(Photo: James Cridland via Flickr)

It was glaringly sunny in Washington, D.C., on April 5, the day President Barack Obama signed the JOBS Act, and there was some confusion as to the location of the afterparty. One faction of Rose Garden attendees gathered on the roof of the W Hotel and wondered where everyone was. The rest assembled at Off The Record, a dimly lit bar in the basement of the Hay-Adams Hotel, and kicked things off with an icebreaker.

About 30 smartly dressed men and women, still sweating out the adrenaline of being three rows away from the president, stood in a circle. Many had worked with each other but never met. Each stated their names, the role they played in the bill, and perhaps a few words about the brave new world of so-called equity-based crowdfunding, which had just been legalized by one of the six constituent laws that make up the JOBS Act. The new rule will allow “ordinary Americans,” in the president’s words, to invest in a nonpublic company in exchange for shares for the first time since the enactment of the securities regulation that followed the 1929 stock market crash.

The mood was triumphant and boozy. Tim Rowe, a Cambridge-based venture capitalist, raised a glass and offered a toast to working together in the future. “The Marine Corps was founded in a bar in Philadelphia,” he said. “Big things can happen starting in a bar.” Attendees signed up to join a trade organization for the newly minted market. “There was the sense of elation that we had cracked the monopoly of Wall Street,” one attendee recalled.

Right now, new businesses have limited ways to raise capital. They can petition venture capitalists to invest, or beg family and friends for cash. Recently, entrepreneurs have also started appealing to the crowd through sites like Kickstarter. After being rejected by venture capitalists, one Palo Alto company called Pebble raised more than $10 million on Kickstarter to build a touch-screen “smartwatch” that can be programmed by an iPhone.

Equity-based crowdfunding, also called crowdfund investing or crowdinvesting (the practice is so new that we’ve yet to settle on a vernacular) is the new IPO. Or rather, it will be in about six months, once the Securities and Exchange Commission hammers out the nuances of the law. Under the new rules, entrepreneurs can solicit up to $1 million from the public in exchange for a slice of future profits. Pebble promised to ship watches in 2013 to everyone who donated. If equity-based crowdfunding had been legal, Pebble could have sent its backers a stock certificate in addition to a gizmo.

Advocates of equity-based crowdfunding believe the change is long overdue. Among those clinking pints at Off The Record were Woodie Neiss, a motivational speaker and former consultant who helped spearhead the 460-day lobbying effort; Amy Cortese, the journalist and author of Locavesting; Jenny Kassan, who three years ago petitioned the SEC to let people invest up to $100 in a business without having to file; and Michael Shuman of Cutting Edge Capital, who argued three years ago that $100 of risk was “no more dangerous to an investor than a dinner for two at a Chinese restaurant.”

Of the equity-based crowdfunding enthusiasts, perhaps the most ebullient are the entrepreneurs who plan to launch websites where unaccredited investors can commit $2,000 to $100,000 in a year, depending on their income and net worth. In exchange, they’ll own a slice of the next Facebook, the next Shake Shack or the next Enron, at the early stage normally reserved for venture capital firms and millionaires.

New York, according to recent Wharton grad Ryan Feit, is the epicenter of crowdfunding—and likely will be the same for equity-based crowdfunding. Mr. Feit’s yet-to-launch site, SeedInvest, works out of the same Soho loft as Kickstarter competitor Indiegogo, and both were supporters of the new law. On a recent Thursday morning, Mr. Feit and three other neatly dressed Wharton grads were stationed at their Macbooks, as they have been for the month since they graduated and moved to New York.

Only one, James Han, is actually building the site. The other three are working on “education,” “setting up partnerships,” talking to the SEC and giving media interviews, Mr. Feit said, when asked what there is to work on given that the first crowdfunded investment is still at least six months away. “A lot of the fun is figuring out what it’s going to look like,” he said. “It’s way more complicated than just setting up a page that looks like Kickstarter. We have to be very nimble to adapt.”

