Tag Archives: U.S. Securities and Exchange Commission

Crowdfunding Update.

David Drake of LDJ Capital and TheSohoLoft.com continues today with his sixth article on his series regarding CrowdFunding for equity solutions, reprinted here with his permission.

Perhaps it was no surprise when Mary Schapiro, Chair of the Securities and Exchange Commission, told a House subcommittee that the Securities and Exchange Commission will not meet the July 4, 2012 deadline imposed under the JOBS Act to implement rules for lifting the general solicitation ban under Regulation 506, Section D (advertising rules).

Ms. Schapiro explained to the House Committee on Oversight and Government Reform on June 28, 2012 that the JOBS Act mandates that the SEC create rules that will require issuers to verify that they are accepting investments only from accredited investors who are responding to a general advertisement. Creating such rules are difficult and will require more time. “We want to create something that is workable and usable,” she said. The SEC Chair expects that general solicitation rules will be issued “this summer.”

The SEC’s commitment to provide general solicitation rules this summer is encouraging and badly needed. Representative Patrick McHenry probably summed up the urgency for the rules the best by advising Ms. Schapiro: “Entrepreneurs are waiting and we urge you to move forward with that.”

As the SEC develops rules for general solicitations, issuers must understand that they will need to move cautiously if the plan to use general advertisement to solicit offerings. The JOBS Acts require that issuers verify that they are accepting investments only from accredited investors under the SEC Act. The SEC rules ultimately will determine what verification process is needed and whether any safe harbors are available. We suggest that issuers looking forward to make general solicitations stay apprised of developments as the SEC formulates its rules, so that issuers are prepared to move forward when the rules go public.

The Securities & Exchange Act in 1933 required that only accredited investors could be solicited for investments and non-accredited investors could not be unless they had an exemption through Reg A, Reg D, a Direct Public Offering or a registered security being traded on an exchange.

Under the 1933 Act, the accredited investor was considered someone who made $200,000 per year the previous 2 years and expected to make $200,000 the following year or a couple making $300,000.  Under a later amendment adopted in 1982, another criteria that would allow you to qualify as an accredited and sophisticated investor would be that you had a net worth of $1,000,000.

While the Dodd Frank Act was under consideration, the SEC pushed for a high net worth amount for an accredited investor. This was highly opposed and removed. What was accomplished out of the Dodd Frank Act was:

a) The equity of your primary home would not count towards your net worth.

b) Debt surpassing your equity would count against your net worth.

c) The equity in your summer / vacation / secondary home would count towards your net worth.

The Dodd Frank Act also prohibited the SEC from adjusting the net-worth threshold for a natural person for four years.

If you take inflation into consideration, the $200,000 per year salary in 1982 would be the equivalent of approximately $1,000,000 today, and the net worth requirement set in 1982 would represent a net worth of approximately $10,000,000 today. Wow, that would not leave many people to invest. Another argument would be that are only rich people entitled to invest in private and exciting deals? Are the select few that made money on Facebook the only ones to ‘give it’ to the less rich?

Granted, $200,000 makes you rich today but I was alluding to the rich just like their counter parts in 1933. Remember, the SEC 1933 & 1934 Act was created to protect the non-accredited investors from fleecing but also to assure that they did not leverage their home 99% and spend all their money on stocks that would not only be worthless but put them jobless and homeless. The 1929 crash that led to the great depression was extreme.

While the status quo remains for determining the financial threshold of an accredited investor, a fundamental change is approaching on solicitation. Currently, any issuer intending to rely on Rule 506 of Regulation D cannot engage in any general solicitation or advertising to attract investors. The Jumpstart Our Business Startups Act (JOBS Act) directs the SEC to remove this prohibition, which the SEC expects to implement during the summer of 2012.

Here is a little history on the non-solicitation rule. Be reminded that there was no TV or internet in 1933. The ban on solicitation to non-accredited investors forced brokers and companies to only talk to ‘rich’ people for investments, that is, the accredited investors. The JOBS Act asked the SEC change the writing in 90 days – that is July 4th, 2012 – Independence day – at which point advertising online, via email to millions or on TV would allow you to advertise you wanted capital for your stock to the general public.

Note, you still could only take money from accredited investors but the monumental change is that you can freely advertise wildly. Yet again, you would lose your exemption status under Reg D 506 if you took one single non-accredited investor and they decided to sue you later for loss of capital — a rare occasion but a legal premise that may hold true. So, will this amendment be implemented by July 4th and we will see media go bananas with everyone with their mother advertising stocks of private companies you can buy?

No, the SEC will not allow such madness as they will implement a safe harbor to assure that the ‘accreditation” of an investor through this means is verifiable and not necessarily just self-monitored by the issuer.

David Drake is a founding board member of CFIRA. Crowdfund Intermediary Regulatory Advocates, or CFIRA, was established following the signing of the Jumpstart Our Business Startups (JOBS) Act. CFIRA is an organization formed by the CrowdFunding industry’s leading platforms and experts. The group will work with the Securities & Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and other affected governmental and quasi-governmental entities to help establish industry standards and best practices. For more information, visit http://www.CFIRA.org. Connect with TheSohoLoft at facebook.com/TheSohoLoft and sign up for newsletters at www.thesoholoft.com, or contact Donna Smith, Communications Manager, for more information at 212.845.9652 or via email at donna@LDJCapital.com.


Pennsylvania Fearmongers Attack Crowdfunding.

Hopping Mad as Commissioners Go Over the Line.

