Two part series on crowdfunding. What it is, how it got started, inclusion into the Jobs (Jumpstart Our Business Startups) Act of 2012 and what that will mean. Is crowdfunding for everybody, some alternative financing methods, and local business examples
TRANSCRIPT
Speaker 1:Okay. Okay. [inaudible].
Speaker 2:I'm Lisa Kiefer and today I'm speaking with Jenny Cason and John [inaudible] from cutting edge capital in downtown Oakland. They're going to be talking about crowd [00:00:30] funding
Speaker 3:here we are in the midst of an amazing nexus of possibility with the Internet, social networking and the maker movements, a hacker movements. We're going to talk today about something that's on a lot of people's minds. Ever since President Obama signed the jobs act and that's the jumpstart our business startups act in April and that is the transformative notion of crowd funding. John, I understand you spoke at a crowdfunding [00:01:00] conference just yesterday and Jenny, I understand that you actually wrote the original petition to the sec for a crowd funding exemption. What is crowdfunding and what led you to do this, Jenny? Well, crowd funding is when any group of people, whether it be a business or just a group of people who need to raise money to get something done, go out to the public and offer an opportunity for people to contribute money to get that thing done.
Speaker 3:Unfortunately [00:01:30] under our current legal system, every time you do that, if you offer any kind of return on the investment opportunity. So if you say, Hey, give me $100 now and I'll give you $110 in a year after this whole thing is a success, you're actually breaking state and federal law. So right now there are crowdfunding websites, but on all of those websites, the only reason why those are legal is because you're only giving a donation. You're not getting anything in return except maybe something, a [00:02:00] very low value, like a tee shirt or something like that. So we've always felt that this was not fair, that people could not offer opportunities to the public to invest in cool projects that they were trying to do. We understand that the reason for these laws is to protect investors. But what if you're only offering a very small investment opportunity?
Speaker 3:So we said, what if you were to go out and offer the opportunity to invest $100 in a project or a business, a [00:02:30] nonprofit that we co founded sustainable economies law center wrote a letter to the Securities and Exchange Commission to ask for an exemption to the general rule that you're not allowed to go out and ask for investment and said, hey, why not allow people to do this if you can only put in up to a hundred dollars per person? Because we figured, you know, if people lose $100, it's probably not going to be the end of the world. So what happened with that petition? The sec didn't really respond. Um, there were a lot of letters of support that sent [00:03:00] and the word started to spread about the idea and little by little more and more people got involved. There were websites started to kind of to promote the idea and the idea actually spread to Congress.
Speaker 3:Some members of Congress started to hear about this letter. They asked Mary Shapiro, the head of the Securities and Exchange Commission. Why is it so scary to allow people to invest up to a hundred dollars in whatever investment they would like to invest in? She responded [00:03:30] in a letter back to this Congress member, um, well, you know, there could be a lot of fraud and we're really concerned and we've seen a lot of bad schemes happening, but Congress started to really question is, is it really necessary to protect people so much that they have no option where they can invest their money, even if they're investing a small amount? At the same time, some members of the White House staff also became aware of this idea and they also were very supportive of this idea that [00:04:00] if you're limiting the total amount that people can lose that why not create an exemption to these very owners rules that make it impossible for us to invest in the kinds of things we want to invest in.
Speaker 3:So a little by little, the idea started growing and amazingly enough, the president announced his support for the idea and then a congress person introduced legislation to actually put this idea into effect. And Amazingly enough, on April 5th the president signed the bill into law. Can you describe what that was like? Well, it was very [00:04:30] exciting. There were quite a few people invited. All the people who had been involved in getting it adopted. There were also people there who would really benefit from the new law and the president made a really short but very compelling speech about how now for the first time in a very long time, Americans will be able to invest in things in their community that they want to see. The big thing that we were trying to change is that under current law, only people that are categorized as accredited investors are actually [00:05:00] allowed to invest in anything they want to.
