sob

'Mandated net worth transaction increase'

Please, let's talk about the actual bill. It's at http://banking.senate.gov/public/_files/AYO09D44_xml.pdf and the relevant regulation is in Sec. 412.

It says that the Securities & exchance commission should raise the threshold, using its existing authority, as the Commission determines is appropriate and in the public interest, in light of price inflation since those figures were determined;

..and in the next section, directs the Comptroller of the Currency (the banking-specific regulator) to examine those investment thresholds and evaluate the feasibility of forming a self regulatory organization for hedge, private equity, and VC funds.

Now, I recognize there's a wide spectrum of opinions on the degree to which government should regulate the financial industry. And I totally agree that angel investment is critical to small businesses like tech startups. And I agree that a million $ in assets or an annual income of $200k is already a fairly high barrier to entry, while technological change since 1982 has significantly lowered startup costs. And so, I agree that just mindlessly jacking up these thresholds would likely be a Bad Thing - for startups, angels, and the economy.

What I'm grumpy about is the meme that the bill does mindlessly jack up the rates. The SEC's existing rules require public consultation on such changes - so if the bill passes, the thresholds will not suddenly shoot up. Rather, the SEC will announce they're considering it and invite input from the public - including people like us - for 3 months. And the SEC has been responsive to that input in the past. Mainly they're worried about not allowing another Bernie Madoff episode; it's entirely possible that they might employ their rulemaking power to carve out an exception for Angels and VCs.

And in the next section, where venture capital is explicitly mentioned, the bill directs the other regulator to study whether and how such funds - which are, obviously, quite different from banks - could be allowed to regulate themselves. the main purpose of this bill is to regulate big wall Street banks. There's a clear understanding here that small funds are not banks; they operate differently, are much more competitive, and probably shouldn't be regulated like banks. The bill supports the idea that such firms will do a better job of keeping each other honest than direct regulation by government!

Participants in a diverse a competitive market (for fund management) are best placed to decide what constitutes 'fair play'. Where self regulation fails is the situation where a few players utterly dominate the market - for example, the fact that 6 large banking firms currently manage about 60% of all capital on Wall Street - and tailor the rules to suit themselves, to the detriment of the smaller players, and of the customers. For that reason, the bill also seeks to put an end to the practice of large banks creating and capitalizing hedge funds that are nominally independent, but in reality are just legal vehicles for large institutions to take advantage of the lighter regulatory and disclosure requirements for hedge funds, while leveraging the reputation and deep pockets of the creating bank to attract customers away from smaller funds.

Why is this important? Because the SEC failed to heed warnings about fund managers like Bernie Madoff and Alan Stafford. Their competitors knew the performance of those funds was 'too good to be true' and repeatedly asked regulatory agencies to step in, but were mostly ignored. The bureaucrats' reporting requirements were being met, and they did not understand the sheer improbability of such consistent profitability in a volatile market. Competitors did: customers preferred fairy tales to honest reporting of market behavior. Hierarchical regulation failed dismally where peer review would have put a quick stop to the abuse.

Result? Jittery investors lost faith in all private capital management and VC funding fell by almost 50% in sectors like biotech and internet from 2008-2009. Some $5 billion was taken off the table - perhaps more. Less VC funding means less angel funding: no mezzanine capital means no exit or equity partnership. You can't grow an oak tree in a one gallon pot.

Self-regulation of the private capital market could reinvigorate capital formation significantly. Reduced red tape and peer review are strong economic incentives for honest and transparent risk management. Investors want transparency, and they want innovation rather than speculation, in which it is all too easy to end up on the wrong side of a zero-sum trade. There is enormous potential here to deepen and diversify the investment pool, and that would be very good news for startups.

So as it affects Angel and VC funds, the bill does two things: directs the SEC to re-examine investment thresholds in the wake of a real financial meltdown; and directs the CotC to consider reducing government regulation of private capital management, rewarding true competition with greater trust.

Instead of seeing this bill as a giant monolithic gravestone for capital formation, entrepreneurs, angels and VCs should look at the potential long-term benefits and use the public consultation process to tell regulators what kind of market they need, and how an open self-policed market could unleash a wave of innovation in the real economy. The giant Wall Street banks do not like this bill, but you can worry about them when you're ready for your IPO. Until then, they won't take your calls anyway. Consider your own interests rather than theirs.