For the last several months I have been working on a paper exploring political cycles in financial regulation. The core argument is that ideally regulation should be countercyclical, getting tougher during booms to help guard against bubbles, and loosening following crises to put fewer obstacles in the way of financial market recovery. And yet (so the argument goes), actual regulation tends to be procyclical, getting looser during bubbles while stronger new rules are introduced following crises. Many have noted the pattern, from John Coffee (in the paper where he notoriously created the label of the Tea Party Caucus) to Roberta Romano (whom Coffee labels a leader of that Caucus), although those two differ critically as to which phase of the cycle they find particularly problematic (my attempted contribution is to sort out where these variants of the story agree and disagree, and to try to referee among them).

Before the paper is done, along comes the JOBS Act, and it's quite an embarrassment. Here is a significant deregulation of securities law while we are still in hard times caused by the worst worldwide financial crisis since the Great Depression. Falsified before I even publish. So, I am struggling to understand what happened. Bob's post is a great help. Currently I am split between three different stories, two pessimistic and one more optimistic.

Pessimistic story one: we are in a new age of limited regulation. Dodd-Frank was a limited anomaly doomed to be strangled in the crib as the financial industry captures the implementation process; the JOBS Act is a return to the new normal. For those of us who see a real if limited role for significant new regulation (the Occupy Wall Street Caucus?), this is discouraging.

Pessimistic story two: Congress is random and thoroughly uninformed. Dodd-Frank is random and poorly informed reregulation, while JOBS is random and poorly informed deregulation. The two parties are struggling for political advantage in a hostile environment which they don't understand, and if someone manages to come up with a package with a pretty enough bow (that name!), it passes no matter what's inside.

Optimistic story: we've matured to a point where we can pass plausible deregulation as a form of regulatory stimulus, as Erik puts it, while still being able to enact new regulation in areas where the crisis showed we have a need. Obviously, much depends upon how plausible one finds the provisions of the JOBS Act. I must say, my first impressions were actually pretty positive. I am particularly attracted to the IPO on-ramp, while being more ambivalent on crowdfunding. But as Joan says, the devil is in the details. Hence, I am looking forward to the analysis from my better informed colleagues.

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The JOBS Act seems to serve as a textbook of example of regulatory stimulus, in which politicians seek to jumpstart financial markets by relaxing financial regulations rather than using traditional tools like fiscal or monetary policy.  Neither of those traditional tools offers much immediate promise of promoting economic growth in this election year.  The Tea Party and bond market concerns with national debt (in both the United States and in Europe) thwarted any further attempt by the President or Congress to play Keynes.  Monetary policy loses traction at the zero bound, which is a fancy way of saying that interest rates are close to zero and the Federal Reserve cannot pay banks to borrow (and even that might not induce banks to lend).

Regulatory stimulus is not without historical precedent.  Japan engaged in financial liberalization after its own real estate bubble popped in the early 1990s.  Not coincidentally, Japan’s central bank was also approaching the zero bound on interest rates then and was effectively out of cards.

So with fiscal and monetary policy off the table, deregulation of securities presented an attractive political opportunity.  But not necessarily a wise one.  Macroeconomic modeling has suffered some withering criticism in the wake of the financial crisis (for a blog compendium, see here).  

But at least it has some basis in theory and empirical data.  As John Coates noted in Congressional testimony on the JOBS Act, we don’t have a lot of data to suggest that these profound legal changes will (or won’t) result in net job creation. 

Legislating with a lack of data should trouble us.  Legal scholars routinely criticize reforms that increase regulation without  a sufficient empirical foundation.  We should insist on a similar level of rigor for deregulatory efforts. 

But the JOBS Act may be better understood as an exercise in legislative marketing than about reasoned policy choices.  Bob Thompson already gave us a succinct account of the political history of this legislation.  The language of the statute provides a master class in drafting financial legislation for political optics (a topic that incidentally has attracted some interesting scholarship in recent years). 

