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The JOBS Act will very nearly legalize fraud in the stock market (rollingstone.com)
229 points by RyanMcGreal on Apr 12, 2012 | hide | past | web | favorite | 105 comments



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.


You raise some excellent points, the kind that stimulate further thinking.

I still remember the bubble years vividly. A couple of indicators of the mania: patent firms were requiring that startups give them a 5% equity piece just to take on their work (this was in addition to paying full fees, i.e., it was akin to a toll charge just to get in); at least one prominent IPO law firm was taking 25% equity pieces for fee deferrals out to IPO (which followed in a compressed time frame of as little as 18 months). Both indicators show that there was a mad rush at the time to get quick sucker money from public purchasers and it had reached such an insane stage that even lawyers, of all people, had become as critical to the value proposition as the entrepreneurs and investors. That is because the value proposition had shifted. At its worst in that era, it was no longer the goal to build a great company. The goal was to package a company profile, fill it with the most extreme hype imaginable, and market it to the public markets via IPO so that both founders and investors could do a quick cash out while leaving the public purchasers holding garbage in the end. Of course, there were also solid offerings but no one can deny - and I certainly don't - that there was a high volume of trash as well.

That said, I believe that SOX was such a piece of heavy-handed regulation that it went too far in choking off the IPO markets. Yes, this means that private equity deals with the dubious stuff, which never sees the light of day in public markets. But, in recent years, it also has meant that a good number of very solid offerings have not seen the light of day either. In practical terms, what this has meant is that founders get short-changed in being left mostly with just the M&A option - this means that (in general) acquisition pricing is suppressed, quick turns of ventures become the rule, and all sorts of conditions are imposed by the acquirers in the deals that further lessen value for founders. The net result is a lessening of founder leverage at the M&A stage because there is no viable alternative for exit. Of course, some companies might choose to go for the long haul, make great profits, and distribute these to owners (as you suggest, and, yes, that is a good thing) but these are by far the exception and not the rule in the startup world.

As to crowdfunding, I have my own reservations and actually agree with your point, even strongly so. I am encouraged, however, by the idea of experimenting with new fundraising techniques that are made possible only by modern technology and I think it is well worth the experiment. If companies use the new provisions to try to load up with a lot of small shareholders from which they seek to get quickie money based on dubious offerings, the experiment will clearly fail in my eyes. I am excited about this but cautious as well.


Investors and founders have had to become more creative and seek other ways to exit ($$). Only a handful of companies have made it through the SOX morass. So, it does seem logical that they are better. But, to suggest SOX might have actually been positive? Like the TSA is positive because more people are learning to fly? (I don't know if this is true).


What parts of SOX do you think are negative?


Multinational I work for with over 100 billion yoyos of revenue and 150,000 employees stepped off the NYSE because SOX was too expensive to be bothered with.


Did they take the company entirely private? Because if they didn't, SOX still applies to them; it isn't an NYSE thing.

Anyways: that's not responsive to my question. What parts of the law are negative? What parts would you do away with?


Non US


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.


I don't consider myself a big-L libertarian, but I can't help but notice the "Regulation failed, we need more regulation!" template. If the incredibly burdensome Sarbanes-Oxley was nonetheless "inadequate", then maybe you just can't protect people from certain specialized types of folly with any sane amount of regulation, and the correct response is to give up on the high social costs of inadequately protecting people from themselves under certain circumstances. To look at it another way, what your argument says is that a certain expensive purchase, namely Sarbanes-Oxley, brought less value than expected. Should we buy more of that stuff because now still more is needed, or buy less because the value proposition is diminished?


Just pointing out some basic logic that may or may not be present in the above, but is not apparent either way: Just because one solution fails, it does not necessitate "all solutions fail, the right answer is no solutions". Perhaps the problem was in SO itself. Perhaps the problem is in the concept of regulation. Maybe a systemic fix would work better than bolted on regulation, and better than same system, no fixes at the same time. Perhaps a rethinking of some of those core components would be nicer.

Edit for those who are apparently thinking this is some sort of troll: Why can we look at code, say a scaling problem, and say "the answer is not a bigger server or a tweak on the existing code base, but a rework of the core components to work horizontally" and get kudos, but when similar questions are asked of government/financial systems, it is instantly and unfathomably bad?


