
Obama Calls For Regulation Of Venture Capital - eugenejen
http://blogs.wsj.com/venturecapital/2009/06/17/the-daily-start-up-obama-calls-for-vc-to-be-regulated/
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sethg
It seems to me that any wholesale reform of financial regulation has to
prevent regulatory arbitrage. Right now, IIUC, banks and mutual funds and
hedge funds and insurance companies and VC firms and non-bank mortgage
companies are governed by different rules and supervised by different
regulatory agencies, which allowed people with sketchy business plans to pick
the corporate structure that gave them the most favorable regulations. (Thus,
for example, non-bank mortgage companies were more lightly regulated than
banks, and more deeply involved with subprime loans.)

We need to move towards a system with one common regulatory framework for
everything (or at least, everything above a certain level of assets under
management), so the people responsible for investing other people's money have
an incentive to focus on choosing good investments rather than gaming the
system.

Even if VC firms had nothing to do with _the current_ financial meltdown, if
they end up as the least regulated class of fund, then they will surely get
drawn into _the next_ meltdown.

~~~
ggchappell
Hmmm ... definitely a thought-provoking comment. Let me try to play devil's
advocate.

> Right now, IIUC, banks and mutual funds and hedge funds and insurance
> companies and VC firms and non-bank mortgage companies are governed by
> different rules and supervised by different regulatory agencies, ...

Yes, but there is a good reason for this: these different types of
organizations _do different things_.

> ... which allowed people with sketchy business plans to pick the corporate
> structure that gave them the most favorable regulations.

Is that a problem? For example, if I want to sell insurance, then regulations
that nudge me toward forming an insurance company, can hardly be seen as a bad
thing.

> Even if VC firms had nothing to do with the _current_ financial meltdown, if
> they end up as the least regulated class of fund, then they will surely get
> drawn into the _next_ meltdown.

I can't disagree with that, even in devil's-advocate mode. :-)

In any case, thanks for making me think.

~~~
sethg
_Yes, but there is a good reason for this: these different types of
organizations do different things._

Well... not always. For example, both banks and mortgage companies issue
mortgages, but the banks are subject to more stringent regulations on how they
do it. Some of the esoteric financial instruments that are involved in the
meltdown looked and walked and quacked like insurance policies, but regulators
didn't account them as insurance policies.

I'm not a finance guy so I can't imagine what the details would look like, but
I'd like to see rules along the lines of "if you borrow short and lend long,
you are a bank and you are subject to these banking regulations, whether or
not you have the word 'bank' in your company name".

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gregbillock
My guess is that Obama just got finished with a terrible fight with the
speculators involved with GM. He probably isn't thinking of the relatively
small money tech VC system, he means them. This is borne out by the first
quote:

"the plan requires hedge funds - “and other private pools of capital,
including private equity funds and venture capital funds” - to register with
the Securities and Exchange Commission (page 38)."

Requiring these speculators to come under regulation is more a response to
their recent involvement with the worldwide financial meltdown and continued
opportunistic obstructionism at attempts to solve it. Still, though, it'd be
good to be careful with real VC funds involved in real investment, and not
accidentally suck them up unintentionally. (See SOX and the IPO situation for
a good example of how unintended consequences of this kind of regulation aimed
at the big guys can accidentally sweep up the unfortunate.)

~~~
yummyfajitas
Opportunistic obstructionism?

Let me get this straight. Certain players in private equity attempted to rely
on the rule of law; in particular, existing bankruptcy/debt seniority rules.
Now the government is going to impose new regulations on that entire industry
(and related industries) in retaliation?

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garply
"[V]enture investors have been trying to solve the mystery of how they could
possibly threaten the financial system."

Couldn't a case be made that venture capital helped fuel the dot-com bust?

~~~
nradov
The dot.com bust didn't create systemic risk for the whole financial system.
Some foolish investors lost a lot of money, but that was about all.

~~~
tptacek
The dotcom bubble created a bear market for equities that dragged down mutual
fund performance and cost general investors --- the "smart" ones, who weren't
picking stocks, or even verticals --- hundreds of billions of dollars.

~~~
jhancock
Hundreds of billions is tiny compared to what's at risk this time. I witnessed
massive fraud in the dot-com bubble. Very little went punished. I have no idea
what the new regulations need to look like. But they need to have real teeth
and need a reasonable sized army of experts overseeing the regulations. The
SEC of the last 10 years was woefully understaffed to deal with our financial
industry's activity.

