June 26, 2012
As a Board member of CfIRA (the Crowdfunding Intermediary Regulatory Advocates), I am involved daily in matters related to the Act. However, my comments here represent my views and not necessarily those of my counterparts.
RE: Fraud Deterrence and Detection
There is much discussion about fraud detection, but "deterrence" should not be overlooked. Relatively simple things can be required, which effectively discourage a very large part of potential fraud.
Things which I believe should be required of portals by regulation:
1. Issuers should be charged a recurring fee for posting their PPM on a portal (e.g. $25/month), payable only by credit card. This nominal fee discourages casual (potentially fraudulent) issuers from posting. It also discourages false posters since the portal now has their real name and address, as verified by the credit card bank. And since it's a recurring fee it becomes highly unlikely that a stolen credit card can be used.
2. Portals should display to potential investors not just the "SEC enforcement history background check" of an issuers officers and directors, but also the results of criminal and civil background checks, as well as FICO scores. Disqualifying events (e.g. a felony conviction) should automatically prevent an offering from being publicly posted, but other events, while not triggering an automatic disqualification (e.g. civil litigation, bankruptcies, misdemeanor convictions, etc) are still important to disclose to prospective investors.
3. No issuer posting a PPM on a portal should be a sole-proprietorship. They must be duly organized entities in the USA. This provides portals and investors with easier due diligence (state databases) and the cost of incorporating, while small, is a deterrence to casual posters (who may be fraudulent). So while an unincorporated business may start crafting their PPM, they may not publicly display it until after they are properly organized.
4. Funds from a successful offering should only be sent via wire or ACH, and only to a business account, exactly in the name of the issuer as displayed on the PPM, and only to a bank in the USA.
5. Portals must prevent issuers from removing negative comments and ratings from their online offering. However portals should be able to remove abusive postings via their admin tools.
6. Post close, portals must not allow any changes to a PPM. Nor may a PPM be deleted or taken offline, as it is now a matter of public record.
7. Any changes to a PPM during the course of an offering must reset all committed investors to a "pending" status. Investors must review the updates and, if they still wish to participate in the offering, reconfirm their participation.
8. Investors who have committed but not yet remitted funds should be clearly notated on the online PPM. This prevents potential fraud of people making fictitious investments in order to create an aura of movement or popularity.
9. Although due diligence required by portals is minimal, and issuers are directly responsible for the disclosures they make, all online PPM's should be reviewed by a properly qualified securities representative prior to the offering being published and displayed to the public.
10. Portals should be required to maintain net-capital at least equivalent to broker-dealers who handle customer funds.
None of these things require much cost. Nor do they prevent the scalability of crowdfunding. And they do not discourage small businesses from seeking even tiny amounts they need to grow (e.g. a bakery or auto-repair shop seeking $10,000 for new equipment).
These things can be done in an efficient manner that is cost and technology practical, while at the same time serving the needs of deterring and detecting potential fraud.
I am available anytime to discuss and provide examples of how these things can be implemented into a portal's online system.