Crowdfunding: Don't panic, don't pout

Last week, as part of the JOBS bill, the Senate passed legislation authorizing for-profit crowdfunding. The Senate language wisely added investor protection to the original version of a crowdfunding measure passed by the House. Now the House must vote on the Senate version. Cue howling in the blogosphere!

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One faction argues that the world is now materially less safe; that fraudsters will lurk behind the azaleas at every senior center, trying to convince grandma to invest in cold fusion. The other side wails that the Senate version fetters the free spirit of crowdfunding and that Congress has missed a chance to unleash the creative power of Internet 3.0 to match entrepreneurs with sources of capital.

As always, the truth is somewhere in the middle.

Websites like Kickstarter.com and Indiegogo.com already offer nonprofit crowdfunding for filmmakers, bands, artists and campaigns that need financing to make their projects a reality. In return for their money, investors are promised a credit in the program, or a t-shirt signed by the band. This do-good, feel-good system has gone along well enough because expectations of return on investment are minimal. But now that the flood gates of for-profit crowdfunding are about to open, we need some real regulations and honest brokers built into the system to make sure it works fairly for everyone.

The fact is, where there is money, there will be fraud. Those who argue that there isn't any fraud in crowdfunding are blinded by their love of the concept. In nonprofit crowdfunding, who cares if the band doesn't deliver the promised t-shirt?  And thus far, the amount of money raised in offshore for-profit crowdfunding venues is miniscule. Opening up crowdfunding in America is going to let the world finally see the potential for truly democratizing access to capital. But with that free-wheeling emerging market, an explosion of activity means lots of deals that will be too good to be true.

As a securities attorney for more than 30 years, I’ve worked for the SEC and for one of the largest law firms in the world, helping entrepreneurs access capital the US and in emerging markets like India, Brazil and Israel. And most recently, as General Counsel of the Congressional Oversight Panel on TARP, I have first-hand experience in forensic accounting and identifying fraudulent business practices. I know, and I hope crowdfunding advocates soon realize, it is imperative that Congress adopt reasonable measures to regulate the marketplace so both entrepreneurs and investors are protected against fraud.

The parameters for crowdfunding in the Senate version of the JOBS Act are somewhat constrained. This is a good thing. It will provide an early warning system to alert us if crowdfunding is going astray. People who are pouting across the Internet need to appreciate that if there is massive fraud at inception, the market will die forever. In the long term, it is better to accept restrictions now that can be loosened later. This is one genie you can't stuff back into a bottle, especially when he's accompanied by a couple dozen African princes who just need you to wire $6,000 so they can  develop their killer “Angry Anteaters” iPhone app. 

Conversely, I hope that the apprehensive opponents of crowdfunding appreciate that constraints are going to thoroughly regulate the market. My career has shown me that when the rules of play are clearly defined, and there are good referees ensuring fair play, the market will work.

Entrepreneurs and investors will both need safeguards to protect themselves and their investments, but crowdfunding is fundamentally an exciting development which will create a more collaborative form of capitalism. Crowdfunding will help the US retake its rightful place as the center of financial innovation in the same way that Silicon Valley has shown that the US is the global leader in technological innovation. I urge the House to adopt the Senate version of crowdfunding legislation as soon as possible so we can allow our markets to harness this creative capital.

Hanks is a corporate and securities attorney whose 30-year career is unique in terms of its geographic breadth and the variety of her professional experience. She recently stepped down as the General Counsel of the Congressional Oversight Panel of TARP and is launching CrowdCheck.biz, a tool for entrepreneurs and investors looking for transparent crowdfunding investments.