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BUSINESS
Securities and Exchange Commission

Delamaide: Crowdfunding rules help investors

Darrell Delamaide
USA TODAY
The Securities and Exchange Commission has proposed rules that could help small companies raise money by selling shares to investors through crowdfunding.
  • The SEC proposes to let small companies offer shares without going through SEC registration
  • Proposal strikes balance between protecting investors and letting process work

WASHINGTON — Investors disillusioned with what increasingly looks like a stock market rigged in favor of high-frequency traders will soon have an opportunity to buy shares in local start-ups and enterprises through crowdfunding.

The Securities and Exchange Commission last week proposed rules to carve out an exemption for small companies to offer shares without going through the burdensome and expensive process of SEC registration.

It also set requirements for "funding portals" — an alternative method of selling these shares that breaks Wall Street's monopoly on securities dealing.

Though viewed with suspicion by consumer advocates who see it opening the door for investor scams, the new rules — part of the JOBS Act (Jumpstart Our Business Startups Act) passed last year — respond to a growing desire for people to invest their money in local enterprises or other ventures they feel a connection to.

Crowdfunding on a private basis already enjoys a good following, and allowing the sale of actual shares will give new impetus to the phenomenon.

Amy Cortese, whose 2011 book "Locavesting: The Revolution in Local Investing and How to Profit From It" chronicles this interest in community investing, says the long-awaited move by the SEC has been held back by numerous misperceptions about crowdfunding.

"One of those misperceptions is that crowdfunding is about get-rich-quick schemes," she wrote in her blog earlier this year. It's not about finding the next Facebook but about keeping your money closer to home, where it can create jobs and build value for the community.

Cortese's book contains examples ranging from an organic dairy cooperative getting funds from several states to a local bakery that police officers bought to keep their supplier of donuts in business.

Money columnist Darrell Delamaide.

The rules proposed last week by the SEC contain numerous restrictions designed to protect investors. These include limits on how much money companies can raise under this exemption and how much individuals can invest in a 12-month period.

Companies raising money must disclose some basic facts about who owns the business and how they plan to use the money. The new funding portals cannot offer investment advice and cannot handle client money.

In general the SEC succeeds in walking the fine line between enough regulation to provide safeguards for investors but not so much that it prevents the process from actually working.

The rules are open to public comment for 90 days, after which it usually takes SEC staff several months to review and tweak them before the commissioners give final approval.

The rules, which were delayed in part by the transition in leadership at the SEC, seem to fulfill the desire expressed by the new chairman, Mary Jo White, in releasing them: "We want this market to thrive in a safe manner for investors."

Traditional broker-dealers have shown little interest in crowdfunding, which is such small potatoes they could never make any money at it. They are likely, however, to flood the SEC with comment letters bemoaning the dangers for investors.

But after a crisis when investors have seen highly regulated banks and brokers recklessly playing with their money, people might feel their chances are better in this smaller, less-regulated market where often they will have some personal connection to the investment.

Crowdfunding and locavesting are efforts to escape the grip of Wall Street on our savings and investment. The array of regulations that has grown up around securities dealings has probably prevented some fraud, but it hasn't stopped the Enrons, the Madoffs, credit default swaps and other high-stakes antics that have cost investors billions.

Oddly enough, many of Wall Street's most virulent critics, such as MIT professor Simon Johnson or former regulator William Black, also oppose these new measures, even though they drive a wedge into a fiercely guarded Wall Street monopoly.

They seem to fear this is a Trojan horse of deregulation, and will lead to further weakening of investor protections.

Rather, as Cortese says, crowdfunding under the proposed SEC rules is "an opportunity to take a broken financial system and make it better."

Ancillary service providers such as CrowdCheck are already working to help vet potential investments and provide disclosure a lot more helpful than those voluminous prospectuses of legal mumbo jumbo that no normal investor can read or understand.

Crowdfunding proponents envision a return of local stock exchanges trading the securities in these local companies. There is already a network of investment clubs, co-ops and other pools supporting local investment.

This can be, in short, an Internet-powered rejuvenation of grass-roots capitalism, rescuing a free enterprise system that has been hijacked by Wall Street and stifled behind a superstructure of regulations that have failed to protect investors.

Darrell Delamaide has reported on business and economics from New York, Paris, Berlin and Washington for Dow Jones news service, Barron's, Institutional Investor and Bloomberg News service, among others. He is the author of four books, including the financial thriller Gold.

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