The Great Debate

A few weeks ago, President Obama signed the JOBS Act into law, making equity-based crowdfunding legal for businesses that want to raise capital in smaller amounts than traditional venture capitalists or accredited investors supply. Depending on who you ask, crowdfunding is either going to democratize access to capital and serve as a boon to small businesses across America, or it will be rife with con artists intent on bilking seniors out of their hard-earned savings.

Let’s hope the former is true. But concerns about fraud must be addressed so the emerging market can thrive without being spoiled by fraud and scams.

The Securities and Exchange Commission is currently writing rules that will govern crowdfunding and, it’s hoped, guarantee its success. (Disclosure: I worked as a securities lawyer at the SEC from 1986 to 1990.) To properly regulate crowdfunding without suffocating it at inception, the regulators at the SEC must strike the right balance between guarding against fraud and allowing the marketplace to work its will.

Here are five actions the SEC should take to help crowdfunding flourish:

Make crowdfunding easily searchable. Work with the industry and the applicable self-regulatory organization to create a standardized national database of crowdfunding intermediaries and businesses seeking crowdfunding that can be accessed by regulators and investors alike. Databases should include search capacity and filtering by characteristics of businesses (e.g., minority, women-owned, food-oriented, Baltimore-based, etc.).

Define social-media boundaries. Provide detailed guidance as to how businesses seeking crowdfunding may use social media. Companies are allowed to give notice of their offering and direct investors to the “funding portal” where it is listed, but the nature of that notice is not spelled out. Can they post on Facebook and Twitter? What impact does it have to encourage people to “like” the investment on Facebook? Is a pin on Pinterest an advertisement? Crowdfunding companies won’t be filing a prospectus with the SEC when they’re looking for funds, and information will be available through all sorts of different channels. Our new world needs new rules.

Allow crowdfunding portals to be selective. Thousands of wacky companies are going to spring up overnight, and portals have to be able to exercise judgment (for instance, declining groups that want to sell racist T-shirts). But if portals do exclude companies, they might be considered to be acting as “investment advisers” that have to be registered with the SEC. The SEC needs to give portals safe harbors to exercise common sense.

Let the private sector work. Acknowledge the important role that the private sector will play in policing crowdfunding. There are going to be companies that focus on due diligence and disclosure, like the one I cofounded, and others that try to measure the amount of risk involved. When such companies are performing a useful function in the market, they do not need to be regulated like a business seeking crowdfunding or a crowdfunding portal.

Don’t smother startups. The SEC must recognize it’s dealing with companies in the very early stages of development. That means it needs to accommodate the needs of startups. Startup culture is disorganized and resource-poor. The SEC should focus on the overall picture and minimize the amount of information required for investors. For example, startups should be asked to provide a list answering the question “what are the specific risks you face?” as opposed to the detailed analysis that is more appropriate for more developed companies that trade on the New York Stock Exchange.

Skepticism of crowdfunding is healthy, and it is entirely correct to assume that where money is changing hands, there will be some fraud.

But fraud is not the biggest risk that investors face. The biggest risk to investors is that most businesses fail. Investors who want to give legitimate businesses a chance, despite the very real risk of failure, are what crowdfunding is really about. It is such an American virtue: We want to give everyone an opportunity to do well, as long as they play by the rules. The SEC has about eight months left to write the rules. I do hope they work.

By John Kemp
The writer is a Reuters market analyst. The views expressed are his own.

LONDON – Should federal government agencies have to prove the benefits of new regulations outweigh the costs before introducing them?

It sounds like a simple question with an obvious answer. But the role of cost-benefit analysis in writing federal regulations (and even laws) is shaping up to be one of the biggest battles between the Obama administration and business groups in 2012.

By Raymond C. Offenheiser
The opinions expressed are his own.

For most of us, this July 15th will be the start of just another hot summer weekend. But for many, the day marks the one-year anniversary of Congressional approval of a landmark law that will lift the veil of secrecy on billions of dollars that flow every year from oil and mining companies to governments around the world.

Tucked into the massive Dodd-Frank Wall Street Reform and Consumer Protection Act is a provision requiring oil, gas and mining companies reporting to the US Securities and Exchange Commission (SEC) to disclose the payments they make to host governments.

From rural villagers in Africa to investors on Wall Street, the groundbreaking law casts the transparency net far and wide, arming the public with information it can use to track the amount of money governments receive from oil and mining companies. The provision, backed by a bipartisan group including Senators Lugar and Cardin, among others, requires annual reporting of taxes, royalties and other payments, and covers a broad range of US, European, Chinese, Brazilian and other companies. By law, the final regulation from the SEC — the regulatory agency responsible for implementing the law — should have been issued in April. However, no final rule has been issued.

Two women are fending off a vicious man-handling of investor protection.

As Congress pettily wrangles over the debt limit and the next budget, Mary Schapiro and Elizabeth Warren are fighting to protect you against the ravages of Wall Street.

Wall Street and its Republican allies would like to make the Dodd-Frank financial reforms disappear. The money trust has been pouring millions into lobbying to eviscerate the budget of the Securities and Exchange Commission and blocking the formation of the Consumer Financial Protection Bureau.

