The JOBS Act and the Free Market Progressive

Free market progressive. Is that a contradiction in terms? Nearly everyone on the Right wing will tell you that it is, and a lot of self-crowned representatives of the Left will agree. Progressives do believe in a vital role for government in protecting individual rights and promoting the collective welfare of a people. But the deep and abiding commitment to the common good is as important to progressives as are equal opportunities and maximum freedoms for every individual. In fact, the two are co-dependent. In the recent memory, Democrats and progressives in the United States have traditionally been as fierce advocates for unions as they have been for small businesses, partly because the two serve the same progressive outcome, the ability of individuals to advocate for and advance themselves in a marketplace dominated by big players.

That is why I was more than skeptical when I heard the usual suspects - and to be fair, some labor and consumer groups - have a meltdown over a recent rare bipartisan measure that the President signed into law: the JOBS Act, full name: Jumpstart Our Business Startups Act (full text). Their main contention seems to be that the same president who enacted the most sweeping financial industry regulations since the 1930s is now hell bent on deregulating the marketplace to make things easier for Wall Street. They say the JOBS Act weakens investor protections, and will usher in the next Enron. I don't think it carries water.

The chief complaint from opponents does seem to make sense at the first look: they argue that the JOBS Act weakens financial disclosure requirements for Wall Street companies and thus invites fraud. But the critics religiously avoid the details of the which companies are exempted from such requirements. The JOBS Act is made up of two main parts: exempting what it calls "emerging growth" companies from certain requirements for their initial public offering of stock (IPO), and providing individuals with the opportunity to fund small businesses through a method known as crowdsourcing. Here is a short description of how the law affects both.

Emerging Growth Companies

Companies labeled as 'emerging growth companies' are exempt from certain SEC and other regulatory requirements on their initial public offerings, including that they only have to produce audited financial statements for the past two years, and they get to avoid a lot of paperwork and some conflicts of interest rules. It would be a major problem if any company could qualify as an emerging growth company or if a company could remain under that umbrella for a long time. That is, however, not the case.

Emerging growth companies are companies that are looking to go public and have less than $1 billion in gross annual revenue. Furthermore, these companies do not get to remain categorized as "emerging growth" companies for any more than 5 years at the most, if other conditions don't disqualify it first. Here is how the legal experts at Orrick describe define emerging growth companies in their summary of the JOBS Act.
Emerging Growth Companies are defined as an issuer that had total annual gross revenues of less than $1 billion (an amount that is to be indexed for inflationevery five years). A public issuer will remain an Emerging Growth Company until the earliest of:

(1) the last day of the fiscal year during which it had total annual gross revenues of $1 billion;
(2) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of its common equity securities;
(3) the date on which it has, during the previous three-year period, issued more than $1 billion in nonconvertible debt; or
(4) the date on which such public issuer is deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) (i.e., has a public float greater than $700 million).
It's clear from the definition that any fears that huge hedge funds or other institutions structurally critical to the US economy would be affected are unfounded. We are not talking about financial giants or the largest privately owned companies. This provision merely seeks to ease the regulatory requirements for small to mid-size companies going public. By limiting the time that a company can remain one and the amount of revenue which an emerging growth company can earn, a couple of important investment protections are maintained: (a) the company would not be able to become structurally threatening to the economy before its exemptions expire, and (b) investors who wish to be extra cautious can simply choose not to buy stocks for as long as a company remains an emerging growth company.

On that note, an emerging growth company may also choose to comply with the usual SEC regulations that apply to all other public companies, and use that as an extra confidence booster for additional investors.

An argument can certainly be raised that the same rules should apply to all players - big, small, or mid-size; new or old, emerging or declining. One-size-fits-all economic solutions, however, have never really worked. The truth is that what is essential requirements to protect the market for the largest firms can become burdensome unnecessary regulations for smaller companies. A parallel example could be give in the pre-Citizens United political fundraising world. McCain-Feingold, while a good and necessary law to regulate big money donations in politics often overburdened local political groups (such as Democratic clubs) that raised or spent more than $1,000 annually - with filing requirements that took up time, set up red tape, and forced them to find or hire legal and accounting experts in some cases. For groups like one I co-chaired that raised money mainly from membership and sent footsoldiers to help progressive campaigns, it made no sense.

There is a reason why Republicans get away with bashing regulations in their broad-brush appeal to business owners. Business owners - most of whom are well meaning - deal with the regulatory framework on an everyday basis. Most business owners and managers - who are not the richest business owners and managers - see many of the regulations as unnecessary and burdensome for their scale and scope of business. There is the chicken and the egg question. Consider a new promising technology company. Its business has been flourishing, and it wants to go public to raise more capital, but it does not have the resources to hire accountants and lawyers it takes to weave through all the SEC rules to go public. The additional access to capital, however, would give it such an ability. Do we want to give it, at best, 5 years to get the capital to both expand its business and begin compliance, or do we make the red tape an impediment from raising that capital?

If we believe in market competition and the opportunity for smaller businesses with big ideas to compete with giants of the market, it seems to me, that we would want the latter route.

Crowdfunding: Grassroots Funding for the Power of Ideas

Who among us politically minded folks don't know the power of grassroots fundraising? Political campaigns have access to every American citizen (and permanent resident) to whom they can pitch their ideas and ask for funding. But our small businesses are left at the mercy of banks and loans from their friends and family members. They cannot ask for funding from the general public, except of course, by going public, which is much more expensive.

