Starr Austen & Miller Suspects the JOBS Act could Lead to Fraud Against Lay Investors

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Mario Massillamany of the Indiana law firm of Starr, Austen & Miller, LLP, announced an alert to the public today regarding upcoming changes in 2013 to private offerings laws with the recent enactment of the JOBS Act. The JOBS Act, formally known as the Jumpstart Our Business Startups Act, was signed into law by President Obama on April 5, 2012.

According to Forbes, this Act has been heralded by many proponents as a way for small business owners and entrepreneurs to have more access to funding opportunities and to gather capital which can help them grown their businesses, and as a result, create more jobs. The idea is to remove the red tape and SEC restrictions that make it difficult, when not completely illegal, for entrepreneurs to raise funds in public.

One of the major ways this legislation does this is through the legalization of equity ownership in companies via the funding method of crowd-funding according to Govtrack.us. Crowd-funding Internet websites, such as Kickstarter and RocketHub have been used now for several years to solicit a large number of small investors for artistic and other entrepreneurial ideas and businesses. In the past, however, because of laws and regulations, this money did not purchase any stake in the company or enterprise. The only way to do this, previously, was through the use of angel investors, who are financially sophisticated individuals as stated by USA Today.

Scott Starr, a partner at the firm has stated, “Now, however, the venture capital game will be expanded from a group of elites with deep pockets to become any lay person off the street with some money in their wallet that they wish to invest, within certain guidelines and restrictions. There is no doubt that this is a seismic shift in the way that businesses can look for funding. Previously small companies looking to raise money without registering their securities with the SEC had to use Reg D 506, a safe harbor exemption for specific types of private offerings. Soon, however, starting in 2013, startups will be able to use the crowd funding exemption instead.” He went on to state, “In addition, the new Act amends Section 12(g) of the Exchange Act to increase the shareholder cap limits that trigger public company reporting requirements, making clear that those shareholders who acquire securities in a crowd funding transaction will not be counted against the shareholder cap.”

With these changes, however, Starr questions how these lay investors will be protected from fraud. He states, “The question then becomes, how to protect lay investors who are playing in this new investment game? Certainly there is a danger that some fraudsters will set up phony companies and lull unsuspecting and unsophisticated investors into giving them cash.” Certainly, Starr is not the only person concerned. In addition, another vocal lawyer raising alarm bells is Columbia Law School’s John Coffee, a shareholder advocate, who in his prepared remarks for the Senate while the legislation was being considered, called it the “boiler room legalization act.”

The SEC has been tasked with drafting regulations for the crowd-funded equity transactions. Starr states, “The hope is that these regulations will create a good balance between the need for new capital infusions for small business and protections for investors against fraud. However, until such regulations can be reviewed it is unknown what the final impact of this legislation will be for investor protection.”