According to JOBS, the new widows-and-orphans investor class must go through so-called “portals,” Kickstarter-esque intermediaries that can ensure a minimum level of diligence so people who are already underwater on their mortgages don’t withdraw their last $3,000 hoping to score big enough to take care of their grandchildren.

Regulatory agencies have until January to write the rules for the portals, and the deadline will likely be extended. Still, portals are already popping up. Crowdfunder, EarlyShares, FundRazr and PleaseFund.us have all already been certified under the nascent Crowdfunding Accreditation for Platform Standards, or CAPS, a program developed by the independent website Crowdsourcing.org. WeFunder, a Boston-based portal, launched two months before the law was passed, with nothing more than a homepage and an online petition addressed to Congress. The site has remained essentially frozen since then. “Soon, you’ll be able to invest as little as $100 in your favorite startups,” it says.

Mike Norman, one of WeFunder’s four founders, acknowledged that he already has competitors in a market that does not yet exist. “You need to get it right,” he said. “There are a lot of folks who are going to try to get into this and it’s not going to go well. A small subset will really rise to the top.”

There are now more than 450 sites offering donation-based crowdfunding or perks-based crowdfunding à la Kickstarter, where the writer Bret Easton Ellis just financed his new film, The Canyons. (Backers who pledged $1 got a digital poster; those who pledged $3,000 or more get to work out with Mr. Ellis and his personal trainer for a week.) This type of crowdfunding has been around for more than a decade but has rapidly accelerated in the last three years, financing multiple multimillion-dollar projects.

But the hype around perks-based crowdfunding is nothing compared to the hype around equity-based crowdfunding. There are at least 100 portals in various stages of development, estimated Vince Molinari, founder of New York-based Gate Technologies, a broker-dealer that plans to provide services to the new portals. “I heard as high as 200,” he said, although “there will be some attrition because of the timeline.”

Maybe it’s the yearning for hope in a desperate economy, or maybe it’s some vestige of post-Occupy Wall Street popular empowerment. Maybe it’s just the glitz of The Social Network and the fact that half the hipsters in Dumbo have quit their bands to do a startup. Fred Wilson of Union Square Ventures, perhaps the best-known early-stage venture capital firm in New York, imagines the market for equity-based crowdfunding could come in around $300 billion. The category has the potential to put some traditional venture capitalists out to pasture—or worse, he joked, drive them into blogging.

“Philosophically, I think it’s wonderful,” said Slava Rubin, the founder of Indiegogo, a crowdfunding platform that, like Kickstarter, rewards backers with perks, not equity. Mr. Rubin, who splits his time between New York, San Francisco and conference keynotes, was also invited to the White House for the signing, although Indiegogo is still evaluating whether to get into the equity-based crowdfunding businesses.

Indiegogo just raised $15 million from venture capitalists for the old kind of crowdfunding, so Mr. Rubin feels no pressure to jump into the new kind. “It’s hard to decide anything when you don’t have the facts yet,” he said. “I think it’s really interesting that so many people are trying to figure out exactly what’s going to happen.”

(Kickstarter cofounder Perry Chen has said Kickstarter will stick to rewards-based funding. "We’re not gearing up for the equity wave if it comes. The real disruption is doing it without equity," he said recently in an interview with GigaOM.)

First, the SEC must finalize the rules for disclosure and advertising, and untangle what accredited and unaccredited investors will be allowed to do on the new portals. (The first thing the agency did was ask for public comment on the proposed rules.) Then the Financial Industry Regulatory Authority must write its own rules for portals. Until that happens, equity-based crowdfunding is illegal, the SEC has said.

There is some concern that the commission will suffocate the new industry. “The SEC is a regulatory body, so they get paid to regulate. They don’t really get paid extra money for not regulating,” Mr. Rubin said. “I’m actually quite surprised this is happening.”

