Themadness of crowd regulators

Crowdfunding should face the open market, but don’t blame anyone if you get burned

It’s taken me a while to come around to this conclusion, but it now looks like crowdfunding — the raising of investment capital using the Internet — is a financial innovation that should be allowed to face the test of a free and open market. Let the investment games begin. Let all investors big and small take their chances on whatever business ventures are being incubated in the cookhouses of Canadian capitalism. Open the gates of Twitter and unleash the power of the web. Free our small entrepreneurs, startups and early-stagers from the hackles of securities regulations, the burden of prospectuses and the curse of regular disclosure. Unleash the funding portals and let in investors, including those with only a few hundred dollars in their pockets but an opportunistic twinkle in their eye.

But don’t call me in the morning when all the big dreams fostered by crowdfunding activists — from U.S. President Barack Obama on down — fail to materialize. And there are a lot of dreams riding on the crowdfunding bandwagon. These include the sophisticated promise of author James Surowiecki in his 2005 book, The Wisdom of Crowds. Surowiecki talks of the vast “collective wisdom” of crowds and how they can be smarter than individual decision-makers. He links this insight to the Internet, in part because “the ethos of the Net is fundamentally respectful of and invested in the idea of collective wisdom, and in some sense hostile to the idea that power and authority should belong to a select few.”

Sounds a little Occupy Wall Street-ish. Crowdfunding doesn’t stop at collective wisdom. Social investment will get a break. Environmental technologies will find fresh capital. Startups and tiny micro-firms will flourish. Suddenly, via Twitter and Facebook, small investors will be exposed to big opportunities. We’ll get more jobs, they say, which is why crowdfunding was embedded as a regulatory mandate in Obama’s 2012 Jumpstart Our Business Startups Act — the JOBS Act.

The assumption is that crowdfunding

Bythe end of this year, to foster crowdfunding, the SECand OSCwill likely have blown away just about every investor protection they’ve installed

can open up the capital markets to millions of small investors around the world who are now squeezed out by the existing fat-cat 1% who control the investing agenda. But at this point, crowdfunding theory tends to look more like a social policy regime than an investment platform. It also runs up against decades of regulatory overkill that has been dedicated to preventing crowdfunding from occurring. The laws and regulations that protect small investors run to tens of thousands of pages. But now that tapping a billion small investors all over the world is seen as cuttingedge economic policy, the world of securities regulators is responding — whether any of the theory is true or not.

The U.S. Securities and Exchange Commission — as mandated by congress and the president — issued a 600- page document last October outlining proposed rules for crowdfunding. The Ontario Securities Commission, under pressure from local advocates, is following suit.

By the end of this year, to foster crowdfunding, the SEC and OSC will likely have blown away just about every investor protection they’ve installed. Example: Let’s say that today you have annual net income of $150,000, net worth of $4 million, and you’d like to get in on a hot new company that’s not listed on any stock exchange, but is being offered around to a small group of maybe 200 potential investors. Sorry, but to protect you from bad deals and high risk, that’s illegal under current rules. But under SEC crowdfunding proposals, you’d be able to invest $2,000 in an Internet-platform startup even if your net worth is less than $100,000.

In investment circles, crowds are usually associated with mob thinking and madness, thanks to a famous 1841 book, Extraordinary Popular Delusions and the Madness of Crowds. Today, crowds are associated with genius and collective wisdom. Call it Extraordinary Official Delusions and the Madness of Regulators.