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The Deal: States Greet Crowdfunding With Hostility

The actions of Ohio and Massachusetts already have caught the attention of entrepreneurs and others in the crowdfunding business, said Douglas Ellenoff, a partner with the Ellenoff Grossman & Schole LLP law firm in New York.

"We are already getting calls from people in the crowdfunding industry seeking to better understand the meaning of the Ohio action," he said. "They're asking whether they should avoid such states."

While Ellenoff said he recognizes that states must monitor the activities of entrepreneurs to police capital markets and ensure compliance with securities laws, he said regulatory discretion is key to ensuring a healthy marketplace.

"Given that we are all figuring out the proper balance of how to operate under these new rules, I would encourage regulators to exercise restraint, where possible and appropriate, in not using unnecessary enforcement tools in order to remind the community at large of their responsibilities," Ellenoff said.

He said that one of the reasons such restraint is necessary is that crowdfunding has attracted many younger professionals, who have good intentions but need constructive guidance.

"Inevitably, there will be missteps along the way and we would suggest that regulators weigh the public interest in establishing a new industry that is good for their respective states with whether actual harm has taken place to investors and the need to weed out bad actors," Ellenoff said.

In the event of a violation, he said that regulators should ask themselves whether it really serves the public interest to be "heavy handed when a less severe means of enforcing compliance" might be available.

Similarly, Ellenoff said it is incumbent on entrepreneurs to understand that crowdfunding is subject to traditional securities laws and regulations.

"No one in the crowdfunding industry benefits if a fraudster who cheats investors out of their hard-earned money isn't prosecuted, criminally and civilly," he said.

However, not everyone in the market believes that some state regulators are off base in their wariness of crowdfunding.

"We welcome having some oversight from states as well as the SEC" and the Financial Industry Regulatory Authority, said Bruce Lipnick, CEO of Asset Alliance Corp., a New York-based alternative investment manager that launched its own crowdfunding portal called Crowd Alliance USA. "A lot of people are new to this business and don't know what they can and can't say."
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