Securities laws, in general, have never been absolute in the United States. When companies offer stock or other securities to purchasers, the broad rule is that "you can offer anything you want, even something junky, so long as you disclose all material elements associated with the offering such that a reasonable investor can make an informed decision in deciding to purchase it." In other words, there is no all-seeing, all-knowing authority supervising the process who declares that the offering is substantively sound. It may or may not be. All that is required is that the issuer meet the requirements imposed by securities laws for disclosing all material facts relating to the investment. That is what the registration statement does in a public offering. And that is all it does. If that is done, and junk is offered, and the public wants to buy junk, the securities laws permit this.
Even respecting disclosure, though, the U.S. securities laws have always tempered the burdens associated with making detailed disclosures of the type required in a registration statement with important rules saying, in effect, "we as regulators realize that requiring companies to go through a multi-million process just to offer their securities to investors is too much and therefore we will exempt a broad number of categories from the registration and detailed disclosure requirements to enable small companies to offer their stock for sale as well." That premise underlies a whole range of securities law "exemptions" that permit small offerings, etc. so that companies can grow and develop without choking on process. The ultimate exemption under federal law is Section 4(2) of the Securities Law of 1933, which basically exempts private placements from the burdens of going through the registration process. Section 4(2) has been around forever and has no formal requirements. It simply provides that anything that is a true private placement, as opposed to a public offering, is exempt. Because the assessment of what is a private versus a public offering turned on detailed facts and circumstances, and this in turn led to substantial uncertainty and lots of litigation (is an offering made to 20 people "public"? how about if you don't know them? how about if you advertise the offering to get them interested? how about if they are small, unsophisticated investors?), the ultimate exemption - or, more accurately, "safe harbor" that assured an issuer that an offering would be exempt - was Regulation D, adopted by the SEC in 1982 and widely used by startups ever since that date to make tons of private placements that have been streamlined, simple, and cost-efficient ways of offering their stock to investors.
As is apparent from the above, the securities laws have always sought to strike a balance between imposing regulatory requirements (and burdens) that are aimed at protecting investors, on the one hand, and moderating the burdens so imposed to facilitate capital formation for situations where it makes no sense to impose needlessly burdensome requirements on small issuers and where less burdensome, fallback protections can be used instead of the full panoply of protections that apply to larger-scale offerings. By definition, this means that U.S. securities laws have always recognized a trade-off between having strong regulatory requirements aimed at investor protection, on the one hand, and lessening such requirements for some situations so as to give practical routes for capital formation for companies unable to meet the rigorous requirements. At many points along the way, the legislators who pass such laws and the regulators who administer them make multiple social policy judgments saying, in effect, "this is a situation that calls for the maximum protections but this one will leave investors fairly protected with more minimal protections in place." That is why it costs many millions of dollars to do the legal and accounting work to take a company public but only a couple of thousand to issue stock in a new corporation and only a few tens of thousands to raise a few million in a Series A private placement. The law is designed to accommodate the practical needs of companies that want to raise capital. Securities laws don't vanish in the private placement context. They simply impose far fewer requirements aimed at investor protection and all the more so when investors are presumed to have a strong ability to protect their interests (this is why offerings are often limited to "accredited investors," i.e., high net-worth or high income individuals, among others).
The JOBS Act is a piece of legislation that takes the rather burdensome accounting requirements first imposed by Sarbanes-Oxley on all publicly traded companies - and adding $1M+ in annual costs to even the smallest issuer in order to attain regulatory compliance under those rules - and exempts a set of relatively smaller publicly-traded companies from having to comply with those requirements for a 5-year ramp-up period after first going public. This part of the Act says, in effect, "we realize that the IPO market has been moribund ever since SOX was enacted and, because part of the reason is the heavy regulatory burdens imposed by SOX, we will seek to encourage more IPOs by giving issuers more incentive to go public without having to face huge expenses right out the gate." Now, this social policy judgment made by Congress may or may not be sound. But it is a policy judgment declaring that the SOX rules are just too much for relatively small companies just going public and therefore should be relaxed for such companies in order to enable them to realize their practical goals of going public, building momentum, and only later having to comply with the full SOX rules. One can question this judgment but one cannot question that it falls squarely within the pattern and practice of U.S. securities laws as implemented for decades. It is always a trade-off between optimum investor protections and practical limitations on such protections in the name of letting legitimate capital formation get done. Will this "legalize fraud," as suggested in this piece? I doubt it. The SOX rules have a short history and securities laws go back to the 1930s, more or less ably protecting investors during their long tenure before SOX took effect. Such protections will continue to exist for offerings made by these small issuers who will get some interim relief from SOX requirements. One can argue that it is bad policy to afford such relief. But to suggest that it "legalizes fraud" is to absurdly overstate the case.
The JOBS Act similarly loosens requirements for crowd-funding, for enabling private companies to have larger numbers of shareholders before having to register as publicly-traded companies, and for other contexts as well. On balance, it is aimed at promoting more effective capital formation by loosening otherwise strict SEC rules when new conditions warrant. This, to me, is very good for startups and the Act as a whole should, in my judgment, lead to many excellent results. That is why it has received almost uniform and very strong support from pretty much the entire startup community. It does not legalize fraud. It strikes a classic balance between formal investor protections and real-world practicalities. If the balance proves wrong, nothing will stop Congress from pulling back. In the meantime, let's see if crowd-funding can be used to give us new ways of raising capital and if the IPO market can't be rejuvenated after a long dead spell. The Act stands to benefit startups in major ways and, though not exempt from criticism, is by no means some radical departure away from investor protection under U.S. securities laws. On the contrary, it stands squarely within the traditions of those laws and is a good example of precisely how such laws have been implemented for many decades.