Financial regulation is certainly a complex problem, and there are many ways of solving the problem, and my ignorance of the subject is vast.

As to why it's "instantly and unfathomably bad" to get rid of regulation: It seems to me that regulation, most of the time (and for most financial "problems") has worked pretty well. Other countries haven't had any where near as much trouble with, for e.g., the recent housing crisis, because they have had better regulation in place. So, At least as far as I can tell, it looks like regulations work fairly well. It's certainly better than no regulation.

There are already huge amounts of regulations in all sorts of fields, such as education, medicine, pollution, the environment, politics, etc... So we know how to make regulations work. There are certainly problems with regulation but it seems better than any alternative I know of.

So, and this could just be ignorance (or a lack of imagination) but I don't think the problem is in the concept of regulation. I honestly can't think of a systemic fix that wouldn't make things worse.

As far as it goes, the US has far more of a problem when laws and regulations are gamed by insiders for their own benefit, at great expense to everyone else. Another way of framing it is basically the "1% vs. the 99%" debate that's been going for the last year or so. So maybe that points at a systemic fix -- open government, especially open regulation, so it's much harder to game the regulations.


Let's talk about security and free-riders. Many varieties of fraud are free-riding: you don't actually do the hard work you need to do, but merely say you did it, for your own personal profit. You're saying, "oh, your regulations didn't prevent free-riding? Well maybe the solution is to deregulate, let everyone ride free, and abandon any pretense of security against free-riders." It's true, that may be a solution, but it sounds to be suspiciously bounded by no-free-lunch theorems.


But the grandparent is more nuanced than that; it points out that regulation failed because it's been steadily stripped down. The attempted framing is not "we need more regulation", but "we need to return to what worked well in the past."

(SOX is just one part of the argument, though IMO the weakest part.)


You are mixing up your meltdowns.

SOX was a corporate regulation in response to Enron's abuse of deregulated energy market in California and the 2001 tech bubble burst.

The 2008 meltdown was due to deregulation of the mortgage and derivatives markets (and also a bit of regulation that promoted bad loans to poor families. )


SOX in turn faced regulatory attack and was scaled back down, which in turn was a contributing factor to the 2008 meltdown from what I recall.


Thanks for the thoughtful response. My comment was focused on developing the theme that securities laws have never been absolute in emphasizing the absolute maximum in investor protections, regardless of practicalities, and that the JOBS Act fits within this tradition (contrary to the underlying piece's claims). It remains to be seen whether it was a correct policy decision in light of the historic events that prompted passage of SOX in the first place. You present a spirited counter-point and you might be right. Only time will tell.


Thanks for staying engaged in the thread, I appreciate all your thoughts!


I think an argument can be made that the regulatory failure in the recent meltdown was more a failure to adapt regulations to changes in the financial markets, than it was a failure to uphold 1930s standards.

In that context I think it is heartening that the JOBS Act passed. The outcomes remain to be seen, but it shows Congress can move quickly to adapt financial regulation.


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.


I was amazed that they may have removed the requirement for an independent audit of the accounting, but after looking into the changes it looks like it absolutely doesn't remove the requirement for an audit. Based on the summary that I read it looks like the main change with respect to an audit is that it only goes back two years from the IPO instead of five, and the auditor doesn't have to do a test of the internal controls. In practice this doesn't diminish the value of the audited financials nearly as much as your post would suggest.

[0] http://auditorsopinion.com/2012/04/04/the-jobs-act-debate/


You are indeed correct, thank you.

The article is highly misleading on that particular point. Given how extraordinary a claim it was (enough for me to take the time to write a response to it), I should have double-checked it from an alternate source!


This is a recurring problem with Matt Taibbi's writing, which is worth knowing, because any time Taibbi writes something that remotely bears on startups, technology, or the finance industry, it's sure to be plastered to the front page on HN.


Thanks for the explanation. You should publish this.


I would politely suggest that he just did. To the most important and selective audience imaginable.


I imagine that the GP's point was that publishing here doesn't reach the same audience Rolling Stone does. If so, I agree.


I would politely suggest that he just did. To the most important and selective audience imaginable.


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.


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.


Thanks for the leanlaunchlab link.

