December 20, 2012
In Comment s70712-195 on December 6, 2012, Bob Snyder wrote:
"I believe that an operating agreement should be in place for any private company raising money. I think some kind of third party trust account managed by a bank or such should be used to manage the funds according to the operating agreement."
This is a very good point that deserves more attention.
The SEC knows, from extensive experience, that a third-party trust account managed by a bank does nothing to prevent fraud or theft of investor capital. See, for example:
SEC vs. MEDICAL CAPITAL HOLDINGS
In the case of Medical Capital Holdings the court-appointed judicial receiver and forensic investigator, Thomas Seaman, was able to locate evidence that the Trustee banks, Wells Fargo Bank and Bank of New York Mellon, had utterly failed to enforce the operating agreements for the managed trust bank accounts and thereby enabled the fraud. See:
The systemic failures of the past notwithstanding, it is obvious to everyone who has attempted capital formation in the unregistered, private, and/or Over The Counter markets that the Securities and Exchange Commission could prevent virtually ALL fraud merely by being the Trustee itself and requiring investors and issuers to show that they are being truthful with each other and possess some basic competency so that they are also being truthful with themselves.
Does it make any rational sense to design a regulatory system that helps facilitate fraud and then punishes it when it occurs? It would be far easier, more efficient, and more effective just to prevent the fraud in the first place.
It may not make rational sense to wait for preventable fraud to occur and then to investigate and punish it, but it does make political sense and it makes market sense. There is more for politicians and bureaucrats to do that appears useful when there is more fraud.
As it was designed and enacted in 1934, the Exchange Act was clearly a full-employment legislation for white collar attorneys, accountants and bureaucrats. The 1934 Exchange Act was enacted for the express purpose of curtailing the unregulated, unregistered free market for startup company capital formation.
Congress and the Executive branch in 1934 chose to make it virtually impossible for startup companies to raise capital from the public unless the companies are first able to pay attorneys, bankers, accountants and auditors in order to demonstrate "compliance" with the 1934 Exchange Act.
Seriously, if material participation in the economy is closed to anyone who does not already have a million dollars with which to pay fees to "helpers" to "comply with regulation" then the United States is not a meritocracy.
For the first time since 1933, Congress and the Executive branch formed a specific agreement and enacted legislation, in the form of the JOBS Act, that legalized free market capital formation for people who have merit but not money. The decision to remove the government from the capital formation process for private issuers and public investors is extremely important and transformative.
Perhaps "caveat emptor" is sufficient protection for investors, but why shouldn't investors be required to first receive some basic economic and legal training from the SEC before they invest in any securities offering? In other countries the securities regulators invest substantially in educating investors and the public, but in the United States not so much.
Any requirement that a "trusted third-party" be required for investors and issuers to meet each other and to exchange securities and capital should clearly be facilitated by the same body of government that will later prosecute and convict, or enforce civil judgments against, bad actors. It has never made any rational sense to leave that "trusted third-party" role to untrustworthy bankers, attorneys, or accountants who only possess their "trusted" role because the 1933 Securities Act removed meritocracy, individual liberty and self reliance from the free market capital formation process in America.
Co-Founder and CEO
Public Startup Company, Inc.