March 16, 2012
-- by Dave Johnson
The Senate is considering the House-passed, typically-misnamed "JOBS Act." This act dramatically cuts regulations and disclosure requirements for companies that want to sell stock. As written it opens the door to the usual scammers, fleecers and fraudsters that feast on deregulation. But I think with some core limits and protections this concept -- not this bill, but this concept -- could transform our economy in some very good ways.
The So-Called JOBS Act
The word "jobs" in the name of the bill does not mean the kind of jobs that millions of people are currently desperate for, it means "Jumpstart Our Business Startups." The bill makes it easier for companies to "go public" -- sell stock to the public for the first time. It lets these businesses sidestep certain additional auditing procedures for up to five years. It opens up "crowdfunding" -- letting companies raise up to $2 million from investors online, while cutting out much of the usual disclosure process that companies now have to go through.
Gatekeepers - Good And Bad
If you are going to start a business you have to raise capital. This can be money you save up or borrow, but a serious business requires a serious investment. Please don't start a business without a careful process of thinking through the first two years of operation and having way more than enough money available to get you through that period! This means that no matter what the business is, you are probably going to need at least a few hundred thousand dollars. Most people don't have that available, which means you are going to have to go out and raise it.
Currently it is very difficult for small businesses to raise capital. The usual path is to go find a wealthy "angel" investor or a group of wealthy investors like a venture capitalist firm. If you have a bigger business and are ready to "go public" you typically have to partner with a Wall Street-style firm to guide you through the process. Selling stock is heavily regulated -- for very, very, very good reasons -- and the regulations make it very, very expensive to go public.
On the one hand, having to raise money usually means your plans will be tested and challenged, which is a good thing. It is a terrible mistake to start a business without going through the planning process and thinking through what you are getting into. A failing business takes a terrible toll on the wealth and health of the participants. On the other hand, because of the way things are currently structured businesses are largely dependent on the already-wealthy to raise capital, and the already-wealthy can demand a lot in return, because the current regulatory structure means they can. And all of this means that the not-already-wealthy do not have the opportunity to participate in these early-stage investments. The way things are today, it takes a whole lot of money to make money. It doesn't have to be this difficult.
"Crowdfunding" is a term used to describe the way the Internet has enabled the raising of large amounts of money quickly from lots and lots of small donors - the crowd. Regular people all across the country can hear from candidates, non-profits, etc., and decide to donate. When lots of people get involved very large amounts can be raised.
Howard Dean's Presidential campaign publicized the concept. The Internet enabled Dean to quickly raise millions of dollars in small amounts from lots and lots of people. During President Obama's campaign he famously raised $1 million in one minute through Internet crowdfunding.
Applying crowdfunding to the process of raising capital for small companies could transform our economy by democratizing the process. It can move the gatekeepers for the already-wealthy out of the way, and open up early-stage investment opportunities to participation by regular people. A small company could raise a million dollars in increments of $100 or even $10, and lots of people can share in the gains if the business is successful.
Online investment pools could examine and rate business plans for small, local businesses, and raise the money they need. Or a tech startup can raise enough "seed money" to get going, and be in a position to negotiate much better deals with venture firms when the time comes to raise much more. The small-amount investors could then be in a position to do quite well as the company grows.
And regular people -- people who don't already have tens of millions in the bank -- can participate in the process and share in the gains -- and, it must always be noted, the losses. But this can only succeed if regular people are protected from the fleecers and fraudsters and scammers.
Opportunities For Fleecing And Fraud
There is a reason for the burdensome regulations that protect investors. Those regulations were proven necessary because fraudsters would set up scam investments and whip up excitement, causing unsophisticated people to lose their life savings. This has happened again and again. Even with the current regulations how many people lost out during the "Tech Bubble" when a company needed only to add "dot com" to its name and its stock would soar?
SEC Chairman Mary L. Schapiro warns,“Too often, investors are the target of fraudulent schemes disguised as investment opportunities."