So, this is obviously a great comment, but two responses:
* The SOX requirements that capped the first Internet bubble clearly retarded tech company IPOs, so that only companies with (say) more than 60MM/yr cash-flow-positive revs could consider IPO'ing. The net effect of that for startups is negative: it virtually eliminates one previously available path to liquidity. But the net effect of that to society has been to transfer a lot of risks that were previously borne by the public markets to private equity and VC. Is that a bad thing?
In other words: yes, way fewer IPOs. But also much higher quality IPOs. Even Groupon is superior in many ways to companies that managed to IPO towards the end of the first bubble. Also: companies without a clear path to acquisition are forced to adopt business models that distribute profits to owners (else why run the company). The end result of that might be pretty positive.
* The Crowdfunding provision in the act clearly doesn't "legalize fraud". That's a hyperbolic claim. But is it hyperbolic to say that it simplifies and eases fraud? Especially if the Crowdfunding disclosure and capital restriction rules place Crowdfunding in a "worst of both worlds" situation in which shady (or just incompetent) companies find it productive to raise from crowds, but valuable companies get fed to insiders at VC funds.
I enjoyed your lengthy comment but you are being selective in the historic context you provide.
In a nutshell, you show how private placements got exempted from certain securities regulations, how those depression-era exemptions were expanded in the 1980s leading to "tons" of new activity, and how those exemptions may now be expanded further, making startups very happy.
What you leave out is that federal investment-activity standards have been shown by recent history to be wholly inadequate. You leave out the recent financial meltdown, a direct result of replacing 1930s era banking regulations with looser laws in the 80s and 90s. And you leave out the dot-com collapse, caused by dubious IPOs of the sort that SOX -- which JOBS would partially repeal -- was subsequently designed to counter.
This context is vital. The aggressively deregulatory JOBS act comes st a time when our regulatory framework has been exposed as woefully inadequate, in the midst of quickly ballooning tech valuations, and as we are seeing financial misstatements already from companies like Groupon that went public under the old, supposedly over-regulatory regime.
So yes, we should consider the historical context around the JOBS act. And I'd choose a vastly different frame than you have: Financial regulations designed to prevent bubble-depression cycles have been steadily stripped away since the 1930s, leading directly to the collapse of our economy in 2008 and the ensuing malaise. Now the JOBS Act proposes to strip these standards down even further.
Long, but you failed to cover the consequences for the single most critical point of this Act: rollback of independent accounting requirements.
No other developed nation in the world would even consider such a fundamental change to public offerings. In the financial world, i.e. financial startups, this would be a direct invitation for fraud, guaranteed.
Also, given how much you have quoted from history, you all of all people must recognise the opportunity cost and consequences from bad legislation is irrecoverable and it itself sets off a chain of other events that in turn are irrecoverable. That is, entropy applies to all systems and that this sentence, "nothing will stop Congress from pulling back" is completely missing the point in terms of damage potential. You do not just "try" new laws, you learn from your mistakes and make sure you put into place only that which causes least harm at the minimum.
Be sure that if this classic Anglo-American capitalist, short-termist legislation is applied, it will do at least as much harm to the startup scene (of all types, not just technology) as the previous boom-and-bust did. It is precisely the kind of legislation and groupthink that creates enormous financial bubbles and will eventually have an impact on completely ordinary people, but not the sharpest of investers, bankers and most of all, lawyers - "just" the rest of us.
Note. None of the large or most powerful technology companies that exist today were formed during such periods of destructive wealth creation.
Turning it from a skilled game of picking stock into a skilled game of avoiding disclosure.
I didn't know that "Florida Swamp Land Inc" was a bad buy. Although it was promoted by a wholly owned subsidirary company that I actually work for from the same desk in the same office - but our internal rules mean that I didn't know that I knew that when I was working for the selling company.
In case you are concerned here is a report from an independent ratings agency that we pay to say this - and coincidentally I also own and work for.
The act allows mom and pop to invest with little or no "burdensome" ongoing disclosure. I run a startup and would love to have their cash, but the sharks will get it instead.
Instead of doubling down on opacity, Congress should take a leaf from the non-profit industry. There, at least everybody's tax return (Form 990) is available for public inspection. Some of them are very illuminating. Even just that would be a better start than this.
The idea that continuous disclosure has to be burdensome is a relic from the past. You want to raise money from my mom? Let me monitor your Quickbooks online account.
III. Requirements on Issuers
(A) name, legal status, address, website, etc.
(B) names of directors, officers, and 20% stockholders
(C) “a description of the business of the issuer and the anticipated business plan of the issuer” – the devil is really in the details of this one, and it remains to be seen whether the SEC will require this “description” to be 4 pages or 40 in order to be sufficient
(D) prior year tax returns, plus financials – see below for details
(E) description of intended use of proceeds
(F) target offering amount, deadline, and regular progress updates through the life of the offering
(G) share price and methodology for determining the price
(H) a description of the ownership and capital structure of the issuer, including a lot of detail about the terms of the securities being sold, the terms of any other outstanding securities of the company, a summary of the differences between them, a host of disclosures about how the rights of shareholders can be limited, diluted or negatively impacted, “examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions”, and a disclosure of various risks to investors
II. Requirements on Intermediaries
The JOBS Act requires crowdfunding intermediaries to register with the SEC, either as a broker (which is an expensive and onerous process), or as a new thing called a “funding portal”. Funding portals will also be required to register with FINRA, the financial industry self-regulatory organization.
A) providing certain disclosures and investor education materials to investors
(B) ensuring that the investor has reviewed educational materials and answers questions indicating that he/she understands the risks involved
(C) performing certain background checks on the issuer
(D) provide a 21 day review period before any crowdfund securities are sold
(E) ensure that an issuer does not receive investment funds until its target investment minimum has been reached, and that investors may cancel their commitments to invest as provided by the SEC (no word yet on how these cancellation provisions are going to look)
(F) ensure that no investor surpasses the investment limits set forth above in a given 12 month period in the aggregate – i.e. the limits described above with respect to investors apply to all crowdfunding investments in a given 12 month period, not just to individual investments, and the burden is on the intermediary to monitor this
(G) take steps to protect the privacy of investors
(H) not pay finders fees to promoters or lead generators with respect to investors (it appears to be okay to pay finders fees for issuer leads)
(I) not allow the intermediary’s directors, officers or partners to have a financial interest in an issuer using its services
There are /plenty/ of disclosure requirements and more coming down the pike when the Commission is through drafting what else is required.
