Brought to you by the Real Law Editorial Team
“Everyone agrees the title was a work of pure genius,” says Dick Phillips of K&L Gates in a recent podcast, referring to the Jumpstart Our Business Startups (JOBS) Act. “It’s impossible to vote against in an election year.” When a law is so well named, it’s important to look a little deeper at what other special terms it’s using and how it might work in practice. The real story is that it’s the most significant change to the U.S. securities law landscape in a generation, and the clever wording goes beyond the name.
First of all, no one knows if this will create jobs. But there’s more: of all the provisions in the JOBS Act, the one that is most unknown concerns the Silicon Valley flavor du jour: crowdfunding. That’s right, terms that are not yet in Webster’s are now included in American law. Generally, this crowdfunding provision allows companies to raise small amounts of money from lots of people through a lightly regulated intermediary.
Specifically, the JOBS Act amends the Securities Act of 1933 with a registration exemption for transactions involving individual investments limited to the lesser of $10,000 or 10% of an investor’s income. Under this exemption, companies can raise up to $1 million this way annually without providing potential investors with audited financial statements. The issuer or intermediary will have to comply with certain requirements related to disclosure and the resale of securities—though these aren’t yet defined—as well as file a notification with the Securities and Exchange Commission (SEC).
“May You Live in Interesting Times”
Though this phrase might not actually be an ancient Chinese curse, it still could be in the legal world. Such new provisions raise a lot of interesting and important questions. What should the structure and rules be? How do you encourage intermediaries to participate? Do you encourage everyone to behave? How will the SEC and state “blue sky” regulators uncover and prosecute fraud? How do you preserve investor confidence, the cornerstone of capital markets? The discussion is rich and ongoing.
Remember that this bill was fiercely opposed by the SEC, old-time securities lawyers, state securities regulators, and the investor protection community. Companies (or potential ones—crowdfunding might attract whole new categories of organizations, depending on the extent to which the legal niceties are observed) will have to think hard about how they are going to use the new freedoms in raising money and even soliciting investment. After all, this is an industry that relies on precedents, accepted practice, and an overall conservative attitude towards adopting new things. No one wants to open themselves up to interesting new types of liability.
Expert opinion is already reflecting this uncertainty. Take John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School, who had some ideas about how to mitigate the risks inherent in this act. In comments to the U.S. Senate, he outlined what he thought was at stake:
Failure to adopt this approach (or some similar variant) would likely mean that every barroom in America could become a securities market, as some unregistered salesman, vaguely resembling Danny DeVito, could set up shop to market securities under the “crowdfunding exemption.” Under the current version of S.1791, such a person could open his laptop on the bar, show slides of a half dozen companies to the bar’s patrons, and solicit sales. This will create few jobs (except for dubious unregistered salesmen) and much fraud.
Coffee offers concrete and constructive criticism of the law, as well as some solutions. Still, you can often identify poorly crafted laws by the bad metaphors that revolve around them.
Remember That Danny DeVito Has Produced Some Very Successful Films
Despite these (very valid) concerns, there are some contravening points to consider. First, of all, the rules for crowdfunding are not set. The SEC was given 270 days to finalize them. Amendments have already been included to reduce the risks posed by crowdfunding, offering investors more protections while holding start-ups and intermediaries more accountable.
Second, no one can claim that U.S. regulation makes it easy for smaller companies. The IPO market in this summer of 2012 has largely dried up—and small- and mid-cap companies have been relatively scarce in the public funding game since the dot-com crash. Efforts to make it easier for these companies to attract capital should be encouraged.
Third, early innovations in this space have met with success, allowing small businesses to access pools of money totally outside of Wall Street. An online equity crowdfunding platform called Launcht has met with success, and a donation-based funding platform called Kickstarter has attracted $346 million in pledges to fund creative projects. That might not be a lot of money in terms of the larger market, but it’s certainly interesting—in a good way.
The Real Law Lesson: Stay Smart on JOBS
F. Scott Fitzgerald said that “the test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.” That is exactly what lawyers will have to do when it comes to the JOBS Act. They will have to prepare for the fraud, rule-breaking, and market uncertainty that this law will inevitably cause. They will also have to identify and understand the exciting opportunities that are now presented. Despite early successes in crowdfunding, donations remain very different from investments. The losses and the gains for American businesses under the JOBS Act might both be great. We’ll know more in about five years.
In the end, the jobs created by the JOBS Act may be exclusively for lawyers. Either way, it’s going to be interesting.