Crowdfunding will provide small businesses and start-ups with access to capital from unaccredited investors, a big shift from previous rules, which only allowed wealthy individuals to invest in nonpublic companies.
Supporters said crowdfunding will revolutionize how small businesses can expand and grow, and it will provide significant economic opportunities for ordinary Americans. They said it will also boost the economy and create jobs.
But critics said that crowdfunding greatly increases the potential and likelihood for investment scams and fraud.
“There is going to be a benefit, in terms of the fact that you will see new start-ups come into being and more innovation and job growth,” said Eric Chaffee, law professor and chair of the Project for Law & Business Ethics with the University of Dayton School of Law. “But I think there will be some people who get hurt, and hurt badly, as a result of it.”
In 2012, the Ohio Division of Securities received 79 formal complaints of violations of securities laws, according to division data. Complaints were down 27 percent from 2011, and 12 percent from 2010.
Investments are risky
Most complaints are lodged by investors who lost money or had issues with an investment, said Ohio Securities Commissioner Andrea Seidt. Complaints come also from other regulatory agencies, other states and financial professionals.
Securities are inherently risky, and financial losses often stem from market conditions, and not misrepresentation and fraud. But most complaints are justified, and the division issues administrative orders such as cease and desist orders, denials of license applications and license suspensions and revocations, Seidt said. The division issued 31 administrative orders in 2012, down from 49 in 2011.
The division also pursues civil actions in order to stop ongoing violations of securities laws. Some investigations result in criminal charges, depending on whether there were serious violations of Ohio securities laws. About four cases were referred for criminal charges in 2012. Last year, four people were criminally indicted, and three people were convicted.
The decrease in complaints last year does not necessarily indicate that there was a reduction in securities violations, because one case can result in dozens of complaints or more. Every situation is different, and several investigators can file a complaint that results in a case, while other times the filing of one complaint can lead to a case, officials said.
“You could have 78 complaints from one case, and that would result in one administrative order,” Seidt said.
The number of complaints also does not reflect the number of people victimized by investment scams.
In November, a federal judge in Indianapolis sentenced three men from an Ohio financial services business to between 10 and 50 years in prison for wire fraud, securities fraud and conspiracy to commit wire and securities fraud.
The men, who worked at the Akron-based Fair Finance, defrauded about 5,300 Ohioans of more than $200 million. They deliberately misled investors and made false statements about the financial condition of their business and what how they were investing their money. It was the largest securities fraud case in Ohio history.
The most common types of investment scams include Ponzi schemes, affinity fraud, promissory notes, distressed real estate schemes and unlicensed and unregistered sales, officials said. Many cases could have been avoided if investors simply contacted the Division of Securities and checked whether the products they were going to purchase were registered or the sellers were licensed, officials said.
New law to help small businesses
Although securities complaints declined last year, Seidt said she expects to see an increase in complaints in coming years as a result of crowdfunding and Internet investments.
“I think we will see more cases,” she said. “I think there will be legitimate businesses that will benefit from (Internet investing), but at the same time, there will be con artists waiting in the wings, and it will be an easy opportunity for those individuals to get at a much bigger market.”
Last April, President Barack Obama signed into law the Jumpstart Our Business Start-ups Act.
The legislation will allow small businesses and start-up companies to sell stakes in their enterprises directly to the public without having to register with the U.S. Securities and Exchange Commission, said Chaffee, the UD School of Law professor.
Companies will be able to sell limited amounts of capital to an unlimited number of small and unaccredited investors, he said. Accredited investors must have a net worth of at least $1 million, not including the value of their home, or have an income of $200,000 or more. The new legal exemption will also allow companies to solicit investors online. The SEC is expected to issue rules about crowdfunding later this year.
Crowdfunding will help about 20 million U.S. small businesses access capital that are unable to obtain it through traditional avenues, such as Angel investors, venture capitalists and financial lenders, said Candace Klein, founder and CEO of SoMoLend, a debt-financing crowdfunding platform headquartered in Cincinnati.
At the same time, the activity will give more people a chance to invest in innovative ideas, companies, industries and products, she said.
“It is an opportunity to build wealth for the everyday American, and it is an opportunity to access capital for the small business owner,” she said.
Americans will learn how to appropriately gauge the risk levels associated with their investments, said Eric Corl, president and co-founder of Fundable.com, a Columbus-based crowdfunding platform that focuses on businesses. He said any investment comes with inherent risks and proper education and disclaimers will help make that very clear prior to investors.
“The idea that people can go to a casino and gamble away their money, but can’t choose to invest in a private company really is a discredit to the American people,” he said.
But some regulators and attorneys said it will be very difficult for small investors to distinguish between legitimate and illegitimate investment opportunities. They said fraud cases will certainly increase because of Internet investing.
“It is basically going to be the wild, wild west, and we’re just going to be flooded with pitches on social media and websites,” said David Meyer, founding principal of Meyer Wilson Co., a law firm in Columbus. “I really think we are looking at the 21st Century boiler rooms, where dodgy deals are peddled in social media to unsophisticated investors.”
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