It is not like there is going to be a Kickstarter where people just start throwing money at random ideas with no way to check who and what they are investing in.
Yes, definitely. One of the really interesting things happening in the startup space right now is substantially increased transparency for advisors and investors. E.g.: https://www.leanlaunchlab.com/
On the other hand, there's a problem with publishing too much information: competitors. If for a modest investment I could buy access to the details of our compeitors' QuickBooks accounts and product plans, I'd do it in a heartbeat.
Still, I agree with your basic point; publishing information is so much cheaper and easier than in the past that we can shift radically in the direction of increased transparency without imposing significantly greater costs on businesses. If that increases the pool of capital available for innovation, society will be net better off.
Author of Rolling Stone piece is focussing on the JOBS act as an enabler for stock fraud. They don't seem to be clear on its alternate function of enabling Quickstarter-type ventures where what's being sold isn't stock in a company that is trying to bypass accounting norms for an IPO, but a one-off product development (like the movie "Iron Sky", or any number of items on Quickstarter). It's a totally different business model.
(Random example: let's say I, as an author, announce that I'm going to write and sell a book if I can get enough pre-purchases; let's set the gate at 10,000 readers willing to pony up $10 each in order to receive an ebook when I've written it, a year down the line. Right now, as I understand it, if I was in the US I'd be expected to undergo the same accounting procedures as a corporation prepping for an IPO because of the number of people involved -- which would make it a non-starter: the accountant's bill alone would exceed the total revenue, especially as writing a book is a one-off project. The JOBS Act is supposed to relax that requirement for the sort of venture I'm describing. But Taibbi doesn't seem to get this at all.)
I don't think product pre-orders are regulated like that. For the SEC to have some jurisdiction, I think you'd have to be promised a share of the company or the eventual profits.
I do think the JOBS Act has been touted as enabling Kickstarter-like things where you actually invest in the enterprise, though: money can be raised from small-net-worth individuals as long as the sums are modest.
everytime i browse kickstarter-like sites I keep wondering how that affect tax.
i'm buying a book from this guy, but it's not a product still, as he will work on it. but it's not service either, because i have no say on what he will write. and i will get a book in the end, so it's a product. unless he never get's to write it.
oh well, one more experience ruined by tax filling month paranoia.
Researching and writing about Goldman pushed Taibbi around the bend on anything having to do with finance.
A few tidbits:
Even worse, the JOBS Act, incredibly, will allow executives to give "pre-prospectus" presentations to investors using PowerPoint and other tools in which they will not be held liable for misrepresentations. These firms will still be obligated to submit prospectuses before their IPOs, and they'll still be held liable for what's in those. But it'll be up to the investor to check and make sure that the prospectus matches the "pre-presentation."
Oh my gosh - you mean before I invest my hard earned money I should read the PROSPECTUS. Say it ain't so.
Then he goes on to say:
In the same way, get ready for an avalanche of shareholder suits ten years from now, since post-factum civil litigation will be the only real regulation of the startup market. In fact, there are already supporters talking up future lawsuits as an appropriate tool to replace the regulations being wiped out by this bill.
Isn't "post-factum civil litigation" an even better mechanism for enforcement?
Look companies that are "bad actors" are going to cheat the SEC and the public anyway, and companies that aren't "bad actors" had to go through the additional expenses to comply with the SEC regs that have now been relaxed.
I would rather have motivated shareholders (and their lawyers) with an axe to grind policing the markets than bureaucrats. If you look at the job bureaucrats have done to date,the track record is not so great.
I understand why you'd be skeptical of Taibbi's vehemence; I often am. But I don't think you make a good case here.
Nobody's saying people shouldn't also read the prospectus. But if people can lie in the pitch and then get out of responsibility through an obscure note in the prospectus, more people will lie. It allows classic "the large print giveth and the small print taketh away" scams.
Civil litigation is a terrible method for enforcement. The longer the feedback loop, the more opportunity for things to go wrong. Short-sightedness is a defining characteristic of most scammers. And litigation will only happen when there's enough money at stake and the chances of recovery are high. Small investors are fucked from the start, as is anybody who gets taken by somebody who spends the money in ways where there's little to recover.
Also, your "bad actors" vs "good actors" thing is a total false dichotomy. Actors aren't the problem; it's actions. If you make it easier for "bad actors" to act, you will have more (and more severe) bad actions. Further, through competitive effects, you push everybody in the direction of bad actions.
> Isn't "post-factum civil litigation" an even better mechanism for enforcement?
Only if you prefer getting ripped off and then having to pay lawyers for ten or fifteen years to get back a tiny part of your losses to not getting ripped off in the first place.
> Isn't "post-factum civil litigation" an even better mechanism for enforcement?
No. The future shareholders of the offending company are the ones who pay. Thanks to corporate liability shields, the offending officers will get away.
> "Look companies that are "bad actors" are going to cheat the SEC and the public anyway, and companies that aren't "bad actors" had to go through the additional expenses[...]"
> Isn't "post-factum civil litigation" an even better mechanism for enforcement?
I'm completely in favor of more civil litigation, but I'm reminded of something Ronald Coase,[1] wrote half a century ago: "The fact that actions might have harmful effects on others has been shown to be no obstacle to the introduction of property rights. But it was possible to reach this unequivocal result because the conflicts of interest were between individuals. When large numbers of people are involved, the argument for the institution of property rights is weakened and that for general regulation becomes stronger." Ronald Coase, The Federal Communications Commission (1959).
