Minnesotans collectively invest billions of dollars and, knowingly or not, rely on regulators to ensure the integrity of the financial community in which they invest. Unfortunately, our state has repeatedly failed to dedicate sufficient resources to police its existing, vibrant financial services community and is ill equipped to assume oversight of investment solicitations using crowdfunding.
Legislation has now been introduced in Minnesota to permit intrastate crowdfunding — the solicitation of small amounts of money from large numbers of people — for Minnesota entities seeking equity investments. The legislation builds on activities already taking place in the charitable contribution arena, where individuals with creative ideas have experienced “no strings attached” contributions through websites such as Kickstarter, Gofundme and Indiegogo.
Proponents argue that crowdfunding will provide much needed access to capital for small businesses and encourage start-up activity. Opponents suggest that it will provide a new online avenue to defraud investors by technically savvy reincarnations of Trevor Cook, Tom Petters and Robert Walker. Actual experience with equity-based crowdfunding in other states suggests that both positions are overstated; however, meaningful regulatory oversight is necessary should the legislation become law. Unfortunately, that oversight is unlikely to occur based on recent history.
The regulatory fabric protecting investors is primarily composed of the SEC, FINRA and state regulators. In its role, the State of Minnesota has registered more than 115,000 individuals and entities engaged in providing investment services, and it has sole regulatory authority over approximately 300 Minnesota-based investment advisors who manage over $5 billion in assets for clients. This regulatory area generates over $33 million annually in registration fees alone. These fees flow directly into the state’s general fund and elected officials have declined to plow these monies back into programs designed to protect investors.
Competing for resources
Unlike other states, Minnesota’s securities regulatory program is buried within the Minnesota Department of Commerce, where it competes for resources with the department’s other missions. In 2011, given the department’s other mandates — insurance, banking, energy, telecommunications — only three people were allocated to the regulation of securities, franchises and timeshares, with only one of those people solely assigned to the securities area. At that time, the department’s annual expenditures for securities regulation was less than $400,000 — approximately one-third of what North Dakota was spending on its securities regulatory program.
A 2012 Hasting Law Review article highlighted Minnesota shortcomings in this space: “In Minnesota, the securities regulator received at least fifty times more in notice filing fees from mutual funds than the regulator expended to administer the state’s notice filing fee regime and to exercise its antifraud powers. …” As of the end of 2014, the number of professionals at the Department dedicated solely to securities regulation increased to 8. Despite this progress, Minnesota’s program is nowhere close to other states its size (Alabama: 50+, North Carolina: 32, Michigan: 24, Wisconsin: 17).
Advocates of crowdfunding now want to hoist additional oversight mandates on this grossly under-resourced area of state government. The pending legislation would require the securities regulatory group to engage in rule-making, new registration activities, monitoring of Internet “portals” and increased monitoring of Internet activity, all on top of its existing unmet mandates.
Intrastate equity-based crowdfunding is controversial and is an area in which fraudulent activities will have to be addressed. In addition, Minnesota’s investors would benefit from education regarding the risks of making investments in companies unable to obtain traditional financing. However, in considering crowdfunding legislation, legislators need to confront the fact that the existing securities regulatory program is resource-starved, and, despite its talented personnel is currently incapable of protecting the hard-earned assets of Minnesota investors.
Proposals to improve regulatory program
Invigorating securities regulation in Minnesota is neither difficult nor expensive, but requires a thoughtful approach. Proposals that have been pending for several years include:
- decoupling the program from the general fund and allowing a meaningful percentage of the $33 million in registration fees generated annually to fund a regulatory program comparable with other states;
- promoting greater deterrence by arming county prosecutors with enhanced criminal penalties for communications fraud;
- incentivizing the private bar by creating private causes of action which will bolster and support public regulatory activities;
- requiring investment advisors to carry meaningful surety bonds or insurance coverage so investors have avenues to obtain relief in the face of misappropriation;
- allowing fines to be used for investor education instead of being siphoned off to the general fund;
- incentivizing whistleblowers, as the federal government has done effectively;
- allowing the state to order restitution to assist aggrieved investors; and
- moving the entire regulatory program out of the bureaucratic basement of the Department of Commerce so its voice is not drowned out by the department’s other activities.
Minnesotans would be well served if legislators focused on the existing inadequacies of the state’s securities regulatory program. Allowing intrastate equity-based crowdfunding merely exacerbates the deeper problem that the state currently faces — namely, a failure to have an adequate number of cops on this very important beat and to make adequate remedies available to aggrieved investors.
Robert Moilanen served as Director of Securities, State of Minnesota, from December 2011 to December 2014.
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