Adventures in Ex Ante Crowdfunded Securities Law

I'm thrilled at the success of Kickstarter and Spot.Us, which partly fulfill a longtime dream scheme of mine. These sites are primary sources of great stuff, and you should check them out if you aren't already familiar with them. The idea behind both is to help people raise funds for ideas that they want to pursue; Kickstarter is designed for any personal projects, and Spot.Us supports journalism.

Donors can get a little something in return through these sites if the projects they fund come to fruition, like a signed copy of a book that's produced (Kickstarter), or reimbursement in credit if a news organization buys the story (Spot.Us). But what if a crowdfunding site could offer donors a piece of the action, not just some thank-you goodies? That's what I would want, and I don't think I'm alone. I want investors for my schemes, not patrons, and if people support me to do something that flies, it would only please me to give them a cut.

Technically, launching something like this wouldn't be too difficult. The Spot.Us code, written in Ruby, is public domain and already uses an accounting system with a Paypal merchant account. The Spot.Us interface is close to what an investment-enabled version would need, and the main tough technical piece would be to add a digital signature scheme for the contracts. I met with Spot.Us founder David Cohn a few weeks ago, and he estimated that once the details about the user experience were all figured out, an appropriately-modified adaptation of the Spot.Us code could be up and running in a few months.

But then I started talking about the scheme with lawyers, including Boingboing counsel Rob Rader, who has been extremely helpful. The legal terminology for my notion, it turns out, is "patronage-plus ex ante crowdfunding," at least in a recent article by Tim Kappel in the Loyola of Los Angeles Entertainment Law Review The short answer is, such a site would probably be illegal under U.S. federal securities law. "Securities" are defined as any investment whose return is dependent upon the effort of others. It's a one paragraph definition, very broad, hard to get around, and there's no de minimis dollar cutoff below which the regulations stop. A lemonade stand venture could be subject to SEC regulation.

Securities regulations don't apply if the investors are genuinely active in the day-to-day management of the venture-- but it isn't enough to just give them access to a project wiki and consider their suggestions; you must demonstrate that they are all critical to the venture's success. So much for that loophole.

Another possibility is the SEC's "Private Placement Exemption" under Regulation D, which allows unregulated investments if the number of investors is limited. Specifically, you can sell shares to at most 35 regular individuals (and an unlimited number of accredited investors, i.e. various institutions, plus people who have a net worth exceeding $1 million, an annual income over $200K, or a personal trust exceeding $5 million).

But Regulation D also prohibits any "general solicitation or general advertising" to let people know about the venture. The only published announcements of such investments are the cryptic "tombstone ads" that you sometimes see in the print versions of the Wall Street Journal or New York Times business section. These ads, which AFAIK have never been published online-only (although this might be possible) must be very limited in their disclosure. It might be OK to say "Paul Spinrad offers shares in a graphic novel based on the life of Elliot Smith" but that's about it. The announcement can't include anything that makes Kickstarter and Spot.Us so fun to browse through-- no details of the project, no wish lists, no video clips of people saying, "I'm so excited about this project-- it's got great indie film potential-- all I need is 4 months time and a round-trip ticket to Portland!"

Another possible loophole is to keep offerings entirely intra-state, in which case the SEC lets a state's "blue sky" laws and regulatory apparatus control them. But this would just mean swapping the California Department of Corporations (for example) for the SEC, with similarly expensive legal and registration costs, and similar restrictions on disclosure. It doesn't make sense to have to spend $50,000 to be able to legally raise $5000. Attorney Jay Parkhill gets into some of these same issues in his 2007 blog post,"The World Isn't Ready For Crowdsourced Securities Offerings." 

Yet another approach, which no lawyer could ever condone, is to make the whole thing run under a honor system. This was the premise behind my 2003 website, Premises, Premises, which now lies on the vast dustheap of failed website experiments. Under this scenario, offerers would set their payback terms as a promise, but would be unfettered legally from just keeping all the money they might make using others' investments. The only "teeth" would be that everyone would know what they did, with an electronic trail to prove it, and would presumably consider them assholes until they made amends. Community reputation based enforcement has succeeded in resolving disputes outside of legal channels in the past. But such a system is unsuitable for serious investment.

