Crowdfunding bill would expose investors to swindles(baltimoresun.com)
baltimoresun.com
Crowdfunding bill would expose investors to swindles
http://www.baltimoresun.com/business/money/bs-bz-hancock-crowdfunding-danger-20111112,0,1311905.column
8 comments
It doesn't even address the main risk of the bill, which is that grandma isn't going to get swindled, she's just going to get sold an investment product with hugely negative capital returns about 90% of the time when executed correctly by talented, honest individuals.
I mean, that has to be the debate, right? Do we allow small, private investors access to investments with a bimodal distribution of outcomes, and if so what amount of regulatory overhead do we impose? With the understanding that every additional quanta of regulatory overhead a) kills some would-be companies at the margin and b) makes some deals inaccessible to small private investors at the margin.
I mean, that has to be the debate, right? Do we allow small, private investors access to investments with a bimodal distribution of outcomes, and if so what amount of regulatory overhead do we impose? With the understanding that every additional quanta of regulatory overhead a) kills some would-be companies at the margin and b) makes some deals inaccessible to small private investors at the margin.
I would accept regulation protecting naive people against bad bets if we didn't have state-sponsored lotteries. No investment is going to be riskier than the Pick-6.
How many middle-class retirees lose their life's savings to the Pick-6?
I'd bet not many, but I suspect there's a fair number of people who never amass a life's savings because of it.
A quick back-of-envelope calculation shows my mom having spent at least 100 grand on lottery tickets (and that's just 20 years of playing), and she's still basically living paycheck to paycheck.
A quick back-of-envelope calculation shows my mom having spent at least 100 grand on lottery tickets (and that's just 20 years of playing), and she's still basically living paycheck to paycheck.
That is easy, all we have to do is to sell collections of stock from, say, fifty, start ups.
How much would it be worth it to buy a share of YC S12?
How much would it be worth it to buy a share of YC S12?
Think about the phrase "do we allow". I ask, what right do "you" have to stop me from investing my money wherever I like?
I could go to a casino and blow $20,000 in a weekend. You're telling me that I can't put it into a startup that takes 2 years to fail? Hell, even if I know its going to fail, getting a board seat there and doing my darndest to help it not fail might be worth $20k for me. Or, say its my best friend from high school, whose always had this crazy idea, he's been plugging away for a decade at it, and he wants to make it happen... I believe in him and want to put up my $50k, $500k, $1M, $5M, whatever. We both know that its a longshot, but if it works, its worth $5B. Who are "you" to say that I can't spend my money that way?
The fundamental problem is not risk. Its this idea that government gets to decide who gets to invest.
They don't do this to protect people from risk, but to keep small investors out of these types of investment. All of this kind of regulation is not to protect people-- that's just the pitch. "won't anyone think about the children?"
Like all regulation the real purpose of this is to protect the larger entities-- the Venture Capital firms and the angels, from competition. And of course, politicians get money by threatening to change the regulations-- I'm sure this crowd funding bill has already raised a great deal of funds for the politicians who are using its passage as a threat against those who would lose the protection from competition.
Imagine if I could be an angel!
I have enough from a previous exit to have put small amounts-- YC level seed funding-- into 10-20 startups. Assuming one of them was successful, I'd have a sustainable seed fund there.
But I'm not able to be accredited given the way the law is written, and I know there are a lot of other people in my position.
Also, for what its worth, I am able to deal with extremely risky investments-- Well out of the money stock option spreads where the upside is %500 and the downside is a %100 loss. I've done this for years, and have consistently made money at it. I'm pretty sure picking startups would be easier, but even if I'm wrong....
Isn't it MY money to risk?
(not attacking you, just using your choice of phrase as a springboard-- people think this is something legitimate to regulate, but it is not. There are casinos across the country. This regulation is nonsense, and its immoral. Who is the government to tell me how I can spend my money? By what right?)
I could go to a casino and blow $20,000 in a weekend. You're telling me that I can't put it into a startup that takes 2 years to fail? Hell, even if I know its going to fail, getting a board seat there and doing my darndest to help it not fail might be worth $20k for me. Or, say its my best friend from high school, whose always had this crazy idea, he's been plugging away for a decade at it, and he wants to make it happen... I believe in him and want to put up my $50k, $500k, $1M, $5M, whatever. We both know that its a longshot, but if it works, its worth $5B. Who are "you" to say that I can't spend my money that way?
