Senator Dodd Reform Bill Could Ruin Angel Investing

'Mandated net worth transaction increase'

Please, let's talk about the actual bill. It's at http://banking.senate.gov/public/_files/AYO09D44_xml.pdf and the relevant regulation is in Sec. 412.

It says that the Securities & exchance commission should raise the threshold, using its existing authority, as the Commission determines is appropriate and in the public interest, in light of price inflation since those figures were determined;

..and in the next section, directs the Comptroller of the Currency (the banking-specific regulator) to examine those investment thresholds and evaluate the feasibility of forming a self regulatory organization for hedge, private equity, and VC funds.

Now, I recognize there's a wide spectrum of opinions on the degree to which government should regulate the financial industry. And I totally agree that angel investment is critical to small businesses like tech startups. And I agree that a million $ in assets or an annual income of $200k is already a fairly high barrier to entry, while technological change since 1982 has significantly lowered startup costs. And so, I agree that just mindlessly jacking up these thresholds would likely be a Bad Thing - for startups, angels, and the economy.

What I'm grumpy about is the meme that the bill does mindlessly jack up the rates. The SEC's existing rules require public consultation on such changes - so if the bill passes, the thresholds will not suddenly shoot up. Rather, the SEC will announce they're considering it and invite input from the public - including people like us - for 3 months. And the SEC has been responsive to that input in the past. Mainly they're worried about not allowing another Bernie Madoff episode; it's entirely possible that they might employ their rulemaking power to carve out an exception for Angels and VCs.

And in the next section, where venture capital is explicitly mentioned, the bill directs the other regulator to study whether and how such funds - which are, obviously, quite different from banks - could be allowed to regulate themselves. the main purpose of this bill is to regulate big wall Street banks. There's a clear understanding here that small funds are not banks; they operate differently, are much more competitive, and probably shouldn't be regulated like banks. The bill supports the idea that such firms will do a better job of keeping each other honest than direct regulation by government!

Participants in a diverse a competitive market (for fund management) are best placed to decide what constitutes 'fair play'. Where self regulation fails is the situation where a few players utterly dominate the market - for example, the fact that 6 large banking firms currently manage about 60% of all capital on Wall Street - and tailor the rules to suit themselves, to the detriment of the smaller players, and of the customers. For that reason, the bill also seeks to put an end to the practice of large banks creating and capitalizing hedge funds that are nominally independent, but in reality are just legal vehicles for large institutions to take advantage of the lighter regulatory and disclosure requirements for hedge funds, while leveraging the reputation and deep pockets of the creating bank to attract customers away from smaller funds.

Why is this important? Because the SEC failed to heed warnings about fund managers like Bernie Madoff and Alan Stafford. Their competitors knew the performance of those funds was 'too good to be true' and repeatedly asked regulatory agencies to step in, but were mostly ignored. The bureaucrats' reporting requirements were being met, and they did not understand the sheer improbability of such consistent profitability in a volatile market. Competitors did: customers preferred fairy tales to honest reporting of market behavior. Hierarchical regulation failed dismally where peer review would have put a quick stop to the abuse.

Result? Jittery investors lost faith in all private capital management and VC funding fell by almost 50% in sectors like biotech and internet from 2008-2009. Some $5 billion was taken off the table - perhaps more. Less VC funding means less angel funding: no mezzanine capital means no exit or equity partnership. You can't grow an oak tree in a one gallon pot.

Self-regulation of the private capital market could reinvigorate capital formation significantly. Reduced red tape and peer review are strong economic incentives for honest and transparent risk management. Investors want transparency, and they want innovation rather than speculation, in which it is all too easy to end up on the wrong side of a zero-sum trade. There is enormous potential here to deepen and diversify the investment pool, and that would be very good news for startups.

So as it affects Angel and VC funds, the bill does two things: directs the SEC to re-examine investment thresholds in the wake of a real financial meltdown; and directs the CotC to consider reducing government regulation of private capital management, rewarding true competition with greater trust.