This goes beyond the statute’s clunky title and the headings of the provisions (“Access to Capital for Job Creators”).  This Conglomerate forum will focus on “emerging growth companies” later in the week.  Our commentators will discuss how companies that fall under that definition are exempt from various auditing, corporate governance, and disclosure obligations.  

However, it bears noting upfront that the term “emerging growth company” has no necessary connection to either “emerging” or “growth” or job creation for that matter.  It just refers to companies with less than $1 billion in annual revenue (a threshold that is indexed to inflation.)

Bob gave us an analysis of why this deregulatory legislation gained traction so soon after a wave of new regulation in Dodd-Frank (much of which is still to be implemented).  The text of the statute also suggests that it buys into a belief that high-growth companies will rescue us from economic torpor.  Wall Street is still bad, but Silicon Valley is riding a white horse again.  There are of course a number of problems with this mythology.

First, as noted above, much of the statute has no necessary connection to high-growth companies.

Second, even if we think that high-growth companies are the best way to promote job creation, innovation, productivity gains, and apple pie (and it would be heresy to question this wisdom (or maybe apostasy in the case of this blog)), why do we think that diluting securities laws is the best tool to promote high-growth companies? 

Third, don’t assume that there aren’t some goodies in the statute for Wall Street too.  Bob and Joan will discuss the IPO on-ramp provisions.  Steven Davidoff focused on the issue of decimalization.  I’ll focus more on the backlash against an obscure but important SEC initiative in a post later this week.  For a preview, suffice to say that when the JOBS Act instructs the SEC to study whether small cap stock should no longer be traded in pennies, but in the old 1/8 increments, Wall Street firms stand to gain.

For now, it is important to note the internal political logic of the JOBS Act.  The first argument is that small growth companies need more capital.  The second argument is that we need to jumpstart the IPO market.  Those two arguments are in quite a bit of tension.  The truth is that VC funding rebounded after the tech stock bubble collapsed (see page six of this report).  Of course it didn’t return to late 1990s levels, but is that a bad thing? 

Now the problem is that VC funds claim they can’t use their traditional IPO exit and many individual funds that raised capital in the aftermath of the bubble years are approaching the end of their lifespan.  But should we run a bulldozer through the regulatory landscape just to perpetuate a particular business model of a fund life of 10 years with IPO as the home run exit?  Wouldn’t a more sensible approach be to ask first whether the VC business model ought to change according to market conditions?

More broadly and deeply, isn’t it possible that the problems in capital markets stem less from legal rules than from the fact that we had two bubbles implode in less than a decade?

There are two looming possibilities with the JOBS Act.  The first is that we are not going to get a lot of stimulus bang for the buck we are paying in terms of changes to securities law protections.  The second is that markets may respond too much.  I’ve spent the last week cleaning up a part of my book that looks at British corporate law in the 19^th century.  A pretty chilling pattern emerges:

1. Parliament promotes financial markets by passing bills that either incorporate new joint-stock companies or liberalize the incorporation process.
2. Incorporations skyrocket, markets boom, railway companies defraud investors.
3. Markets collapse in the Panic/Crisis of 18__.
4. Parliament is “shocked, shocked to find that gambling is going on in here.”
5. A few years pass, then Parliament rinses, lathers, and repeats.

Perhaps we have gone back to that political and market cycle.  (At least in this century, we can take comfort that central banks will act as lender-of last resort, Right? Right?) 

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Bob’s initial post provides a great summary to start us off.  I will just add two general things about the JOBS Act at this juncture—a policy observation and some additional resources for your consideration (and possible review).