Still, most equity crowdfunding proponents are careful to pay homage to the SEC, wary of accusations that equity-based crowdfunding will open the door for widespread ripoffs. As an investment, few things are riskier than a startup. The Washington State Department of Financial Institutions is already worried, issuing a press release after the JOBS Act passed: “When you see an offering on the Internet—whether it is on a crowdfunding portal, in an online newsletter, on a message board or in a chat room—you should assume it is a scam until you have done your homework and proven otherwise.”

Equity-based crowdfunding is already legal in the U.K., where the rules amount to basically “buyer beware.” Kickstarter, Indiegogo and other perks-based crowdfunding platforms have had low levels of fraud despite a firm “caveat backer” approach, and scams that do slip through are often detected right away.

Internet sleuths discovered at the end of April that a video game project raising $80,000 on Kickstarter was ripping off other artists’ work (and was likely manned not by a team of 12 industry veterans, as it claimed, by just one young man with no experience building video games). Although the project’s creator initially protested that the game was “well in progress and is NOT a scam of any kind,” the story spread from forum to forum and eventually reached his former employer, who started emailing journalists. Within 24 hours, the would-be entrepreneur canceled the campaign and disappeared.

Last year, venture capital firms invested $41 million in a social network called Color that was declared an immediate failure after botching its highly-publicized launch. Color went into hiding, reemerged about eight months later as a video app for Facebook and is unlikely to ever make money. Scores of startups that went through the elite accelerators at Y Combinator and TechStars, which accept between one and three percent of applicants, fail every year. Even Mark Cuban lost money on Facebook.

It's true that crowdfunding can test whether there is a market for an idea and provide an evangelical base of early users. But given the dubiousness of companies that are already being professionally funded, we’re in for a spate of boneheaded startups now that Joe Blow, MBA, can blast an email out to his frat brothers and hustle up $500,000 for the world’s first unmanned fast-food delivery drone.

As it turns out, overambitious projects are more common than outright scams on Kickstarter. Eco-friendly sandals, artsy-looking jellyfish tanks and a $100 pen made by a Brooklyn design studio all disappointed backers by failing to meet expectations, or simply never delivering a finished product at all. The equity crowdfunding provision passed in part on hopes that it would create jobs. It’s worth remembering that when the economy is bad, fraud tends to spike—and so do sales of lottery tickets.

Frank Mazzola

It looks like the Securities and Exchange Commission's yearlong investigation into trading private shares on the secondary market may finally be coming to a close.

Yesterday afternoon, Bloomberg first reported that the SEC is preparing to bring civil charges against Felix Investments, a Wall Street broker-dealer perhaps best-known for its twin funds Facie Libre 1 and Facie Libre II–meaning face book in Latin. "The firm is expected to be accused of violating securities laws related to soliciting investors," DealBook wrote in a follow-up, adding that Felix "aggressively accumulated" and actively promoted shares of companies like Facebook and Twitter, going as far as to cold-call Facebook employees to try to get them to sell.

The SEC is also reportedly "nearing a settlement" with SharesPost, an online platform for selling private shares.  "Regulators had expressed concern that SharesPost was not registered as a broker-dealer when it began facilitating trades in private company shares in 2009," noted DealBook.  SecondMarket, a SharesPost competitor which registered as a broker-dealer early in its history, however, "is not the subject of an SEC inquiry," spokesman Mark Murphy told Betabeat.

The irony here, of course, is that the SEC's action comes as many of the companies that were actively traded on the secondary market, like Groupon, Zynga, and LinkedIn have already gone public. In the wake of Facebook's S-1 filing, for example, some wondered about the future of SecondMarket. A yearlong investigation seems par for the course of glacially-paced federal authorities like the SEC, who didn't start sending out letters about "pre-IPO pooled investments" to Facebook, SecondMarket, and the like until late December, 2010, long after anxious headlines about bubbilicius valuations and the frenzy to invest.