Instead of seeing this bill as a giant monolithic gravestone for capital formation, entrepreneurs, angels and VCs should look at the potential long-term benefits and use the public consultation process to tell regulators what kind of market they need, and how an open self-policed market could unleash a wave of innovation in the real economy. The giant Wall Street banks do not like this bill, but you can worry about them when you're ready for your IPO. Until then, they won't take your calls anyway. Consider your own interests rather than theirs.

Anyways, as soon as I fit the criteria for an accredited investor I started getting calls for what seemed to be obvious scams. There were generally of two types. One type was a call from a boiler-room type operation from some guy with a hilariously exaggerated Jersey accent asking me to buy some over the counter stock. They would suggest a stock for me and then call a couple of months later and say "see the stock we suggested before doubled in price, you should have invested with us, why not try this new stock we are suggesting now." Of course OTC stocks are so thinly traded one can easily manipulate the price.

The other type of scams are calls that are made to sound like they were accidentally made by people that have their cell-phones in their pockets and accidentally press a button. It is usually conversation between two people that is supposed to be private and you are only hearing it by accident. The two people then disclose "important inside information" that is supposed to make you rush out and buy a certain stock.

So yes those scams are out there. There are boiler-room operations all over the place trying to bilk people that are on the lower end of the accredited investor spectrum.

Usually, they prefer accredited investors because stocks that require such investors do not require SEC filings so the scams are easier.

Massachusetts didn't let its residents invest in the Apple IPO: http://news.ycombinator.com/item?id=1303133

But thanks for pointing out that often overlooked detail WRT to primary residence, as that will knock a whole lot more angels out of the game.

No system can work if you have fools running it. Our big C Constitutional system has worked better in times past when better people were in office ... and worked worse when worse people were in, e.g. Hoover and FDR making their economic mess worse and prolonging and worsening the agony.

It's just not that bad yet. While e.g. Cash for Clunkers was pure "broken window" bogus economics, do we have anything quite as vile as the Agricultural Department destroying food and preventing its production while at the same time they calculate 1/4 of the nation is malnourished (which the DoD confirmed in the WWII draft)?

Well, maybe this is as perverse, although not hardly as vile. As grellas details in some length, in a period of bad economic times (starting with the dot.com crash) our ruling class as seen fit to steadily destroy the foundations for startups. And it's a general bipartisan thing, e.g. a ruling class problem.

There are, realistically (ignoring the rosy projections of going below a trillion in FY 12, a Presidential election year), trillion dollar annual Federal deficits stretching out as far as the eye can see. Where is this money going to come from? Not from new enterprises and new industries, there will be few if any new Apples, Suns or Googles ... hmmm, Microsoft managed to bootstrap itself, but such opportunities don't come along often and the computers and their components that ran Microsoft Basic and so on were largely/almost entirely not self-funded.

Bleah.

These provisions of Dodd's bill have been discussed extensively on Hacker News: http://www.google.com/search?q=dodd+site%3Anews.ycombinator....

And I think you underestimate the significance of the editorial board of The Wall Street Journal taking a strong position on this issue in a house editorial.

This paper's editorial page will argue against anything the current majority party does. Their news reporting is fine, but it's widely known that the editorial page leans strongly to the right.

This same editorial page argued that the healthcare bill contained death panels. Republican politicians, including Palin and Dick Cheney, are regular writers.

I think it's quite dangerous to assume such provisions aren't going to make it past whatever partisan wrangling goes on; I doubt either the dems or the GOP are going to give much of a damn about the startup ecosystem unless a lot of noise gets made about it.

How many startups will still be alive after they've waited as many as 120 days for the SEC to bless their fund raising effort? How many will be able to run the gauntlet of state regulators? If the Massachusetts regulator is as conservative as it was in the '80s, there will be no angel financing in that state, full stop. How bad will nanny state California be???