True, the competitors argument is the first thing people would cite against continuous meaningful disclosure. The counterargments are 1) Not as important if everyone is disclosing on a level playing field. 2) More information supports better functioning markets==better decisions by the private sector. This is a huge benfit IMO. 3) Often a red herring for hiding weak management, not competitive information. 4) Truly sensitive information can be scrubbed or aggregated. There, a real job for a regulator besides napping.

Bonus point. The startups built around disclosure and analytics could be more interesting than the capital raising jam job companies that are going to be spawned.


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.


(A) Name, legal status, address, website

(B) Names of directors, officers, and 20% stock holders

(C) Description of the business of the issuer and business plan of the issuer

(D) Prior year tax returns & financials

(E) Use of proceeds

(F) Target offering amount, deadline, and progress updates

(G) Share price and methodology for determining price

(H) Cap structure

A, B, E, F, and G are trivially generated (note that the sharks will have fronts to avoid having to put up the same names constantly). F and G are trivial to the point of boilerplating.

C and D may look like serious requirements, but if we're talking about early stage company investments here, how stringent do you think these requirements could be? What do you think the tax returns for a 1-year-old pre-VC tech company look like?

Even the full SEC disclosure policy for IPOs was insufficient to keep clowns out of the public market in '99.


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.


Yup, that's right. Kickstarter already operates in the clear. What JOBS enables is kickstarter with equity involved. That opens up a lot more opportunities.

Consider the case of someone who wants to launch a small business to do something that can't be doled out in small chunks to backers. Let's say I want to build a better wheelchair, for example. Well, even if people can tell from my descriptions and existing work that I really know what I'm doing and have a fantastic idea, few people actually need a wheelchair. So with the kickstarter model this could be a tough project to get going, but if equity could change hands it could be a lot easier.

Yes, there's going to be fraud with this, lots and lots of fraud. But there's already a lot of fraud in the market. It's not important to attempt to eliminate fraud, it's more important to make sure people have enough information to know when they're doing something risky. On the whole I think it's vastly better for everyone if we enabled startups at the low end at the risk of widespread small scale fraud than if we keep everyone's investments locked away with the "too big to fail" companies where large scale fraud and malfeasance has the potential to topple governments and destabilize the world economy.


> It's not important to attempt to eliminate fraud, it's more important to make sure people have enough information to know when they're doing something risky.

I suspect it's at least as hard to do the latter as it is to do the former, and almost certainly harder. At least with the regulatory framework in place, the person you have to con is a professional auditor. Without that regulation, it's going to be trivially easy to con the average investor.


Just because a piece of legislation has a nice feature doesn't mean it can't be horrible for its other properties.


Absolutely correct!

But it still seems to me that Taibbi is focussing on one particular aspect of it without any indication that he noticed the other angle.


Taibbi focused on the aspect of the JOBS act because the angle you propose is already legal and the advertised angle (kickstarter for IPOs) is (as far as he and others are concerned) just a veneer used to sell it to the rubes.


Similarly, just because a piece of legislation has a horrible feature, doesn't mean it can't be fantastic for its other properties.

Fraud exists. Fraud will exist after this bill goes into effect. So will non-fraudulent business models and investment opportunities that were unworkable before the bill. Does the benefit of those new opportunities outweigh the cost of the increased fraud potential? I think so, perhaps you think not, neither of us know for sure.

What I do know is that I worry more about the entire economy being destroyed by the current powers that be through both fraud and simple incompetence than I worry about losing money to fraudsters preying on unaccredited investors like myself, and I very much look forward to having the opportunity to do so.


I'm a fan of the JOBS Act but doesn't the existence of Kickstarter imply that your scenario was already legal?


From my understanding, pre JOBS act, you could not use something like kickstarter to sell equity in your company (especially bc investor accreditation issues.) Kickstarter has been used for preorders/donations.

Post JOBS act, I believe a tool like kickstarter could be used to sell micro portions of equity in a company.


Kickstarter specifically excludes businesses, leaning towards projects only. I don't think they specifically preclude offering equity, however.


