
Senator Dodd Reform Bill Could Ruin Angel Investing - mbowcock
http://online.wsj.com/article/SB10001424052748704671904575194483171910348.html?mod=WSJ_Opinion_AboveLEFTTop
======
grellas
Congress has not been friendly to startups this past decade.

A few results of their well-intended efforts:

1\. Startups today have little or no realistic hope of gaining liquidity
through an IPO, leaving them in a position where M&A is their only realistic
exit, with the result being that valuations are lowered for founder exits (the
consequence of Sarbanes-Oxley, among other new laws).

2\. Startups today can't simply price their stock based on the reasonable
business judgment of a board of directors, nor can they use a simple 10 to 1
ratio in pricing their preferred versus their common stock, but must instead
incur significant expense in having to do independent outside appraisals just
to take simple steps such as issuing stock options (the new 409A statute and
accompanying regulations have brought this about).

3\. The VC market has been all but dead for the past two years, owing in no
small part to congressional actions that helped fuel the Fannie/Freddie
subprime mess, leading to a financial meltdown.

4\. Add to this the hammer that is about to fall on angel funding as reflected
in the Dodd bill, and startups will not only have their VC funding sources
largely dried up but will have far more restricted access to early-stage
funding across the board. In practical terms, this will mean that funding
activities will need to be based on: (a) having access to comparatively
wealthy angel investors (maybe 25% of the current pool) while being prepared
to incur significant delays in getting funds pending a minimum 4-month wait;
or (b) relying on Section 4(2), which is the section of the 1933 Securities
Act that offers an exemption from registration for private placements but
without benefit of the safe-harbor approach of Regulation D and its rules
relating to accredited investors (the equivalent of "walking on the high wire
without a net").

Maybe any given point above is over-simplified or overstated but the broad
pattern is clear. No individual item is ruinous but each contributes to costs
and restricts options. It is not a good trend for startups.

~~~
hristov
Freddie and Fannie did absolutely nothing to fuel the subprime mess. They were
not allowed to invest in any subprime mortgages during the bubble and were
later forced by law to invest in them when the crash was already happening,
because that was Bush's plan to stop the crisis. This is just an excuse that
people that caused the sub-prime mess use.

~~~
dagheti
What is the source of this? If you look at
<http://en.wikipedia.org/wiki/Subprime_crisis_impact_timeline> and search for
subprime you'll see many cases of Freddie and Fannie buying or guaranteeing
subprime activity.

\- In 2000 Fannie buys $600 million, and Freddie buys $18.6 billion, and
guarantees 7.7 billion more. \- 2002-2006 the GSE's buy 38-90 billion a year
in subprime mortagages

As far back as 1999 you can find stories stating that Fannie was being
pressured into subprime:

[http://www.nytimes.com/1999/09/30/business/fannie-mae-
eases-...](http://www.nytimes.com/1999/09/30/business/fannie-mae-eases-credit-
to-aid-mortgage-lending.html)

Their activity appears smaller than the market at large, but it's not non-
existant. It doesn't seem on face value that they were not allowed to invest.
Is there some rule I am missing?

~~~
hristov
It seems I was wrong about that. But still their activity was just a small
part of the market at large and they only bought the safest tranches. Saying
they were responsible for the mess is just wrong, imo.

------
DanielBMarkham
<rant>I am amazed at the things people find important enough to take action on
-- or not.

Seems to me, just guessing, can't be sure, but a bill that has these things in
it should be the #1 item on HN, and we should be organizing as a community to
stop it. I don't care what your politics are, this is a political thing that
needs to be stopped.

Parallel Haskell is awesome and all, and goodness knows I want to hear more
about Apple and Flash, or linux, or iPads, or Adobe, or browsers, or Jon
Stewart's jokes last night, but this is real, live stuff that could impact
anybody with a startup.

If the Philadelphia news ran a story "Philly on fire!" people would come out
to try to put the fire out. HN runs a story "VC investing seriously
challenged!" and you can hear the crickets chirp.</rant>

~~~
hristov
The bill does not have these things in it. It is merely a huge overreaction.
Most people that complain about this section, are really worried about other
parts of the bill but do not want to admit that they are worried about those
other parts of the Dodd bill. So this is merely a red herring and people that
know what they are doing recognise it as such.

