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SEC votes to “unleash wisdom of crowds,” approves crowdfunding rule

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Commissioners at the Securities and Exchange Commission voted unanimously Wednesday to go forward with a proposal that will let small businesses raise money on the internet from mom-and-pop investors without having to go through cumbersome SEC procedures to register securities.

In an open meeting webcast on Wednesday morning, the five Commissioners each described the proposal (embedded below) and then voted to approve it, which will launch a public comment period that will lead to the final rule going into effect.

One Commissioner said the agency had decided to “unleash the wisdom of crowds,” in describing the SEC’s long-awaited step to implement a new phase of the JOBS Act, a law intended to overhaul America’s financial regulations and make it easier for companies to raise money.

While other parts of the JOBS Act have gone into effect, such as permitting firms to advertise online to accredited investors (a move that Om said “changes everything)”, the crowdfunding proposal has been delayed for almost a year, in part because of concerns about fraud and how to implement the procedures.

Under the proposal approved on Wednesday, a key role falls to so-called “funding portals,” which are required intermediaries between companies and investors — they will be responsible in part for ensuring that investors meet the limits for participating. Right now, the U.S. has many such portals — like Kickstarter — but, while investors can donate money to projects, they can only receive in-kind rewards in return, not cash.

Under the new model, investors with a net worth or annual income of less than $100,000 can only contribute $2,000 or 5 percent of their income; the companies issuing the investment can raise up to $1 million in a 12 month period. The level of oversight increases on the basis of how much a company wants to raise; for funding rounds of less than $100,000, an officer must simply produce a financial statement, while higher amounts require sign-off from an accountant and, if more than $500,000, an auditor.

In approving the proposal, all of the Commissioners repeatedly invoked crowdfunding’s potential as a way to promote employment and small business growth. One claimed that $2.7 billion in crowdfunding was raised around the world last year, and another Commissioner quoted a panel at tech festival SXSW, which described the tool as a “global fight to provide access to capital.”

One of the most difficult issues associated with implementing crowdfunding is the process for verifying investors’ worth. As the Washington Post and Bloomberg explain, it is impractical for companies to verify that investors actually meet requirements; as such, the verification will largely rely on investors disclosing their worth to the third party portals that broker the transactions.

Update: here’s a copy of the proposal courtesy of Liz Gannes at AllThingsD:

SEC crowdfunding fact sheet

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3 Responses to “SEC votes to “unleash wisdom of crowds,” approves crowdfunding rule”

  1. It’s important to note that the public comment period on this might be lengthy — there are 295 questions in the document soon to be published by the SEC. The Commissioners also repeatedly used the word “reasonable”, and weighed heavily on protective measures.

    Some safe harbors were also referenced, to which funding portals will likely flock. The SEC has tackled a lot of technical problems this way, so I hope the list therein is specific enough to provide guidance and incentive to the private sector to implement them. Until we have substance to that on paper, it’s difficult to get a sense of what that shield from liability will entail.

    As for the reasonableness of verifying income and/or assets (as one may do now in vetting accredited investors for Title II crowdfunding), the SEC may leave this to the market, as well. The media criticism to date has been far from thorough in its analysis of this point, but I agree with one theme: investors uploading/sharing sensitive documents with each funding portal on which they wish to transact is likely *far* from the best solution. Investor protection should not come at the price of sacrificing investor privacy.

    Brian Fending
    CTO, CrowdBouncer