So my question now is, how can we make this legal? I want to pursue this. For example, how does one go about changing securities law to establish a de minimis exception for total offerings-- say, less than $10,000 and individual investment less than $100. This is chump change for the SEC, and they shouldn't waste their time worrying about activities at that level. Aren't there other laws that protect naive investors from being cheated out of their last $100?

If I can Kickstart up the funding for some lawyer-time to draft a such a bill, who in Congress might sponsor it? The legislation would help artsy types and grassroots ventures, while also lifting financial regulations and oversight-- so it sounds like a candidate for bipartisan support! It's a stimulus bill, it's an investment in American ingenuity, it's "new thinking," it helps the little guy! Meanwhile, I can try to talk to people at the SEC-- I'm happy to just call their listed phone number and see if I can explain my way in to someone who might actually help, but does anyone in boingboing-land know someone who works at the SEC, who might be interested in this?

If you want updates on this quest, please email me! I don't want to include my email address here, but it's pretty easy to find.




  1. Max Keiser’s new Pirate My Film site (still in beta) is offering people a small piece of the action to invest in peoples’ films. Too early to know how well it’s working.

  2. I’m less than optimistic about the “working within the system” solutions. The regulations are set up at least in part to protect the existing investment banking system. The established players will see crowdsourcing as competition, and they run the regulatory agencies to suit their own needs.

    I wonder whether a better solution would be to offer to the public shares in a “real” corporation that functions as intermediary – and then have the “real” corporation’s bylaws set up so that each shareholder has exclusive control over a proportionate share of the corporation’s investments (and is paid a proportionate dividend on their earnings). The corporation can then be the sole investor in the crowdsourced projects, circumventing the “blue sky” laws.

    One major drawback is that everything will be multiply taxed. The project owner will have to pay income tax before paying back the corporation, the corporation will have to pay corporate taxes before paying a dividend, and the individual investor will then owe taxes on the dividend. But the opportunity for multiple taxation is the only reason that I could see the government approving such a scheme – because it still provides the entrenched players with a competitive advantage.

  3. I was incredibly excited the moment I heard of kickstarter. It was like a lightbulb went on: OF COUSE something like that existed. Then I looked deeper at it and was slightly less excited – due to Amazon’s policies only folks in the US can start a kickstarter project, and I’m in Canada. No one I know is going to be using kickstarter (for incoming), so this feeling of “and if I wanted to, I could do it too” goes out of it. I’m not sure I can explain why that’s so much of a loss, but it is, even though I wasn’t about to start one anyways.

    Don’t get me wrong, I’m still very excited at this kind of ‘crowdfunding’ existing.

  4. Your best bet is probably to set up the company in a less well regulated jurisidiction. Just be sure to report the earnings to the IRS.

  5. What about simply hosting the fund raising project site outside the USA? Sealand springs to mind. IANAL, but it seems that if everyone paid their taxes in a responsible manner, there would be relatively little to complain about…

    1. @ #2: That would be treated, like all obvious dodges, as a security. While its true the laws protect the system to an extent, they were enacted in the wake of 1929 to protect regular folks from manipulative brokers, especially ones pitching dubious penny stocks. To the SEC, there is little way to distinguish this venture from a dubious penny stock meant to fleece Grandma out of her savings.

      @ #4 & #5: U.S. citizens offering securities, or foreign entities directing offering at U.S. citizens, are within the SEC’s jurisdiction.

      @ #6 & #7: Debt is still a security. It is the original security.

  6. You seem focused on equity, but much of this could be obviated by using debt. This would be easy to put together on as a loan. Loans put the pressure on the borrower, so while it’s still “crowdsourced,” you’re under more pressure to perform and “give them a cut.” You retain the upside beyond the debt repayment, which is a long shot, as you would acknowledge. But if you are confident of your ideas and don’t want to run up a huge legal bill trying to change a securities law that has been in place since the Depression, do what small businesspeople have been doing for centuries: borrow.

    It is asking a lot to expect people to throw money at you on the premise of some activity having a slim chance of them getting an unspecified “cut” from you later, and yes, that kind of activity is exactly what securities laws were set up to oversee. If you aren’t confident enough to commit to borrowers, then you should go through the full conventional PPM process.