As written, the JOBS Act only removes protections against fraud, without adding any protections for regular people. The AFL-CIO has issued this statement, The Jobs Act—A Cynical and Dangerous Return to the Politics of Financial Deregulation,
Workers’ retirement savings will be in greater risk of fraud and speculation if securities market deregulation once again is railroaded through Congress. Once again our economy will be at risk from the folly of policymakers promoting financial bubbles and ignoring the needs of the real economy. The AFL-CIO calls on Congress to set aside the politics of the 1%, the old game of special favors for Wall Street, and turn to the business of real job creation. The labor movement strongly opposes the JOBS Act and any other effort to weaken the Dodd-Frank Act.
We support the efforts of Senate Democrats such as Jack Reed, Carl Levin, and Mary Landrieu to amend the “JOBS Act” to lessen the harm it does to investors, pension funds, and the U.S. economy.
Jesse Eisinger, writing at ProPublica in Congress’s Genius Jobs Plan—for Fraudsters, Shills, and Wall St. Analysts, makes the case
John Coffee, a Columbia Law professor, has hailed the bill as "the boiler room legalization act." And rightly so. Boiler room operations were one of the unsung job creators of the 1990s, producing some of America's greatest penny stocks and boom times for yacht makers and coke dealers.
... Taking advantage of the revolutionary possibilities of the Internet, the bill loosens decades-old investor protections so that companies can directly advertise to those who would like to be separated from their money. It does that by giving broad exemptions for start-ups that want to "crowdfund" by raising small amounts of money over the Internet. I.P.O. pitches next to "Lose Your Belly!" ads. Sounds like a great idea!
Nigeria shouldn't be the only country to benefit from the web. Right here in America, the elderly are increasingly attractive to a variety of entrepreneurial spirits. If JOBS becomes the law, such innovators could flourish.
Other provisions in the JOBS Act allow companies to solicit investors, with advertising, etc. This is a mistake.
Fixing The Bill
Crowdfunding is enabled by new technologies, and should be explored for democratizing and expanding investment opportunities. If done right this is an opportunity to enable companies to bypass the gatekeepers-of-wealth, and regular people to participate in a democratic investment economy. But it has to be done right, with adequate protections in place from the start.
The legislation has to limit what people can lose and ensure sufficient transparency, to make sure an investment is real and viable and is not a scam designed to take off with the cash.
...limits the companies that would qualify as “emerging companies” to those with less than $250 million in gross revenue and by eliminating the House bill’s exemptions from accounting rules, say-on-pay and golden parachute vote requirements, and executive compensation disclosures. And it provides somewhat greater protection than the House bill against a resurgence in the kind of abusive securities analyst practices that fueled the tech stock bubble and bust.
... It includes stronger pro-investor provisions from the Senate Reg A bill, including requirements for audited financial statements, SEC authority to require up-front disclosure and periodic reporting, and a negligence-based litigation remedy. Importantly, it improves on that bill by limiting companies to raising $50 million through Regulation A offerings over three years, rather than once every 12 months, thus significantly reducing the risk that this provision will be used to evade public reporting requirements for larger companies.
... takes important steps to minimize the potential for harm, in particular by requiring that crowd-funding be conducted through an appropriately regulated Internet portal and requiring offerings of all sizes to provide financial information to investors subject to regulatory requirements appropriate to the size of the offering.
- Allow entrepreneurs to raise up to $1 million per year through an SEC-registered crowdfunding portal.
- Free people to invest a percentage of their income. For investors with an income of less than $100,000, investments will be capped at the greater of $2,000 or 5% of income. For investors within an income of more than $100,000, investments will be capped at 10% up to $100,000.
- Require crowdfunding portals to provide investor protection, including investor education materials on the risks associated with small issuers and illiquidity.
This looks to be right on the money to me. Limit how much can be raised. Limit how much people can invest (lose). Require the online portals to provide information and transparency.
It is important that the House JOBS Act not pass as written. It is a scam-enabling bill that does what you would expect a Republican-written law to do. Namely, it would let the 1%ers fleece the 99% of whatever might remain in our bank accounts.
But internet-enabled crowdfunding of small and local businesses democratizes investment, and could transform our economy. Let's open up the regulations to let this begin, on a very small scale at least for now, and with good protections that keep people from being conned out of their money.
Posted by Dave Johnson at March 16, 2012 10:31 PM
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