------
hga
For the full text see
[http://www.google.com/search?q=%22minimum+interference+from+...](http://www.google.com/search?q=%22minimum+interference+from+regulators.+The+law+requires+only+that%22+site%3Awsj.com)

A good official house editorial, it discusses the more likely worse regulatory
aspects before getting into the mandated new worth threshold increase.

~~~
anigbrowl
_sob_

'Mandated net worth transaction increase'

Please, let's talk about the actual bill. It's at
<http://banking.senate.gov/public/_files/AYO09D44_xml.pdf> and the relevant
regulation is in Sec. 412.

It says that the Securities & exchance commission should raise the threshold,
using its existing authority, _as the Commission determines is appropriate and
in the public interest, in light of price inflation since those figures were
determined;_

..and in the next section, directs the Comptroller of the Currency (the
banking-specific regulator) to examine those investment thresholds and
evaluate the feasibility of forming a _self_ regulatory organization for
hedge, private equity, and VC funds.

Now, I recognize there's a wide spectrum of opinions on the degree to which
government should regulate the financial industry. And I totally agree that
angel investment is critical to small businesses like tech startups. And I
agree that a million $ in assets or an annual income of $200k is already a
fairly high barrier to entry, while technological change since 1982 has
significantly lowered startup costs. And so, I agree that just mindlessly
jacking up these thresholds would likely be a Bad Thing - for startups,
angels, and the economy.

What I'm grumpy about is the meme that the bill does mindlessly jack up the
rates. The SEC's existing rules require public consultation on such changes -
so if the bill passes, the thresholds will not suddenly shoot up. Rather, the
SEC will announce they're considering it and invite input from the public -
including people like us - for 3 months. And the SEC has been responsive to
that input in the past. Mainly they're worried about not allowing another
Bernie Madoff episode; it's entirely possible that they might employ their
rulemaking power to carve out an exception for Angels and VCs.

And in the next section, where venture capital is explicitly mentioned, the
bill directs the other regulator to study whether and how such funds - which
are, obviously, quite different from banks - could be allowed to regulate
themselves. the main purpose of this bill is to regulate big wall Street
banks. There's a clear understanding here that small funds are _not_ banks;
they operate differently, are much more competitive, and probably shouldn't be
regulated like banks. The bill _supports_ the idea that such firms will do a
better job of keeping each other honest than direct regulation by government!

Participants in a diverse a competitive market (for fund management) are best
placed to decide what constitutes 'fair play'. Where self regulation fails is
the situation where a few players utterly dominate the market - for example,
the fact that 6 large banking firms currently manage about 60% of all capital
on Wall Street - and tailor the rules to suit themselves, to the detriment of
the smaller players, and of the customers. For that reason, the bill also
seeks to put an end to the practice of large banks creating and capitalizing
hedge funds that are nominally independent, but in reality are just legal
vehicles for large institutions to take advantage of the lighter regulatory
and disclosure requirements for hedge funds, while leveraging the reputation
and deep pockets of the creating bank to attract customers away from smaller
funds.

Why is this important? Because the SEC failed to heed warnings about fund
managers like Bernie Madoff and Alan Stafford. Their competitors knew the
performance of those funds was 'too good to be true' and repeatedly asked
regulatory agencies to step in, but were mostly ignored. The bureaucrats'
reporting requirements were being met, and they did not understand the sheer
improbability of such consistent profitability in a volatile market.
Competitors did: customers preferred fairy tales to honest reporting of market
behavior. Hierarchical regulation failed dismally where peer review would have
put a quick stop to the abuse.

Result? Jittery investors lost faith in _all_ private capital management and
VC funding fell by almost 50% in sectors like biotech and internet from
2008-2009. Some $5 billion was taken off the table - perhaps more. Less VC
funding means less angel funding: no mezzanine capital means no exit or equity
partnership. You can't grow an oak tree in a one gallon pot.

Self-regulation of the private capital market could reinvigorate capital
formation significantly. Reduced red tape and peer review are strong economic
incentives for honest and transparent risk management. Investors want
transparency, and they want innovation rather than speculation, in which it is
all too easy to end up on the wrong side of a zero-sum trade. There is
enormous potential here to deepen and diversify the investment pool, and that
would be very good news for startups.

So as it affects Angel and VC funds, the bill does two things: directs the SEC
to re-examine investment thresholds in the wake of a real financial meltdown;
and directs the CotC to consider reducing government regulation of private
capital management, rewarding true competition with greater trust.

Instead of seeing this bill as a giant monolithic gravestone for capital
formation, entrepreneurs, angels and VCs should look at the potential long-
term benefits and use the public consultation process to tell regulators what
kind of market they need, and how an open self-policed market could unleash a
wave of innovation in the real economy. The giant Wall Street banks do not
like this bill, but you can worry about them when you're ready for your IPO.
Until then, they won't take your calls anyway. Consider your own interests
rather than theirs.

