Not This Time: JOBS Act A Bad Idea

March 21, 2012 By

Let’s be honest. The crowdfunding provisions in the JOBS Act currently moving through Congress are not designed to help small businesses as you know them raise money. They’re a mechanism to allow large investors and venture capital firms to shift some of the risk of funding tech startups from their portfolio to the public. And the self-management and self-regulation provisions for “third-party intermediaries” simply invite fraud.

We learned through the Enron/Global Crossing era that businesses simply can’t be trusted to self-regulate. And if we didn’t learn, the message was hammered home by Goldman Sachs and the big banks in the late 2000′s. And, in light of those massive frauds, what did the Congress of the United States require in this crowdfunding legislation to ensure that fraud is kept to a minimum?  They are required to take “reasonable measures to reduce the risk of fraud with respect to such transaction.”

And if no intermediary is used and the company trying to raise money does so directly with the public? How do regulators ensure that everything is on the level? They are required to take “reasonable measures to reduce the risk of fraud with respect to such transaction.” Oh, that’s just precious. Really? They’re supposed to take “reasonable measures” that they’re not committing their own fraud? Nice, Congress.

And those that would benefit from this speculation are making stupid arguments like:

Now imagine a world in which we preclude anyone from making an investment in which they might lose money. Or, imagine a world in which we legislate that accountants double-check every transaction in every company. Or, imagine that we put in place draconian penalties for all errors, after-the-fact, intentional, or unintentional. That’s a world in which FedEx, Apple, Intel, Genentech, and Facebook, just to name a few prominent American success stories, wouldn’t exist. Neither would Wal-Mart or IBM.

That’s the classic second-grade overreaction argument — from a Harvard professor! I have the same argument with my 8-year-old twice a week. And it ignores two things. First, there’s a difference between an INFORMED investment and an UNINFORMED investment. And two, FedEx, Apple, Intel, et. al. had stringent regulations on their capital formation – and they did just fine.

Truth be told, there are already crowdfunding options that serve the needs of local businesses – and then some. Services like Kickstarter, IndieGoGo and Lucky Ant that use the cash-for-perks model have proven overwhelmingly successful. This bill could ruin those services by lumping them in with the bill’s “third-party intermediary” classification, either in legislation or in the SEC rule-making process. Make it harder for the good guys and easier for the bad guys? That’s Congress for you.

There are voices out there warning of the risks:

Former SEC Chairman Mary L. Schapiro said that the crowd-funding provision “needs additional safeguards” and that the bill “would weaken important protections.”

Former SEC chief accountant Lynn Turner went even further:

The package of bills awaiting Senate action after receiving broad bipartisan support in a House vote last week would destroy safeguards dating as far back as the laws that created the Securities and Exchange Commission, according to Lynn E. Turner, a former SEC chief accountant.

“It won’t create jobs, but it will simplify fraud,” Turner said in an interview last week. “This would be better known as the bucket-shop and penny-stock fraud reauthorization act of 2012,” he said, referring to practices banned under securities law.

Jesse Eisinger of non-profit news outlet ProPublica pulled no punches:

The JOBS bill fixes that. Taking advantage of the revolutionary possibilities of the Internet, the bill loosens decades-old investor protections so that companies can directly advertise to those who would like to be separated from their money. It does that by giving broad exemptions for start-ups that want to “crowdfund” by raising small amounts of money over the Internet. I.P.O. pitches next to “Lose Your Belly!” ads. Sounds like a great idea!

Even more critics piled on in this San Francisco Chronicle article:

“My guess is the Republicans cannot believe they have suckered the Democrats into taking up their idea that deregulation is the way to promote job growth. It flies in the face of what the Democrats were arguing just a couple years ago. It completely undermines what they are trying to do to shore up our system of financial regulation,” says Barbara Roper, director of investor protection for the Consumer Federation of America.

She is not the only investor advocate fuming about the bill. “It’s an ill-advised, fundamental restructuring of the securities laws,” says Mercer Bullard, president of Fund Democracy.

Columbia Law School Professor John Coffee has nicknamed the bill’s crowd-funding provision, which would let private companies raise money from mom-and-pop investors over the Internet, the “boiler room legalization act.”

AARP, Americans for Financial Reform, the North American Securities Administrators Association and the Council of Institutional Investors have strongly opposed all or some parts of the bill.

Arthur Levitt, chairman of the Securities and Exchange Commission under President Bill Clinton, told me, “The bill is a disgrace.”

I am naturally, instinctively, habitually pro-business. Anyone who knows me knows that I’m a huge proponent of crowdfunding and locally-owned small businesses. And those businesses are desperately in need of funding options. So I’m dying to look on the bright side of this legislation and see all of the capital that will flow. But we as a society have been burned way too many times by the business of finance. And there are no real protections here. No requirement that businesses demonstrate basic competence. No requirement for audited financial statements up to $1 million. And not only that, but investing in startups is a ridiculously risky endeavor already. Lots of people will lose lots of money by being seduced into thinking they’re backing the next Facebook.

This is not to say that I’m down on crowdfunding as a concept. I just believe that it can be done on a smaller scale, and with greater protections. I also believe, as I state in this post, that the existing and emerging options in the “cash-for-perks” model are sufficient for most local businesses. Finally, I’ve found in my discussions with people that most local, small businesses don’t want to give up stock to strangers, which would be part of  a “cash-for-stock” model like what’s being proposed in the JOBS Act.*

Many times in the past, I’ve been an eager cheerleader for deregulation. This time, I’m listening to the critics. And the bill is going to pass, so I just have to hope I’m wrong. But in the end, crowdfunding can be legalized in a much, much better fashion than this legislation.

I strongly urge people to strengthen their locally-owned business communities to provide resilience against the next global finance casino implosion. Buy locally-grown food and locally-made products. Instead of crowdfunding big tech startups, fund local businesses in your community. Investigate local energy production and even local currencies. No community can totally leave the global economy, nor should you. But the more you can feed and provide for your own community, the better off you’ll be if this all comes crashing down.

 

UPDATE 3/23: The JOBS Act passed the Senate, but not before the Merkley-Brown amendment was added, greatly increasing the consumer protections. It won’t eliminate the fraud, but it will make it much harder for fraudsters to operate, without making it harder for legitimate businesses to crowdfund. It’s an improvement that makes the bill much more palatable.

 

* – The crowdfunding provisions would likely also permit loan-based and revenue-sharing options, though I expect most of the offerings to be equity based.

photo: the-o, via flickr

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    Dave Burris provides Internet solutions like WordPress websites, social media training and email marketing for locally-owned, independent small businesses. Learn more about Dave and his company, Burris Digital, at DaveBurris.com.

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