By Sarah Morgan
The SEC’s crackdown on alleged abuses in pre-IPO investing could be a setback for “crowdfunding” legislation designed to make it easier for entrepreneurs to raise money from retail investors, observers say.
A bill called the JOBS Act that’s currently under consideration in the Senate would relax the rules around private-company investing, allowing small private businesses to raise up to $1 million from retail investors online. But the SEC recently fined a website that lets wealthy investors buy private-company stock for not registering as a broker-dealer, and charged two money managers who sold private-company stock with misleading or overcharging investors, the Wall Street Journal reports. “This SEC action is a perfect illustration of how dangerous and misguided the JOBS Act is,” says Barbara Roper, the director of investor protection at the Consumer Federation. “If it passes it will result in increased fraud, and that will hurt both investors and the small companies it is supposed to benefit,” Roper says.
Currently, only wealthy investors can buy stock in companies that aren’t publicly traded, such as Twitter or Facebook. Investors generally must be “accredited,” meaning they have a net worth of at least $1 million (not including the value of their home) or an income of at least $200,000 a year. “The rules are designed to make sure that people have a certain amount of financial ability to tolerate the risk of these investments,” says Charles Rotblut, the vice president of the American Association of Individual Investors. Without a liquid, public market for a stock, and without the financial disclosures public companies have to make, it’s much harder to determine how much a share is worth, Rotblut says. “When you’re buying shares on a private market, you’re basically paying what sellers are asking for. It’s equivalent to going on StubHub and buying tickets for a sold-out concert,” he says.
It makes sense to tweak these rules a bit, but the “crowdfunding” bill removes too many protections for retail investors, says Robert Pozen, a senior lecturer at Harvard Business School and a senior fellow at the Brookings Institution. “Of course we want to encourage capital-raising, but we need to do it in a way that’s reasonable from an investor’s point of view,” Pozen says.
Small businesses should have to make some financial disclosures to raise money online, and websites selling these shares should have to register with the SEC in some way, he says. It may also make sense to set a fairly low limit on how much individuals can risk, say $1,000, to ensure that retail investors don’t lose significant amounts in risky ventures, Pozen says. “The reality is that unfortunately for every Facebook there are hundreds that don’t work out, and we need to make sure that people who are investing in this understand the risk involved and can bear losses without doing some terrible things to their families,” he says.