook, I'd be licking my chops over this."

Why Crooks Are Licking Their Chops
A more fitting name for the act might be the Entrepreneur and Scam Artist Access to Capital Act. A Baltimore Sun columnist provided the following tongue-in-cheek preview of the Internet pitches that may be popping up in your inbox:

May I offer you an opportunity? I have perfected nuclear fusion in my basement, working with alligator kidneys, artisanal sea salt and a Keurig coffee maker. . . . Buy stock now on hahasucker.com, and pay no attention to the account I just set up in the Cayman Islands.

Entrepreneurial supporters of the bill either ignore or are seemingly indifferent to the risk of increased fraud. One such proponent, who described the bill as "open source funding," acknowledged that "this new capability (if it passes) is going to be abused (bucket shops across the country are gearing up in anticipation)," but "most of that will be sorted out in time." The ongoing financial crisis presumably will also be "sorted out in time," but that's not particularly reassuring.

Even the SEC has rolled over in the face of the bipartisan love fest, expressing only mild skepticism about the bill. This is the same agency that, after loosening the rules on small offerings in the mid-'90s, changed its mind because the rule was being "abused by perpetrators of microcap fraud" in so-called "pump and dump" schemes. And this was before the ubiquity of the Internet created the perfect vehicle for fraudsters.

If the SEC's mid-'90s reforms opened the door to scam artists, the crowdfunding bill will hand them the keys to the house. In short, the bill strips away investor protections in six critical respects. It:

Mercer Bullard is president and founder of Fund Democracy, a mutual fund shareholder advocacy organization, an associate professor of law at the University of Mississippi School of Law, a senior adviser for financial planning firm Plancorp Inc., and a former assistant chief counsel at the Securities and Exchange Commission. He has testified frequently before Congress on regulatory issues. He can be reached at bullardm@funddemocracy.com. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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