In that paper he was talking about property rights in spectrum, but the principle is generalizable. Legal action is a great way for a few individuals to enforce claims against a few other individuals. When large numbers of peoples' rights are violated, however, general regulation becomes a more efficient mechanism for enforcement.
[1] An economist whose theories are a bedrock of modern conservative thinking.
> Isn't "post-factum civil litigation" an even better mechanism for enforcement?
That hasn't worked out well for Madoff's "investors".
> Look companies that are "bad actors" are going to cheat the SEC and the public anyway...
And Congress passed Sarbanes-Oxley to prevent future Enrons and WorldComms. HR 3606 repeals SOX for the first 5 years of an "emerging growth company" stock issuance and returns us to the "good old days" when fraudsters were able to run wild.
No after the fact litigation is usually a bad idea because by that time most of the money is gone. You will only get part of your investment and then you will have to pay about half of what you get to the lawyers. And that is if you are lucky. In most securities fraud the money is usually all gone by the time they catch the bad guy.
Furthermore, if you have a couple of bad high profile thefts, that would poison the water for the honest companies too.
As in most cases prudent prevention is better than punishment.
And by the way Taibbi's right. Allowing people to lie on presentations is always a bad idea and will always result in people lying in presentations.
Not only that but the required intermediaries for the crowdfunded companies will be required to do background checks, verification of financials...etc, etc. The details on what will be required, reporting wise, from these companies and the intermediaries that handle the crowdfunding are being worked out now.
I can guarantee it is going to involve a bit more than a powerpoint presentation.
I have a feeling that the JOBS act could actually be a very, very good thing if the right company (or, better yet, marketplace of companies) came around to offer a gateway service to these micro-investments.
Personally I would implement - or would purchase an account on - such a site where companies would advertise for investment, and would be required to provide a certain minimum of disclosure. The site would provide avenues for that disclosure (basically, a feed of reports issues by the companies themselves and perhaps also relevant news stories, a'la Google News) as well as investment portfolio tracking.
It would (still) be up to the user to verify the disclosure and make sure they are looking at companies that are disclosing the right quantity, quality, and purview of information - but the site would hopefully make it very clear what is and isn't being disclosed and how that compares to other companies.
Of course another key feature could be investor/analyst reviews, but this would need an extremely well-engineered system to prevent or discourage astroturfing & other social engineering schemes. Personally I doubt anything less than only allowing authenticated professional journalists (affiliated with reputable publications) could be acceptable, at which point you wonder about the real utility of such a thing.
I feel like this would make an excellent Startup, actually, and might do some work in that regard. I think step 1, though, is spending a lot of time reading about the ins and outs of the law. It would be very easy to grab a 'legal third rail' with both hands with this project and expose yourself to a lot of liability. I find that intimidating, but maybe not too much so.
Sounds like a free market version of a SEC regulated exchange. Not sure what the free market theory is for why it would be less susceptible to regulatory capture.
The law makes it easier for startup companies (particularly tech companies, whose lobbyists were a driving force behind its passage) to attract capital by, among other things, exempting them from independent accounting requirements for up to five years after they first begin selling shares in the stock market.
Now small businesses and producers can get financing from the crowd? I've been dreaming about this. Yet I really had no idea the jobs act was pushing it.
Whoever needs a developer partner to launch a crowd funder for private shares, hollar at me. I want to focus on local goods and manufacturing.
Haha. Honest startups are going to be at a disadvantage to those who make their projections on the back of a napkin.
We're honest as hell but if you invest based on the detailed and honest projections we made in the first five years and not more so on the team, market and other real data, you're an idiot.
Just discussed this bill with the head of a mid-size investment bank today. The crowd funding provisions are not really that important. He said that the most impact will be the reduction of disclosure requirements for emerging growth companies enabling them to raise up to $50 million rather than just $5 million.
It will mostly be institutional investors buying into even smaller size IPO shares -- these are savvy investors and the mania of the dot-com bubble has certainly not been forgotten.
The thing is there isn't really a huge market for these deals at the moment -- his bank specializes in deals of this size and I asked him if he thinks more mid-range banks will popup to serve this market and he said that probably not until the deal flow comes in.
The JOBS act really helps my company -- we're too far along for VC, but not far enough along for a public IPO. The post-VC, private equity market makes the most sense, but as you noted, the amount of money you can raise that way pre-JOBS act is far too low, making companies like mine (Pixar for live-action filmmaking) either at the mercy/generosity of a Steve Jobs-like figure (literally), or simply not funded at all since we exist in the Government-created financial no-mans land. Either is far from ideal.
The JOBS act, at least for our company, changes this and makes a previously non-viable-through-inadvertent-regulation company suddenly viable. That's why I supported it, and continue to do so.
I disagree with Taibbi on this one. Making it easier for startups to raise money does not equate to fraud on Wall Street. Yes, there are some who will take advantage. But it will also means that the engines of the economy, small businesses and startups will get a massive lift off.
In the end, you have to balance regulation with ease of doing business, raising capital, etc.
According to [0] "...new research by the Treasury Department finds that small businesses — defined as those with income between $10,000 and $10 million, or about 99 percent of all businesses — account for just 17 percent of business income, and only 23 percent of them pay any wages at all." It's pretty hard to argue that makes them the "engines of the economy."
Any investor that is worth their salt will do their own homework and come up with their own metrics for how they value a company.
The government should get out of the business of deciding what is appropriate for companies to report. As history has shown the government does a terrible job(Volt, Solar, etc.) of investing / guiding investments(mortgages).
Could an existing company take advantage of this by doing some new stock offering? They could put parts of their business behind this "wall" and operate unreviewed for five years. That's plenty of time to drain the coffers and set sail for a sunny island.
I'm no expert - but I did work part-time for a new business.
It was hard as heck to raise capitol. So much so that it was nearly not worth the effort. We spent as much, or more, time on investing than we did working.
