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.