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Capital Formation vs. Investor Protections: A JOBS Act Discussion with Jeffrey Rubin
© Image: Eric Blattberg / (photo:

Capital Formation vs. Investor Protections: A JOBS Act Discussion with Jeffrey Rubin

A partner at international law firm Hogan Lovells and a nuanced critic of the JOBS Act, Jeffrey Rubin is chair of the federal regulation of securities committee for the business law section of the American Bar Association. Earlier this week, we posted the first part of our JOBS Act discussion with Rubin. In this second part of our discussion, he touches upon some of the JOBS Act's non-crowdfunding components, notably the introduction of the "emerging growth company." Toward the end, however, we return to crowdfunding as Rubin ruminates on the Act's overall effects.

Eric Blattberg, So given your skepticism about some of the crowdfunding portions of the JOBS Act, what do you feel are some of the more valuable aspects of this bill?

Jeffrey Rubin: I believe that the elimination of general solicitation and general advertising prohibitions was prudent. In the old days, when things were printed on paper, you could easily restrict the flow of information just by restricting the number of pieces of paper you printed, but since it’s so easy to distribute information through the Internet or other means, trying to impose limitations on offers became very difficult — and, in some cases, traps in case there was any advertent disclosure that could effectively kill a private placement. So I think the elimination of general solicitation and general advertising restrictions makes sense. The SEC is now preparing the proposed rules [regarding those changes], which they are obligated to implement before July 4.

I think increasing the triggers on Section 12(g) registration makes sense. I think Congress should have gone a bit further and increased the levels for (d) registration. The jury is still out on whether the numbers are correct or not, because to get good securities laws, holders of record are counted. It’s somewhat archaic considering how securities are currently being held. The SEC is required under the JOBS Act to look at the holders of records’ standards. I think that’s a good thing.

I think it’s a good thing that the SEC is required to review some of the implications of the ticker and things like that affecting brokers, because its been claimed that the problem with the IPO market isn’t so much the burdens on companies, but that many of the restrictions — many of the changes to the broker-dealer marketplace, I should say — have driven brokers and dealers to support smaller companies. So that’s a positive thing.

I’m of two minds about emerging growth companies. First, under the JOBS Act, you can be an emerging growth company if you’ve got revenues of a billion dollars. To me, that seems very, very high. And if you fall into the category of emerging growth company, you’re given basically what they call an “on-ramp” to the public reporting stage; you’re given various accommodations. Some of those I think are fine; others of those I think are less desirable.

Do you have specific examples?

Well, for example, financials would typically be required for three years of public companies, and five years of so-called “selected” companies. The JOBS Act brings both of those to two years. First, if a company has available additional financials, I think it would have been appropriate to require it to provide them. Secondly, the concept of selected financials was to give investors a chance to see trends over time; that’s why five years of selecteds as opposed to auditeds. Having both be two years, you’ve eliminated the additional trend information that the selected financials provide.

Also, the JOBS Act removes certain restrictions on research reports associated with emerging growth companies in connection with their IPOs. I am not sure that change is fully appropriate. In other words, I think many aspects of what was called the global settlement with brokers will stay in place, but I’m concerned that some of the problems that Eliot Spitzer and the SEC identified a few years ago in connection with the linkage between investment bankers and research analysts may, in fact, reappear. Against the statutory provision, it may be hard for the SEC to delve in there to restrict certain research practices.

The basic concept there was it was claimed that before the global settlement, that brokers and dealers were basically assuring clients that they would receive positive research if they chose that brokerage firm to be an underwriter in connection with their offerings. This was unlawful; the global settlement made that clear. I think it’s going to be incumbent on brokers to still be very sensitive to the risks of the involvement of research analysts in connection with capital raising transactions, in connection with research reports, and about the time of an offering. I think there’s room for the brokers to make sure that the research reports that they publish have integrity, and aren’t merely being used as a way of attracting investment banking businesses.

On a broad scale, do you think this is going to negatively affect company transparency as a byproduct of the capital markets, kind of cutting into the effects of Sarbanes-Oxley?

Well, I think Sarbanes-Oxley and Dodd-Frank, to my mind, had some things right and a lot of things wrong.

In Sarbanes-Oxley, Congress I think was not wrong in requiring internal control reviews and audit. Because the PCAOB (Public Company Accounting Oversight Board) adopted a very robust standard, however, and because the SEC didn’t have any guidance on management responsibility, for the first few years of Sarbanes-Oxley, this became a very expensive proposition for companies and something of a nightmare for management. It’s what many people claim led many foreign issuers to leave the U.S. markets, although there’s empirical evidence that questions the extent of that. You know, it wasn’t until a couple years later that the PCAOB basically superseded Auditing Standard No. 2, which was the internal control standard, with Auditing Standard No. 5, which was the more risk-based and sensible approach.

In Dodd-Frank, there are a lot of things that are problematic. I have significant concerns with the conflict minerals provisions, which impose on public companies an obligation to basically follow the path of the so-called conflict minerals that are used in products almost back to their source. It’s an effort to achieve a humanitarian goal that I’m sensitive too, but I think that the tools that Congress used are the wrong tools, because they impose significant burdens on companies without any exception.

I have a high degree of regard for the SEC. I think it is the most effective agency of government, and has within its numbers the most talented staff, so when I see Congress pretty much usurping — or, not usurping, because Congress has that right — but when I see Congress restricting the ability of the SEC to provide the market flexibility and the investor protection that the SEC thinks is appropriate, then I become concerned. The SEC is in the trenches every day. The SEC sees the capital markets and the way that they operate, the SEC sees investor frauds and understands the ways in which they need to remedy it. You know, the SEC is clearly not perfect — they certainly wish they could've caught Madoff before he abused so many investors and institutions — but they do a damn good job at what they do, so when Congress becomes very prescriptive, it really calcifies the SEC's ability to reflect market needs and investor protection needs.