Because of the overall political nature of the legislation as a deregulatory reaction to Dodd-Frank and as a face-saving exercise (given congressional inaction on partisan grounds) and also as a result of the bundling of multiple initiatives in the JOBS Act (all as described in more gentile terms by Bob in his post), the policy underpinnings of the JOBS Act are confused.  Let’s face it.  This legislation is not about jobs.  It is (at least facially) about helping keep certain small issuers private (even though they have many shareholders), decreasing the costs to small public issuers, and engaging new investors in small business capital-raising.  But these objectives, especially when viewed in the light of the overall policies underlying the federal securities laws , may work at cross-purposes to each other.  The ability of the JOBS Act initiatives to serve its ostensible objectives and the balancing of those objectives against the overall investor and market protection norms of the Securities Act of 1933 and the Securities Exchange Act of 1934 remains to be seen.  The SEC’s significant rulemaking authority under the JOBS Act will certainly have something to say about this issue . . . .

As further background to the forum for this week, I want to direct you (by way of links to the Social Science Research Network) to articles written by Professor Nikki Pope, me and Ryan Hoffman (a former student), Professor Steve Bradford, and Professor Tom Hazen.  These articles provide some immediate background to the JOBS Act, focusing on crowdfunding, the subject of the CROWDFUND Act (Title III of the JOBS Act).  Although crowdfunding will be the main subject of posts on Thursday, these four articles also cover other aspects of the JOBS Act, including (in text and citations) a lot of background on small capital formation generally and the role of Section 12(g) in that context.  (Section 12(g) of the Securities Exchange Act is the principal focus of posts in this forum tomorrow.)

Folks, as with a lot of legislation, the devil’s in the details on this one.  This is ugly legislation in many respects, and I agree with Steve Davidoff that Congress should not have waded as deeply into these waters as it did.  Like Sarbanes-Oxley and Dodd-Frank, the JOBS Act represents a hodge-podge of disparate provisions.  However, while Sarbanes-Oxley and Dodd-Frank arguably were intended principally to put fingers in actual holes in a dike, the JOBS Act appears in pertinent part to put fingers in perceived—or at least unsubstantiated—holes in a dike.  It remains to be seen whether the SEC will be heroes or villains in this story (and people have different views on what a hero and a villain might be in this context).  The SEC is soliciting pre-proposal comments.  Comments can be posted here.  They have started to roll in.  Let the fun begin!

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Less than two years after the Dodd Frank Act added hundreds of pages of new rules for securities law and financial regulation more generally, we have new securities regulation of a decidedly deregulatory bent. President Obama signed the JOBS Act (the Jumpstart Our Business Startups Act) on April 5, 2012 and the results will immediately affect those who teach either securities regulation or corporations courses. In a series of posts that follow, Joan Heminway and I will address key aspects of the new legislation including : (1) amendments to Section 12(g) of the Securities Exchange Act of 1934 raising the threshold for this gateway to reporting status from 500 shareholders of record to 2000 shareholders of record or 500 unaccredited shareholders; (2) the “on-ramp” which will free most companies doing an Initial Public Offering from having to comply with a whole series of obligations of reporting companies for up to five years after their public offering; and (3) crowdfunding which seeks to facilitate capital raising by permitting issuers to raise up to $ 1 million without having to comply with the core provisions of the Securities Act of 1933. This post provides a brief introduction and a bit of history underlying the act’s development and passage.

In a period in which the news has brought us numerous examples of Republicans and Democrats not able to agree on legislative policy, it is surprising that securities regulation has been a point of bi-partisan agreement in an election year. The JOBS Act received almost 400 votes in the House and passed the Senate 73-26. What explains such success? In part, it is the opening left by the unpleasantness of the 2011 debt ceiling and budget fiascos; both parties had some incentive to show they could agree on something. Nurturing capital raising was easily subsumed within the label of job creation which remains the more salient tag line for this election cycle. And never underestimate the value of a catchy acronym in the passage of legislation. When six different pieces of legislation, with sometimes long and nondescript names, got bundled within a single bill that could be described as the JOBS Act, prospects of passage improved. It probably also mattered that securities regulation was relatively unimportant to legislators, as compared to the debt ceiling or even changes to transportation or aviation regulations, so that once the bill gained momentum, serious opposition could not gain traction.

