ThinkProgress’ Schizophrenia on Crowdfunding and the JOBS Act
ThinkProgress, the blogging arm of the liberal Center for American Progress, is usually pretty good on enforcing the political left’s party line. But two of its bloggers seem to have radically different viewpoints on crowdfunding, the pooling of resources through online social networking for a given product or production.
Liberalization of securities laws governing crowdfunding is at the center of the debate around the Jumpstart Our Business Startups (JOBS) Act, which had sailed through the House with the Obama administration’ support and 390 votes (including from vocal liberals such as Reps. Barney Frank, D-Mass., and Maxine Waters, D-Calif.) on March 8, yet has encountered resistance from Democrats in the Senate due to its alleged riskiness.
In her post Tuesday afternoon, TP culture blogger Alyssa Rosenberg hailed the crowdfunding effort on the website Kickstarter for the Web series Husbands, a romantic comedy about a gay couple. But she noted the limitations of the donation model of crowdfunding.
Rosenberg wrote that she was “glad to see we’re at a point where it’s basically a sure thing that an established artist can get project funding from their fans now.” But she wondered, “Will fans be content to be paid in swag unrelated to the products they’re funding, as is the case in most Kickstarter campaigns, if the projects they’re supporting become commercially viable?” She concluded that if fans “start acting as investors, maybe they should be treated that way.”
But there is a simple reason why fans aren’t treated that way. Crowdfunding that offers any type of investor return or profit sharing — as opposed to token rewards like t-shirts or film credits — is most likely illegal under federal securities laws. Under the Securities Exchange Act of 1934, any firm with 500 or more shareholders becomes subject to many of the same costly reporting rules faced by publicly-traded companies. These include the Sarbanes-Oxley Act of 2002, which costs companies an average of $2.3 million in compliance costs every year, according to the Securities and Exchange Commission (SEC).
Since the SEC defines “shareholder” very broadly, and since it is easy to hit 500 “friends” or “followers” in a social network, crowdfunding outside the donation model becomes prohibitively expensive due to regulatory costs. But there is a bill that would change this. Alyssa Rosenberg, meet the JOBS Act.
The House-passed JOBS Act liberalizes crowdfunding rules in two ways. First it lifts the “threshold” for many SEC mandates from 500 to 1,000 shareholders (and to 2,000 shareholders for community banks). This threshold, which hasn’t been raised in more than 50 years, is woefully out of date given that many social network uses have way more than 500 connections. This limit also prevents growing firms from rewarding rank-and-file employees with ownership stakes.
The bill then allows an exemption from these mandates for crowd funding, or pooling capital, of up to $2 million. Ordinary investors are permitted to invest the lesser of $10,000 or 10 percent of their income. As Patrick Ruffini notes at Huffington Post, the JOBS Act “limits the size of investments so that no investors could lose their shirts in the same way they did with traditional investments in GM, Fannie Mae.”
This should please Rosenberg. Her favorite Web programs, independent films, and musicians could raise more funds from small investments, rather than donations, without facing millions of dollars in SEC red tape. But Rosenberg’s desires seem to conflict with those of her colleague Travis Waldron, a policy blogger at TP.
Waldron parrots the line of The New York Times, the AFL-CIO, and Senate (but not House) Democrats on crowdfunding and the JOBS Act. “It’s [sic] exemption for crowd funding, meanwhile, would make it easier to organize online scam operations at a time when Americans — particularly the elderly — are more susceptible to online scams than ever.”
Yet what is it about buying small stakes in small businesses online that is any more prone to fraud than the millions of Internet transactions that take place? Users of eBay, for instance, buy and sell cars, valuable antiques, and even real estate on the site. If anything, these transactions require more due diligence’s than the purchase of shares of stock.
Current rules that punish fraud in securities and fraud on the Web should suffice as a deterrent. There are also market mechanisms such as the private ratings system for participants in sites like eBay and Kickstarter. The JOBS Act also requires crowdfunding operators to provide notice to the SEC to be shared with state securities regulators, and prevents “bad actors” from engaging in crowdfunding.
True, the bill does not force on investors and entrepreneurs all the accounting minutiae from Sarbanes-Oxley, but these mandates — burdensome as they are for legitimate entrepreneurs — didn’t exactly protect investors from the implosions of Lehman Brothers and MF Global. For emerging growth companies going public, the JOBS Act also wisely delays the most onerous provisions of Sarbanes-Oxley and Dodd-Frank until five years after their initial public offering? No investment is risk-free, so why not let investors choose the levels of “protection” they think they need?
Like Rosenberg, I also had the privilege of seeing the possibilities of crowdfunding earlier this month at the South by Southwest entertainment and trade festival in Austin, which I attended as a correspondent for The Daily Caller. As Rosenberg noted, many of the films premiering there were supported by fan donations online.
In the technology panels, speaker after speaker hailed the revolutionary implications of crowdfunding and urged the attendees to tweet the Senate to pass the JOBS Act. At one such panel, David Geertz, founder of the Canadian crowdfunding site SoKap, told me that if the JOBS Act passes, Canada is “going to have a massive brain drain” unless it follows through with similar legislation. “With crowdfunding established, Canadian firms will move to the United States to obtain U.S. funding,” he said
But given Senate Democrats’ resistance on the JOBS Act, as shown this yesterday when Majority Leader Harry Reid (D-Nev.) pulled the vote on the House bill that he had promised, the U.S. may have to wait to realize the potential benefits of crowdfunding. Insisting that capital-raising over the Internet be governed by 1930s laws enacted before many homes had a telephone is static thinking that certainly doesn’t represent progress.