Speaker 3:What does that mean, accredited investor? So an accredited investor is something that is defined under federal law. There are a lot of categories of accredited investors, but basically you have to be at least a millionaire. You have to have at least a million dollars in net worth, not counting your home, or you have to have an annual income of at least $200,000 or 300,000 with your spouse. Or if you're a business or an entity of some kind, you have to have at least $5 million [00:05:30] in assets. So that's of course a tiny percentage. We estimate maybe about 1% of the population meets that definition. So under current law, if you do meet that definition, the business that wants to offer an investment to you has much fewer hoops that it has to jump through to be able to comply with the law. But the minute someone wants to offer an investment to someone who doesn't fit into that category, they to spend tens, if not hundreds of thousands of dollars [00:06:00] in legal fees, accounting fees, et Cetera, to be able to do all the legal work required to make it possible to actually offer the investment to unaccredited investors. So that's what we were trying to create, uh, an exemption for
Speaker 4:and initially turned into a proposal by a allowing people to invest as much as $10,000 per investment up to a million dollars, up to $2 million. Big numbers were starting to float around a personally, I became uncomfortable about that [00:06:30] because once a lot more money gets introduced into the scheme, you really do need to start to worry a lot more about market abuse fraud and then naturally the notion of intermediaries was introduced initially, I think you weren't really thinking about the intermediary concept as much today with the legislation having been signed by the president and conferences such as the one I just attended. A lot of people [00:07:00] are thinking about the intermediary space right now and because of that, naturally the regulatory agencies are going to have to put a lot more time, a lot more effort and a really serious thought and stringent rules and requirements around how to ensure that the intermediaries are behaving, how the intermediaries can ensure that the companies and the investors are appropriate and behaving limits are being met, all sorts of things. Now have to [00:07:30] be thought about and developed because it grew from the initial idea of really just a little seed concept into something much more meaningful.
Speaker 3:How long will it take the sec to review [00:08:00] this exemption and what he expects gonna Happen Out of that?
Speaker 4:Well, it says in the, the law that was passed that even though it's effective immediately, the SCC has 270 days to do its rulemaking. What's going to be really interesting here are two things. One is the 270 days doesn't necessarily mean that that's the end date that the sec has to come up with something. If you look back at the 2008 financial crisis, [00:08:30] you'll see a number of, uh, requirements that were provided to the sec about rulemaking within specific certain period of time, including 270 days and some other day limitations that they blew through. And unfortunately for the STC and the rest of us, they, as they say themselves, they're drinking from a fire hose. They have so many things going on right now. So many pressures, so many demands from Congress, Dodd, frank, a financial crisis, all the other things that they naturally take [00:09:00] on and do and limitations and staff, you know, enforcement issues and problems from Madoff and re designing how they should think and do things.
Speaker 4:This one is not on the top of their wish list to do because there's so many others on the top of their list, number one. Number two, they don't really like it. They never did. Um, as Jenny mentioned before and, and numerous other speeches from commissioners, we're pretty clear that we're not comfortable with [00:09:30] this. So when we see the final legislation or rulemaking that the sec comes out with, whether it's within 270 days or they blow through that and it's another date, even then it's going to be interesting because we don't even know what they're going to require. We don't know what kind of self-regulatory organizational rules and requirements have to be developed after that. And it's going to be really difficult to say, oh, okay, when this all is done and all the rules [00:10:00] are in place, now we can see the vision of the future for crowd funding. I don't think anybody can say that right now.
Speaker 5:Well, there seems to be quite a gap between the regulatory world and people out there starting up these crowdfunding sites. I read about them every day in the paper. They're already doing this. Can you talk about that gap and what that's going to create?
Speaker 4:You mentioned earlier that crowd funding was donation-based. Um, now we're into a world where it looks like not a donation and, [00:10:30] and it looks like not a project because now you see companies that may already be in existence that have a product they want to bring out and one such watchmaker just raised $7 million to go to China to have their watches built. And then these donations are actually not donations. They're preorders for the watches.
