Another Hard Knock for Crowdsourced Securities, and a Glimmer of Hope

December 1st, 2008

I have written a bunch about applying principles of crowdsourcing to securities offerings, including an article last year in Business Week.  The prospects have been dim.  I also met Kiva.org founder Matt Flannery a couple of years ago and asked him if the company would pay interest on Kiva loans.  His response was “No.  We do not want to be regulated like a bank”.

It comes as no surprise, then, that the SEC has told crowdsourced lender Prosper.com that it needs to stop matching lenders with buyers on its site.  Borrowers on Prosper submit loan requests, lenders bid for them, then Prosper packages the loans and manages the borrower-lender relationships.  Borrowers and lenders never know one another’s identities.

The SEC reviewed the facts and applicable law and decided that the operation was really a sale of securities that needed to be registered, esp. based on the facts that the lenders put money in explicitly looking for a return and have essentially no ability to affect transactions- the loans are passive investments intended to make money.

Again, no great surprise here.  There is (still) a lot of capital available in retail-level amounts and it would be great to see Prosper go through the SEC registration process and come out the other side with a vehicle people can use to borrow money and to make some additional income in a novel way.

My guess is that Prosper has known this was coming for some time and was simply building enough business to make the registration process worth the expense.  The SEC reports that it has facilitated $174M in loans, so it could well be there.  I look forward to seeing them register, come back with an SEC-compliant and take a big step forward for crowdsourced securities everywhere.  Fittingly, the SEC registration documents are all public records, so maybe the next company can use Prosper’s process and SEC feedback to make the process a little smoother the next time around.

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The SEC vs. the Body of Internet Law

November 6th, 2008

The SEC spends a lot of time thinking about public statements- and misstatements.  It looks at a company’s communications and holds the company liable for *everything* it says publicly, whether statements were made as part of a formal “announcement” or just in some marketing collateral.  This is reasonable- to do otherwise would let companies cite one set of facts “on the record” for shareholders and paint a different picture elsewhere.

In August, the SEC published some proposed rules governing websites.  It seems to be worried that companies could use third-party websites to get around the integrated-communications policy.  E.g. a company could describe some negative results in a press release while simultaneously linking to a an analyst’s blog that offers mitigating opinions.

Most people can probably agree this would be a manipulative business practice.  The SEC would like to hold companies liable for statements made on sites hyperlinked from a company website.  On its face that seems like a reasonable proposition.  Unfortunately, it flies straight into one of the bedrock rules for conduct and liability on the Internet: site owners are not liable for statements made by third parties.

The law that creates this rule is known as 47 USC Sec. 230, was enacted by Congress in 1996 and has been interpreted and upheld numerous times over the past twelve years.  It is as fundamental as any rule gets in the still-young arena of Internet law.

Santa Clara University Professor Eric Goldman wrote a comment letter to the SEC about the conflict between Sec. 230 and the SEC’s proposed rules.  In addition to explaining why the SEC’s rules are problematic, the letter does a fantastic job summarizing Sec. 230, major cases under it and its position today.  Definitely a worthwhile read for operators of sites that solicit third-party content and the people who advise them.

I find this area fascinating.  The SEC has a very long history of regulating corporate communications and its new rules flow directly from that tradition.  At the same time, the civil liability it seeks to impose is clearly preempted by Sec. 230, creating a head-on collision between the SEC and existing law.

Criminal liabilities are a different matter- 230 does not address them at all.  In the end this may be the way through, but it would be a tight, unhappy squeeze if third-party statements could lead to criminal liability, but not civil ones.  Stay tuned to see how the SEC’s proposed rules evolve based on comments it receives.

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