By Andres J. Trujillo, CrowdFund Beat Guest Contributor,
Prior to the enactment of the JOBS Act (“the Act”) in April of 2013, income and wealth have been a proxy for investor “sophistication” under U.S securities laws. This assumption produces a rather odd result: regardless of an individual’s actual level of sophistication or knowledge in a particular investment class, they have been deemed “sophisticated” to invest in otherwise risky and restricted alternative investments.
The JOBS Act and its various titles amended certain U.S securities laws for the first time in 80 years, not only lifting the ban on general solicitation of accredited investors under Title II, but also opening the private investment markets up to “unaccredited” or “unsophisticated” investors. Many dissenters of the “Crowdfunding Act” (Title III of the Jobs Act) claim this loosening of regulation will create much trouble for unaccredited investors by subjecting them to fraud and risky investment opportunities that are not suitable for them financially.
I believe the JOBS Act has potential to produce the antithetical result—unaccredited investors could in fact become more knowledgeable, on average, than many investors who qualify as accredited or sophisticated investors based on wealth or income.
Education by Law—Throughout its various titles, the Act requires affirmative disclosures and investor education materials to be distributed and reviewed by investors in the unaccredited class. Moreover, many platforms in the equity based crowdfunding space have made diligent efforts to provide investors with educational materials regarding the types of securities listed on their platform. These materials are not only disclosure-type materials but also strategy-type materials, allowing for a deeper understanding of both the individual investment opportunities and the investment class. I predict that active investors on these platforms will have an opportunity to—and could in fact become—more “sophisticated” than many investors deemed accredited by wealth and income. For example, consider John, a chemical engineer working at Exxon, who earns $250,000 a year, and has never invested in a real estate project. Under the law, John can invest in a complex commercial real estate deal despite a lack of any substantive knowledge on the investment class. Mean while, Lisa, the graduate with a masters degree in Real Estate Finance who took an entry level position making $90,000 a year, cannot invest in the project, despite having the requisite knowledge to truly understand and analyze the deal. Such a result highlights the arbitrary effects of the law.
Results: Crowd Intelligence and Platform Screening—Data that has been released tends to show crowdfunding produces astonishingly good results regarding project screening for fraud, and weeding out poor or overly-risky investment opportunities. For example, data from CrowdCafé shows with over half a billion dollars raised for more than 3,200 offerings on six equity crowdfunding platforms, there have been zero incidents of fraud. Another startling anecdote is found in the Backcountry, where the Australian Small Scale Offerings Board (ASSOB, an equity based crowdfunding platform) has successfully served both accredited and non-accredited investors since 2005, raising over $130,409,669 since inception. ASSOB has funded over 132 companies to date, 83% of which are still in operation without a single case of fraud. Comparing these numbers to U.S venture capital success rates, where 3 out of 4 start-up ventures fail, speaks volumes about the power of crowd intelligence. While U.S data on this subject remains limited, it is mainly due to the fact that crowdfunding is not legal until the SEC releases final rules. Once that occurs, I anticipate we will begin to see encouraging data as it becomes available.
These high success rates and virtually non-existent cases of fraud can be attributed in large part to the screening and vetting procedures that crowdfunding platforms employ for selecting the issuers and projects featured on their platforms. Platforms offering online private security placements to investors may look to securities compliance standards initially, but in choosing issuers and projects, companies must go deeper and conduct a de facto underwriting. This de facto under writing process, necessary for platforms to build a trustworthy brand, provides a pre-screening element that allows only a certain quality of investment opportunities to reach investors. For example, on GlobalGroupFund.com, an emerging real estate crowdfunding platform, there is a thorough due diligence process for Real Estate Developers interested in raising funds on our platform. Before we even begin to discuss a potential offering, we conduct a thorough deep dive into the background of the issuer, including a financial health analysis, analysis of track record, current liabilities, licenses and insurance, etc. Our extensive vetting analysis serves two primary goals: (1) filter bad actors and low quality issuers to provide added protection to our investors (and ourselves), and (2) build a brand of quality listing partners and investment opportunities. Only after an issuer has passed this first stage of vetting do they gain limited access to our investor network, and then individual projects are screened with the same vigor as well. While our method is unique in many ways, virtually all crowdfunding platforms conduct a similar review.
Ultimately, given the painfully slow release of the final SEC Rules on the Act, and the amendments that will likely be introduced and passed after the mid-term GOP take-over of Congress, I believe this topic needs to be more widely addressed, publicized, and discussed within the legal community and the crowdfunding space. While securities attorneys and capital raisers are facing the largest substantive amendment to the securities laws in 80 years—it may also be time to reconsider the age-old concept of what constitutes “sophistication” under our securities laws.
Andres J. Trujillo, Founder and CEO of GlobalGroupFund, Inc, an emerging real estate crowdfunding platform. GlobalGroupFund is a real estate crowdfunding platform with a comprehensive and forward-looking equity based model of crowdfunding. GGF is currently redesigning their backend platform to elevate the user experience for their investors and issuers. Andres also serves as a consultant to start-ups in the NYC area.