D.J. Paul is one of the most knowledgeable people in the industry on regulation A+ and the JOBS Act. He has testified in Washington and played a key role in bringing together regulators and alt-fi stakeholders to discuss the industry. Mr. Paul is a featured speaker at the second annual Fintech Global Expo which takes place in San Diego on May 28 and 29.
Mr. Paul will update attendees on the latest happenings with Regulation A+ and Title IV.
A recent interview with Bankless Times provides a nice preview of Mr. Paul’s presentation.
On the heels of the Regulation A+ announcement, the Securities and Exchange Commission (SEC) has another decision to make.
The SEC Advisory Committee on Small and Emerging Companies is considering the benefits of a venture exchange for private placements and illiquid securities. Three years in and the JOBS Act has yet to reach its potential in helping the American economy. Both the SEC and Congress recognize this and see such an exchange as one way to improve liquidity in a market exceeding $1 trillion in annual offerings.
The SEC is faced with two different styles for such an exchange, and instead of choosing one or the other, an industry insider believes the market should have final say.
D.J. Paul has been a key player in the battle to get lawmakers to adopt crowdfunding laws conducive to the business development America and the world so badly needs.
A member of the SEC’s Advisory Committee on Small and Emerging Companies, Mr. Paul testified before Congress in January 2014 about securities issues and the JOBS Act. In April 2012 he organized the first post-JOBS Act meeting between the SEC and investment crowdfunding stakeholders. Mr. Paul is also co-chair of Crowdfund Intermediary Regulatory Advocates (CFIRA).
Mr. Paul recently spent some time with Bankless Times and discussed small business funding travails, the American economy, the future of crowdfunding and a host of other topics.
Now is not a good time for small businesses in search of financing. Low rates and cheap money give banks little reason to lend when they can make a similar return buying treasuries. This has been a drag on America’s recovery because small businesses, creators of 80 percent of jobs, cannot create them without access to capital.
“It is too bad because there’s this great need, there always is, but particularly when we’ve had a net job loss,” Mr. Paul said. “The difficulty in accessing capital for small businesses has absolutely contributed to both the slowness of this recovery.”
Perhaps the lack of movement in some areas is because not everyone was equally hurt by the recession.
“Wealthy people have done very well in the last six to seven years,” Mr. Paul said. “Middle class and poor people have not done nearly as well. That can be directly attributable to small business not having the capital to lift them up.”
Regulation A+ will help somewhat, as small investors will be able to participate in small IPO’s, but what about the thousands of business sitting somewhere on the continuum between the bright idea and that IPO?
That’s where the venture exchange comes in, though the term itself gives reason for pause.
“The term venture creates images of venture capital and that’s fine,” Mr. Paul said. “(Venture capital) represents truly a small percentage of the Regulation D market, maybe hundreds of millions or even billions. But remember you are talking about a market that was $1.3 trillion last year in new issuances.”
Mr. Paul said there are two different proposals in play. The first calls for a venture exchange which would be a lighter regulatory regime than the current stock exchange.
The second is for the creation of a broker/dealer network. Brokers and dealers can take on an Alternative Trading Service (ATS) designation. ATS-designated companies mostly trade between institutions in secured private placements. Mr. Paul sees the possibility of making an ATS more robust by allowing trading from high-net-worth individuals or accredited investors as a way of adding more liquidity to the market.
Our expert thinks the SEC should resist the urge to decide which option to implement and instead let the market determine which one it prefers, or if a hybrid solution is most suitable.
“Both are valid both are good,” Mr. Paul believes. “There is this misconception that it needs to be one or the other. I don’t share that I think we should do both. We may find certain issuances are better traded on a venture exchange while some are better traded on OTC (over the counter) market.”
Having been there at the birth of the JOBS Act, and now looking back three years later, is he surprised things have moved so slowly?
“Am I surprised it’s taken this long? Yes I am a little surprised. Am I shocked? I am not shocked.”
“I set up the first meeting between the crowdfunding community and the SEC on April 20, 2012 and have been working with them since then. I’ve been able to watch the process and I’ve seen it go slow. Look we got Title I, Title II was lit up a year and a half ago, Title II is still pending, and Title IV is happening.”
“We are on our way. We are talking about the creation of Title III which is the big outstanding thing. It’s the creation of an entirely new securities class. It’s a big job. Three years is a long time, but since it’s been effectively 82 years since the Securities Act of 1933-34. Three years in that context is not too long.”