This is a re-post by David Drake of LDJ Capital & The Soho Loft.

A shocking press release hit the net last week, purportedly from the Pennsylvania Securities Commission. The link to the “advisory” goes to http://www.psc.state.pa.us, but that site doesn’t seem to host a copy. Even so, if the press release is accurate, it amounts to an unfair characterization of the JOBS Act and new Crowdfunding regulations.

Crowdfunding under the Act is portrayed as creating a Wild West style free-for-all that will attract fraud and con artists of all stripes. They cite the current lack of hard and fast rules to govern the sector and then assume no rules will be in place before next year’s launch. That’s nuts.

Here’s a typical quote:

Commissioner Steven Irwin summarized, “The way the new law was written, it’s pretty much ‘Buyer beware.'” He added, “It’s not that we don’t need new incentives to attract more investments in startup companies. It’s just that the lax oversight implicit in the new law is likely to attract people trying to game the system and scam people out of their hard-earned money.”

Excuse me?  RocketHub has had zero fraud incidents since launch in 2009. 

The plain fact is that we do need a new structure to help start-ups. Crowdfunding and micro-financing is an ideal way for new investors to participate and energize our sluggish economy. Small entrepreneurs find themselves shut out of the game. A game that already has its critics.

Take a look at the analysis of VC opportunities as they exist now – you have the WSJ exposing a scheme where GP’s rake in the major profits while late-comers to an investment bear the burden of more risk and lower rewards.

A history of overblowing risks!

It seems the PASC takes their watchdog role very seriously. They did a similar warning back in 2010, only then it was another piece of federal legislation: PA Regulators Warn: Investor Scams, Like Flu Virus, Will Mutate to Adapt to New Federal Financial Reform Bill. Here are some of the entries on their top ten list of investment traps then: ETFs, forex, gold and precious metals, “green” investments, and oil and gas.

It seems their motto is, “panic first.” And that may be their charge. After all, as a state run commission, they should have one eye on regulations and another looking out for scofflaws. But this latest hit piece goes too far.

Of course there needs to be rule-making to regulate the Crowdfunding market. Everyone agrees on that.

Of course disclosure and investor protections have to be front and center.

And read what Pennsylvania Securities Commission Chairman Robert Lam had to say in their Spring Bulletin: “The Internet is a powerhouse, and maybe – just maybe – Crowdfunding will be a good thing once it matures and we have some ground rules in place.” Somehow Mr. Lam moved from cautious optimism to fear monger – while the rules are still being written at the SEC. At the risk of being repetitive – That’s nuts.

Our real concern isn’t about one small department in one state. Our concern is that this mischaracterization of Crowdfunding will catch on without those in authority positions doing their homework. Crowdfunding is worthwhile and it offers something no other framework can – access to funding for those too small to interest VC players.

Good ideas and good companies deserve a chance to present their case to the public, and the public deserves a chance to reap the rewards.

A turf war between federal and state regulators shouldn’t have the ability to libel an entire market. Should it?

One editorial comment: The very essence of crowdfunding, aka the crowd, is the built-in protector acting on behalf of all the investors, aka the crowd. The crowd will quickly, in fact virtually instantly, call out the fraudsters and the system gamers before any crowdfunded offering gets off the ground. Um, that is the whole idea behind crowds.

So, my question is, would you rather place your $100 in the hands of a Wall Street banker to invest in, I dunno, Proctor and Gamble? Or, would you rather place it in the hands of the next Facebook, with the support of 1,999 others (aka a crowd)?


Mad As Hell! And, See You In Court.

That didn’t take long.

Facebook Inc and Morgan Stanley, the lead underwriter of social networking company’s IPO, were sued by shareholders who claimed the defendants hid Facebook’s weakened growth forecasts ahead of its $16 billion initial public offering.

The lawsuit also names underwriters JPMorgan Chase and Goldman Sachs among others, and follows quickly on the heels of Facebook’s May 18 stock market debut, which was plagued by technical glitches.

Facebook shares fell 18.4 percent from their $38 IPO price in the first three trading days. In early afternoon trade today, Facebook shares were up 2.1 percent at $29.51.

Hey, I just lost $2 Billion. Don’t bug me with your problems!

The legal action accused the defendants, including Facebook Chief Executive Mark Zuckerberg, of concealing “a severe and pronounced reduction” in revenue growth forecasts resulting from increased use of Facebook’s app or website through mobile devices.

Facebook was also accused in the lawsuit of telling its bank underwriters to “materially lower” forecasts for the company.

“The main underwriters in the middle of the road show reduced their estimates and didn’t tell everyone,” said Samuel Rudman, a partner at Robbins Geller Rudman & Dowd, which brought the lawsuit. “I don’t think any investor in Facebook wouldn’t have wanted to know that information.”

Regulators including the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and Massachusetts Secretary of the Commonwealth William Galvin have begun looking into how the IPO was handled. The U.S. Senate Banking Committee is also reviewing the matter. Busy, busy, busy. Let no self-respecting agency appear as though they aren’t busy looking into things. Problem: Horses are already gone. 

“The SEC has since the 1990s broadly condemned the trickling out of material non-public information, which would include that savvy, well-paid analysts are lowering estimates,” said Elizabeth Nowicki, an associate professor at Tulane University Law School and a former SEC lawyer. Condemned? Or, is it actually against the law?

Syndicate banks “are on the hook in terms of liability by not making accurate, complete disclosure,” she added. “Selective disclosure of analyst outlook changes is not acceptable.” Not acceptable? Or, against the law?

