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  • More laws tending to encourage class stratification & stagnation

    Posted by ken on July 6th, 2005 (All posts by )

    Here’s something I had not been previously aware of.

    Kim du Toit informs me that, unless you have a net worth of one million dollars or more, or you run a bank, or you personally know the individuals running the start-ups you intend to fund, you are forbidden by law to be a venture captialist on any scale.

    Yep. That’s right. The oligarchy is here. One law for the fat cats, another law for you. If you’re not a “qualified investor” (i.e., a wealthy one), your ability to invest in start-ups is severely limited.

    Read it for yourself.

    Supporters of the law, including many on the left that keep railing about the oligarchy that laissez-faire advocates are supposedly trying to establish, will insist that the law is necessary to prevent fat cats from ripping off poor, naive, misguided investors, and that funneling all investment from “ordinary people” through investment banks and other mechanisms that allow fat cats to take their cut is either an unrelated phenomenon resulting from not having enough economic regulation in place or perhaps an unfortunate side effect. But, yet again, laws that are sold as a means to protect ordinary consumers have the “unexpected side effect” of protecting incumbent vendors of all sorts (by making it harder to get a new start-up off the ground) and enriching other well-connected people (in this case, investment bankers). I’m sensing a pattern here.

    Not a conspiracy theory, mind you. Different groups of wealthy and powerful people just find the same tool (dress up a law keeping ordinary people in their place as a way to “protect” them) useful for their purposes, and keep using it over and over, and will keep using it until a majority of the electorate finally decides that protecting fools from their own folly isn’t worth narrowing their opportunities or restricting their options for achieving their own ends. Or until enough wealthy and powerful people figure out that their private jets are as horsedrawn carts next to the wonders that “new blood” can come out of left field with if we stop trying to control them, and that letting someone come out of nowhere and become richer than you is worth it if you get richer than you are now in the process.

    Maybe our friends on the left will one day figure out where oligarchies and class stratification actually comes from and sign on to economic as well as “personal” liberty, and point out the (all-too-frequent) times when their opponents on the right are pushing neither, and win elections on that basis. I’d join that party in a heartbeat, assuming that it didn’t oppose fighting as appropriate and defeating dangerous enemies of the United States and liberal society in general with a powerful all-volunteer military.

     

    9 Responses to “More laws tending to encourage class stratification & stagnation”

    1. Jonathan Says:

      I agree that the rules are excessive. However, there are usually ways to do what you want to do. I don’t understand Kim du Toit’s venture, but small startup businesses that need capital might be structured as limited partnerships or similar. Maybe he needs better advice.

    2. Ken Says:

      There’s usually a way around most laws, sometimes even ways entailing relatively little risk. And it’s good that simple subversion can sometimes limit the ability of the state to do things it shouldn’t.

      But when you wish to trade with others in some way, a law discouraging those others from trading in that way, regardless of whether a foolproof way exists to evade the law, significantly limits your opportunity to trade with otherwise willing partners. If you wish to buy something that an individual dreamed up, or you wish to invest in that something, then your wish will be thwarted if that individual is dissuaded by the authorities from producing and selling it – whether or not he could have overcome the barriers placed in front of him by some devious and possibly expensive means. While you may be willing to employ such means, he may not be, and thus the barrier has prevented the trade from taking place.

      (Of course, in a pure laissez-faire system, he may still be disinclined to produce and sell it, since it may not appeal to enough other people besides you to make it worth his while. But why discourage him in cases where this is not true?)

      So instead of this being a case where a particular individual needs better advice or more fortitude, it’s a case where you and I need lots of smart strangers to find it as easy as possible to put their new ideas and products into the marketplace by whatever means available that involve willing cooperation among all concerned, or else you and I miss out on a lot of new and better products that I would like to buy, and we miss out on the opportunity to profit by investing in products that consumers really want but had resigned themselves for decades to never being able to obtain.

    3. Jonathan Says:

      I agree with you as to how world could be made better. What I am saying is that if your current priority is to get something practical done, rather than to make a test case in order to improve the system, there are usually ways to do it.

    4. Jim Bennett Says:

      There is a filing category that permits companies raising up to 1 million in a year to accept non-qualified investors. (“qualified” means the list of characteristics you mentioned.)

    5. nc Says:

      Trust me, I am no lover of governmental regulation, but Kim is just flat out wrong and his lawyer either gave him bad advice or he misunderstood his lawyer. The general point of federal securities laws is not to prevent people from raising money, or to prevent people (even stupid people) from buying stock, but rather the laws are intended to ensure that sufficient information has been made availble from the stock seller to the stock buyer. The level and amount of information that has to be made available varies greatly on the size of the deal and the type of investor. If you want to punish yourself, you can read my general discussion of the basic federal laws applicable to offers and sales of securities below (though, if you’re looking to raise money for a company, you really should talk to a good lawyer to see how your own situation should be handled). Contrary to what some may think, stupid, poor people can invest in really risky companies, provided the investment was done in accordance with the law.

