Saturday, September 14, 2013

Kitch & O'Connor: Should Crowdfunding Be Regulated?

"I think I'm here because I wrote an article called The Nature and Function of the Patent System..." This is how Edmund Kitch, Professor of Law at the University of Virginia School of Law, began his talk at a lively panel I attended on Thursday, September 12 at "The Commercial Function of Patents in Today's Innovation Economy," the inaugural academic conference on intellectual property at George Mason University School of Law's new Center for Protection of Intellectual Property (CPIP). Kitch, of course, was referring to his famous article on the role of patents in facilitating commercialization and efficient coordination of research. But patents were not Kitch's topic. Instead, Kitch was here to talk about what he sees as another important mechanism for facilitating commercialization of new ideas and business models: crowd funding.

Crowdfunding is relatively new. Sean O'Connor, Professor of Law at the University of Washington School of Law, who spoke after Kitch on the panel, defined crowdfunding generally as "web-based general solicitation of funds for a venture." The most famous instance is Kickstarter, which allows the general public to provide small donations for discrete projects in exchange for a promise (e.g. a ticket to the show you plan to put on, a sample of the watch you plan to manufacture, or "I promise I'll do it soon...") But Kickstarter, O'Connor emphasized, is project-based financing and only a limited version of what we could ultimately get from crowdfunding platforms: enterprise financing, where disperse investors put money into a company in exchange for an equity stake, just as they do in public securities markets. Moreover, O'Connor explained, the recent JOBS Act (2012) (which awaits implementation) was ostensibly passed partly in response to funding mechanisms like Kickstarter. But JOBS actually has very little to say about Kickstarter, which operates within a variety of limitations, including that it can only be used to fund discrete, time-limited projects and cannot be used to fund ongoing business operations or to "raise equity or solicit loans." What JOBS does do, O'Connor said, is create a new system for regulating crowd-based enterprise financing that is actually quite burdensome and may pose many of the same risks for participating companies as traditional SEC regulations do for large companies (e.g. costly disclosures, conservative management).

Kitch, for his part, was not particularly concerned about either the distinction between project and enterprise financing, or the details and potential consequences of the JOBS Act. Kitch sees no difference between public investments in projects and enterprises. They are both "securities contracts" under the Howey test, he says, it's just that on Kickstarter financiers enter into "debt contracts" that are "payable in things versus dollars." Kitch's view is that all forms crowdfunding should be allowed based on citizens' right to invest in whatever they choose. The securities laws, Kitch said, were designed in part to protect investors from "unwise" investment decisions. (The laws do this by ensuring that buyers of public securities receive complete and accurate information before they invest and by prohibiting "material" misrepresentations and fraudulent market manipulations.) But Kitch recommends that we treat unregulated investing more like gambling or the lottery - let people make whatever bets they want, but find a way to profit from it. And what about the SEC? Kitch does not think it should be abolished - at least not right away. Instead, he thinks businesses should be able to advertise for general financing on sites like Kickstarter, so long as they make clear that the offerings are "not cleared by the SEC." Then investors can "vote with their feet," choosing either to invest in companies regulated by the SEC or in companies that solicit on unregulated crowdfunding markets. It could be, Kitch concluded, that this system will work very well, and that one day will be selling securities along with books and used clothing. (Beware, late night shoppers!)

Kitch's views on crowdfunding are controversial, but not altogether surprising given his general emphasis on the importance of efficient allocation of resources to financial prospects, and previous work in which he's written favorably about market-based approaches to regulation by corporate law scholars such as Yale Law School's Roberta Romano. However, I am intrigued by O'Connor's insight that there is a major difference between project-based and enterprise-based crowdfunding, which might warrant very different regulatory approaches. I look forward to reading more on what O'Connor has to say about this difference. Moreover, as I mentioned to Professor Kitch after his talk, no matter how strong the argument is for letting people invest their money however they want, I can't believe the Internet - by giving entrepreneurs the ability to reach a far broader audience, and by making it possible for investors to invest their money "with just one click" - does not change things. If Kitch's vision (let's call it "Kitchstarter") does come to pass, who will participate? Only the sophisticated, or only the stupid?

No comments:

Post a Comment