(Reuters) - As lawmakers prepare to vote on legislation that would make it easier for small businesses to raise capital, state securities regulators are scrambling to have authority over a funding strategy they say can harm investors.
At issue is “crowdfunding,” a capital-raising strategy in which investors buy small stakes in ventures through various websites. Regulators say crowdfunding isn’t a major problem yet, but recent legislation aimed at helping small businesses and creating jobs could change that.
The possible unintended consequences of the Jumpstarting Our Business Startups Act, or JOBS Act, have state securities regulators fearing they will be powerless to prevent potentially fraudulent offerings.
State securities regulators want authority to review the crowdfunding offerings Congress wants to allow, before investors plunk down money. They say this would help to prevent scams by ensuring the offerings meet state regulatory requirements.
But a bipartisan bill that was passed by the U.S. House of Representatives last week would strip states of that authority. The U.S. Senate is taking up the issue, with a vote expected by the end of the month. Legislation introduced this week in the Senate that would amend the House bill also leaves state regulators without that oversight.
The battle highlights the tensions between web-savvy investors and entrepreneurs against a regulatory structure that critics say isn’t compatible with the Internet age.
“I wish the state regulators would just let it go,” said William Carleton, a Seattle-based lawyer who advises start-ups. “The idea that you can regulate crowdfunding in the old securities paradigm just doesn’t work,” said Carleton, who believes the process would be “suffocating” for budding entrepreneurs because of the legal complexities of regulation.
State regulators, however, are not buying that argument and are in the midst of developing model rules to regulate crowdfunding and push for last-minute changes to the JOBS Act. U.S. Securities and Exchange Commission Chairwoman Mary Schapiro also urged lawmakers to add investor protection improvements.
States were unexpectedly sucked into the debate on crowdfunding in October, when North Carolina Republican Representative Patrick McHenry introduced a bill aimed at helping small businesses raise capital in a challenging economy. One measure in the bill would let issuers sell securities through crowdfunding websites, such as those of Indiegogo, Kickstarter and Peerbackers. McHenry’s legislation eventually became part of the JOBS Act.
Neither the version of the bill that was passed by the House last week nor an amendment in the Senate would allow state regulators to require issuers to register crowdfunding offerings with them before soliciting investors’ funds.
That would curb investor protections, said Jack Herstein, president of the North American Securities Administrators Association, or NASAA, an organization of state securities regulators who review thousands of registrations for many of the securities sold in their states. At best, issuers would have to notify the SEC about offerings, and details would be passed along to state regulators.
But that solution is inadequate, Herstein contends. “We might not get the information until after the offering is already out there,” he said.
That could be dangerous to investors, especially as the current use of crowdfunding sites shifts, Herstein said. Currently, the sites are mainly used as fundraising vehicles for small projects, such as a simple invention or exhibit. Investors can donate as little as $10 and typically receive a small thank-you gift in exchange, not a return on equity.
But stakes for investors could be much higher in the future under the House version of the bill. For example, the bill allows issuers to use crowdfunding to raise up to $2 million, if they give audited financial statements to investors - and $1 million if they do not. Under recent Senate legislation, investors can sink up to $100,000 in an individual deal.
“I don’t think anyone has a problem with someone who wants to start a T-shirt shop and raise $25,000 in $25 chunks,” said Joseph Peiffer, a New Orleans-based lawyer who represents investors. “But this bill allows a lot more than that,” he said.
Those on the other side of the issue say the legislation will improve an unregulated system. Right now, “anyone can donate whatever amounts they want” without any promise of a financial benefit, said Sally Outlaw, president of Peerbackers, a crowdfunding site based in Jupiter, Florida. While small donations are common, investors occasionally give thousands of dollars to certain projects, she said.
As the battle unfolds, NASAA is developing a rule it says will balance investor protection with the need for web-based capital-raising strategies.
The rule would generally require issuers to file one offering notice in their home state, NASAA’s Herstein said. It would include details about the project, funds needed and information about officers and directors.
The model rule could be ready this spring, said Herstein. States would adopt it individually, which in most cases would take three to six months.
But that may not be fast enough for U.S. lawmakers, who are anxious to spur job creation efforts as the 2012 election nears.
Reporting By Suzanne Barlyn; Editing by Jennifer Merritt and Dan Grebler