How Wise Is the Reg CF Crowd? 

According to the SEC’s Reg CF, you can invest in crowdfunded securities without mingling or interacting in any way with the crowd. But why would you? In other words, why wouldn’t you benefit from the insights, questions, and research from other members of the crowdfunding platform on which you invest?

While you’re at it, share your insights with them – it’s the decent thing to do, especially if you want to continue interacting with the crowd on various deals.

Remember that while the crowd may include experienced angel investors and savvy securities analysts, it may also contain charlatans, nincompoops, and frauds.

The SEC established regulations for equity crowdfunding portals under Regulation CF (Reg CF). Like social networks, these portals allow investors to collaborate on everything from deal selection to due diligence. Users share personal and professional profiles so that others can assess their expertise, their credibility, and gain from the wisdom of the crowd.

Accredited Investors and Non-Accredited Investors

Accredited investors have sufficient knowledge and experience in financial and business matters to evaluate the unique risks of private equity, venture capital, and hedge funds. Whereas non-accredited investors using equity crowdfunding platforms are generally less experienced and less able to sustain the loss of an entire investment.

Collective Wisdom

Reg CF states, “A premise of securities crowdfunding is that investors would rely, at least in part, on the collective wisdom of the crowd to make better-informed investment decisions.” Reg CF requires intermediaries “to provide communication channels for issuers and investors to exchange information about the issuer and its offering.”

Members of an equity crowdfunding platform (or equity offering platform operated by a broker-dealer) have access to

• Forums where questions and responses are posted for all members to see
• Shared research, discussions, and sometimes free professional advice
• Off-platform messaging to engage in private discussions
• Investor Meet-up groups in major cities nationwide

The premise of James Surowiecki’s book The Wisdom of Crowds is that

“Under the right circumstances, [crowdfunding] groups are remarkably intelligent and are often smarter than the smartest people in them. Groups do not need to be dominated by exceptionally intelligent people in order to be smart. Even if most of the people within a group are not especially well informed or rational, it can still reach a collectively wise decision.”

But Caution Is Advised

Looking at investors particularly, Surowiecki shows that “investors, as individuals, are irrational, but it’s still possible that the “crowd” will be rational and smart.”

However, under the wrong circumstances, the crowd can be an irrational, destructive mob.

Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay, describes how mass manias and collective follies cause stock market bubbles and riots where “aggregating individual decisions produces a collective decision that is utterly irrational.”

Mackay also quotes Bernard Baruch (1870-1965), an American financier and adviser to U.S. presidents, who said, “Anyone taken as an individual is tolerably sensible and reasonable — as a member of a crowd, he at once becomes a blockhead.”

Wisdom, Not Madness

What are the circumstances under which a crowd – specifically a crowd of average investors on a Reg CF platform – will be wise, not mad? Surowiecki identifies three such conditions:

• Diversity — Members of the crowd have a wide variety of perspectives, knowledge, experience, and sources of information. Funding portals typically let members see the profiles of the other members who take part in discussions, so you can evaluate their diversity and expertise. Smaller groups tend to be less diverse.
• Transparency — If a portal accepts members who do not provide their true names and contact information – or if issuers do not require verification of members’ identities – be wary of making investments within that portal.
• Independence — Crowd members are free to express their own opinions without suppression or intimidation. The funding portal should not limit the kinds of communication among members beyond basic civility and lawful expression (e.g., members should not be permitted to commit libel or slander).
• Decentralization — There are no dominant leaders or moderators unduly influencing the crowd. The operator of a funding portal, for example, could bias crowd wisdom by introducing their own agenda into discussions.

Crowdfunding platforms can be ideal environments for crowd wisdom when the funding portal’s operators and the members are wise and follow the rules.

But Reg CF platforms should enforce the same wise practices. Platforms should require investors to use their real names and verify their identities when they participate in on-platform discussion forums. Using their own identities encourages less self-interest-at-all-cost behavior. If someone suspects a scam, it’s more likely they’ll come forward than just anonymously abandon ship.

It’s easy to get irrationally swept up in the crowd of equity crowdfunding. But with careful research and planning, the right crowdfunding platform can deliver big-time with perfectly rational exuberance.

We think you’ll also like:

• Why Business Crowdfunding Is About Brand, not Product
• Portals and Broker-Dealers: Comparing Types of Investments
• Alternative Assets and the “Average” Accredited Investor

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

• Securities Crowdfunding for Intermediaries
• Investing in Real Estate Through Equity Crowdfunding
• Webinar Series: Crowdfunding

This is an updated version of an article originally published on 8/20/19.]

©2022. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.