NEW YORK (TheStreet) -- Lately I've been wondering who has more reason to be annoyed with President Obama -- Republicans and conservatives, or the Democrats and progressives who are, supposedly, his "base" (in the sense that they, uh, got him elected in the first place). It seems to me that if you more or less fall into the latter category, you've got a lot more reason to be annoyed with the president than if you belong to the former category. What has gotten my mind twirling in this direction is a simply atrocious piece of legislation that is grinding its way to passage on Capitol Hill. It's called the Jump-Start Our Business Start-Ups Act, which the president has endorsed.
Like a lot of bad legislation its title is positively Orwellian. Honestly, folks, I just don't know where to begin, this bill is so bad. John Coffee, a prominent securities law professor at Columbia, has called it the "boiler room legalization act." That's because of its unbelievably naïve (at best) "crowd-funding" provision, which I dealt with in this column back in September. Follow TheStreet on Twitter and become a fan on Facebook.
I love being ahead of the curve -- except at a time like this. That's because the White House's early endorsement of "crowd-funding" demonstrated that it was completely clueless on the subject of securities fraud. The "Jump-Start" act, erroneously referred to in the media as a "jobs bill," is actually just an underhanded way of rolling back investor protections.
"Crowd-funding," as I explained in September, is little more than a method of legalizing fraud in the private placement of securities. Though some of its advocates are well-intentioned, they are naïve because of the history of fraud in private placements, which are even more flagrant and prone to abuse than stock fraud because little or no public information is available on them.
"Crowd-funding" would allow private placements to be bought and sold on the Internet, like used Deep Purple CDs. The Jump-Start Act would carve "crowd-funding," and the private placement fraud that is certain to go with it, directly into the statute books.
In theory it sounds lovely -- technology to the rescue of startups! It has a Seattle-ish, high-tech aspect to it. But I firmly believe that reality is likely to be a lot grimmer. In my 2003 book Born to Steal I describe how a typical private-placement scam works. It's very simple. You print up a private placement memorandum, and then you get on the phone with people. No need to file papers with the Securities and Exchange Commission or any other regulatory fol-de-rol. In just a few months, the central character of my book, Louis Pasciuto, had raked in $360,000 from unwary investors he had found through cold-calling.
Why, that's chump change, compared to the riches crooks can snare if this law is passed. If and when that happens, the Internet will make such schemes multiply like rabbits. The bill would allow stock promoters to solicit investors via direct mail and the media, as well as the Net. Promoters would be able to raise up to $2 million via the Internet. Any one individual would not be able to put more than $10,000, or a 10th of his income into any one promotion. But he could throw all of his money into 10 different private placements -- and you can rest assured that there will be plenty of scams out there to choose from.
If Pasciuto were still scamming investors (he went legit after a time in the clink), he'd be celebrating. But President Obama, in endorsing crowd-funding months ago, put it this way: "We're also planning to cut away the red tape that prevents too many rapidly growing start-up companies from raising capital and going public." Baloney.
And mind you, that's just one of several retrogressive aspects of this legislation -- the full text, if you can stomach it, can be found here -- which passed in the House of Representativeswith overwhelming, bipartisan support, including some mainstays of the Democratic side of the House.
I can almost understand the fervor behind crowd-funding among the unwary and naive. But the rest of the bill is nothing less than a hasty regulation-slashing effort:
Companies could raise up to $50 million without registering with the SEC, up from the previous, already too-high limit of $5 million.
It would create a new category of regulation-free company called "emerging growth companies," defined as having less than $1 billion in gross revenues. For as long as five years after going public, these companies -- historically the most prone to stock fraud -- would be exempt from a slew of securities laws. Among them are the provisions of Sarbanes-Oxley that require auditors to attest to a company's internal financial controls. They'd have to produce only two years of audited financials when going public, instead of three, and would be exempt from the Dodd-Frank provisions requiring a nonbinding shareholder vote on executive compensation.
Evidently the Democrats have succumbed to the logic that a weakening of the securities laws will result in "job growth" -- a fallacy that the AFL-CIO, which you'd assume would be foursquare for job growth, has rejected. AFL-CIO President Richard Trumka says that the bill "will destroy jobs by reducing investor confidence in small companies." He's absolutely right.
Yet, amazingly, the bill was backed not just by the Obama administration but by some leading progressives in the House of Representatives. Note that one of the "aye" votes, in the roll call I linked to above, came from Gary Ackerman, the Queens Democrat, now retiring, who is famous for reaming out regulators and Wall Street execs during televised hearings on Bernie Madoff and other scandals.
This bill would preempt state regulators from imposing their own rules on "crowd-funding." The North American Securities Administrators Assn. is, understandably, upset. If he were staying on in the House, would Ackerman be bawling out state regulators at some future televised hearing for carrying out the law that he just voted for? I wonder.
The last time Democrats and Republicans linked arms to supported retrogressive legislation like this was in 1999, also during a Democratic administration, when the Glass-Steagall Act was repealed by a bipartisan majority, in a bill euphemistically entitled the "Financial Services Act of 1999." It was a "services act," all right -- servicing the biggest banks, removing key regulatory restraints and paving the way for the financial crisis of 2008.
It's happening again. Having cowed the Obama administration and bulldozed the House of Representatives, the advocates of this atrocious legislation have put it before the Senate. It's a mighty fast-moving body when the prerogatives of the securities industry are at stake. By the time you read this, a new golden age of stock fraud may already be upon us.
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