Securities Regulation Harms Businesses

I attended a panel discussion yesterday on the problems startups have in raising capital caused by securities regulation. Startups have to hire a lawyer before they raise the first dollar of capital. It’s a real catch-22.

Entrepreneurs are often surprised to find that raising capital means selling securities. They cannot legally sell securities to just anyone. They are restricted to Accredited Investors (basically people with high income or high net worth). Most young entrepreneurs don’t have a rolodex full of such investors. There are other restrictions, for example, they can’t hire someone to help them raise capital unless he has a license to sell securities.

Welcome to compliance hell. It’s perfectly legal to fail, to lose your own money and even your house. It’s fine by the law if your dream dies, your marriage fails, and all of the other negative consequences occur when a business does not succeed. But if you raise money, you better be fully compliant. Where’s the concern for people?

The stated purpose of regulation is to protect investors from fraud and bad actors. However, fraud was illegal even before regulation. It is already a crime to lie to someone to take his money. Regulation does not change that. It does not make crime more illegal.

Regulation offers a tantalizing promise. We don’t have to wait for criminals to strike their victims. We can make it impossible for them to commit the crime in the first place. We just force them to comply with regulations. No matter how many Enrons and Bernie Madoffs happen, few stop to ask if the theory is even valid. Can regulators proactively prevent bad things from happening?

Nor do people ask if investors deserve to be treated as children. It used to be (before the Nanny State) that once you reached the age of 18, your majority, you were able to enter into any contract or do anything that any adult could legally do. Now 18 is just one milestone. Until you have a million dollars net worth, you aren’t an adult investor and cannot invest in startups. It’s for your own good, you understand. You might make a bad investment.

While we’re at it, we should also ask the age old question: qui bono–who benefits? Lawyers are one obvious group. More importantly, it protects big and wealthy incumbents. Wall Street can easily afford compliance, unlike its small would-be competitors. More insidiously, regulation implicitly supports Wall Street’s model and makes it more difficult or impossible to develop a new one. This is why no one has done the Uber or AirBnB of the stock market yet.

I found it odd that when several speakers on that panel began with apologies, “of course, we want to protect investors.” They began with total capitulation, saying in effect, “I can’t be trusted without a government minder.” Any reform based on this will be little more than deck chair rearrangement on the Titanic. There is a real solution, and it’s simple. The law should treat adults like adults. Let entrepreneurs raise capital without having to get permission at each step, so they can build new products to offer us, make money for themselves, and create jobs.

2 thoughts on “Securities Regulation Harms Businesses

  1. a Texas libertarian

    Great post Keith! The whole notion of government protecting consumers is absurd. This would be equivalent to protecting a pile of dry hay bales from theft with a flamethrower; it might prevent SOME theft, but its going to do a lot of damage in the process, whether by accident or on purpose to either justify the need for more resources (flamethrowers) or simply to enrich and aggrandize the monopolist “protectors” in the process.

    The idea of “Accredited Investors”, a concept which I was only recently introduced to reading Peter Schiff’s, “The Real Crash”, is completely insane. This struck me immediately as a way to keep those with lower capital out of the game of venture capitalism. If you’re a potential investor, you are barred from a chance to profit from your knowledge of a promising investment, and if you are a promising entrepreneur, you have to pander to the Accredited Investors to get your business off the ground, and thus another avenue of decentralized wealth generation for the common man or woman has been shut down, for our own “protection” of course.

    The market response to this injustice? Crowd funding! Kickstarter and Indiegogo are marvelous examples of market innovation, especially in response to government intervention. I think, however, that if the restrictions on investment were removed, people would rather invest in a start-up company rather than donate, and we’d see the phenomenon of crowd funding disappear.

    Another interesting parallel to this topic is the very concept of private securities, or “junk” bonds as they’re so affectionately called by, well almost everyone, including supposed free market supporters. This market innovation, made famous by Michael Milken in the 80’s, shook up the stuffy elite power structure of Wall Street at the time by providing up and coming businesses a new way of generating capital outside the restricted channels of the regulatory structure. How was Michael rewarded for this heroic capitalist achievement? He was thoroughly denounced by both conservatives and liberals and thrown in jail on some phony charges of racketeering and insider trading.

    First of all the government locking someone up for racketeering is just hilariously absurd, since this is the very job description of every bureaucrat or government agent who’s ever lived. Of course Ron Paul might say, “Don’t racketeer; the government hates competition.” Second, insider trading shouldn’t even be a crime. Why should people be punished for knowing more than others and using that knowledge to increase their standard of living? This mentality is a result of the egalitarian concept of “fairness” invading the subconsciousness of society, which if left unchecked by rational criticism, will eventually turn the beautifully diverse human existence, that (relative) freedom has allowed to blossom, into the collectivist ant heap of totalitarianism, where we can all enjoy how fair life is when everyone is poor and miserable (except of course those making sure life is “fair” for everyone else).

    “The law should treat adults like adults” I agree 100%.


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