In my recent paper, my analysis of recent exemptions to US securities law under the CROWDFUND Act, which allows for limited public solicitation of equity crowdfunding, reveals a legislative design that strongly favors exempt issuers at the expense of investor protection. Touting this new equity scheme as a rational modernization of capital formation, both the United States Congress and the Securities and Exchange Commission (SEC) have characterized the new law as striking a fair balance between investor protection and the capital formation requirements of small business entities. Yet, while couched in the language of protection, in fact, the legislation makes enormous room for lay investors to participate in some of the riskiest equity ventures imaginable. While stating that investors will be shielded from overexposure by setting investment limits based on income, the regulators declined to adopt a database that would have prevented abuse of those limits. Bowing to expedience and industry pressure, the SEC instead chose to allow investors to self-certify using a tick-box approach, with no requirement for independent verification.

Further, while the SEC has employed an accreditation standard for exempt equity investors for nearly forty years, with the CROWDFUND Act not only are the regulators continuing to rely on the same income metrics first devised in 1980, they have actually lowered the $250,000 minimum accreditation standard to $100,000 for equity crowdfunding participation at the highest investment level. Without factual support for their rationale, Congress and the SEC seemingly drew the lower income threshold out of thin air, with the only discernable effect being a three-fold expansion in the number of investors that can participate at the higher rate. The net effect of this rule is to leave a large swath of investors above the arbitrarily lowered income threshold, who lack the alleged sophistication of an accredited investor, yet are still exposed to potentially “unaffordable losses” in investments that “are likely to experience a higher failure rate than more seasoned companies.”[1] The legislation also relies heavily on the use of registered intermediaries, where it is envisioned that investors will receive sufficient disclosures to make informed investing decisions.

Yet, even this is largely an illusory protection, as the SEC discovered years ago that “[i]t is clear that many investors do not read disclosure documents for companies and funds in which they invest, and those that do spend relatively little time reviewing these documents, considering the breadth of information they contain.” Beyond these shortcomings, perhaps the most insidious aspect of the equity crowdfunding legislation as enacted is not that it is open to abuse, but more that it appears likely to act as a way of decentralizing losses in questionable ventures, with no recourse for the unwary investors who participate in them. For, if a lay investor purchases a $1000 stake in a speculative security, but then the project drags on for two years before being abandoned, is that investor realistically going to file a complaint? Even if they did, how many resources will the regulators be able to devote to the issue?

The research demonstrates that this legislation serves the needs of business speculators quite well, but it does so on the backs of those that can least afford it. This flies in the face of the history and origins of US securities law, and represents a reversal of policy that is couched in language artfully drafted to falsely give the impression of rational modernization. There is ample space to provide for the capital needs of small business, and with very modest changes, the CROWDFUND Act could easily achieve a balanced approach to equity crowdfunding. While the modernization efforts undertaken by the various stakeholders are definitely a step in the right direction, my paper reveals that more work is needed in order to ensure that the investor protections envisioned by the Securities Act remain intact under this new scheme.

Linn White is an adjunct professor for the graduate program at Thomas Jefferson School of Law in San Diego, CA.

 

[1] Jumpstart Our Business Startups Act, Title III, § 302 Crowdfunding Exemption, Pub.L. 112­­­-106, § 302,126 Stat. 306, 315 (2012) (codified at 15 U.S.C. § 77d); Crowdfunding; Final Rule, 80 Fed. Reg. 71388 (2015).