When I was in law school, one of my professors explained two diametrically opposed methods of securities regulation. One paradigm involves creating a fair marketplace by carefully proscribing the actions of all players in the marketplace, dictating precisely what information must be disclosed and when and where that information must be disclosed. In theory, everyone ends up with the same information about a company, leveling the investment playing field.
Challenges to this paradigm include coming up with enough laws and regulations to capture all the ways that people use to obfuscate what is really happening in a business, closing the loopholes through which companies disseminate information to favored parties, and ensuring that information is properly disseminated so that everyone has equal access to information. Since no regulatory scheme can anticipate every potential problem, the legislature and regulators end up layering on an ever-growing body of law and regulations dedicated to closing loopholes and solving problems created by the last set of laws and regulations.
The other paradigm is to simply put a sign at the door saying “buyer beware,” and allow the free market to operate to regulate securities trading. Over time, the marketplace will develop methods of ensuring trades are fair, information is properly shared and companies are held to high standards of reporting and disclosure. The market will reward honest executives who produce outstanding results for shareholders, and criminal penalties can remain in place for those who defraud investors.
Given the primacy of the regulatory paradigm in the United States, I have always assumed that the Securities and Exchange Commission and Congress would lead an inexorable charge toward more and complex regulations. Over my twenty-five years in practice, my assumption has held true (witness, e.g., Dodd Frank). Which Congressman would ever want to sponsor the “Joe Smith Bill for Less Transparency and Accountability in Securities Trading”?!
Thus, I have been very surprised about the efforts of Congress to open the aperture on “Crowdfunding,” liberalizing both who can be solicited for investment and who can ultimately invest in private companies. From allowing general solicitation (e.g., advertising to the general public as opposed to prior rules limiting solicitation only to so-called “accredited investors”) to (eventually) allowing non-accredited investors to invest in private placements without delivery of full disclosure documents, the new laws in theory can aid in capital formation for private companies, encouraging business activity and, hopefully, job growth.
I’m a big fan of anything that encourages capital formation, and I believe we do need to find creative ways to support entrepreneurs and early stage companies that don’t have access to the deep pockets of Wall Street. That said, investing in early stage companies is inherently risky, with many (most) investors suffering significant losses. Even for investors who invest early in a successful company, often during the 5 to 10 years it takes for a company to mature, that company will raise additional rounds of financing that, at best, will significantly dilute the early investors. At worst, those rounds can squeeze out the early investors, leaving them with only good feelings about having seeded a great new company (how altruistic of them!).
I suspect that we will see both success and failure come from this experimentation in deregulation (not a very bold prediction). The inevitable disappointments and failures will lead for a call to tighten a few rules, close a few loopholes and increase the regulatory oversight to prevent the problems from recurring. My (slightly bolder) prediction is that, over time, we will end up approximately where we were when Congress first tried liberalizing the rules!