A Solution For Title III?

Lots of smart people attended the CFGE Crowdfund Real Estate Summit in Austin last week. On Thursday, there was a wonderful and heated discussion about Title III of the JOBS Act.

Some thought that regular, non-accredited investors should be allowed to invest in whatever they want, whenever they want, without the protection of the government. Some of the more opinionated think that the word “protection” in the preceding sentence should be in quotation marks, or even preceded by the phrase “so-called.”

Title III tries to balance two competing interests: on one hand, giving ordinary people the chance to invest in private deals; and on the other hand trying to protect ordinary people from the risks inherent in private deals.

It does so using the tools of traditional securities laws – namely, disclosure, transparency, reporting, and regulation. These were the tools introduced back in the 1930s at the height of the Great Depression. The Securities Act of 1933 and the Securities and Exchange Act of 1934 cleaned up the cesspool that Wall Street and become, and that approach has served the country extremely well over the last 80 years.

But we’re finding that it doesn’t quite work in Title III. Those traditional tools, which have worked so well for so long, are too expensive, so expensive that they defeat the purpose of the JOBS Act. Specifically, the traditional tools make capital so expensive that entrepreneurs can’t afford it.

Over lunch I thought of a different approach, one that is more attuned to the times.

Suppose a deal sponsor is raising capital for Project X. I propose that regular, non-accredited investors should be allowed to invest under the following conditions:

  • Accredited investors unrelated to the sponsor invest at least 25% of the capital for the project.
  • Each non-accredited investor is limited to 10% of income or net worth.

That’s it. No cumbersome reporting or regulation.

Why does this work? The whole point of Title II is that accredited investors are smart and sophisticated enough to protect themselves. If accredited investors are taking 25% of the deal, it means that smart, sophisticated investors have decided that it’s an investable deal. Or to put it in modern terms, the Crowd, through accredited investors, have validated the deal. And by limiting the amount of the investment to 10% – borrowing a rule from proposed Regulation A+ – we ensure that regular investors don’t over-invest.

This is a modern solution to a modern problem. It balances investor participation with investor protection through a mechanism that relies on the Crowd, not the government.

I’m interested to hear what others think.

Questions? Let me know.

4 thoughts on “A Solution For Title III?

  1. Good idea Mark. Wondering how we could assert that the accred’s are truly arm’s length from the sponsor…? Could be as simple as a self-certification check box with a penalty for perjury or something more in depth. Thoughts?

    1. We would use a self-certification, based on an existing definition of “affiliation.” For example “A person shall be deemed an ‘affiliate’ of another person if and only if such person is related to such person within the meaning of section 267(b) or 707(b) of the Internal Revenue Code.”

      If this rule were adopted, we could actually merge Title II and Title III, opening up the market to 300 million Americans with very little regulatory cost.

  2. I like this direction, Mark, at least on the investor side of the equation. I would add simply the idea that by simply allowing unaccreditor investors the opportunity to participate on equal footing with accredited and institutional investors IS by design protecting the investor. Absent an accessible, legal method, people will take bigger risks with less transparency, oversight or direction by doing “deals” on their own. Often these unsolicited and legal funding of private deals results in individuals risking their entire life savings to participate in substantially unvetted deals investing in their neighbor’s business or by becoming a real estate investor without training and guidance. Think back to “Prohibition” or “Roe v Wade”…people want what they can’t have and will take greater risks to get it. Anytime the government says, we are making this unaccessible in order to “protect you”, we can expect more harm than good.

  3. Another thought to consider…I woke up to this concern playing devils advocate a bit here – What if the motivation of the accredited investor do not align with that of the unaccredited or “the crowd” in this scenario. Let me expand. Assume the primary motivation of the accredited investor is purely monetary and the desired outcome is simply a decent return on investment or rate of return. Assume the primary motivation of the unaccredited investor is not just monetary. Yes, they want a decent return as well, but they want to diversify their investment pool in supporting entrepreneurs that have clear social impact or they really just wanted to help a woman owned business succeed or they really liked the product line. Because they may be investing or lending $25 per business over 100 businesses, they think what the hell is $25. I think the main issue here is access, transparency and choice. Give the crowd the ability to make their own decisions with their hard earned money. If we continue to hold high standards of the entrepreneur to provide accurate and valid data, and platforms curate those issuers, I think we’ll see that the public isn’t as dumb as the government makes out. I’m in support of the investment caps as a percentage of income. That minimizes the risk of loss for the “unsophisticated” investor. Also, let’s add as a final thought, given that I have educated many high income earners about money, Being accredited doesn’t not equate to wealth consciousness, an understanding of how to analyze financials of a business, nor does making $200k/yr qualify someone as having more business or real estate investment savvy than the individual making $75k/yr. Being accredited simply suggests that they can afford to loose all of their money on a lousy investment and turn around next year and make it all back and not end up on welfare. Though I LOVE the simplicity of your idea, I realized that it might not fully allow crowdfunding in its purest form to spread its wings and fly. I’m excited to see how it turns out.

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