The JOBS Act eases rules for startup companies seeking seed money, but threatens protections for non-accredited and accredited investors.
The JOBS Act, a law receiving speedy approval from Congress this week and now headed for President Obama’s signature, would ease rules for startup companies seeking cash and, at the same time, undermine consumer protections for non-accredited and accredited investors.
The JOBS – or Jumpstart Our Business Startups - Act has been heralded by venture capitalists and legislators eager to reduce the red tape limiting the ability of startup companies to raise seed money. The bill has been vigorously opposed by consumer advocates and current and former federal regulators, who fear the measure will create conditions ripe for fraud. Of greatest concern, is the easing of rules regarding the solicitation of private equity to both non-accredited and accredited investors.
Accredited investors are wealthy individuals or large institutions who have access to private financial offerings largely unregulated by the U.S. Securities and Exchange Commission. Federal laws allow accredited investors to purchase equity shares in private companies and hedge funds, but until the passage of the JOBS Act, these riskier and more opaque products will be off-limits to non-accredited investors who, in the eyes of regulators, lack the resources or sophistication needed to drive in this financial fast lane.
The SEC defines accredited investors as a large trust, institution or company, an executive or partner in the company, or a business owned entirely by accredited individuals. Under current law, individual accredited investors must have a net worth exceeding $1 million, excluding the value of his or her primary home. Alternatively, accredited investors can qualify if they have income exceeding $200,000 in the past two most recent years and a reasonable expectation of the same income level in the current year.
Should the controversial JOBS Act become law, individuals who do not meet the standards for accredited investors will be able to invest in startup ventures through crowdfunding, a solicitation process that takes place via the Internet. The act, in essence, lifts the ban on widespread public advertising of private equity offerings. Under SEC Rule 506 Regulation D, private equity offerings can only be made to accredited investors and a handful of non-accredited investors who are “sophisticated.” A sophisticated investor is one who has “sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment,” according to SEC rules.
The crowdfunding provision of the JOBS Act “makes a mockery of the whole premise of Regulation D,” Barbara Roper, director of investor protection for the Consumer Federation of America, said today in a phone interview. Venture capital funds lose money on six to seven of every10 companies they back, said Roper, adding “And these are the experts. How do you think the average investor is going to do? Most people who invest in crowdfunding will probably lose part of all of their money.”
Advocates for the nation’s senior citizens – the most frequent victims of financial fraud – feel Internet solicitations to non-accredited investors put the elderly at extreme risk. The exemption “fundamentally opened up a whole can of worms for a greater range of very unsophisticated people,” said Mary Wallace, a senior legislative representative on financial security and consumer protection for AARP. “History has shown this ban is needed.”
The JOBS Act also creates a new class of company – called an Emerging Growth Company – that will be subject to less stringent reporting requirements for shares sold to accredited investors.