This past Thursday, President Obama signed the JOBS Act, legalizing crowdfund investing in the United States. Although numerous people influenced the legislative process surrounding crowdfunding and JOBS Act, Sherwood Neiss and his fellow Startup Exemption co-founders were central figures in that process. The bill would not have passed — in fact, would not even exist — if not for the tireless efforts of these three individuals over the last 15 months. Neiss and his partners crafted the original crowdfund investing framework (which remains largely unchanged in the final JOBS Act), testified at two Congressional hearings surrounding access to capital for entrepreneurs, and lobbied vigorously on Capitol Hill for the ideal implementation and passage of a crowdfund investing bill.

Eric Blattberg of Crowdsourcing.org recently spoke with Sherwood Neiss about the JOBS Act: its conceptualization, the subsequent legislative process, its ultimate passage, its potential benefits and drawbacks, its media and public reception, and much more. The first part of that discussion is below; part two is available here.

Eric Blattberg, Crowdsourcing.org: To kick things off, tell me about your experience at the White House JOBS Act signing ceremony on Thursday. I imagine that must have been pretty exciting, right?

Sherwood Neiss, Startup Exemption: It was surreal. That’s the only word that can describe it. To have a vision, to see it play out, and to attend the celebration of that vision with the President of the United States… (laughs gleefully) It was a vision that I don’t know how many people get to live out. I mean, people pay $100,000 to be in the proximity of the President. And we were 20 feet from him yesterday. That’s just weird.

Eric Blattberg: And you weren’t just having dinner at a fundraiser, but signing a bill that you helped craft into law…

Sherwood Neiss: When I saw Obama standing there talking about entrepreneurs, access to capital and [the JOBS Act as a] “game changer” … I started kicking Zak [Cassady-Dorion, co-founder and partner of Startup Exemption,] and whispering, “Man, we did this.” We sat down over beers and thought this whole thing up, merging crowdfunding with seed capital financing. But as [Startup Exemption co-founder Jason Best] says, we all learned and accomplished different things. For Zak, it was having that vision of what we wanted to do. For Jason, it was putting the stake — our [crowdfund investing] framework — in the ground, and literally saying, “This is our framework, and we are sticking by this as policy, and we’re not getting involved in the politics.” And for me, it was forking out our own cash, irrespective of the seemingly insurmountable cost it would take to get it done. That and showing up, because we’re passionate about getting this done and making sure that we stay on message, which wouldn’t have happened if we weren’t hopping on planes and walking into offices saying, “Hey, we’re back, let’s talk, because there are some misperceptions being spread out there in the media.” If we’re not going to address them, I don’t know who else is, but we’re damn sure not going to let misleading statements deter the conversation.

Blattberg: How did this whole experience change your perspective of politics in Washington, if it did at all?

Neiss: I have a much deeper appreciation for the insanity that goes on in Washington. I’ve been describing the experience as having your tooth pulled while on a rollercoaster: it’s painful whether it’s an exciting thing or it’s at the bottom. (laughs) That’s another thing that we learned in D.C.: the currency here is information. The people that carry that information are like the traders at the banks; you’re dealing that information to the other key parties. We found ourselves being the currency in Washington and sharing information with even people of the same party. It was random and weird, but at the same time, we were like, “Well if that’s the way Washington works, I guess our job is to educate everyone in the same party, everyone in the opposite parties, and just everyone that we need to influence.”

Right now, Congress’ approval rating is hovering in the low teens. After this experience, do you fall into the small percentile of Americans satisfied with our nation’s lawmakers?

Well that’s a tough question to answer, because I can see things from the insider’s perspective now, but I still understand the outside perspective, too. Before we showed up here, all we kept on thinking was: if we as American citizens understand that collaboration, communication, cooperation, consideration — all the “Cs” — are necessary in our daily lives, then why can’t they exhibit those attributes and strategies in Washington? That’s why they have a negative approval rating, because it’s become very strictly partisan, where one side says this, and the other side says that, and they cannot come to a middle ground. Being in the middle, and being part of the process, the amazing thing was the bipartisan nature that came out of it. Being in the middle of it, you didn’t think it was ever going to be bipartisan; rather, you got the feeling, “I don’t know how anything is going to get done here because these people are so stuck in their ways.”