Andrew Noyes, a Facebook spokesman, said: “We believe the lawsuit is without merit and will defend ourselves vigorously.”

Andrew Noyse.

Morgan Stanley had no comment. It said on Tuesday that Facebook IPO procedures complied with all applicable regulations, and were the same as in any initial offering.

The shareholders said the disclosures about Facebook’s business risks were inadequate, and that the company should have told everyone, not just “preferred” investors, that analysts knew those risks and cut their business outlooks accordingly.

Should have? Or, were they bound under the law to disclose to everyone?

 


You Say You Want A Revolution?

The JOBS Act – what it really means for the future of Crowdfunding.

So, my assumption here is that you already know about Crowdfunding, either because you have been following my blog or just because. But, maybe everyone on the planet doesn’t know. In case that’s true, let me explain. Crowdfunding is a mechanism that takes advantage of the reach of the Internet to offer opportunities to invest in startup enterprises to anyone with Internet access and a credit card or a PayPal account.

The whole idea is to bring the world of startup investments to ordinary citizens who would like to gamble some of their money on what might become the next Google. In addition, it provides a simple platform for entrepreneurs to post their business plans and raise money to launch their businesses. The JOBS Act is legislation that was passed recently in the U.S to kick-off a startup economy. The Securities and Exchange Commission has 270 days to examine and propose regulations that will support this legislation when it becomes law in February of 2013. The JOBS Act will have thrown 80 years of SEC laws relating to securities under the bus, so the SEC needs this time to temper the Congressional zeal for this passage.

The original driving energy really came from the credit markets that are still broken and would appear set to remain that way for a long time to come, and the regulatory requirements governing most businesses, which usually come later in the lifeline of a startup project. Congress seems to have wanted to find a way to reduce the regulatory oversight while still offering a modicum of risk management by establishing rules that govern the offerings of startup businesses on these Internet platforms. In early discussions, the SEC seems focused on education and not so much on risk warnings. In fact, the JOBS Act turned out to be the result of a conflation of six separate bills, all trying to put forward the same rough objectives.

Congress did what Congress always does, and ended up with a compromise bill that reduces the burden of some of the regulations found in the Sarbanes-Oxley act while still inffusing the new act with some form of  regulatory relief. As is always the case, we never get a pure solution to a simple problem from these guys. It isn’t in their DNA.

The main issues are around education, risk management and the scope of these offerings. Congress tried to reduce the reporting requirements and corral the size of individual and overall investments in a single project, by suggesting some limits for investors and some basic reporting requirements by the businesses. Presumably, the Obama administration and the SEC will take the narrowest possible interpretation of the reporting requirements, so it doesn’t become another source of opaque business practices of the sort that led us into the worst recession since the 1930s. I mean, really sophisticated investors clearly had no idea what they were buying when they purchased the top-trench of a collateralized CDO in the mortgage market, yet they were heavily vetted and qualified as to their level of “sophistication”. We know where that led. So, the SEC argument to focus on the education component of these investments rather than the risk disclosures seems silly, and I hope they see the light before they implement something that failed so miserably on Wall Street only five years ago.

If anything, the financial advice the SEC should require should be along the lines of “Do you understand that most startups fail and that you could lose all of your investment?” And, “It is a really good idea to spread your investment across a broad portfolio of startups, so that if a few fail, you are protected by the one or two that might succeed.”

One of the cool things that has happened in the CrowdFunding space as (I believe) an unintended consequence of the Kickstarter phenomenon, has been this notion of aggregating a built-in customer base WHILE one is in the process of creating product, and the result, which is often squeezing out the failed attempts through the initial market response inherent in the project funding. So, in other words, if your project gets over-subscribed, there is probably a market for what you are trying to produce, and if everyone hates the end-result, you get instant market feedback long before you have committed lots of capital to a failed design.

And, to be clear, Kickstarter is NOT a CrowdFunding platform, even though at first glance it may appear as such. Kickstarter helps aggregate donations for projects. If in return for your donation, you get a coffee mug or an invitation to a film party, then cool. It does not raise money for people to build companies. That indie film is not being produced in a distribution environment. Kickstarter is very careful about which projects it approves. And, it may never choose to participate in the SEC-regulated Crowdfunding space next March. If it ain’t broke, don’t fix it and who wants the SEC breathing down your back?

So, at the end of the day, I think the SEC will err on the side of education vs. risk management, there will be far greater funding restrictions than the JOBS Act intended, the Crowdfunding space will look really different in 24 months than we envision it today, with perhaps far more entertainment related endeavors (games, music, video, films, TV pilots) getting funded in much the same way as the music business became more indie in the last 10 years, and the venture capital community will basically remain unaffected one way or another, as entrepreneurs learn how difficult it is to round up all the devils in all the details.

There is a unique opportunity for the VC community to form an incubation-like support structure to provide infrastructure nourishment for all these startups, but I would be surprised if that happens. It seems more likely to me that the platforms themselves will look to provide these sorts of services as part of their service suite. There is also an opportunity to form a “Startup University” to prepare young entrepreneurs for this new “industry” in much the same way as MIT prepared young software engineering students for the computer technology evolution.

And, lastly, the nascent industry’s attempts at self-governance, while really well-intentioned will likely have little or no real impact on the space. People tend to do what they want.

Whatever forms all of this takes, I think we will have lots of job creation, a new rapid-development technology revolution, and the beginnings of an expansive and exciting world of commerce within the U.S. economy. And, it is really cool!


P2P Lending. Not American Greed.

