Online crowdfunding for small investors is an industry chomping at the bit to race but it can’t go full tilt until federal regulators approve the final rules. Figuring out how to regulate or insure the risks of small businesses raising money from small investors online is taking longer than anticipated.

The JOBS (Jumpstart our Business) Act of 2012 was written to make it easier for small businesses wanting to raise money and small investors wanting to invest without hassle to get together. It seeks to give equity crowdfunding a push by exempting some transactions from various securities laws and registration requirements.

The crowdfunding industry, which has grown 1,000 percent in the last five years, was expected to grow 92 percent this year with help from the JOBS Act, adding 270,000 jobs and injecting more than $65 billion into the economy, according to crowdfunding platform Fundable.com. The site also predicts crowdfunding will eventually contribute $500 billion in funding per year, generate $3.2 trillion in economic value and create more than 2 million new jobs by 2020.

“The concept was to increase capital raising for small business. If they can raise capital they can hire more people and create more jobs,” said Ty Sagalow, president of Innovation Insurance Group, a consultant firm that works with the insurance industry on developing products. “[Currently] if you want to raise money from the public through an IPO, there are a lot of hoops to go through and it is very expensive and deals with multiple filings. It’s not for the weak of heart.”

Crowdfunding has been around for a while in the form of sites seeking charitable contributions. Websites including Indiegogo and Kickstarter serve as donation portals for small businesses or individuals soliciting donations for a new business, merchandise, or TV/film project. They offer incentives including named recognition, t-shirts or tote bags, or the physical item itself to contributors. The JOBS Act looks to modify and capitalize on this crowdfunding model by soliciting investments from financial backers rather than donations.

Currently, equity crowdfunding is not at a complete standstill. The Securities Exchange Commission (SEC) has already opened crowdfunding to accredited investors – that is sophisticated investment companies, banks, or nonprofits with assets exceeding $5 million, and individuals with a net worth more than $1 million or an annual income exceeding $200,000.

But rules for the section (Title III) that would open up crowdfunding to less affluent individuals and so-called non-accredited investors remains a work in progress. This is the population of investors crowdfunding advocates believe can make a big difference for small businesses.

The SEC’s proposed rules would set caps to protect non-accredited investors. There would be one set of investment limits ($2,000 a year or five percent of income or net worth) for non-accredited investors with annual incomes or net worth less than $100,000, and another set of limits ($100,000 a year or 10 percent of income or net worth) for non-accredited investors with net incomes of more than $100,000.

Under the JOBS Act, businesses can raise up to $1 million from non-accredited investors through crowdfunding, but no more.

But until the SEC issues final Title III regulations, the full promise of the JOBS Act and crowdfunding for small businesses and investors remains unfulfilled. Insurers, most states, investors, operators of crowdfunding portals, lawmakers and small businesses are all waiting on the final regulations.

“The notion that these small companies can go without oversight to the public and raise $1 million is a scary thing to the SEC,” says Sagalow. “No one was surprised it has taken them so long to come up with implementing regulations.”

The JOBS Act called for the SEC to implement rules for Title III within 270 days of enactment, which was April 5, 2012 when President Obama signed the measure into law. The SEC issued its proposed regulations in October, 2013 and is expected to finalize the rules sometime this fall.

Some states have gotten ahead of the SEC with equity crowdfunding because of an SEC exemption that allows in-state crowdfunding. Twelve states– Alabama, Colorado, Georgia, Idaho, Indiana, Kansas, Maine, Maryland, Michigan, Tennessee, Washington and Wisconsin – have passed laws allowing equity crowdfunding and adopted their own crowdfunding regulations. Eleven other states, including North Carolina and California, are in the process of following their lead, according to crowdfundinsider.com. A few states are even changing the rules and allowing higher crowdfunding amounts.

The catch is that crowdfunding deals in these states are restricted to intrastate investors only, at least until federal regulations are imposed.

Insurers, uncertain over the risks of crowdfunding and the demand for protection, are for the most part on the sidelines waiting and watching.

However, there is one insurance jockey ready to go. John Vassilliw is an insurance veteran with 30 years of experience in the insurance industry including as a former vice president of AIG working in product development for the Financial Guarantee Division and currently as president of Walnut Street Brokerage Co. in New York.

He says he has already designed a crowdfunding insurance product called Investors Security Fraud Bond and has been trying to find an insurer willing to back him for more than a year.

“Everyone’s afraid in this industry to create,” he says. “They don’t want to be the first and they don’t want to think it through.”

Vassilliw says his Investors Securities Fraud Bond protects investors contributing to equity crowdfunding campaigns. It works as a first party policy where the company that is issuing the stock buys the coverage on behalf of the investors through a trustee. It is not a liability policy. The bond provides protection to investors in the buying or selling of securities in the event of securities fraud, mail fraud or wire fraud and the inability to collect under a court order. The business risk of the investment is not covered under the fraud bond.

For fraud bond issuance, the company must also have directors and officers insurance, which will provide the directors and officers with coverage for allegations of fraud and is an underwriting requirement of the coverage.

