Yesterday I blogged the start of the joint SEC/NYU “Dialogue” on federal crowd funding for the sale of securities. Late yesterday SEC Commissioner Stein released a public statement on matters focused by that Dialogue, suggesting that not only is crowd funding still rare but also it is suffering from a variety of weaknesses.
All transactions must be done through FINRA-regulated “funding portals” which must make sure that the company disclosures required by the SEC Rule are posted (investors cannot deal directly with issuers). No big surprise here: weakness in enforcing disclosure led to offers being withdrawn, and one portal was expelled. Is there a “race to the bottom” whereby portals are lax for the purpose of attracting business? Does this problem require even further regulation by the SEC?
About a quarter of the crowd funding was with SAFEs, an instrument that is a contract to sell securities at a discount once there is a priced subsequent round of investment. The SEC asks if retail investors are sophisticated enough to understand that this is not equity, not debt, that a company may never have a subsequent priced round of investment and thus the investor has — zero? This is a legitimate regulator’s concern, but that very same question fairly could be addressed to the entire idea that retail investors should be making these kinds of investments in the first place; this latter concern resulted in a multi-year delay in the SEC even permitting these transactions notwithstanding being specifically charged with doing so in the JOBS Act.
Finally, there is great geographic concentration among companies using the portals; 60% of all deals, and 90% of all closed funding, were in California, Texas and along the East Coast. The SEC asks if they should undertake further outreach to educate entrepreneurs elsewhere. The question was emotionally presented: can the SEC make crowd funding “accessible to everyone from the businesswoman in Missouri to the immigrant in West Virginia”? The thought was not expressed that perhaps that businesswoman and that immigrant were just too smart to engage in this process to begin with….
I close with an anomaly which, readers here know, is a class of logical disconnects which always intrigue me. Our economy and regulatory scheme seem to be fostering investment by retail investors in speculative new companies at the same time that retail investors have somewhat abandoned the public marketplaces, where information is far more robust and substantive protections for the investor are clearly in place. As a matter of policy, that may be the exactly wrong result…..