Why shouldn't individuals be allowed to pick the ideas they want to invest in? They should, and the JOBS Act lets them. Once the SEC enacts rules to facilitate this, small businesses will be able to raise up to $1 million annually without all the reporting requirements and from groups of small investors, not just large 'accredited' investors. To safeguard investors and to weed out opportunists from this market while keeping in contention truly promising ventures, the JOBS Act provides some restrictions:
Individuals with annual income or net worth of less than $100,000 will be able to invest no more than the greater of $2,000 or 5% of their annual income or net worth in any 12-month period, and those with annual income or net worth greater than $100,000 can invest up to 10% of their annual income or net worth annually (with a cap of $100,000 per investor annually). There will be requirements with respect to a company’s financial statements depending upon the amount of funds raised:
  • raising amounts up to $100,000 annually requires the certification of the principal financial officer that the financial statements are true and correct;
  • raising amounts between $100,000 and $500,000 annually will require review by an independent public accountant; and
  • raising amounts above $500,000 annually will require audited financial statements.
Imagine being able to go online to a website protected by SEC regulations and being able to pick legitimate businesses with good ideas you like that are struggling for cash. Imagine solar and wind energy startups. Imagine emerging medical technologies or medical offices with new approaches to health care to reduce cost. There are all sorts of businesses banks don't fund because they either don't see a short term return or they see conflicts with their other clients. What if you, along with thousands of others, could suddenly be the bank for the ideas of the future? What if you could be an angel investor for the battery manufacturer that will make the internal combustion engine obsolete, or the company(ies) that will make clean energy so cheap that  oil becomes a thing of the past? Hell, what if you could just invest in a local mom-n-pop store to keep it going when Wal Mart tries to move in next door?

That would be a good thing, according to Connie Evans, the President and CEO of the Association for Enterprise Opportunity, a group focused on microbusinesses.
The JOBS Act will allow small businesses, like Tamara's and Mike's to raise up to $1 million annually through approved, online crowdfunding intermediaries without having to deal with any kind of SEC registration or filing. Investors will be able to invest up to $10,000 annually without any kind of SEC requirements. In the microlending community, $10,000 is approximately the average loan size. According to data from the U. S. Census' Survey of Business Owners in 2007, over 43 percent of women owned businesses were started or acquired with less than $10,000 in capital.
Crowdfunding works. It works, and it forces banks to compete of become irrelevant in the businesses of financing the industries of tomorrow. And it makes the leaders of those industries less beholden to venture (or vulture) capitalists and big banks.

In Conclusion...

Is this a perfect law? No. Does it have potential risk? Sure. The White House, for example, would have preferred stronger investor protections. But on balance, the reforms are common sense, exemptions are limited in time and targeted in financial scope, and crowdfunding is targeted to small business.

Let's all remember why we need regulations. The father of capitalism, Adam Smith, describes a system of free enterprise in the capitalist bible, the Wealth of Nations. Smith imagined a system in which the free market had many components that made it truly free:

  • Businesses and consumers - market actors - would interact with each other freely, and the price of a given product would be determined by aggregate supply and demand.
  • No one market actor - seller or buyer - would have the power to influence price.
  • It would be easy for any one actor to enter and exit the market at any time, without affecting price.
It's easy to see that we don't live in a perfect free market world. In such a world, giants like Microsoft, Apple and GM would never happen. Nor would we get the benefit of the products that they make that require significant resources which only large entities (that are coincidentally large enough to influence price) can provide. And of course, there would likely be no such thing as a stock market with big investors.

Because we live in a world where large corporate entities are needed because of the resources they can leverage for products that become useful and sometimes ubiquitous, the need to regulate those corporate entities so that they cannot harm the average person is born. That's the purpose of regulation; that's the genesis of regulation. Regulations are not a good in and of themselves, but in the protections they provide to average citizens from the excesses of the system.

Therefore, where regulations are needed, they must be enacted and strengthened. But it is equally crucial to understand that regulations must be modernized with a changing world, and where they serve as an impediment to the emergence of new ideas and growth, they must be modified allow innovation to take root. One of the easiest and most common sense ways of doing this is limiting certain regulations to the largest players in the market - ones that have the ability to affect the system - while allowing smaller and newer emerging businesses more flexibility and time to adjust.

The Right wing's problem is that they extend this common sense concept of allowing flexibility for smaller companies and newer industries to all players in the market, no matter how big, old, and systematically threatening an institution is. By this false extension, they demand broad and sweeping deregulation for the largest, most established, and oldest industries.

The Left has a similar problem. Instead of the Right's fallacy of applying common sense flexibility to those who truly need to be regulated, the Left starts the thought process on the other end. We start the thought process on the regulatory end - and correctly count the necessity of strict regulations on the largest businesses to protect against the excesses. They then extend that logic to smaller, newer, and more-recently emerging markets, demanding that the exact same regulations be applied to all, regardless of size, age, or status of industry a company is in.

Both approaches are based on applying assumptions meant for one set of market players to others, and both are ideological and incorrect. Perhaps one is not as bad as the other - I happen to think that if you are going to apply a one-size-fits-all solution, then you ought to err on the side of regulations - but we do not have to settle for a one-size-fits-all solution. We need what could be called free market progressive solutions. The free market is not our enemy. What we need to work for is to protect the free market - the freedom of consumers to choose based on full information and the freedom of businesses to leverage the force of their ideas - from becoming a wild market. That means making it easier for emerging new companies to compete, and for individuals to be allowed to be "angel" investors in ideas that appeal to them.

That's what the JOBS Act does, albeit imperfectly.