At one point I was named as a defendant by one state for the content of an email I sent on behalf of the CEO.
We settled that, the boss got me removed from the thing, paid the fine. Paid the investor back his funds.
The investor took the money, went to his _other_ home across the state line, sent the money back.
It seemed like a lot of work on the part of the state regulatory branch - going after a small company for a negligible amount of money, on behalf of the sole investor from that state who really wanted to invest.
It sure soured me on the idea of taking any company I launch public.
As opposed to the fraud that IS the stock market today? (For the average person the stock market offers no return, the 20th century was good but now it is so efficient that any extra is skimmed off by the smarter hedge funds).
There is an overinvestment in the stock market today, the excess money needs to go somewhere so elsewhere, which for the past few years was the housing bubble. However housing is not a wealth producing exportable industry (and is already overinvested/iverpriced), and so the capital needs a new outlet - private equity (which includes venture capital). The fact that this investment option has been closed of to ordinary people is the real fraud (that has been occurring for 80 years now).
[+] [-] grellas|14 years ago|reply
Even respecting disclosure, though, the U.S. securities laws have always tempered the burdens associated with making detailed disclosures of the type required in a registration statement with important rules saying, in effect, "we as regulators realize that requiring companies to go through a multi-million process just to offer their securities to investors is too much and therefore we will exempt a broad number of categories from the registration and detailed disclosure requirements to enable small companies to offer their stock for sale as well." That premise underlies a whole range of securities law "exemptions" that permit small offerings, etc. so that companies can grow and develop without choking on process. The ultimate exemption under federal law is Section 4(2) of the Securities Law of 1933, which basically exempts private placements from the burdens of going through the registration process. Section 4(2) has been around forever and has no formal requirements. It simply provides that anything that is a true private placement, as opposed to a public offering, is exempt. Because the assessment of what is a private versus a public offering turned on detailed facts and circumstances, and this in turn led to substantial uncertainty and lots of litigation (is an offering made to 20 people "public"? how about if you don't know them? how about if you advertise the offering to get them interested? how about if they are small, unsophisticated investors?), the ultimate exemption - or, more accurately, "safe harbor" that assured an issuer that an offering would be exempt - was Regulation D, adopted by the SEC in 1982 and widely used by startups ever since that date to make tons of private placements that have been streamlined, simple, and cost-efficient ways of offering their stock to investors.
As is apparent from the above, the securities laws have always sought to strike a balance between imposing regulatory requirements (and burdens) that are aimed at protecting investors, on the one hand, and moderating the burdens so imposed to facilitate capital formation for situations where it makes no sense to impose needlessly burdensome requirements on small issuers and where less burdensome, fallback protections can be used instead of the full panoply of protections that apply to larger-scale offerings. By definition, this means that U.S. securities laws have always recognized a trade-off between having strong regulatory requirements aimed at investor protection, on the one hand, and lessening such requirements for some situations so as to give practical routes for capital formation for companies unable to meet the rigorous requirements. At many points along the way, the legislators who pass such laws and the regulators who administer them make multiple social policy judgments saying, in effect, "this is a situation that calls for the maximum protections but this one will leave investors fairly protected with more minimal protections in place." That is why it costs many millions of dollars to do the legal and accounting work to take a company public but only a couple of thousand to issue stock in a new corporation and only a few tens of thousands to raise a few million in a Series A private placement. The law is designed to accommodate the practical needs of companies that want to raise capital. Securities laws don't vanish in the private placement context. They simply impose far fewer requirements aimed at investor protection and all the more so when investors are presumed to have a strong ability to protect their interests (this is why offerings are often limited to "accredited investors," i.e., high net-worth or high income individuals, among others).
The JOBS Act is a piece of legislation that takes the rather burdensome accounting requirements first imposed by Sarbanes-Oxley on all publicly traded companies - and adding $1M+ in annual costs to even the smallest issuer in order to attain regulatory compliance under those rules - and exempts a set of relatively smaller publicly-traded companies from having to comply with those requirements for a 5-year ramp-up period after first going public. This part of the Act says, in effect, "we realize that the IPO market has been moribund ever since SOX was enacted and, because part of the reason is the heavy regulatory burdens imposed by SOX, we will seek to encourage more IPOs by giving issuers more incentive to go public without having to face huge expenses right out the gate." Now, this social policy judgment made by Congress may or may not be sound. But it is a policy judgment declaring that the SOX rules are just too much for relatively small companies just going public and therefore should be relaxed for such companies in order to enable them to realize their practical goals of going public, building momentum, and only later having to comply with the full SOX rules. One can question this judgment but one cannot question that it falls squarely within the pattern and practice of U.S. securities laws as implemented for decades. It is always a trade-off between optimum investor protections and practical limitations on such protections in the name of letting legitimate capital formation get done. Will this "legalize fraud," as suggested in this piece? I doubt it. The SOX rules have a short history and securities laws go back to the 1930s, more or less ably protecting investors during their long tenure before SOX took effect. Such protections will continue to exist for offerings made by these small issuers who will get some interim relief from SOX requirements. One can argue that it is bad policy to afford such relief. But to suggest that it "legalizes fraud" is to absurdly overstate the case.
The JOBS Act similarly loosens requirements for crowd-funding, for enabling private companies to have larger numbers of shareholders before having to register as publicly-traded companies, and for other contexts as well. On balance, it is aimed at promoting more effective capital formation by loosening otherwise strict SEC rules when new conditions warrant. This, to me, is very good for startups and the Act as a whole should, in my judgment, lead to many excellent results. That is why it has received almost uniform and very strong support from pretty much the entire startup community. It does not legalize fraud. It strikes a classic balance between formal investor protections and real-world practicalities. If the balance proves wrong, nothing will stop Congress from pulling back. In the meantime, let's see if crowd-funding can be used to give us new ways of raising capital and if the IPO market can't be rejuvenated after a long dead spell. The Act stands to benefit startups in major ways and, though not exempt from criticism, is by no means some radical departure away from investor protection under U.S. securities laws. On the contrary, it stands squarely within the traditions of those laws and is a good example of precisely how such laws have been implemented for many decades.
