Far from the Maddening Crowd: Does the Jobs Act Provide Meaningful Redress to Small Investors for Securities Fraud in Connection with Crowdfunding Operations

If the country is to flourish, capital must be invested in enterprise. But those who seek to draw upon other people's money must be wholly candid regarding facts on which the investor's judgment is asked.-Franklin D. Roosevelt1IntroductionSigned into law by President Barack Obama on April 5, 2012, the Jumpstart Our Business Startups ("JOBS") Act seeks to afford startups access to previously unavailable capital in order to grow the American economy.2 Title III of the JOBS Act amends Section 4(a)(6) of the Securities Act of 1933, as amended (the "Securities Act"), to allow startups to offer up to $1 million worth of their securities to the public during a twelve-month period.3 These "crowdfunding" offerings would, in theory, allow startups to solicit potential investors through online social networks and grant startups access to a previously untapped well of ital.4 lending and donation-based crowdfunding websites have experienced tremendous success in raising capital for small enterprises, Title III goes a step further in allowing investors to purchase an equity stake in the startup itself.5Although Title III could provide marginalized startups with a much-needed capital injection through crowdfunding offerings, potential crowdfunding investors may face serious hazards.6 Purchasing a startup's securities may expose small unsophisticated investors to unknown financial risks and higher incidents of issuer fraud.7 Small unso- unso- phisticated investors generally lack the necessary financial acumen to understand the nuances of investing-especially concepts related to financial risk, portfolio management, and limiting exposure.8 Crowdfunding investors lacking financial know-how stand to gain little from Title III's requirement that startups issuing securities provide sures to Additionally, many startups will not have done enough business to have generated sufficient financial information to disclose to potential investors.10 Furthermore, assuming that crowdfunding investors understood the information disclosed by the issuer, even seasoned investors would find evaluating and verifying the quality of that information difficult.11 Finally, small investors lacking financial acumen are unlikely to have sufficient investable assets to withstand a loss of their entire investment in the event of fraud.12 AlthoughTitle III affords crowdfunding investors a private right of action in the event of issuer fraud, small investors may-in practice- lack the ability to sue crowdfunding issuers for securities fraud.13 Investors bringing suit under Title III's private right of action may only recover up to the amount invested, which for small investors may amount to less than the cost of bringing suit in the first place.14 Given the economic disincentives for bringing a securities fraud action against a crowdfunding issuer, a class action lawsuit is the only economically fea- fea- sible option for small individual investors.15 Unfortunately, the Private Securities Litigation Reform Act of 1995 (the "PSLRA") would effectively prevent classes of small defrauded crowdfunding investors from the advantages of Title III's private right of action.16 The PSLRA, which operates to prevent manufactured plaintiff classes from bringing meritless securities fraud suits against issuers seeking settlement, would require classes of small defrauded crowdfunding investors to plead scienter as well as loss causation with particularity.17 Because many fledgling startups are unlikely to have generated much financial information (e.g., tax returns or audited financial statements), defrauded crowdfunding investors would find that meeting the PSLRA's heightened pleading requirements difficult, if not impossible.18 The PSLRA's heightened pleading requirements could, therefore, effectively eliminate plaintiffs' already limited remedies under Title III's private right of action, creating "litigation-proof" offerings.19Despite the federal interest in deterring meritless class action securities fraud lawsuits, the PSLRA should not curb classes of small defrauded crowdfunding investors from seeking redress under Title III's private right of action. …