IndieGoGo, one of the big competitors to Kickstarter, is a better example. It actually has a category for Small Businesses and doesn't limit what kinds of projects are allowed on the site like Kickstarter does. They do, however, explicitly disallow offering equity as a contribution reward because of the very issue the JOBS act is about. From their FAQ:

"What violates our terms? - Offering any monetary return on investment or real property, including: real estate, annuities, lottery contracts, profit-sharing, cash, securities, equity or debt-repayment"

The site actually had some excited-sounding announcement about the JOBS act recently, but I can't seem to find it.


Just to clarify.

Taken from http://www.kickstarter.com/help/faq/kickstarter%20basics#Doe...

"Does Kickstarter take some percentage of ownership or intellectual property of things made through Kickstarter?

Absolutely not. Project creators keep 100% ownership of their work."

If I'm not mistaken in this context I'm pretty sure "percentage of ownership" is synonymous with equity. At least the way equity as a word is being used in the context of this conversation.

Edit: Clarification


Among their list of prohibited items is "Financial incentives (ownership, share of profits, repayment/loans, etc)".

I suspect existing law forbids them from selling equity.


Kickstarter offers no recourse to participants. Whatever equity is, it is not a no recourse payment.


Author of Rolling Stone piece is focussing on the JOBS act as an enabler for stock fraud.

That's because, at this point in time, fraud should be the focus of anything related to the financial sector.


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.


When you order a pizza it doesn't exist at the time you order. That doesn't change the fact that you're purchasing a product.

Though I think with kickstarter you're technically making a donation. Either way I don't see how that could affect your taxes (other than sales tax) unless you're backing something you want use as a deduction...


Donation is very different from purchase.

but i was thinking mostly for the guy receiving the money. There's then a distinction for selling and servicing.

The pizza analogy is not that fitting, because there's no wording saying the pizza may not materialize.


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.

Read more: http://www.rollingstone.com/politics/blogs/taibblog/why-obam...


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.


I agree that civil litigation can be a terrible method of enforcement, however it's like the criticism of democracy being a terrible form of government but better than the alternative.

The problem with "ex ante" regulations governing conduct is you force a lot of wasteful work on a lot of people and companies that becomes a drag on the economy, productivity, whatever you want to call it.

Let's make an analogy that's appropriate for this time of year. Some people cheat on their taxes. Some cheaters get audited and caught, some don't. Since we know that some people cheat on their taxes and an audit will uncover it should we force every tax filer in the US to submit receipts and other documentation for every deduction claimed on their return, at the time of filing?

Can you imagine how much time that would take for filers and the IRS? Can you imagine the outrage on the part of filers?

The Taibbi article sites to a Bloomberg opinion piece that baldly states that people can lie in their pitch and get away with it. However, if you read the legislation (or at least credible legal analysis of it): A) the pre-prospectus presentations can only be made to qualified investors and institutions (meaning you are supposed to be a sophisticated investor, not the general public and will read or pay someone to read the prospectus when it is filed) and B) the actual regulations that will enact the law haven't been written yet.

There definitely will be (and need to be) reasonable regulations to enact this law, I don't argue that at all. I just think the whole tone and content of this article is over the top and biased. I enjoyed reading his evisceration of GS, but I do think it has influenced his writing about anything having to do with the securities markets or finance in general.


Sure, but you can come up with real analogies that cut the other way. And you don't even have to go to hypotheticals.

Take food. The US has reasonably strong food laws. Nobody in their right mind would suggest that we go for China-style food safety laws (mmm, melamine infant formula and "meat" made from whatever fits in the grinder) and then hope that suits from individual sick people fixes it.

Also, you're ignoring half the costs. I have confidence that I can buy pretty much any food in any store or restaurant in my city with very low odds of getting sick and zero odds of getting poisoned. Complying with food safety regulations may be expensive for the producer, but removes very expensive burdens from consumers.

Moreover, a well-regulated market is more friendly to consumers via increased competition. If our food safety laws were poor, then I'd only buy from producers who had very strong reputations. The risk of trying a new product or a cheaper competitor would be much higher, so innovation would be lower and overall prices would be higher.

I think investment in the US is closely analogous. Well-regulated markets can help all participants, buyers and sellers alike.

Also, Taibbi's skepticism of Wall Street is well earned. The recession we are still working out of was mainly caused by financial shenanigans, but nobody is in jail and regulatory fixes have been minimal. Anthony Mozillo, for example, made north of $600m; his eventual punishment was to have to give back 10% of that. Lesson learned, I'm sure!