Speaker 3:Yeah, we really are in a wild west world, even before this legislation passed, there is very little understanding out there of the laws that [00:11:00] govern what you can. And can't do when you're raising money. So even before this legislation was even a glimmer in the eye of the president, um, people were already doing things on the Internet that were illegal and they didn't realize it. And because the SEC is so overwhelmed, very few people got caught flat out investment offerings on the Internet that were illegal. And usually people would realize after a little while that they were illegal and take it down. The also, a lot of people don't understand what [00:11:30] the definition of a security is. Some people might have a vague idea that, oh, I'm not allowed to sell securities to the public without going through a lot of regulatory hoops. The definition of a security is incredibly broad.
Speaker 3:It includes loans. It includes any offer to give someone money in the future if they give you money now. So it doesn't have to be a stock, it doesn't have to, you know, a membership in an LLC. It doesn't have to be an equity investment to make matters even more complicated. [00:12:00] Um, there the states have, even some of the states have an even broader definition of what a security is. In, in about 15 states, they defined security so broadly that it can even include the promise to provide anything at all a value in the future in those states, the pre-selling of a product that doesn't exist yet, where you're putting in your money and taking a risk by putting in your money that, you know, maybe, or maybe not this product is actually going to get made. That [00:12:30] is actually considered a security in 15 states.
Speaker 3:This has been going on on Kickstarter for quite a while. And as far as I know, there hasn't been any crackdown from the regulators, but that certainly could happen at any time. And now that this new legislation has passed, I think there's even more confusion about what you can and can't do because a lot of people don't realize that the legislation really hasn't gone into effect yet because the rule making still needs to happen. So from what I understand, there are now more websites out there offering opportunities to fund various [00:13:00] projects. It sounds like these onerous rules regulations could end up costing megabucks for these people and you're back at square one again. Absolutely. I mean it doesn't really sound necessarily like an improvement. Where do we stand competitively with the rest of the world and crowd funding?
Speaker 4:The United States regulatory program or scheme or however you want to think about it is an interesting one in that it was really the first primary uh, nationally regulated [00:13:30] or large governmentally regulated kind of a system for investments and naturally here, because we took off in the industrial revolution and nobody was close to where we were, the button would tree came about in New York. Philadelphia started a stock exchange way earlier than most everybody else thought about forming something of a structural regulatory position around selling of securities [00:14:00] except maybe Holland around the tulip market. We developed early on state by State even interesting strong regulatory structures to try to help people be safe when they were making investments. And naturally after the 29 crash and the federal government realized that things were getting a little bit out of control, we were really the leaders when it came to developing a very interesting framework that now you can refer [00:14:30] back to 33 and 34 act that still governs today a lot.
Speaker 4:Almost all of what happens aside from some amendments that have been introduced since then. It is a very strong, very interesting but very old structure like our constitution in the United States in many ways. There's lot of analogy there. Lot of countries have learned from us. They've developed better, stronger, more interesting things off [00:15:00] of it. The things that I think other places or other countries learned and adopted and introduced new measures and new methods based upon newer technology based upon even the Internet. We're a bit strapped with some old rules that we have to keep trying to fit everything into. While we're heading progressive in one way and strong and robust, we're not real flexible and not necessarily as progressive [00:15:30] so we are behind in some ways we're heading some butt behind and some, there is another interesting thing that's happened with the SEC. Uh, very recently they just put out a new statement on their website and you can go and look at it.
Speaker 4:sec.gov and it pretty much says we have a long time left to figure out what we're going to do with rulemaking and just as a reminder to everybody out there you can't be violating the current existing rules and regulations by [00:16:00] developing new platforms or intermediary concepts. Even those kinds of things are going to face increased scrutiny right now because not only the sec but other regulatory agencies are probably thinking we have to do something right now to try to stem this outbreak, this virus that's out there and we have, we may have to come down hard on a few people
Speaker 2:[inaudible]
Speaker 3:[00:16:30] Matt [inaudible] articles in rolling stone and others have come out strongly against the jobs act. He talks about is the wisdom of the crowd enough? Is Is this just opening up for the grandmas of the world to be abused? What do you think about that? We have to be really clear when we're talking about the jobs act. Are we talking about the part about [00:17:00] crowd funding or are we talking about some of the other parts? I think it's true that the first section does something that is quite questionable. It, it exempts from a lot of regulations, um, something called emerging growth companies. So I know a lot of the criticism of the jobs act has been focused on that, but there has has also been criticism of the actual crowd funding piece and I know that there is a lot of fear out there that it could lead to fraud.