Of the two potential results of the investigation, the potential civil charges facing Felix Investments appear to be more serious. A number of news outlets have exposed emails from the firm, which DealBook once described as "not part of Silicon Valley’s elite." The emails show the firm engaging in comically aggressive sales tactics. Take this snippet, posted by CNBC, regarding a “special purpose” secondary fund called Pipio Associates 1 LLC (Latin for tweet) also set up by Felix:

"If you do not own stock in Twitter already it is a must. If you already own Twitter you need to add to your position.”

A source familiar with the industry called Felix's solicitation brazen. “It’s the Boiler Room type thing, ‘You gotta get it on now! The price is going up tomorrow,'" said the source. "They were just blatantly violating some of the securities rules. Honestly, Felix is just on another level. What they were doing was so egregious and obvious.”

Felix doesn't agree, which means the SEC should be prepping for a fight. As DealBook reports, Frank Mazzola, Felix's chief executive, did not back down when he received notices from the SEC and FINRA last year.

In Finra’s report, Mr. Mazzola said he believed that “he acted appropriately at all times” and that he would “aggressively defend himself in this matter.”

The rumored settlement with SharesPost seems likely to go smoothly. SharesPost managing director of transaction services Tim Sullivan emailed Betabeat last month to say that SharesPost received its broker-dealer approval from the Financial Industry Regulatory Authority (FINRA) on January 3rd of this year, although the company says the registration went through on December 14th.

Registered broker-dealers are prohibited from doing things like showing pricing, said a source, because that implies you're trying to attract new buyers and goes against rules about general solicitation. SharesPost used to list still lists pricing on their site, as well as the logos of startups like Facebook.

UPDATE:Another source familiar with the situation reached out to Betabeat to confirm that SharesPost is indeed nearing a settlement with the SEC expected "in short order."

"The specific area of inquiry was centered around whether the company should have been a broker-dealer," confirmed the source. Prior to getting FINRA approval, SharesPost was using third-party broker-dealers for transactions, the source explained. While DealBook reported that Felix Investment received a Wells Notice (typically a sign that the agency is planning enforcement proceedings) from both the SEC and FINRA, the source says SharesPost did not receive a Wells Notice. "The investigation [into SharesPost] was not a result of any customer complaint or result of any securities fraud, it only centered around whether the company was a broker-dealer," said the source.

As to why SharesPost didn't seek to register itself as a broker-dealer earlier, the source thought it had to do with the fact that existing "regulations were unclear."

The source also said that SharesPost continues to list pricing, historical pricing and logos of startups whose shares are traded on its exchange because, "Information is power." Those specific concerns, added the source, were not part of the SEC's inquiry.

Meanwhile, SecondMarket, arguably the highest-profile company in the space, has managed to stay out of the fray. In a statement to Betabeat, the company attributed it to spending significant resources to make sure its playing by the rules:

"The private companies, buyers and sellers that utilize SecondMarket trust that we understand and comply with the regulatory framework governing secondary transactions.  SecondMarket is a FINRA-registered broker-dealer and SEC-registered alternative trading system.  Our top-notch legal, compliance and operations teams, which include former regulators, ensure that we correctly follow the relevant rules and regulations.  For the secondary market to continue to prosper, it's important that all market participants act honestly and follow the rules."

But that doesn't mean SecondMarket has remained entirely unscathed. As we told you last year, Felix Investments filed a suit against SecondMarket for a failed attempt to buy 75,000 Facebook shares from one of its software engineers. Although the engineer returned the purchase price back to Felix, the firm sued for damages based on Facebook's current valuation, rather than the valuation at the time it tried to buy the shares. We're guessing if you're sending emails like this to "accredited" investors, you'd be motivated to sue too (emphasis ours):

“We have Facebook stock at $34 which implies a market cap of about $74 billion. They will file on Tuesday "we believe" and price the IPO in May in the mid $50's and we believe the stock will be north of $100 when we can sell in November. If we are wrong here and are disappointed with the transaction it will be because we only doubled our money - which would be a major disappointment but a highly unlikely one in my opinion! Let me know if you have an interest. We had $10 million and have about $2 million left."

SecondMarket has filed a motion to dismiss the suit and is currently waiting for a ruling.