October 31, 2013
Dear 22 Southeast Angels,
I read with interest your recent comment letter to the SEC, published here:
Thank you for providing your email addresses to make it easy for follow-up conversations.
Without question, I would gladly accept capital from each of you, and any investor in your Angel groups. Anyone would. You have doubtless provided funding to launch hundreds, or perhaps collectively thousands, of new ventures -- many of which would not have existed without your funding. Thank you for taking a risk and investing your time, effort, skill and experience helping others to improve and to contribute meaningfully to the economy in ways that bank lenders did not historically accommodate. Statistically-speaking, at least 20% of the ventures you have funded probably survived and may still be providing jobs in your local economy, even if they were acquired by more established companies in order to survive, which as you know is often the case with startups. It is difficult to understand how any Angel group actually makes money, which makes what you do even more important to the lucky few who receive your gifts and your trust and your generosity. You are truly benefactors of your communities.
However, nothing that you do has anything at all to do with Federal Securities Law. Like the other Angel groups from around the country who have been complaining loudly about the JOBS Act general solicitation Rule 506(c) you seem not to have bothered to consult with your attorneys before taking to the streets to voice your concerns. You do not even seem to be aware that Congress, when passing the JOBS Act legislation, mandated that any sales of unregistered securities marketed to the general public using the revised Rule 506 only occur to accredited investors, and then only after "reasonable steps" are taken to verify the investors' accredited status. You, and the other Angel groups who have complained about the existing and proposed SEC Rules enacted pursuant to the JOBS Act, are urging the SEC to do something that it does not even have the power to do: rewrite the JOBS Act so as to restore a privilege that you never even truthfully had in the first place: the privilege of self-certifying your accredited investor status in connection with Federal jurisdiction-regulated unregistered securities Offerings, marketed to you through a means of general solicitation such as through the mail or unsolicited telephone calls or Pitch Events open to any member of the general public or anyone who chose to join your Angel group. In all the time that you have made investments in your local economies in the past, I question whether a single one of you has legitimately participated in a Federally-regulated multi-State unregistered securities Offering. It seems to me that you have primarily, if not exclusively, invested in unregistered securities Offerings that were properly, truthfully, only subject to State regulations, up to the point in time perhaps that you got involved and started bringing in other investors from out of State.
I noted that not one of you indicated in your comment letter that you are attorneys. Perhaps a few of you are, but it appears to me that most of the Angel investor groups across the country are operated by successful businesspeople who want to help launch and foster the growth of like-minded people (who are not going to compete in the local economy in the industries where the Angel investor group participants have personally made their fortunes). Perhaps the reason that none of the Angel capital groups appear to be run by attorneys is that attorneys understand conflict of interest, and don't see a way for the Angel capital business model to avoid outrageous conflicts of interest. Also, any attorney who understood State and Federal securities regulation, historically, would have known that the only way that the Angel capital business model could properly, legally operate in America was in compliance with the 1940 Investment Company Act.
Most Angel investors' private investments would be exempt from this Act, apparently, thanks to the old Rule 506(b) and the Blue Sky regulations adopted in each State, but only insofar as the Angel investor conscientiously avoided investing in companies that were discovered through a form of general solicitation or advertising, and provided that the issuer was a person with whom the Angel first formed a substantive relationship before investing. Both of these preconditions for exemption from the 1940 Investment Company Act were hard to achieve in practice because they required the discovery of an investment opportunity across state lines without any form of inter-state advertising or solicitation (because general solicitation and general advertising was prohibited), and the Angel investor would have been required to form a "substantive" long-distance relationship with the issuer before investing in the issuer's securities.
Angel investments that involved no inter-state commerce and that were strictly reserved for people in the local vicinity of the Angel investor WERE NEVER SUBJECT TO FEDERAL JURISDICTION IN THE FIRST PLACE. It is therefore very confusing to see so many Angel investor groups up in arms in protest at having their rights taken away from them, especially their right to pretend to be making Federally-exempted investments in unregistered securities Offerings that they learned about through their local business community and that result in new ventures launched next-door, where the investor can keep a close eye on the growth and operations of their protege. Nothing other than your local ordinances and State laws have ever infringed your right to select for yourselves what, and whom, to invest in next door to you in your local economy!
Complaining to the SEC that Congress should not have taken away your right to make private investments in your local economy based on your own self-certification of sophistication and net worth makes all of you seem like idiots or worse. It is truly astonishing that you do not seem, as a group, to comprehend the most basic facts of life and that nobody who mentored you, and no securities lawyers who have advised you previously, bothered to explain the difference between State and Federal regulation. If you are given the benefit of the doubt, you are not idiots, then the question remains: just what is it that you think you are trying to protect for yourselves, and your current or future protege, that actually involves Federal jurisdiction? If your State Securities Regulator wants to allow Pitch Events and give you exemptions that allow you to receive Offers to invest, merely because you have a certain net worth or sophistication, then your local regulator can do that and always could have done that, ever since 1933. Go complain to the people who have control over the thing you are complaining about!
