Potential Pitfalls of ‘Crowdfunding’ for Main Street Investors

The murky world of crowdfunding is creating growing concerns among securities regulators and investor advocates for its apparent lack of investor safeguards, and now one state – Massachusetts – is taking action. Last week, Secretary of the Commonwealth William Galvin filed fraud charges against two out-of-state oil and gas operations in connection with sales of unregistered securities to Massachusetts investors.

Crowdfunding is an online finance-raising strategy that began as a way for the public to donate money, often through social networking Websites, to help finance projects or sometimes causes. Through the Jumpstart Our Business Startups (JOBS) Act, however, small businesses and entrepreneurs could be able to tap into the “crowd” in search of investments to finance their business ventures.

The Securities and Exchange Commission (SEC) hasn’t released its final crowdfunding guidelines, but several state securities regulators have voiced concerns about crowdfunding for several months now and the potential that crowdfunding has to open the door to fraud for Main Street investors.

Indeed, as reported by Investment News, Galvin has called upon the SEC to “adopt meaningful and effective ‘bad actor’ rules that will disqualify securities law violators, brokers with revoked licenses and other fraud operators from using these exemptions from the securities registration requirements.”

In the Massachusetts crowdfunding case, the fraud charges focus on two oil and gas companies accused of selling unregistered securities by phone and using illegal crowdfunding. One company, Prodigy Oil and Gas LLC, allegedly employed a cold-caller who had been found guilty of theft. According to the complaint, Prodigy principal Shawn Bartholomae was subject to three state securities regulatory actions and two criminal charges.

Prodigy allegedly sold at least $464,000 in unregistered securities to oneMassachusettsinvestor, according to the complaint. Fraud charges against Synergy Oil LLC of Oklahoma and two of its executives allegedly involve the sale of $35,000 of unregistered securities to two investors.

Meanwhile, the North American Securities Administrators Association made its own statement about crowdfunding last week. Specifically, NASAA said that crowdfunding’s presence on the Internet has risen sharply in recent months in anticipation of rules to allow small businesses and entrepreneurs to raise investments online.

“Investors soon can expect to be inundated with crowdfunding pitches, legitimate or otherwise,” said Heath Abshure, NASAA President and Arkansas Securities Commissioner.

An analysis of Internet domain names by state and Canadian securities regulators found nearly 8,800 domains with ‘crowdfunding’ in their name as of Nov. 30, up from fewer than 900 at the beginning of the year, according to NASAA. Of these Websites, about 2,000 contained content, more than 3,700 had no content and more than 3,000 appeared to be ‘parked’ and serving as placeholders to reserve a domain name for later use or sale. Of the domains with ‘crowdfunding’ in their name, about 6,800 have appeared since April 2012, when the JOBS Act was signed into law by President Obama.