The fundamental problem is not risk. Its this idea that government gets to decide who gets to invest.
They don't do this to protect people from risk, but to keep small investors out of these types of investment. All of this kind of regulation is not to protect people-- that's just the pitch. "won't anyone think about the children?"
Like all regulation the real purpose of this is to protect the larger entities-- the Venture Capital firms and the angels, from competition. And of course, politicians get money by threatening to change the regulations-- I'm sure this crowd funding bill has already raised a great deal of funds for the politicians who are using its passage as a threat against those who would lose the protection from competition.
Imagine if I could be an angel!
I have enough from a previous exit to have put small amounts-- YC level seed funding-- into 10-20 startups. Assuming one of them was successful, I'd have a sustainable seed fund there.
But I'm not able to be accredited given the way the law is written, and I know there are a lot of other people in my position.
Also, for what its worth, I am able to deal with extremely risky investments-- Well out of the money stock option spreads where the upside is %500 and the downside is a %100 loss. I've done this for years, and have consistently made money at it. I'm pretty sure picking startups would be easier, but even if I'm wrong....
Isn't it MY money to risk?
(not attacking you, just using your choice of phrase as a springboard-- people think this is something legitimate to regulate, but it is not. There are casinos across the country. This regulation is nonsense, and its immoral. Who is the government to tell me how I can spend my money? By what right?)
The Las Vegas example is the one I use also. I could get on a plane, go to Vegas, spend every last penny I have, borrow all I could and spend it, and what happens? Nothing. People might tell me how stupid I was. Yet if I do the same thing with startups, somehow I've been swindled and the public has an interest in protecting me.
Huh? So how about if I created a roulette game where you spin a wheel and one time out of 50 you get in on a hot startup. The other times you lose your money. Would that be acceptable?
I read the article, desperately trying to find something redemptive. I think the key statement is here:
..."The idea that a company could do this with no oversight is frightening because there are plenty of people out there who are willing to separate investors from their money," says Melanie Senter Lubin, Maryland's securities commissioner. "We are concerned about anything where investors have the potential of losing money or where they're making an investment without the information they need to make an informed investment decision."...
So you put a up big huge disclaimer that says you have an extremely small chance of ever seeing your money again.
I think that pretty much covers it, doesn't it? How much more informed do we have to be to spend our own money?
Huh? So how about if I created a roulette game where you spin a wheel and one time out of 50 you get in on a hot startup. The other times you lose your money. Would that be acceptable?
I read the article, desperately trying to find something redemptive. I think the key statement is here:
..."The idea that a company could do this with no oversight is frightening because there are plenty of people out there who are willing to separate investors from their money," says Melanie Senter Lubin, Maryland's securities commissioner. "We are concerned about anything where investors have the potential of losing money or where they're making an investment without the information they need to make an informed investment decision."...
So you put a up big huge disclaimer that says you have an extremely small chance of ever seeing your money again.
I think that pretty much covers it, doesn't it? How much more informed do we have to be to spend our own money?
Many nonqualified investors don't understand bimodal probability distributions very well. They probably understand the risk of 'investing' their money at Las Vegas, and don't understand the similarity of this to angel investing.
Politicians have a vested interest in avoiding large blocks of unhappy voters, and vote to optimize their lives, not yours.
Politicians have a vested interest in avoiding large blocks of unhappy voters, and vote to optimize their lives, not yours.
I am more or less in agreement with you. However, (and although IANAL) I think it worth pointing out that your "best friend from high school" investment is probably fine under rule 505 of regulation D: http://www.sec.gov/answers/rule505.htm
The rules don't generally prohibit per se certain investments from taking place. They require companies that take such investments (e.g. from unaccredited, unsophisticated investors) or that solicit investment from the general populace (i.e. not your best friend from high school), to comply with the regulations pertaining to publicly traded companies.
The rules don't generally prohibit per se certain investments from taking place. They require companies that take such investments (e.g. from unaccredited, unsophisticated investors) or that solicit investment from the general populace (i.e. not your best friend from high school), to comply with the regulations pertaining to publicly traded companies.
Look, I agree with you in terms of most of this. However, if there is anything we can learn, it is that eventually the majority will impose their will if they feel ills are being perpetrated. Right now the best thing is to work with the legislators to put in some regulation around education and transparency rather. Otherwise the potential for this type of thing to eclipse Nigerian letter scams could kill the idea altogether, which nobody wants. So it needs to be steered away from sophisticated investor type rules just towards a standard pack of the sort you have to sign off on if you're going to undertake options trading.