The JOBS Act could be entirely innocuous, but "once bitten, twice shy" seems reasonable to me.


> The problem with "ex ante" regulations governing conduct is you force a lot of wasteful work on a lot of people and companies that becomes a drag on the economy, productivity, whatever you want to call it.

You're asserting this based on religious beliefs; you've read and heard this statement a lot in the popular media, and it's part of the Republican catechism. But it's false. In fact, the truth is quite the opposite - a heavily regulated environment is the BEST for business, the economy, and productivity. The United States is a good place for business precisely because it is heavily regulated. Nobody steals your plant equipment because there are lots of cops and Marines. People pay their end of the contract because there are lots of courts. Banks don't steal your deposits because the bank regulators are strong, well, that one may be inoperative in 2012 but it used to be true.

The closer the United States comes to non-regulated countries like Somalia, the closer its economy will be to Somalia's.


Excellent point. But I think it's not just dogma that drives this.

There's also tendency toward convenient over-simplification that's common among we nerds. It's a valuable tool; classical mechanics is a lot easier to learn and reason about if you ignore things like air resistance. One of the most important skills for a software developer is willfully ignoring 99% of the complexity to extract the 1% it's worth teaching the computer about.

But it's also dangerous. The simplifying assumptions of economics are things like perfect information, perfect rationality, unlimited mental processing power, unyielding will, and entirely unbiased cognition. That's useful in theory, but misleading in practice. Misleading twice over, because that's how people would like to see themselves. "I don't need regulation! I'm too smart to ever be fooled!"


Small investors are fucked from the start

This has always been the case. The stock market, corporate bonds, land trusts, and any other investment made by a person who isn't an expert in the field is just putting their money into a big black box, crossing their fingers, and hoping more money comes out.

If you've got $100k to invest, go buy a car wash. It's a much safer bet than randomly sticking your money into the mystical black box.

If you've got $10k to invest, find 10 friends and buy a McDonald's. Yeah, it might be buying a job, but those things print money, and if you lose money, you will have lost it betting on yourself.

These are far more sensible solutions to manage your extra cash than throwing it into a mutual fund or a 401k or a savings account managed by someone you don't know in a way that you don't understand. You're just setting yourself up to be victimized when you thought you were 5 years away from retirement.


Non-optimal returns are very different than being screwed over by scammers. One of the reasons that the US has such strong capital markets is that common investments are rarely out-and-out frauds. Whether that's due to the nobility of bankers or our relatively strong regulations is left as an exercise to the reader.

I think you vastly underestimate the costs of real businesses. Looking at BizBen.com, maybe 3% of car washes for sale are under $100k. The average McDonald's grosses $2.2m/yr and is reported to have profits in the 7% range, which would be ~$150k/yr. There's no way you can buy $150k/year in income for $100k.

You also don't account for the opportunity cost of the time and energy, or the increased risk. If I'm taking my investment money and buying myself a job, then if my investment fails my job is gone too. For a lot of people it's better just to put the money in a (tax-advantaged) 401k and spend their energy on what they're actually good at, which is probably not the evaluation and operation of small businesses.


Investing is simply choosing who you want to get to use your money to try to grow.

If you're focussed on returns, unless you have significant control over the companies you invest in, investing anything but a low-overhead tracker of a well-known index is not investing but just plain betting.

If you're not just focused on returns though, you should invest 'on principal' in what you believe in.

I always believed that small companies would in general do/be better, therefore I would've invested in small-caps. Some people want to fund a more eco-friendly world and invest in CleanTech funds. Now if you believe want a world with more startups, you can invest in that.

But yes, having a managed 401k is giving your money to a bunch of dispassionate bureaucrats which in general is not that smart of move.

[EDIT: I didn't know that 401k has tax benefits which might offset the overhead of the bureaucrats.]


How on Earth can you speak about the intelligence of contributing to a 401k if you didn't know their tax benefits?


Not everyone on Earth is an American :)

As wpietri correctly assumed, I thought that a 401k was by definition a managed fund and my comment was directed at managed funds in general.


