The Shady Spam Crowdfunding Could Unleash

One of the first objections that’s commonly raised in response to proposals to legalize crowdfunding – small investments by anyone into private companies – is the potential for fraud. The common response to this (which I buy) is that companies like eBay have proven pretty good at eliminating fraud in other contexts, and similar platforms will emerge to do so for crowdfunding.

In fact, the crowdfunding proposals before the Senate require such an “intermediary” to manage transactions. But the bill that passed the House at the end of last year doesn’t, and that could be a problem. Tim Rowe, CEO of the Cambridge Innovation Center and a major crowdfunding proponent, wrote in a recent post at AllThingsD that lack of such a provision isn’t necessarily:

The House version allows start-ups to do this without an intermediary, but that’s not going to happen in practice (it would be like trying to sell your item on the Web without eBay).

As I and others pointed out in the comments, selling your item online without eBay exists. It’s called Craigslist.

Meanwhile, a must read piece yesterday at Reuters on shadiness in the secondary market for private stock gives us reason to believe that fraud, or at the very least bad behavior, could be possible without an intermediary.

Reuters reports on companies that facilitate the resale of private stock, sometimes with questionable marketing tactics. As Reuters notes, “For now, SEC rules clearly prohibit general solicitation for private stock sales, though not all-purpose introductions.”

And companies like Felix Investments and Advanced Equity seem to be toeing that line, to put it mildly. Here’s an example:

The voicemail from Felix Investments broker Jared Carmel sounded like a typical cold-call from an aggressive stock salesman.

“What’s interesting is some of the access to opportunity that we have, i.e. companies like Groupon, Facebook, we had LinkedIn before the IPO, things of that nature,” Carmel told a prospect he had never met, according to court documents.

“So if you have a moment or two, if you could give me a buzz, I’d love to touch base.”

The company also sends mass emails with headlines like “Facebook Due Diligence Report Presented by Felix Investments,” which it claims do not violate SEC rules because they’re based on public information.

Right now, the targets of these solicitations are the rich, as SEC rules restrict investment in private stock to “accredited investors” who must have $200,000 in annual income or a net worth of over $1 million.

But if crowdfunding becomes legal without the requirement of an intermediary, what’s to stop such solicitations from hitting all of our inboxes? If companies are already spamming potential investors to buy private stock, you can bet they’ll do the same for even less sophisticated investors if crowdfunding becomes legal.

That the House bill caps investment at $10,000 or 10% of income is little comfort as that’s still a lot of money to lose for plenty of people.

None of this is an argument against crowdfunding; it’s an argument for doing it right by requiring an intermediary as the Senate bills wisely do. Rowe noted in the comments at AllThingsD that he expects the intermediary provision to be included in the final bill. Let’s hope so.

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