Speaker 3:The 99% of us who are not what we call accredited investors [00:17:30] have very few choices about what we can invest in. And many of us are just sick and tired of putting our money into Wall Street. We just feel like that money is not doing anything that we feel good about. It's leaving our community. It's going God's know God knows where and doing God knows what and we would like the option to invest in businesses in our communities or social ventures in our communities that we know are doing good. I think this was just an attempt to find a reasonable balance. There's never going to be a fraud free [00:18:00] situation. There's fraud under the current situation. There will be a way that you can and you can have more options about what you invest in and there will be a fairly large amount of regulations on these intermediaries that John keeps referring to.
Speaker 3:They have to be registered with the SEC. They have to be members of FINRA, which is the regulatory body for the financial industry. There's all kinds of requirements about what they have to do to vet anyone who lists on their site. I think there will be a fair amount of protections [00:18:30] for people and I do think there is a lot of wisdom to the crowd. If you talk to Indiegogo for example, as far as they know, there has never been a case of someone succeeding in, in raising money for a fraudulent project. There has been an attempt to do that, but the crowd actually caught the person and figured out that what they were offering was not legitimate and they shut the whole thing down. So I think that now that we live in an age where the crowd, you know, can actually chime in on a lot [00:19:00] of things. I mean Ebay is a great example of that. I think the, you know, the ratings that you see on Ebay after you have a bunch of 'em you, they start to have some meanings. So I think that people chiming in on, hey, this is a really great business. Or Hey, I went to that business the other day and they treated me terribly. I don't think anyone should invest in them. I think these are the kinds of things that will be really helpful for people in making their decisions.
Speaker 4:Six or seven years ago, Jenny and I started working on an idea around how could we develop [00:19:30] an alternative mechanism for non accredited investors, the 99% to be able to begin investing in local community companies through an alternative kind of an exchange. The um, work that we did on that developed into a a paper that I presented at a corporation 2020 which is a think tank that's based out of Boston designed to try to find appropriate new measures for what companies [00:20:00] should look like in 2020 and you know to have clear vision 2020 vision. When you think about what companies could look like and could be and, and the work that Jenny and I have been doing with regard to a local exchange was perfectly suited for what they were thinking about in terms of what they thought companies should look like and how companies should be run.
Speaker 4:What we were working toward were two different things. One was how do you try [00:20:30] to ensure that the interaction between the offer and the investor can be something that is trustworthy, can be information, can be validated, appropriate transparency can happen and the development of a sense community. And our thinking was at the time that if we tried to minimize the geographic footprint in terms of where individuals and investors were meeting up with companies, we thought [00:21:00] that we might have a better idea or a better approach in terms of trying to limit the inherent part of human nature to scam or defraud or manipulate or abuse that process. The efficient transfer of savings to investing. What we were really thinking about was how do you ensure that you know what you're getting into, how, how can you be safe in terms of what you're investing in?
Speaker 4:How can [00:21:30] you not get ripped off and how can you do this as one of the 99 percenters when the world seems to provide much more opportunity for those who are wealthy or sophisticated and giving definitions around sophisticated, that in my view are insulting to the rest of the 99% of the world or the United States where there are many sophisticated, very smart people who probably could do much better if they had an opportunity. Fast forward [00:22:00] to the time when Jenny began to work on that petition. It was really closely connected with what we have begun to do six or seven years ago. And what I think is gonna we're gonna see is that what turns into something successful is going to be when you can recreate community, recreate knowing about something, recreate a transparent approach, and possibly even recreate some of the things that [00:22:30] stock exchanges were all about in their early stages before they all moved toward electronic trading where no one knows each other and no one sees each other anymore.