Also, after switching employers, you can roll your 401k over to an IRA and invest in whatever you want.


It wasn't my comment, but I suspect his focus was more on the managed funds that most people use in 401ks rather than the 401k account type itself.

That's a reasonable suspicion. Warren Buffett's involved in a million-dollar bet on the same topic: http://longbets.org/362/


> 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.


Assuming there's anything left to sue for...


> 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.

And oh, cure is better than prevention, right?


> "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 it a universal argument against any law?


See my analogy above to income tax filing requirements. It's not an argument against any law but rather reporting requirements. If you lie, cheat or steal, it's against the law. However what you have to do to prove you have not lied, cheated or stolen(prior to any accusation being leveled against you) is the point of reducing the regulatory burden.


Have you ever read a prospectus from start to finish?

Groupon's is ~270 pages long: http://www.sec.gov/Archives/edgar/data/1490281/0001047469110...


1. the only time the pre-prospectus info can differ from the prospectus is before the prospectus is filed. 2. the only people that can legally receive the pre-prospectus information are qualified investors (accredited) or institutions, who supposedly can take care of themselves. 3. if you don't want to read the prospectus but want other information that's "guaranteed" to match the prospectus and you are an individual investor, just read the information that is provided after the prospectus is filed (which is all you should be able to get your hands on anyway, absent the above exclusions).


Section 201 of HR 3606 says

> Not later than 90 days after the date of enactment of this Act, the Securities and Exchange Commission shall revise subsection (d)(1) of section 230.144A of title 17, Code of Federal Regulations, to provide that securities sold under such revised exemption may be offered to persons other than qualified institutional buyers, including by means of general solicitation or general advertising...

http://www.govtrack.us/congress/bills/112/hr3606/text

They no longer have to limit their pre-prospectus info to qualified investors - it is now wide open to advertising to everyone. And instead of only selling to qualified investors, they now can sell to anyone that the seller reasonably believe is a qualified institutional buyer. I can imagine the conversations now: "I can only sell to qualified investors wink, so since you want to buy it, I believe that you are a qualified investor!"


I think there is an opportunity here in dealing prospectus of public companies for investors.


> 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 don't know why they are spreading this FUD.


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.


It wouldn't be susceptible because there could be more than one competing. Different providers would optimize for different types of investors.


There would be two types of customers to compete over between the exchanges, startups and investors. Since there is a natural tension between investors and the businesses as far as how much disclosure and oversight there is, it would probably depend on which class of customers was more profitable as to which side the industry as a whole would favor.


I wonder if all the problems with Groupon's train wreck IPO would have been discovered ahead of time under this new regime.


Seems it would be the opposite:

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.


Correct! If Groupon started today we would still be at least a year and half away from having any chance at all to discover their fraudulent accounting, and their stock would probably be at $1000/share.


He seems to be griping about all the best parts.

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.


Can you disclose the bank?

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 don't want to post on a forum but send me you email and I can connect you.


Thanks! My email is eocean@fohr.com.


Apparently third time's the charm for this story. See also:

http://37signals.com/svn/posts/3160-lets-ride-this-bull


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.


>Making it easier for startups to raise money does not equate to fraud on Wall Street.

Eliminating independent accounting requirements is as close to equaling fraud as makes no difference.


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."

[0] http://www.nytimes.com/2011/10/24/opinion/small-businesses-a...


Not quite.

When people say things like "the engines of the economy, small businesses and startups", they are referring to job growth and innovation. Large businesses have most of the revenue, but small, new businesses are where tomorrow's champions come from:

Each wave of firm startups creates a substantial number of jobs. In the first years following entry, many startups fail [...] but the surviving young businesses grow very fast. In this respect, the startups are a critical component of the experimentation process that contributes to restructuring and growth in the U.S. on an ongoing basis. -- http://www.nber.org/papers/w16300.pdf


It's not just startups and small businesses. The JOBS act covers companies with annual income up to $1 billion.

The crowd funding stuff in the bill is great, but it's like a few drops of honey on top of a turd.


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.


What? There isn't fraud in the stock market today?

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.


What will this mean for RSUs?


If its legal is it fraud?

Just sayin..


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).


Don't forget the scum that is HFT...ooh, I'm sorry, I meant to say "liquidity providers".




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