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natmaster
READ: "Obama hammers final nail in economic coffin."

~~~
sachinag
As a former analyst at a venture capital firm, with all due respect, you have
no idea what you're talking about.

Regulation doesn't make VC any less attractive for LPs, who provide the funds.
As long as there are people who want to commit to the asset class, there will
be VC funds willing and available to take their cash.

Furthermore, registration with the SEC increases paperwork, but not in a way
that does anything other than provide additional transparency. It's a bit of a
pain in the ass, and maybe it means the CFO has more work to do, but to say
this is dumb or will kill innovation is misguided. It's the same damn
paperwork that every mutual fund has to file. It won't make or break any
decent-sized fund.

Everything the NVCA says in their position paper is right
([http://www.magnetmail.net/images/clients/NVCA/attach/VCandSy...](http://www.magnetmail.net/images/clients/NVCA/attach/VCandSystemicRiskFinal.pdf)
[PDF]), but excluding VC funds from regulations when you want to look at PE
and hedge funds - which can and do pose systemic risks, as we saw with LTCM -
is impossible given that all three share the same basic legal structure: LPs
and a GP, where the GP is the manager of the fund.

The societal cost of overextending mere registration requirements to VC funds
is far outweighed by the cost of not having greater transparency into their PE
and hedge fund siblings.

~~~
lionhearted
Have family and friends in the SEC and OCC, and know some corporate cats who
deal with Sarbanes-Oxley. The SEC doesn't want to be dealing with investments
for accredited investors, since they already have too much on their plate. On
the business side, nobody wants to fill out paperwork, which consumes time and
money. IPO on one of the American exchanges used to be a total no-brainer for
most companies except a couple industries and geographies. Now London is
getting greater play, more companies are staying private, and there's less
IPO's on American exchanges - I'm not sure about Japan, Dubai, Hong Kong, or
China, but I'm going to guess they're picking up some of the slack too.

Marginally more USA regulation on venture capital = marginally less VC in the
States. Marginally more regulation on VC = marginally less SEC time spent on
investments for unsophisticated investors, who probably need more protection.
You could make a case for it, but I think it's probably an overall slightly to
mediumly bad thing.

~~~
sachinag
In a vacuum, I'm not in favor of registration requirements for VC firms - but
we're not in a vacuum. We're about mitigating systemic risk to the system.
Given that the legal structures are the same, how do you propose to regulate
the people who use leverage (PE and hedgies) and leave out the VCs?

Furthermore, if you don't think the SEC is getting a _massive_ influx of
capital, I'll be happy to sell you a bridge. Over the East River, Chicago
River, Mississippi River: take your pick.

~~~
lionhearted
Good comment/questions. I don't have a hardcore finance background, as my
background is more business/project management/hint of technology. But two
things that really jump out to me -

> We're about mitigating systemic risk to the system. Given that the legal
> structures are the same, how do you propose to regulate the people who use
> leverage (PE and hedgies) and leave out the VCs?

Leverage is inherently risky and if you let people leverage to the hilt,
they'll find a way to break something. I'm not so much in favor of putting a
leash on the leveragers as increasing the cost of money quite a bit. We've
been handing out money basically for free for the last ten years. Raise
interest rates, take the hit that comes with that, print less, and do a mix of
cutting government spending and increasing taxes at least until the budget is
balanced. Then do something about the crazy trade deficit. I don't think you
can effectively regulate tons and tons of free money. Free money finds a way
to cause problems.

> Furthermore, if you don't think the SEC is getting a massive influx of
> capital, I'll be happy to sell you a bridge. Over the East River, Chicago
> River, Mississippi River: take your pick.

At its core, the SEC works like a law enforcement agency. No matter how big it
is, it'll won't nail every criminal. Any task assigned to the SEC means less
time on other tasks. You could triple the SEC's budget and staff, and they'd
still be nowhere near fully covering everything. Probably sensible to limit
the scope of the agency to the most important parts of the finance sector - VC
is accredited investor only, who are people who tend to be financially
literate and can afford risk. As for systemic risk, stop handing out free
money. Raise interest rates, reserve requirements, balance the budget. I guess
that's kind of radical-crazy-go-nuts thinking these days.

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Eliezer
I'm surprised. Obama doesn't usually do things that are outright stupid.

~~~
param
I'm surprised. You managed to press send before adding any justification or
references to why you think so.

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JMyers
The way Obama is currently conducting his presidency has a lot of parallels to
what happened when Rosie O'Donnell took over McCalls magazine. The magazine
was a strong brand and publication for 117 years. Drastic changes were then
applied, including re-branding as "Rosie Magazine", and was destroyed in 17
months.

~~~
JMyers
Who would ever think there would be so many followers on here instead of
leaders.

