Equity crowdfunding will soon be legal.  The JOBS (“Jumpstart Our Businesses Start Ups”) Act that the President signed days ago mandates that the SEC implement rules for a new crowdfunding securities registration exemption within 270 days.  The President heralded this provision as a “game changer” for “small businesses and start-ups,” stating “for the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”

It’s scary stuff because it’s further confirmation of a frightful reality – that many in Washington have no clue how the business world works.  This will end up ranking right up there with the Solyndra-type debacles, the disgraceful Freddie and Fannie spending, the Medicare double counting schemes, the phony budget benchmarking, the crazy GSA boondoggle waste, the intolerable bond rating downgrade, the shameful neglect of disabling debt crisis risks, and a lengthy list of other items that no responsible business could tolerate.

In less than a year, private business ventures of all types will be using the internet to sell unregistered securities to “ordinary Americans” who have no capacity to evaluate what’s being offered.  All the targeted investors will see are ground floor opportunities to play like the big dogs.  The maximum amount that a business can raise through this crowdfunding tool in a 12-month period is $1 million – not serious money in the world of business development.  Those who have an annual income and a net worth of less than $100,000 may invest the greater of $2,000 or five percent of their income or net worth in a single deal.  Those who exceed the $100,000 threshold many invest 10 percent of their income or net worth up to a maximum of $100,000.

Here’s the likely scenario. A budding entrepreneur with a hot-sounding business idea will use the internet to raise, say, $450,000 from 150 investors (average investment of $3,000) who have an average income and net worth of $60,000.  The 150 investors will need attending to and will soon become a nuisance.  They will have questions and concerns. They will want reports and information, to be assured that everything is on track.  Of course, there will be no market for the stock, but some will want out anyway because of a lost job, a sickness, or a desire for a new car.  A few will file bankruptcy, and their stock will end up in the hands of a  bankruptcy trustee.  An investor will die, and the heirs will demand the lowdown.

Meanwhile, the $450,000 will be spent on salaries, fees and start-up expenses.  Soon more money will be needed to keep the plan alive.  But what savvy investor will want to partner-up with 150 needy neophytes who can’t bring any more to the table?  If such an investor does surface, a plan will be developed to flush out the original 150 investors at the lowest possible cost.  The more likely outcome is that the entrepreneur, having consumed the money, will just move on to the next deal after advising the investing crowd that there’s no more money, the plan is dead, and they may be entitled to a tax deduction for a worthless investment.

Is this fraud?  It might be.  It might just be incompetence, stupidity or greed. Either way, the uninformed investors end up losing. Investing in unregistered securities of start-ups is a super high-risk game that always poses serious risks of fraud, abuse, and complete loss.   That’s why, to date, it’s a game that has been off limits to general solicitation and advertising and has been limited to sophisticated investors and those with a certain level of wealth.  It is no place for unsophisticated investors of modest means.

This assessment is not unique.  The President of the North American Securities Administration Association (NASAA) recently stated, “Congress has just released every huckster, scam artist, small business owner and salesman onto the internet.”   Ralph Nader claimed that it’s a “return to the notorious boiler room practices” where any start-up “can sell stock to investors like the old Wild West days with little disclosure or regulation.”

Will there be any serious oversight?  In his speech days ago, Obama promised that the SEC will play an “important role” to insure that “the websites where folks go to fund all these start-ups and small businesses will be subject to rigorous oversight.”

Now this is the same SEC that failed to spot Enron, Worldcom, Madoff, the dot-com bust, the derivative showdown banking industry, the subprime mortgage lunacy, the financial meltdown, and a host of other huge messes.  It’s the same SEC that is too busy to implement required Dodd-Frank reforms and has no capacity to provide any effective oversight of unregistered private placements targeted at sophisticated and deep-pocket investors.  Yet, somehow, this SEC now is going to have the capacity to scrutinize countless internet unregistered peanut offerings designed specifically for unsophisticated crowds of investors.  It makes no sense.  I keep thinking of the stimulus “shovel ready job” oversight bust, or the GSA boondoggle oversight mess, or the masses that now successfully file bogus disability claims, or the hordes that fraudulently collect unemployment or food stamp benefits, or the rampant Medicare fraud and abuse that we now accept as unavoidable, or the fast and furious oversight debacle, or the ….

How about state securities regulators helping out with oversight and regulation?  No hope there.  The new law specifically provides that the federal exemption will cut off all state involvement.  It’s kind of like the Department of Justice’s position on border control.

So why are we now being given this “game changer” exemption?  It’s election year politics.  It’s something to talk about.  It can be heralded as a perk for small businesses that promises to allow “ordinary folks” in on the lucrative start-up action and creates the illusion of countless new jobs in the future.  It’s likely that the SEC’s implementing rules won’t even surface until after the election.  Only then will we know the nature and extent of the chaos and risks of abuse that will follow.

But what’s really key (and depressing) is that this new talking point will be used as another gimmick to divert attention from the real problem – that we remain hamstrung by intolerable tax, fiscal, regulatory, energy and healthcare uncertainties that our present leaders have no capacity to deal with.

April 16, 2012