Crowdfunding and the Federal Securities Laws

Abstract

Crowdfunding - the use of the Internet to raise money through small contributions from a large number of investors - could cause a revolution in small-business financing. Through crowdfunding, smaller entrepreneurs, who traditionally have had great difficulty obtaining capital, have access to anyone in the world with a computer, Internet access, and spare cash to invest. Crowdfunding sites such as Kiva, Kickstarter, and IndieGoGo have proliferated and the amount of money raised through crowdfunding has grown to billions of dollars in just a few years.

Crowdfunding poses two issues under federal securities law. First, some, but not all, crowdfunding involves selling securities, triggering the registration requirements of the Securities Act of 1933. Registration is prohibitively expensive for the small offerings that crowdfunding facilitates and none of the current exemptions from registration fit the crowdfunding model. Second, the web sites that facilitate crowdfunding may be treated as brokers or investment advisers under the ambiguous standards applied by the SEC.

I consider the costs and benefits of crowdfunding and propose an exemption that would free crowdfunding from the registration requirements, but not the antifraud provisions, of federal securities law. Securities offerings for an amount less than $250,000-500,000 would be exempted if (1) each investor invests no more than the greater of $500 or two percent of the investor’s annual income and (2) the offering is made on an Internet crowdfunding site that meets the exemption’s requirements.

To qualify for the exemption, crowdfunding sites would have to (1) be open to the general public; (2) provide public communication portals for investors and potential investors; (3) require investors to fulfill a simple education requirement before investing; (4) prohibit certain conflicts of interest; (5) not offer investment advice or recommendations; and (6) notify the SEC that they are hosting crowdfunding offerings. Sites that meet these requirements would not be treated as brokers or investment advisers.

Keywords: crowdfunding, securities, exemptions, offerings

JEL Classification: K22