How the Courts Just Saved Crowd Investing

Crowdfund Investors Rejoice and Beware

A little watched court case was decided by the U.S. Court of Appeals, DC Circuit on June 14, 2016 in favor of the Securities Exchange Commission (SEC) and crowdfunded investing. The case was brought by Montana's State Auditor and Massachusetts' Attorney General against the SEC. If the case had been successful, it could have put an end to crowdfunded investing from a practical standpoint. 

Why The Case was Important

One of the most important features of the SEC's rules on crowdfunded investing is that companies seeking investors need only comply with a single regulatory and disclosure requirement. Before the rules, companies had to go through what's called a blue-sky review where every state subjected the company to their own regulatory review. Small companies had three choices to attract investors.

  1. Spend hundreds of thousands to millions of dollars on an Initial Public Offering
  2. Spend hundreds of thousands of dollars on an army of lawyers to comply with 50 different regulatory requirements
  3. Only allow millionaires to be investors

With those three options, most small companies chose option three. As a result the average investor never had an opportunity to invest while companies were still small.

Under the JOBS Act, the SEC's disclosure and regulatory requirements preempt the state requirements. This allows companies to comply with one federal regulatory rule rather than 50 state rules. All of a sudden, early stage investing is finally available to the masses--but Minnesota and Massachusetts wanted to go back to the old way.

A Warning to Investors 

The two states argued in court that "the Commission [SEC] failed to explain adequately how it protects investors." The states' argument that the SEC's regulations don't go far enough in protecting investors was denied by the courts, but it should be a warning to investors. Although the warning should not keep you from investing through crowdfunding, it should signal that you need to investigate these companies more than you might other investments.

If you wish to invest through crowdfunding, make sure you understand the risks of crowdfunded investing and seek professional advice. You should also investigate thoroughly the business plans of the companies you invest in.

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