Takeaways from the SEC Forum on Small Business Capital Formation


The 2012 Forum on Small Business Capital Formation is in the books.

Industry leaders met with representatives from the SEC in an effort to build consensus on regulatory recommendations for crowdfunding’s implementation in the US.

Although the movement has come a long way, there is still a lot of work to do.  It is becoming clear why there is an emerging consensus that crowdfunding under the JOBS Act won’t be implemented in the United States until sometime in late 2013.

There are two constituencies that need to be protected in order for this to work.  Investors need to be adequately protected.  That is the SEC’s mandate, of course.  Nobody wants to see the public fleeced, and the reality is that one crowdfunding disaster could ignite a media firestorm and drive investors away from the industry.

Having said that, the reality is that investor protection cannot come at the cost of financial incentive for crowdfunding portals to exist.  A heavily regulated crowdfunding industry means higher operating costs for portals.  Who is set to absorb at least some those costs?  Small businesses and their investors, and those businesses need every penny they can get.

Portals desperately want to help small businesses easily generate the capital they need to succeed, but they also need a regulatory framework that encourages a profit.

It is a difficult balance.

Much of the conversation around regulation centered around two aspects of investor protection: preventing fraud and the participation of bad actors, and determining how to vet investors.

In general terms, bad actors are individuals who are deemed unfit to participate in securities offerings.  The obvious example of a bad actor is anyone with a previous conviction for securities fraud.  However, that definition may be subject to change.

As far as vetting investors, there are specific rules on the criteria for investment in crowdfunding offerings as described under the JOBS Act.  The question lies in how to ensure investors are participating legally.

How do we ensure unaccredited investors aren’t investing more than the allotment allowed in law?  Who inherits the responsibility of due diligence?

The process could be as simple as investors agreeing to accept liability if they are in violation, similar to checking the box when visiting a brewery’s web site to confirm you’re 21 or over.  It could also be as complex as portals or other interests having to individually vet every unaccredited investor.  Again, the difference will directly impact the economic model for having portals in the first place.

Suggestions will be presented to crowdfunding’s SRO (presumably FINRA) for finalizing these rules.  Those decisions could swing the economic case for equity and debt crowdfunding in the US, and in turn affect decision making for small business capital formation now and for years to come.

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