The timeline for the bill begins in the aftermath of the passage of Dodd Frank in 2010 and the success of Republicans in elections later that year, but the intellectual origins date back much longer. When Republicans gained control of the House and its committees, they held hearings on a series of deregulatory bills in securities, including crowdfunding, which in some sense reflects the ideas of microfinancing that have grown around the world in recent times. Congressman Darrell Issa, chair of an important committee, and SEC Chair Mary Shapiro exchanged letters in the spring of 2011 with the congressman pushing for a series of deregulatory changes and the SEC’s head setting out a series of possible agency actions. One of the issues the congressman raised related to Facebook which, in the winter of 2010-2011, explored ways to stay longer in its unregulated status before making an IPO. In addition there had been discussions ever since the bursting of the dot.com bubble at the turn of the century that the United States was suffering from a decline in its share of IPOs, an issue that had the attention of New York’s senators. In the fall of 2011 a private task force, with strong Silicon Valley representation, proposed the on-ramp. President Obama came out in support of the reform effort. Although institutional groups and Mary Shaprio raised concerns about the changes, the bill was on its way to passage. Opponents of the bill could not get the supermajority 60 votes necessary to block consideration of an alternative bill in the Senate, achieving only amendments to the crowdfunding provisions that added additional fraud protections for issuers and platforms.

Thus we have a bill that provides the first change in the public/private line of 1934 Act in almost half century, a dramatic bifurcation of regulation for 1934 Act reporting companies, and new freedom for smallest issuers in raising funds. Details will be discussed in subsequent posts.

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As announced last week, we at the Glom are pleased to be hosting a special forum this week on the JOBS Act.  In that announcement I included some links for those interested in getting up to speed on the Act.  Here's a link to the main text, weighing in at a slender 22 pages.

But what a lot those 22 pages contain!  We're fortunate to have Joan Heminway and Bob Thompson to steer us through some of the exciting issues the JOBS Act poses for securities regulation.  And we're hoping to hear from some regular Glommers and Masters along the way.

Here's our schedule for the week:

Monday 4/23: Introductory remarks and overview

Tuesday 4/24: Increase in 12(g) shareholders from 500 to 2000

Wednesday 4/25: The IPO on-ramp and emerging growth companies

Thursday 4/26: Crowdfunding

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April is, indeed, the cruelest month for law professors--law review submissions season is grinding on, classes are ending, we're scrambling to fit in last lectures, review sessions, and pre-graduation festivities. With these important claims on my attention, is it any wonder that I haven't gotten up to speed on the biggest change to U.S. securities laws since 1933?   Hmmm.  I, for one, am feeling some guilt about not having made time to focus on the JOBS Act.

 So we at the Glom are holding a special forum on the JOBS Act's effect on U.S. securities laws for four days next week.  Our main posters will be current Master Joan Heminway and special guest and friend-of-Glom Bob Thompson.  I'm hoping that Glommers and Masters will chime in, and of course we hope all of our readers will participate via comments. 

In need of a crash course, I asked our trusty librarian to run down some law prof blogosphere discussion of JOBS, roughly divided into overview, pro, and con.

Overview:

Here's a link, via M&A Law Prof Blog, to a Proskauer Rose client memo summarizing the key components of the Act.

Here's a summary from the Harvard Law School Forum on Corporate Governance and Financial Regulation.

FAQs on JOBS from the SEC.

Steven Davidoff says time will tell on the net benefit, but Congress' lawmaking made sausagemakers look good.

Con:

Peter Henning argues internal controls matter for small corporations.

Barbara Black worries about the overly inclusive definition of emerging growth companies, relaxation of rules on analysts, and crowdfunding.

Pro:

[to follow?] [maybe?]  

Tune in next Monday for the start of our special forum!

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