Originally published in The Street
By Douglas Fink
On Halloween, the SEC finalized long-awaited rules that will allow non-accredited investors to buy shares of privately held companies via crowdfunding portals. Crowdfunding, as outlined by regulators, has elements that are fun and risky. So it seemed fitting that this came down on a spooky holiday.
Non-accredited investors, which comprise most of the population, are those investors who do not meet the accredited investor definition: a net worth of at least $1 million, excluding a main residence, or an income of at least $200,000 or, if married, $300,000 for each of the last two years.
So that means that almost anyone can invest in these pre-IPO startups. One example is the three-wheeled, 84-MPG vehicle that Elio Motors is building through crowdfunded investment capital.
The rules, part of Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012, could permit this activity soon after the beginning of the new year.
As inherently risky as these investments can be (startups have a 95% failure rate), what’s more frightening is that Title III portals are not required to be licensed broker-dealers.
Moreover, given that non-accredited investors, from day traders to the proverbial widows and orphans, can be the the most vulnerable players in the market, it is imperative that this group do their due diligence.
Background: Title III crowdfunding platforms are expected to be required to register with the SEC or a broker-dealer, and to become a member of the Financial Industry Regulatory Authority (FINRA) a self-regulatory organization.
FINRA, looking to streamline the crowdfunding process as much as possible, also asked that its rules on reporting requirements, conduct, advertising and supervision govern and, if necessary, discipline the portals as a new separate category.
Unfortunately, the rules for this new category, as they stand, do not require fidelity bond coverage or written anti-money laundering programs. So, it’s caveat investor, as always. But the risk with these investments may be so high that moms and pops with some mad money might be better off in crowdfunding pools or funds, which would add diversification and time horizon protection, as well as professional management if operated by a properly licensed and registered investment advisor.
To be fair, FINRA has stated that additional regulation — including licensing of crowdfunding personnel — may be desirable in the future, once the nascent portals launch.
The industry group also believes that SEC rules will cover some of the regulatory gaps.
The attitude is not surprising, given the support for crowdfunding, potentially one of the most innovative forms of capital-raising in decades. Globally, crowdfunding is a $34.4 billion industry that grew 167% between 2013 and 2014. Only recently have the evolving regulations allowed the participation of U.S. investors. It’s likely that its more qualified younger sibling, crowd finance, to revolutionize capital formation for private, middle market companies.
With a higher degree of real regulation in this space, however, the new Title III crowdfunding portals could become a first resort for companies looking to expand their funding beyond self-funding and accredited investors. It could also be a place where average Americans can take a flier on an alternative investment with potentially unlimited upside, as well as downside.
Promoting innovation while protecting small, unschooled investors is a difficult, perhaps impossible, balancing act. But is there any doubt, really, which way the scale should tilt?
Douglas Fink is the CEO of Group Capital LLC.