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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.




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