Speaker 4:There's always going to be an attempt at fraud. How do you limit fraud? How do you limit abuse? One way I've seen by my experience being a general counsel at and regulator at stock exchanges for more than 20 years now is when people know each other. That doesn't mean that they like each other or that they trust each other, but when they know each [00:23:00] other, there's an opportunity for them to know when somebody is acting badly and then there's an opportunity for them to make sure that that person gets yanked from the process. So that there's more trust built into the system. I think we're going to see that. I don't know how exactly yet, but I believe that when we see success in all of this, it's going to be because we have figured that out.
Speaker 2:[inaudible]
Speaker 4:[00:23:30] while we're waiting for the SEC to figure out this new capital crowd funding, how would
Speaker 5:I as a, you know, you talk about local, I eat local, I spend my money locally. How do I invest local? In the meantime, what, I know you guys have, uh, you've started a consulting firm that does help people decide to set. Can you talk a little bit about what are some of the things that I could do?
Speaker 3:[00:24:00] Unfortunately, if there aren't that many opportunities right now, but we are trying to help businesses find ways to be able to deal with the current regulatory structure to actually allow them to offer investments to their community. Interestingly, there really is already crowd funding going on. Just the way that John described it under the current legal regime there, it is possible to do something that we call a direct public offering under the new law. It'll be much easier to do this. But under the current [00:24:30] law it is possible. What you have to do is complete a very detailed, um, prospectus describing your business, describing what it is that you're offering and you file that perspective in your state. And if you're only doing it in your state, you don't have to worry about federal regulations. It's a little bit more complicated than that. But generally if you're, if you're focused within your state and you're only offering the investment to residents of your state, it's a bit easier cause you don't have to do a federal filing, [00:25:00] you just file with the state and then your state securities regulators will give you the, okay, hopefully to go ahead and offer the this, the securities, whatever they are, whether it's a loan, whether it's a presale of a product, whether it's a stock, you can get the okay to, to offer that to the public.
Speaker 3:And we do have some clients that are currently doing that. It varies from state to state how easy it is. Unfortunately in California it's a little bit more difficult. They are stricter and also it takes them a longer [00:25:30] time to do the approvals. But we have clients in New York, um, in Washington who are currently offering securities in their communities. We have one client in the state of Washington in a small town called Port Townsend, which is, uh, it's like a general store and it's a startup but they're very well known in their community. It's a small town that's very involved and active and you know, community revitalization projects. They have already raised over I think over 500,000 to open this [00:26:00] community store and they've made the offering to the public in their community. If you have co-ops in your community and you become a member of the Co op, that is a way to invest in your local community. Unfortunately, there aren't many opportunities right now.
Speaker 4:It's going to be interesting to see how the states react, how the federal government reacts, what happens when they're abuse or, or you know, other kinds of frauds begin to happen if they happen. And then if you run that [00:26:30] side by side against what Jenny just described in terms of the alternatives that exist today, I don't know that you could really easily say that one is going to be a better approach than the other right now. And in fact, we may find that the one that we're actually operating within right now could turn out to be something even lighter from a regulatory approach. That's the problem. We just don't know and it's going to take quite a bit of time.
Speaker 3:Well thank you John Cavett and Jenny Cason, [00:27:00] cofounders of cutting edge capital in Oakland, California. And where can people go to find out more information about this if they had some questions, what would you suggest? Check out cutting edge capital.com we have a lot of information about the legal issues and the changes in the law and examples of communities all over the country that are raising money and keeping money local. Are there any authors that you would recommend people check into or
Speaker 4:absolutely. Um, Marjorie Kelly and her seminal [00:27:30] work, the divine right of capital and a new book that's coming out this summer on generative ownership opportunities is fantastic.
Speaker 3:Amy Cortinez loca vesting, and I read that book. It's awesome. Yeah. And Michael Schumann, local dollars, local sense. Those are great books. Good. Well, thank you for being on method to the madness. Appreciate you guys coming out. Sure. Thank you.
Speaker 2:[inaudible].
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