Before we discuss how crowdfunding may provide opportunities in boiler room enabling, it may be helpful to explain what a “boiler room” is by way of YouTube.
This classic film inspired a few others, including the more recent Wolf of Wall Street. Not all brokerage firms or New York investment banks operate in this manner. But where there is money to be made (i.e. stolen), people get greedy and grey area slips quickly to black. It’s one of the main reasons we have organizations like the SEC and FINRA.
In my conversations with people, I heard a naysayer attorney make the comment the other day:
[Equity] crowdfunding is nothing more than a mechanism for boiler room enabling.
If not properly implemented, he may be right. Which is likely the biggest reason Title III of the JOBS Act has been so slow to be implemented. The rules may seem overly stringent, but they’re there for a reason: for the protection of investors.
Here are some issues that may prove problematic and my person input on how we can work to ensure they don’t leave the same black-eye stain on crowdfunding as some of the reverse merger, pump-and-dump stock transactions perpetrated by the likes of some of Wall Street’s most nefarious.
General Solicitation. Despite it’s touted brilliance, general solicitation could present a major issue, especially once Title III is implemented. You bet organized groups of telemarketers, Twitterers, email spammers and other web promoters will not hold back when touting the next Oculus Rift opportunity on some equity crowdfunding portal. Plenty of clarity and divulging of financial information may not prove enough for some of these deals, but I personally find it less likely
Limitations on Investment. Australia, the United Kingdom and all the interstate crowdfunding folks have restrictions on the amount unsophisticated investors are able to invest in a single deal in a year, tracked directly with investors’ annual income. This is likely one of the most effective ways to ensure non-accredited folks are unable to blow their entire wad on some ill-conceived and fraudulent equity crowdfund campaign.
Diversification & Risk. Brokers will often sell large blocks of a single stock on a company with some promising idea or technology. Crowdfunding is no different. Without the ability to truly pool one’s investments through a crowdfunding fund of funds (do you like how many times I said “fund” there?), the risk piles on. But, that’s what the people want. “Why can’t normal people get access to venture capital and private equity deals?” If they want in, they too will need to understand the high risks that most of these deals represent. Sometimes euphoria replaces education and when the bottom comes out, so do the knives. Liquidity in crowdfund investing is what we assist in. It helps to at least solve some of the capital lock-in problem, particularly when investors are overly exposed to a single stock.
The self-filter of the crowd has also proven to be pretty amazing. If you take a look at the companies that have actually received widespread acceptance and their own “tipping point” through the funding, they generally have some of the same characteristics. Most of the characteristics boil down to legitimacy. The campaign, team and plans are doable based on the facts given. The crowd doesn’t back them otherwise. If they do and fail, the founders are crucified and will likely be blacklisted. This effective self-filter is likely to transition to equity-based crowdfunding portals once they’re full implemented as well. Personally, I think this may be one of the best and most effective mechanisms, unless of course the boiler rooms help to take the campaign to its tipping point.
In the shared video above, they’re targeting doctors. I expect the typical Title III non-accredited equity crowdfund campaign will look less like a private equity deal and more like a mobile app or gaming company with a large swath of unsophisticated people that love gaming and are willing to bet some money on such and such next big app. Maybe I’m looking at it too much like Kickstarter, but there will be some fall-out and likely more laws that will help to protect both investors from getting burned and the entrepreneurs from going to jail. The latter will indeed need to be abreast of the changes to ensure they’re staying above board.
My personal take here is that there will always remain a large amount of risk, but the regulations set forth in the JOBS Act help to clarify and protect investors from themselves. In addition, we just have to look to some of our neighbors (Australia, UK, etc.) and now some of the states to understand what’s been working and what hasn’t and how we can avoid the stigma that equity crowdfunding will be an enabling tool for boiler rooms.