The Texas State Securities Board today warned investors to consider the potential fraud in crowdfunding, an online money-raising strategy given new emphasis by the recent Jumpstart Our Business Startups (JOBS) Act.
Crowdfunding began as a way for the public to donate small amounts of money, often through social networking websites, to help artists, musicians, filmmakers and other creative people finance their projects. Through the JOBS Act, small businesses and entrepreneurs will be able to tap into the "crowd" for investments to finance their business ventures. The concept has been promoted as a way of assisting small businesses and startups looking for investment capital.
President Obama signed the JOBS Act into law last month. The act directs the SEC to adopt rules within 270 days to implement a new exemption to allow crowdfunding. Until the rules are adopted, "any offers or sales of securities purporting to rely on the crowdfunding exemption would be unlawful under the federal securities laws," according to the SEC.
"Before the SEC rules are adopted, investors should beware of promoters who jump the gun by offering investments through crowdfunding now," said John Morgan, Texas Securities Commissioner. "Once exempt, crowdfunding investments will not be reviewed by regulators before they are offered to the public.
Investors will need to prepare themselves to be bombarded with all manner of offerings and sales pitches." Investors with questions about crowdfunding offerings should contact the State Securities Board at 1-888-663-0009 before investing.
Q&A on crowdfunding
How much can a business raise through crowdfunding?
$1 million each year.
How does crowdfunding differ from other investment opportunities?
Traditionally, investments are offered by professionals, such as broker-dealer firms and investment advisers, who must recommend investments that are based on their clients' investment objectives and levels of sophistication. Through crowdfunding, individuals are able to invest in entrepreneurial startups through an intermediary, such as a broker-dealer or a "funding portal." By law, these portals are not allowed to provide investment advice.
What is a funding portal?
It is a website, also called a platform, which advertises the investment opportunities and facilitates the payment from the investor to the issuer. Some portals advertise a variety of investment opportunities on one website, allowing the investor to select one or more projects in which to invest.
Why investors must be extremely cautious about crowdfunding
Funding portals must be registered with the SEC and comply with rules the SEC may issue. Crowdfunding investments, then, cannot be offered legally until the SEC adopts rules to permit them. Beware of offerings that seek your money immediately.
Issuers using funding portals may be inexperienced. Their track records may be unproven, unsubstantiated, or fraudulent.
Information about an investment is limited to what is provided through the funding portal. Investors need to do their own research to determine the issuer's track record and risk level of the investment.
State regulators are not allowed to review crowdfunding issuers or their offerings. Since regulatory oversight is limited, investors may be left on their own to pursue costly private lawsuits when investments fail.
Crowdfunding investments are mostly illiquid. Investors should be prepared to hold their investments indefinitely. It may also be difficult or impossible to resell these securities due to the lack of a secondary market.