Crowdfunding: Critcisms and Defenses
With the recent discussion surrounding the JOBS Act and crowdfunding, we thought it was a good time to discuss some of the criticisms surrounding crowdfunding, as well as reasons why some of the criticism may be lacking legitimacy.
Loosening regulations opens the door to reckless investing and scam artists
Much of the criticism over the passing of the JOBS Act stems from the fear that loosening investment regulations is an invitation for get-rich-quick scam artists to take advantage of a larger pool of investors via the Internet. Economist Robert Reich argues that crowdfunding is just a means by which people whose net worth is less than $100,000 can “gamble away” up to 5 percent of their annual incomes. Another critic, Jack Hernstein, states that because of relaxing the rules on advertising, in combination with the crowdfunding elements, investors should be ready to be “bombarded” with all manner of offerings and pitches.
The opponents argue that passing the JOBS Act proves that we’ve learned nothing since our prior reckless financial “innovation” plunged the world into a massive recession. Instead of tightening the screws down on financial investing, we’re loosening them, effectively opening the door to reckless investing.
What are the Proponents saying?
Advocates of crowdfunding have a much different idea about the passage of the JOBS Act. Here are two of the major reasons why they are excited about crowdfunding and believe it is a viable investment strategy.
First, much has changed since the original securities regulations were written in the 1930s. It was much more difficult to investigate into whether or not an investment opportunity was actually a scam. Today there is a greater level of scrutiny, and a much more developed framework for analyzing investment opportunities. Needless to say, the Internet has given people the ability to get their hands on a wide range of information with just a click.
Second, the “wisdom of the crowd” will identify scam artists, while promoting those legitimate issuers who actually deserve support. Proponents argue that the easiest way to reduce risk of fraud is to keep the investment local, i.e. where you have social ties and relationships with individuals who have knowledge about the market. Proponents believe that social media and the collective intelligence of an investment community, e.g. a crowdfunding investment portal, will reduce the risk of fraud for investors. For example, “crowd expertise” can occur when a large enough number of investors comment about a company’s lack of marketability. This “crowd expertise” is regarded as legitimate investment information about that particular company or that particular market. Similar to Wikipedia, which is constantly updated by its large base of users, crowdfunding may become a viable investment strategy and source of investment information.
There’s another argument proponents believe deserves some attention: you can gamble away everything you own in a casino, but for those with less means, you can only lose $2,000 in crowdfunding. The limits placed on investing acts as a control on people’s ability to dump money into risky startup companies, or to scam artists as the opponents argue.
Proponents believe that, in the end, this democratizing financial innovation will deliver a benefit to our society. Finance is, for the most part, about controlling risk. Proponents argue that if we can disperse sophistication about risk management throughout society with greater effectiveness, it could reduce social inequality.
Let us know how you feel about the JOBS Act, specifically the crowdfunding elements of the Act, by commenting below.