FINRA Warns Investors To Beware Of Shiny New Objects

Most of us know what probation feels like. We’ve had jobs where we’ve been told “for the next so-and-so months, you’ll be on probation.”

Translation: Don’t mess up. Don’t come into work mid-morning. Don’t take three-hour lunches. Don’t ask to take a week off to visit your elderly aunt in Cancún. And do your damn job.

I thought I’d never get to say this: Equity crowdfunding has begun. Startups are already raising money from everybody – not just the moneyed – under the new equity crowdfunding rules.

It’s a new ball game. New rules. New opportunities.

Exciting? Sure. But the newness of equity crowdfunding also means it hasn’t had a chance to plant deep roots. It’s the fresh face in town, unblemished and enticing. But also without history or track record.

Through no fault of its own and because it’s so new, it hasn’t had a chance to prove itself.

Which means, like anyone starting a new job, it can’t afford to mess up.

Equity crowdfunding is on probation.

Two Schools

The buildup to May 16 revealed two schools of thought. One school thinks equity crowdfunding is a good thing – for both startups and investors.

Startups – especially those outside the cozy ecosystem of Silicon Valley – can now entertain other sources of funding besides venture capital money.

As for investors? They can diversify their portfolios with a new class of equity that provides a very different risk-return calculus.

The second school is louder and more skeptical. It thinks equity crowdfunding is dangerous.

Not only is it full of risks, but these risks are new to investors and therefore much harder to recognize and handle.

It took the government four years to figure out the regulations governing equity crowdfunding. Evidently, it wasn’t enough time. Equity crowdfunding still gives the government the shakes.

What Investors Should Know

Last Friday – one business day prior to the launch of a more open and fair world for startup investing – FINRA made one last-ditch stab at playing Big Brother.

It issued an Investor Alert (spelled out in red, I kid you not) titled “Crowdfunding and the JOBS Act: What Investors Should Know.”

Now, if you want to learn how to safely take advantage of equity crowdfunding’s capacity to hand investors outsized profits, go to the article we posted last week called “Equity Crowdfunding Tips and Tools.”

But if all you want to know is how to shield yourself from the so-called scary risks posed by equity crowdfunding, then let the government-salaried folks from FINRA be your guide.

They avoid talking about how to recognize startups with promising technology and upside. Instead, they issued four tips to help investors avoid being ambushed by scheming founders…

1. Ask yourself if you can handle the risk – and the potential loss of your investment.
2. Read and understand the educational and financial information, and all disclosures, provided by the issuer and crowdfunding intermediaries.
3. Recognize that fraud is a possibility.
4. Revisit your financial goals.

Beware of Shiny New Objects

It’s not that this advice isn’t useful. It’s that it’s so one-sided. If you have any doubts of FINRA’s views on this, listen to this piece of advice from its senior vice president of investor education…

Investing in unregistered emerging securities carries significant risk, and investors have to beware the attraction of the shiny new object and make an informed, rational investment decision [emphasis mine].

Shiny new object? Oh my, it sure seems like FINRA thinks it’s talking to 4-year-olds, doesn’t it?

FINRA and the SEC see eye to eye on the so-called dangers of equity crowdfunding. Issuing regulations that impose strict limits on how much investors can put down on the startups of their choice isn’t enough.

Which is why the SEC seems so determined to pounce on companies or individuals playing fast and loose with these rules. But even this isn’t enough.

The Perfect Solution

So the SEC has come up with the perfect solution.

It’s happily sharing its enforcement responsibilities with the startup funding portals, sort of turning them into mini-SEC agencies.

Here’s how Mary Jo White, the chairwoman of the SEC, put it in a recent speech…

“We are counting on brokers and funding portals to be bulwarks of investor protection in this space. We will hold them to that responsibility.”

That’s the ticket. Let the portals do the SEC’s job. If they fail, it’ll be their fault and not the government’s.

I was talking to a top executive at one of these portals today. The portal had done over $100 million in funding startups in the last 12 months. But it hadn’t moved into the equity crowdfunding space, at least not yet.

“We’re interested in seeing what happens in the next few months. How smoothly things go. If any scams derail the momentum toward more openness,” he told me.

The Government Is Watching

As I said, equity crowdfunding is on probation. Many people are taking a “wait and see” attitude. The government, in particular, is watching.

It needs to be on its best behavior.

Maybe it’s my imagination, but I get the feeling some in the government want a scandal to erupt… to give it an excuse to return to the good ol’ days.

Not going to happen.

There’s no going back. Equity crowdfunding will start small and just keep on growing and growing as investors move from being spectators on the sidelines to being enthusiastic participants.