Same here. This article just got my blood boiling. Oh the poor investors! Like they're 5 years old... Rule #1 of humanity, Treat people like they're stupid and they will act stupid. This has been proven in traffic and street sign design.
It seems like there are only 2 sides to this argument. The "leave it all alone and let people learn the hard way" (which has been shown to collapse economies, create bubbles, and get manipulative corrupt / stupid tyrants into office) and "regulate everything to down the subatomic level" (which stagnates human progress and creates a society comfortable and stupid enough to drink anything that doesn't have a warning label on it).
I lost money in Bitcoin and it was MY fault, not the government's. I'm glad I had the opportunity and freedom to make that mistake. Rather than keep people safe from risk we should allow risk but FORCE warnings. When you explicitly tell grandma and grandpa that 93% of startups go out of business in their __ year and the company they're investing in can go belly up and leave their pockets empty at any moment, you've done your job. If they still invest their ENTIRE retirement into a YouTube clone there's nothing you can really do for them. It's sad but it's reality.
People already rack up $3,000 of credit card debt, $100,000 of student loans. Call it the Financial Darwin Awards. What can you do? What should you do? Personally I believe in a "Educate Against but Allow" philosophy. Humanity must be allowed to make mistakes, it is the universal way to learn and grow. The same way we MUST be exposed to bacteria and viruses otherwise our immune systems go to shit. (Google: "washing your hands too much")
Anyway, if these "hand holding legislators" put as much effort into fixing the country's broken and inadequate drivers license tests as much as they try to prevent anyone from taking a financial risk, 40,000 people in the USA wouldn't die every year from auto related accidents. I wish they'd over-regulate something that needed it.
It seems like there are only 2 sides to this argument. The "leave it all alone and let people learn the hard way" (which has been shown to collapse economies, create bubbles, and get manipulative corrupt / stupid tyrants into office) and "regulate everything to down the subatomic level" (which stagnates human progress and creates a society comfortable and stupid enough to drink anything that doesn't have a warning label on it).
I lost money in Bitcoin and it was MY fault, not the government's. I'm glad I had the opportunity and freedom to make that mistake. Rather than keep people safe from risk we should allow risk but FORCE warnings. When you explicitly tell grandma and grandpa that 93% of startups go out of business in their __ year and the company they're investing in can go belly up and leave their pockets empty at any moment, you've done your job. If they still invest their ENTIRE retirement into a YouTube clone there's nothing you can really do for them. It's sad but it's reality.
People already rack up $3,000 of credit card debt, $100,000 of student loans. Call it the Financial Darwin Awards. What can you do? What should you do? Personally I believe in a "Educate Against but Allow" philosophy. Humanity must be allowed to make mistakes, it is the universal way to learn and grow. The same way we MUST be exposed to bacteria and viruses otherwise our immune systems go to shit. (Google: "washing your hands too much")
Anyway, if these "hand holding legislators" put as much effort into fixing the country's broken and inadequate drivers license tests as much as they try to prevent anyone from taking a financial risk, 40,000 people in the USA wouldn't die every year from auto related accidents. I wish they'd over-regulate something that needed it.
While I strongly support the crowdfunding bill, I do get nervous about the argument that says "regulations should not protect people from the risks of their own decisions." Because as we well know, people are not perfect (or even good) reasoners; and in particular, investments are a case where, absent regulation, there is one set of people with a huge financial incentive to deceive a second set of people by any means necessary. And in such cases I think one has to be careful about "allowing" the second set of people to act freely on the bad information the incentives will ensure they receive.
"Because as we well know, people are not perfect (or even good) reasoners"
People are capable of reason. Whether or not they actually apply reason in their own lives is a matter of choice.
People are capable of reason. Whether or not they actually apply reason in their own lives is a matter of choice.
If you read the work of Eliezer, to whom I was replying, you will find that a large portion of it is dedicated to dispelling the myth that people are good at reasoning.
Not to mention that it would make people smarter/more savvy - although of course, having them "protected" from this kind of stuff gives the politicians control over them, which is hard to let go of.
Everyone here seems to reject the argument outright. I agree we need crowdsourcing, but it needs to be done right.
Crowdfunding was once legal, this led to all sorts of scams and lots of elderly losing their retirements.