What we learned is that these guys are so busy working on so many different things, and they’re stuck in their positions trying to represent the interests of their constituents, that we had to sit there and craft policy — crowdfund investing policy — and share with them data and reasons why, for each of these pieces, this was the way to go. They read it, and they listened to it, and they implemented it. That was the coolest part of it. The House took our framework — and it’s still the same framework that’s on our website from essentially January 2011 — and we worked with them as they took out different components of it, and Jason and I were like, “What are you doing?!” We looked at this from the point of view of the entrepreneur, the investor, the intermediary and the SEC. The whole point was to make it balanced: it has to allow for capital flow, but it also must have sufficient investor protections and the right oversight. If you start pulling out the SEC oversight, if you start taking out the intermediaries — essentially the platforms themselves — then you’re defeating the purpose of the crowd and crowdfunding, because this is all based on social networks. But what we learned in Washington is that one party strips it out, the other party adds it up, adds more in, and then they come to a middle ground — and that’s what happened. The House took out a bunch of the components that we had, and in their negotiations to get it passed in the House, the Democrats added a few more components back in…

And here we’re talking about McHenry’s original bill, H.R. 2930, the Entrepreneur Access to Capital Act?

Right. Then it went to the Senate where Bennet, Merkley and Brown individually all added their different components to it — some of which, in the initial stages, went way too far.

Can you provide an example?

Brown reduced the maximum investor cap to $1,000. We were like, “At this point, it’s not even worth going through this exercise. Let’s just pull the plug right now.” If you need to raise, say, $250,000, you’re not going to do it with that limit. The 80/20 rule applies to crowdfunding, where while 80% of the pledges are going to come from small dollar investments, 20% of the pledges will make up 90% of the financing, so that limit needs to be greater than $1,000. So that’s when we started getting data from Crowdcube in the U.K., IndieGoGo and ProFounder. We took their data, crunched it through [Microsoft] Excel, and really proved the theory. So we went back to these lawmakers and they listened, they admitted, “Ok, you’ve got a point.” So it was really cool to go back and sit down with them and have them listen.

The fear is: ok, they made their decision and they’re not going to budge. You have to remember, a lot of this stuff is ego-driven. It’s a balancing act. These are very powerful people, much more powerful than we are. We’re just three entrepreneurs. These are people that got elected by tens of thousands of people. So to go there and try to create an argument that influences them while simultaneously making sure you don’t say the wrong thing [is tough]. The most exhausting days are the ones where you show up here in Washington, because you have to be so sensitive about what you’re trying to do to avoid offending anyone.

I have to tell you, I cried the day that the bill fell apart on the floor of the Senate. When they had a deal that they were going to add the Export-Import Bank part to it, and we were like, “Well, we don’t know anything about that, but if that’s how they’re going to get the votes, then that’s fine with us.” So they negotiated this behind closed doors. Then, all of the sudden on the floor, the Republicans changed their minds: they voted down the Merkley amendment, they voted down the Export-Import Bank piece, and Reed was furious. I mean, Jason and I were sitting there completely demoralized, thinking the whole thing just fell apart. We thought, there’s no reason for them to pick it back up — because at that point, we feel like it’s a win for the Republicans if it’s passed, and that’s not the message they’re going to want to send. So that day we walked back to the hotel completely defeated. This entire time we felt like we needed to get this done for Main Street. And that day, I felt like I let all of America’s entrepreneurs down.

So we spoke a bit about Export-Import and all these other added components, some of which passed before the JOBS Act was signed into law. What components of the final JOBS Act are you displeased with? Are there any elements that feel like necessary evils included to ensure the passage of the crowdfund investing portion of the bill?

It’s not that we’re uncomfortable with any specific parts — some things just remain unclear. It’s unclear as to the liability issues related to what happens naturally in business. If a business fails for good reasons like if the customers lost interest in the product — not for malfeasance or fraud or anything, but just because you know it didn’t pan out right — we don’t think an entrepreneur should be held liable for that. It’s not necessarily clear in the legislation where liability begins and ends. We’ve had really good conversations about it where they said, “Listen, if you can just prove your intent was to do something, and you lived up to that intent, and you didn’t fool anyone because you’ve got a proven track record and, importantly, a written record where you’ve said things to people, all that is good.”

We’ll see how it plays out. The point of legislation is to have it written into law and to have it followed as law, but it’s unclear what the SEC is going to do with this now. And they going to follow the written legislation, are they going to follow the intent of the legislation, or are they going to write their own legislation?

If you were the SEC, how would you best interpret the final text of the JOBS Act? Or, more realistically, what advice would you give the SEC in interpreting this bill?

