(CN) - The North American Securities Administrators Association issued a warning to investors about online fundraising known as crowdfunding, which will soon be exempt from certain Securities and Exchange Commission registration regulations.
Crowdfunding is a money-raising strategy that allows members of the public to donate small amounts of money to finance various projects, often creative endeavors such as making a film or releasing an album. Kickstarter.com and ArtistShare.net are prominent examples of online crowdfunding platforms, whereas Kiva.org has used the method to fund microcredit loans in developing countries.
In April 2012, the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012, sponsored by Sen. Jeff Merkley (D-OR), was passed as an amendment to the Jumpstart Our Business Startups (JOBS) Act.
Also known as the Crowdfund Act, it directed the SEC to issue new rules for raising money online within 270 days which include an exemption to allow crowdfunding.
"The Internet has opened the doors for business growth and innovation of all kinds. The Crowdfund Act will allow that innovation to continue by allowing small investors to pool their resources to fund promising new ventures," Merkley said in a statement. "At the same time, this bill protects those investors and sets fair rules of the road. We'll be creating new opportunities for small businesses and investors alike."
Currently, under the Securities Act of 1933, only accredited investors may invest in private companies. For an individual to qualify as an accredited investor, he or she must be worth over $1 million or make at least $200,000 a year.
However, in an advisory warning to investors, the North American Securities Administrators Association (NASAA) sounded the alarm about crowdfunding investment opportunities, especially when the 270 days are up and the SEC relaxes its regulation of such investments.
"Because the potential for fraud is significant, investors must be extremely cautious about crowdfunding investments," said Jack E. Herstein, NASAA president, in a press release. "Once exempt, crowdfunding investments will not be reviewed by regulators before they are offered to the public, nor will they be required to provide the same level of disclosures to investors or regulators required of securities offerings. Investors will need to prepare themselves to be bombarded with all manner of offerings and sales pitches."
Bob Webster, a spokesperson for NASAA, told Courthouse News, "Crowdfunding sites have been operating for some time now, but they are not offering equity investment, only 'donation.' In other words, people who make donations are not expecting much in return and are not purchasing an equity stake in the venture." He continued: "Once the exemption is in place, firms that qualify will not have to register their securities with the SEC before they are offered to the public. The exemption will allow these firms to bypass federal securities registration requirements."
Peer-to-peer lending, often called social lending, which allows a community of donors to lend money in small individual amounts to a borrower without the intermediation of a financial institution, may also be affected by the Crowdfund Act.
Online peer-to-peer lending sites, most notably Prosper.com, ran into trouble with state securities regulators a few years ago over the sale and offer of unregistered securities and the omission of material facts in connection with the offers. In 2008, Prosper entered into a settlement agreement under which it paid a $1 million fine to the states, and now only offers securities to accredited investors.
The SEC is scheduled to issue the new exemption for crowdfunding by in January 2013.