This is what led to the current SEC requirements of 1+M net worth accreditation and the 499 max investors cap.
It's definitely possible to do, BUT IT IS HARD. Here are some ways YOU as the entrepreneur could be in trouble:
* Think of the nightmare of having 1000+ investors in your startup.
* Every unhappy investor is a potential liability. Now think of one of those investors loving your idea, pouring his life savings (Say 200K) then filing a suit in case the startup fails.
* Investing is not a simple "here's $20,000K give me whatever that's worth in stock". The shares can be voting/nonvoting, privileged non/privileged etc. Will there be protection attached?
* Your horrible idea could be funded. Think of startup ideas your uncle Vinny gives you, now imagine him investing in them. Smart investors shred bad ideas in minutes.
* You miss out, on a lot. A startup doesn't just need money, it needs well connected investors. For example, see why Asana still needs investors even though Dustin is a billionaire: http://www.quora.com/Asana/Why-would-Dustin-Moskovitz-need-i...
There'a a reason the SEC was created. And the other side of the argument needs to be heard and addressed, not dismissed outright.
It's definitely possible to do, BUT IT IS HARD. Here are some ways YOU as the entrepreneur could be in trouble:
* Think of the nightmare of having 1000+ investors in your startup.
* Every unhappy investor is a potential liability. Now think of one of those investors loving your idea, pouring his life savings (Say 200K) then filing a suit in case the startup fails.
* Investing is not a simple "here's $20,000K give me whatever that's worth in stock". The shares can be voting/nonvoting, privileged non/privileged etc. Will there be protection attached?
* Your horrible idea could be funded. Think of startup ideas your uncle Vinny gives you, now imagine him investing in them. Smart investors shred bad ideas in minutes.
* You miss out, on a lot. A startup doesn't just need money, it needs well connected investors. For example, see why Asana still needs investors even though Dustin is a billionaire: http://www.quora.com/Asana/Why-would-Dustin-Moskovitz-need-i...
There'a a reason the SEC was created. And the other side of the argument needs to be heard and addressed, not dismissed outright.
says Melanie Senter Lubin, Maryland's securities commissioner. "We are concerned about anything where investors have the potential of losing money or where they're making an investment without the information they need to make an informed investment decision."
One of us hasn't understood what an investment is, and I think it's her not me.
One of us hasn't understood what an investment is, and I think it's her not me.
Lubin may also want to investigate another rigged scheme swindling Maryland residents, for which there are no income requirements or limits on amounts-at-risk. In fact, a defenseless Marylander could lose his entire life savings, and then even more by maxing his credit cards, with absolutely no legal recourse. The URL for this scam is:
http://mdlottery.com/
http://mdlottery.com/
"Maryland's securities commissioner"
I think this is someone who understands quite well where her bread is buttered.
Heaven forbid people fall out of her control.
I think this is someone who understands quite well where her bread is buttered.
Heaven forbid people fall out of her control.
You're deliberately and hyperbolically misreading her statement. She isn't "concerned" about the concept of risk; she is saying, "we are paying extra attention to vehicles where there is significant risk of normal people losing significant money".
Yeah sorry, I'm a huge fan of hyperbole. And while I was using that, my point wasn't really to suggest that she doesn't understand what an investment is, more that her statement made no sense.
Well yes, if you don't use your head.
Falling for these kind of swindles have always been possible and as an investor you can, and should, ask for whatever information you feel you need. The fact that there is no longer an official requirement for what to show doesn't mean that it isn't still fraud to show something that is false (so even if the books haven't been audited if they contain false information, they still go to jail). It can still happen to you today, the guys just have to fake the audit as well.
On the other hand, how much information do you really require to invest in bingocardcreator.com or bobs burgers?
Falling for these kind of swindles have always been possible and as an investor you can, and should, ask for whatever information you feel you need. The fact that there is no longer an official requirement for what to show doesn't mean that it isn't still fraud to show something that is false (so even if the books haven't been audited if they contain false information, they still go to jail). It can still happen to you today, the guys just have to fake the audit as well.
On the other hand, how much information do you really require to invest in bingocardcreator.com or bobs burgers?
Indeed, there are no shortage of swindles out there, according to the most recent review of my Spam folder. There is already an appreciable amount of awareness out there of what are probably scams. Besides, there are already de-facto, and generally arbitrary, limitations imposed presently by popular crowd-funding services, e.g. Kickstarter. Kickstarter in particular seems to turn down applications it considers too entrepreneurial, and they do so inconsistently.