~~~
anamax
> Please, let's talk about the actual bill. It's at
> <http://banking.senate.gov/public/_files/AYO09D44_xml.pdf> and the relevant
> regulation is in Sec. 412.

Yes, let's do that.

> It says that the Securities & exchance commission should raise the
> threshold, using its existing authority, as the Commission determines is
> appropriate and in the public interest, in light of price inflation since
> those figures were determined;

Actually, it says "shall". Should is a request. Shall is a mandate.

There's some wiggle room in "determines is appropriate and in the public
interest" but the marching orders are pretty clear. Do you really think that
they're going to come in significantly lower than where the inflation numbers
come out?

I'm serious - the inflation numbers give us $2.3M. What's your "I was wrong"
number? Is it anything over $2M? How about $1.5M?

Note that Section 412 has two parts. The second "(2) adjust that threshold not
less frequently than once every 5 years, to reflect the percentage in crease
in the cost of living." doesn't have any discretion.

~~~
hristov
There are no requirements that the increase follow inflation numbers. It only
says that the SEC should increase the rates as "the Commission determines is
appropriate and in the public interest, in light of price inflation." I
guarantee you the SEC will not double the standards over night. They will have
a long rule making session will ask for comments from the public as they are
required, and will slowly increase the standards while studying the effects.

So yes every article that says "The Dodd bill also raises the net worth and
income thresholds to $2.3 million and $450,000, respectively" like this WSJ
article is dead wrong. The Dodd bill does no such thing.

~~~
anamax
> There are no requirements that the increase follow inflation numbers.

There's some discretion in the intial bump but, as I quoted, there's no
discretion for subsequent and regular increases.

> It only says that the SEC should increase the rates as "the Commission
> determines is appropriate and in the public interest, in light of price
> inflation."

That's only for the initial bump.

> I guarantee you the SEC will not double the standards over night.

"Guarantee" implies that money will be changing hands if you're wrong....

Yes, they'll probably have hearings, but they've been told how they "shall"
compute the new number. That's why I asked what you're "I was wrong" number
is. I'm asking again.

~~~
anigbrowl
_I'm asking again._

I apologize, I thought that was a rhetorical question. I'll be surprised if it
goes over $1.25m.

------
patio11
Have I missed a runaway profusion of investment scams targeting people with
net worths between 1 million and 2.3 million? The perceived need for this just
perplexes me.

~~~
yummyfajitas
Something must be done. This is something. Therefore, we must do this.

~~~
DanielBMarkham
Look! I did something! It looks good on TV and 98% of the voters are not
directly hurt by it.

Looks good, gets votes, it is good.

------
jimdeterman
This article leaves out that along with moving the net worth from 1 to 2.3
million for accredited investors, they are also not allowing primary residence
to be counted anymore, which for many people is a large part of net worth.

The SEC filing for startups is insane. The last thing we need is further
roadblocks and delays for early stage startups.

PG, would this affect y-combinator? YC is the first investment for companies
in your portfolio. Would they have a 120 day delay? Four months is a long time
in startup land. This would certainly give a head start to bootstrapped
companies.