This piece was concocted by CNBC as a promo for the TV reality Show titled: American Greed.

In it, you will notice how the article bounces off the leading and legitimate P2P lenders, Lending Club and Prosper, to the illegal scam artist James Lull, who  ran an investment scam in Hawaii that bilked 50 investors out of millions of dollars (Lull me to sleep), thus making it appear that these entities shared common ground with, and were somehow legitimizing scam artists like James Lull. Nothing could be further from the truth and I am both shocked by and ashamed of the standards of CNBC journalism.

This is a classic case of editorial and advertising guys clearly feeding from the same trough, and journalistic integrity be damned. This makes me, a jerk-off blogger, feel like Rachel Maddow might invite me to dinner. So, read on:

The art of matchmaking is not just to find the perfect mate. It is also used to connect investors to borrowers.

It is called peer-to-peer lending and occurs directly between individuals. Much like matchmaking for love, the use of this process has exploded online.

“They use this platform through the Internet to bring together and make the match between the borrower and the lender,” said Lori Schock, director of the Securities and Exchange Commission’s Office of Investor Education and Advocacy. Written as though it were a super-market tabloid expose. As in, “They use the Internet to hook up black market sex traders with innocent young Russian girls who are looking to come to America through these marriage sites.”

For the investors, it provides the opportunity to make a higher return than rates offered by other investments. For the borrowers, it allows them to receive funding if they do not qualify for conventional loans. Hundreds of millions of dollars in loans have been funded through online websites. As in, “Hundreds of millions of dollars are being laundered through these online black market web sites.”

One of the reasons peer-to-peer lending has grown in popularity is because of tighter lending restrictions imposed by banks.

For example, this process can help a borrower pay down debt. It is successful for borrowers if they have accumulated credit card debt and are stuck paying it back at a high interest rate. With peer-to-peer lending, borrowers may be able to receive a loan to pay off the debt and then pay back the loan to the private investor at a lower interest rate than offered by the credit card.

Two of the largest peer-to-peer lending sites are now regulated by the SEC and are required to disclose information about the investment products. As if they were finally wrangled into the tent of regulatory protection on behalf of the poor defenseless consumer and forced, forced I say, to disclose and become (shocked face) transparent!

Joseph Toms, chief investment officer of Prosper, one of the major companies that brings borrowers and lenders together, says this type of lending is a friendly alternative.

“Really the difference in peer-to-peer lending is it does not have a bank involved. It has a wide democratic group of investors who decide independently whether they want to fund you or not,” Toms said.

Potential borrowers post information about how much money they need, as well as why the money is needed.

“You have to give some information about you, such as an address and social security number and allow us to pull a credit report on you to assess what kind of credit risk you are,” Toms said.

These online platforms also work to obtain a borrower’s FICO score, which uses factors such a person’s previous payment history, current level of debt and length of credit history to determine the credit risk.

“The platforms do their due diligence in trying to get the FICO score of the borrower. They also get their asset information,” said Schock.  (And, here it comes) “But, there is also the risk that someone may not be truthful in disclosing their ability to repay the loan.” 

It is critical to do research before investing. The reality of the situation is that if the borrower is unable to repay the loan, it is difficult for the private lender to get back the money. Really? Where’s the evidence? Oh, that’s right. You were just using the legitimate P2P platforms as a ramp to your story of a bogus scam artist on the Islands. Oh, yeah.

Sub-prime mortgages, I guess we the tax-payers were the private lenders who found it “difficult” to get back our money on that one.

“I would be remiss to suggest anyone invest with one that is not registered with the SEC,” Schock said. Really? You mean like Bernie Maddoff? Right. He was registered with the SEC. How’d that work out for you Maddoff investors?

But, here comes my favorite segue. It almost broke my neck: 

If the website or individual is not regulated, it could open the door to scams like the one former mortgage broker James Lull was accused of orchestrating. While facing sentencing in 2009 for wire fraud in Hawaii, Lull died after his SUV plunged off a cliff.

Prosecutors say Lull, based in Hawaii, offered investors the opportunity to help distressed homeowners by funding high interest bridge loans. He claimed it would help people pay off debt to boost their credit scores, so they could qualify for an affordable mortgage and provide investors with a high rate of return. However, Lull’s loans became too popular among his investors.

“James Lull actually at some point had more investors than he had actual bridge loans to put their money within,” FBI Special Agent Tom Simon said.

Investigators believe without loans to fund, Lull pocketed the money and bilked tens of millions of dollars out of about 50 investors.

It is just like saying that because the Peer-to-peer lending sites have become popular while encouraging investors to put their money with them, that they are just like James Lull’s scam. Amazing feat of journalistic jujitsu.

Now, back to the legitimate P2P lending markets:

To reduce the risk for investors, regulated sites determine the credit risk of borrowers and reject those who do not meet established criteria, such as a minimum required FICO score. Once the credit risk of the borrower has been determined, the loan request is listed in the online marketplace for investors to view.

“The marketplace looks at your loan and all these different investors bid on the loan at as little as $25 a piece or the full value of the loan,” Toms said. “So over about a 14 day period, you will either be funded and get 100 percent of your money or 70 percent of your money.”

Both Schock and Toms suggest that investors reduce their risk by funding small portions of multiple loans, instead of simply funding a single loan.

“The main thing is you need to make sure you have diversification. Don’t invest all of your money in one note,” Schock said. “Maybe spread it out amongst several notes, so that in case of a default, you do not lose all of your money.”

