Times are changing. The way businesses raise money may be set to change drastically after the Securities and Exchange Commission last week issued its proposed rules on crowdfunding.
What, before, was often set in motion amid the lush dÃ©cor of investment firms located in multistory buildings, may in the future be done with a computer and an Internet connection.
Crowdfunding, as the name suggests, is when a business or individual attempts to raise money from a large number of people, with most people contributing small amounts. The business connects with the crowd through a crowdfunding website. And after the business or individual presents its project objective, including things like what the money will go to, contributors choose whether or not to fund the project.
There is nothing new to this, however. Crowdfunding has been around for several years now. But here's where the government's proposed rules matter: Before, those contributing money were donors and could not expect a return on their contribution. So if a business wanted to fund a film about China, for instance, it could. But not with the expectation of receiving money back if the movie became a blockbuster.
Constraining the use of crowdfunding as a form of investing was largely the Securities Act of 1933. Under that law, companies offering an investment opportunity are required to register with the Securities and Exchange Commission unless an exemption is available.
Without an exemption, an issuer must not only register but also comply with a host of other federal securities laws, which can be complex and expensive to comply with. This all made crowdfunding, which involves raising relatively smaller amounts of money, cost-prohibitive.
Things began to change, however, when Congress passed, and President Obama signed, the Jumpstart Our Business Startups Act in 2012, referred to as the JOBS Act. The law envisioned an exemption to the registration requirements of the Securities Act for crowdfunding. The Securities and Exchange Commission, for its part, was mandated to come up with rules, which it did only last week.
Note that these are only proposed rules, which will not go into effect until after a required notice and comment period. Once finalized, however, businesses will be able to raise money from the general public, which inevitably raises issues related to Utah businesses, particularly, whether the crowdfunding exemption will fuel Utah's entrepreneurial spirit or instead fuel Utah's unfortunate track record with securities fraud.
Several years ago Utah was placed No. 5 nationally for generating fraudulent Ponzi schemes, with the FBI naming Utah as a "Ponzi hotspot" in 2010, after an analysis of investment fraud found that there were approximately "4,400 victims who had lost an estimated $1.4 billion to investment fraud."
Utah has also had an ugly history of affinity fraud. This is where a fraudster preys on a group of people who the fraudster shares a common bond with, which in Utah has often meant members of the LDS Church being defrauded.
Affinity fraud was bad enough that Utah, in 2011, became one of only two states to pass an amendment to its laws mandating higher criminal penalties when a person commits affinity fraud. Naturally, with crowdfunding on the horizon, some are asking if fraudsters won't now simply take to the Internet to do what before they did in church halls or by word-of-mouth.
Zaven A. Sargsian is a graduate of S.J. Quinney College of Law and an associate attorney at Shumway Van & Hansen's Salt Lake City office.