[+] [-] tptacek|14 years ago|reply
* The SOX requirements that capped the first Internet bubble clearly retarded tech company IPOs, so that only companies with (say) more than 60MM/yr cash-flow-positive revs could consider IPO'ing. The net effect of that for startups is negative: it virtually eliminates one previously available path to liquidity. But the net effect of that to society has been to transfer a lot of risks that were previously borne by the public markets to private equity and VC. Is that a bad thing?
In other words: yes, way fewer IPOs. But also much higher quality IPOs. Even Groupon is superior in many ways to companies that managed to IPO towards the end of the first bubble. Also: companies without a clear path to acquisition are forced to adopt business models that distribute profits to owners (else why run the company). The end result of that might be pretty positive.
* The Crowdfunding provision in the act clearly doesn't "legalize fraud". That's a hyperbolic claim. But is it hyperbolic to say that it simplifies and eases fraud? Especially if the Crowdfunding disclosure and capital restriction rules place Crowdfunding in a "worst of both worlds" situation in which shady (or just incompetent) companies find it productive to raise from crowds, but valuable companies get fed to insiders at VC funds.
[+] [-] mapgrep|14 years ago|reply
In a nutshell, you show how private placements got exempted from certain securities regulations, how those depression-era exemptions were expanded in the 1980s leading to "tons" of new activity, and how those exemptions may now be expanded further, making startups very happy.
What you leave out is that federal investment-activity standards have been shown by recent history to be wholly inadequate. You leave out the recent financial meltdown, a direct result of replacing 1930s era banking regulations with looser laws in the 80s and 90s. And you leave out the dot-com collapse, caused by dubious IPOs of the sort that SOX -- which JOBS would partially repeal -- was subsequently designed to counter.
This context is vital. The aggressively deregulatory JOBS act comes st a time when our regulatory framework has been exposed as woefully inadequate, in the midst of quickly ballooning tech valuations, and as we are seeing financial misstatements already from companies like Groupon that went public under the old, supposedly over-regulatory regime.
So yes, we should consider the historical context around the JOBS act. And I'd choose a vastly different frame than you have: Financial regulations designed to prevent bubble-depression cycles have been steadily stripped away since the 1930s, leading directly to the collapse of our economy in 2008 and the ensuing malaise. Now the JOBS Act proposes to strip these standards down even further.
[+] [-] drucken|14 years ago|reply
No other developed nation in the world would even consider such a fundamental change to public offerings. In the financial world, i.e. financial startups, this would be a direct invitation for fraud, guaranteed.
Also, given how much you have quoted from history, you all of all people must recognise the opportunity cost and consequences from bad legislation is irrecoverable and it itself sets off a chain of other events that in turn are irrecoverable. That is, entropy applies to all systems and that this sentence, "nothing will stop Congress from pulling back" is completely missing the point in terms of damage potential. You do not just "try" new laws, you learn from your mistakes and make sure you put into place only that which causes least harm at the minimum.
Be sure that if this classic Anglo-American capitalist, short-termist legislation is applied, it will do at least as much harm to the startup scene (of all types, not just technology) as the previous boom-and-bust did. It is precisely the kind of legislation and groupthink that creates enormous financial bubbles and will eventually have an impact on completely ordinary people, but not the sharpest of investers, bankers and most of all, lawyers - "just" the rest of us.
Note. None of the large or most powerful technology companies that exist today were formed during such periods of destructive wealth creation.
[+] [-] ricardobeat|14 years ago|reply
[+] [-] excuse-me|14 years ago|reply
I didn't know that "Florida Swamp Land Inc" was a bad buy. Although it was promoted by a wholly owned subsidirary company that I actually work for from the same desk in the same office - but our internal rules mean that I didn't know that I knew that when I was working for the selling company.
In case you are concerned here is a report from an independent ratings agency that we pay to say this - and coincidentally I also own and work for.
[+] [-] T_S_|14 years ago|reply
Instead of doubling down on opacity, Congress should take a leaf from the non-profit industry. There, at least everybody's tax return (Form 990) is available for public inspection. Some of them are very illuminating. Even just that would be a better start than this.
The idea that continuous disclosure has to be burdensome is a relic from the past. You want to raise money from my mom? Let me monitor your Quickbooks online account.
[+] [-] clavalle|14 years ago|reply
II. Requirements on Intermediaries
The JOBS Act requires crowdfunding intermediaries to register with the SEC, either as a broker (which is an expensive and onerous process), or as a new thing called a “funding portal”. Funding portals will also be required to register with FINRA, the financial industry self-regulatory organization.
A) providing certain disclosures and investor education materials to investors (B) ensuring that the investor has reviewed educational materials and answers questions indicating that he/she understands the risks involved (C) performing certain background checks on the issuer (D) provide a 21 day review period before any crowdfund securities are sold (E) ensure that an issuer does not receive investment funds until its target investment minimum has been reached, and that investors may cancel their commitments to invest as provided by the SEC (no word yet on how these cancellation provisions are going to look) (F) ensure that no investor surpasses the investment limits set forth above in a given 12 month period in the aggregate – i.e. the limits described above with respect to investors apply to all crowdfunding investments in a given 12 month period, not just to individual investments, and the burden is on the intermediary to monitor this (G) take steps to protect the privacy of investors (H) not pay finders fees to promoters or lead generators with respect to investors (it appears to be okay to pay finders fees for issuer leads) (I) not allow the intermediary’s directors, officers or partners to have a financial interest in an issuer using its services
There are /plenty/ of disclosure requirements and more coming down the pike when the Commission is through drafting what else is required.
It is not like there is going to be a Kickstarter where people just start throwing money at random ideas with no way to check who and what they are investing in.