“This is a numbers game, which means that if you only lend to two or three people you are taking significant risk,” Toms said. “But, the data shows if you actually lend to hundreds or thousands of people, your risk of losing money goes down dramatically.”

However, Schock still says there are some warning signs to watch out for when considering this type of unsecured lending.

“I think one of the red flags is that you do not know with whom you are doing business,” she said. “The second red flag is that in case something happens with the borrower and they are not able to repay the loan, your recourse is extremely limited and you might lose all of the money that you have invested in this.”

It is important for both the borrower and investor to do their research and verify the trading platform itself.

One can verify individuals or organizations that facilitate peer-to-peer lending through the free EDGAR database at www.sec.gov or by checking with that state’s securities or banking regulator to see if the platform is registered with them.

“Remember, even though you might know the background or why they say they want to borrow the money, you still do not know the individual,” Schock said. “It is nice if someone says I need this money to buy an engagement ring, and you want to help that person, but you just need to make sure that you are doing your due diligence.”

Without doing research or dealing with a trusted borrower, investors could find themselves in a similar situation to that of lender Claire Mortimer, who invested with Lull. Mortimer thought she was providing money for loans that would help borrowers pay down debt, while she collected a 12 percent return on her money. Instead, Mortimer lost hundreds of thousands of dollars.

“It could happen to anybody,” she told CNBC. “It happened to me. I’m an educated person. I think of myself as being pretty savvy, but I got ripped off big time.”

So, CNBC, my fledgling industry has to thank you for conflating the wholly legitimate and regulated peer-to-peer lending space with a scam artist who ripped off 50 investors, which have nothing to do with each other, while shamelessly promoting your wonderful new show, American Greed. Sounds like you might want to adopt the name of the show for your brand of journalism. Just saying.


Rounding Errors.

SEC charges five with insider trading from AA tip

This is really getting wierder by the minute.

Securities regulators charged two Ameriprise Financial advisers and three others with insider-trading, saying they made $1.8 million in illicit profits based on confidential merger information one of the advisers learned through an Alcoholics Anonymous relationship.

Honest to God, is this the best we can do? What about John Corzine of MF Global and formerly CEO of GSAX, who is walking away scott free after billions disappeared from MF Global? Or, Lloyd Blankfein, the current GSAX CEO? Or, Ray McDaniels of Moody s, who jacked all the ratings on those worthless CDOs under his watch? Oh … that’s right. Too big to fail. So, what does Justice do? Goes after rounding error criminals? Come-on Man!

I’d be laughing too!

The Securities and Exchange Commission said Timothy McGee, one of the advisers, was tipped about a pending merger of insurer Philadelphia Consolidated Holding Corp and Tokio Marine Holdings.

The SEC said he learned of the deal from a Philadelphia Consolidated senior executive who was confiding in him through their relationship at Alcoholics Anonymous about pressures he was confronting at work. Be careful of what you say in those AA meetings.

McGee purchased Philadelphia Consolidated stock in advance of a merger announcement on July 23, 2008, and tipped Michael Zirinsky, a fellow Ameriprise adviser, the SEC said.

Zirinsky bought stock for himself and also for accounts that belonged to his wife, mother and grandmother, the agency said. He also told his father, Robert Zirinsky, and a friend in Hong Kong, Paulo Lam, about the tip.

Lam in turn informed another friend, and that friend’s wife, Marianna sze wan Ho, also traded on the non-public tip, the SEC said.

Altogether, the SEC said, the Zirinsky family made illegal profits of $562,673 and McGee made $292,128. Lam, meanwhile, made an illegal profit of $837,975 while Ho made $110,580. Are you kidding me? That doesn’t even come close to the cost of the prosecution.

Lam and Ho have agreed to settle the SEC’s charges without admitting or denying the allegations, and pay $1.2 million and $140,000, respectively.

The SEC is pursuing penalties against McGee, Michael Zirinsky and Robert Zirinsky.

Attorneys for McGee and Robert Zirinsky could not be immediately reached for comment, and an attorney for Michael Zirinsky declined to comment. An attorney for Lam and Ho did not immediately respond to a message left outside of normal Hong Kong business hours.


We’re Getting Close!

The Senate appears ready to follow the House’s lead and pass legislation that would make it easier for small companies to obtain capital from investors.

Senate Majority Leader Harry Reid, a Democrat from Nevada, announced early last week that the Senate would move forward on bills “to spur small-business growth” by streamlining rules on capital-raising while still protecting investors.

The House overwhelmingly passed legislation in November that would allow businesses to use “crowdfunding”—soliciting small equity investments from large numbers of people via the Internet—as long as the total raised is $2 million or less. The bill limits individual investments in crowdfunded securities to $10,000 or 10 percent of the investor’s income.

In addition, the House raised the threshold for stock offerings under the Securities and Exchange Commission’s Regulation A from $5 million to $50 million. This would allow more companies to raise capital without registering the stock with the SEC.

The Senate Banking Committee has held two hearings on these proposals and are planning more in the next couple of weeks.

“This is something we should agree on,” Reid said. “These companies need the ability to get cash to innovate, grow, and build.

Karen Kerrigan, president and chief executive officer of the Small Business & Entrepreneurship Council, was optimistic about the passage.

“Access to capital continues to be a major struggle for small businesses and entrepreneurs. It is a no-brainer for the Senate to move forward with this package of capital formation bills,” she said. “Based on my positive interactions with Senate offices on both sides of the aisle, I believe we are on track for getting the package of capital formation bills through the chamber.

