Fighting for JOBS

PE capital formation should be made easier for startup businesses by the JOBS Act. U.S. Rep. David Schweikert and attorney Scott Gluck discuss the Act’s bi-partisan support, a coming battle with the SEC, and letting some sunshine into PE deals.

Privcap

The way the JOBS Act was conceived and came to fruition is a complex story. Can you summarize the factors that allowed it to be signed into law?

Schweikert

If you have only been in Congress one term and you are sort of stupid, you can make things happen. Two-thirds of the bills in the JOBS Act are mine, and I had a couple of simple bills on Regulation A. I could not get anyone to take an interest. I kept visiting [Rep.] Barney Frank’s (D-MA) staff, and I convinced them the bills were not a Republican plot. We made changes, and Barney Frank gave his blessing. We had this cascade of individual bills that we packaged into one; the SEC should have done some of it on its own, but was never going to.

Privcap

What was the selling point to get the support of Barney Frank and the Democrats? Was access to capital a key benefit that dovetailed with their agenda?

Schweikert

New York is the capital center, represented by some of the most liberal members of Congress. They are often the most hostile, unless someone has said to them, “This isn’t an evil plot.” We were able to break down partisan barriers.

And I’m going to take some personal credit on this for my willingness to spend time with [Rep.] Maxine Waters (D-CA)—and particularly her staff—and say, “Look, this is OK.” I think she ultimately voted against it, but she didn’t block it. You have to be tenacious and honest that this is about the next generation of capital formation, which is tough because, for a lot of these folks, it doesn’t play to their base.

Privcap

You’re saying that, specifically, private equity—not the broader private markets—is where you see an appetite on at least one side of Capitol Hill to further define, seek further clarity, seek further disclosure?

Schweikert

We were trying to find a more egalitarian way to access information. You have a country with 318 million people and we have, what, about 600,000 who are qualified investors?

I’m passionate about broadening that definition [of a qualified investor], because we’re locking out so much of our society from being able to take incremental risk and participate in investments that they have high knowledge of, because they haven’t met the definitions the SEC produces. Say my buddy has a Ph.D. in electrical engineering and doesn’t have a million bucks in the bank, but a deal happens to be for a company specializing in that space. If he’s truly an expert, why shouldn’t he be allowed to invest?

Gluck

… As you probably know, the GAO came out with a report by now, maybe five or six months ago, talking about how the threshold limits for the definition of accredited investor haven’t been increased in a long time. There are even some proposals to retroactively index the threshold limits for inflation.That would dramatically reduce the amount of people who meet the qualification of accredited investor.

Privcap

A world where it’s easier for capital to connect with projects or businesses or funds—that’s good for the formation of funds and for innovation, but it does increase the risk of fraud. What do you think the appropriate protection should be, if any, to guard against, or at least discourage, the fraud that would naturally creep into a more open system?

Schweikert

One of the great failings in the SEC’s rule set for equity crowdfunding is, “How do I use sunshine? How do I use that crowdsourcing of information?”

Here’s your intermediary hosting the crowdfunding platform, and here’s Mary’s Bakeshop. She wants to raise a quarter-million dollars, and there’s a blog where people are talking about her cupcakes, or saying it’s in a horrible neighborhood. I’m a powerful believer that filing another piece of paper that almost no one reads is not modern regulation. Having something instantaneous, easily accessible and digestible—particularly for the lower-market investor—that’s where regulation has to be more about sunshine and access to information, rather than creating another series of forms to file. But the innovation is electronic filing. How many of you use Yelp or these sorts of things to choose a restaurant?

Privcap

Sure. All the time.

Schweikert

You’re going to trust that to make a financial decision on what you’re going to stick in your tummy. We’ve already experienced this. How do we pull that into other activities around us?

Privcap

If you look at the way private equity and any private-fund industry has evolved, it is highly confidential. Is the JOBS Act going to give way to a more open way of exchanging information?

Schweikert

The [private and public approaches] will coexist until one starts to demonstrate that its cost of raising funds is more efficient. I used to represent a wealthy man in Scottsdale; my job was as much to keep stupid deals away from him as to keep people from knowing what he was investing in. Often, when he would jump into a deal, we had snipers who would try to raise our price or screw with us. That world will exist, it will be uncomfortable for certain dealmakers to talk, and I would like to fix some of the liability issues. It is healthier for the economy to have many opportunities, discussions, fights, and debates over where to park your money.

Privcap

Scott, what will be the battlegrounds where the outcome could be different, based on how things break?

Gluck

In private equity, funds with more than $150 million generally have to be registered under the Investment Advisors Act, which was never intended to apply to PE fund managers. They are subject to a host of regulations, like keeping track of their employees’ personal trades, even though the funds invest in privately held companies. It is expense with virtually no benefit of reducing insider trading.

The SEC has given favorable guidance with respect to things like the custody rule, but it might take some sort of legislative fix. Unless you get a Senate more conducive to easing regulatory burdens on private-equity funds, it will be difficult to implement changes.

Privcap

Institutional investors who commit capital to private equity, as well as the PE firms, wonder if their lives are going to get better or more difficult in the future.

Schweikert

There is a tug-of-war. I watch the House Committee on Financial Services, and you have one side fixated on no one losing money and the other fixated on access and capital availability.

We were hearing noise about private equity from regulators. There is a coming battle with the SEC over what should be disclosed and registered, how deep that registration should go, and who gets to play. Some of us are trying to create an environment that says, “If you’re not playing with government-insured money,
not taking money from the general public, ultimately, what do we care? It’s yourrisk capital. t is your job to build a rate of return for your investors. It is not our job to babysit you.”

Also, be prepared to have to fight through the fungible definition of who and what a private placement deal is, what private equity is and what it’s investing in, and what falls into a space of disclosure.

Privcap

You mentioned a coming battle. Will the ultimate outcome be more pain for the capital-formation world and bringing regulations in line with technology and
society? How do you think it will break?

Schweikert

No one will like the first part of my answer; it is the worst of both worlds. Those in the capital-raise or dealmaking business are thinking, “Give me a bad rule, but dammit, just give me the rule.”

We desperately need capital formation, and some of the “paint all the financial industries with a broad brush of being evil” from 2008 is fading. Something like equity crowdfunding takes a year and a half or two years for the SEC to produce a set of rules; they end up being overly cautious and bureaucratic. Waiting is the problem. I hope it does not stop folks from putting a deal together.