The architecture of the JOBS Act is very Frank Gehry – it flaunts its flashy surfaces for cheap crowd-pleasing thrills but displays little structural sense. The statute upends the traditional structure of securities law without any grounding in engineering principles. I fear we will now be living in a legal edifice that leaks and sags (and hopefully not anything worse).
Let me illustrate this with two examples. First, Title I of the statute grants exemptions to “emerging growth companies” for various securities disclosure, auditing standards, and internal controls. Again, “emerging growth companies” is a fancy label for companies with less than a billion in annual revenue. This contrasts starkly with the way in which securities law has evolved over the years to lessen the disclosure of larger companies – think integrated disclosure, shelf registration, WKSIs, etc. etc. This traditional structure makes sense not because we want to favor big companies, but because market efficiency means investors are more likely to have information on these companies.
The JOBS Act emerging company exemptions flip this logic of market efficiency on its head. Thanks to Title I, we are now going to get less disclosure and less auditing on companies about which the markets already have less information and are less efficient. Like Gehry, the architects of the JOBS Act chip away at the foundations.
Second, Bob Thompson pointed out yesterday that in redrawing the “publicness” line for what constitutes a reporting company, Title V is making “accredited investor” definition do more work. To recap, the statute replaces the old 500 shareholder of record standard for when a company needs to file reports under the ’34 Act with a threshold of either (i) 2,000 persons or (ii) 500 persons who are not accredited investors. Bob draws our attention to the potential concerns with the growing importance of the accredited investor standard.
This concern should be underscored. The JOBS Act is making this one definition do too much work or, to belabor the architecture metaphor a little more, to carry too much of the structural load of securities law. Legal scholars and practitioners have long questioned whether the accredited investor definition – particularly net worth and income standards for natural persons -- is too rough a proxy for the capacity of investors to make sophisticated decisions or bear financial risk. As the load that this definition must bear increases, so too should our urgency in seeking alternative pillars or proxies for sophistication and risk-bearing ability.
It is also critical to rethink whether the purpose of this standard – or securities laws generally – is really to protect unsophisticated investors from markets or – more provocatively – to protect financial markets from unsophisticated investors. But that kind of thinking won’t win votes.
The constant political pressure on securities laws makes over-reliance on the accredited investor definition particularly worrisome. When boom times come back, investors, politicians, and financial firms will want to relax the definition of accredited investor to let more of the public share in the bounty. And when one definition does double and triple duty in the regulatory framework, it becomes harder to predict the rippling consequences of changing that definition. We’ve seen with the use of credit rating agencies the dire consequences of creating single points of failure in the architecture of financial regulations.
We've also seen in the last ten years, how creating exemptions and exceptions to part of financial regulations (even if they look innocuous by themselves) can have systemic effects, as money flows to the point with the lowest regulatory tax. That is the real problem with many of the JOBS Act provisions -- from the IPO on-ramp to crowdfunding: it creates leaks in the regulatory framework. Let's hope that doesn't it damage the structural integrity.
Photo of Frank Gehry's Fred and Ginger House in Prague, by Dino Quinzani, subject to Creative Commons ShareAlike 2.0 Generic License:
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