Perhaps this bill, albeit adjusted with some sensible yet minimal regulatory scheme, would permit crowd-funding schemes otherwise impossible. It could at least help encourage consistency in how crowd-funding could be (or not be) regulated.
Perhaps this bill, albeit adjusted with some sensible yet minimal regulatory scheme, would permit crowd-funding schemes otherwise impossible. It could at least help encourage consistency in how crowd-funding could be (or not be) regulated.
As opposed to Goldman Sachs, which would never expose investors to swindles? Give me a break. The powers that be oppose crowdfunding because the financial industry jealously defends their legal barriers to competition, not because they're looking out for the common man.
The solution to solving the "swindles" problem will be reputation. With the internet it's possible to record an incredible level of detail regarding the reputation of people seeking investments and the business they are building (if it already exists).
If swindling becomes a problem, you can be sure that the market will work to provide a solution to that problem.
If swindling becomes a problem, you can be sure that the market will work to provide a solution to that problem.
I'd like to think so, and it certainly would be nice if it turned out that way, but it's not entirely clear to me that that's inevitable.
A difference between investments of this kind and ordinary purchase transactions is that in the latter situation, the business selling the product expects to have repeat business. That is, there's a cycle wherein the business can sell a product, and the purchaser's reaction to the product can propagate through the market to influence subsequent transactions.
In the case of an investment like this, however, the good being purchased, which is a future return, may not even be expected to be produced for years after the transaction occurs. There's no chance for the information cycle to work; all the investment occurs up front. A swindler may not even need to establish a positive reputation to attract investment; a good story would likely suffice. Indeed, that's the whole point, isn't it?
I like the idea, but I think the per-person limits should be reduced by a factor of 10, maybe even 100. That won't lock swindlers out, but it will force them to work quite a bit harder.
A difference between investments of this kind and ordinary purchase transactions is that in the latter situation, the business selling the product expects to have repeat business. That is, there's a cycle wherein the business can sell a product, and the purchaser's reaction to the product can propagate through the market to influence subsequent transactions.
In the case of an investment like this, however, the good being purchased, which is a future return, may not even be expected to be produced for years after the transaction occurs. There's no chance for the information cycle to work; all the investment occurs up front. A swindler may not even need to establish a positive reputation to attract investment; a good story would likely suffice. Indeed, that's the whole point, isn't it?
I like the idea, but I think the per-person limits should be reduced by a factor of 10, maybe even 100. That won't lock swindlers out, but it will force them to work quite a bit harder.
OTOH, a person who gets relieved of $100 is not going to ask too many questions about how it happened, encouraging the "entrepreneur" to try again. Someone who lost $10,000 might lawyer up.
It's also possible to convincingly falsify that information, and appear to be reliable to uninformed investors.
The market will provide a way to find only reliable investments, but it will also provide many ways for swindlers to find their marks.
I think a lot of people are going to have really great ideas funded that would otherwise be impossible, and a lot of people are going to be cheated out of their money. Unregulated crowdfunding is more of a gamble than an investment.
The market will provide a way to find only reliable investments, but it will also provide many ways for swindlers to find their marks.
I think a lot of people are going to have really great ideas funded that would otherwise be impossible, and a lot of people are going to be cheated out of their money. Unregulated crowdfunding is more of a gamble than an investment.
It will be argued that reputation is a way of keeping down the innovative little guy who is most in need of funding.
Also, any reputation service will be opt-in, so we can imagine that cons will just move elsewhere. Also, intermediaries may have a vested interest in remaining ignorant of scams.
Also, any reputation service will be opt-in, so we can imagine that cons will just move elsewhere. Also, intermediaries may have a vested interest in remaining ignorant of scams.
I think the cons run the reputation system. Its just gambling anyway. If it wasn't, there wouldn't be any risk. So how can you tell the difference between a "genuine" reputation system, and one that has been gamed by con-men? I don't think the sample size will be big enough to distinguish between cons and legitimate failures.
Yeah because Enron and Worldcom were small ripples in an ocean.
Edit: Also financial crisis.
Edit: Also financial crisis.
and coming from startup mecca of baltimore.. oh wait.
YES, if you make investing possible, some investors may get exposed to swindles! Deal with it! It's worth it for investing to be possible!