From Idea to Law: A JOBS Act Discussion with Startup Exemption’s Sherwood Neiss

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Eric Blattberg / Crowdsourcing.org (photo: Startup Exemption)

I recently published part one of my interview with Sherwood Neiss, co-founder of Startup Exemption, on Crowdsourcing.org. Check it out here.

For those of you who don’t want to read the whole thing — I don’t blame you, it’s quite long — one of the more interesting topics discussed was his reaction to the critics who claim the bill is “fraud-friendly,” “criminogenic,” even an “atrocity.” Neiss discusses just how difficult it is to actually invest through one of these crowdfunding intermediaries. Here’s that discussion…

So let’s talk about fraud for a minute, because there’s been an enormous outcry from William Black, Eliot Spitzer, Andrew Ross Sorkin and other vocal critics of this legislation. I’m sure you’ve seen Black’s Huffington Post article calling the JOBS Act “criminogenic” and “fraud-friendly,” and Sorkin’s New York Times piece about the JOBS Act jeopardizing the safety net for investors. How would you respond to those critics, particularly to the fraud fears?

Sherwood Neiss, co-founder of Startup Exemption: Well first let’s talk about how hard crowdfund investing is going to be for entrepreneurs and investors, because once we understand how hard it’s going to be, that addresses the issue of fraud.

First of all, all equity-based crowdfunding will only take place on websites — also known as intermediaries — that are registered with the SEC. So right off the bat, the website is going to have this sort of VeriSign or Better Business Bureau seal on it. The whole point of rallying a self-regulatory organization and getting everyone together right now is to make sure that everyone is in agreement that we need this seal of approval. So if you are going to be crowdfunding, people will be looking to see if the website is a bona fide, registered crowdfunding intermediary. So if you’re a website owner, you’re going to have to submit to registration requirements by the SEC.

Second, if you’re a fraudster that thinks, “I want to debunk people out of $50,000,” this is how you’re going to have to do it. You’re first going to have to come up with a dollar amount; could be $10,000, could be $50,000. And you have to be a first-time fraudster, by the way; this won’t work for anyone that has committed fraud before because when you register on any of these SEC platforms, the first thing they do is a fraud background check on you. The SEC might also require a minimum credit score, so if they ask for a score of 760 or 780, I’m sorry, but you’re out. The fraud barometer will be pretty high, so to speak — not that it can’t happen, because it can.

Of course, fraud permeates every other type of capital market, too…

Exactly. But when all these mechanisms are in place, I see how this system is going to function transparently. So here’s the next part: you, a fraudster, are going to be stealing money from your friends. You are going to be stealing money from your social network. What I mean by that is, you load your idea up onto one of these platforms, and the way in which you solicit people is by clicking the email button, the LinkedIn button, the Facebook button, the Twitter button, the Google Plus button on the petition itself, on the idea. That’s connected to your personal social network. You have an IP address on your email, while Facebook and the like already integrate your identity, and that goes out to your friends, family, acquaintances and other connections. So now you’re stealing money from the people you know and maybe even love. I mean, I’m sure that happens all the time, but again, the principles of crowdfunding entail that you’re doing this from the people that are closest to you.

So now let’s flip to the other side, to the potential investors receiving this solicitation. Crowdfunding is based on helping people that you know. You should not be responding to solicitations from people that you don’t know — not that it won’t happen, it most certainly will, so let’s talk about that. You are a person that receives a solicitation for some guy that is selling snake oil, and you’re like, “Wow, snake oil can reduce wrinkles on my face. I’m a 70 year-old woman trying to avoid Botox and this is going to change the world for me. I don’t know who this guy is but this sounds great, I’m going to click on this link from this random nobody.” That takes you to a crowdfunding platform where you now need to register with your social security number, date of birth, credit card information — all this personal information for which you’ve been told over and over again: don’t give this information to anyone.

But let’s say you do, because you’re just that one person that believes you have to get through the hoops and hurdles of doing things that you’ve been told never-ever to do so you can give your money to this snake oil guy. Then it says, before you can actually invest any money, you must now take a test. You know when you sit down on a plane, and before the plane takes off that screen pops down and says, “In case of emergency, put the mask on yourself before your child” and so on. You go through this five-minute dialogue that teaches you everything you need to know about safety on a plane. That’s the exact same kind of information you’re going to receive about crowdfund investing. There’s going to be an old lady, an old man, a pretty young lady, a pretty young guy — I don’t care, whoever — but there’s going to be a community of people like you see on those silly but very important airline briefings that educate you about crowdfunding. It’ll say: crowdfunding is about people you know and trust, it is about local investing, and it will be powerful when you can see, know and trust the product and person behind the campaign. Don’t ever invest money with someone you don’t know and trust.

You’re going to have to sit there and listen to this thing, and at the end of it, you’re going to have to take a test. That test will have CAPTCHA fields attached to it that you’re going to have to type in to answer questions like, do you understand that you should never invest money with someone you don’t know? Did you receive a solicitation from someone you don’t know? And it will tell you, are you aware that your chance of getting a return is very limited? That you might never see a return? That it could be very far off? Unless you answer “yes” to questions like this, you can’t proceed.

So we’ve raised the hurdle for fraudsters on that level, then we’ve raised the hurdle for investors, too. That’s why we keep on saying, in theory, this is great because it’ll get capital flowing, but think about our ADD when we go to websites — what is it, three seconds [we spend browsing each page on average]? You have to put a significant amount of energy and effort into follow-through to make sure you can give that fraudster probably something around $80. All I’m trying to say is that when this is up and running, the people that are really sincere about getting behind the people that they know and trust are going to be fine doing that, because they know and trust and believe in that entrepreneur and that product, and they’re probably going to be consumers of it. But if they don’t know that guy, they’re going to be given so many red flags as to why they shouldn’t do it, that the chances are, they’re going to drop off before they even go through all the registration procedures. We just don’t feel comfortable today giving out our personal information. We’re not going to do it for some random person.

And for the projects that do grow so large that they really attract that substantial layer of investment from relative strangers — well, I suppose they probably won’t reach that level if they’re shams. Social capital means nothing when you have a Facebook account with 1,000 “friends,” but it’s not attached to your real name or your real friends, because they’re not going to give you any money.

Right. And there are people with 1,000 friends on Facebook, but really, people just don’t friend [random] people anymore — people are more likely to “de-friend” people these days. Your social network is becoming akin to your social security network in many ways, where you want to keep people out. Personally, for me, my Facebook is strictly immediate friends and family, period. No offense, but I wouldn’t connect with you on Facebook, because I wouldn’t want you seeing all those pictures of me. (laughs) I don’t care if they’ve got those different layers set up now, that’s just how I am. It’s on LinkedIn or Twitter where I have connections outside of my immediate network but still know and interact with. I’m not the only one that’s like that; most of my friends seem to act the same way. Those people with 1,000 friends… do they really know 1,000 people? Doubtful. And those strangers or fellow partygoers from years past aren’t very likely to invest in your startup.

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