Regulation and Compliance > State Regulation

JOBS Act Is Dangerously Flawed Product of a Rush to Legislate

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Congress and the White House are sacrificing investor protection for politics and are in danger of repeating a legislative mistake that has allowed promoters of fraudulent securities offerings to steal millions of dollars from investors since 1996.

Immediately after the Senate passed an amended version of the Jumpstart Our Business Startups (JOBS) Act, the White House issued a statement hailing the legislation and said it will be “vigilant … to ensure the overall bill achieves its goal of helping entrepreneurs while maintaining protections for investors.”

But the JOBS Act that passed the Senate is by and large the same bill that passed the House early this month and has been steadily lambasted by consumer and investor advocate, academics and the media for its rollback of critical investor protections.

Make no mistake. The JOBS Act remains the fundamentally flawed product of a rush to legislate.

This legislation will needlessly exposeMain Streetinvestors to greater risk of fraud by creating new jobs for promoters of Internet investment scams. Unfortunately, many investors may be harmed before this mistake is corrected.

I believe election-year politics have blinded Congress and the White House to the unintended consequences of their actions, which however well intentioned could open the floodgates to investment fraud.

The Senate failed to correct the oversight gap in the House-passed legislation by needlessly preempting states from reviewing crowdfunding offerings before they are sold to investors. Crowdfunding is an Internet-based fundraising technique promoted by the White House as a new tool for raising money for small and startup businesses. 

Preempting state authority is a very serious step and not something that should be undertaken lightly or without careful deliberation, including a thorough examination of all available alternatives. In its quest for deregulation, the Senate rushed to judgment.

In 2004, the Bush Administration preempted numerous state consumer financial protection laws in order to facilitate greater ‘financial innovation,’ especially in mortgage lending.  Most of us remember how that experiment ended, but it seems that Congress has already forgotten.

Congress made a similar mistake in 1996 with the passage of the National Securities Markets Improvement Act (NSMIA), which preempted state authority to review private offerings made under Securities and Exchange Commission Regulation D Rule 506 and created a regulatory “black-hole” by entrusting the SEC to police these offerings.

Since NSMIA, the provisions of Rule 506 and other limited or private offering provisions have been and continue to be used by unscrupulous promoters to evade review and fly under the regulatory radar with little scrutiny by the SEC.

In a 2009 report, the SEC’s Office of the Inspector General concluded the agency does not give these offerings a substantive review and “does not generally take action” when it learns that issuers have failed to comply with the requirements of the Regulation D exemptions.

State enforcement records show that these offerings are the most frequent source of enforcement cases handled by state securities regulators. In the past three years, state securities regulators have reported 580 enforcement actions involving Regulation D Rule 506 offerings, according to NASAA’s 2011 enforcement survey.

Lacking adequate funding, the SEC has neither the resources nor the time to effectively police these relatively small, localized securities offerings before they are sold to the public. As a result, crowdfunding offers are likely to receive little regulatory scrutiny until after a fraudulent sale has been committed. This is an investor-protection disaster waiting to happen.

Under current law, states can only take action after a fraudulent sale is made. That’s like being the ambulance at the bottom of a cliff, rather than the fence at the top, and is little comfort to an investor whose money has been stolen.

State securities regulators do not object to the concept of crowdfunding. In fact, since last year NASAA has been working on a model rule that would permit crowdfunding while preserving a state’s ability to prevent scam artists from exploiting Main Street investors.

Instead of preempting states, Congress and the White House should allow the states to take a leading role in implementing an appropriate regulatory framework for crowdfunding.

Expanded access to capital markets for startups and small businesses can be beneficial if done reasonably and only if investors are confident that they are protected, that transparency in the marketplace is preserved and that investment opportunities are legitimate.

States are the only regulators in a position to effectively police the small emerging crowdfunding market and protect its participants. Unfortunately for investors and small businesses alike, Congress has provided another example of the old adage, “those who ignore history are doomed to repeat it.”