Wieffering: Start-up bill results in less-informed investors

The Jumpstart Our Business Startups Act is that rarest of Washington objects: a bill signed by President Obama, heartily endorsed by both Democrats and Republicans and championed by the likes of the U.S. Chamber of Commerce.

Which means everyone will get to share in the blame a few years from now, when fleeced investors begin filing lawsuits.

The JOBS Act, as it is known, makes it easier for start-up companies to raise money, and it makes it easier for the public to invest in start-up companies. Fine and dandy, if you're OK with exposing all those new investors to higher risks of fraud.

Indeed, it's helpful to consider the JOBS Act in the context of the kind of firm it's designed to aid: start-ups with less than $1 billion in revenue.

Companies like Bixby Energy Systems, for example. The privately owned firm, based in Ramsey, generated a big buzz a few years ago when it claimed it had developed a way to convert coal to clean-burning natural gas.

More recently, though, Bixby has been in the news because executives and individuals associated with it have pleaded guilty to criminal and/or civil charges in connection with investor losses totaling an estimated $43 million.

Amazingly, some of the things that individuals have been charged with or pleaded guilty to in connection with Bixby would be okey-dokey under the JOBS Act, including:

The number of investors: Bixby allegedly had as many as 2,000 shareholders, which means it would have run afoul of current regulations that require a company to register its common stock with the SEC once it has 500 or more shareholders. The JOBS Act lifts that limit to 2,000 investors.

The kind of investors: Current SEC rules restrict investments in private companies to individuals with high incomes or whose net worth, excluding the value of their homes, exceeds $1 million. The SEC is still investigating, but Bixby allegedly recruited unaccredited investors, for whom a total loss could have more dire financial consequences. The JOBS Act allows emerging growth companies to actively solicit unaccredited investors.

The quality of financial disclosures: Bixby tried to file for a public stock offering, but the SEC returned its application, according to one lawsuit, because it "operated without meaningful internal controls" and didn't fully comply with Sarbanes-Oxley, a 2002 federal law enacted in the wake of accounting scandals at Enron and WorldCom.

The JOBS Act loosens the accounting and audit requirements for any emerging company for up to five years. And remember the issues related to Groupon's accounting standards, which were first revealed in its preliminary stock offering application with the SEC? The JOBS Act allows companies to initially file confidential stock offering documents with regulators, which ensures those issues will now remain behind closed doors.

The JOBS Act again allows analysts to write research reports ahead of an initial stock offering that's being marketed by investment bankers at the same firm. They can also write one immediately after the IPO, instead of waiting for a 40-day blackout period, as current rules require.

Cheerleading, it's called. For those with short memories, the practice was at the heart of a major Wall Street investigation following the collapse of dot-com stocks more than a decade ago. E-mails subpoenaed by investigators revealed a sharp difference between what analysts at companies like Merrill Lynch and Piper Jaffray really thought about a company ("piece of crap," "awful CEO"), and the shameless shilling that occurred in the research reports they churned out for public consumption. Wall Street firms paid $1.4 billion to settle the charges.

The rationale behind the JOBS Act is that promising ideas that could turn into big companies die premature deaths because banks, venture capitalist and private investors are generally too cautious, too greedy, or too unaware of the opportunity.

The evidence to support this notion is flimsy, at best. Even during the dot-com mania of 1999-2000, when venture capitalists poured about $150 billion into companies nationally, the whining from people shut out of the action was incessant.

It goes without saying that not every idea deserves funding. In fact, it's a pretty good rule of thumb that only those ideas that can attract private financing should become real companies.

True, entrepreneurs sometimes have a difficult time letting the world know about their ideas. And many of them would like to tap into a network of potential investors without having to hire an investment banker. Proponents of the JOBS Act are particularly excited about its "crowdfunding" provisions, which loosen restrictions on how companies can recruit potential investors.

Crowdfunding has been a great tool for raising money for causes, and filmmakers and other artists have used it to drum up sponsorship of particular projects. In theory, it could serve as an effective financing tool for businesses as well, though I fear its promise may be oversold.

Does a company founder really want dozens, hundreds or even thousands of shareholders? Carl Sommerstad, co-founder of an investment website, the Network Connect, doesn't think so.

"Your general goal is to have as few investors as possible," Sommerstad said. "I can't imagine the headaches that would come with having a nonpublic company that has hundreds of individual investors."

ericw@startribune.com • 612-673-1736