The SEC recently released long awaited proposed rules permitting companies to offer and sell securities through crowdfunding (SEC Press Release). Crowdfunding refers to the process of individuals networking and pooling money, usually through the internet, to support efforts initiated by others. A popular example is Kickstarter, where creative projects (everything from the arts to video games) raise donation-based funding. In theory, the “crowd” helps select which projects to support by gravitating toward those with the most promise. After witnessing the success of crowdfunding in other contexts, Congress enacted Title III of the Jumpstart Our Small Business Startups Act (more commonly known as the “JOBS Act”) to create a new mechanism allowing a “crowd” to invest in startups and small businesses. 

The proposed rules can be divided into three components. First, the SEC has proposed caps on the amount that companies can raise and individuals can invest.  Companies will be capped at raising $1 million per year. Individuals will have different caps on investing depending on their whether their income or net worth is above or below $100,000. If below, an investor can invest per year $2,000 or 5% of their annual income or net worth. If above, the cap is 10% of annual income or net worth. The second component is authorizing “crowdfunding platforms,” which are funding portals through which an investor can invest (roughly similar to Kickstarter). Either existing broker dealers or new entities can serve as “crowdfunding platforms,” though existing broker-dealers may have a leg up because the new platforms will still be regulated by FINRA. Platforms must provide educational materials to investors, take steps to reduce the risk of fraud, and are not allowed to offer investment advice, make recommendations, or solicit the purchase or sale of securities. Finally, companies wishing to raise funds must also meet certain disclosure requirements, which include providing information on company leadership and ownership, descriptions of the use of the funds, and audited financials, among other items. 

Proponents hope the combined “wisdom of the crowds” will help identify quality investing opportunities and infuse new capital into the market. Critics question whether the “crowd” can effectively identify good investments, whether the regulations will chill any use of the tool, and whether crowdfunding will become a haven for fraud. The window to comment on the proposed rules expires January 21, 2014.

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