So that's a longer picture. Time will tell whether any of these changes will be successful. I would hope that Congress will acknowledge that, in its rulemaking, the SEC can provide appropriate exemptions, guidance, and supplemental rulemaking that basically help the process along. If it's all entangled in legislation and the SEC can do nothing to change it, then, as you know, the legislation can easily be calcified. Trying to get a bill through Congress is not an easy matter, so somebody may acknowledge a problem and it might take years before it's resolved. But if it was left to the SEC's discretion through rulemaking, the SEC can correct errors in a matter of months, and through guidance and interpretation more quickly. To a large degree, I'm concerned in situations where congressional legislation is so prescriptive that it deprives the ability of the SEC to be flexible.

So we've certainly touched on this, but if you could peer into your crystal ball and see a future two or three years from now, how do you think this will all play out? Will the JOBS Act be a net positive? Will the SEC take that looser interpretation of the contents of the legislation?

Well a lot depends on not just what the legislation provides, but it also depends on what market participants do. For example, an emerging growth company may be able to avoid the need for additional financial disclosures, and might be able to avoid the need for certain kinds of compensation disclosures and other things, but if they're going public the investment bank may insist that they provide more information. To the extent that it's not mandated by the JOBS Act, it doesn't mean that market forces may not require additional information to be provided by companies that otherwise would be able to enjoy certain accommodations under the JOBS Act. So what the market participants do is important. The same goes for research reports. That the JOBS Act provides that there can't be restrictions on certain research reports during an IPO of an emerging growth company doesn't mean that brokers won't seriously consider whether they want to permit the issuance of research reports during the course of an IPO, or at least without special scrutiny. So it's not just the statute, it's how it's implemented.

I think what you have to do though is identify what you consider to be success. If crowdfunding is able to permit a lot of younger companies to raise money without unnecessary expense, and investors in crowdfunding ventures see reasonable returns on their investments to justify the risks involved, then people will say it's been a success. If, on the other hand, they don't see returns on their investments to justify the risk, it will have been a failure. If the availability of emerging growth company status encourages companies to do IPOs and brings more companies into the public capital markets, people consider that to be a good thing. If it doesn't have that effect, then it won't be a failure, it just won't have achieved the objective for which it was intended. If the increase of 12(g) triggers or 34(x) reporting prevents companies from being effectively under an obligation to either manage their shareholder numbers very, very carefully — or else, have to incur the huge costs associated with being public — then that would be a good thing. On the other hand, the fact that the trigger points have been increased might mean that some companies that would be public companies will not be, because they have just decided not to do an IPO and under 12(g) have decided not to register. This is all very nuanced.

I think it really comes down to a larger question, one not just for the United States but also for the international community: how should we regulate our capital markets? How should we provide for capital formation without giving up investor protections? Where should we draw the lines in terms of disclosure? What's public? What's private? What kind of burdens should we put on public companies and public company executives? The liabilities associated with being a public company are very high, and many public company executives spend a considerable amount of time dealing not with running the business, but with disclosure compliance issues. Just like I can probably avoid shoplifting in a store by putting a cop every three feet, I can avoid securities fraud by providing for lots of controls and lots of disclosures. But if the implication is that I'm taking resources away from other matters that the company could be spending that matters that would accrue to benefit investors, then there is a reasonable question to be raised: is it money well spent? There needs to be a balancing. I think that the Dodd-Frank Act and the Sarbanes-Oxley Act were hugely prescriptive and added burdens to companies, and, for the most part, the JOBS Act removes burdens. I see the pendulum swinging back and forth, but it's just really trying to find the right place to provide both investor protection and capital formation. So that's a larger picture issue as I see it.

As you see, my views on the JOBS Act are not unidimensional. There's good in it, and there's questionable in it. If crowdfunding attracts reputable people creating platforms of integrity that give investors confidence — where, while not every company is going to succeed, there's been some diligence done, as [CrowdCheck CEO] Sara Hanks and others are doing — and there's an effort to create a brand and a standard of quality, then maybe it'll succeed. I just express my skepticism because I'm aware of all the abuses that have taken place in the markets, and my concerns that the best way of curbing the abuses is to protect smaller investors and to have effective enforcement mechanisms. We'll see where it gets to, but like I say, if you were to check with me a year or two after crowdfund investing goes into effect in the United States, I'll have a better sense of whether it's met its objectives was or if it was a good idea that just didn't achieve what people anticipated.

You know, crowdfunding certainly has a sort of populist appeal. You can think of young, bright people who want to raise money and make their dreams happen, and that's crowdfunding at its best. But, for the reasons I mentioned, I am concerned. If you could only have ethical and well-intentioned people involved in business and the capital markets, you could just throw away your enforcement laws and things like that, because people are going to do the right thing. The problem is that reality is not that way. Wherever you find money, you oftentimes find people trying to exploit the system.

As far as emerging growth companies go, I think I would've been happier if Congress had said that you could be in emerging growth company if you had revenues of $100 million, and then, given a chance to see how it worked, expanded it if it didn't seem to be bringing people into the public sphere. But to have revenues of $1 billion strikes me as just too generous and effectively risking denying disclosure to people who otherwise might have expected more robust disclosure from companies. But again, I don't have a crystal ball.

Thank you so much for speaking with us, it's been hugely informative.

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