I would tell them that the bill was very well thought out, that the framework to do exactly what needs to be accomplished is there, and that right now we need to come up with the details around what defines disclosure, what defines rights for investors, what defines a background check. I’d add color to each of these existing components without adding new components, just adding the color to the sketch itself. I’d address the standardized forms that we’re going to be using among all platforms, because this is about reducing the costs of getting this stuff done by standardizing a lot of these procedures. So, I’d tell the SEC, we’re not reinventing the wheel here: we’ve got great examples from angel lists — they use standard templates — and even NASAA’s SCOR form.

It may be obvious to you or to I, but perhaps not the SEC, that many components of those are the same that you’d see on a Kickstarter funding pitch now, it’s just called different things. People just don’t understand that. We just need to educate the SEC, we need to show them that they might think this is new, but this has been happening for five years on Kickstarter and IndieGoGo; this is what they call it and here are the fields that they show it on. Don’t get me wrong, we might need some new ones — we’re probably going to have to add a use of proceeds breakdown as a requirement, and that’s fine. People should think about how they’re going to use they money they’re going to get. There’s nothing wrong with that. If it’s business, let’s treat it like business. If it’s a business idea that you’re going to start, let’s think about it as a business: at some point, it’s going to have to have a profit-and-loss statement. So if you’re serious about starting a business, let’s start getting you thinking along those lines, too. It’s not asking too much of an entrepreneurs, after they raise $50,000, to be thinking of how exactly how they are going to use that money.

Yeah, the current legal ambiguity of Kickstarter is pretty confusing. If two entrepreneurs ask for $10,000 to create a “product,” but then they receive $100,000, exceeding their funding goal 10 times over, they have some serious seed capital to start their own business — but if they call it that, then it’s illegal.

Exactly. What Kickstarter is doing falls into a gray area of securities laws. You know, yesterday I was talking to Kevin Lawton, who said he could name a bunch of different areas where Kickstarter in plainly breaking the law right now. But the company is doing something good, so we don’t want to derail it, but the fact of the matter is that there are securities laws that legally prevent the Kickstarter team from doing exactly what it’s doing.

This pre-selling of a product, if you think about it, is a promise to give you something of value. From the SEC’s point of view, giving something of value is regulated. So we call it donation-based because if for some reason you don’t get your money — that value — back, you’ve donated it. But people are thinking right now that they’re pre-ordering that video game, and if the company doesn’t follow through, there are going to be issues of fraud. All we’re doing with the JOBS Act is saying, “Great, now that we’ve thought about it, we’ve come up with a legal framework for what you can and can't do.”

So let’s talk about fraud for a minute, because there’s been an enormous outcry from William Black, Eliot Spitzer, Andrew Ross Sorkin and other vocal critics of this legislation. I’m sure you’ve seen Black’s Huffington Post article calling the JOBS Act “criminogenic” and “fraud-friendly,” and Sorkin’s New York Times piece about the JOBS Act jeopardizing the safety net for investors. How would you respond to those critics, particularly to the fraud fears?

Well first let’s talk about how hard crowdfund investing is going to be for entrepreneurs and investors, because once we understand how hard it’s going to be, that addresses the issue of fraud.

First of all, all equity-based crowdfunding will only take place on websites — also known as intermediaries — that are registered with the SEC. So right off the bat, the website is going to have this sort of VeriSign or Better Business Bureau seal on it. The whole point of rallying a self-regulatory organization and getting everyone together right now is to make sure that everyone is in agreement that we need this seal of approval. So if you are going to be crowdfunding, people will be looking to see if the website is a bona fide, registered crowdfunding intermediary. So if you’re a website owner, you’re going to have to submit to registration requirements by the SEC.

Second, if you’re a fraudster that thinks, “I want to debunk people out of $50,000,” this is how you’re going to have to do it. You’re first going to have to come up with a dollar amount; could be $10,000, could be $50,000. And you have to be a first-time fraudster, by the way; this won’t work for anyone that has committed fraud before because when you register on any of these SEC platforms, the first thing they do is a fraud background check on you. The SEC might also require a minimum credit score, so if they ask for a score of 760 or 780, I’m sorry, but you’re out. The fraud barometer will be pretty high, so to speak — not that it can’t happen, because it can.