President Barack Obama has endorsed these bills and also has proposed phasing in securities regulations for smaller companies in their first few years after going public.


Steal a Car, Go to Jail. Crash the Global Economy. Nothing.

More than three years after their September 2008 government takeover, mortgage giants Fannie Mae and Freddie Mac are back in the news.

Just last week, the inspector general of the Federal Housing Finance Agency, which regulates the pair, reported that Fannie has had to ante up nearly $100 million to defend three former officials of the companies—including Fannie’s ex-CEO Franklin Raines—as a result of an accounting-fraud scandal that erupted in 2004. This of course, has become the U.S. taxpayer’s burden.

The allegations paint a picture of executives hell-bent on loading their companies with shaky loans to boost their bonuses.

Then there’s the fierce debate among conservatives and liberals over whether Fannie and Freddie were primarily responsible for the Great Recession by making home loans to low- and moderate-income folks who couldn’t afford the payments—or whether the culprit was Wall Street, which fueled the housing market by securitizing the risky subprime and alt-A (aka low-documentation or liar) loans that produced most of the mortgage defaults and credit losses. How about both?

OVERARCHING ALL OF THIS are two security-fraud complaints filed late last year by the Securities and Exchange Commission in the U.S. district court in Manhattan. The agency is charging, among others, Daniel Mudd, another former Fannie CEO, and Richard Syron, his counterpart at Freddie, with a variety of civil offenses connected to the 2008 collapse that pushed their companies into government conservatorship. The underlying motive for the alleged misdeeds was greed, the agency asserts. Both the companies’ stock prices and their executives’ bonuses were linked to financial results. The more mortgages processed, the better the reported numbers would be.

The complaints, backed by various statements of fact agreed to by Fannie and Freddie in accompanying non-prosecution agreements, paint a sordid picture of what went on at the two government-sponsored enterprises from 2005 until their collapse in September 2008.

The allegations, although couched in bloodless prose, paint a picture of executives hell-bent on loading up their companies with high-fee subprime and alt-A mortgage guarantees, while hiding from investors, regulators and even Congress the outsize risks involved. The effort allegedly involved shenanigans such as mislabeling mortgages as prime that clearly weren’t and systematically debauching decades-old credit standards for acceptable mortgages, such as an 80% loan-to-value maximum and a strong FICO credit score for borrowers.

Syron’s lawyer, Thomas Green of SidleyAustin LLP, called the charges against his client “senseless.” He added that, during Syron’s tenure, Freddie Mac had been scrupulous in “disclosing information about the character of all the loans in its single-family portfolio. There was no inadequate disclosure.” Daniel Mudd’s lawyer was unavailable for comment about the SEC case. But Mudd has said he didn’t attempt to mislead anyone and that the government had all the relevant information on Fannie’s loan book. Syron asserts that Freddie wasn’t the victim of wrongdoing, but rather of a once-in-a-century home-price collapse. They have apparently changed their tune from one of “We were only looking out for the shareholders.”

The complaints focus on Fannie and Freddie’s primary business: guaranteeing interest and principal payments on single-family home mortgages they buy from lenders throughout the U.S., and then repackage into “agency securities” sold to investors worldwide. The guarantee remains attached to individual mortgages throughout their lives in securitization. The two agencies’ single-family portfolios account for over half of their combined $5.3 trillion book of business.

The SEC alleges that mislabeling dramatically understated the extent of both companies’ exposure to subprime and alt-A mortgages. Fannie, for example, claimed in its second-quarter 2008 report, issued just a month before the company’s seizure, that its alt-A mortgages accounted for only $306 billion of its guarantee exposure, when the real number was $647 billion, the SEC says.

Fannie was able to fudge the number, contends the complaint, because it pre-arranged with many alt-A lenders to code only a certain percentage of their alt-A loans with that designation. When a lender screwed up, which the complaint claims happened occasionally, it would draw a rebuke from Fannie, which would accept the loans only after the lender dropped the alt-A tag. The SEC states that the company euphemistically referred to mislabeled mortgages as “lender-selected loans.”

ACCORDING TO THE SEC COMPLAINT, there were yawning gaps between Freddie’s reported and actual subprime and alt-A exposures. By the second quarter of 2008, Freddie was claiming in filings that subprime comprised an infinitesimal $2 billion to $6 billion, or less than 0.2%, of its total single-family book, when the real number was an estimated $244 billion, or 14%. Just before Freddie’s collapse, alt-A had grown to $541 billion, or 30% of the book, rather than the officially reported $188 billion, or 10%.

Bizarrely, the SEC reports, beginning perhaps in 2004, Freddie began to buy mortgages that had passed muster on Fannie’s automated underwriter system, Desktop Underwriter, instead of using its own Loan Prospector. The SEC alleges that Freddie preferred Underwriter because it generated more mortgage-purchase approvals as a result of its looser FICO credit and loan-to-value standards. By 2007, Freddie was getting more loans (31%) via Fannie’s system than its own (27%).

In their heyday, before being seized, Fannie and Freddie embraced pell-mell growth. And why not? Shareholders wanted growth and the higher stock prices that it typically fuels, and that’s what earned the managers big bucks from stretch-goal bonuses and the like. Periodic genuflection to the companies’ supposed social mission—cheap mortgages for all deserving Americans regardless of income status—camouflaged greed.

By 2007, Freddie Mac was well along toward its ultimate plunge over a cliff, but its stock (ticker: FMCC) was doing great, trading near $65 at one point. Fannie’s shares (FNMA) also were in the 60s for part of that year. Now, both fetch less than 40 cents a share in over-the-counter trading.

