Golden Fleece: The JOBS Act

The 112th Congress, after months of near paralysis, suddenly popped out a doozy in late March: the JOBS bill. Quickly signed and sealed and now officially the JOBS Act (for Jumpstart Our Business Startups), the new law opens up some genuinely golden opportunities for investors and entrepreneurs through “crowdfunding.” That’s on one hand. With a wave of the other, it paves Wall Street with fools’ gold. The new law will open wide an avenue for con artists to fleece a public stripped of key investor protections. It won’t be long, we fear, before confidence in the securities markets will be eroded, and that bodes ill for everyone.
It was a Faustian deal from the beginning. After scant debate, the JOBS bill was voted with broad bipartisan support by a profoundly unpopular Congress anxious to show a skeptical public that it could actually accomplish something. Shortly thereafter, President Obama, beaming, signed the bill into law. In the signing photo, Eric Cantor (R-Va), the House Majority Leader, can be seen grinning over the president’s shoulder.
The fruits of this unholy alliance are intended to seed economic growth and employment in small companies. But with one part sweet, the others bitter, the aftertaste is likely to be pleasing mainly to lawyers. Overall, the Act transfers risk from entrepreneurs and speculators to the small investor.
First, the positive: crowdfunding could become a big time boost for entrepreneurs. The Internet is rife with possibility for collecting and sharing resources, including ideas (“crowdsourcing”) and money. In the last few years, the Web has proven to be a highly effective tool for raising money in many small doses to support new ventures. Readers here will be familiar with Kiva, now one of dozens of crowdfunding sites that elicit money—in amounts often as small as $25–from hundreds of thousands of lenders on behalf of microenterprises. According to its Website, last year Kiva loaned out $89 million and funded 110,000 microloans, the vast majority in the developing world. Soliciting loans on the Internet is sanctioned because Kiva loans pay zero interest, and therefore, they are not subject to securities regulation.
Another type of crowdfunding has recently eclipsed microloans. From its inchoate beginnings in 2006, rewards-based crowdfunding raises money for profit-making ventures for the promise of non-cash rewards, but with no direct financial return. Again, dozens of crowdfunding Websites have appeared, and they come in as many varieties as Heinz, but Kickstarter is arguably the best known and a prototype. Visitors to the site are greeted with hundreds of innovative venture ideas ranging from art to film to food to gaming software to geeky inventions like 3-D home printers. Those who choose to pledge receive no cash or equity interest but rather rewards related to the project at hand. At Kickstarter , funders are not charged until the project receives its goal in pledges. That site, in particular, has been a phenomenon. Since its inception three years ago, $200 million has been pledged by some 1.8 million backers. The site claims that over 20,000 projects have been successfully funded, including an adventure game, Double Fine, which alone received $3.3 million.
The JOBS Act is designed to move crowdfunding beyond the no-interest and non-cash-reward systems to an arrangement offering investors a share of the profits. The SEC regulations on crowdfunding will be in gestation for nine months after the law’s April 5, 2012 enactment, but when issued, the rules will presumably enable approved Websites and brokers to sell securities to investors as long as the investments don’t amount to more than 5% (or 10%, in some circumstances) of the investor’s annual income or net worth. The cash raise for crowdfunders will be relatively small: the Act limits enterprises to selling a maximum of $1 million in securities every 12 months.
The remainder of the Act is all about deregulation (“cutting through red tape” in Fox Newspeak) and the further unraveling Wall Street’s bêtes noires, the Sarbanes-Oxley law of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The JOBS Act creates a category called “Emerging Growth Companies,” startup companies that may, in fact, have up to a $1 billion (!) in revenues. The goal is to ease the process of raising capital for these EGCs.
Try this on. If an EGC wishes to raise money through offering stock on a public exchange, they’ll no longer have to bother with those pesky annual financial audits. After issuing stock, the EGC is exempt from that inconvenience for up to five years. Also, companies would be excused from the new national accounting standards for that period, even suspending our SRI industry’s hard-fought regulation that requires, under Dodd-Frank, a periodic shareholder advisory vote on executive pay.
Or how about the Act’s ushering back the old “pump and dump” routine. Banks and brokerages used to hawk a company’s stock to unknowing investors as it came out, so they could pump up the offering price. Then, when the brokerage’s inventory of stock was sold out, they would allow the demand bubble to burst, letting shareholders take the hindmost. In 1999, reacting to massive fraud particularly preying on the elderly, the SEC had banned “general solicitation” of this type, but now it’s officially ba-a-ck.
During the tech boom, brokerages and banks would routinely sell their financial analysts’ “strong buy” opinions in exchange for a company’s underwriting business. That practice was exposed by Eliot Spitzer and ended decisively by the SEC some years ago. Ended until now.
Until now, companies wishing to raise money in private markets had to restrict themselves to soliciting “accredited” investors, i.e. those with assets of at least $1 million or an annual income of $200k. The premise has been that high-risk investments shouldn’t be the province of those who depend on their assets and current income to meet basic living expenses. The JOBS Act drops the assets threshold to $100,000. This certainly opens up millions of additional doors for entrepreneurs seeking capital. That’s a good thing. And this certainly will put real families on the dole when their investments in start-ups don’t pan out. Not so good.
Markets go up; markets go down. Regulating them can and does dampen the free flow of commerce, and current regulation affecting startups unquestionably presents a mire of convoluted hurdles. But wise regulation reduces fraud and exploitation, tempers boom-and-bust cycles, and most important, protects the integrity of markets. The effects of the JOBS Act—a complex piece of legislation with many interrelated parts—won’t be measurable. But if, as we fear, the Act seriously undermines investors’ confidence in the fundamental fairness and honesty of U.S. markets, we will have sacrificed one of our most precious assets for a shibboleth of the right.