It is interesting to watch the growth of equity crowdfunding and other alt-fi measures which are helping small businesses in such places as Australia and the United Kingdom. Their success should provide both hope and direction while also serving as a warning America is losing this innovation battle.
Little of that seems to be happening.
“Why other countries were able to move faster than the U.S. can be summed up in one word: politics,” Mr. Paul said. “We have a particularly fraught political system for the last 10 years maybe longer.”
“The polarization in Washington has become acute and that tends to paralyze forward moving progress. That is not to say there aren’t opposing forces in other countries. It’s just that they tend to put aside their differences a little more quickly than we do and that’s too bad.”
Where can we look to for best practices?
“Notably in the equity market look at Australia, where they have crowdfunding bridging the gap between Regulation D and Title III. They’ve had that since, I believe, 2007 or 2008. If you look at the numbers they’ve been phenomenal. The failure rate is less than 20 percent, that compares broadly to 50 percent for new businesses. Default on debt is very low.”
Another example is closer to home and being accomplished by a traditional ally.
“Look at markets in the UK,” Mr. Paul suggested. “Delinquencies are very low, defaults are very low. It’s impressive to see how well it’s working which is heartening for us, given our much bigger economy, and greater culture of entrepreneurship.”
When it happens in the United States, expect the gap to quickly be erased, Mr. Paul said.
The sentiment hidden just under the surface of the rationales given by crowdfunding skeptics for not implementing some of these rules seemingly is the need to protect unsophisticated investors from themselves. More than most people I talk to, Mr. Paul sees at least the rationale for the original rules put in place.
“We have securities laws which were put into place in the 1930’s and not in a vacuum,” Mr. Paul said. “They were put into place because so many unsophisticated investors were taken advantage of in the crash of 1929 and subsequent depression. That is where the securities act of 1933 and 1934 came from. There is a need to keep bad actors from taking advantage of the unsophisticated.”
It is possible that original intent has been taken too far some 80 years later.
“Protecting idiots from their idiocy may not be the appropriate role of government,” Mr. Paul cautioned.
“Protecting people from fraudsters absolutely is. But if somebody is placing some of their money in a venture they think is going to do well, and not through fraud, it fails because it was a bad idea, or it didn’t execute, or the market changed, or they misjudged, I do not think we should be protecting them from failure.”
Mr. Paul went on to say regulators confuse the three F’s of failure, fraud, and fulfillment. They should protect people from fraud, but failure not from misdoing should be outside their responsibility. Fulfillment problems, famously seen in some big Kickstarter and Indiegogo campaigns, occurs when a company underestimates demand and experiences significant shipping delays which serve as a growth drag. While unfortunate, unless fraud is proven, government should stay away.
That is not always the case with demographic-sensitive legislators afraid of turning off a support bloc, D.J. Paul said.
“You need to make a distinction between bad actors and less than competent actors. It’s a very different proposition when somebody steals from you then when somebody misjudges. We don’t treat that the same in any other aspect of the law and we ought not to treat it the same in securities law.”
Bankless Times spoke with Mr. Paul the day before Regulation A+ was announced, so we asked him to crystal ball some of its effects a few years from now. He sees real estate and some tech companies benefiting the most, though there is no reason he can see for any sector to not gain. He does not see many million-dollar raises but expects the number of raises to increase in step with the dollar amount.
“A company that’s successfully raising say $35 million is a small company by most definitions but it is not a startup,” Mr. Paul said. “The good part about that is that companies further along in their life cycles usually have gone further through the difficult times, and have a higher likelihood of surviving. The jobs they create are better paying.”
“And that’s what we need – bridging the gap between startups and the IPO market that over the last 10 to 15 years have moved to where very few IPO’s are done that are less than $200 million.”
“This opens up the IPO market to smaller companies maybe companies who never get to a $200 to $300 million-dollar valuation. There are lots of good companies who are just small, who will never be a billion-dollar company. Those are where the jobs are made and most Americans work for companies like that.”
Prior to his involvement in crowdfunding, D.J. Paul was an independent film and television producer. Given the successful coupling of the two fields, what are his thoughts on crowdfunding’s impact on film and television?
“So far the greatest impact that crowdfunding defined broadly has had is on the independent film world. You can see from Sundance and SXSW, where I think 40 percent of films have got some portion of their funding from some sort of campaign.”
“It’s proven to be a very effective tool for raising microbudget and smaller budget films. There’s no reason not to think that when Title III is lit up that it will become a great source of funding for low budget films. Title III will be limited to $1 million but those are often the good ones. The majority of films I made in my 15-year career as a film and television producer cost less than $1 million.”