Also in 2007, Freddie CEO Richard Syron got almost $20 million in compensation, according to an SEC filing—a $1.2 million salary, $3.45 million in bonuses, $770,000 in other compensation, plus stock and options worth $14.3 million at the time of their grant. To be sure, the stock and options ultimately were smoked in Freddie’s collapse into federal conservatorship. Syron also received a car and driver for commuting, a free home-security system and $100,000 to pay his legal fees in negotiating his contract.

For a time in the 1990s and early in the present millennium, rising home ownership ensured smart growth for Fannie and Freddie. The two government-sponsored enterprises’ retained-investment portfolios grew to $1.7 trillion, combined, as they bought more mortgages and other paper to capitalize on the handsome spread between their rock-bottom cost of funds (debt implicitly guaranteed by Uncle Sam) and the yield on their investments.

BUT THAT GAME ENDED IN 2004, when their regulators accused them of hiding gains and losses on their interest-rate hedges, to mask their financial results’ volatility. Several senior officers of the companies, including Franklin Raines, ultimately were forced to walk the plank. And, later that year, Raines and two others were named in a class-action suit that accused them of having used bogus accounting to produce larger bonuses for themselves. The departures ushered in the Syron and Mudd eras, setting the stage for the much bigger debacle that was to follow, four years later.

The 2004 incident concluded with the companies’ being hit with surcharges on their capital by federal regulators and enjoined to stop expanding their retained portfolios.

To keep growing, the Mudd and Syron regimes plunged into the subprime and alt-A guarantee business, which threw off substantially higher guarantee fees than prime loans. Fannie and Freddie argue that this helped them meet their affordable-housing goals for low- and moderate-income borrowers. They also assert that Wall Street’s origination and securitization machines were stealing the march on them in the fast-growing subprime and alt-A markets, and that they had to compete to stay relevant. The rising risk this entailed, the SEC contends, was obscured by the underreporting of their actual exposure.

A Bush administration official, who had a ringside seat to the GSE collapse in 2008, recalled recently that both the White House and Treasury woke up to the unfolding disaster only in the summer of that year. This person says that the White House was particularly miffed at Syron (“a real empty suit”) and Freddie’s board (“a bunch of incompetents”) who refused to raise more capital, as they had agreed to in March. Fannie, on the other hand, honored its agreement by selling preferred stock.

MUDD, HOWEVER, INSPIRED MORE confidence among the Bush officials, this person says. Whereas Syron reportedly cut a somewhat buffoonish figure by insisting on being called Dr. Syron in recognition of his Ph.D. in economics, Mudd was a CEO out of central casting. He had much of the gravitas of his father, former network anchor Roger Mudd. Tall and articulate, he had been a decorated Marine officer. He worked at the Defense Department and GE Capital before joining Fannie in 2000 as its chief operating officer.  After Franklin Raines, his boss, was sacked as a result of the 2004 accounting scandal, Mudd smoothly slid into the CEO position late that year. In the end, his charisma didn’t matter.

Fannie’s mortgage-default rate has consistently topped Freddie’s since the seizure. Freddie has cost U.S. taxpayers $72.2 Billion in capital injections; Fannie, $112 Billion. A total of $184.2 Billion. If found guilty, shouldn’t these guys be in prison for the rest of their lives?

The SEC is seeking disgorgement from Mudd, Syron and four other executives of what the agency considers the fruits of their misconduct. Effectively, this applies to only the bonuses they received in their last three years or so at the GSEs. For Mudd and Syron, the hit probably wouldn’t exceed $10 million each. The SEC also wants to bar any of the six defendants from serving as an officer or director of a public company. That’s all? That’s it?

In January, Mudd, 53, resigned as CEO and a director of the hedge-fund company Fortress Investment Group. He had gone on leave from the company just days after the SEC filed its action in December.

Typically, the SEC prefers to settle cases like these, rather than stretch its limited resources by going to trial. The defendants sign a consent decree that carries no finding of guilt, innocence or liability. In this case, this means that any monetary penalties would be paid by Fannie and Freddie’s directors-and-officers liability policies, rather than by the executives themselves.

Absolutely amazing!


Crowdfunding Set to Explode with Passage of Entrepreneur Access to Capital Act.

Nearly $100 million in seed money was pledged to start-ups and creative projects through the crowdfunding platform Kickstarter.com last year–just one of many websites now dedicated to matching projects with people who have some means and desire to support them. What Kickstarter donors got in return were things like “thank you” credits in films, DVDs, tee-shirts, flowers, cookies, and concert tickets. Federal and state securities laws prohibit these start-up operations from offering equity to their investors. The good feeling that comes from supporting innovation seems to be the main reward for many people who hand over cash to support the schemes of others online.

But what if there was potential for a financial return on these crowdsourced investments? If startups could offer stock to their small-stake supporters, some (including Amy Cortese in this New York Times Op-Ed) predict that the practice of crowdfunding would explode, opening up far more resources to entrepreneurs, spurring innovation, and creating jobs.

That’s exactly what the Entrepreneur Access to Capital Act (HR 2930) aims to achieve. The bill, has the support of President Obama and was passed by an overwhelming majority in the House in November but has been hung up in the Senate ever since.

Portfolio.com and Reuters reported on Tuesday that Senate majority leader Harry Reid announced plans to push the legislation forward. According to Reuters, the bill would:

“Create a regulatory framework to let private businesses use crowdfunding … to raise up to $2 million annually from investors pledging no more than $10,000, or 10 percent of their annual income.