The anticipated premium cost for a three year non-cancelable policy is three to four percent of the amount being raised with limits up to the full value the company is raising ($1 million per year under the JOBS Act with a congressional proposal to raise the limit to $2 million) plus reimbursement of legal fees up to 15 percent of the limit.

Vassilliw says the coverage would provide peace of mind to investors and help crowdfunding entities and portals prove their legitimacy, but so far he has yet to find a carrier willing to take on the risk in this emerging industry.

“The Investor Securities Fraud Bond could be very important for getting crowdfunding off the ground,” he says. “I’ve been to every market out there and have been working on it for over a year. No one in the industry wants to offer it.”

For now, his product is “business process patent pending,” meaning Vassilliw has applied for a patent for the process and the policy with the U.S. Patent Office.

Insurance Industry Reaction

Insurers hesitation with crowdfunding is in part because it blurs the line between public and private companies, according to Kevin LaCroix, vice president of RT ProExec in Beachwood, Ohio, and author of the dandodiary.com, a blog that focuses largely on securities and directors and officers issues.

“From an intellectual standpoint it makes carriers uncomfortable and nervous because it doesn’t fit comfortably in either bucket...Private company insurers would not expect to have exposures from federal securities liabilities,” he says. “That is something the carriers are unsure about and most are waiting to see what happens.”

LaCroix says the main exposure for this class is directors and officers liability, but the equity crowdfunding entities are likely to be very small enterprises.

“We are really talking about start-ups and companies in the initial stages – will those even buy D&O insurance?” he asks. “Then there is the question of how real is the liability exposure? How frequently will the directors and officers be held accountable under the securities laws? All of that lies ahead and is yet to be known.”

While crowdfunding hasn’t been an issue for his clients yet, LaCroix has seen several insurers address the issue. Chubb added a JOBS Act Endorsement that insures securities offerings created through crowdfunding to its ForeFront Directors & Officers and Entity Liability insurance policies. Another carrier, which he declined to mention, is developing a similar product. LaCroix says he also knows of at least one company – Monitor Liability Managers – that has excluded coverage for crowdfunding under the JOBS Act, but Monitor would neither confirm nor deny if this is the case when contacted.

Something else to consider is that unless insurers are specifically excluding crowdfunding under D&O policies going forward, they may be unwillingly covering it, says Innovation Insurance Group’s Sagalow.

“Carriers have not put a lot of time into this yet because they are all waiting on the SEC and they haven’t completely thought through how their current D&O policy applies to crowdfunding,” he says.

What’s Next?

One stipulation of the crowdfunding securities exemptions is that issuers must use the services of an intermediary that is either a broker or funding portal registered with the SEC. The portals are to be used only to collect investments on the crowdfunding entities behalf. They may not solicit purchases, sales or offers to buy securities; compensate employees, agents, or other persons for such solicitation; hold, manage, possess, or otherwise handle investor funds or securities.

These crowdfunding portals are also required to become members of an Exchange Act registered national securities association.

The National Crowdfunding Association is one group that formed in 2012 after the passage of the JOBS Act to advance equity crowdfunding and has yet to go live. David Marlett, founder and executive director of the NLCFA in Dallas, says there is frustration among those who have put money into building crowdfunding portals and services.

“There are a lot of portals that have come and gone and people wanting to serve this industry and they are all still waiting,” says Marlett.

A 2013 report from the World Bank titled “Crowdfunding’s Potential for the Developing World” had the number of crowdfunding investing portals in the U.S. at 344, which was significantly more than any other country in the world – the second highest was the United Kingdom at 87, followed by France at 53. A list of 21 crowdfunding portals on crowdedmarket.com indicates that at least 15 are interested in or plan to participate in equity crowdfunding once the JOBS Act Title III legislation is passed.

In the meantime, other countries have long passed the U.S. in accepting and utilizing equity crowdfunding successfully. They include Canada, Italy, Sweden, the U.K., and New Zealand. In 2012, crowdfunding had raised nearly $2.7 billion globally through all business models, according to the World Bank Study.

Vassilliw also started a group called the American Crowdfunding Investment Association back in 2012. It has yet to become fully operational or solicit members. Vassilliw also maintains a website, cfabstracts.com, where he provides information on crowdfunding insurance exposures and needed coverages for crowdfunding entities, portals and investors.

Vassilliw says there have been few incidents of fraud so far in other countries offering equity crowdfunding, and the insurance industry should look at the economic and business successes as examples of what is possible.

“Crowdfunding will be very significant for the economy,” he says. “Offering [crowdfunding insurance products] is a good promotion for an insurance company because it shows they are helping small businesses grow in a stagnant economy.”

Marlett agrees and says it will take an insurer willing to think outside of the box push to this insurance market forward.

“I hear a lot ‘It doesn’t make sense for us’ and maybe it doesn’t now but it’s a brave new world and it will take something that hasn’t been thought of,” he says. “Crowdfunding doesn’t fit in the public or private company boxes and that’s where the innovative thinking has to come in – forget the old boxes and ask ‘Is there a new box I can create?’”