Of course, fraud permeates every other type of capital market, too…

Exactly. But when all these mechanisms are in place, I see how this system is going to function transparently. So here’s the next part: you, a fraudster, are going to be stealing money from your friends. You are going to be stealing money from your social network. What I mean by that is, you load your idea up onto one of these platforms, and the way in which you solicit people is by clicking the email button, the LinkedIn button, the Facebook button, the Twitter button, the Google Plus button on the petition itself, on the idea. That’s connected to your personal social network. You have an IP address on your email, while Facebook and the like already integrate your identity, and that goes out to your friends, family, acquaintances and other connections. So now you’re stealing money from the people you know and maybe even love. I mean, I’m sure that happens all the time, but again, the principles of crowdfunding entail that you’re doing this from the people that are closest to you.

So now let’s flip to the other side, to the potential investors receiving this solicitation. Crowdfunding is based on helping people that you know. You should not be responding to solicitations from people that you don’t know — not that it won’t happen, it most certainly will, so let’s talk about that. You are a person that receives a solicitation for some guy that is selling snake oil, and you’re like, “Wow, snake oil can reduce wrinkles on my face. I’m a 70 year-old woman trying to avoid Botox and this is going to change the world for me. I don’t know who this guy is but this sounds great, I’m going to click on this link from this random nobody.” That takes you to a crowdfunding platform where you now need to register with your social security number, date of birth, credit card information — all this personal information for which you’ve been told over and over again: don’t give this information to anyone.

But let’s say you do, because you’re just that one person that believes you have to get through the hoops and hurdles of doing things that you’ve been told never-ever to do so you can give your money to this snake oil guy. Then it says, before you can actually invest any money, you must now take a test. You know when you sit down on a plane, and before the plane takes off that screen pops down and says, “In case of emergency, put the mask on yourself before your child” and so on. You go through this five-minute dialogue that teaches you everything you need to know about safety on a plane. That’s the exact same kind of information you’re going to receive about crowdfund investing. There’s going to be an old lady, an old man, a pretty young lady, a pretty young guy — I don’t care, whoever — but there’s going to be a community of people like you see on those silly but very important airline briefings that educate you about crowdfunding. It’ll say: crowdfunding is about people you know and trust, it is about local investing, and it will be powerful when you can see, know and trust the product and person behind the campaign. Don’t ever invest money with someone you don’t know and trust.

You’re going to have to sit there and listen to this thing, and at the end of it, you’re going to have to take a test. That test will have CAPTCHA fields attached to it that you’re going to have to type in to answer questions like, do you understand that you should never invest money with someone you don’t know? Did you receive a solicitation from someone you don’t know? And it will tell you, are you aware that your chance of getting a return is very limited? That you might never see a return? That it could be very far off? Unless you answer “yes” to questions like this, you can’t proceed.

So we’ve raised the hurdle for fraudsters on that level, then we’ve raised the hurdle for investors, too. That’s why we keep on saying, in theory, this is great because it’ll get capital flowing, but think about our ADD when we go to websites — what is it, three seconds [we spend browsing each page on average]? You have to put a significant amount of energy and effort into follow-through to make sure you can give that fraudster probably something around $80. All I’m trying to say is that when this is up and running, the people that are really sincere about getting behind the people that they know and trust are going to be fine doing that, because they know and trust and believe in that entrepreneur and that product, and they’re probably going to be consumers of it. But if they don’t know that guy, they’re going to be given so many red flags as to why they shouldn’t do it, that the chances are, they’re going to drop off before they even go through all the registration procedures. We just don’t feel comfortable today giving out our personal information. We’re not going to do it for some random person.

And for the projects that do grow so large that they really attract that substantial layer of investment from relative strangers — well, I suppose they probably won’t reach that level if they’re shams. Social capital means nothing when you have a Facebook account with 1,000 “friends,” but it’s not attached to your real name or your real friends, because they’re not going to give you any money.

Right. And there are people with 1,000 friends on Facebook, but really, people just don’t friend [random] people anymore — people are more likely to “de-friend” people these days. Your social network is becoming akin to your social security network in many ways, where you want to keep people out. Personally, for me, my Facebook is strictly immediate friends and family, period. No offense, but I wouldn’t connect with you on Facebook, because I wouldn’t want you seeing all those pictures of me. (laughs) I don’t care if they’ve got those different layers set up now, that’s just how I am. It’s on LinkedIn or Twitter where I have connections outside of my immediate network but still know and interact with. I’m not the only one that’s like that; most of my friends seem to act the same way. Those people with 1,000 friends… do they really know 1,000 people? Doubtful. And those strangers or fellow partygoers from years past aren’t very likely to invest in your startup.

Part Two of Crowdsourcing.org’s comprehensive interview with Sherwood Neiss, co-founder of Startup Exemption, is available here.