Though a report in the Wall Street Journal earlier this month suggested that the U.S. Securities and Exchange Commission might stand in the way of the bill, Reuters reported yesterday that:

“The SEC is considering updating its own rules to foster capital formation. Earlier this month, an SEC advisory panel urged the agency to relax outdated rules that trigger public financial reporting for companies, but it stopped short of backing crowdfunding, citing concerns about investor protection.”

In a TechCrunch interview at the Techonomy conference last November, AOL founder Steve Case pointed out the irony in current rules that limit investing to the accredited, noting that you don’t have to be accredited to go to Las Vegas and lose $10,000 at a table in an hour.

But “there are real concerns,” as Cortese noted in her Times Op-Ed:

“The S.E.C. must balance its dual mission of facilitating investment and protecting investors, and as we all know, snake-oil salesmen are alive and well on the Internet. Furthermore, Wall Street banks are likely to fight any efforts to encourage crowdfunding because it cuts them out of the equation. But the potential rewards outweigh the risks. With such sums, the hazard to any single investor is limited. And information is more freely available today than in the 1930s, when the regulations were written.”

Just how great is the potential of the policy to spur economic growth? A Capital Creation and Crowdfunding Conference in Los Angeles next month promises to explore “how the rising private markets will lead the nation toward an era of economic prosperity.”

And the industry publication The Daily Crowdsource is hoping to figure it out for us. They’re using the crowdfunding platform RocketHub to raise capital to conduct a crowdsourcing market research report.


Congressman McHenry Promotes His Crowdfunding Bill And Trashes Competing Senate Legislation.

Congressman McHenry promotes his crowdfunding bill, trashes competing Senate legislation

© Image: Eric Blattberg / Crowdsourcing.org

Representative Patrick McHenry (R-NC), the driving force behind the H.R. 2930 crowdfund investing bill currently under consideration in the U.S. Senate, discovered crowdfunding the same way many of America’s college frat houses sate their thirst: through Pabst Blue Ribbon.

Scrolling through his twitter feed, McHenry stumbled upon a tweet by advertising executive Michael Migliozzi II asking people to invest in Pabst Brewing Company for as little as $5 dollars. By the end of February 2010, roughly five million Americans had pledged over $200 million dollars to own a stake the ailing brewing company. Of course, the five million funders ever-so-slightly surpassed the U.S. Securities and Exchange Commission’s 35 unaccredited investor limit, so the SEC put a stop to the purchase — but for McHenry, the PBR experiment demonstrated the massive potential of crowdfund investing.

In an economic environment where the dollar faces increasing pressure, where bank lending is scarce and expensive, where 25 million Americans are out of work, we cannot afford to “operate under the same rules and regulations … we used in the era of the rotary telephone,” said Representative McHenry Monday at the SoHo Loft Capital Creation and Crowdfunding Conference in Manhattan.

Representative Patrick McHenry, left, chats with event attendees (Photo: Eric Blattberg)

Onerous regulation is holding back businesses seeking to raise capital, argued McHenry, and nowhere is that more apparent than in state regulation. Under current state regulations on securities registrations, for example, “If you raise [capital] from 30 individuals in the state of Connecticut, you’re limited to only five in the state of Colorado,” scoffed McHenry.

After listening to testimony from the folks at Startup Exemption, McHenry drafted H.R. 2930, “The Entrepreneur Access to Capital Act.” Based largely on Startup Exemption’s proposed  crowdfund investing framework, the bill creates crowdfunding exemptions for firms and businesses seeking to raise up to $2 million dollars through online platforms — or “portals,” as McHenry calls them. It also includes a threshold of $10,000 or 10% of income as the individual investment cap, removes the ban on general solicitation by preempting the Blue Sky Laws, and overrides state regulatory authority. McHenry feels that “light-touch regulation” from the SEC is sufficient, though he failed to specify precisely what actual mandates the organization plans to enact.

McHenry’s original H.R. 2930 proposal changed as it continued its journey to become law — he originally proposed a $5 million investment cap, compared to the modified $1 million limit (or $2 million if a company audits its financials) — but such is the nature of lawmaking. House Republicans and Democrats worked together to amend the bill, originally one and a half pages, to its the current dozen-page format. A result of rare bipartisan cooperation and compromise, the bill sailed through the House with an overwhelming 407–17 majority vote. It even garnered a statement of support from the Obama administration. “To get a bipartisan bill through the House of Representatives — and to get President Obama to sign on — is kind of the equivalent of getting [JPMorgan Chase CEO] Jamie Dimon down to Zuccotti Park to play in the drum circle,” joked McHenry.

Some senators weren’t satisfied with H.R. 2930, however, opting to introduce their own competing legislation. Jeff Merkley (D-OR) proposed S. 1970, and Scott Brown (R-MA) put forward S. 1971 (more details here). Even if H.R. 2930 flounders and dies in the senate — as McHenry worries it might — he would not support either of the senators’ proposals in their current forms. “They don’t open the space up enough,” said McHenry of the senators’ crowdfunding legislation. “They don’t preempt Blue Skies, they don’t allow enough dollar raising … and the Merkley bill still demands state regulation.”

As previously mentioned, H.R. 2930 is currently awaiting review in the Senate. “Most good things go to the Senate to die,” declared McHenry. “We have to make sure this legislation does not die so we can free this space up and actually get capital flowing. That’s what it’s all about.”


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