~~~
hga
As indicated in my first comment, the article is focusing on the regulatory
problems first; as you note, filing with the SEC with a 120 day delay is
awful. Letting the regulators of all the states into the game might be worse,
in that I'm sure angel investments would be de facto or de jure outlawed in
many states (the state residence of the firm and/or of the angel).

Massachusetts didn't let its residents invest in the Apple IPO:
<http://news.ycombinator.com/item?id=1303133>

But thanks for pointing out that often overlooked detail WRT to primary
residence, as that will knock a whole lot more angels out of the game.

------
fthead9
Wow, the economy is stumbling and the only way out is innovation and now they
are trying to make it harder to start a company. Just how do they propose we
get the economy back on track? Sorry printing more money is not a long term
solution to economic recovery. It amazes me that our elected officials have
zero grasp of how the economy works. These are supposedly educated people and
yet they consistently treat the economy like some grade school battle for
teacher's pet honors. Sorry for the rant but crap like this makes me question
the viability of our current governing system.

As @rmaccloy I'm not against the idea of bank reform but these types of
provisions and attachments to bills are causing so much waste and then we
wonder why we have such a huge deficit.

~~~
hga
I think it's more our current ruling class than the system per se, although
that depends on how you define "system".

No system can work if you have fools running it. Our big C Constitutional
system has worked better in times past when better people were in office ...
and worked worse when worse people were in, e.g. Hoover and FDR making their
economic mess worse and prolonging and worsening the agony.

It's just not that bad yet. While e.g. Cash for Clunkers was pure "broken
window" bogus economics, do we have anything quite as vile as the Agricultural
Department destroying food and preventing its production while at the same
time they calculate 1/4 of the nation is malnourished (which the DoD confirmed
in the WWII draft)?

Well, maybe this is as perverse, although not hardly as vile. As grellas
details in some length, in a period of bad economic times (starting with the
dot.com crash) our ruling class as seen fit to steadily destroy the
foundations for startups. And it's a general bipartisan thing, e.g. a ruling
class problem.

There are, realistically (ignoring the rosy projections of going below a
trillion in FY 12, a Presidential election year), trillion dollar annual
Federal deficits stretching out as far as the eye can see. Where is this money
going to come from? Not from new enterprises and new industries, there will be
few if any new Apples, Suns or Googles ... hmmm, Microsoft managed to
bootstrap itself, but such opportunities don't come along often and the
computers and their components that ran Microsoft Basic and so on were
largely/almost entirely not self-funded.

Bleah.

------
rmaccloy
Some past posts on this issue:

[http://www.avc.com/a_vc/2010/03/startups-get-hit-by-
shrapnel...](http://www.avc.com/a_vc/2010/03/startups-get-hit-by-shrapnel-in-
the-banking-bill.html)

[http://www.huffingtonpost.com/robert-e-litan/proposed-
protec...](http://www.huffingtonpost.com/robert-e-litan/proposed-protections-
for_b_511284.html)

I'm surprised this hasn't been brought up more on HN. I'm not against bank
reform, but these provisions seem clearly detrimental to prospective founders
without providing any actual protections to people who need them. Correct me
if I'm wrong...

------
jbooth
If someone's going to make this case, could they please do so from somewhere
without a paywall and if at all possible, from a source who's logic is more
honest than "are republicans or democrats in office right now"?

IF the claims are correct though, then that needs to be fixed in the bill,
particularly the part about filing with the SEC.

~~~
hga
Second source???

These provisions of Dodd's bill have been discussed extensively on Hacker
News:
[http://www.google.com/search?q=dodd+site%3Anews.ycombinator....](http://www.google.com/search?q=dodd+site%3Anews.ycombinator.com)

And I think you underestimate the significance of the editorial board of _The
Wall Street Journal_ taking a strong position on this issue in a house
editorial.

~~~
jbooth
The Wall Street Journal's opinions are driven entirely by which political
party controls Congress.

After 8 years of the "deficits don't matter" administration, all of a sudden
these guys turn into budget hawks 1 month after Obama inherits their fiscal
situation. They're against quote "socialized" healthcare even though the bill
didn't socialize anything that wasn't already a government program.. but the
more expensive Medicare Part D program was just ducky with them. Etc, etc etc.

I have no problem believing there are problems with the bill that would
accidentally affect startups. But if we're talking pithy 2-sentence
characterizations from a source with a history of partisanship? Citation
needed.

