State and provincial securities regulators have put the new investment phenomenon of crowdfunding at the top of their annual investment scams list, highlighting a recent controversial U.S. law that relaxes capital-raising rules on small companies.
The North American Securities Administrators Association, whose members include the regulators, evaluated emerging and ongoing threats to investors in its recently released 2012 list of top investor traps. The list also included mid-size investment advisers, and oil- and gas-drilling schemes.
Crowdfunding, which allows fundraising for projects via websites, is relatively new, and scams are just getting started, the regulators said.
New law on horizon
The idea is to make investment in start-up ventures easily available to the masses. Portions of the Jumpstart Our Business Startups Act (JOBS Act), which go into effect in 2013, will push crowdfunding from a "donation" model to a true investment model, and that will make it even more of a lure for swindlers, NASAA said.
The JOBS Act passed Congress with bipartisan support and became law in April, but it faced opposition from some Democrats and advocacy groups who said it would roll back important investor protections.
"The number of entities out there already pitching themselves as crowdfunding entities online has risen in a significant fashion," said Matt Kitzi, NASAA enforcement section chair and Missouri Securities commissioner. "Just look at Web domain names: It has gone from a couple hundred to well over 1,600 in the past year."
In early August, the Massachusetts Securities Division charged a Lowell, Mass., man in a crowdfunding scam, saying he bilked $153,396 from 20 investors.
Secretary of the Commonwealth William Galvin, who brought the case, wrote to the Securities and Exchange Commission urging regulators not to let the JOBS Act changes become a tool for financial fraud and abuse: "Long-standing problems in the markets for small and speculative stocks show the pitfalls of relying on the wisdom of crowds."
NASAA's list is broken into two parts this year; the first is composed of emerging threats to investors. Besides crowdfunding, NASAA is worried about mid-size investment advisers, who recently transferred to supervision by state authorities instead of the SEC.
"There's plenty of advisers out there who just shouldn't be in business," said Robert Stammers, director of investor education for CFA Institute, an association of investment professionals. "Most advisers will applaud this, because they find inappropriate advice brings down the whole industry."
New threats are emerging, but existing threats may be more dangerous because they involve more people, says Jack Herstein, NASAA president and assistant director of Nebraska's Department of Banking & Finance, Bureau of Securities.
The most common scam involves marketing investments, like oil and gas drilling, not registered with the SEC. The JOBS Act relaxed rules on this type of investment and allowed broader advertising, which NASAA says will make fraud easier.
1. Crowdfunding and internet offers.
2. Inappropriate advice or practices from investment advisers.
3. Scam artists using self-directed IRAs to mask fraud.
4. Gold and precious metals offers.
5. Risky oil- and gas-drilling programs, with names like Reg. D/Rule 506 Private Offerings.
6. Promissory notes.
7. Real estate schemes, often linked to Ponzi schemes.
8. Unlicensed salesmen giving liquidation recommendations.
Source: North American Securities Administrators Association