Mary Schapiro, who chairs the SEC, said she can't kick start the myriad pro-investor rules of Dodd-Frank without adequate funding. Republicans, lead by Budget Committee Chairman Paul Ryan, want to "starve the beast" in their fiscal year 2012 proposal.

The following is a guest post by Dana Radcliffe, a senior lecturer of business ethics at the Johnson Graduate School of Management at Cornell University. The opinions expressed are his own.

The day after the Securities and Exchange Commission announced its $550 million settlement with Goldman Sachs, three noted business journalists appeared on a popular current affairs TV show. They concurred that the deal was a win for Goldman since the dollar amount was surprisingly low — equal to what the firm earns in just a few weeks. They felt the SEC’s case was weak and that, legally, Goldman had done nothing wrong and would have prevailed in court.

They also agreed that people were understandably appalled by some of the firm’s conduct in the subprime mortgage crisis in light of the flood of emails and other internal company documents released by Congress and Goldman. Grasping for a way to express what was repellent about such actions, one of the writers described them as “icky.” Another airily noted that they might be seen as wrong “in some ethical, moral, or philosophical sense.”

The following is a guest post by Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics. You can also follow him on twitter. The opinions expressed are his own.

As Congress was approving financial reform legislation yesterday, Goldman Sachs agreed to pay $550 million to the SEC to settle a civil lawsuit that claimed Goldman had misled investors in a subprime mortgage product as the housing market began to collapse three years ago. The settlement marks the beginning of the end of Goldman’s public humiliation for its relatively small part in the subprime debacle, but the firm still has a great deal of work to do to satisfy the conditions of its settlement, repair its relationship with clients and mend its damaged public reputation.

I have had a “neutral” rating on the forward operating results of GS since Q1 of this year and will leave that rating in place for two reasons. First, the carry trade reflected in record net interest margins in the banking industry is going to slowly diminish at GS and many other banks. Unless the Fed allows interest rates to rise soon, all of the assets of banks and funds will gradually re-price to near-zero. When the media waxes euphoric over the “trading” results of firms like GS, they fail to realize that much of trading revenue comes from simple interest rate spreads over funding.

Wall Street’s diminished influence in Washington was made plain yesterday when the Senate voted to approve financial reform legislation by 59 votes to 39.

Industry lobbyists will point out the bill only just managed to scrape the required votes needed to end debate and forestall a filibuster. It fell far short of a lopsided bipartisan majority.

But the formal tally on HR 4173 (Wall Street Reform and Consumer Protection Act 2009) as amended by S 3217 (Restoring American Financial Stability Act 2010) conceals a much wider bigger majority of 63-37 for enacting far-reaching reforms.

— Charles K. Whitehead is an Associate Professor of Law at Cornell Law School.  He practiced in the United States, Europe, and Asia as outside counsel and general counsel of several multinational financial institutions, including as an associate in a law firm representing Goldman, Sachs & Co.  The opinions expressed are his own —

The civil action brought by the SEC against Goldman, Sachs & Co. has placed it squarely in the cross-hairs of those who argue, in the debate over new financial regulation, that Wall Street needs a new moral compass.  But it’s important, I think, to separate our frustration with Wall Street from the strength of the SEC’s case.  The case for reform is relatively easy to make.  After all, who needs smoke when we have just put out the fire?  The case against Goldman Sachs, I argue, is not nearly as convincing.  And, while there is – and, no doubt, will continue to be – a he-said, she-said quality to some important facts, it may be useful to consider the core case the SEC has brought.

The SEC’s charge, if proved, is fairly straightforward:  Goldman Sachs defrauded investors in notes whose value was based on a portfolio of assets selected by a hedge fund, Paulson & Co., first, by failing to disclose Paulson’s involvement in the selection process, and second, knowing that Paulson had placed bets on the portfolio declining in value.  To prevail, the SEC must show a substantial likelihood that the failure to disclose Paulson’s involvement and its short position was significant to a reasonable investor, considered within the total mix of information available at the time the purchase was made.  That may be difficult to do in light of what was being sold.

Stock up on canned goods, the authorities appear to be opening a new front in the War Against Speculation; this time taking aim at the people who might profit from Greece and its European partners’ woes.

Just days after the U.S. Securities and Exchange Commission voted new limits on short selling, Germany is investigating the credit default swap trading of speculators to try to prevent them from profiting from any bailout of Greece.

“It would be bad if it were to emerge after a rescue that the money had gone into the pockets of speculators,” a source with knowledge of the efforts told Reuters.

Once again someone in charge — Mary Schapiro of the U.S. Securities and Exchange Commission this time –  is going on about how they are making changes in order to “preserve investor confidence.”

As if this were in some way a good thing.

I would feel a whole lot better if instead the SEC were talking about making investors more sceptical.

The SEC on Wednesday moved by a 3-2 vote to place additional limits on short selling of stocks, the practice of betting on a decline in a given stock by borrowing shares, selling them and contracting to buy them back later at what the seller hopes will be a lower price.