[+] [-] wpietri|14 years ago|reply
On the other hand, there's a problem with publishing too much information: competitors. If for a modest investment I could buy access to the details of our compeitors' QuickBooks accounts and product plans, I'd do it in a heartbeat.
Still, I agree with your basic point; publishing information is so much cheaper and easier than in the past that we can shift radically in the direction of increased transparency without imposing significantly greater costs on businesses. If that increases the pool of capital available for innovation, society will be net better off.
[+] [-] cstross|14 years ago|reply
(Random example: let's say I, as an author, announce that I'm going to write and sell a book if I can get enough pre-purchases; let's set the gate at 10,000 readers willing to pony up $10 each in order to receive an ebook when I've written it, a year down the line. Right now, as I understand it, if I was in the US I'd be expected to undergo the same accounting procedures as a corporation prepping for an IPO because of the number of people involved -- which would make it a non-starter: the accountant's bill alone would exceed the total revenue, especially as writing a book is a one-off project. The JOBS Act is supposed to relax that requirement for the sort of venture I'm describing. But Taibbi doesn't seem to get this at all.)
[+] [-] wpietri|14 years ago|reply
I do think the JOBS Act has been touted as enabling Kickstarter-like things where you actually invest in the enterprise, though: money can be raised from small-net-worth individuals as long as the sums are modest.
[+] [-] leot|14 years ago|reply
[+] [-] DennisP|14 years ago|reply
[+] [-] el_presidente|14 years ago|reply
That's because, at this point in time, fraud should be the focus of anything related to the financial sector.
[+] [-] gcb|14 years ago|reply
i'm buying a book from this guy, but it's not a product still, as he will work on it. but it's not service either, because i have no say on what he will write. and i will get a book in the end, so it's a product. unless he never get's to write it.
oh well, one more experience ruined by tax filling month paranoia.
[+] [-] joeag|14 years ago|reply
A few tidbits: Even worse, the JOBS Act, incredibly, will allow executives to give "pre-prospectus" presentations to investors using PowerPoint and other tools in which they will not be held liable for misrepresentations. These firms will still be obligated to submit prospectuses before their IPOs, and they'll still be held liable for what's in those. But it'll be up to the investor to check and make sure that the prospectus matches the "pre-presentation."
Oh my gosh - you mean before I invest my hard earned money I should read the PROSPECTUS. Say it ain't so.
Then he goes on to say: In the same way, get ready for an avalanche of shareholder suits ten years from now, since post-factum civil litigation will be the only real regulation of the startup market. In fact, there are already supporters talking up future lawsuits as an appropriate tool to replace the regulations being wiped out by this bill.
Isn't "post-factum civil litigation" an even better mechanism for enforcement?
Look companies that are "bad actors" are going to cheat the SEC and the public anyway, and companies that aren't "bad actors" had to go through the additional expenses to comply with the SEC regs that have now been relaxed.
I would rather have motivated shareholders (and their lawyers) with an axe to grind policing the markets than bureaucrats. If you look at the job bureaucrats have done to date,the track record is not so great.
Read more: http://www.rollingstone.com/politics/blogs/taibblog/why-obam...
[+] [-] wpietri|14 years ago|reply
Nobody's saying people shouldn't also read the prospectus. But if people can lie in the pitch and then get out of responsibility through an obscure note in the prospectus, more people will lie. It allows classic "the large print giveth and the small print taketh away" scams.
Civil litigation is a terrible method for enforcement. The longer the feedback loop, the more opportunity for things to go wrong. Short-sightedness is a defining characteristic of most scammers. And litigation will only happen when there's enough money at stake and the chances of recovery are high. Small investors are fucked from the start, as is anybody who gets taken by somebody who spends the money in ways where there's little to recover.
Also, your "bad actors" vs "good actors" thing is a total false dichotomy. Actors aren't the problem; it's actions. If you make it easier for "bad actors" to act, you will have more (and more severe) bad actions. Further, through competitive effects, you push everybody in the direction of bad actions.
[+] [-] smacktoward|14 years ago|reply
Only if you prefer getting ripped off and then having to pay lawyers for ten or fifteen years to get back a tiny part of your losses to not getting ripped off in the first place.
[+] [-] luser001|14 years ago|reply
No. The future shareholders of the offending company are the ones who pay. Thanks to corporate liability shields, the offending officers will get away.
And oh, cure is better than prevention, right?
[+] [-] praptak|14 years ago|reply
Isn't it a universal argument against any law?
[+] [-] a3camero|14 years ago|reply
Groupon's is ~270 pages long: http://www.sec.gov/Archives/edgar/data/1490281/0001047469110...
[+] [-] rayiner|14 years ago|reply
I'm completely in favor of more civil litigation, but I'm reminded of something Ronald Coase,[1] wrote half a century ago: "The fact that actions might have harmful effects on others has been shown to be no obstacle to the introduction of property rights. But it was possible to reach this unequivocal result because the conflicts of interest were between individuals. When large numbers of people are involved, the argument for the institution of property rights is weakened and that for general regulation becomes stronger." Ronald Coase, The Federal Communications Commission (1959).
In that paper he was talking about property rights in spectrum, but the principle is generalizable. Legal action is a great way for a few individuals to enforce claims against a few other individuals. When large numbers of peoples' rights are violated, however, general regulation becomes a more efficient mechanism for enforcement.
[1] An economist whose theories are a bedrock of modern conservative thinking.
[+] [-] Tangurena|14 years ago|reply
That hasn't worked out well for Madoff's "investors".
> Look companies that are "bad actors" are going to cheat the SEC and the public anyway...
And Congress passed Sarbanes-Oxley to prevent future Enrons and WorldComms. HR 3606 repeals SOX for the first 5 years of an "emerging growth company" stock issuance and returns us to the "good old days" when fraudsters were able to run wild.