  7. I’ve been looking for a way to get small private investments to put up a warehouse for my start-up organic produce distribution company. The answer I’ve been getting from farmers who have raised funding from customers and supporters is to write up a promissory note. I haven’t had time to work out the details with a lawyer yet, but my impression is that we can write it how we want. Our plan is to have a 5-year term so that cash flow is not bound up in the beginning. Here is an old NYT story about a fellow PA farmer who did this:

  8. I’ve been poking around this space for a while and have heard conflicting reports from different sets of lawyers – one of whom says it’s doable, the other claiming we’ll get arrested! So short answer, I haven’t figured out something that works yet, but I know people who have done something similar.

    The Age of Stupid for example, was a crowd sourced movie, which accepted donations (like Kickstarter etc) as well as investments. Their faq ( calls the investment vehicle a “limited recourse debentures” – basically making them more like loans and less like shares. I’m looking at things more in that direction these days, rather than purely as equity.

    Would love to hear others’ thoughts on this…


  9. @ #9

    I thought they might make a claim like that. What about just excluding the US, and instead running in whatever jurisdictions would allow this sort of scheme? Do the UK and Canada have the same regulatory structure to prevent this sort of thing? Once the system is in place and working somewhere, it may be an easier sell to legitimize with American authorities.

  10. I actually looked into something similar for a graduate school capstone project. What I decided early on is that setting up your own market for securities exchange (equity or debt) was going to be a real headache, so I decided to go down the non-profit crowdfunding donations route (alas, without any specific concept of rewards), which appears to be Kickstarter’s entire model. I see some structural differences and some eye-openers, but the concept was otherwise identical. Regardless, I think there’s still room in that space to innovate, and my recommendation would be to search it out a bit more. It’s certainly easier than trying to either circumvent or change laws that may still serve a useful purpose.

  11. The problem with this whole thing, as has been pointed out, is that there is this thing would be quite literally the perfect way to scam people. You can talk about internal protections and audits whatnot all you want. The SEC was set up, and this type of thing was specifically outlawed, for VERY good reasons. Those reasons do not go away just because you throw the word “internet” into the mix. In fact, the protections become far more important.

    Just because you have a generous attitude and would want to share proceeds with others who would be willing to support such ventures doesn’t mean that it should be legal. I have the same attitude, and I’ve learned that you have to assume people on both ends will be dishonest. I believe that most people want to be honest, but the ones that don’t are very, very good at leading others down a very harmful path. Most people in civil society accept a facade of legitimacy as the real thing. That’s why we’re in the economic situation we’re in right now. Corporate attorneys literally sit around all day trying to come up with a way to take something illegal outside of the regulatory framework and make it look legal, at least for a while, so that some parties can benefit.

    Going forward with this would make you one of those people who ultimately is just manipulating the system for your own benefit. Sorry.

  12. I agree that the way to do it is to do it sufficiently small and grass roots that it would fly under the radar for a while. Then see what happens.

    I’ve written quite a bit about this. This post has specific suggestions on crowdfunded securities:

    There are several of us working on new kinds of technology for banking and finance based on some of these principles here. With several OpenSource offerings out there.

  13. I agree. The SEC laws are ripe for some innovation here. The Securities Acts of 1933 and 1934 were written to protect the widow in Texas from investing all her savings with that sketchy oil speculator. At the time, the laws were useful and important and are still to this day… for large investors and investments.

    But the internet has opened up a new world of possibility around micro-finance and/or micro-patronage. To protect investors you can:

    > require disclosure
    > limit exposure (i.e. limited $ invested)

    The current laws on the books adhere to the former approach. I believe innovation is coming as more of uscontinue to explore the latter approach.

    (In my prior life before IndieGoGo, I was a analyst on Wall Street – CFA and all, so SEC laws are something I’m quite familiar with).

    That said, I’d love to see you raise funds to push a bill forward. You can use IndieGoGo to raise money and offer perks in the process.

    IndieGoGo is a collaborate way to fund ideas and fuel innovation. Anyone can pitch their projects and offer perks to their funders in return.

    I’d fund your bill project if I could give you feedback on the bill or get my name at the bottom as a perk.

    IndieGoGo is in over 90 countries. Both US and non-US projects are welcome.

    There’s no funding time limit either (unless you set one yourself). You keep all the funds you raise; so it’s not all-or-nothing.



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