The SEC Takes A Step In The Right Direction

The other day SEC chairperson Jay Clayton said he’d like to find a way for more private investors to gain access to private deals.  This is a good idea and it’s the first time the SEC has recognized that there is a disconnect between private and public markets which has occurred over the last ten to twenty years.  That disconnect has made it harder for average individuals to take risk and build wealth.

If we look at a lot of the money that is raised in crypto markets, I think some of it can be traced back to bad public policy.  When investors who want to invest are shut out of all opportunities, they manufacture their own. A friend told me some stories about crypto and how people who probably shouldn’t be trading it are trading it on their phones.  They work as laborers at a car wash.

On the other hand, when you talk to someone that gets a stable job and starts to earn a living, one of the first things they want to do is learn how to invest.  It’s one of the reasons WLV invested in Holberg Financial.  My wife spoke with an Uber driver once that couldn’t get a job due to his background. Driving for Uber he was able earn some disposable income.  He started buying stocks.

The problem with a lot of popular stocks is their period of rapid price appreciation happens before they go public.  As a VC, if I invest at a seed round of sub-$8MM valuation and the thing takes off and becomes worth a billion dollars in the private market me and my LPs get a fantastic return.  It’s one of the few places as an angel you could invest $25,000 and have it turn into $25MM like an investment in Uber would have done.

From time to time, I have blogged about the closing of capital markets to people from the upper middle class on down to the rest of American citizens.  Under IRS rules, if you have a liquid net worth of $1MM or make $200k per year you can invest in private companies, hedge funds, PE funds and other alternative assets.  The little guy is not welcome to the party.  Why?

My personal feeling is that if you earned the money you ought to be able to decide where you want to invest it.  If you make a good investment, it can be life changing for you and your family.  On the trading floor where I worked for almost all of my life, guys that barely made it out of high school competed against elite business school grads.  I wasn’t wealthy when I went down.  My parents weren’t wealthy.  My father was a teacher and he grew up poor.  I was practically broke and had to move back home.  I found someone to back me and I took a lot of personal risk and worked my ass off to make it.  The Executive Chair of CME didn’t graduate from college but because of the opportunity afforded him he did all right.  Why shouldn’t all Americans have that opportunity?

I understand that charlatans exist.  Even with tough SEC rules, Bernie Madoff came and went.

For sure, exogenous events that are uncorrelated to the private and public capital markets have influenced the behavior of the parties participating in them.  When the cost of capital at the Fed Window is 0%, it affects the private cost of capital as well.  Those exogenous events have created a situation where private companies have an incentive to stay private longer because their cost of capital is lower in the private market than it is in the public market.

Some of the cost is because we have bad public policy.  Dodd-Frank is one piece of legislation that is a total piece of junk.  It was thrown together by people that have suspicion of capital markets in a time when there was a lot of fear in our country.  Dodd-Frank didn’t make markets better, it just raised the cost of entering the market and operating transparent markets.  It eliminated competition and spurred on more crony capitalism.  Competition is fundamental to American capitalism.  Sarbanes-Oxley increased the cost to go public, tripling accounting costs.  Sarbox was written post Enron and did very little to safeguard investor money in public markets.

Some people will say they “fixed” the legislation but that legislation shouldn’t have been passed in the first place.

Being public is a good thing for a company.  It offers transparency that private markets do not.  The trade off for that transparency is that more people can have access to your company via the capital markets.  Being public brings a discipline and a cadence that is not there in the private market.  A lot of the startup world looks at an IPO as the end of a journey when in fact it just puts the company at the bottom of another mountain it needs to climb.

It’s been written and talked about before but it bears repeating.  Microsoft went public and raised $39.4MM.  It’s valuation after the first day of trading was $777MM.  Great for them, but what about the average Joe.  If you knew about Microsoft via your job, you might have bought some at $21/share on the IPO.  Maybe you realized it later and bought in the 30’s or 40’s.  In 2012, a $1000 investment would have brought you $100,000 if you bought on the IPO and did nothing.  That’s building wealth and right now, most of America is shut out from building that kind of wealth which adds to the income inequality a lot of folks talk about.

The other hard thing is that pension funds are often shut out.  Some pension funds allocate to VC but most probably don’t.  The same with foundations.  Those pension funds and foundations support the lives of millions of Americans that aren’t wealthy enough to participate today simply because of public policy.

We also live in a different time.  There is a lot more transparency on things if people decide to communicate.  With Facebook, Twitter etc, we can find out about fraudsters a lot faster than in the past.  News moves faster.  That makes it tougher for the fraudsters.

One of the greatest joys I experience as an investor is when companies do well. When a founder who might not have had a lot of means growing up builds a business and gets wealthy from doing it.  I cannot tell you how happy that makes me feel for them.

I really hope they tackle this policy and get it right. There will be a lot of lobbying from existing big companies to have a tighter more restrictive policy because they don’t want competition.  Wonder how the Chamber of Commerce will weigh in?  There will be a lobbying from trial lawyers, who will want a thicket of regulations and laws that are actionable in court.  Congresscritters on both side of the aisle will likely fan the flames of fear to scare people that if the SEC does move in a direction that democratizes capital and gives average people more access that we will be laying the seeds for the next financial crisis.  This isn’t going to be an easy snap your fingers process.

For my part, I am really glad the SEC is looking at this.  It will benefit all Americans if done right and it will be a benefit to any company, startup or cash flow business, that wants to tap private markets for investment.  Investing and building wealth should be democratic and open to all.  That’s what America is about.  Opportunity, taking risk and accepting the rewards from assuming that risk or the failure that happens from taking it.