[+] [-] hristov|14 years ago|reply
Furthermore, if you have a couple of bad high profile thefts, that would poison the water for the honest companies too.
As in most cases prudent prevention is better than punishment.
And by the way Taibbi's right. Allowing people to lie on presentations is always a bad idea and will always result in people lying in presentations.
[+] [-] clavalle|14 years ago|reply
I can guarantee it is going to involve a bit more than a powerpoint presentation.
I don't know why they are spreading this FUD.
[+] [-] unknown|14 years ago|reply
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[+] [-] eblume|14 years ago|reply
Personally I would implement - or would purchase an account on - such a site where companies would advertise for investment, and would be required to provide a certain minimum of disclosure. The site would provide avenues for that disclosure (basically, a feed of reports issues by the companies themselves and perhaps also relevant news stories, a'la Google News) as well as investment portfolio tracking.
It would (still) be up to the user to verify the disclosure and make sure they are looking at companies that are disclosing the right quantity, quality, and purview of information - but the site would hopefully make it very clear what is and isn't being disclosed and how that compares to other companies.
Of course another key feature could be investor/analyst reviews, but this would need an extremely well-engineered system to prevent or discourage astroturfing & other social engineering schemes. Personally I doubt anything less than only allowing authenticated professional journalists (affiliated with reputable publications) could be acceptable, at which point you wonder about the real utility of such a thing.
I feel like this would make an excellent Startup, actually, and might do some work in that regard. I think step 1, though, is spending a lot of time reading about the ins and outs of the law. It would be very easy to grab a 'legal third rail' with both hands with this project and expose yourself to a lot of liability. I find that intimidating, but maybe not too much so.
[+] [-] guelo|14 years ago|reply
[+] [-] guelo|14 years ago|reply
[+] [-] hammock|14 years ago|reply
The law makes it easier for startup companies (particularly tech companies, whose lobbyists were a driving force behind its passage) to attract capital by, among other things, exempting them from independent accounting requirements for up to five years after they first begin selling shares in the stock market.
[+] [-] NHQ|14 years ago|reply
Now small businesses and producers can get financing from the crowd? I've been dreaming about this. Yet I really had no idea the jobs act was pushing it.
Whoever needs a developer partner to launch a crowd funder for private shares, hollar at me. I want to focus on local goods and manufacturing.
[+] [-] earbitscom|14 years ago|reply
We're honest as hell but if you invest based on the detailed and honest projections we made in the first five years and not more so on the team, market and other real data, you're an idiot.
[+] [-] stanfordkid|14 years ago|reply
It will mostly be institutional investors buying into even smaller size IPO shares -- these are savvy investors and the mania of the dot-com bubble has certainly not been forgotten.
The thing is there isn't really a huge market for these deals at the moment -- his bank specializes in deals of this size and I asked him if he thinks more mid-range banks will popup to serve this market and he said that probably not until the deal flow comes in.
[+] [-] erichocean|14 years ago|reply
The JOBS act really helps my company -- we're too far along for VC, but not far enough along for a public IPO. The post-VC, private equity market makes the most sense, but as you noted, the amount of money you can raise that way pre-JOBS act is far too low, making companies like mine (Pixar for live-action filmmaking) either at the mercy/generosity of a Steve Jobs-like figure (literally), or simply not funded at all since we exist in the Government-created financial no-mans land. Either is far from ideal.
The JOBS act, at least for our company, changes this and makes a previously non-viable-through-inadvertent-regulation company suddenly viable. That's why I supported it, and continue to do so.
[+] [-] unknown|14 years ago|reply
[deleted]
[+] [-] jellicle|14 years ago|reply
http://37signals.com/svn/posts/3160-lets-ride-this-bull
[+] [-] raheemm|14 years ago|reply
In the end, you have to balance regulation with ease of doing business, raising capital, etc.
[+] [-] jellicle|14 years ago|reply
Eliminating independent accounting requirements is as close to equaling fraud as makes no difference.
[+] [-] adestefan|14 years ago|reply
[0] http://www.nytimes.com/2011/10/24/opinion/small-businesses-a...
[+] [-] whyenot|14 years ago|reply
The crowd funding stuff in the bill is great, but it's like a few drops of honey on top of a turd.
[+] [-] hager|14 years ago|reply
The government should get out of the business of deciding what is appropriate for companies to report. As history has shown the government does a terrible job(Volt, Solar, etc.) of investing / guiding investments(mortgages).
[+] [-] rachelbythebay|14 years ago|reply
[+] [-] bdunbar|14 years ago|reply
It was hard as heck to raise capitol. So much so that it was nearly not worth the effort. We spent as much, or more, time on investing than we did working.
At one point I was named as a defendant by one state for the content of an email I sent on behalf of the CEO.
We settled that, the boss got me removed from the thing, paid the fine. Paid the investor back his funds.
The investor took the money, went to his _other_ home across the state line, sent the money back.
It seemed like a lot of work on the part of the state regulatory branch - going after a small company for a negligible amount of money, on behalf of the sole investor from that state who really wanted to invest.
It sure soured me on the idea of taking any company I launch public.
[+] [-] patrickgzill|14 years ago|reply
Free Jon Corzine! Oh, nevermind...
BTW, Univac (I believe) got their start issuing stock in exactly this fashion. You could buy a share for either $1 or $5.
[+] [-] joshbuddy|14 years ago|reply
[+] [-] 10dpd|14 years ago|reply
Just sayin..
[+] [-] marshallp|14 years ago|reply
There is an overinvestment in the stock market today, the excess money needs to go somewhere so elsewhere, which for the past few years was the housing bubble. However housing is not a wealth producing exportable industry (and is already overinvested/iverpriced), and so the capital needs a new outlet - private equity (which includes venture capital). The fact that this investment option has been closed of to ordinary people is the real fraud (that has been occurring for 80 years now).
[+] [-] seanp2k2|14 years ago|reply