      First, a person or company (often called an “issuer” in securities law speak) can generally offer or sell securities (i.e., stock or other types of investment interests) to anybody if they register the stock for sale under Section 5 of the Securties Act of 1933. Of course, for all but a few issuers, it is usually too time consuming and expensive to comply with all the regulations required to publicly register securities for sale. So most issuers offering or selling securities, rely on exemption from the Securities Act’s registration requirements.

      One of the exemptions often relied on is Section 4(2) of the Securities Act. Under Section 4(2), an issuer is exempt from registering the offer or sale of any securities made in a non-public transaction. So if the transaction is not a public transaction, an issuer can offer and sale securities free of federal regulation (though there may still be state laws that regulate the transaction).

      Of course, the issue of whether something is a non-public transaction is kinda complicated and there are quite a few court rulings from the Supreme Court and various federal circuit courts of appeal (not all of which are consistent) that attempt to define a non-public transaction. In order to lessen some of this confusion, the SEC promulgated some regulations (notably Rule 506) that created a safe harbor to lessen this confusion. Basically, if an issuer complies with Rule 506, he is deemed to have complied with Section 4(2) of the Securities Act of 1933. Subject to some qualifications which I am not going to go into, Rule 506 basically allows an issuer to offer or sell securities to an unlimited number of “accredited investors” and up to 35 unaccredited investors in any given securities offering (the question of what is an offering is complicated, so I won’t go into that here). Generally speaking an accredited investor can be a person who has more than $ 1 million in assets, a person who has makes a lot of money on an annual basis (generally between $200k and $300k per year on a regular basis), a corporation or similar entity with more than $ 5 million in assets, certain types of trusts, and directors and executive officers of the issuer. Now unaccredited investors do not have to meet any salary or net worth requirements (though they or their representative may have to meet a sophistication test), but if the issuer sells securities to an unaccredited investor and is relying on Rule 506 for his exemption, he is required to make some fairly detailed disclosures in order to ensure that the investors are aware of all material risks associated with investing in the start-up. As a result, lawyers usually caution companies against including unaccredited investors in a 506 offering, unless they are willing to spend the time and money to have a proper disclosure document prepared.

      There are of course other exemptions which can be relied on. Somebody mentioned the exemption applicable to offers and sales of securities where less than $ 1 million is being raised (I believe that is found in Rule 504 of the SEC’s exemption regulations). Subject to some detailed qualifications, there is also an exemption from federal registation requirements available for offers and sales of securties made by an issuer resident in a state if all offers and sales are also directed to other residents of that state (there may still be state laws that have to be complied with). Somebody mentioned that selling limited partnership interests is a way around the rules, but I would not recommend that, as there are quite a few cases which suggest that limited partnership interests are in fact securities subject to federal regulations on offers and sales of securities.

      This just real high level discussion of some the applicable laws, but the point is that through good planning, you can start up a company and get investors. How much you have to spend in complying with the law will vary depending on the types of folks investing. But for crying out loud, if you are starting a company and asking people to invest in it, you ought to spend a little money to make sure you are doing it right.

    6. Fredrik Nyman Says:

      Do bear in mind that 1) widespread individual stock ownership, research and trading is a pretty recent concept (90’s dotcom era), and that 2) these laws are significantly older.

      In fact, they’re old — part of the Securities Act of 1933, which came on the heels of the Depression and was in part a legislative reaction to the many financial scandals of the era. Sort of like Sarbanes-Oxley was a response to Enron, Worldcom, Andersen and all the other scandals we’ve seen the past few years.

    7. David Mercer Says:

      nc, while everything you write is true (I’ve done 3 startups), that does not lessen that fact that the regulations you mention are horribly complicated, and that there are many irreversible (or VERY expensive to change later) decisions to be made under them. It’s a land mine.

      I’d never personally take a company public post-Sarbox, and I was itching to before it.

      It’s just that much worse now.

      I think that a simple requirement that ALL securities offerings include 1) proper balance sheet disclosures and 2) in LARGE RED LETTERS on the top of the front of any offering or advertisement for the same, a notice stating “DO NOT MAKE THIS INVESTMENT IF YOU CAN’T AFFORD TO SET THE MONEY ON FIRE INSTEAD” would be sufficient, rather than the current anti-market mess of regs. we have in place.

    8. Tim Oren Says:

      nc, without disputed any of what you’re saying, there’s one issue that may mean Kim is getting decent advice: There’s no reg or case law at all on whether mentioning raising money on a blog is an open solicitation, and it sounds like you’d be quite aware that that potential interpretation raises a host of issues. “Friends and family” is a well set precedent for small businesses finance, but stretching to “readers of my blog” could give one heartburn. There’s going to be a test case on that someday, but one can understand not wanting to be that case.

      From what I understand of Kim’s direction, the suggestion about an LP structure might well be a good one.

    9. A Scott Crawford Says:

      Kim was doing his fire breathing thing, and sometimes the “Texan Dialectical Method” of debate relies less on actual facts than on the pitch and venom of a particular days argument and enemy. However well founded his concern, this example is such a glaring Straw Man fallacy that it deflects from the larger issue, which is over-regulation vs. over-protection re some public fiscal matters.