Wall Street Journal Flubs Crowdfunding

Wall Street Journal Flubs Crowdfunding

The Wall Street Journal came out guns a-blazing against equity crowdfunding, namely the Regulation A exemption known as Reg A+. The headline says it all: “The Shortcut That Allows Risky Startups to Raise Billions From Rookie Investors.” The piece decries “slick marketing” and “lighter-touch rules” compared to IPOs.

Lighter touch may be an understatement. The writer, Dave Michaels, suggests the companies can raise millions with “little oversight.” As proof of the potential fleecing, Michaels offers two examples, Aptera, a solar car company and Boxabl, a miniature home manufacturer. Michaels warns:

Aptera and Boxabl have both relied on catchy social-media campaigns that hype their progress creating game-changing technologies. Crowdfunding platforms—such as StartEngine and Republic—match the fledgling firms with novice investors who can behave more like fans than shrewd financiers looking for a solid return on their investment.

Putting aside that StartEngine and Republic are mostly used for a different exemption, Regulation Crowdfunding (Reg CF), are the WSJ claims about equity crowdfunding warranted?

Wall Street Journal Flubs Crowdfunding by Never Asking ‘Compared to What’?  

It does seem the two companies the piece features are struggling to survive and the founders of one may have engaged in financial subterfuge. (Many of their issues seem typical for startups, e.g. design changes, vendors going out of business).

Nonetheless, if either have defrauded investors the Securities and Exchange Commission (SEC) should prosecute them. But the larger question Michaels never asks is, compared to what?

Are public companies free from fraud? Is Reg A+ really a “shortcut”? Is there “little oversight”? Should retail investors be barred from private capital markets because some startups fail or turn out to be frauds? The answer to these questions is, emphatically, no.

Reg A+ is heavily regulated

The onerous disclosure requirements the SEC imposes on public companies has not stopped fraud; lying for gain is simply a part of human nature that must be punished when exposed. As professors Stuart R. Cohn and Gregory C. Yadley wrote in 2007:

[E]xamination of the securities violations that are of principal concern reveals that no amount of technical exemption requirements will hinder the fraud artists from their endeavors. . . . Fraudulent and deceptive schemes have unfortunately continued unabated and independent of formal registration or exemption requirements.

Reg A+ was part of the Jumpstart Our Business Startups (JOBS) Act of 2012. It is not a shortcut. Congress designed it to be on an onramp for companies headed toward registration to ease into the substantial burdens of being public companies, hence its nickname “mini-IPO.”  

The exemption has proven popular in finance, insurance, and real estate. Community banks, for example, have used it successfully to raise capital from a larger potential investor pool whilst maintaining their private status.

And far from containing “little oversight” the SEC must “qualify” offerings–usually a months-long process. Reg A+ “Tier II” issuers (overwhelmingly the preferred use) must produce an offering circular, annual, semi-annual, and current-event reports. This includes independent audits. Retail investors also face investor limits based on a net worth/annual income scale.

If some don’t research their purchases properly, the market will soon discipline them. And current rules ensure they won’t lose their shirts. In fact, the real tragedy of Reg A+ was that the SEC refused to “cover” secondary trading, preventing markets from arising because of state-level restrictions. A free and open trading market would include price signals that reflect the success or failure of companies and give potential investors more data to evaluate beyond CEO bluster.  

Young companies should be able to integrate fans, investors, and customers

Beyond these false claims is a normative one. Is it bad, as Michaels infers, that “novice investors . . . behave more like fans than shrewd financiers looking for a solid return on their investment”? No. Being a company fan is part of the allure. It brings people closer to companies they like by becoming investors. Reg CF offerings uniformly come with swag escalating with larger investments.

For the company this proves the loyalty of their current or future customers. These small investors are often happy to help advertise the offering or the company’s products for free. As startup capital raising evolves, melding customers and retail investors will become ever more integral.   

Despite what the Wall Street Journal and their academic, regulatory, and nonprofit allies believe, ordinary people should be able to risk their money on their favorite startup. Most of these companies will fail, some will be frauds. A few, however, will become giants. The frauds must be punished. But freedom means the ability to take the chance to get in early on the big one.

By Jossey PLLC

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