Note from Bill: The following is a guest post by Robert Weiss, a finance and securities lawyer based in New York City. We met at the Docracy "Equity Crowdfunding Dissected" event in Brooklyn, and in the week since have been exchanging thoughts (including comments on the "Individual Crowdfunding Account" idea). Follow Rob on Twitter or connect with him on Linkedin.
This post is a response to an exciting post by Thomas Klein published at
In that post, Mr. Klein argues that truly effective reform of US securities regulation would result from creating competition between state legislators and securities regulators, on the
one hand, and the US Congress and the SEC, on the other hand.
The “competition” would be over issuers (or perhaps more precisely over filing fees, taxes or other kinds of revenue a jurisdiction, whether it be state or federal, would raise from
securities issuances under its authority).
Drawing on empirical research regarding the salutary effects of
regulatory competition in the corporate law context, Mr. Klein concludes that
regulatory competition in the securities context would benefit both issuers and
investors by (1) improving the quality of both regimes and (2) providing
maximum flexibility for issuers of securities.*
Among other areas, Mr. Klein directs his argument to the
JOBS Act, and specifically the new law's crowdfunding provisions, which he finds to be unworkable because too restrictive. We are more likely to find. he argues, a workable solution through regulatory competition between
state and federal regulatory regimes.
Mr. Klein’s argument does indeed address problems inherent in the JOBS Act’s structure and provisions. It probably is folly to expect that, by piling on "more of the same" from the tried and true paradigm of additional disclosure, a meaningful crowdfunding exemption can result.
But I have a couple of counter-points I think we should consider.
(1) Corporate law may not be the right analogue to equity crowdfunding.
Mr. Klein (and others) present strong evidence
that regulatory competition in corporate law has benefited both companies and, at
least with respect to public companies, their investors.
The research also points out that most public
company equities are held by institutional investors that are likely to be more
sophisticated than the SEC itself. (Many
people advocating for less regulation make this point.) This distinction is critical to getting the benefits from
regulatory competition in corporate law: smart investors prefer investing in companies subject
to good corporate governance regimes, and states want to attract successful
companies so as to increase franchise or corporate tax revenues; accordingly, states have
an incentive to have good corporate governance regimes so as to attract those
kinds of companies.
It’s not clear,
though, that less sophisticated investors (e.g., small investors participating
in equity crowdfunding) could or would impose the kind of market discipline
necessary to make regulatory competition worthwhile in equity crowdfunding. Other industries, where there are greater
asymmetries among participants, may be more analogous to equity crowdfunding,
and regulatory competition in those areas has not always been beneficial.
Consider the insurance industry. Each US state regulates insurance business conducted within its
borders. There is no federal insurance
regulator or regulatory regime (though the federal government has imposed
regulation in certain areas, most recently with the Affordable Care Act and
Dodd-Frank). Now, insurance seems far
afield from securities regulation. After
all, insurance companies must be licensed ex ante to do business in each state;
except for those states whose blue-sky laws include merit board reviews (which
are few and dwindling), complying with the securities laws is a disclosure
matter, and problems are resolved ex post. But the first and foremost purpose of insurance regulation is to protect
policyholders, who are almost always at a distinct disadvantage in
understanding the terms of insurance policies.
Similarly, one of the hard problems in crowdfunding is whether and to
what extent we are willing to expose potentially unsophisticated investors to
extremely opaque, and highly risky, investments. At least as far as protecting investors who
may not be informed or sophisticated, insurance regulation may be a better
analogue than corporate law.
The benefits of regulatory competition in insurance regulation for
policyholders are not clear. Opinions
differ, of course, but there is evidence that having over 50 separate
regulatory regimes (1) imposes substantial cost on insurers that want to do
business in multiple state, and, more importantly for this analysis, (2) pressures
legislatures and regulators to deregulate in order to attract business to the
state, a regulatory “race to the bottom” that puts state revenues, rather than
policyholders, first. (See, for example,
Professor Daniel Schwarcz’s article “Regulating Insurance Sales or Selling
Insurance Regulation?: Against Regulatory Competition in Insurance”, 94 Minn. L.
Rev. 1707 (2010).)
To combat these
effects, insurance regulatory regimes have converged on certain key points;
associations of regulators like the National Association of Insurance
Commissioners have created model rules and forms that diminish the costs of
operating in multiple states while attempting to ensure minimum levels of
policyholder protections. In other
words, an important result of regulatory competition in insurance is the
convergence of state standards toward a single set of common rules that
arguably serves its primary purpose (protecting policyholders) less well than
it otherwise might.
(2) Who would pay for it?
Nearly all the states are struggling to
handle their current corporate, tax and other administrative burdens. Few states currently have both (a) securities
laws and regulations robust enough to address all of the issues raised in
modern securities issuances and (b) enforcement authorities large, expertised
and resourced enough to handle an upsurge in issuances. Requiring the states (whether directly or
indirectly) to take on securities regulation would impose tremendous new
burdens on them.
Who would pay for this?
Some commentators argue that those states
that don’t want to incur great expense here could simply instantiate federal
law. But why would we recreate the wheel? If we ended up with 50 state
regimes that more or less mimicked the current federal regime, what would we
There are fundamental issues with the JOBS Act, as Bill and
others have described at great length. It’s important for us to resolve those questions, and I think many are
resolvable. (For example, as noted
above, we need to decide under which conditions we’re willing to expose
non-sophisticated investors to ultra-high risk investments.) In theory, having 50 different
problem-solvers each taking its best shot at resolving them would be
great. But given the other constraints
on time and resources, and the questionable value of regulatory competition in
the crowdfunding context, it seems better, at least in my opinion, to address
them at the federal level.
*Legal scholars have made comprehensive arguments for and against regulatory competition in the securities context. Mr. Klein cites an especially good article in support of regulatory competition by Professor Roberta Romano of Yale Law School that I recommend if you are interested in the topic. The article is “Empowering Investors: A Market Approach to Securities Regulation”, 107 Yale L.J. 2359 (1997-1998).
Photo: Frank Farm / Flickr.