New Law on Crowd Financing Should Help Small Business Financing – And Also Help Stock Fraud Artists Make More Money

A Rare Win-Win in Financial Legislation for Investors and

Zero Mostel/Nathan Lane

The Congress has passed a reform of financial regulations that will allow small companies and start up companies to raise equity capital with far less of the disclosure requirements and investor protections associated with larger firms.  Generally this is a good idea and the provisions of the new law seem reasonable.

The JOBS Act would designate a new category of “emerging growth” companies that could conduct initial public offerings of stock while being exempt from certain financial disclosure and governance requirements for up to five years. It would also provide a new form of financing to small companies. Through crowd-funding, or the sale of small amounts of stock to many individuals, companies could solicit equity investments through the Internet or elsewhere, raising up to $1 million annually without being required to register the shares for public trading with the Securities and Exchange Commission.

Most importantly, small start up companies can get access to capital markets if they are not planning on raising a lot of money.

Companies seeking to raise $100,000 or less must also provide tax returns and a financial statement certified by a company principal; those raising up to $500,000 must provide financial statements that are reviewed by an independent public accountant.

The downside, of course, and there always is a downside in finance is this will open up a whole new market for stock fraud.  Thousands of people will start companies for the sole purpose of raising money, which they will pocket. A nice set of fake financials will convince investors that their money was lost in a good but flawed enterprise.

One might call this the ‘Producers’s model after the Mel Brooks film and play that illustrated how to do something like this in entertaining detail.

a few detractors worry that the measure will bring back the “boiler rooms” of the 1990s Internet stock bubble, where hucksters peddle stock tips to unwitting amateur investors. Pension funds, the lobby for older Americans AARP and the chairwoman of the securities commission had opposed aspects of the bill.

This commentator has difficulty generating sympathy for those who are swindled in financial schemes, usually finding that except in cases where the person was mentally incapacitated the victims are usually a victim of their own greed.  The good news here is that the amounts a person can lose is limited, and in many cases the victims will be intelligent and wealthy people who just did not do their homework. 

But the laws of economics cannot be over-ridden, and those laws say everything has a cost.  In this case the cost of providing easier access to capital for some companies will be the loss to investors from fraud and mis-representation.  There is just no way to avoid it.