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It Actually Worked, or How Technology Is Changing Financial Regulation | |
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> | A misleading title. The actual subject might be better described as "one way technology is changing one aspect of financial regulation." | | | -- By AlexeySokolin - 27 Nov 2011
Finally, our grandparents can invest in the latest hot technology start-ups! In the last few years, online tools have sprung up to challenge financial regulation of private offerings and capital markets. Surprisingly, securities regulation is bending to technology and accepting the new paradigm thanks to the economic pressure of the current recession. | | | Kickstarter is one of the most successful crowd-funding websites. It allows regular, unsophisticated, unaccredited people to provide capital for projects and receive benefits in exchange. The transaction is structured as follows: a project owner sets some minimum amount that they are raising, and then associates certain contribution levels with certain rewards. For example, a $25 contribution may be a pre-order of the product when it is made; a $500 contribution may be an autographed copy of the product, along with special commentary and extra personalized goods. If the minimum tipping point is reached, the project is funded and the author commits to carrying it out. Most projects are creative, in music and visual arts, and cost below $1,000, but some are as large as $200,000 and have more than 6,000 backers. This model skirts fixed income and equity altogether, replacing the concept of securities with a large sum of micro-transactions. | |
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> | The important point is
rather that this is contribution, not investment. Kickstarter
contributors are neither loaning money at interest nor acquiring
equity. You fudge this crucial point, by talking about their
receiving benefits. A t-shirt or even an more expensive premium with
a significant market value promised in return for a contribution (not
contingent upon the success of the enterprise, I should point out) is
not investment in the sense we are
discussing.
Kickstarter is a mechanism for cooperative fundraising. It is part
of another aspect of the 21st century economy enabled by the Net, a
sector of trust-based, non-profit, or community-linked enterprises
occupying ecological niches unreachable under 20th century conditions
because of transactions costs and transportation expenses eliminated
by the Net. The sector thus enabled is substantially larger than the
existing global industrial economy. Its growth and development over
the next hundred years is as large a change in the overall nature of
humanity's material culture as the process we call "the Industrial
Revolution." Everything we are talking about in this course, let
alone in this essay, are small evanescent surface features on the
immensity of that phenomenon.
One of the less evanescent surface phenomena is the decentralization
of capital accumulation, as cooperative systems of finance—which
have traditionally met enormous barriers of transactional complexity
and cost, as well as hostile regulatory capture, but which are also
more durable and older than finance capitalism by thousands of
years—become hyper-functional and efficient under conditions of
global hyper-connection. Thinking about Kickstarter plus PayPal can
be helpful in modeling the primitive pre-eukaryotic form of the new
financial organisms. And naturally you have a pretty good
understanding of dinosaur neuroanatomy. It's the stuff in between
you're not seeing quite as clearly. | | | AngelList is a social network for angels—individuals that themselves had a lucrative career, are likely accredited investors, and qualify for the Regulation D exemption. Driven primarily by reputation and references, this network quickly accelerates traditional fundraising timelines. Instead of going door-to-door with a presentation, entrepreneurs can take advantage of network effects and access a large number of people simultaneously. This is convenient. As an entrepreneur, you want to put your materials in front of every single person that could potentially invest, which would run afoul of the rule against promotion of securities. AngelList? deals with this by facilitating personal introductions and warning against solicitation. Warned or not, the entrepreneur is one click away from tweeting an investment update to thousands of strangers. A competitor site, Gust, serves a similar function for investor networks. Stronger restrictions on mass communication make it less convenient to spam your investment materials to venture firms, but not less feasible.
Another innovation in marketing private equity is represented by secondary market exchanges. After an initial public offering, public stock is traded on secondary markets like NYSE and NASDAQ. As stressed before, financial regulation mandates compliance using accounting and disclosure standards so that risks about the security are known. When those securities are private, compliance is far less rigorous; the stock must not be widely traded and is restricted to institutional and accredited investors. However, recent years have seen low IPO activity and high demand for private company stock (e.g., Facebook). Companies like Second Market and Share Post built online exchanges for restricted share, creating prices and convenient trading platforms. Although members are limited to legally appropriate categories, the line is being blurred and the SEC had launched investigations into trading members. | | | Emerging Legal Foundation
It is no surprise then that these companies consider existing regulation outdated and are lobbying to change the rules. Combined with the pressure of a stagnant economy, tight lending, and politically appealing “small business” demographic, it may be working. The House passed several bills to make private investment easier: increasing the number of maximum shareholders for closely held banks by 1,500 and growing the exemption from SEC registration from $5 million to $50 million. Other proposals on the table would allow broad soliciting and advertising, replace the accredited investor rule with a 10% of income rule, and empower online services to offer equity. In a refreshing twist, the failure of traditional finance to generate a recovery from the current recession is building the legal foundation for future innovation and creativity.
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> | This is so emphatically
the least of the significance of what's going on that the essay winds
up reminding me of the bird that flew ever faster in ever smaller
circles until the inevitable happened, and ....
From my point of view, if the fate of Regulation D is the angle
subtended by your telescope, this analysis is descriptively correct.
It seems to me a little like explaining what's going to happen to one
sandcastle on the beach in Thailand as the Boxing Day tsunami moves
in. Some effort to describe the phenomena overall not in terms of
traditional terminology, but rather in terms reflective of the
situation at the other end of the process might be helpful.
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