If you want to be able to accept unsolicited investment pitches from unknown persons using instruments and modes of communication that involve inter-state commerce, then either become a registered investment company pursuant to the 1940 Investment Company Act, or comply with the simple "reasonable steps" verification requirement imposed by Congress and prove that you have at least a million dollars of net worth excluding the value of your primary residence, or prove that you are consistently a high-income professional. The accredited investor verification steps are reasonable, and if you don't qualify then simply accept the fact that you will need to wait until next year when the new crowdfunding portal Rules go into effect, at which time you will once again be able to invest alongside all the other non-accredited investors.
Hundreds of the investors in my publicly-traded company reside in Newport Beach, California. Almost all of them were considered accredited under the old Rule, which did not exclude the value of the investor's primary residence. You can't own a home in Newport Beach, California without having a million dollars or more of home equity, or you're paying at least $20,000.00 per month just for your mortgage payment! It is not at all clear how many of my existing investors are considered accredited today when their home equity is excluded from consideration, but I believe it to be very few. Maybe 10% of the hundreds of millionaires who invested in my company previously would be allowed to invest today under Rule 506(c). In my opinion, THIS IS WHAT YOU AND THE OTHER ANGEL GROUPS ARE TRULY UPSET ABOUT! The fact is, you cannot qualify as accredited investors any longer, especially not after your various low-interest or no-interest debts are taken into account.
In my opinion, based on my experience with this subject for the last 15 years, the thing you are all honestly upset about is that you are all highly-leveraged but in reasonable ways, like banks, and you don't like the fact that Congress has ordered you to de-leverage if you want to continue making speculative investments in out-of-state companies, or if you want to continue hiding from your local regulator by pretending to be investing in Federally-exempted unregistered securities WHEN WHAT YOU ARE HONESTLY ALL DOING IS JUST EXTENDING THE GIFT OF FINANCIAL LEVERAGE TO THE PEOPLE IN YOUR LOCAL COMMUNITY WHO YOU CHOOSE TO HELP GROW RICH!
Your old business model of shadow banking is dead. Lehman Brothers, Goldman Sachs, WaMu, Wachovia, Indymac Bank, Bank of America, Citicorp and the other large Federally-regulated banks and investment banks killed the shadow banking business. You didn't get a bailout, but some of them did, and that's unfair. But you are doing nobody a service by so inartfully attempting to defend your shadow banking business using absurd, illogical assertions such as Angel investors need to be allowed to continue to rely on Federal Securities Regulations when making in-state local investments!
If you would like to offer me shadow banking leverage to come to your city or State and open another branch office, then I will accept your offer and you can participate in a Federally-regulated registration-exempt unregistered securities Offering that makes your local economy bigger (and in my opinion, better, because I know how valuable my expertise, ethics and creative aspirations are to your local economy) -- but if you are not trying to attract people TO your local economy from elsewhere but are only investing IN your local economy for the benefit of its current resident businesses then please write the SEC an apology letter for mucking up the national debate with your local politics and misinformed unregulated shadow banking business model.
Please come right out and explain your true concerns, honestly, it would help regulators and the investing public understand the role that leverage plays in the growth of an economy. Without leverage, we all have to find a gold mine or an oil well and extract raw materials from the ground in order to have any capital for anything at all. Instead of pretending that your core problem and primary complaint is something illogical such as your desire for privacy, when the reality is simply that you don't want to lose your shadow banking leverage and position in the economy, it would be more honest and more ethical for at least one of you to explain the truth so that financial leverage can be better understood and perhaps even better developed as the form of intangible natural resource that it is. Shadow banking leverage can be sensibly engineered, and it can become less shadowy, without requiring each of you to register and be regulated as banks.
Maybe one of your State Legislators, or one of the members of U.S. Congress from your State, could draft a proposed "Defense of Shadow Banking Act" and get it passed into law to ensure that your Angel capital groups can continue to hand out money that you have borrowed from a bank, giving you equity investment upside and leaving the bank with all the downside! There is something to be said in defense of shadow banking, and there is definitely a very important role for leverage in the economy -- but your Angel capital groups do not seem smart enough to figure out what that role is, and as a result you are supposed to lose it.
That's what's good and right and proper about a meritocracy.
Co-Founder and CEO
Public Startup Company, Inc.