Thomas Lee Hazen at UNC Chapel Hill recently published a draft paper entitled "Crowdfunding, Social Networks, and the Securities Laws – The Inadvisability of a Specially Tailored Exemption Without Imposing Affirmative Disclosure Requirements." You can check it out below or at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1954040
Hazen is critical of recent crowdfunding exemption proposals because they dramatically reduce disclosure requirements. After citing several, he asks, "If the exemption is conditioned on limiting amounts from each investor, who monitor[s] investors’ claims that they meet the exemption’s qualifications?" He repeats the question later:
If, as the proposals suggest, the limited dollar exposure of each investor is a precondition of the exemption, who will monitor this? Will crowdfunding operations have to do their due diligence to assure than investors in fact qualify? If not, what is to prevent an investor from making multiple investments that are not in compliance with the exemption’s limitations?
I can't pretend to be a lawyer, but as an former software engineer, Hazen's question strikes me as akin to asking a retail bank, "If you limit the daily amount that I can withdraw from an ATM, what prevents me from going to an ATM multiple times and withdrawing more than the limit allows?" The answer, I would assert, is a simple software check designed to prevent disallowed transactions. Such a check might fail in the instance of an eager investor with multiple identities and SSNs, each having their own bank accounts-- but such an individual would be in violation of federal law already.
Hazen also suggests that "limiting investments to small amounts from each investor does little if anything to provide meaningful investor protection without either sophistication or disclosure requirements." He later elaborates:
Why does a small amount of money from many investors present less of an investor protection threat than more significant amounts of money from fewer investors? While the argument that the limited risk exposure per investor warrants less regulation may have some surface appeal, a deeper analysis does not support this as the primary basis for a specially tailored exemption.
In my reading of Hazen's article, this assertion seems unsupported. Consider an individual investment cap of $10, for example, or $0.01. If Hazen concludes that the possibility of losing $0.01 does not present "less of an investor protection threat" than the possibility of losing $10,000, I would like to see more of his deep analysis.
Having said that, Hazen's heart is clearly in the right place, and he brings up a point that did change my opinion, which I appreciate. In a footnote citing some of his earlier work on gambling, he points out:
It has been suggested that people who cannot afford the risk are lured to gambling as a chance to hit it big in order to exit from their dire economic circumstances.
To me, this suggestion evokes the scenario of a big-hearted soul with little money but ample trust and optimism, who might come to ruin by repeatedly investing in ill-conceived (or fraudulent) schemes presented by various members of his or her community. That's bad. To mitigate this, I think there should be a cap not just on individual investment in a crowdfunded offering, but also a cap on an individual investor's total annual investment in exempted crowdfunded securities, perhaps three or four times the individual investment cap. What do you think?
I do agree with Hazen that transparency and disclosure are important for any investment offering, no matter how limited. I just believe that the specific requirements for such can be lighter (as they are in H.R.2930 and S.1791) if only small-dollar investments are allowed, and that open communication will foster transparency and disclosure where it is most needed.