~~~
hga
[http://blog.heritage.org/wp-
content/uploads/obama_budget_def...](http://blog.heritage.org/wp-
content/uploads/obama_budget_deficit_2010.jpg)

~~~
jbooth
Hang on, I mention the fact that WSJ is hopelessly biased, and you respond
with a link to an _even more biased_ source?

Ok, let's back up and try to engage your brain for a second. So you have a set
of 10 year projections there. Those are predictions about the future. With me
so far?

Now think about what they were on January 15, 2009 as opposed to January 25,
2009.

Do you think that the act of Obama taking office changed the future and
mandated a ton of future government spending? Or do you think these might be
fundamentals that we were going to have to deal with regardless?

For bonus points: How much of those future deficits would you guess have to do
with the increasing cost of healthcare?

And I'll leave out entirely what they might look like if we hadn't just
endured 8 years of studied fingers-in-the-ears idiocy from the Bush
administration. Remember that surplus in 2000?

Heritage and WSJ are concerned about deficits. Who did they support in 2000
again?

~~~
yummyfajitas
You asked for a second source, you have it: the CBO and the White House. The
fact that heritage put CBO numbers onto a graph does not make them invalid.

~~~
jbooth
I asked for a second source regarding _the financial reform bill_. I'm well
aware of the approximate projected size of our federal deficit, thanks.

The fact that Heritage supported Reagan, opposed Clinton, supported Bush and
now claim to be concerned about deficits says a lot about the Heritage
Foundation.

EDIT: Awesome, downvoted for clarifying a willful misinterpretation of my
original comment. Ladies and gentlemen, your conservative movement -- it's not
about facts, it's about which side you're on.

~~~
yummyfajitas
You were given several other sources for that as well, all of which were
posted here. You also criticized another source simply for being conservative,
which is what I was responding to.

Regardless, please clarify your point. Do you believe the WSJ is lying about
the contents of the bill? If not, then what is the relevance of pointing out
their opinion on other political matters?

~~~
jbooth
I believe they're extremely prone to exaggerate any bad parts, and there was
room for a lot of weaseling in their descriptions. Especially considering that
the bill isn't finished yet.

I'm still waiting to see the death panels. Since they'd never lie, of course.

I didn't criticize Heritage for being conservative. I criticized Heritage for
being Republican, regardless of principle or policy.

EDIT: To clarify, it's entirely possible that the provisions in the bill still
being written are just as bad as the WSJ says. It's also possible that they're
significantly less bad. Regardless of which they are, the WSJ would have
written this exact article. Does that make my complaint regarding their worth
more clear?

------
sutro
If Congress wants to help the economy they should go in the opposite
direction: don't increase the accredited investor threshold, remove it.

------
sachinag
Oh, for fuck's sake. We're not hurting for a lack of angels because of the
accredited investor rules. We're hurting for a lack of angels because there
aren't a lot of people who are willing to cut checks to young companies
without revenue after other people they know said no. Jacking up the minimum
threshold to $2.3 million from $1 million (assuming this passes in current
form, _which it won't_ ) is a complete non-event for almost every founder.

~~~
rmaccloy
I think the minimum NW change is the most minor of the issues here (especially
in SV). Imposing more of a regulatory burden isn't going to make anyone more
likely to cut checks, and increasing the barrier and latency to initial
funding is going to make plenty of potential entrepreneurs decline to make the
leap.

I think it's quite dangerous to assume such provisions aren't going to make it
past whatever partisan wrangling goes on; I doubt either the dems or the GOP
are going to give much of a damn about the startup ecosystem unless a lot of
noise gets made about it.

~~~
hga
" _[...] increasing the ... latency to initial funding is going to make plenty
of potential entrepreneurs decline to make the leap._ "

That's a very good insight. Up to 120 days is a long time to develop second
thoughts, have something else come up that changes things for the investor,
etc.

I suppose you could include a CD or DVD of porn as a bribe to overall speed up
the SEC's processing of your request ^_^.

