Tuesday, November 22, 2011

Congress Considering Allowing On Line Sales and Solicitation of Equity Funding for Start Up Companies

Some are Worried About Fraud – They Shouldn’t Be

In the aftermath of the Great Depression of the 1930’s Congress passed stringent laws that regulate how companies can go about the business of selling stock.  In order to sell stock to the public the companies must engage in full and complete disclosure (no this doesn’t mean they actually do this, just that they are required to do so.)  Also if the sale is being conducted by a third party that party must be a registered broker/dealer and be licensed and subject to the rules and regulations involving broker/dealers.

Now some want to allow an exception that will allow start up companies to raise money over the Internet.

Associated Press
Fargo Beer raised $41,000. Above, founders
John Anderson, Jared Hardy, Aaron Hill
and Chris Anderson.
And Let's Hope They Don't Drink the Profits.

At least 100 supporters of a so-called "start-up exemption" to allow equity crowd-funding by sites such as ProFounder are planning to rally on the sidewalks near SEC headquarters in Washington on Thursday.

Two weeks ago, the House approved a bill that would let companies sell up to $2 million in equity online, with investors buying stakes of up to $10,000 year, or 10% of their annual income, whichever is less.

The concern of course is that this will open the door to major fraud by shell companies whose only purpose is to take money raised from the Internet and pocket it. 

Because the proposals call for an overhaul of federal securities laws, and pre-emption of state laws as well, some critics believe they may increase the chance that unsophisticated investors will get scammed by people who aren't really starting new businesses. Some also point out that the impersonal nature of the Internet should call for more investor protections, rather than less.

"The potential for fraud in this area is real and potentially enormous," Jack Herstein, president of the North American Securities Administrators Association, a trade group of state regulators, warned in a letter to members of Congress last month.

These fears should not stop Congress from approving limited Internet funding of business without being subject to regulatory control for the simple reason that anyone investing in a business solely on the basis of its pitch on the Internet deserves to lose his or her money. 

The Dismal Political Economist is a strong believer in financial regulation, but knows the limits of such.  In some cases the level of stupidity is so great that even regulation cannot prevent the greedy and the stupid from losing their money in an investment, and people who invest over the Internet have shown they have reached that level of stupidity.  Our message to them, "Good luck folks, you're on your own."

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