The JOBS Act and Middle-Income Investors: Why It Doesn't Go Far Enough
Williamson, James J., The Yale Law Journal
The 2008 recession sparked broad calls for tighter financial regulation. (1) Yet, at the same time, small businesses and entrepreneurs lobbied to loosen restrictions on the funding of start-ups. (2) Frustrated by stagnant credit markets and limited access to capital, advocates pushed for reforms that would ease restrictions on investment and thereby encourage economic growth and job creation. (3) The result--the 2022 Jumpstart Our Business Startups (JOBS) Act--allows small businesses to raise capital through "crowdfunding," the acquisition of small amounts of money from a large number of investors, for the first time. (4) One of the Act's key provisions, the so-called "crowdfunding exemption," will allow start-ups to obtain investment from a broad spectrum of investors without the cumbersome and expensive SEC registration requirements normally demanded of public equity issuers. (5) Lawmakers and commentators alike have hailed the potential of the JOBS Act to increase the flow of funding to start-ups, (6) while offering middle-class investors financial opportunities previously available only to the wealthy. But, unfortunately, the Act contains a critical shortcoming that will limit the ability of middle-income investors to take advantage of these new opportunities. Because most scholarly commentary on the JOBS Act has focused on the possibility of fraud under the crowdfunding exemption, (7) it has largely overlooked the potential benefits available to investors and the harmful effects of a flaw in the Act that prevents diversification. This Comment addresses this omission.
Part I describes the landscape of early-stage investing and SEC regulations limiting this practice to wealthy investors. It also discusses how the JOBS Act loosens those restrictions. Part II considers the failures of the JOBS Act and argues that its bar on investment funds will prevent diversification and keep middle-class investors from taking advantage of the benefits of the Act. Finally, Part III explores the legislative history of the JOBS Act and shows that the provisions excluding investment funds cannot be justified by legislative purpose or existing policy rationales. Overall, this Comment argues that because of these defects, the individuals who are supposed to be among the intended beneficiaries of the Act will be blocked from realizing its benefits.
I. EARLY-STAGE INVESTING AND THE JOBS ACT
The JOBS Act was designed to allow a wider class of Americans to invest in start-ups. Start-up investing, referred to as "venture capital," offers the potential for exceptional returns, as investors provide risky early financing to young businesses that appear ripe to grow quickly. (8) Some venture capitalists focus on the most turbulent and potentially most profitable part of the market by investing in extremely young companies, a practice typically referred to as "angel funding," and its providers as "angels." (9)
The Securities Act of 1933 severely restricted how all companies, including these early-stage ventures, could raise funds. The 1933 Act prohibited any offering or public sale of a security unless it was registered with the SEC or satisfied one of the statutory exemptions to the registration requirements. (10) Registration is expensive and time-consuming, thus effectively requiring smaller, growing firms to rely on an exemption in order to raise capital. (11) Several important exemptions allow "private sales" (12) to wealthy "accredited investors" without registration. (13) An individual can qualify for accredited investor status by acquiring a net worth of $1 million or earning an annual salary over $200,000. (14) This exemption allows wealthy venture capitalists to angel invest, while also barring middle-class investors. Thus, before the JOBS Act, small companies seeking to avoid expensive SEC registration could generally seek funding only from wealthy investors who learned of the start-up in a private sale, that is, through a close-knit network. …