Below is an article by MarketWatch entitled "You're rich? We'll take your word for it".
You're rich? We'll take your word for it
By: Jen Wieczner, MarketWatch Editor
July 22, 2013
Startup companies can soon market themselves to investors like soft drinks, thanks to new Securities and Exchange Commission rules that for the first time allow advertising of private securities. And while only those wealthy enough to be considered accredited investors are technically allowed to write checks, experts say there is not much to stop people with smaller bank accounts from taking a chance on the next Facebook.
The current process for determining whether an investor is accredited is similar to the way bars determine whether patrons are 21, or customs officials determine the value of what’s in a foreign traveler’s suitcase: Companies typically take investors at their word that they have at least $1 million in assets or make $200,000 a year.
The SEC rules announced last week, which pertain to the 2012 Jumpstart Our Business Startups, or JOBS, Act, pave the way for small companies to raise more capital, especially by soliciting investments online through “equity crowdfunding” websites. At least 100 of these sites have already “pre-launched” and are ready to begin processing investments when the new JOBS Act rules take effect in about two months, according to Kevin Berg Kartaszewicz-Grell, research director for crowdfunding advisory firm Massolution.
But many of those sites just ask investors who are interested in joining to swear that they are accredited—much the same way sites ask consumers to check a box saying they agree to the terms of service, or that they are a certain age.
“It is very much an honor system,” says Kartaszewicz-Grell.
Until now, dishonesty hasn’t been a concern in the startup fundraising world, where investments often come from angel investors or venture capital funds with known reputations. Those deals are done over lunch, in boardrooms and on roadshows, “so you sort of get rid of the rotten apples via personal interaction,” he says. “But crowdfunding changes the scene in one actual way, and that is access to capital from people you’ve never met.”
That is when the honor system might fail, says Judd Hollas, CEO of crowdfunding site EquityNet, which has helped startups raise more than $200 million. People may pretend they are wealthier in order to invest in a company they see advertised. “A lot of these people who go to Vegas I think would love to roll the dice on the next Facebook, but they may not qualify,” Hollas says.
The SEC declined to comment, but in a document explaining the new rules, it wrote that Congress’s decision to allow private companies to advertise their stock offerings was contingent upon new safeguards to ensure that only accredited investors buy those securities, and that companies take “reasonable steps” to verify that accreditation. “In other words, there is no restriction on who an issuer can solicit, but an issuer faces restrictions on who is permitted to purchase its securities,” the SEC wrote.